THE AFRICAN JOURNAL OF FINANCE AND MANAGEMENT - VOLUME 22 NO.

2, 2013: 47-56

The Impact of Taxation on the Economic Growth of Tanzania

Zawadi Ally*

Abstract
The objective of this study is to investigate and provide some insights into the relationship between
taxation of different sources of income and economic growth. It goes further to examine whether tax
revenues in the form of personal income tax, value added tax, corporate income tax, customs duty and
excise duty affect the economic growth of Tanzania, measured with gross domestic product . To capture
this, time series data was culled from 2000-2014. On the basis of the findings, the results show that the
coefficients of regression of personal income tax, value added tax, corporate income tax, customs duty
and excise duty appear statistically significant and negative in explaining the economic growth. The study
concludes that, statistically, taxation is the main determinant of Tanzania’s economic growth. Thus, the
result offer tantalizing evidence that taxation is an instrument of economic growth in Tanzania .
Keywords: economic growth, taxation, time series data, Tanzania

1. Introduction* accomplishment of political, economic and

The economic development of a country
depends upon the amount of revenue collected
for the provision of infrastructure in a country.
However, one means of generating the amount
of revenue required for providing the needed
infrastructure is through a well-structured tax
system. Tax is the main source of government
revenue in a country. Governments use tax
revenue to fund their traditional functions, such
as the provision of public goods, maintenance
of law and order, defence against external
aggression, regulation of trade and business to
ensure social and economic maintenance.
Therefore, tax policies need to attract potential
investors, and the revenue from tax should be
sufficient enough to meet the infrastructural
expenditures of a government. Taxation is a
microeconomic and fiscal policy instrument
that involves the transfer of resources from the
private to the public sector for the
*Institute of Finance Management, Dar es Salaam,
Tanzania: zawally2001@yahoo.com
social goals (Apere, 2003). It is a tool the
government employs to access, measure and
control the informal sector that dominate
developing economies of the world (Wambai
& Hanga, 2013). Tax is a compulsory levy
imposed on a subject or upon his property by
the government to provide security, social
services and create conditions for the
economic well-being of the society (Appah &
Oyandonghan, 2011; Appah, 2004). Taxes are
imposed to regulate the production of certain
goods and services, protection of infant
industries, control inflation, promote business
and reduce income inequalities among the
societies (Anyanfo, 1996: Anyanwu, 1997).
Taxes are used in the country as proxy for fiscal
policy and have five possible impacts on
economic growth of a country. First, taxes such
as corporate tax, income tax and capital gain
taxes, if not well structured, can reduce
investment rate in the country. Second, high tax
rate can reduce labour supply by disposing
labour leisure choice in favour of leisure. Third,

AJ FM 22(2), July 2013

Zawady Ally
poor tax policy has an adverse effect on
productivity growth through its discouraging
effect on research and development
expenditures. Fourth, taxes can result into
resources moving to a sector that has low
productivity; and finally, high taxes on labour
supply can distort the efficient use of human
capital even though they have high social
productivity (Tosun & Abizadeh 2005).
The economic impacts of tax system include
micro effects on the distribution of income and
efficiency allocation of resources, as well as
macro effect on the level of capacity on
production, employment, prices and growth.
However, the use of tax as an instrument of
fiscal policy cannot be achieved because of a
decreasing level of revenue generated as a
result of ineffectiveness of government officials
(Musgrave & Musgrave, 2004).
Effective tax systems are central for a
sustainable development because they can: (i)
mobilize the domestic tax base as a key
mechanism for developing countries to escape
aid or single resource dependency; (ii) reinforce
government legitimacy through promoting
accountability of the government to taxpaying
citizens and good public financial management;
and (iii) achieve a fairer sharing of the costs and
benefits of globalization (Fjeldstad, 1995).
In Tanzania, the government has to play an
active role in promoting economic growth and
development because private initiative and
capital are limited. Fiscal policy has become
an essential tool in promoting growth and
development in the country. Taxation is an
important part of fiscal policy that can be
employed effectively by government. Taxation
plays a very important role in the economic
growth of a country.
