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PolicyResearchWorkingPaper10943

TaxingforGrowth

Revisitingthe15PercentThreshold

RishabhChoudharyFranzURuch

EmiliaSkrok

WORLDBANKGROUP

Macroeconomics,TradeandInvestmentGlobalPracticeOctober2024

PolicyResearchWorkingPaper10943

Abstract

Taxrevenuecollectionisessentialtothestate’sabilitytoaddressmarketfailures,providegoodsandservicessuchashealthandeducation,investininfrastructure,stabilizetheeconomyinresponsetoshocks,andmaintainsustainabledebtdynamics.Usingaregressiondiscontinuitydesign,thispaperdemonstratesthatthereisataxthresholdaround15

percentofgrossdomesticproductwherefutureinclusivegrowthimprovessignificantly.Thismaybeduetoincreasedproductivespending,moreprogressivetaxes,andloweroutputvolatility.Thepaperalsoshowsthatlow-incomecountriesgraduatetomiddle-incomestatusaroundthesamethreshold.

ThispaperisaproductoftheMacroeconomics,TradeandInvestmentGlobalPractice.ItispartofalargereffortbytheWorldBanktoprovideopenaccesstoitsresearchandmakeacontributiontodevelopmentpolicydiscussionsaroundtheworld.PolicyResearchWorkingPapersarealsopostedontheWebat

/prwp

.Theauthorsmaybecontactedatrchoudhary@,fruch@,andeskrok@.

ThePolicyResearchWorkingPaperSeriesdisseminatesthefindingsofworkinprogresstoencouragetheexchangeofideasaboutdevelopmentissues.Anobjectiveoftheseriesistogetthefindingsoutquickly,evenifthepresentationsarelessthanfullypolished.Thepaperscarrythenamesoftheauthorsandshouldbecitedaccordingly.Thefindings,interpretations,andconclusionsexpressedinthispaperareentirelythoseoftheauthors.TheydonotnecessarilyrepresenttheviewsoftheInternationalBankforReconstructionandDevelopment/WorldBankanditsaffiliatedorganizations,orthoseoftheExecutiveDirectorsoftheWorldBankorthegovernmentstheyrepresent.

ProducedbytheResearchSupportTeam

TaxingforGrowth:Revisitingthe15PercentThreshold

RishabhChoudhary,FranzURuch,andEmilia

Skrok1

Keywords:Taxthreshold;inclusivegrowth;healthandeducation.

JELcodes:H21;O11.

1RishabhChoudhary:FiscalPolicy,WorldBank.Email:rchoudhary@

FranzURuch:FiscalPolicy,WorldBank.Email:fruch@

EmiliaSkrok:FiscalPolicy,WorldBank.Email:eskrok@

ThispaperwasfundedbytheKDISchoolofPublicPolicyandManagement.WebenefittedfromvaluablecommentsandsuggestionsfromAartKraay,SuhyunLee,MarioMansour,SilverNamunane,andDarioTortarolo.Thefindings,interpretationsandconclusionsexpressedinthispaperareentirelythoseoftheauthorsandshouldnotbeattributedtotheWorldBank,itsExecutiveDirectors,orthecountriestheyrepresent.

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1.Introduction

Thechallengeofachievingsustainableandinclusivedevelopmentinlow-andmiddle-incomecountriesisintrinsicallytiedtotheirabilitytomobilizesufficienttaxrevenues.Anation’sabilitytofundessentialpublicservicesandinfrastructuredirectlyimpactsitseconomicprogressandsocialequity.Manymiddle-andlow-incomecountries,however,collectfarlessthantheglobalmediantaxrevenueof22percentofGDP,whichraisesconcernsabouttheirabilitytomeettheirneeds.Insufficienttaxrevenuerestrictsinvestmentsincriticalareaslikeinfrastructure,education,andhealthcare—sectorsessentialforboostingproductivityandfosteringhumancapital(BomandLigthart,2014).Withoutadequatefunding,thesecountriesstruggletoprovidetheservicesnecessaryforsustainablegrowthandequitableopportunities.

