Panels A and B in Figure 18 show the relationship between the VAT rate and the perceived e¤ect of taxes on incentives to work and invest, respectively, for a sample of 123 countries for the year 2014.<sup>42</sup> Supporting our previous ...ndings, the relationship is highly non-linear. While the perceived e¤ect of taxes on the incentives to work and invest barely changes as VAT rates increase at low/moderate levels (approximately until the VAT rate reaches 14 percent), it falls rapidly for high levels of VAT rates.

# 6.6 Non-linearities in action IV: It works in empirics, but does it work in policy?

In the recent past, two of the most pressing policy challenges faced by governments around the world have been (i) how to regain the lost economic growth of the 2000s and (ii) how to deal with larger and more persistent ...scal de...cits (161 out of 191 countries had ...scal de...cits in 2017 and 120 governments have plans for ...scal adjustment in 2018).<sup>43;44</sup> In this section, we evaluate the extent to which our nonlinear ...ndings are, in a broad sense, actually being taken into account by countries’...scal authorities when dealing with these key challenges. If the tax multiplier is essentially zero for countries with relatively low/moderate initial tax rate levels, then their governments could contemplate conducting ...scal adjustments by raising tax rates and, consequently, revenues. By the same token, it would prove ine¤ective to reduce the VAT rate to increase economic activity. In contrast, if the tax multiplier is largely negative for countries with high initial tax rate levels, it would prove quite costly to mobilize revenues by increasing the VAT rate and quite bene...cial to reduce such a rate to boost economic activity. Figure 19 shows the relationship between the VAT rate (as of November 2017) and the expected change in cyclically-adjusted revenues (as a percentage of GDP) between 2017 and 2018 (�CAR).<sup>45</sup> The evidence is quite striking in that countries’...scal authorities with low rates are, indeed, planning to boost revenues as part of their adjustment e¤orts, while countries with high tax rates are not only not planning to substantially increase revenues, but also trying to reduce such a burden. In fact, the expected change in cyclically-adjusted revenues (as a percentage of GDP) is (i) 0.4 percentage points (statistically signi...cant at the 1 percent level) for countries with VAT rates between 6 and 13 percent (with 83 percent of these countries planning increases in �CAR), (ii) -0.15 percentage points (statistically not signi...cant) for countries with VAT rates between 14 and 18 percent (with 45 percent of these countries planning increases in �CAR), and (iii) -0.52 percentage points (statistically signi...cant at the 1 percent level) for countries with VAT rates between 19 and 27 percent (with 76 percent of these countries planning decreases in �CAR). Figure 20 shows the same regularity when

> 42 Figure 18 does not include 19 countries that, in spite of having Global Competitiveness Index data, lack a VAT scheme.

> 43 For these purposes, a ...scal adjustment plan is identi...ed as a situation where the overall ...scal balance (being it de...cit or surplus) is expected to increase from 2017 to 2018.

> 44 While the number of countries planning to conduct ...scal adjustment in 2018 represent about 63 percent (or 120 out of 191) of the total number of countries, their economies represent about 86 percent of global output.

> 45 It is worth noting that the correlation between the VAT rate (as of November 2017) and the revenue (as a pecentage of GDP) for 2017 is 0.62 (statistically signi...cant at the 1 percent level).

38