Essays in Honor of Roy Bahl
- Studies in Fiscal Federalism and State–local Finance series
Edited by Richard M. Bird and Jorge Martinez-Vazquez
Chapter 2: New approaches to measuring tax effort
In this chapter we attempt to take a fresh look at the classical question of the determinants of tax effort. Our goal is to better understand the fundamental economic logic of the different approaches that have been used in the previous literature, consider alternative measurements which may provide a more direct intuition of what the concept of tax effort attempts to measure, and to compare quantitatively the rankings of tax effort produced by all these different approaches. As we see it, the fundamental issue is how to move forward toward a definition of tax effort that has a higher relevance to the developmental needs and budgetary ambitions of a country and as an indicator of potential tax reform needs. Fundamentally, all tax effort indicators are calculated by comparing actual collection performance against a measure of potential collections. This definitional choice lays out several dimensions for the conduct of tax policy in a country. These include the need for reform to raise revenues with reference to some potential, the desirable timing and urgency of those reforms, and the extent of the gains in national welfare that are achievable with these reforms. While the first two dimensions have been examined in different ways in the previous literature, in this chapter, for the first time in this literature, we will examine how much the two different approaches to estimation of tax effort matter as compared with those conventionally used.
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