Corruption and Tax Burden: What Is the Joint Effect on Total Factor Productivity?
Round 1
Reviewer 1 Report
Referee Report for the paper Corruption, Tax Burden and Total Factor Productivity
This paper studies the effects of corruption and tax burden on total factor productivity. The authors use panel data from 90 countries for the time span of 1996-2014. I find this time range to have the minimum time series dimension to proceed with the research. The Authors should consider updating the dataset or consider using World Bank Control of Corruption data which is time comparable as opposed to TI data.
The results show that both corruption and tax burden deteriorate TFP, but that an increase in tax burden mitigates the negative effect of corruption. The language of the article is also clear and precise. However, upon careful reading – I find some room for improvement.
In general, my argument boils down to the recommendation that the Author should provide a much better motivation and explanation for carrying out the research. Having three interesting variables is not enough if there is not a well-argumented storyline behind it all. Most importantly, thereby, the article suffers from a bit obscure description of a mechanism that relates these variables of interest.
The literature review feels very disjoint and in general, it applies to GDP growth only. Therefore, it lacks applicability to the TFP investigation, since the Authors focus on the latter in their research. The authors claim that corruption hampers economic development, but the view on its specific channels is less clear. For example, Cieślik and Goczek (2018) and Grundler and Potrafke (2019) do a good job in explaining specific channels (please include in the literature review). For instance, Cieślik, Goczek (2018) argue that bribes, unlike taxes, involve unpredictable distortion in the discretionary and uncertain use of the government power that is higher than the values of bribes themselves. This provides costs to businesses and alongside resources allocated to directly unproductive activities (such as military spending, also investigated in this paper) impose an extra burden on the economy.
In addition, no discussion of control hypotheses is present, until the results are shown. From the methodological point of view, the hypotheses should first be theoretically backed up and only then tested.
In contrast, the author does a great job of discussing the results and compares them to the literature very efficiently. I appreciate this very much. However, the literature review has not given the correct ground to assess these results. The general link between tax burden, corruption, and TFP is only explained in the final section. This is definitely too late to call. The spin-off hypothesis saying that variations in the tax burden affect the negative impact of corruption is not explained at all. It is not obvious to me that the spin of the hypothesis is a valid assumption so this definitely should be developed more extensively in the literature part since it is the cornerstone of the analysis.
I find the econometric investigation to be correct (other than the sample being dated). However, the author concentrates too much on spilling out all of the uninteresting side-tests results on a one by one basis. This is difficult to read, I would expect any research to go through such tests as the author did, but I would cut down reporting to a necessary minimum. In contrast, it would be much better to provide more explanation as to the interpretation of the results for the main argument to hold. Right now the article is not easy to follow for someone who has not done this kind of research on their own and as far as I know, the journal applies to the general reader. Also, the title of the paper is as uninteresting as it gets and should be changed.
Refs
Andrzej Cieślik, Łukasz Goczek, Control of corruption, international investment, and economic growth – Evidence from panel data, World Development, Volume 103, 2018, Pages 323-335, ISSN 0305-750X,
https://0-doi-org.brum.beds.ac.uk/10.1016/j.worlddev.2017.10.028.
Klaus Gründler, Niklas Potrafke, Corruption and economic growth: New empirical evidence, European Journal of Political Economy, Volume 60, 2019, 101810, ISSN 0176-2680, https://0-doi-org.brum.beds.ac.uk/10.1016/j.ejpoleco.2019.08.001
Author Response
Dear Reviewer
We are thankful of your invaluable comments and respond as follows:
Comment: "I find this time range to have the minimum time series dimension to proceed with the research. The Authors should consider updating the dataset or consider using World Bank Control of Corruption data which is time comparable as opposed to TI data."
Response: We have discussed the limits of the study on rows 413-417: As usual, there are some caveats in the study. First, the time span 1996-2014 is quite short as a time series dimension. Second, the Corruption Perceptions Index provided by Transparency International is truly comparable over time only from 2012. Use of other measures of corruption like the World Bank Control of Corruption data might solve both issues. We leave that to future studies.
Comment: "Author should provide a much better motivation and explanation for carrying out the research. Having three interesting variables is not enough if there is not a well-argumented storyline behind it all. Most importantly, thereby, the article suffers from a bit obscure description of a mechanism that relates these variables of interest."
