Applied Economics, 2005, 37, 2251–2263

Economic growth and tax

components: an analysis
of tax changes in OECD
Mehmet Serkan Tosuna,* and Sohrab Abizadehb
a
Bureau of Business and Economic Research, College of Business
and Economics, West Virginia University, Morgantown,
WV 26506-6025, USA
b
Department of Economics, The University of Winnipeg, Winnipeg,
Manitoba, Canada R3B 2E9

The paper examines empirically the changes in the tax mix of the OECD
countries in response to economic growth from 1980 to 1999. It is found
that economic growth, measured by GDP per capita, has had a significant
effect on the tax mix of the OECD countries. Analysis reveals that different
taxes respond differently to the growth of GDP per capita. It is shown that
while the shares of personal and property taxes have responded positively
to economic growth, shares of the payroll and goods and services taxes
have shown a relative decline.

I. Introduction studies suggest that the higher the income, the

Since the end of WWII we have witnessed a
number of major changes in the tax system as
well as the tax mix of different countries overtime.
These changes have not only been due to fluctua-
tions in major economic variables, but also due
to a variety of factors including changes in the
structure and policies of governments, prevailing
economic circumstances and the overall social
and political environment and ideologies. In the
past three decades or so a number of researchers
have examined the trends in taxation of different
countries at different stages of economic
development using tax ratio, defined as the ratio
of total tax revenues to GDP or GNP, as a
proxy for such a trend.1 The findings of these
degree of openness, the level and degree of indus-
trialization and the level of urbanization, the higher
the overall tax ratio would be. This amounts to a
positive relationship between economic development
and tax ratio.
More recent literature in the area of tax
component/structure changes has concentrated on
the relationship between tax structure and the
economic structure as related to the level of economic
development (Abizadeh, 1979; Chelliah, 1989).
These studies conclude that, based on both historical
and cross-sectional empirical analysis, the share of
indirect taxes to total tax revenues fell while that
of direct taxes rose with economic development, lead-
ing to the transformation of the economic structure.
(Chelliah, 1989, p. 154).

*Corresponding author. E-mail: metosun@mail.wvu.edu

1
See, for example, Martin and Lewis (1956), Shin (1969), Bahl (1971), and Chelliah (1975).
Applied Economics ISSN 0003–6846 print/ISSN 1466–4283 online # 2005 Taylor & Francis 2251
http://www.tandf.co.uk/journals
DOI: 10.1080/00036840500293813
2252
Other researchers have looked at the more
specific issue of the tax mix of different countries.
However, research in the area of tax components
changes, has received only scant attention in the
literature (Volkerink and De Haan, 1999, p. 3)
which is rather surprising, given the importance
and frequency of recent tax reforms which
have generally led to a change in the tax mix in
developed countries. Meanwhile, with the more
recent interest in growth theory and alternative
economic policies that may result in economic
growth, a number of researchers have concentrated
their attention on the effect of tax policy changes
on economic growth. The debate has been centred
on the overall positive/negative effects of lower/
higher taxes on the rate of economic growth.2
However, while a wide variety of studies have
examined the effect of taxes on economic growth,
the converse relationship has not been thoroughly
addressed.
During the 1980s, following the implementation
of some major conservative economic agenda, one
of the main economic objectives was a reduction in
both personal as well as corporate tax rates in the
industrialized countries along with the broaden-
ing of the tax base. Later changes occurred mainly
due to a number of tax reform initiatives, e.g. the
1986 Tax Reform in the USA, known as TRA86.
During the 1990s, countries have either introduced
some new kind of Value Added Tax (VAT) or
changed its rate if the tax was already in place
(Messere, 1998, p. 2).
Chelliah (1989) when analysing the effect of
economic development on the tax structure of
developing countries states that, ‘. . . since the process
of development would give rise to new potential
tax bases and also generates the capability and
conditions for collecting the more difficult forms of
taxation, the evolution of the tax structure would be
influenced strongly, even if not governed, by the
changes in the economy.’ This statement equally
applies to the group of industrialized and highly
developed countries, which have experienced a
relatively high rate of economic growth in the past
two decades.
The situation in the OECD countries provides
an excellent case for the study of the tax mix.
That is to say, economic growth, and improved and
computerized accounting techniques have allowed for
the introduction of new and more sophisticated
types of taxes and have made their implementation
2
See, for example, Engen and Skinner (1999).
M. S. Tosun and S. Abizadeh
and administration more feasible and manageable.
These changes, along with the advent of globalization
and trade liberalization and countries’ desire for
strengthening their global competitiveness, have
further allowed for reduced reliance on trade
related taxes resulting in additional changes in tax
components of those countries.
Since the need for revenues to enable the govern-
ments to carry on their relevant fiscal and social
mandates is expected to continue, we may not
observe a decline in the overall government revenues
even as certain taxes disappear from the tax structure.
Instead, the emphasis may fall on other taxes in the
tax system. Accordingly, it is hypothesized that
as economic growth proceeds, it becomes possible
for the governments to search for alternative sources
of revenues leading to changes in the tax structure
and tax mix.
The main objective of this research is to
examine the changes that have occurred in the tax
mix of the OECD countries in response to eco-
nomic growth from 1980 to 1999 and to determine
the main factors that have caused changes
in the relative importance of each and every specific
tax category including personal taxes, corporate
taxes, social security contributions, payroll taxes,
property taxes, goods and services taxes, and inter-
national trade taxes. We attempt to investigate
and report if any of these changes have followed
a systematic pattern or moved in an ad hoc
manner.
The remainder of the paper is organized as
follows; Section II provides a background for
our work outlining some historical trends in differ-
ent economic variables in the OECD countries.
Section III renders a theoretical background
while Section IV introduces the empirical model,
discusses issues surrounding the empirical specifica-
tion and also presents econometric tests for
the robustness of the empirical analysis. Section V
presents the empirical results and their interpre-
tation. Section VI gives a summary and conclusion
for this research.
II. Economic Trends and Tax Structure
Changes in OECD Countries
OECD countries have enjoyed a relatively high
rate of economic growth during much of the 1980s
and 1990s. Figure 1 shows changes in average growth
Economic growth and tax components
in GDP per capita in 24 OECD countries
(see Appendix, Table A1 for a list of these
countries). There has been a strong growth in
GDP per capita except in periods of recession in
early and late 1980s. Average growth of GDP per
capita rose from 0.8% in 1980–1982 to 2.9% in
1997–1999. The overall annual average percentage
rate of growth of GDP per capita between 1980
and 1999 was 2.64%. Countries like Ireland,
Luxembourg, and Turkey, respectively, enjoyed
high average rates of growth of 4.99, 4.80, 4.04,
while others had an average rate of economic
growth of less than 2%. Notably, those countries
are Greece, Switzerland and Denmark with an
average rate of growth of 1.32, 1.54, and 1.78,
respectively. Nonetheless, the overall economic
performance of the OECD countries, based on the
rate of growth of GDP during this period has been
very respectable.
OECD countries also experienced considerable
changes in their tax structures during the period
1980–1999. Table 1 shows these changes by
3.5
GDP per capita growth
2253
comparing the average tax shares at the begin-
ning of 1980s (1980–1982) with the ones at the
end of 1980s (1989–1991) and at the end of 1990s
(1997–99) for a sample of 24 OECD countries.
First, we see that there have not been major
swings in the tax shares except for international
trade taxes. These taxes have become virtually
non-existent by the end of 1990s. This is not
surprising since a number of countries went through
substantial trade reforms, eliminating or lowering
tariffs and other barriers to free trade. In addition,
reliance on personal taxes on income, profits
and capital gains, and payroll and workforce
taxes also diminished. On the other hand, there is
a visible increase in the reliance on goods and
services taxes (excluding trade taxes) and
corporate taxes. Social security and property tax
shares also showed increases albeit at less notable
magnitudes.
Tax share changes in individual countries
have been more pronounced. Table 2 shows the
percentage changes in the tax shares of 24 OECD
countries between 1980 and 1999. There is sub-
stantial variation across countries in the tax share
changes except for international trade taxes.
All countries in our sample exhibited decreases

