**_Policy, Planning, and Research Working Paper Series_**

25 cation is to charge fees for public schooling.

ButrecentWorld Bankstudiesofsecondary level data in Thailand, Colombia, Tanzania, and the Philippines point to a second, more cost-effective option: rely on private schools to handle the growing demand for education.

Private school students generally outperform public school students on standardized math and language tests. This finding holds, even after studies account for the fact that, on average, private school students in these countries come from slightly more advantaged backgrounds than their public school counterparts. In addition, school expenditure data show that unit costs for private schools are dramatically lower than those of public schools.

The comparative advantage of private schools has important policy implications for public schools. Some efficiency gains can come from replicating the input mix (teacher/student ratios, teacher qualifications) of private schools. The data show that private schools, among other practices, make more efficient use of teachers and have better teaching processes (more tests, more homework, orderly classrooms).

Also effective would be to mimic the organizational incentive structures of private schools. Their administrators have considerable economic and bureaucratic autonomy, and are motivated to encourage better teaching practices - using staff more effectively and cheaply - because they must compete for students and remain accountable to parents who pay the bills.

This paper is a product of the Education and Employment Division, Population and Human Resources Department. Please contact Teresa Hawkins, room S6224, extension 33678.

# 73. **Taxation and Output Growth** In Africa

# Jonathan Skinner

_A revenue-neutral shift from import taxes and personal and corporate levies to sales or excise taxes may increase growth rates in developing countries._ Can tax policies be designed to encourage economic growthin developing countries? One view holds that by providing the govemment with a stable source of funding and reducing the current account deficit, tax revenues encourage long-term growth. In this view, the economic distortions aggravated by tax rates are slight in comparison to such institutional constraints as price controls, foreign exchange allocations, and trade quotas. The other view is that high marginal tax rates constrain long-term economic development by discouraging business expansion, investment, and foreign trade. The contention is that the benefits of a carefully designed, moderate tax structure exceed the costs of budget deficits or spending cuts.

Thispaperteststhese viewsbymeasuring the effect of government spending and taxation on output growth. In theory, higher tax rates shift investment and employment to sectors withlow-or even - negative tax rates, such as import-substitution or underground sectors. The lower returns to investment and labor in these sectors mean that the economy will generally record lower growth rates.

Data from 31 African countries show the medium- and long-term effects of fiscal policies on growth during 1965-73 and 1974-82. Government investments for the earlier period were sufficiently productive to justify the distortions imposed by the relatively high tax rates necessary to finance them. By 1974-82, however, the return on government investments had fallen to almost zero, suggesting that the burden of personal and corporate taxes led to a contraction in growth. Although taxes on imports did not affect output directly, such taxes reduce investment and thereby indirectly curtail growth. On balance, sales and excise taxes had the most moderate effects on growth and investment.

In sum, a balanced increase in government spending financed by sales and excise taxes, or by a shift from personal and corporate taxes to consumption taxes, can increase growth rates.

This paper is a product of the Public Economics Division, Country Economics Department. Please contact Ann Bhalla, room N10-061, extension 60359.

# 74. **Fiscal Stabilization and Exchange Rate Instability**

# Andrew Feltenstein and Stephen Morris

_Cuts in public spending can, in some cases, be inflationary and should be coordinated with appropriate exchange rate_

# and _monetary policies._

A perfect foresight, intertemporal general equilibrium model can be used to analyze the fiscal impact of reductions in public spending. The model permits a consistent analysis of government spending, deficit financing, and exchange rate behavior.

It incorporates features important to analyzing public policy in Mexico, including the cost of producing government infrastructure, a tax system and government exchange rate policy similar to those in Mexico, and the estimated savings behavior of domestic consumers.

Mexican public spending increased from 25.6 percent of GDP in 1973 to 46.5 percent in 1982. This rise was accompanied by dramatic increases in inflation, the government deficit, and external debt.

Policymakers look at such a situation and automatically conclude that stabilization depends on reduced public spending. But when appliedtoMexican datafor 1983-85, the model shows that public spending cuts alone maybe inflationary if they cause a reduction in the productivity of private capital.

The model does not estimate the elasticity of private output to public infrastructure. But even if low elasticity is assumed, spending cuts may produce a reduction in private productivity that will have an undesirable effect.

A decline in productivity may outweigh the impact of falling monetary growth rates and reduced budget deficits. If it does, the benefit of spending on infrastructure outweighs its costs. If, however, government spending produces no useful infrastructure, a reduction in spending will have the desired result of reducing inflation.

Various simulations with the model indicate that dogmatic recommendations for spending cuts can at times be counterproductive.

This paper is a product of the Public Economics Division, Country Economics Department. Please contact Ann Bhalla, room N10-061, extension 60359.

# **75. Welfare Dominance and the Design of Excise Taxation In the C6te d'lvoire**

# Shlomo Yitzhaki and Wayne Thirsk

_The concept of conditional welfare domi-_