metadata: authors: 0: author: Gunter,Samara
1: author: Riera-Crichton,Daniel
2: author: Vegh Gramont,Carlos Alberto
3: author: Vuletin,Guillermo Javier
count: World
docna: 0: docna: Policy Implications of Non-linear Effects of
            Tax Changes on Output
docty: Policy Research Working Paper
subtopic: Macro-Fiscal Policy,Taxation & Subsidies,Economic Adjustment and Lending,Mining & Extractive Industry (Non-Energy),Commodity Risk Management,Public Finance Decentralization and
            Poverty Reduction,Public Financial Management,Public Sector Economics,Industrial Economics,Economic Theory & Research,Economic Growth
teratopic: Agriculture,Public Sector Development,Industry,Macroeconomics and Economic Growth
abstracts: cdata!: An earlier paper titled "Non-linear
            effects of tax changes on output: The role of the initial
            level of taxation," estimated tax multipliers using (i)
            a novel dataset on value-added taxes for 51 countries (21
            industrial and 30 developing) for the period 1970-2014, and
            (ii) the so-called narrative approach developed by Romer and
            Romer (2010) to properly identify exogenous tax changes. The
            main finding is that, in line with existing theoretical
            distortionary and disincentive-based arguments, the effect
            of tax changes on output is highly non-linear. The tax
            multiplier is essentially zero under relatively low/moderate
            initial tax rate levels and more negative as the initial tax
            rate and the size of the change in the tax rate increase.
            This companion paper first shows that these findings have
            important policy implications, given that the initial level
            of taxes varies greatly across countries and thus so will
            the potential output effect of changing tax rates. The paper
            then turns to some specific policy applications. It focuses
            on the relevance of the arguments for revenue mobilization
            in countries with low levels of provision of public goods
            and social and infrastructure gaps, as well as in
            commodity-dependent countries. The paper then considers some
            practical implications for the standard debt sustainability
            analysis. Lastly, it evaluates the implications of the
            findings for the Laffer curve.
repnme: repnme: Policy Implications of Non-linear Effects
            of Tax Changes on Output
display_title: Policy Implications of Non-linear
            Effects of Tax Changes on Output
listing_relative_url: /research/2019/01/30790392/policy-implications-non-linear-effects-tax-changes-output
topicv3: Economic Growth m1326241 471,Public Finance Management m1326316 716,Taxation m1327615 1121,Tin m1503520 2938,Commodity and Resource Prices m1503849 3034
publishtoextweb_dt: 2019-01-28T00:00:00Z
historic_topic: Agriculture,Public Sector Development,Industry,Macroeconomics and Economic Growth
no_of_pages: 18
author_keys: 0: author_key: 1239900
1: author_key: 1172435
2: author_key: 743651
model_extractions: WPS8720 Policy Research Working Paper 8720 Policy Implications of Non-linear Effects of Tax Changes on Output _Samara Gunter Daniel Riera-Crichton Carlos Vegh Guillermo Vuletin_ Latin America and the Caribbean Region Office of the Chief Economist January 2019
Policy Research Working Paper 8720

# **Abstract**

An earlier paper titled “Non-linear effects of tax changes on output: The role of the initial level of taxation,” estimated tax multipliers using (i) a novel dataset on value-added taxes for 51 countries (21 industrial and 30 developing) for the period 1970–2014, and (ii) the so-called narrative approach developed by Romer and Romer (2010) to properly identify exogenous tax changes. The main finding is that, in line with existing theoretical distortionary and disincentive-based arguments, the effect of tax changes on output is highly non-linear. The tax multiplier is essentially zero under relatively low/moderate initial tax rate levels and more negative as the initial tax rate and the size of the change in the tax rate increase. This companion paper first shows that these findings have important policy implications, given that the initial level of taxes varies greatly across countries and thus so will the potential output effect of changing tax rates. The paper then turns to some specific policy applications. It focuses on the relevance of the arguments for revenue mobilization in countries with low levels of provision of public goods and social and infrastructure gaps, as well as in commodity-dependent countries. The paper then considers some practical implications for the standard debt sustainability analysis. Lastly, it evaluates the implications of the findings for the Laffer curve.