3 in international trade taxes that range from

2.5
14% for Norway to
97% for Greece. While
2
countries like Canada, Germany and the United
States experienced relatively small changes in tax
1.5
shares, some other countries like Iceland, Ireland
1
and Sweden showed substantial changes with
0.5 percentage increases exceeding 100% for some
0 taxes. Changes in tax shares also vary
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999

significantly between different taxes. This is also

Year indicated in the average of percentage changes
Source: World Development Indicators 2002, World Bank. at the bottom of Table 2. The average percentage
Fig. 1. Average growth in GDP per capita in 24 OECD increase is largest for the corporate taxes and
countries (1980–1999) property taxes. Besides the international trade

Table 1. Changes in tax composition in OECD countries (1980–1999)

Average shares in total tax revenuesa

1980–82 1989–91 1997–99
Personal taxes on income, profits and capital gains 0.320232 0.295726 0.283864
Corporate taxes on income profits and capital gains 0.074427 0.076449 0.08922
Social security contributions 0.233363 0.239321 0.240728
Payroll and workforce taxes 0.012222 0.010946 0.010567
Property taxes 0.053703 0.055567 0.057947
Goods and services taxes excluding trade taxes 0.272095 0.287047 0.293737
International trade taxes 0.026079 0.016792 0.00539
a
The figures in the table indicate three-year averages for the period shown in the column heading. See appendix Table 1
for a list of countries in the OECD sample.
Source: OECD Revenue Statistics 2001.
2254 M. S. Tosun and S. Abizadeh
Table 2. Percentage changes in tax shares in OECD countries (1980–1999)a

