Research Article: Taxation and economic sophistication: Evidence from OECD countries

Date Published: March 20, 2019

Publisher: Public Library of Science

Author(s): Athanasios Lapatinas, Alexandra Kyriakou, Antonios Garas, Benjamin Glass.


Taxation policies can explain the differences in countries’ capacity to produce and export more sophisticated products. We develop a theoretical model considering elements from standard models of economic growth to highlight that a country’s productive structure is implied by the appropriate fiscal policy that is necessary for the development of sophisticated products. We show that economies that rely less on capital relative to labor taxation tend to produce more complex products, while countries that rely more heavily on capital relative to labor taxation produce simple products. These relationships remain robust across alternative econometric specifications. Furthermore, we demonstrate the differential effect of a country’s level of economic development on the nexus between the structure of taxation and economic sophistication. We show that the negative impact of capital taxes on economic sophistication becomes stronger for countries that are more developed.

Partial Text

The ability of a country to develop and grow depends on the transformation of its productive structure, as pointed out early on in the development economics literature [1–4]. On this topic, a series of recent works explain economic development and growth as a process of information development, i.e., a process of learning how to produce and export more complex products [5–8]. In other words, the development path of a country lies in its capacity to accumulate the ‘knowledge’ part of Robert Solow’s growth model, which is required to produce varied and more sophisticated goods [8–10]. However, answers to the questions of (a) why some countries are more developed than others, and (b) how a country can transform its productive structure are still elusive.

In this section we model the hypothesis to be tested building on a model similar to the one developed by Lapatinas and Litina [26], considering elements derived from standard models of fiscal policy and growth. To study the relationship between fiscal policy and product-sophistication, we first construct the measure of economic sophistication (EXPY) using the framework developed by Hausmann et al. [15]. This index captures the productivity level associated with a country’s export i.e. it is a proxy for the most productive set of products the country can produce at a given time. In order to calculate the EXPY index goods are ranked according to the income levels of the countries that export them. Products exported by prosperous countries are ranked higher than products exported by poor countries. The aggregation of these product-level calculations leads to the country-wide indexes of economic sophistication.

To calculate the measure of economic sophistication used in this work, we rely on the methodology described in Hausmann et al. [7]. In short, let us assume that we have trade information for l number of countries and k products. With this information we can fill an (l × k) exports matrix E, so that matrix element Eij will be equal to the monetary value country i gains by exporting product j. Of course, if country i does not export product j, then Eij = 0. From this matrix it is easy to calculate the ratio between the share of a given product in a country’s exports and the share of this product in the total global exports. This ratio is called the Revealed Comparative Advantage (RCA) [40], and is given by
where Xcp is the total value of product p exports by country c. As previously discussed by others [6, 24, 25], a country has a comparative advantage in a product (in other words, is a competitive exporter of a product) when RCAcp ≥ 1.

To study the effect of countries’ tax structures on the sophistication of their productive structures, we use dataset 1 (see Data section). The dataset includes 17 OECD countries and spans the period 1970-2001, for which there is information available on both effective/implicit taxation and economic complexity.

It is empirically established in the literature that the sophistication of the products exported by a particular country is related to the country’s pattern of diversification and economic growth. However, what structure of incentives might be most appropriate to enhance investment in the production of more sophisticated goods is still an open question. Here, we explore the effect of the interplay between economic and political factors on the process of government spending transfers from activities of lower productivity into activities of higher productivity.