Theshortfallintaxrevenuenotonlyhamperseconomicdevelopment,butalsoexacerbatesincomeinequality(Ostry,Berg,andTsangarides,2014).Progressivetaxationandwell-fundedsocialprogramsarevitaltoolsforreducinginequality,yettheydependonsufficienttaxcollection.Countrieswithinadequaterevenueoftenresorttoforeignaidandexternaldebttocoverpublicexpenditures,whichcanleadtounsustainabledebtlevels,particularlyduringeconomicdownturns(BaumandKoester,2011;Guptaetal.,2004).Recentglobalcrises,includingtheCOVID-19pandemicandthechallengesposedbyclimatechange,haveunderscoredtheurgentneedforincreasedpublicinvestmentinhealth,socialprotection,andclimateresilience.Thesedemandsrequirehigherrevenuestreamstoensurethatcountriescanrespondeffectivelytocriseswhilecontinuingtopromoteinclusivegrowth.Ultimately,achievinginclusivegrowth—characterizedbyreducedinequality,jobcreation,andequitableaccesstoservices—maynecessitateevenhigherlevelsoftaxrevenuethanwhatiscurrentlycollectedinmanycountries.

Thispapermakesseveralkeycontributionstotheliteraturebyexploringtherelationshipbetweentaxrevenueandinclusivegrowthincountrieswithlowtaxcollectionandenrichestheliteratureontheinterplaybetweentaxationandeconomicgrowth(Acosta-Ormaechea,Sola,andYoo2019;JaimovichandRebelo2017;andLeeandGordon2005).First,itidentifiesacriticaltax-to-GDPratiothresholdthatfacilitatesstrongerandmoreinclusiveeconomicgrowth.Specifically,thestudyfindsthatatax-to-GDPratioofaround12.5percentisassociatedwithasignificantaccelerationinfutureeconomicgrowth,measuredasthecumulativerealGDPgrowthpercapitaoverthenexttenyears.TheestimatedtippingpointisakintotheexistingliteratureestimatesbyGaspar,Jaramillo,andWingender(2016).Forinclusivegrowth,thethresholdisslightlyhigher,atabout13percent.Thesefindingssuggestthattargetedtaxpoliciesaimedatachievingthesethresholdscouldplayacrucialroleinaddressingthedevelopmentchallengesfacedbylow-andmiddle-incomecountries.

Second,thepaperdelvesintothemechanismsthroughwhichhighertaxrevenuescanenhancefutureinclusivegrowth,focusingoneconomicstability,progressivityintaxation,andproductivepublicspendingonhealthandeducation.Itdemonstratesthatincreasedtaxrevenue,particularlywithinthe7percentto15percentofGDPrange,leadstomoreinvestmentinthesecriticalareas,therebyenhancingproductivity,humancapital,andreducingeconomicvolatility.Theresearchfurtherhighlightsthatataxrevenuelevelof15percentofGDPiscrucialforcountriestransitioningfromlow-tomiddle-incomestatus.Aneventstudyshowsthatcountriesmakingthistransitiontypicallyachieveanaveragetax-to-GDPratioof15percent,withamedianof12.9percent,inthedecadepriortotheshift.

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Finally,thepaperexploresthebroaderimplicationsofthesethresholds.Forcountriescurrentlycollectingtaxesatlowlevels—typicallyaround7percentofGDP—raisingthisfigureto15percentcouldyieldsubstantialbenefits.Movingfromataxthresholdof7percentofGDP(typicalofworstperformingeconomies)to15percentofGDPisassociatedwithanadditional10percentagepointsofcumulativegrowthoverthenexttenyears.Inthecaseofinclusivegrowth,thesameincreaseintaxtoGDPratioresultsinthereductionoftheprosperitygapbyabouthalfintenyears;thatis,thefactorbywhichtheaverageindividualinacountryhastomultiplytheirincometogetto$25perdaywhichis“theincomeofatypicalpersonlivinginacountrythatmovesfrommiddleincometohighincomestatus”(Prinslooetal.2023).