Personal taxes Corporate taxes Goods and

on income, on income Social Payroll and services taxes
profits and profits and security workforce Property excluding International
capital gains capital gains contributions taxes taxes trade taxes trade taxes
Australia
5.20 35.63 NA 25.62 24.67
8.88
54.18
Austria
4.00 39.14 9.48
6.79
52.57
7.27
91.88
Belgium
15.13 56.93 9.19 NA 50.41
2.15
75.86
Canadab 8.62 3.99 20.24 6.99 13.67
19.63
78.98
Denmarkb
2.08 95.28 54.44 8.11
29.71
10.62
79.05
Finland
18.37 117.37 33.74 NA 18.98
8.91
91.49
France 34.00 14.71
11.65
3.03 48.06
8.74
77.29
Germany
15.10
15.42 14.32 NA
22.13 5.73
80.33
Greece
5.45 106.71
5.78
66.84 1.08 7.86
96.58
Iceland 55.83 50.47 303.20
100.00 17.01
1.05
92.82
Ireland
0.78 130.18
11.25 139.54 13.61
11.13
75.96
Italy 3.88
2.66
17.67
85.16 43.01 8.05
86.39
Japan
21.96
32.74 24.29 NA 26.38 21.98
43.82
Luxemburg
27.26 22.83
9.65 NA 51.64 17.95
55.37
Netherlands
38.42 53.33 1.14 NA 41.85 17.07
71.18
New Zealandb
30.77 43.73 NA
48.39
28.96 71.02
43.49
Norway 0.87
35.73 10.07 NA 45.17 7.03
13.94
Portugalc 8.86 59.74
4.51 NA 25.13 1.81
93.22
Spain 1.14 56.40
26.29 NA 40.70 53.78
92.41
Sweden
13.42 104.59
3.11 104.99 302.39
6.57
84.23
Switzerland
15.49 6.07 18.76 NA 8.72
0.91
58.09
Turkey
41.05
21.41 15.97 NA
44.70 97.62
81.76
United Kingdom
6.81 22.36 3.74
100.00
14.37 19.49
77.78
United States 1.09
1.88 6.26 NA 1.92
9.29
26.22
Average of %
6.13 37.90 19.77
10.41 24.25 9.76
71.76
Changes

Notes: aThese percentage changes are for the three-year average tax shares between 1980–82 and 1997–99. ‘NA’ stands
for ‘not applicable,’ which refers to the specific tax that has not been used in that country throughout the period of study
or that its share has been minuscule.
b
For these countries payroll and workforce tax share changes are for percentage changes between 1989–91 and 1997–99.
c
Due to missing data for the early 1980s, all tax share changes for Portugal are for the period 1989–91 to 1997–99 instead
of 1980–82 to 1997–99.

taxes, personal taxes and payroll and workforce
taxes also exhibited decreases on average. In
the next section, we discuss how income growth
can change tax structures together with arguments
on the relationship between growth and fiscal
policy.
III. Theoretical Considerations
The relationship between fiscal policy and
economic growth has been a widely addressed subject
in growth literature. The theoretical investigation
into the effect of fiscal policy on growth does
not provide a definitive answer. Researchers have
used either taxes or government expenditures to
test for their theories/hypothesis regarding this
relationship.
On the expenditure side, the debate goes back to
the Wagnerian approach, which basically argues
that economic growth leads to higher government
expenditures.3 This approach has been questioned
in recent years by macroeconomic models that are
based on the Keynesian paradigm. Since then
many economists have maintained that government
expenditures can jump-start the engine of economic
growth. Conte and Darrat (1988), in an exami-
nation of OECD countries, provide mixed evidence
regarding this debate. Their results indicate that
the public sector growth caused a decline in the rate

3
See Abizadeh and Gray (1985) for more on Wagner’s Law.
Economic growth and tax components
of economic growth for twenty-two countries,
positive growth rate in three countries, and had no
effect on economic growth of the remaining fifteen
countries.
When taxes are used as a proxy for fiscal policy,
Engen and Skinner (1999) outline five possible
mechanisms by which taxes can affect economic
growth. First, taxes can inhibit investment rate
through such taxes as corporate and personal income,
and capital gains taxes. Second, taxes can slow down
growth in labor supply by distorting labor-leisure
choice in favor of leisure. Third, tax policy can
affect productivity growth through its discouraging
effect on research and development expenditures.
Fourth, in a Harberger framework, taxes can lead
to a flow of resources to other (lower taxed) sectors
that may have lower productivity. Finally, high
taxes on labor supply can distort the efficient use of
human capital by discouraging workers from jobs
that carry high tax burdens even though they have
high ‘social productivity.’ However, Engen and
Skinner (1999, p. 306) conclude, ‘while many
economists would agree with the proposition
that ‘high taxes are bad for economic growth,’ this
proposition is not necessarily obvious, either in
theory or in the data.’
A major issue related to tax component changes
is that of political and institutional factors. Winer
and Hettich (1998) warn researchers of the problems
that they may encounter if the collective choice issues
are left out of their analysis. In the meantime,
Volkerink and de Haan (1999), in an empirical
study of factors determining the tax mix in OECD
countries, conclude that ‘political and institutional
factors are not important explanatory factors for
the actual shape of the tax mix . . . and that the impact
of political orientation of government on tax ratio is
not stable over time.’ (pp. 34, 35). Abizadeh and
Gray (1992), in their study of factors determining
government spending in the Canadian provinces,
have arrived at a similar conclusion with respect
to the effect of political institutions on the size of
government expenditures. They conclude ‘. . . the
level and growth of provincial spending is not
influenced by the position of the party in the political
spectrum.’ (p. 533).4
Meanwhile, the neoclassical growth models
following Solow (1956) imply that steady state
growth is not affected by tax policy.5 In these
models, taxes can only affect the short-term or
4
In light of these findings, we will not venture into the collective choice aspect of the tax components.
5
See, for example Sato (1967).
6
See, for example, King and Rebelo (1990) and Stokey and Rebelo (1995).
2255
transition growth rates. The ‘new’ endogenous
growth theory pioneered by Romer (1986) produced
growth models6 in which government spending and
tax policies can have long-term or permanent
growth effects.
In general, there are three main causes of changes
in tax structures. The first comes from the optimal
taxation literature and can be considered as attempts
to make a tax system ‘better’. Here, efficiency and
equity concerns play an important role in optimal
taxation theory. The second is economic development
and economic growth which impacts on different
tax bases, thus changing the tax shares. The third
one has to do with political economy and can be
explained as the actions of policymakers in their
attempt to satisfy a political objective function.
Based on the above, we focus on the tax structure
as representative of the fiscal structure. It can be
shown that income growth can affect different
taxes differently. To demonstrate this, consider a
tax structure with two taxes, tax A and tax B.
Shares of these taxes in total tax revenues can be
written as
ta AðY Þ