Due to the important role that taxation plays
in the economic development of a country, the
government of Tanzania has undertaken
various tax policy reform measures. It has also
48 | AJ FM 22(2), July 2013
embarked on a comprehensive tax reform
process, while undertaking piecemeal reforms
of particular taxes on since the late 1960s
(Fjeldstad, 1995). There are several reasons
why the government has designed and
implemented tax policy reforms. These include
the extensive tax evasion and avoidance,
reflecting poor compliance and poor
administrative capacity as well as other
institutional constraint (Fjeldstad, 1995). Since
the tax policy reforms the government has
taken several efforts to raise taxes revenues
collection by improving tax administration. To
some extent these efforts have contributed to a
more efficient tax administration during the
last few years. The improvement of tax
administration after tax policy reforms has also
enabled the collection of significantly bigger
amounts of revenues (both in absolute and
relative terms). Revenue collections in
Tanzania through various taxes have increased
in absolute terms from an equivalent of
US$1,575m in 2004/05 to US$3,742m in
2009/10. Also, revenue to GDP ratio has
increased from 10.8% in 2004/05 to 14.6% in
2009/10 (Kitillya, 2011)
Ogbonna and Ebimobowei (2012) argue that a
well-structured tax system offers itself as one of
the most effective means of mobilizing a
nation’s internal resources, and tends to create
an environment conducive to the promotion of
economic growth. On his part, Myles (2012)
found that in developing countries, tax
contributes to almost 10% of the gross
domestic product of the economy, thus
resulting in an economic growth.
Given the significant importance of taxation to
the economic development, therefore, the
objective of this study is to investigate and
provide some insights into the relationship
between taxation of different sources of income
and economic growth. It goes further to
examine how tax revenues—in the form of
personal income tax, value added tax, corporate
income tax, customs duty and excise duty—
affect the economic growth of Tanzania.
 The Impact of Taxation on the Economic Growth of Tanzania
The rest of the study is organized as follows.
Section 2 reviews the relevant literature
regarding to theoretical framework and
empirical literature. Section 3 presents the data
and methodology to be applied, while section
4 contains the empirical results. Finally,
section 5 concludes the study.
2. Literature Review
2.1 The Theoretical Framework
A taxation theory may be derived on the
assumption that there need not be any
relationship between tax paid and benefits
received from state activities. In this group,
there are two theories: socio-political theory;
and expediency theory (Bhartia, 2009).
A taxation theory may be based on a link
between tax liability and state activities. This
reasoning justifies the imposition of taxes for
financing state activities and also providing a
basis for apportioning the tax burden between
members of the society. This reasoning yield
the benefit received theory and cost of service
theory. There is also the faculty theory of
taxation (Ogbonna & Ebimobowei, 2012).
Socio-political theory
This theory of taxation states that social and
political objectives should be the major factors
in selecting taxes. The theory advocates that a
tax system should not be designed to serve
individuals, but should be used to cure the ills
of society as a whole.
Expediency theory
This theory asserts that every tax proposal must
pass the test of practicality. It must be the only
consideration weighing with the authorities in
choosing a tax proposal. The economic and
social objectives of the state as it effects a tax
system should be treated irrelevant (Bhartia,
2009).
Benefit received theory
This theory proceeds on the assumption that
there is basically an exchange relationship
between tax-payers and the state. The state
provides certain goods and services to the
members of the society, and they contribute to
the cost of these supplies in proportion to the
benefits received (Bhartia, 2009). Anyanfo
(1996) argues that taxes should be allocated on
the basis of benefits received from government
expenditure.
Cost of service theory
This theory is similar to the benefits received
theory. It emphasizes the semi-commercial
relationship between the state and the citizens
to a greater extent. In this theory, the state is
being asked to render basic protective and
welfare functions. It is to scrupulously recover
the cost of services. Therefore this theory
implies a balanced budget policy.
Faculty theory
According to Anyanfo (1996), this theory states
that one should be taxed according to the ability
to pay. It is simply an attempt to maximize an
explicit value judgment about the distributive
effects of taxes. Bhartia (2009) argue that a
citizen is to pay taxes just because s/he can, and
his relative share in the total tax burden is to be
determined by her/his relative paying capacity.