Whilemobilizingtaxrevenuescancontributetoeconomicandinclusivegrowth,significantlyincreasingtaxcollectionishardanditisnotapanacea.Theimplicationsofthesethresholdsarethatcountriesthathavelowlevelsoftaxrevenuecouldsignificantlyincreaseinclusivegrowthiftheyeffectivelymobilizetaxrevenues.Whileweacknowledgethatincreasingtaxesmayleadtobetterandmoreinclusivegrowth,itisnotacure-allsolution.Itsimplycreatesthefiscalspacefordevelopmentoutcomes,andtheeffectivedeploymentoftheseresourcesisjustascrucialindeterminingthesuccessofdevelopmentaloutcomes.Also,withcountriesthatwereabletoincreasetaxrevenueonlyachievinga3-percentagepointincreaseintax-to-GDPonaverageoveraten-yearperiod,boostingtaxcollectionby8percentofGDPrequiresamammotheffort.

2.Thecaseforataxthresholdandpreviousevidence

Seminalpaperslinkingtaxestolong-rungrowthusingendogenousgrowththeoryshowthattaxescanimpactchoiceson(humanandphysical)capitalaccumulation,labor-leisuretrade-offs,andsavings(Barro1990;KingandRebelo1990;andJones,Manuelli,andRossi1993).Thisleadstoatrade-offbetweengrowthandthesizeofgovernment(andthetypeoftaxesusedtofinanceitsspending)wherelowlevelsoftaxcanbedetrimentaltogrowth.Asimpleexampleofthistrade-offisprovidedinBarro(1990),replicatedbelowinfigure1,whichshowsthegrowthrateagainsttheexpenditure(andtax)shareinincome.Thetrade-offisaconsequenceoftwoopposingforces.First,highergovernmentspending(andtaxestofinancethatspending)raisesthemarginalproductof(humanandphysical)capital.Second,andinopposition,ahighertaxrateimpliesthathouseholdskeepasmallerfractionofthatincome.Therefore,atlowlevelsofspendingthefirsteffectdominatesasthemarginalproductofcapitalincreases.Barro(1990)quips“anarchyisveryunproductive”.Anotherwaytostatethisisthatgovernmentsspendonmanythingsthatcanboostinvestmentandproductivity.Asthetaxrateincreasesthesecondeffectstartstodominate,withtaxesnegativelyaffectinggrowth.

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Figure1:Growthrateandthesizeofgovernment

Source:Barro(1990).

Themainobjectiveoftaxationistoprovideresourcestofinancegovernmentspending(BurgessandStern1993).Despitecriticismsofinefficiencyandcorruption,governmentspendingisessentialformarketeconomies.Itpromotesgrowthandreducespovertythroughredistribution,createspublicgoodslikeinfrastructure,ensuressafetythroughlawenforcement,stabilizesthebusinesscycle,respondstodisasters,andprovidessocialsafetynetsforvulnerablepopulations.Anobviousfactisthatalthoughgovernmentscanfinancethatspendinginmanyways—includingthroughdebt,orofficialaidandgrants—thatatafundamentalleveltheabilitytospenddependsontheabilitytocollecttaxes.Countriesthathavelowertaxrevenueingeneralspendlessthencountrieswithhighertaxrevenue.Asimplescatterplotoftherelationshipbetweentaxrevenue(includingsocialsecuritycontributions)toGDPandtotalexpendituretoGDP(figure2.A)showsthis.Toestimatethebasicrelationshipbetweenexpenditureandtaxeswefitafractionalpolynomialregression.