a ¼ , ð1Þ
T
tb BðY Þ

b ¼ , ð2Þ
T
where
a is the share of tax A, and
b is the share
of tax B. A is the base of tax A and ta is the average
tax rate for A. B is the base of tax B and tb is the
average tax rate for B. Both A and B are functions
of the level of income Y. T is total tax revenue,
which is equal to taA(Y ) þ tb B(Y ). Since
a þ
b ¼ 1,
both tax shares will depend on the tax rates, tax
bases, and income. This can be written as
j k

¼ f ta , tb , AðY Þ, BðY Þ : ð3Þ
For given tax rates, change in tax share will
depend on relative changes in the tax bases. Thus,
income growth will change the tax structure when
it affects the bases of different taxes. While tax
rates can change exogenously due to major tax
reforms (including international trade reforms) or
endogenously through a political process, here we
focus on the relationship between income or GDP
growth and the tax structure.
Then, the question becomes which tax base
is affected by income growth and by how much?
2256
While there is no consensus on which tax base
is more or less affected by income growth, the pro-
position that different tax bases will be affected
differently, as economic growth occurs, may prove
to be valid. Groves and Kahn (1952) and Sobel and
Holcombe (1996) provide two examples for the
income elasticity comparisons for different taxes.
Both studies, using data from the USA, show
considerable dispersion in income elasticities of
various taxes. Holcombe and Sobel (1997) also dis-
tinguish between long-run and short-run elasticity
estimates and show that there is greater variability
in short-run estimates.
Based on the relationship between income
levels, tax bases, and tax shares that is depicted in
Equations 1–3 and empirical evidences that exist
on the differences between income elasticities of
various taxes overtime, we proceed with an empirical
investigation of the changes in tax structures and
components in response to income growth in the
OECD countries.7
IV. The Empirical Model
While theoretical discussions and developments
on the relationship between fiscal policy per se and
growth have been quite numerous, these have led to a
relatively few empirical studies. Among these, Engen
and Skinner (1999) show that fiscal policy has a
negative and significant effect on output growth rate
in both the short and the long term. While this
confirms the theoretical results of King and Rebelo
(1990), it is different from the assertions made in
some other endogenous growth models literature.
They find that it is government spending, rather
than tax rates, that has the largest effect on growth.
Engen and Skinner also argue that endogeneity of
fiscal policy is a serious problem in their analysis.
Easterly and Rebelo (1993) argue that high corre-
lation between fiscal variables and the initial level
of income makes it difficult to isolate the effect of
fiscal policy on growth. They emphasize that the
evidence on the effect of tax rates on growth rate is
disturbingly fragile. They present endogeneity of
fiscal policy as a major factor in forming the
M. S. Tosun and S. Abizadeh
empirical relationship between fiscal policy and
economic growth. Gerson (1998) provides a com-
prehensive survey of the relationship between
taxation, government spending and growth and
concludes that, based on empirical studies, the
impact of taxes on growth is rather weak.
In particular, the empirical stalemate caused by
the endogenous nature of fiscal policy hints at the
possibility of a reverse causation between fiscal
policy and growth. It is very likely that income
growth affect the fiscal structure.8 This is the point
of departure for our hypothesis and the ensuing
empirical work.
Some past studies have used tax/GDP ratio to test
the impact of economic development on different
sources of tax revenues. Since we are interested in
the structural tax changes caused by economic
growth, we define tax ratio as the relative share
of each tax in question to total tax revenue. This
will appropriately reflect changes in the relative
importance of different taxes in total tax revenue
and thus changes in the tax structure.9 Bahl (1971)
makes a clear distinction between the tax effort
and the tax ratio models. After decomposing the
inter-country tax ratio variances, he introduces two
approaches in identifying the determinants of
these variances. First, to explain the variations in
tax ratio, (defined as tax/GDP ratio), he proposes a
stochastic model with tax ratio as its dependent
and Xi as a set of independent variables that are
used as proxy measures for the determinants of
differentials in taxable capacity and tax effort. This
may be termed as tax ratio approach (p. 571).
Second, he proposes that if one wants to identify
inter-country differences in tax effort then Xi is
defined as a set of variables that will reflect only
the variances in taxable capacity. According to
Bahl, the basic difference between the tax ratio and
tax effort views of the problem turns on the restrictive
definition of the independent variables in the latter
approach (p. 571).
Empirical specification
We begin by looking at major components of total
tax revenue. Eight major tax classifications are used.

