Academic journal article The Journal of Developing Areas

Stock Market and Tax Revenue as Determinants of Economic Growth: Panel Data Evidence from Developing Asia

Academic journal article The Journal of Developing Areas

Stock Market and Tax Revenue as Determinants of Economic Growth: Panel Data Evidence from Developing Asia

Article excerpt

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

Does stock market together with fiscal policy affect economic growth? Prior empirical literature advocated the role of fiscal policy in establishing economic growth (Schumpeter, 1911, Solow, 1956, Mckinnon, 1973, Shaw, 1973, Zagler and Durnecker, 2003), but it made no attempt to investigate the role of the stock market and taxation as the potential determinants of growth. This is mainly because traditional growth theories concentrated on steady-state level of capital stock per worker or productivity, but not on the rate of economic growth which in turn was attributed to arise due to exogenous technical progress (Mohtadi and Agarwal, 2004). In contrast to traditional growth models, endogenous growth models (EGM) suggest that government taxation policies can affect the economic growth, and this effect can manifest not only in level but also affect the long run rate of growth (Lucas, 1990, Jones and Manuelli, 1990, Kim, 1997, Marsden, 1983). These models suggest that

the rate of growth depends on the net rate of return from investment, which depends on tax rates (Siddiqi and Ilyas, 2011).

The literature tends to study either the impact of financial market on economic growth or the impact of tax policies on economic growth, but not the joint impact of taxation and financial market of economic growth. For example, a large and diverse body of theoretical and empirical literature (Odedokun, 1998, Ram, 1999, Beck et al., 2000, Naceur and Ghazouani, 2007, Naceur et al., 2007, Kyereboah-Coleman and Agyire-Tettey, 2008, Akimov et al., 2009) has created the view that the development of a strong financial system is crucial for the short-term and long-term economic growth of a country. In addition to the financial system, taxation policy is also a fundamental element that determines the growth process (Karran, 1985, Barro and Sala-I-Martin, 1992, Futagami et al., 1993, Lee and Gordon, 2005). The role of taxation in influencing investment activities, which later affects the growth rate, was also discussed by Yamarik (2000). He finds that the increases in property tax rates lower the return on capital, which leads to a reduction of growth in investment, output and productivity. In contrast, Strulik (2003) argues that the reduction in tax (in this case corporate tax rate) will lower the expected growth rate because this reduction will contribute to firm's the welfare gain.

Among those few economic theories explaining the stock market and taxation as joint determinants of the economic growth are Levine's (1991) EGM and the Laffer - Khaldun (1978) curve. In Levine's (1991) model, the stock market allocates risk and alters investment incentives in ways that change steady growth rates under the assumptions of different tax rates. When both corporate taxes and taxes on capital gains are too high, the growth rate of the economy will be affected by reducing the quantity of resources available for future production and investment. Moreover, capital gains tax can be seen as a direct taxation of stock market activities which can change the resource allocation by reducing the expected post-tax resale price of firm stock. This subsequently reduces the fraction of resources available for firms' investment and hence leads to decline in the economy's steady state growth rate. Laffer-Khaldun (1978) curve relates tax rates to taxation revenues and has inverted U-shape because distortionary taxation reduces the tax base on which tax revenue is collected (Vogel, 2012). Since taxation of investment income introduces

a wedge between investment costs and the net returns to capital, the equilibrium stock of productive capital is likely to be reduced (Vogel, 2012). Therefore, reduced tax rates on investment income would stimulate economic growth which would in turn generate more tax revenue.

Although the nexus between taxes, stock market and economic growth has been proposed to exist in theory, not many studies have been devoted to empirically examine such a relationship. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.