Taxation and Income Inequality in Developing Countries: An Empirical Investigation

This paper studies the relationship between taxation and income inequality in 46 Developing countries. The research takes an empirical approach to analyze the effects of taxes revenue, taxes on goods and services, taxes on income, profits, and capital gains and taxes on international trade on income inequality. Mobilizing a dynamic panel data over the period 2000-2012 and using the system GMM estimator to address endogeneity issues, the econometric results yield that (i) there is a negative and robust relationship between taxes revenue and income inequality (ii) there is a positive and robust relationship between taxes on goods and services and taxes on income, profits, and capital gains and income inequality (iii) there is a positive relationship between taxes on international trade and income inequality. To allow the marginal effect of one explanatory variable to depend upon the level of another explanatory variable, the study further incorporates interaction terms of taxes and governance variables in the model and analyses there effect on income inequality.