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Atverylowlevelsoftaxationthereseemstobeastrongpick-upintotalspendinglikelyreflectingresourcerichcountriesthatarerelativelywealthyandcanaffordtospenddespitecollectinglittle,andlow-incomecountriesthatcanfinancespendingthankstosignificantinternationalsupportthroughgrants.Beyondthisexceptionallylowtaxleveltherelationshipbetweentaxrevenueandspendingispositiveandlinear.

Economiesthathavehighertaxlevelsalsotendtospendsignificantlymoreonhealthandeducation.Theincreaseinproductivespendingcanbeseeninfigure2.Bwhichplotspublichealthandeducationspendingagainsttaxrevenue.Highertaxcollectionallowsgovernmentstofundpublicserviceswithoutcompromisingotherareasofthebudget.Efficientandwell-managedpublicspendingonhealthandeducationleadstohigherproductivityandeconomicgrowth(Herrera,2015).

Lowtaxrevenue,hence,maybedetrimentaltoeconomicdevelopmentandfutureinclusiveeconomicgrowth(Gaspar,Jaramillo,andWingender2016).Figure2.CandDplotstherelationshipbetweentaxesandfutureinclusivegrowth,andtaxesandfuturegrowthoverthenexttenyears(and

2Thefractionalpolynomialmodelisaflexiblewaytofitseveralfunctionalformsincludingnon-linearities.

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againfitsafractionalpolynomialregression).Thescatterplotssuggestthatthereisaleveloftaxesthatmayraisebothfuturegrowthandinclusivegrowth.LowlevelsoftaxtoGDPareassociatedwithlowlevelsofdevelopmentandonlyfewcountrieshavereachedahighlevelofdevelopmentalongsidelowtaxcollection(forexample,oil-richmiddleeasterneconomies).However,astaxesrise,theprosperitygapnarrows.Thereisasimilarassociationwithtaxesandfuturegrowthinfigure2.Dandremarkablylikethatsuggestedbytheoryinfigure1.Atlowlevelsoftax,futuregrowthseemstobesignificantlyundermined.Astaxesrisesodoesfuturegrowth,andrapidlyso.Atsomepointoftax-to-GDPthemarginalincreaseintaxesbecomeslesssupportivetofuturegrowthorevenleadingtoitsslowdown.Atanypointoftaxationlevel,itisespeciallyimportanthowrevenueisused.

Figure2Taxesanddevelopment

A.TaxesandtotalgovernmentspendingB.Taxesandproductivespending

C.TaxesandinclusivegrowthD.Taxesandgrowth

Source:InternationalMonetaryFund,Kraayetal.(2023),Authors’calculations.

Note:Scatterplotsreflectcountry-yearpairs.“Predicted”basedonafractionalpolynomialregression.

B.“Productivespending”isclassifiedashealthandeducationspending.

Therelationshipbetweentaxationandeconomicdevelopmentisnuancedandmultifaceted,influencedbyarangeoffactorsincludingeconomicconstraints,theinformalsector,andstatecapacity.ResearchbyTanzi(1992)andBurgessandStern(1993)indicatesthatcountrieswithahigheragriculturaldependencyandlowerimport-to-GDPratiosoftenexhibitlowertaxationlevels.GordonandLi(2009)underlinetheconnectionbetweentaxationandformalfinance,whileKleven,

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Kreiner,andSaez(2009)demonstratetheefficacyofthird-partytaxenforcementindevelopednations.Conversely,Jensen(2011)andBenedeketal.(2014)associatediversifiedrevenuesourceswithreducedtaxburdens.Meanwhile,Barro(1990)andBarroandSala-i-Martin(1992)arguefortheproductivity-boostingpotentialofwell-designedtaxsystems.BesleyandPersson(2011,2013,2014a,2014b)stressthepivotalroleofstatecapacity—embracingfiscal,legal,andcollectivedimensions—infosteringeconomicgrowth.Thedynamicsoftaxcompliance,influencedbysocialnormsandgovernance,furthershapegrowthoutcomes(KiserandLevi,2015;Levi,1988).