Response: We have rewritten the paper from Introduction to Conclusions to improve the argumentation. The storyline is condensed in the beginning of the Abstract on rows 4-7: A common consent in the literature is that both corruption and taxation hamper economic growth. It is also plausible that both affect total factor productivity which, by the famous Solow residual, is a vital driver of economic progress. Moreover, corruption and tax burden are supposed to be intertwined. This paper focuses on the proposedly linked effects of corruption and tax burden on total factor productivity. In Introduction, the negative correlation of corruption and taxation with TFP is then reasoned with appropriate references on rows 72-88, and the link between corruption and tax burden is speculated on rows 89-115. The reinforced storyline is held up throughout the text.
Comment: "The literature review feels very disjoint and in general, it applies to GDP growth only. Therefore, it lacks applicability to the TFP investigation, since the Authors focus on the latter in their research."
Response: The main idea concerning the connection between growth and TFP (including the link through 'social infrastructure') is documented on rows 53-79, and we have added a sentence on row 79: So, it is reasonable that variables that affect growth should affect also TFP.
Comment: "The authors claim that corruption hampers economic development, but the view on its specific channels is less clear. For example, Cieślik and Goczek (2018) and Grundler and Potrafke (2019) do a good job in explaining specific channels (please include in the literature review)."
Response: We have deleted the claim about unclarity and write on rows 27-28: The evidence about the specific channels of the effects of corruption on economic progress is substantial but somewhat mixed (Cieślik and Goczek, 2018). Moreover, we write on rows 104-105: Cieślik and Goczek (2018) argues that bribery, unlike taxation, causes unpredictable distortions in governance; and on rows 140-143: We are aware of the fact that the CPI values are comparable in time only from 2012 on (Fisman and Golden, 2017; Gründler and Potrafke, 2019). The respective references are on rows 451-452 and 473-474.
Comment: "In addition, no discussion of control hypotheses is present, until the results are shown. From the methodological point of view, the hypotheses should first be theoretically backed up and only then tested."
Response: We have added the list and discussion of the controls on rows 152-163 after the presentation of the main variables and way before the tests.
Comment: "The general link between tax burden, corruption, and TFP is only explained in the final section. This is definitely too late to call."
Response: In Introduction, we have added the following paragraph on rows 116-121: Our panel analysis shows that tax burden and corruption are positively correlated, but a high tax burden makes corruption less harmful. In a worldwide context, hard taxation is usually attached to developed countries with established institutions, effective social and technical infrastructures, and a small black market. On the other hand, in developing and poor countries, one may find high taxes but also distorted allocation of resources, messy institutions, scrappy infrastructures and a flourishing shadow economy.
Comment: "The spin-off hypothesis saying that variations in the tax burden affect the negative impact of corruption is not explained at all. It is not obvious to me that the spin of the hypothesis is a valid assumption so this definitely should be developed more extensively in the literature part since it is the cornerstone of the analysis."
Response: In Introduction, we have added more reasoning of the spin-off hypothesis on rows 104-105: Cieślik and Goczek (2018) argues that bribery, unlike taxation, causes unpredictable distortions in governance; rows 111-115: Moreover, Wu and Schneider (2019) postulates a U-shape evolution of the informal sector against economic growth: "First, the informal sector tends to decrease but may even start to revive at some level of development." This suggests that the informal sector can generate some positive effects on the formal sector.
Comment: "However, the author concentrates too much on spilling out all of the uninteresting side-tests results on a one by one basis...I would cut down reporting to a necessary minimum."
Response: All side tests are now presented with less detail.
Comment: "In contrast, it would be much better to provide more explanation as to the interpretation of the results for the main argument to hold."
Response: We have added explanations to the results concerning the main argument on rows 370-377: The summary aligns with Olson, Sarna and Swamy (2000) which reports that corruption tends to hinder productivity growth. In fact, the results are not too far from Méon and Weill (2010) which suggests that corruption can improve efficiency: Reading the effect of the interaction term the other way round says that an increase in corruption mitigates the negative effect of tax burden on total factor productivity. Broadly interpreted, this matches also with the argument by Wu and Schneider (2019) about positive impacts from the informal sector to the formal sector.