7
We are conscious of the distinction made by Engen and Skinner (1999, p. 308) regarding the changes in the level of GDP as
opposed to the changes in the rate of growth of GDP. For this reason, we are very clear and specifically use the rate of growth
of real per capita income as a proxy for economic growth in our empirical models.
8
This amounts to the detection of causality between any fiscal policy measure (tax or expenditures) and economic growth.
Accordingly we will test for causality prior to testing our main hypotheses, to ensure robustness in our empirical analysis.
See, the section on empirical specification below.
9
Note that defining tax ratio in terms of GDP, although possible, may result in some econometric problems since this will
mean that GDP will appear on both sides of the equation.
Economic growth and tax components
These are adopted from 2001 OECD Revenue
Statistics. Accordingly, total taxes (T ) is defined as
T ¼ PT þ CT þ SST þ PAYT þ PROPT þ GST
þ IT þ OT ð4Þ
where PT is personal taxes on income, profits
and capital gains, CT is corporate taxes on income
profits and capital gains, SST is social security
contributions from both the employees and the
employers, PAYT is payroll and workforce taxes,
PROPT is property taxes,10 GST is goods and
services taxes excluding international trade taxes,11
IT is international trade taxes12 and OT is all other
taxes.
To examine the relationship between economic
growth and changes in the tax mix of countries,
we use panel data of 480 observations that include
24 OECD countries for the years 1980 to 1999. Fixed-
effects and random-effects procedures are the
two typical approaches for estimating panel data.
A fixed effects model has the advantage of removing
the bias from the estimation caused by a possible
correlation between explanatory variables and time-
invariant country specific effects. This approach in a
sense uses countries as controls for themselves.
Another important characteristic of the fixed effects
model is that it produces consistent estimates
even when the random effects model is valid.13
Accordingly, our regression equation can be
written as
TAXit ¼  þ lnðGDPcapit Þi þ Zit  þ fi þ t þ "it ,
ð5Þ
where ‘TAXit’ is the share in total tax revenues
for each tax category shown in (4) in country i at
time t.14 GDPcap is GDP per capita in constant
1995 US dollars. In Equation 5 the coefficient of
interest is i which is an indicator of the response
of the tax share to economic growth. fi represents
2257
the unobservable country specific, time-invariant
effects, t represents unobservable time specific effects,
and "it represents time-variant unsystematic effects
and is i.i.d. We use country dummies and year dum-
mies to control for these country specific and time
specific effects.
Zit is a matrix that includes all remaining control
variables where  is a vector of coefficients. All
variables except dummies are logged. One of the
key variables is openness, which is an index
measured as the ratio of the sum of exports and
imports of goods and services to the gross domestic
product net of net-exports.15 Clearly, a liberalized
trade structure is expected to trigger a shift from
international trade taxes to other taxes in the tax
structure.16
The share of international tourism receipts in total
exports is used to control for the tax exporting
behaviour of countries. We expect countries that
attract considerable number of tourists to rely more
on general sales or excise taxes, as taxes on inter-
national tourism expenditures are easy to export.
Gross capital formation, in constant 1995 US dollars,
is used to capture the direct effect of the specific base
expansion from capital taxation. Similarly, unemploy-
ment rate is included to control for direct base
changes in such taxes as personal income and payroll
taxes. It is defined as the total number of unemployed
as a share of the total labor force. Old-age dependency
ratio is used to control for relatively heavy reliance
on certain taxes such as social security contributions
due to a higher proportion of elderly population.
A dummy variable for the European Union countries
is used to control for the mandated changes in the tax
structures of EU countries.17
Finally, years after 1986 is a ‘dynamic’ dummy
used to capture the impact of widespread tax and
trade policy changes imposed in 1986. 1986 is a key
year since it marks the end year of the period in which

10
This category also includes estate, inheritance and gift taxes and taxes on financial and capital transactions.
11
This category includes value added taxes, general sales and excise taxes and various license fees and use taxes that are
imposed at the federal, state and local levels.
12
These include customs and import duties and export taxes.
13
An alternative is to use a seemingly unrelated regression (SUR) model instead of running eight different regressions. This
would be relevant when separate regressions are related because the errors associated with the dependent variables may be
correlated. However, when same set of explanatory variables is used, SUR gives the same results in terms of coefficients and
standard errors as separate regressions.
14
Natural logarithms of tax shares are not taken due to zero shares for some taxes in some countries.
15

Exports þ imports
Openness ¼ :
GDP
ðExports
importsÞ
16
See Tosun (2005) for an analysis of the changes in tax structures in response to trade liberalization.
17
This dummy variable accounts for the new entrants to the EU between 1980 and 1999. These countries are Austria, Finland,
Greece, Portugal, Spain and Sweden.
2258 M. S. Tosun and S. Abizadeh
Table 3. Descriptive statistics

Number of Standard
Variable Observations Mean Deviation Minimum Maximum
Personal taxes on income, 471 29.888 10.488 9.733 61.614
profits and capital gains (%)
Corporate taxes on income profits 471 7.744 4.287 0.513 24.713
and capital gains (%)
Social security contributions (%) 480 24.001 12.734 0.000 48.539
Payroll and workforce taxes (%) 480 1.103 1.819 0.000 7.549
Property taxes (%) 480 5.536 3.090 0.885 13.451
Goods and services taxes excluding 480 28.904 8.181 11.818 49.505
international trade taxes (%)
International trade taxes (%) 480 1.703 2.267
0.047 15.993
Other taxes (%) 477 0.965 2.672 0.000 18.984
GDP per capita in constant 1995 480 22 834 9732 1959 52 711
US dollars
Openness (%) 473 64.836 44.489 13.600 258.000
Share of international tourism 462 7.839 6.324 0.424 35.061
receipts in total exports (%)
Gross capital formation in constant 473 183 000 348 000 1090 1 920 000
1995 millions US dollars
Unemployment rate (%) 457 7.444 4.344 0.200 23.900
Old-age dependency ratio (%) 480 19.938 3.980 7.055 27.662
European Union dummy 480 0.504 0.501 0.000 1.000
Years after 1986 480 5.550 4.504 1.000 14.000

