Working Paper: NBER ID: w11661
Authors: Roger Gordon; Wei Li
Abstract: Observed economic policies in developing countries differ sharply both from those observed among developed countries and from those forecast by existing models of optimal policies. For example, developing countries rely little on broad-based taxes, and make substantial use of tariffs and seignorage as nontax sources of revenue. \nThe objective of this paper is to contrast the implications of two models designed to explain such anomalous policies. One approach, by Gordon-Li (2005), focuses on the greater difficulties faced in poor countries in monitoring taxable activity, and explores the best available policies given such difficulties. The other, building on Grossman-Helpman (1994), presumes that political-economy problems in developing countries are worse, leading to worse policy choices. The paper compares the contrasting theoretical implications of the two models with the data, and finds that the political-economy approach does poorly in reconciling many aspects of the data with the theory. In contrast, the forecasts from Gordon-Li model are largely consistent with the data currently available.
Keywords: Tax Structures; Developing Countries; Political Economy; Gordon-Li Model
JEL Codes: H21; O23; O17; F13; F23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| poorly functioning financial sector (F65) | larger informal economy (E26) |
| larger informal economy (E26) | narrow tax base (H26) |
| narrow tax base (H26) | high effective tax rates for firms using financial sector (H32) |
| high effective tax rates for firms using financial sector (H32) | incentivizing others to operate informally (J46) |
| government policies shaped by lobbying from powerful industries (L52) | tax structures favoring these industries (H29) |
| Gordon-Li model (C20) | observed tax policies (H29) |
| poorer countries (F63) | utilize tariffs and seignorage more heavily than richer countries (H69) |
| political economy model (P16) | does not explain tariffs and state ownership in developing countries (O25) |