Tax Effort in Developing Countries: What do Regression Measures Really Measure?

During the past decade a number of studies ¹ have attempted to measure the ‘tax effort’ of less developed countries (LDCs) from cross-section regression analysis. Typically, factors thought to be important determinants of tax capacity are chosen as independent variables partially explaining behaviour of the tax ratio (i.e., tax revenues as a percentage of aggregate income). The residuals are then taken as crude measure of tax effort in the sense that a higher residual would suggest a greater tax yield relative to tax capacity. In short the ‘fitted’ values of the tax ratio are used as proxies for tax capacity.