This paper is a product of the Office of the Chief Economist, Latin America and the Caribbean Region. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/ research. The authors may be contacted at gvuletin@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# Policy Implications of Non-linear E¤ects of Tax Changes on Output<sup>�</sup>

Samara Gunter Daniel Riera-Crichton Colby College World Bank Carlos Vegh Guillermo Vuletin World Bank World Bank JEL Classi...cation: E32, E62, H20.

Keywords: tax multiplier, tax policy, tax rate, value-added tax, non-linear, narrative.

�We would like to thank sem inar participants at the International M onetary Fund, Inter-Am erican D evelopm ent Bank, World Bank, Federal Reserve Board, Europ ean Stability M echanism , Central Bank of Argentina, Central Bank of Chile, Central Bank of Spain, UN Econom ic Com m ission for Latin Am erica and the Caribb ean, G eorge Washington University, Johns Hopkins University, W illiam s College, D avidson College, Universidad Nacional de La Plata, Sao Paulo School of Econom ics-G etulio Vargas Foundation, Escola Sup erior d’Adm inistració i D irecció d’Em preses (ESAD E), Institute of Education and Research (INSPER), International M acro Workshop-RID G E, Latin Am erican and Caribb ean Econom ic Association (LACEA), Annual Sym p osium of the Spanish Econom ic Association, and XLIV M eeting of the Network of Central Banks and Finance M inistries-ID B for m any helpful com m ents and suggestions. We would also like to thank Alb erto Alesina, Silvia Albrizio, Leop oldo Avellan, Frank Bohn, Fernando Broner, Eduardo Cavallo, Javier G arcia-Cicco, Aitor Erce, D avide Furceri, Vitor G aspar, Alejandro Izquierdo, Herm an Kam il, G raciela Kam insky, Aart Kraay, G erardo Licandro, Alessandro Notarpietro, Peter M ontiel, Eduardo M oron, Ilan Noy, Pablo O ttonello, Peter Pedroni, Javier Perez, Rob erto Ram os, D avid Robinson, D iego Saravia, O lena Staveley-O ’Carroll, Jay Shambaugh, Ham ilton Taveras, Teresa Ter-M inassian, and M artin Urib e for helpful discussions, and José Andrée Cam arena Fonseca, D iego Friedheim , Pablo Hernando-K am insky, and Luis M orano for excellent research assistance.
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# 2 Policy implications I: On the relationship between the size of the government and economic development

The role and the size of the government in an economy have been studied from different perspectives in the literature. Some of the main determinants of government spending as a proportion of GDP include trade openness (Rodrik, 1998), country size (Alesina and Wacziarg, 1998), degree of economic development (Wagner, 1883, 1893; Easterly and Rebelo, 1993), political organization (Persson and Tabellini, 1999; Milesi-Ferretti, Perotti, and Rostagno, 2002), and business cycle volatility (Fatas and Mihov, 2001).

Within this broad set of theories, one that has received considerable attention focuses on the relationship between the size of the government and the degree of economic development. In fact, one of the best-established empirical regularities in public finance is the existence of a positive relationship between the size of government spending (relative to GDP) and real GDP per capita. This so-called Wagner’s Law, also known as the law of increasing state activities, is named after the German economist Adolph Wagner’s empirical analysis of Western Europe at the end of the 19th century. Wagner (1883, 1893) pointed out that, as national income rises, public spending tends to increase, both at the extensive margin (i.e., new activities are undertaken) and at the intensive margin (i.e., existing activities are performed on a larger scale). Specifically, Wagner argued that the public sector would take over and expand administrative, regulatory, and protective activities previously performed by the private sector because, as nations develop, they face increased complexity in terms of legal and administrative frameworks. Wagner also predicted the expansion of public expenditures related to culture and welfare based on the presumption that, as income rises, citizens will increase the demand for services, such as education, public health, old age pension, and other social protection programs. In fact, these types of goods and services are viewed as luxury goods (i.e., the income elasticity of demand exceeds unity) and have, in principle, more characteristics of public goods than private goods, in which case public provision seems to be the norm. Finally, Wagner was of the view that government intervention would be required to manage and finance natural monopolies and ensure the smooth operation of market forces. While not uncontested, these arguments were later refined by, among others, Peacock and Wiseman (1967), Musgrave (1969), and Bird (1971).