Source: Author’s calculations.

the original tariff reductions of the Tokyo Round
were phased in and it also marks the beginning
year of the Uruguay Round of trade talks. It also
coincides with a major tax reform in the USA
(Tax Reform Act of 1986), which led to significant
tax rate changes in other industrialized countries
(Messere, 1997, 1998, 1999). It is dynamic in the
sense that, unlike a standard dummy that takes
the value 1 for all the years after 1986, it takes the
value equal to the number of years since 1986 for
each year after 1986.18 This form is used to capture
the lagged effect of these extensive tax and trade
reforms since it may take time for tax rates to
respond to changes in 1986. Table 3 gives descriptive
statistics on the variables explained above.
Econometric tests
We conduct Hausman specification test19 for
random effects to check the robustness of the
fixed effects specification. In a random effects
model, the assumption is that individual country
effects fi in Equation 5 and all other regressors
are uncorrelated. However, if they are correlated
then the coefficient estimates of the regressors in
a random effects model will be inconsistent and
systematically different from those for a fixed
effects model, and the fixed effects model is strictly
a better choice. In Hausman specification test, the
null hypothesis says that coefficient estimates of the
fixed effects and random effects models are not
systematically different from each other. Out of
eight regressions, we reject the null hypothesis
for the personal income tax, corporate income
tax, social security contributions, property tax,
international trade tax and other taxes regressions
with chi-square test statistics 35.5, 91.1, 54.1, 152.0,
48.4, and 78.7, respectively. In other words, fixed
effects specification is clearly more appropriate
for these six regressions. However, we do not reject
the null hypothesis for the payroll tax and goods
and services tax regressions with respective test
statistics 23.3 and 15.8. Thus, in these latter
regressions, random effects model can still be run.
Given that fixed effects regression produces
unbiased and consistent estimates of the coeffi-
cients, we will use the fixed effects model in all of
our empirical examinations.20

18
All the years before 1987 take the value 1 so that the natural logarithms of the values are equal to 0.
19
See Hausman (1978) for the original description of this test.
20
See Greene (2003, pp. 287–303) for more on this issue.
Economic growth and tax components
A major concern regarding the use of time
series data is the direction of causality between the
dependent and independent variables. There exist
ample empirical evidence that show government
revenues and expenditures are co-integrated. In
other words, empirical evidence tends to support
the tax-and-spend and spend-and-tax hypothesis.21
Such bidirectional relationships require detailed
analysis of the empirical data prior to testing any
hypotheses posed in this regard. For example, as
Engen and Skinner (1999) point out, when trying to
examine short run ‘relationship between the changes
in the tax burden, typically measured as the ratio
of tax revenue to GDP, and the percentage growth
rate in GDP,’ then ‘any positive measurement error
(or short term shock) in GDP will shift GDP
growth rate up but also tends to shift the tax-
to-GDP ratio down, thereby introducing a spurious
negative bias in the estimated coefficients’ (p. 317).
There is a need to establish a clear foundation
for such analysis by determining the bona fide
direction of cause and effect between taxes in general
and different taxes in particular and economic
growth. Once a clear direction of causality is
established, we take the next step and proceed with
testing our main hypothesis that economic growth
allows for substantial changes in the tax structure
and the tax mix of a country, particularly the
more advanced and industrialized ones like the
OECD countries.
When it comes to testing for causality, ‘for
most purposes, it seems that Granger causality, or
rather its opposite, Granger noncausality, is the
most useful concept.’ (Davidson and MacKinnon,
1993, p. 629). Meanwhile, when testing for causality,
the number of lags chosen is critical. Maddala (1992)
claims that the lag length chosen can be arbitrary.
As Armah (1997, p. 96) points out, this arbitrariness
in the choice of lags is a major shortcoming of
the Granger test. Armah following Hsiao (1979,
1981, 1982) overcomes this problem by combining
Akaike’s (1969 and 1970) Final Prediction Error
(FPE) criterion with Granger’s causality test.22 This
method, in addition to determining the optimal
number of lags for both the dependent and inde-
pendent variables, allows for the determination of
the direction of causality based on the values of
FPEs calculated for the models as specified in
21
See, for example, Joulfaian and Mookerjee (1990 and 1991) and Jones and Joulfaian (1991).
22
Note that there is no universal agreement as to whether lag lengths should be chosen to minimize FPE. Jones (1989), for
example, demonstrates that, under certain conditions, lag lengths based on some arbitrary and ad hoc method may be
preferred.
23
See Armah (1997) for detail calculation of FPE and determining the direction of causality using this method.
2259
Equation 5.23 Using this method, we tested for
causality between pairs of variables. Since the main
focus of this work is on the effect of economic growth
(using rate of growth of per capita income) and
different types of taxes, we ran this causality test
between the rate of growth of per capita income
and different tax ratios as defined above. Based on
our results, without any exception, no direct casual
relationship between any of these pairs of variables
was detected. Given these results, we proceed with the
estimation of our regression models.
We also tested our models for heteroscedasticity
by using the Cook–Weisberg test. Based on the
results of this test we rejected the null hypothesis
that variances are constant in all regressions except
in personal income tax regression. Subsequently,
Huber/White/Sandwich robust standard errors were
used to correct for heteroscedasticity.
Based on the initial estimation of our model,
using OLS, and the Durbin–Watson statistics
obtained, autocorrelation is found to be a concern.
We subsequently estimated our fixed effects
model using an AR(1) procedure for first-order
autoregressive disturbance terms.
V. Empirical Results
Fixed effects results and interpretations
We begin with the fixed effects regression results
that are presented in Table 4. We get mixed results
on the effect of economic growth on the tax mix
of countries. GDP per capita is a statistically signifi-
cant factor in four of the eight regressions that
are reported in the table. While this variable
appears to have a statistically significant negative
effect on the shares of payroll and goods and services
taxes, our results show that it has a statistically
significant positive effect on the share of personal
taxes and property taxes. As for the remaining
four tax shares, GDP per capita seems to have had
a positive but not significant effect.
In the case of the personal tax share shown
in column (1), the positive sign on the coefficient
for GDP per capita is consistent with our expec-
tation that income growth expands the base of
personal income taxes. In this regression, the
coefficient for the old-age dependency ratio carries
 2260
Table 4. Fixed effects regressionsa

