Revenue substitution in resource-rich economies: Evidence from a new dataset

Ernesto Crivelli, Sanjeev Gupta, 27 May 2014

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With rising commodity prices and new discoveries, revenue from natural resources1 accounted for over half of government receipts in many natural resource-rich countries in 2011 (Figure 1). Over time, data show that there has been a substitution to natural resource revenues from non-resource tax revenues; for example, the share of petroleum revenues in total revenue rose from an average of 80% to 87% during 2000-11 (Figure 2). This trend is less marked for countries exporting minerals (IMF 2012). In both cases, revenues appear to have moved in line with commodity prices.

These revenues have created room for resource-rich countries to scale up spending on both infrastructure as well as provision of critical social services. This raises the question: Is heavy reliance on resource revenues appropriate for promoting growth?

Figure 1 Revenue from natural resources, selected countries, 2011

Source: IMF staff estimates.

Figure 2. Revenue from natural resources

Source: IMF staff estimates.

One could argue that the increasing share of resource revenue has allowed natural-resource-rich countries to reduce their reliance on distortionary taxation. This would help promote private sector activity and thereby encourage economic growth. Recent analysis of OECD economies suggests a growth hierarchy amongst taxes, with property taxes and broad-based consumption taxes – particularly VAT – being the most growth-friendly, with little distortion to savings and investment (OECD 2010, Acosta-Ormaechea and Yoo 2012). At the other end, income taxes (along with corporate income taxes) are seen to have the most adverse effects on growth, as they interfere directly with economic decisions (see also Heady 2011).

The answer to this question lies in understanding how a higher reliance on resource revenues impacts different components of non-resource revenues: direct versus indirect taxes, income taxes versus consumption or trade taxes. If resource revenues offset the government’s take from corporate or income taxes, then the strategy of relying on resource revenues should be seen as growth enhancing. This analysis would be useful for policymakers engaged in designing growth-friendly tax policy and administrative reform.

The empirical challenge

Assessing the impact of resource revenue on non-resource revenue and its components is challenging because:

  • Data on government revenue from natural resources are typically quite poor. This is because of insufficient transparency of instruments used to mobilise resource revenues, and the need to separate out resource-related revenue from standard tax instruments such as corporate taxes.
  • Potential endogeneity of natural resource revenues further complicates identification. Larger fiscal deficits in the presence of a negative shock to the non-resource sector may increase the need to rely more on revenue from the natural resource sector.

Revenue substitution: Empirical findings from a new dataset

In a recent paper we construct a database for 35 resource-rich countries during 1992-2009 that not only disaggregates data between resource and non-resource revenues, but also disaggregates non-resource revenues into its components: taxes on goods and services (including VAT), income and international transactions (Crivelli and Gupta 2014).

Our econometric results show that substitution between natural resources and domestic (non-resource) tax revenue has indeed occurred. We find that 30 cents in non-resource tax revenue are lost with each additional dollar in resource revenue. What is more relevant for us is the large differential effect on the main taxes. The largest negative impact is found on taxes on goods and services – in particular VAT – while a more modest impact is found for income and trade taxes. Our results are robust to the inclusion of control variables, the exclusion of outliers, and alternative estimation methodologies, addressing in particular concerns related to the endogeneity of resource revenue in our estimations. Countries in this sample have reduced, over the last two decades, their share of revenue from taxes on goods and services and trade, while increasing the share of income tax in total non-resource tax revenue (Figure 3).

Figure 3 Domestic (non-resource) tax revenue structure (percent of total tax revenue)

Policy implications

There are a number of reasons why a well-diversified tax base which comprises taxation of the non-resource sector is a worthwhile policy goal. To start with, natural resources may not last forever, and building a reliable tax base and a culture of tax compliance takes time. Moreover, resource revenues tend to be highly volatile, and in the absence of an appropriate fiscal framework, this volatility is transmitted to the budget. Furthermore, there is ample evidence to suggest that countries with a heavy dependence on resource revenues are less democratic, suffer from the ‘resource curse’, experience higher levels of corruption, and have little incentive to strengthen their tax systems to mobilise revenues from non-resource sectors. Unless the population pays taxes, there is inadequate motivation for them to hold their government accountable.

While resource-rich countries – especially those where resources are expected to last for a long period – could reduce reliance on distortionary taxation, our results suggest the opposite: these countries have in fact reduced reliance on taxes that are considered to be best suited for fostering economic growth.

Resource-rich countries should carefully monitor the evolution of non-resource revenues; if the offset between resource and non-resource revenues that are growth-friendly is large, they should consider examining the design of their tax policy and revenue administration. In particular, attention would need to be paid to the design and administration of individual taxes, as exemptions and special tax treatments may have grown with rising resource revenues while revenue administration has weakened. Regarding VAT, for instance, besides having a somehow lower standard rate, resource-rich countries tend to have a larger number of reduced rates and exemptions (Figure 4).

Figure 4 VAT design, by geographic region, 2012

Source: IMF’s Fiscal Affairs Department Database.

Disclaimer: The views expressed herein are those of the authors and should not be attributed to the IMF, its executive board, or its management.

References

Acosta-Ormaechea, S and J Yoo (2012), “Tax Composition and Economic Growth,” IMF Working Paper 12/257, (Washington: International Monetary Fund).

Arezki R, T Gylfason, and A Sy (2012), “Beyond the curse: Policies to harness the power of natural resources,” VoxEU, July 8.

Canuto, O and M Cavallari (2012), “Natural wealth: Is it a blessing or a curse,” VoxEU, October 12.

Crivelli, E, and S Gupta (2014), “Resource Blessing, Revenue Curse? Domestic Revenue Effort in Resource-Rich Countries,” European Journal of Political Economy (forthcoming).

Heady, C (2011), “Tax policy to aid recovery and growth,” VoxEU, March 14.

International Monetary Fund (2012), “Fiscal Regimes for Extractive Industries: Design and Implementation,” Board Paper, August (Washington: International Monetary Fund)

OECD (2010), “Tax Policy Reform and Economic Growth,” OECD Tax Policy Studies 20, (Paris: Organization for Economic Co-operation and Development).


1 This includes revenue from royalties, taxation of companies extracting resources, exports of natural resources, and production sharing agreements.

Topics: Taxation
Tags: distortionary taxation, natural resources

Economist, Fiscal Affairs Department, IMF
Deputy Director of the Fiscal Affairs Department, IMF