TheideathattaxrevenuecanplayakeyroleinfuturegrowthisexploredinGaspar,Jaramillo,andWingender(2016,henceforthGJW).Theyemployaregressiondiscontinuitydesign(RDD),akintoCard,Mas,andRothstein(2008),toexplorethepointwherethereisatippingpoint(ordiscontinuity)atwhichtax-to-GDPratios'impactonGDPgrowth.TheymodelthecumulativeGDPpercapitagrowthrateoveraspecifichorizonasafunctionoftax-to-GDPlevels,allowingfordiscontinuitiesatanunknownthreshold.Specifically,theyadoptatwo-stepmethod.First,theyidentifythetippingpointwheretax-to-GDPratiocausesadiscontinuouschangeinGDPgrowthbymaximizingR-squaredofthemodel(throughagrid-search).Whilelocatingthetippingpoint,theyomitcovariatesandfixedeffectstoimprovestatisticalpowerofthemodel.Theauthor’snotethatthefullmodelperformspoorlyacrossvariousgrowthhorizons,promptingthemtoapproximatethefunctionalrelationshipbetweentaxthresholdandeconomicgrowthwithaconstantfunction.Second,theyestimatethemarginaleffectusinganRDDestimator,assumingthethresholdisknown.WefollowtheapproachinGJW,however,modifyitbyusingacomprehensivemodelwithfixedeffects,recentdata,andfocusingoninclusivegrowth.Thenextsectiondiscussesthisapproach.

3.Methodology:Identifyingataxthreshold

Inthissection,weexaminethepossibilityofatax-to-GDPratiothresholdthatdelineatesatransitiontohighersustainedGDPgrowthratesandmoreinclusivegrowth.Buildingonthepremiseoutlinedintheprecedingsection,wepositthatonceatax-to-GDPthresholdisachievedeconomicgrowthincreasessharplyandinasustainedmanneroverthefollowingdecade.Thegrowthaccelerationissupportedthroughvariousmechanismsincludingcreationoffiscalspacetofinancegrowthenhancingspendingthatboostinvestmentandproductivity,andloweringeconomicvolatilityanduncertainty.WeusearegressiondiscontinuitydesignfollowingCard,Mas,andRothstein(2008)andimplementedfortaxinGJW.ThehingesonpinpointingadiscontinuityinGDPgrowthratesandselectingathresholdthatoptimizesthemodel'sexplanatorypower.Initially,theydetermineastructuralbreakintherelationshipbetweenthetax-to-GDPratioandsubsequentGDPgrowth,effectivelyidentifyingataxlevelatwhichgrowthshiftsinadiscontinuousmanner.ThispotentialtippingpointisdeterminedbycalibratingathresholddummyvariabletomaximizetheR-squaredofthemodel,whichincludesonlythetaxthresholddummyastheexplanatoryvariable.Uponconfirmingthestatisticalsignificanceofthistippingpoint,thesubsequentphaseinvolvesderivingtheestimateforthecoefficientontaxthresholddummyusingtheconventionalRegressionDiscontinuityDesign(RDD)estimator,treatingthethresholdvalueasaknownquantityfromthefirststep.

OurstudyenhancestheapproachusedinGJWinthreeways.First,weadoptamorerobustmodelthataccountsforotherpossibledriversofgrowthincludinginvestment,populationgrowth,andcountryandyearfixedeffects.Wealsoensurethatweaccountforthebudgetconstraintbyincluding

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debtandotherrevenuecomponents(AdamandBevan2005).Thiscomprehensiveapproachmitigatestheriskofspuriousresultsthatcouldarisefromomittedvariablebiasaffectingthetax-to-GDPratio,andsubsequently,economicgrowth.Second,weextendthedatasetto2021,providingamorecontemporaryanalysis.Whileweexcludepre-1980historicaldata,wepositthatfocusingonmorerecentdata,withsufficienttemporalcoverage,iscrucialtoidentifyarelevantthresholdreflectiveofthemoderneconomiclandscape'sstructuralshifts.Third,ourresearchprobestherelevanceoftheidentifiedthresholdbyexaminingitsinfluenceonalternativedependentvariables,specificallytheprosperitygap,therebyofferingamorenuancedunderstandingofthetax-to-GDPratio'simpactoninclusivegrowth.