Personal taxes Corporate taxes Goods and services

on income, on income Payroll and taxes excluding
profits and profits and Social security workforce Property international International Other
capital gains capital gains contributions taxes taxes trade taxes trade taxes taxes
Variable (1) (2) (3) (4) (5) (6) (7) (8)
GDP per capita 6.546** 0.372 1.731
1.344** 3.201**
9.712*** 0.649 0.307
(2.928) (2.207) (2.640) (0.592) (1.307) (3.078) (0.928) (2.696)
Openness
1.972 3.936***
7.451*** 1.602*** 0.837 1.218 0.956* 0.464
(1.346) (0.931) (1.476) (0.254) (0.606) (1.198) (0.571) (1.687)
Share of international 0.844 0.564 0.348 0.034 0.800***
0.605
0.905***
0.243
tourism receipts in (0.603) (0.516) (0.590) (0.092) (0.186) (0.522) (0.256) (0.444)
total exports
Gross capital formation
0.908 1.428
0.271
0.424***
1.709*** 0.091 1.212*** 0.577
in constant (1.275) (0.916) (1.015) (0.157) (0.539) (1.011) (0.437) (1.431)
1995 US dollars
Unemployment rate 0.296
0.061 1.240***
0.223*** 0.071
0.832**
0.086 0.046
(0.423) (0.264) (0.372) (0.062) (0.129) (0.354) (0.187) (0.320)
Old-age dependency ratio
0.309***
0.477***
0.173 0.020 0.233*** 0.484*** 0.027 0.077*
(0.088) (0.047) (0.117) (0.025) (0.052) (0.087) (0.029) (0.041)
European Union dummy
1.103*** 0.994*** 0.014
0.158
0.228** 1.358
0.328**
0.442***
(0.345) (0.242) (0.661) (0.124) (0.110) (0.861) (0.148) (0.146)
Logged years after 1986
0.632
0.225 1.415***
0.130
0.336 0.932**
1.322***
0.284
(0.409) (0.331) (0.394) (0.084) (0.213) (0.454) (0.182) (0.563)
R2: 0.91 0.74 0.96 0.64 0.85 0.91 0.62 0.82

