Is tax revenue as a percentage of GDP useful?

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Is tax revenue as a percentage of GDP useful?

We have talked about withholding tax before, but we have not addressed tax to the degree that it deserves to be addressed.  Taxes are always a complicated topic, but when you look to infer the investabiltiy or potential of a country, using tax policy and tax rates, things become a mess.  There are numerous organizations, such as the heavily-biased, and partisan organization, The Heritage Foundation, which tries to create a story about tax and economic development.  No simple narrative suffices for taxation and economic development.

The figure below, looks at tax collected as a % of GDP versus GDP per capita.  There is no pattern to the data.

FM Tax - Chart - Tax collected per GDP vs. GDP per capita

What this should tell us, is that the failure of a government to collect a large amount of tax, relative to its GDP is not indicative of a country that would be unable to grow.  We also think it is essential that one looks at what tax rates are like in each country to assess the government’s success/failure to collect revenue.  See the table below.

FM Tax

To really drive this point home, Canada and Germany collect about 12% of GDP in tax revenue; Sweden collects 27% and Sweden collects 21%.  These are huge differences, but one would be hard-pressed to notice a massive difference in quality of life, medical services, and quality of infrastructure in these countries.  We think this area needs to be studied more extensively, possibly as a Masters or Doctorate thesis.  It has been studied in the past, but certainly not focusing on Frontier Markets, and certainly not to from the perspective that we would like.

One of the most notable papers is from Skinner and looks at the impact of tax policy on growth by studying US history.  The conclusion is that tax policy helps economic growth, but certainly accommodates for the vast differences in tax structures and allows for the difficulty in cross-country analysis due to no accepted way of measuring marginal tax burden across geographies.  The OECD also had a short note here, however this focuses more on the structure of the tax code.

We certainly agree with every economist we know, in that a simple tax policy is business and growth-friendly.  However, how that relates to absolute levels of tax to us, is very unclear.  We will also accept that those countries with extreme low-levels of tax collection such as Nigeria (1.6%) must increase tax collection in order to thrive; we do not believe this carries over to countries such as Bangladesh or Pakistan which collect approximately 10% of GDP as tax revenue.

If you read this post, we hope the one thing that you can takeaway is relying on tax collection as a % of GDP as a reliable indicator for a country’s well-being is dangerous.  Be cautious of investors or academics that rely on this number too heavily, and focus more on the tax structure to make an assessment of how tax policy is likely to impact returns and growth in a country.  One measure which we were unable to find, but we think would be far more interesting is a comparison of how thick tax codes are from country to country.

Having dealt with the IRS in the United States, we are certain that US GDP growth could be significantly higher, if the US moved to a flat tax or cut out 80% of the inane and nonsensical provisions with the US tax code.

As always, any questions, please ask.

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