Figure 3 shows that, as predicted by Wagner’s law and a large, and more recent, body of empirical evidence, there is indeed a very strong association between GDP per capita and the size of government spending (relative to GDP).<sup>1</sup> Based on this framework, countries above (below) the fitted line are

> 1 Most of the recent empirical evidence regarding the existence of Wagner’s law is based on country-specific analyses as opposed to cross-sectional analyses (like the one shown in Figure 3). While, strictly speaking, a cross-sectional analysis is technically less accurate (as it does not control for other country determinants that may be constant over time), this more

4
<!-- Start of picture text --> 80 G/GDP = 121.5*** - 29.9*** x In(GDP pc) + 2.1*** x In(GDP pc)?<br>[3.2] [-3.4] [4.3]<br>70 R?= 0.61 Finland<br>[VAT rate 24%6]<br>Greece<br>60 [VAT rate 23%]<br>e<br>Argentina . a<br>[VAT rate 21%] e -<br>50 Barbados * 6<br>[VAT rate 17.5%] ° e <<br>a Jamaica e e<br>[G} [VAT rate 16.5%] . . e 8<br>—~ 40 Honduras ° eo e<br>i) [VAT rate 15%] e aae e<br>30 Co wee<br>e . & Oe e<br>eo ef ww © e @<br>20 e 8 0 ot eee . ee ”® . Australia<br>a ee aow . ceee ° [VAT(AT raterate 10%10%]<br>e e 3 . e e e<br>10 e e . ee ° e . New Zealand<br>Philippines Thailand [VAT rate 15%]<br>[VAT rate 12%] [VATGuatemalarate 12%] [VATCostaRicarate 13%] Ivar rate 7%]<br>0<br>400 1,100 3,000 8,100 22,000 60,000 160,000<br>GDP pc, PPP (constant 2011 international $)<br><!-- End of picture text -->
<!-- Start of picture text --> VAT rate = 16.2*** + 0.3*** x "Excess" spending<br>[43.9] [5.5]<br>30 R2=0.22<br>25 e e e<br>e e<br>eee<br>ee<br>20 ee e Ceo See)<br>& eo @ @ © com memes<br>. e ee 09.88<br>& eo 8 ee @ ee<br>> 15 e e © 00 206 eo 08 © (0 e<br>10 aan e e e @e ar)<br>ee<br>.%e<br>e<br>5e<br>0<br>-25 -20 -15 -10 -5 0 5 10 a5 20 25<br>"Excess" spending = G/GDP- predicted [G/GDP]<br><!-- End of picture text -->
This view about the importance of revenue mobilization in countries with low levels of provision of public goods and social and infrastructure gaps is, indeed, in line with the evidence presented in Figures 3 and 4 In a similar vein, and mainly due to the need to reduce the fiscal deficit, Costa Rica’s fiscal authorities sent to Congress in 2016 a draft law to increase the VAT rate by one percentage point in 2016 (i.e., from 13 to 14 percent) and another one in 2017 (from 14 to 15 percent).

# 3 Policy implications II: On revenue mobilization in commoditydependent countries

Since the fall in commodity prices in 2014, most commodity-rich countries (especially those whose fiscal revenue structure depends “excessively”upon commodity revenues) have been facing a growing fiscal challenge as the price fall has increasingly been perceived as more permanent than temporary in nature. Indeed, Figure 5 shows, for a sample of 55 countries for which commodity revenue data were available, that the share of commodity revenues (as percentage of total revenues) tracks very well that of commodity prices.<sup>3</sup> Since commodity prices are expected to remain low in the years to come, so will commodity revenues. This, in turn, shows the serious challenge faced by commodity-rich countries and particularly by those with high commodity revenue dependency.