Theeconometricspecificationisasfollows:

yc,t+j−yc,t=β0+β1Ⅱ(Taxc,t>γ)c,t+β2Ⅱ(Taxc,t>γ)c,t∗Taxc,t+β3Taxc,t+βXc,t+κc+κt+ϵc,t(1)

Inequation(1),thedependentvariablerepresentsthej-periodaheadcumulativegrowthrate.Here,yc,tsignifiesthelogarithmofrealGDPpercapitaforcountrycinperiodt.TheindicatorfunctionI(Taxc,t>γ)c,trepresentsthetaxthresholddummy,whichassumesavalueof1ifthetax-to-GDPratioexceedsthethresholdγ,and0otherwise.Taxc,tdenotesthetax-to-GDPratioforcountrycinperiodt.ThevectorXc,tincludescovariatesfromgrowththeoryandthegovernment’sbudgetconstraint,includingtheinvestment-to-GDPratio,debt-to-GDPratio,percapitaincome,andtherevenuegeneratedfromothersources.WeincludetheinteractionbetweendebttoGDPandtaxthresholdtoallowforpotentialnon-linearitiesintheimpactofdebtongrowth.Thetermsκcandκtrepresentcountryandyearfixedeffects,respectively.Weemploythismodeltoanalyzethej-periodaheadprosperitygapasanalternativedependentvariable.

GJWmethodologyrecommendschoosingthethresholdtomaximizetheR-squaredofthemodelviaagridsearchacrosspotentialthresholdvalues,butthismethodmaypresentcertaindrawbacks.Forexample,theincrementalincreaseinR-squaredmightlackstatisticalsignificancesuggestinganinabilitytomeaningfullychooseacrossthresholdoutcomes.Moreover,themaximizedR-squareddoesnotnecessarilymeanthatthecoefficientofinterestwhichreflectsthemagnitudeofthediscontinuousjumpinthegrowthrate,willbeatitsoptimalvalueatthesamethreshold.Toaddresstheseconcerns,ourapproachfocusessolelyonthecoefficientofthetaxdummythreshold,asitismorerelevantforcapturinganydiscontinuousjumpsintheeffectongrowthorthedependentvariableofinterest.

4.Data

Themainvariablesusedinthispaperaredescribedintable1andtheirdescriptivestatisticsintable2.Therevenue-basedindicatorsarefromtheInternationalMonetaryFund’sGovernmentStatisticsFinance(GFS)database.Weselectthelevelofgovernmentforeachcountry(thatis,general,central,orbudgetarycentralgovernment)tomaximizethenumberofnon-missingobservationsinasetofspendingandrevenuecategoriesoverthesample.Thereislikelyavitalrolethatfiscaldecentralizationcanplayintherelationshipbetweentaxandgrowth,however,givendatalimitations,weuseaggregateddatafocusingongeneralwheredataisavailableorcentralgovernmentintheremainingcountries.WealsofocusontaxrevenueincludingsocialsecuritycontributionstoGDPandusethisdefinitionoftaxrevenuethroughoutthepaper.Sincecoverageofgovernmentdebtdata

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onGFSislimited,weinsteadusegrossdebtfromWorldEconomicOutlook(WEO).AllgovernmentvariablesareasaratiotoGDP.

Thispaperfocusesontheimpactoftaxontwomeasuresofeconomicoutput.First,wecalculate10-and15-yearaheadgrowthasthelogchangeinrealGDPpercapitafromtheWorldBank’sWorldDevelopmentIndicators(WDI).Tomeasureinclusivegrowth,weusetherecentlycreated“prosperitygap”byKraayetal.(2023)andagainlookatthe10-and15-yearaheadleveloftheprosperitygap.Theprosperitygapisdefinedastheaveragefactorbywhichincomesneedtobemultipliedtobringeveryoneinacountrytoanincomeof$25perday.

