between 15 and 64. It is expected that the higher the age dependency ratio, the lower the productive population and hence the narrower the tax base. Thus, we would predict that demographic characteristics, both population growth and age dependency ratio, are negatively correlated to the tax and fiscal revenue collections.

_Trade openness_ . Trade openness is an aggregated level of export and import calculated as a fraction of GDP. Traditionally, trade taxes have been one of the key sources of revenue in the developing world. The sector is more formalized and it is relatively easy to tax. However, globalization and international competition have gradually led countries to reduce their reliance on trade taxes. The governments, especially those in middle- and highincome countries, are obligated to reduce tariffs at their borders over time. A growing concern in developing countries is how to strengthen domestic revenue system to compensate for the expected losses in trade taxes. However collections from the borders remain high, especially in low-income countries in Africa. We expect to observe a positive relationship between trade openness and taxable capacity, but the strength of this correlation should be gradually decreased (Rodrik 1998).

_Agricultural value added_ . Agricultural value added is measured as a fraction of GDP. Value added is the net output of the agricultural sector after adding up all outputs and subtracting intermediate inputs. Agriculture is one typical hard-to-tax sector; most developing countries exempt from taxes a large share of agricultural activities due to its inherent difficulty to collect the tax or due to equity and political reasons. Thus a higher level of agricultural value added is expected to correlate with a lower level of taxable capacity. In addition, countries with a relatively larger share of agriculture in the economy generally have lower demand for public goods and services since most high-value public services are city-based (Tanzi 1992).

_Corruption index and bureaucratic quality._ The International Country Risk Guide (ICRG) provides alternatives for gauging the quality of the institutional setting of a country, particularly the corruption index and bureaucratic quality. The ICRG staff collects political information and financial and economic data, converting these into points for each individual component on the basis of a consistent pattern of evaluation. The political risk assessments are made on the basis of subjective analysis of the available information and the assessments are conducted on an annual basis.<sup>9</sup> The corruption index measures the extent of corruption by assigning a numerical value to a country. The index ranges from 1 to 6, where a higher number means lower corruption.

The bureaucracy quality index is an alternative institutional indicator of governance. The index assesses political stability of a country and ranges from 1 to 4. The higher scores are given to countries where the bureaucracy has the better strength and expertise to govern without having to resort to drastic and frequent changes in policy or to interruptions in government services (ICRG 2006). To make the comparison of the regression results based on the use of these two alternative indicators and to facilitate our presentation of the institutional impact on tax effort, we follow Tanzi and Davoodi (1997), by rescaling the original ICRG corruption index and bureaucracy quality indicator to a range of -6 (least corrupt or best bureaucratic quality) and -1 (most corrupt or worst bureaucratic quality). Our

> 9 <u>http://www.prsgroup.com/ICRG_Methodology.aspx</u>

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