Causal Relationship between Government Revenue Growth and Economic Growth in Ethiopia

Abstract

The main aim of this study is to demystify the mystery surrounding the belief that, high government revenue growth rates engineered through the government multiplier process. The relationship between government revenue growth and economic growth is investigated for Ethiopia during the period 1974/75-2013/14. Theoretically and empirically it has been shown that revenue especially generated from taxes affect the allocation of resources and often distort economic growth. While, analyzing the long run and short run relationship between government revenue growth and economic growth the study applied Johansen’s cointegration test, VAR, granger causality test, and VECM. Government revenue growth in general and with its component though affect economic growth found to have no causal relationship with economic growth in the long run. This implies there is fiscal independence between tax revenue and economic growth. Furthermore, in the short run the finding showed that there is independence relationship and the speed of adjustment is slow; only 27% and 7% for the components and total revenue growth with economic growth models, respectively. However, compared with post tax reform periods the latter has high speed of adjustment; meaning the speed of disturbances corrected each year in the short run become fast. Based on the findings the study highlighted some major issues that policymakers should consider for effective taxation policy formulation and implementation in line with the dynamic nature of the Ethiopian economy.

Keywords: Economic Growth, Total revenue growth, Causality.