Anyanwu (1997) defined taxation as the
compulsory transfer or payment (or
occasionally of goods and services) from private
individuals, institutions or groups to the
government. The main purpose of tax is to raise
revenue to meet government expenditure and to
redistribute wealth and management of an
economy (Ola, 2001; Jhingan, 2004; Bhartia,
2009). According to Nzotta (2007), four key
issues must be understood for taxation to play
its functions in a society. First, tax is a
compulsory contribution made by citizens to
the government, and this contribution is for
general common use. Secondly, a tax imposes a
general obligation on the tax payer. Thirdly,
there is a presumption that the contribution to
the public revenue made by a tax-payer may not
be equivalent to the benefits received. Finally,
AJ FM 22(2), July 2013| 49
Zawady Ally
tax is not imposed on a citizen by the
government because it has rendered specific
services to individuals. Thus, it is evident that a
good tax structure plays a multiple role in the
process of economic development of any
nation, and Tanzania is not an exception.
The level of taxation affects the level of public
savings, and thus the volume of resources
available for capital formation. Both the level
and structure of taxation affects the level
private saving (Musgrave & Musgrave, 2004).
According to them, a system of tax incentives
and penalties may be designed to influence the
efficiency of resource utilization; the
distribution of the tax burdens plays a large
part in promoting an equitable distribution of
the fruit of economic development; the tax
treatment of investment from abroad may
affect the volume of capital inflow and rate of
reinvestment of earnings there from; and the
pattern of taxation on imports relative to that
of domestic producers affect the foreign trade
balance (ibid.). The stabilization function of
taxes seeks to attain high level of employment,
a reasonable level of price stability, an
appropriate rate of economic growth, with
allowances for effects on trade and on the
balance of payments (Musgrave & Musgrave,
2006).
Economic growth:
According to Dwivedi (2004), economic growth
is a sustained increase in per capita national
output or net national product over a long
period of time. It implies that the rate on
increase in total output must be greater than the
rate of population growth. Another
quantification of economic growth is that
national output should be composed of such
goods and services that satisfy the maximum
want of the maximum number of people.
Economic growth can be determined by four
important determinants, namely: human
resources, national resources, capital formation
and technological development.
50 | AJ FM 22(2), July 2013
The theories of economic growth can be
examined under the Harrod-Domar theory of
growth, the Kaldor model of distribution, the
Pasinetti model of profit and growth, the Joan
Robinson’s model of capital accumulation,
Meade’s neo-classical model of economic
growth, and the Slow model of long-run
growth. We now examine these models of
economic growth and the various views of
scholars on the most suitable explanation of
economic growth.
2.2 Empirical Evidence
Several empirical studies have been carried out
by various authors on the impact of taxes on
economic growth. The empirical studies of
Anyanwu (1997), Engen and Skinner (1996),
Tosun and Abizadeh (2005) and Arnold
(2011) provide different explanations of taxes
on economic growth.
Engen and Skinner (1996) in their study of
taxation and economic growth of the US
economy, large sample of countries and use of
evidence from micro level studies of labour
supply, investment demand, and productivity
growth. Their result suggests modest effects on
the order of 0.2 to 0.3 percentage points
differences in growth rates in response to a
major reform. They stated that such small
effects can have a large cumulative impact on
living standards. In their study of economic
growth of tax changes in OECD countries
from 1980 to 1999, Tosun and Abizadeh
(2005) reveal that economic growth measured
by GDP per capita has a significant effect on
the tax mix of GDP per capita. They show
that while the shares of personal and property
taxes respond positively on economic growth,
shares of the payroll and goods and services
taxes show a relative decline. Arnold (2011)
found that short-term recovery requires
increase in demand, while long-run growth
requires increase in supply. As short-term
concessions can be hard to reverse, this implies
that policies to alleviate this crisis could
compromise long-run growth.
 The Impact of Taxation on the Economic Growth of Tanzania
In their study of the effect of taxation in sub-
Saharan Africa, Chiumia and Simwaka,
(2012) found that taxes levied on personal and
corporate income reduces economic growth.