Figure 6 shows the association between the economy’s dependency on commodities (proxied by the commodity GDP as a percentage of total GDP) and the commodity revenue dependency (proxied by commodity revenues as a percentage of total revenues). Not surprisingly, the fitted line shows that the higher is commodity GDP, the larger is the share of commodity revenues in total revenues.<sup>4</sup> For example, in a country like Kuwait, where oil production represents about 60 percent of total GDP, oil revenues constitute about 90 percent of total revenues. In contrast, in the Philippines, oil production represents less than 1 percent in both GDP and fiscal revenues. One can view countries above the fitted line as countries whose fiscal revenue structure depends “excessively”upon commodity revenues relative to a typical country with the same level of economic dependency. The opposite is true for countries below the fitted line. For example, while in Papua New Guinea commodity production represents about 32 percent of GDP and revenue dependency is about 34 percent, in Nigeria commodity

> 3 Commodity revenues include income from mining and/or hydrocarbons. The list of countries and commodity coverage comprises the following. For both mining and/or hydrocarbons commodities: Australia, Bolivia, Brazil, Canada, Colombia, DRC, Indonesia, Mauritania, Papua New Guinea, and Vietnam. For hydrocarbons commodities: Algeria, Angola, Azerbaijan, Bahrain, Brunei, Cameroon, Chad, Congo Republic, Ecuador, Equatorial Guinea, Iran, Iraq, Ivory Coast, Kazakhstan, Kuwait, Libya, Malaysia, Mexico, Myanmar, Namibia, Niger, Nigeria, Norway, Oman, Philippines, Qatar, Russia, Saudi Arabia, Sudan, Syria, Timor-Leste, Trinidad and Tobago, United Arab Emirates, United Kingdom, Uzbekistan, Venezuela, and Yemen. For mining commodities: Botswana, Chile, Ghana, Guinea, Guyana, Kyrgyz Republic, Lesotho, Mongolia, Peru, Sierra Leone, Tanzania, and Zambia.

> 4 Unlike Figure 3, Figure 6 suggests that a non-linear estimation would not increase the predictive power relative to the linear estimation.

7
<!-- Start of picture text --> soo — — Price of minerals<br>— — Price of oil<br>— Commodity revenues (as % of total revenues) 7<br>so. 3<br>250 Fy<br>=$ov<br>2 oN\ 8o<br>== 200 1moeTS 4 =5S<br>°— ~~, ou N xo<br>E a ‘ &<br>8 iso 4 / Nua 8<br>S , \7 3<br>9 fi Vy \ 4 6<br>< le Vv Sole ee — Fa<br>2 7 2<br>100 Sf fin ~_--7 3s><br>af - °<br>4 —<br>~ “oe 35 =<br>a ~.VWe%rd e3<br>0 30<br>eranmzseuerReeaexuxams§sRS 8FR RRRRRRRRRRRKRRKKRKKRKRR8S SS S8SsSBSSERESESESESE4» oRSESE REASESBS<br>Commodity rev. (as % of total rev.) = 6.8* + 1.6*** x Commodity GDP (as % of GDP)<br>[1.9] [12.2]<br>R? = 0.74<br>a<br>7 Nigeria Bahrain Brunei Iraq<br>5 [VAT rate 5%] [No VAT rate] [VAT rate 0%] [VAT rate 0%]<br>>a a<br>Ss ° * * ° ee °<br>x Yemen . we<br>2 80 [vat rate 5%] ; . we .<br>o<br>35 ee? a<br>g 60 Malaysia; Ecuador ° —a<br>a [VAT rate 6%] [VAT rate 12%] em”<br>= we Republic of Congo<br>z ws [VAT rate 18%]<br>3 40 e ° we Azerbaijan<br>z e . ro . [VAT rate 18%]<br>= e we e<br>8 ° oawe . eg Equatorial[VAT rate Guinea15%]<br>20 See<br>wn Be o*<br>oe e ¢ \ Chile Papua New Guinea Trinidad and Tobago<br>0 @,TM#_¢ e © [VAT rate 19%] [VAT rate 10%] [VAT rate 12.5%]<br>0 10 20 30 40 50 60 70 80<br>Commodity GDP (as % of GDP)<br><!-- End of picture text -->
<!-- Start of picture text --> VAT rate = 11.9*** - 0.2*** x "Excess" commodity rev. dependency<br>[1.9] [12.2]<br>R? =0.28<br>25 e<br>2. * .. - oo<br><x e ‘ee... e<br>10 e e oo ee,<br>ty) ° a °<br>-40 -30 -20 -10 0 10 20 30 40 50<br>"Excess" commodity rev. dependency =<br>Commodity rev. (as % of total rev.) - predicted [ Commodity rev. (as % of total rev.) ]<br><!-- End of picture text -->
proposals ranging from 7.5 to 10 percent. This view about the importance of revenue mobilization in countries whose fiscal revenue structure depends “excessively” on commodities is in line with the evidence presented in Figures 6 and 7. Indeed, several commodity-dependent economies including Nigeria, Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates (with no VAT or GST taxes) are planning to increase/implement a VAT rate.

