An Instrumental Variables Approach to Estimating Tax Revenue Elasticities: Evidence from Sub-Saharan Africa

Consistent estimation of the tax revenue elasticity is complicated by the endogenous response of GDP to changes in tax rates and measurement error in national accounts statistics. This paper exploits the significant response of real GDP growth of Sub-Saharan African countries to exogenous international commodity price and rainfall shocks to construct instrumental variables estimates of the tax revenue elasticity parameter. IV estimates yield that a 1 percent increase in GDP increases tax revenues by up to 2.5 percent. IV estimates therefore point to large responses in the tax revenues collected by Sub-Saharan African governments.