Optimal tax rate for growth in Ghana: An empirical investigation

• Published date: 01 May 2021
• Author: Grace Ofori‐Abebrese,Samuel Tawiah Baidoo,Stephen Tetteh Olesu
• Date: 01 May 2021
• DOI: http://doi.org/10.1002/pa.2223

ACADEMIC PAPER

Optimal tax rate for growth in Ghana: An empirical

investigation

Grace Ofori-Abebrese | Samuel Tawiah Baidoo | Stephen Tetteh Olesu

Department of Economics, Kwame Nkrumah

University of Science and Technology, Kumasi,

Ghana

Correspondence

Samuel Tawiah Baidoo, Department of

Economics, Kwame Nkrumah University of

Science and Technology, Kumasi, Ghana.

Email: samueltawiahbaidoo@yahoo.com

The external debt burden of many developing countries has increased their borrow-

ing risk and interest charges on loans. The 2007–2008 global financial crisis exposed

the vulnerability of developing countries' dependence on the international financial

market (IFM). Given the uncertainty and higher borrowing risk, which limit access to

external funds, it has become necessary that developing countries increase their

internally generated revenue through taxation to facilitate growth and development.

For effective distributive effect of tax policy, the tax burden ought to be optimal. This

study estimates the optimal tax rate that maximises the economic growth for Ghana,

using quarterly data from 2007 to 2017. Based on Scully's model, the study con-

cludes that for the economy to grow at an average rate of 8.88% instead of the cur-

rent 6.25%, the optimal tax rate should be raised from the current 15.30% to

27.69%. For policy purposes, the study highlights the implication of ensuring effi-

ciency in revenue mobilisation through taxation.

1|INTRODUCTION

The gross domestic product (GDP) of economies comprises consump-

tion, investment, government expenditure and net exports. Govern-

ment spending is, therefore, a component of aggregate demand and

consequently consumption levels in economies. Government spending

also depends on government revenue, which largely comes from taxa-

tion. Kizito (2014) reported that there is a nexus between consump-

tion and income tax. Logically, if households spend their after-tax

income then higher income tax means lower level of disposable

income for private consumption or saving in the economy, ceteris

paribus.

According to Myles (2009), economic growth explains the level of

prosperity of economies but the rate of economic growth is

influenced by policy choices on public revenue mobilisation and

spending. The importance of taxation in strengthening the operations

of countries has been reiterated (see, for instance, IMF, OECD, UN, &

World Bank, 2011). It is also documented that there is no nation in

the world, developed or developing, that can develop without a sound

tax system (see, for example, Emmanuel, 2013, 2010; Padda &

Akram, 2009). Gale and Samwick (2014) noted that reducing taxes

may encourage saving and investment, which may lead to economic

growth or cause budget deficit, which will, in turn, reduce the national

savings and raise the price level in the long run. Thus, a tax level that

can encourage saving and investment without causing budget deficit

may be an apt driving force for a long-run economic growth. A tax

policy choice of how much rate of tax to impose to generate income,

therefore, becomes crucial to sustained economic growth.

Ghana sought assistance from the International Monetary Fund

(IMF) and the World Bank between 1983 and 1991, for a major struc-

tural adjustment programme to liberalise the economy from regulation

and low growth, which characterised the country after independence

in 1957 and to encourage investment (Anaman, 2006). The economic

reforms aimed at deregulating the economy, pursuing trade

liberalisation policies, which seek to encourage competition, so as to

enhance the capacity of the industrial sector, particularly, and priva-

tisation of the public enterprises, among others, in order to stabilise

the macro economy (Vernhout, 2014).

The size of the government during the 2001 and 2005 averaged

about 20.43%—making the private sector the largest, and real GDP

growth rate averaged about 5.46% (Anaman, 2006). The IMF reported

that Ghana grew at 5.90 and 7.90% in 2005 and 2010, respectively,

Received: 9 January 2020 Accepted: 11 June 2020

DOI: 10.1002/pa.2223

J Public Affairs. 2021;21:e2223. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons, Ltd 1of9

https://doi.org/10.1002/pa.2223