The revenue raising capabilities of a VAT system in developing countries

Abstract

The paper attempts to elaborate on the revenue-raising capabilities (economic efficiency and viability) of a value-added tax (VAT) system, particularly in developing countries. The analysis concentrates on the effect of a VAT on tax revenues raised, and the main objective is to determine whether a VAT system generates greater benefits than previously-utilised sales taxes, i.e. pre-existing sales taxes (PEST). Using a panel data regression analysis, our results indicate that while all countries gain revenue from the presence of VAT, it is significantly more in developed countries, although the dummy VAT variable interacted with trade openness enters positively for the lower- and upper middle-income groups. This proves the importance of trade for VAT revenues, but also that VAT combined with interaction variables is conducive to higher tax revenues.