From their study, one may be tempted to
conclude that tax structure is largely irrelevant
in less developed economies, but embedded in
an effective tax system are benefits for both the
taxpayers and the government. Adereti et al.
(2011) explored value added tax and economic
growth in Nigeria. Their findings showed that
there is no causality existing between GDP
and VAT revenue, and a positive and
significant correlation between VAT revenue
and GDP.
Worlu and Emeka (2012) examined tax
revenue and economic development in Nigeria
using the three stage least square estimation
technique. This study found that tax revenue
stimulates economic growth through
infrastructural development. It also highlights
the channels through which tax revenue
impacts on economic growth in Nigeria, and
also reveals that tax revenue has no dependent
effect on growth through infrastructural
development and foreign direct investment but
just allowing the infrastructural development
and foreign direct investment to positively
respond to increase in output. Ferede and
Dahlby (2012) test the impact of the Canadian
provincial governments’ tax rates on economic
growth using panel data covering the period
1977 to 2006. The study found that higher
provincial statutory corporate income tax rate
is associated with lower private investment
and slower economic growth. Their empirical
estimation suggested that a 1 percent point cut
in the corporate tax rate is related to a 0.1–0.2
percentage point increase in the annual growth
rate. Their findings indicate that sales tax
boosts provincial investment and growth when
switched from retail sales tax to a harmonized
sales tax with federal value added.
Nwakanma and Nnamdi (2013) examined
taxation and national development with the
least square methodology and specification on
the lin-log model of human development
index. Their findings reveals that petroleum
profit tax, company income tax and excise tax
exhibit a positive relationship with the level of
national development, and a negative
relationship between human development
index and corporate tax.
Dackehag and Hansson (2012) studied how
statutory tax rates on corporate and personal
income affect economic growth using panel
data from 1975 to 2010 for 25 rich OECD
countries. They found a negative influence on
economic growth from both taxation of
corporate and personal income. Their study
revealed a more robust economic growth in
correlation with corporate income tax. On
their part, Koester and Kormendi (1989)
constructed measures on average and marginal
income tax rates by regressing tax revenue on
GDP, and summed the measures in a growth
regression. Their results detected no
statistically significant relationship between
taxes and economic growth. Also, their
findings showed tax rates seem to have a
negative impact on the growth rate, though
with marginal tax rate having negative effect
on the level of activity.
Poulson and Kaplan (2008) studied the impact
of tax policy on economic growth in the US
within the framework of an endogenous
growth model. They applied the regression
analysis to estimate the impact of tax on
economic growth in the US from 1964 to
2004. They found a significant negative impact
of higher marginal tax rate on economic
growth. Their analysis, however, underscores
the importance of controlling for regressively,
convergence, and regional influences in
isolating the effect of taxes on economic
growth in the US.
Some of the strongest evidence for an
empirical link between taxation and growth is
reported in Plosser (1993), who regresses the
AJ FM 22(2), July 2013| 51
Zawady Ally
rate of growth of per capita GDP on the ratio
of income taxes to GDP for OECD countries,
and found a significant negative relationship.
This review of literature shows that these
particular studies are lacking for most
developing countries, Tanzania included.
Hence, the findings of this study will
contribute to the literature on the impact of
taxation policy on economic growth from the
perspective of developing economies,
particularly Tanzania. Therefore, the present
study fills an important gap in the existing
literature on the extent to which effective tax
policies brings about economic growth.
2.3 Conceptual Framework
The present study sought to provide answers on
the impact of specific categories of taxes in a
country’s economic growth. Based on that, the
conceptual model was constructed as shown in
Fig.1. The model shows a relationship between
taxation (measured by income tax, value-added
tax (VAT), customs duties and excise duties),
and economic growth (measured by GDP).
