Tax burden and economic growth in Lesotho: An estimate of the optimal tax burden

Abstract

Lesotho faces fiscal deficits due to high government expenditure as characterized by the huge wage bill regarded as one of the highest in the world (UNICEF, 2018). The aim of this research paper is to investigate the tax revenue impact as a share of Gross Domestic Product (GDP) on economic growth in Lesotho. This research is provoked by the theoretical postulations and empirical evidence that their relationship is positive up to a certain optimal level which is the point at which economic growth rate is maximized. The study used data from 1988 to 2017 to investigate the relationship between tax burden and economic growth in Lesotho by applying the log-linearized model of Scully’s tax optimization model transformed into an ARDL bounds testing framework. Granger causality test and error correction model was employed to investigate the long run relationship between tax burden and economic growth in Lesotho. The findings of study revealed a long-run relationship between economic growth rate and tax burden with a unidirectional causality running from economic growth to tax burden. Granger causality revealed no causal effect running from tax burden to economic growth in Lesotho despite expectation of significant causal effect following both theoretical and empirical literature from various studies. Error correction results further supported a co-integrating relationship running from economic growth to tax burden with 100 percent speed of adjustment in the short-run towards a long-run equilibrium level. An optimal tax burden could not be established as the variables of interest were negative and insignificant signifying the insignificance of tax policy in stimulating the economic performance.