Comment: "Right now the article is not easy to follow for someone who has not done this kind of research on their own and as far as I know, the journal applies to the general reader."
Response: We have done our best to improve readability throughout.
Comment: "Also, the title of the paper is as uninteresting as it gets and should be changed."
Response: We have changed the title to "Corruption and Tax Burden: What is the Joint Effect on Total Factor Productivity?"
Reviewer 2 Report
Although the subject has been researched for so long, this paper manages to make a considerable contribution and investigates the implications of corruption and tax burden over economic development (through total factor productivity). The paper is well structured and innovative. The research hypothesis is well formulated according to the paper research question. Literature review is also actual and is considering some valuable experiences in order to better sustain the arguments of the research and conclusions drawn at the end of the paper. Although, the author/s could bring in the research more details about the positive effects generated by informal economy on formal economy, as can be found in Friedrich Schneider's papers. The aim of the paper and the methodology are clearly defined. Both quantitative and qualitative methods are well explained. The study is complete, it takes into analyses an appropriate number of countries and a convenient number of years. The interpretations and conclusions are justified by the results and are useful for both theory and practice. I believe that it would be interesting to show the limits of the analysis. It will also bring a major plus to the research, if the authors, using already obtained quantitative results, will give more arguments to sustain the conclusion: "an increase in tax burden mitigates the negative effects of corruption" and make the difference between short run and long run analyses. Another plus it will be to give some recommendations in terms of a common strategy to fight corruption.
Author Response
Dear Reviewer
Thank you very much for your valuable and supportive comments. We have responded to them as follows:
Comment: "Although, the author/s could bring in the research more details about the positive effects generated by informal economy on formal economy, as can be found in Friedrich Schneider's papers."
Response: We have referred to Friedrich Schneider's important ideas on rows 111-115: Moreover, Wu and Schneider (2019) postulates a U-shape evolution of the informal sector against economic growth: First, the informal sector tends to decrease but may even start to revive at some level of development. This suggests that the informal sector can generate some positive effects on the formal sector; rows 193-195: Another explanation is that, after some stage of economic development, the informal sector starts to generate positive effects on the formal sector (Wu and Schneider, 2019); on rows 375-377: Broadly interpreted, this matches also with the argument by Wu and Schneider (2019) about positive impacts from the informal sector to the formal sector. The reference is added on rows 528-529.
Comment: "I believe that it would be interesting to show the limits of the analysis."
Response: We have discussed the limits of the study on rows 413-417: As usual, there are some caveats in the study. First, the time span 1996-2014 is quite short as a time series dimension. Second, the Corruption Perceptions Index provided by Transparency International is truly comparable over time only from 2012. Use of other measures of corruption like the World Bank Control of Corruption data might solve both issues. We leave that to future studies.
Comment: "It will also bring a major plus to the research, if the authors, using already obtained quantitative results, will give more arguments to sustain the conclusion: "an increase in tax burden mitigates the negative effects of corruption" and make the difference between short run and long run analyses."
Response: Concerning the conclusion, we have added argumentation with suitable references on rows 370-377: The summary aligns with Olson, Sarna and Swamy (2000) which reports that corruption tends to hinder productivity growth. In fact, the results are not too far from Méon and Weill (2010) which suggests that corruption can improve efficiency: Reading the effect of the interaction term the other way round says that an increase in corruption mitigates the negative effect of tax burden on total factor productivity. Broadly interpreted, this matches also with the argument by Wu and Schneider (2019) about positive impacts from the informal sector to the formal sector. The short vs. long run question is tackled on rows 397-398: The paper yielded short-term results, but they have also some long-term implications.
Comment: "Another plus it will be to give some recommendations in terms of a common strategy to fight corruption."
Response: We have added common strategy recommendations on rows 407-412: In terms of global strategies in the fight against corruption, the findings of the paper suggest that upgrading the efficiency of the formal sector in developing countries, including both their economy and governance, is possibly the best way to tackle corruption. Defeating corruption as such is an endless mole-whacking game unless more profound reforms are made. Practical experience tells that interventions by international organizations are most successful in this respect.