2.4 Research Hypotheses
The hypotheses formulated to be tested are
stated below in Null form, thus:
H1 - The general proposition of this study is that
there is a positive relationship between tax
revenues and economic growth in Tanzania
H2 - There is no significant relationship between
tax revenues and economic growth in Tanzania
Income Tax
VAT
Taxation Corporation
tax TaxDuty
Import
Excise Duty
Figure1: Conceptual Framework
52 | AJ FM 22(2), July 2013
3. Methodology
3.1 Data and Source of Data
To produce the above-mentioned research
objective, time series secondary data sourced
from the Tanzania Revenue Authority (TRA)
and the Bank of Tanzania (BoT) was used. The
macroeconomic data cover tax revenue (TR)
and economic growth (GDP) from 2000 to
2014.
3.2 Empirical Model and Proxies Variables
3.2.1 Dependent Variable
The study used Gross Domestic Product
(GDP) to measure economic growth, and as
the dependent variable. GDP is a monetary
value of all the finished goods and services
produced within a country’s borders in a
specific time period, though it is usually
calculated on an annual basis. It includes all
private and public consumption, government
outlays, investments and exports less imports
that occur within a defined territory.
3.2.2 Independent Variables
Five different independent variables of taxes
were used in the analysis. The independent
variables used to test the hypotheses composed
of the following:
(a) Income Personal Tax
(b) VAT
(c) Corporate income tax
(d) Customs duty
(e) Excise duty
Economic
Growth
(GDP)
 The Impact of Taxation on the Economic Growth of Tanzania
The study used multiple regression analysis to
test one dependent variable with five
independent variables. The specification is:
GDP = F (PIT, VAT, CT, CD, ED) (1)
Where:
PIT- Personal Income Tax
VAT- Value Added Tax
CT - Company tax
CD - Customs duty
ED - Excise duty
Increased tax revenue is expected to increase
gross domestic product. So GDP/TR:
GDP = α+β1PIT+β2VAT + β3CT
+ β4CD + β5ED + ε (2)
In the previous equation, α is constant; β is
coefficient of variables, while ε is the residual
error of the regression. All estimations have
been performed using STATA.
The study is expected that personal income
tax, value added tax, corporate income tax,
customs duty and excise duty have negative
effect on economic growth.
4. Results and Discussion
This section of the study examines the results
and discussions of the relevant findings from
an econometric analysis.
Table 1 shows the results of white hetero-
skedasticity test. The results show that the p-
value is 58%, which is greater than the critical
value of 5%. This indicates that there is no
evidence of the presence of heteroskedasticity.
Table 1: Results of White Heteroskedasticity
F-statistic 0.6899 Prob. 0.8618
Obs.* R-squared 11.502 Prob. 0.5848
Source: Authors
Table 2 shows the results of Ramsey RESET
test. The results show that the p-value is 68%,
which is greater than the critical value of 5%.
This indicates that there is no apparent non-
linearity in the regression equation, and it
would be concluded that the linear model is
appropriate.
Table 2: Results of Ramsey RESET Test
F-statistic 0.40508 Prob. 0.68643
Log likelihood 0.58709 Prob. 0.48867
Source: Authors
Table 3 shows the results of the Breusch-Godfrey
serial correlation LM test for the presence of
autocorrelation. The result of the test shows a p-
value of about 34%, which is greater than the
critical value of 5%. This indicates the non-
existence of autocorrelation.
Table 3: Results of Breusch-Godfrey Serial
Correlation LM Test
F-statistic 1.40371 Prob. 0.340564
Obs.* R-squared 4.43984 Prob. 0.1214393
Source: Authors
The results of explanatory factors, namely,
personal income tax (PIT), value added tax
(VAT), corporate income tax (CIT), customs
duty (CD), and excise duty (ED) are given in
Table 4. The results indicate that the variable
values of determination coefficient (R-sq) are
0.996 during last of 15 years time period,
implying that the explanatory power in the
equation model is significantly high.
The implication is that the independent
variables under the model caused more than
99.6% of the variation of the dependent variable
(i.e., GDP). The results of the regression are
significant at 95% level of significance. The F
statistics test computed show a figure of 225.4 at
a significance of .05, indicating that the model
is a good fit for the data which indicate that
income personal tax, VAT, corporate income
tax, custom duty and excise duty are the
important factors for determining the GDP.
The F-statistics confirm the significance of the
overall regression equation.
