Tax Composition and Output Growth: Evidence from Sri Lanka

The role of taxation in determining output growth has been at the centre stage of debate amongst economists, policy makers and researchers over the period. One of the major areas that was more vigorously debated in the field of public finance is whether the changes in tax composition are matters for output growth in the long term. On the empirical front, less conclusive results have been highlighted in the literature. The purpose of this study is to estimate the effects of revenue-neutral tax structure changes on long term economic growth in Sri Lanka within the framework of an endogenous growth model using time series annual data over the period 1980 to 2013. The empirical results of this study indicated while there is an unidirectional causality which is running from income taxes, value added tax and international taxes to output growth, the excise taxes and other taxes are caused by output growth. The study also found negative and statistically significant impacts of income taxes and other taxes on growth. This reflects, apart from income taxes, other taxes which are taxes on other economic activities has hindered the long term growth. Hence, the only robust result appears to be that shifts in tax revenue towards consumption taxes are associated with faster growth.