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growth could increase the ratio of taxes to GDP. So, a positive coefficient is expected for this variable.
The effect of inflation on the ratio of taxes to GDP is not clear. On one side, higher inflation
increases inflation tax for government and decreases the need to levy conventional taxes. Also, in
inflationary conditions, firms and individuals tend to evade or at least to delay paying taxes to benefit
from the erosion of their real tax liabilities due to inflation. On the other hand, inflation increases tax
liabilities because nominal incomes increase and taxes are usually levied on nominal incomes.
The size of government or the ratio of government expenditures to GDP is included as a control
variable because countries with bigger governments tend to have higher ratio of taxes to GDP on average.
Therefore, a positive effect is expected for this variable.
The data for the ratio of taxes to GDP, per capita GDP and its growth rate, the share of agriculture
sector in GDP, the degree of openness, the rate of inflation, and the ratio of government expenditures to
GDP are from IMF and World Bank.
Regarding two important variables that are the focus of this study, the data is from the following
sources. For corruption two different indices have been tried. The first one is the Control of Corruption
Index from World Bank which has a range between -2.5 and 2.5, with a lower level of corruption for the
higher values of the index. The second one is the Freedom from Corruption index from Heritage
foundation which has a range between 0 and 100, again a higher value implying less corruption. Since our
theoretical analysis implies a negative effect from corruption on the ratio of taxes to GDP and since both
above indices imply less corruption for higher values of the indices, a positive coefficient is expected for
these indices in the regressions. For democracy and the kind of government, the data is from the study of
Marshall et al (2010). The index is between 0 and 10 and a higher value implies higher level of democracy
and political freedom. Based on the theoretical analysis in the previous section, a positive coefficient
(although not very significant) is expected for this variable. It should be added that countries with
substantial changes in the kind of government (for example, countries that have been subject to coups) are
excluded to get better and more reliable results.
Our sample includes 117 countries and the time period under study is 1996-2010 for which data is
available.
Empirical results
Based on the results of Fixed Effects and Hausman tests, the method of fixed effects is used in all
estimated regressions. The estimated regression is summarized in Table 1 when the Control of Corruption
Index is used as the proxy for the level of corruption. As it is seen in Table 1, all variables have the
expected sign except the rate of inflation that its effect is not clear theoretically. Therefore, this variable is
excluded in the final estimation that is reported in the last column. When both per capita GDP and the
share of agriculture sector in GDP are included, the latter has expected sign for its coefficient but
insignificant. It could be attributed to the high correlation of these two variables (on average, countries
with higher per capita GDP have lower share for the agriculture sector in GDP). When per capita GDP is
excluded, the coefficient of the share of agriculture sector in GDP is negative and quite significant that is
consistent with the above justification. The degree of openness has a positive and significant coefficient in
all regressions, as expected. The size of government has a positive and significant coefficient that means
countries with bigger government size have higher ratios of taxes to GDP that is necessary to finance
government expenditures. The growth rate of per capita GDP has a positive and significant coefficient
that is acceptable.
Both the index of democracy and the index of corruption, DEMOC and CORR, have positive
coefficients. But just the latter is significant, which is consistent with our theoretical model. In other
words, corruption is more important in affecting the willingness of people to pay taxes compared to
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