M. S. Tosun and S. Abizadeh

Sample size: 426 426 435 435 435 435 435 432

Notes: aStandard errors are shown in parentheses. The dependent variables shown in column headings are shares in total tax revenues.
*Indicate 10% significance level.
**Indicate 5% significance levels.
***Indicate 1% significance levels.
Economic growth and tax components
a negative sign and is statistically significant.
With population aging, the relative reliance of
governments on personal tax revenue is expected to
diminish. This is true since those who retire will
earn pension income significantly lower than their
employment income.
The results for the corporate taxes in column (2)
show that the coefficients for per capita GDP and
gross capital formation carry positive signs albeit
without statistical significance. This suggests that
the relative importance of corporate taxes have not
changed significantly with economic growth in
OECD countries. While the aging of the OECD
populations seem to have had a statistically signifi-
cant negative effect on the share of both personal
and corporate taxes, openness of countries had a
strong positive and significant effect on the share of
corporate taxes. This could be driven by a relatively
strong growth in the income of corporations that
concentrate in the international trade related sectors
of the economy.
As for the social security contributions in column
(3), the coefficient for GDP per capita carries a
positive sign, although it is not statistically signifi-
cant. Openness of the economy to international
trade seems to have had a statistically significant
negative effect on the share of this tax. Social security
contributions seem to have responded positively to
the major tax or trade reforms in mid-1980s. As the
coefficient of the natural logarithm of years after 1986
shows, this effect has been stronger the greater the
number of years after these reforms.
The results in column (4) show that GDP per
capita appears to have had a strong negative and
significant effect on the payroll tax share. This result
points to the possibility that during the course of
economic growth governments may be reluctant to
increase such taxes fearing an adverse effect on
work incentives. Gross capital formation has a
negative sign and is statistically significant. This
would be consistent with an increasing substitution
of capital for labor in production technologies.
The results also show that unemployment rate had
a negative significant effect. This is not surprising
since greater unemployment rates might indicate a
shrinking labor force.
The estimated model using the property tax
share in column (5) reveals several interesting results.
The coefficient for our growth variable carries
a positive sign and is statistically significant.
24
We expect this trend to continue in the foreseeable future as baby boomers, who hold a very high proportion of national
wealth, begin to reach their retirement age.
2261
The same result holds for the dependency ratio. It
follows that the OECD countries have increased
their relative reliance on property taxes along with
economic growth. Our empirical result also shows
that possibly the brunt of the burden of these taxes
had been carried by the elderly. This is an interesting
finding, in that the governments of OECD countries
seem to be exploiting the property owners. This is
not surprising given the fact that most of the wealth
is owned by the older cohort of the population in
developed countries such as the OECD countries.24
It is also quite possible that economic growth
might be creating an excess demand for property,
shooting up property prices and assessed valuations
and boosting tax revenues.
The results for goods and services tax in
column (6) show that the coefficient for GDP per
capita carries a negative sign and is statistically
significant. This result is consistent with the results
for the personal taxes. Since income growth has
had a strong positive and significant effect on the
personal tax share, we would expect lower reliance
on other taxes in the tax structure. This would
happen despite the fact that the tax base of goods
and services tax may be growing. As we demon-
strated in our simple theoretical model, it is the
relative, not the absolute, growth in tax bases that
changes one tax share against another. Based on
what we showed earlier in Table 1, we would expect
to see a rise in the goods and services tax share
as governments may have tried to substitute these
taxes (particularly value added taxes) for the relative
decline in other taxes such as international trade
taxes. We do see an evidence of that since the
natural logarithm of years after 1986 variable is
positive and significant. This is consistent with the
findings of Tosun (2005) who showed a statistically
significant move away from international trade
taxes to domestic taxes on goods and services in
response to widespread trade reform in mid-1980s.
The results also show that old-age dependency ratio
had a positive and significant effect on this tax share.
In aging economies, growing number of dissavers
constitute a significant consumer group.
In the case of international trade taxes in column
(7), the coefficient for GDP per capita has a
positive sign but is statistically insignificant. It is
expected that the share of these taxes would decline
in response to trade liberalization of the 1980s. The
natural logarithm of years after 1986 dummy
2262
captures this effect. As expected, it has a negative sign
and is statistically significant.
Finally, our results for all other taxes in column
(8) do not reveal a particularly convincing
pattern leaving us to believe that there has not
been much movement on the part of the OECD
countries to increase their reliance on other taxes
but the traditional ones.
Economic significance of results
While we have shown the statistical significance of
the effect of GDP per capita on the tax shares of
personal taxes, payroll taxes, property taxes and
goods and services taxes, economic significance
remains to be addressed. Using the average shares
for the taxes mentioned above, we can derive average
‘dollar’ changes in these specific taxes holding all
other factors constant. For this, we used the average
tax shares for personal taxes, payroll taxes, property
taxes and goods and services taxes reported in
Table 3. We first calculated the average annual
deflated total tax revenue for the period 1980–1999
which was found to be $241.2 billion. We then
multiplied this value by different average tax shares
in order to find the dollar revenue attributed to each
of the four sources. These are calculated as $72.1,
$2.7, $13.4 and $69.7 billion for personal taxes,
payroll taxes, property taxes and goods and services
taxes, respectively. Using the statistically significant
coefficients shown for GDP per capita in Table 4,
the average impacts of a 1% increase in the GDP
per capita for the OECD would have been $15.8,

$3.2, $7.7 and
$23.4 billion for personal taxes,
payroll taxes, property taxes and goods and services
taxes, respectively. While the dollar impacts are
relatively large for both the personal taxes and the
goods and services taxes, the biggest dollar impact is
on the goods and services taxes.
VI. Summary and Conclusions
In this paper, we argued that along with economic
growth come changes in the tax structure of
the OECD countries. Those changes are due to the
variations that we observe in the relative importance
of different kinds of taxes in the overall tax revenue.
Researchers have examined taxes by either looking at
changes in the total taxes as a percentage of GDP or
percentage of different taxes in total tax revenue.
Either way, the objective has been to investigate the
effect of economic growth on taxation. Results from
our empirical analysis show that economic growth
measured by GDP per capita has had a significant
M. S. Tosun and S. Abizadeh
effect on the tax mix of the OECD countries.
However, we have not found significance in all tax
categories. For example, we have not found signifi-
cant response to growth by corporate tax and inter-
national trade tax shares. Meanwhile personal taxes
and property taxes have increased their relative share
in total tax revenue in response to economic growth
and payroll taxes and goods and services taxes have
lost their relative share in total tax revenue in
response to growth. Average dollar magnitudes of
changes in the shares of these taxes were also cal-
culated. Accordingly, per capita GDP growth had a
relatively large dollar impact on personal taxes and
goods and services taxes with the biggest impact on
the goods and services taxes. While we also attempted
to provide some explanations for these growth driven
tax share changes, the question of why these taxes
changed in the way they did requires further analysis
in the future.
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