(iii) international trade relative to GDP, and (iv) demographic composition as captured by the age dependency ratio.

Per-capita income as a proxy of the level of development of a country’s economy is positively related to revenue potential. This is so because both the capacity to collect and the ability and willingness of taxpayers to pay taxes tend to increase with higher development (Gupta 2007; Khwaja and Iyer 2014). In addition, higher levels of income are typically associated with greater demand for public goods and services (Le et al. 2008). This, in turn, may strengthen “demand” for higher revenues to finance public services. These views are supported by a large body of empirical evidence of a strong positive relationship between revenues and GDP per capita, including in developing countries (Stotsky and Wolde-Mariam 1997; Ghura 1998; Piancastelli 2001; Le et al. 2008). In our data set, there is a clear positive correlation between revenues and GDP per capita that is consistent with these findings (see Figure 2 in Section III).

The sectoral composition of output matters for revenue mobilization because certain sectors of the economy are easier to tax than others. In particular, the share of agriculture in GDP is considered to be negatively related to revenue potential, especially if it is dominated by a large number of subsistence farmers which are considered a “hard-to-tax” group (Gupta 2007; Le et al. 2008).<sup>5</sup> In accordance with this view, many empirical studies find that the share of agriculture in GDP is significantly negatively related to revenues (Leuthold 1991; Tanzi 1992; Piancastelli 2001; Le et al. 2012) or, alternatively, that the share of industry and service is positively related to revenues (Khwaja and Iyer 2014). As shown in Figure 2, there is a negative correlation between revenues and the share of agriculture in GDP in our data that is consistent with these findings.

In addition, more international trade relative to GDP is commonly considered to be an important determinant of revenue potential. Since taxes from imports and exports represent important sources of revenues that are relatively easy to collect even with weaker tax administrations, trade openness is considered to be positively related to tax base and revenue potential (Gupta 2007; Aizenman and Jinjarak 2009; Khwaja and Iyer 2014).<sup>6</sup> This view is supported by empirical evidence (Leuthold 1991; Tanzi 1992; Gupta 2007; Le et al. 2012) and also consistent with the positive correlation between revenues and trade openness observed in our data (see Figure 2).

Finally, a higher age dependency ratio<sup>7</sup> tends to reduce countries’ revenue potential as it indicates a lower share of productive population and, hence, a narrower tax base. In accordance with this view, empirical evidence shows that a higher age dependency ratio is associated with lower levels of revenue mobilization, including in developing countries (Le et al. 2012; Khwaja and Iyer 2014). The correlation in our data shown in Figure 2 (Section III) is consistent with these findings.

# **III. Empirical Strategy**

The analysis uses non-parametric frontier analysis (DEA) to quantify efficiency in domestic revenue collection at the country level. The obtained efficiency scores are then used as the dependent variable in a regression framework based on country panel data.

> 5 Countries with a larger share of agriculture in GDP also tend to have lower demand for public goods and services since most high-value public services are based in cities (Tanzi 1992; Le et al. 2008).

> 6 Note that, in general, higher trade openness may have an ambiguous effect on revenue mobilization. On the one hand, trade liberalization often occurs through reductions in tariffs which imply losses in tariff revenue. On the other hand, given that higher trade openness facilitates economic growth, eventually more revenues can be collected in open economies. Many authors argue that the second effect dominates and trade openness has a positive effect on fiscal revenue (Rodrik 1998; Le et al. 2012). In addition, revenue may also increase if trade liberalization occurs mainly through tariffication of quotas, eliminations of exemptions, reduction in tariff peaks, or improvements in customs procedure (Keen and Simone 2004).

> 7 The age dependency ratio is the number of people of non-working age (zero to 14 and over 65), compared with the number of those of working age (15 to 64).

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