Finance and Tax Structures in Developing Countries: Many Puzzles and a Possible Explanation

The past academic literature on tax policy has focused almost entirely on the analysis of tax structures in the richest countries, particularly the U.S. Overall the optimal tax models explain reasonably well the observed tax policies in these countries. As summarized in Gordon (2000), for example, past theoretical work suggests that taxes on consumption or labor income should dominate use of capital income taxes in open economies under plausible assumptions. Consistent with this, value-added taxes, personal income taxation of labor income, and payroll taxes are the most important sources of revenue in many countries. Even under the income tax, a large fraction of personal savings in practice is tax exempt.