AJ FM 22(2), July 2013| 53
Zawady Ally
Table 4: Results of Multiple Regressions
Variable Coefficients Standard Error
Constant 8530.095289
PIT -41.59870958
VAT -34.60189033
CT -31.21891104
CD -11.1455181
ED -19.7049934
R. Squared 0.996463342
Adjusted R Square 0.992042519
Standard Error 798.7312271
Observations 15
ANOVA
F. Statistics 225.4022484
Sources: Authors
The results of the regression conforms with the
study expectations because the parameter
estimates of personal income tax, value added
tax, corporate income tax, customs duty and
excise duty appear with negative signs;
meaning that an inverse relationship exist
between taxation and economic growth
measured by GDP. The coefficients of
regression of personal income tax, value added
tax, corporate income tax, customs duty and
excise duty have shown statistically significant
and negative in explaining the economic
growth since the p-values are less than 0.05,
then rejecting the null hypotheses at 5% level
of significance; and accepting the alternative
hypotheses that taxation is negatively and
statistically significantly influence economic
growth in Tanzania. These results are
consistent with (Dowrick, 1993: Widmalm,
2001: Lee & Gordon 2005).
The results indicate that 1% increase either in
income tax, value added tax, corporate income
tax, customs duty or excise duty (ED) will
result in the level of economic growth to
decrease by 41.6%, 34.6%, 31.2%, 11.1% and
19.7%, respectively. The implication on this is
that taxation lowers the return on innovations
and reduces the amount spent on research and
development, which impact growth negatively.
In addition, tax discourages investments both
domestically and internationally by reducing
54 | AJ FM 22(2), July 2013
t Stat P-value
1425.907574 5.982221742 0.003924984
6.160526539 -6.752460089 0.00250801
9.162349953 -3.776530094 0.019494133
4.4983032 -0.270971294 0.023821545
11.93397251 -3.447763778 0.026107748
7.087268751 -2.780336699 0.049801358
foreign direct investment, and hence hampers
economic growth. This suggests that low levels
of tax rates have a positive influence, while
higher rates hamper economic growth.
5. Conclusion and Recommendations
5.1 Conclusion
In order to design efficient and well-structured
tax systems in a country it is crucial to know
how distortive and harmful different taxes are
to economic growth. The objective of this
study was to investigate and provide some
insights into the relationship between taxation
of different sources of income and economic
growth. It went further to examine whether tax
revenues in the form of personal income tax,
value added tax, corporate income tax,
customs duty and excise duty affect the
economic growth of Tanzania, measured with
gross domestic product. To capture this, time
series data were culled from 2000-2014.
Generally, the results show that the
coefficients of regression of personal income
tax, value added tax, corporate income tax,
customs duty and excise duty appear
statistically significant and negative in
explaining economic growth, hence low
taxation enhances growth, while higher rates
retard growth. The study concludes that,
statistically, taxation measured by personal
income tax, value added tax, corporate income
 The Impact of Taxation on the Economic Growth of Tanzania
tax, customs duty and excise duty are the
determinants of Tanzania’s economic growth.
Therefore, higher tax rates may be more
distortionary, and hence impact growth
negatively; while lower rates may generate
revenues that are spent in productive ways.
5.2 Recommendations
To ensure that the taxation system in
Tanzania becomes more effective in increasing
its impact to economic growth of the country,
the following recommendations should be
adopted:
(a) Since taxation is an inevitable source of
government revenue, the problem of
double taxation should be avoided, and
tax incentives in the form of tax cut
should be provided to tax payers.
(b) The government should complement
fiscal policy with monetary policy in
order to achieve macro-economic
objectives.
(c) The government, through the monetary
authority, should implement taxation
laws that stimulate the aggregate level of
investment in Tanzania.
(d) Tax revenues should be properly
distributed so that economic growth can
be harnessed, especially in providing
basic social amenities, as well as
infrastructures in Tanzania.
(e) There should be a feedback from tax
payers to improve operating efficiencies
and avoid weaknesses.
(f) Publicity and public tax awareness
among the general populace should be
enhanced.
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