5.Results

5.1Identifyingthethreshold

Wefindthattheoptimaltax-to-GDPratioformaximizingfuturecumulativeGDPgrowthvariesisabout12.5percent(figure3).Thisthresholdisdeterminedbyexcludingresource-richeconomies,

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whichoftenexhibitlowertaxrevenues

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buthigherandvolatilegrowthoutcomes.Fortheoptimalthreshold,weconductagridsearch,commencingfrom7percent(the5thpercentileofthetax-to-GDPratio)to30percent,withintervalsof0.1.TheresultsareinlinewiththosepresentedinGJW.Interestingly,thethresholdhasnotmovedupdespitethesignificantgrowthinspendingneedssincethepreviousempiricalworkwasconducted.

Figure3:ThegrowthmaximizingtaxtoGDPratiohoversaround12.5percent

(10-yearahead)(15-yearahead)

90%ConfidenceintervalsCoefficient90%ConfidenceintervalsCoefficient

6060

4040

20

20

0

0

-20

-20

-40

-40-60

-60-80

79111315171921232527297911131517192123252729

TaxtoGDPTaxtoGDP

Source:Authors’calculations.

Note:Thedepictedfigureprovidesanestimationofthecoefficientonthetax-to-GDPthresholddummyinEquation1.

Thesequenceofthefiguresrepresentstheimpactoncumulativegrowthratesoverdifferenttimehorizons:theleftfigurepertainstoa10-yearperiod,andtherightfiguretoa15-yearperiod.Dashedredlineindicatestheoptimalthresholdvalue.

3TheresourcericheconomiesareidentifiedasthosewithnaturalresourcerenttoGDPratioexceeding19.4percent.

4Resource-richcountriesoftenhavelowertaxcollectionduetosignificantrevenuesfromnaturalresources,whichareusedtoattractinvestmentandfostereconomicgrowth.

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Theoptimaltax-to-GDPratiothatnarrowstheprosperitygapdiffersovervarioushorizons,yetitconsistentlyshowsastatisticallysignificanteffectwhenexceedinga12.5percentthreshold.Foraten-yearaheadhorizon,theoptimalratioisat13.3percent,whiletheprosperitygapforafifteen-yearaheadhorizonisminimizedat12.9percent,asillustratedinfigure4.

Figure4:Thelongrunimpactonprosperitygapismaterializedaround13percentthreshold.

(10-yearahead)(15-yearahead)

90%ConfidenceintervalsCoefficient90%ConfidenceintervalsCoefficient

2015

1510

10

5

5

0

0

-5

-5

-10-10

-15-15

1113151719212325272911131517192123252729

TaxtoGDPTaxtoGDP

Source:Authors’calculations.

Note:Thedepictedfigureprovidesanestimationofthecoefficientonthetax-to-GDPthresholddummyinEquation1butwithprosperitygapasthedependentvariable.Thesequenceofthefiguresrepresentstheimpactonprosperityn-

periodahead:theleftfigurepertainsto10-yearahead,andtherightfigureto15-yearahead.Dashedredlineindicatestheoptimalthresholdvalue.

5.2Implicationsforgrowthandinclusivegrowth

Inthissectionwepresenttheresultsfortheten-year-aheadgrowthoutcomesandtheprosperitygapattheoptimalthresholdandshowtheconsequencesofincreasedtaxcollectionforgrowthandinclusivegrowth.Weusea10-yearhorizonforthetaximpactongrowththatgivesusa12.4percentthresholdforgrowthand13.3percentthresholdfortheprosperitygap.Theregressionsareasdescribedinequation(1)andpresentedintable3.Thefirstthreecolumnsarerelatedtocumulativerea