# 4 Policy implications III: Debt sustainability analysis (DSA)

This section explores some practical implications of the non-linear effect of tax changes on output for DSA. The most basic equation that characterizes the evolution of public debt dynamics at a horizon h in DSA is given by<sup>5</sup> where d, r, and g denote public debt, revenue, and primary spending, respectively, expressed as a percentage of GDP, and ρ is the real interest rate paid on public debt, typically assumed to be constant. Notice that θ, the growth rate of output, is assumed to be exogenous. While θ is sometimes allowed to change over time (to take into account the debt implications of different growth paths), such a path is set exogenously and does not capture the endogenous response to, for example, a change in tax policy.

Given our findings regarding the non-linear response of output to tax changes, equation (1) should, ideally, internalize the endogenous response of output. Naturally, the same would be true of any other fiscal shock such as, for example, an increase or decrease in government spending. While the DSA could, in principle, also endogenize the response to any other type of shock, these endogeneity considerations seem more obvious when dealing with variables that enter directly equation (1). To analyze the effects of tax rate changes on output in the context of the DSA, we will rely on a simple, back-of-the-envelope type of analysis that enriches equation (1) by including the effect of tax changes not only on revenue collection (i.e., r), but also on output growth (i.e., θ).

To characterize the effect of changes in tax rates in a simple way, we assume that where R and Y are revenues and output, respectively. Moreover, we will assume that the growth rate

> 5 This basic approach does not take into account the currency of denomination of debt (e.g., Diaz-Alvarado, Izquierdo, and Panizza, 2004) or the uncertainty of the debt-to-GDP ratio by exploiting the variance and covariance among debt determinants (e.g., Arizala, Castro, Cavallo, and Powell, 2008).

10
at horizon h depends on the change in tax rate at h = 0. Specifically, where θ is an exogenous source of change in growth and the second term on the right-hand side of (3) captures the effect on economic growth at horizon h of the change in the tax rate h periods before. For example, when evaluating θt+h at h = 0, one would be endogenizing the impact effect of a tax change on economic growth.

We will now resort to equations (1)-(3) and use a set of initial conditions for the variables involved to evaluate the effect of alternative approaches to DSA. Specifically, we will assume an initial stock of public debt of 50 percent of GDP, an exogenous growth rate of 2 percent (i.e., θ = 0.02), a real interest rate of 3 percent, and a primary deficit of 2 percent. When evaluating the effects of tax changes on growth and debt-to-GDP ratio, we will focus on the effects, after 2 years, of an increase in the VAT rate of 1.5 percentage points (as in Figure 2).

Based on equation (1), Figure 8 shows, as a benchmark, that if there were no change in the VAT rate, the debt-to-GDP ratio would increase by 5 percentage points (i.e., from 50 to 55 percent) after 2 years. Naturally, in this first benchmark scenario, there would be no change in output. In the second scenario, we evaluate the effects of a 1.5-percentage-point tax hike on the debt-to-GDP ratio, without considering its effect on economic activity (the typical assumption in DSA). Given equation (2), this would imply an increase in revenues (expressed as a percentage of GDP) of 1.5 percent and, as a result, a reduction of 1.5 percent in the 2 percent primary deficit (i.e., the new post-tax hike primary deficit equals 0.5 percent). Such a reduction in the primary fiscal deficit lowers the increase in debt/GDP by 3 percentage points. In other words, the debt-to-GDP ratio increases from 50 to 52 percent (under the tax hike scenario) compared to 55 percent (under the no tax change scenario).

In the third scenario, economic activity is allowed to be affected by the tax hike in a linear way (i.e., according to conventional linear estimation strategies). Based on Gunter et al ’s (2018) estimations, output falls by a total of 0.9 percent after 2 years. This fall in economic activity increases the debtto-GDP ratio which, in turn, partially offsets the positive effect on debt reduction of the fall in the primary fiscal deficit. Specifically, as indicated in Figure 8, the debt-to-GDP ratio increases by 2.4 percentage points in this case, compared to 2.0 in Scenario 2. But this begs the question: is this the proper way of endogenizing the role of tax changes on output in the DSA, given the non-linear effect of tax changes on output? Certainly not. To illustrate this, scenario 4 in Figure 8 compares two cases depending on the initial VAT rate: (i) the initial VAT rate is set at a low level (12 percent) and (ii) the initial VAT rate is set at a high level (24 percent). The difference between the two cases is 11
<!-- Start of picture text --> 10 No change Increase in VAT of 1.5 percentage points<br>in VAT (1)<br>8 No output Linear output Non-linear output effect (4)<br>effect (2) effect (3)<br>—1__ ee<br>Initial VAT Initial VAT<br>6 rate of 12% rate of 24%<br>©,< 5.0 —— ee<br>o<br>s<br>ze #4 3.4<br>2<br>90o 2.0 24 2.0<br>=o<br>Co2o<br>pi 0| L —<br>-0.9<br>-2<br>-2.8<br>-4<br>m@ Change in debt to GDP ratio lm Endogenous change in output<br><!-- End of picture text -->
<!-- Start of picture text --> _a] 2<br>& 15<br>fe<br>Q<br>% 1<br>£<br>5 08 VAT rate of 32%<br>a oO@ 0 4<br>i) Q<br>oT Wwa -0.5<br>2%<br>Se 1<br>2s<br>dic -1.5<br>3a -2<br>cD)<br>SG<br>2 25<br>Cc<br>o -3<br>~~5S} 35<br>0 5 10 15 20 25 30 35 40 45 50<br>InitialVAT rate<br><!-- End of picture text -->
For suffi ciently low initial levels of the VAT rate, the increase in revenues (as a percentage of GDP) is around 1.5 percentage points (reflecting the fact that the tax base does not respond much). In contrast, the increase in revenues falls with higher initial levels of the VAT rate. In fact, for VAT rates higher than 32 percent, an increase in the VAT rate would actually decrease revenues as the response of the tax base more than offsets the direct effect of the tax rate change.

Figure 9 also shows the number of countries that, as of November 2017, have different VAT rates as well as their implied location in the estimated relationship. For a total of 172 countries with VAT taxation, the size of the dots reflects the number of countries having different current VAT rates. Small-sized dots indicate VAT rates present in 1 to 6 countries, medium-sized dots indicate VAT rates present in 7 to 11 countries, and large-sized dots indicate VAT rates present in 18 to 24 countries. The median and average VAT rate, 16 percent, is far from the VAT rate of 32 percent. While the minimum VAT rate is 5 percent, the maximum VAT rate is 27 percent (for only one country). In other words, no country in the world has a VAT rate above 32 percent, indicating that no country could reduce the VAT rate and still increase the corresponding revenue collection. In sum, while the Laffer curve is theoretically plausible in our framework, in practice no country is on the “wrong”side of the curve.

This evidence suggests that countries like, for example, Nigeria, with “excessive” dependency on commodity fiscal revenues could quickly mobilize revenues from non-commodity related activities by increasing their VAT rates with relatively little effect on economic activity.

# 6 Concluding remarks

Based on our paper titled “Non-linear effects of tax changes on output: The role of the initial level of taxation,” this companion paper discusses some relevant policy implications. We first focused on the relevance of our arguments for revenue mobilization in countries with low levels of provision of public goods and social and infrastructure gaps (measured as deviations from the predicted value based on Wagner’s law). Since such countries have typically low initial tax rates, we concluded that they could increase the VAT rate, and thus tax collection, at little or no cost and thus raise productive government spending.

We then focused on commodity-dependent countries and showed that countries with “excessive”dependency on commodity revenues tend to have a relative low VAT rate or none at all. Hence, as in the previous case, these countries could increase the VAT tax rate at little or no cost and thus reduce their dependency on commodity revenues. Thirdly, we explored some practical implications of our empirical findings for debt sustainability analysis. In particular, we showed that, when initial VAT 14