The effect of institutional quality on tax structure in East African countries

Abstract

This study investigated the effect of institutional quality on tax structure in East African countries. Using macroeconomic data spanning 26 years (1996–2021), the study employed the Panel Autoregressive Distributed Lag (ARDL) model to analyze how factors such as political stability, control of corruption, government effectiveness, and accountability influence tax structure in the region. Data was sourced from the Worldwide Development Indicators (WDI 2021), Government Revenue Datasets, and the Worldwide Governance Indicators (WGI 2022). The findings revealed that, in the long run, government effectiveness positively and significantly influences the ratio of direct to indirect taxes at a 10% significance level, suggesting that efficient governance supports the design and implementation of tax structure that favor direct taxes over indirect ones, promoting equity. Control of corruption also has a positive and significant effect at 10% significance level, indicating that reducing corruption enhances the fairness and potentially encouraging greater reliance on direct taxes. Political stability shows a strong positive effect at 1% significance level emphasizing its importance in creating a stable environment that enables effective administration and a progressive tax structure. However, in the short run, control of corruption and government effectiveness have a statistically significant negative effect on the ratio of direct to indirect taxes. This suggests that initial efforts to combat corruption and improve governance may disrupt existing tax systems, leading to a temporary reliance on indirect taxes or challenges in increasing the share of direct taxes. Over time, these reforms are expected to stabilize and improve tax performance. The study recommends that East African governments enhance government effectiveness and control corruption to achieve a better balance between direct and indirect taxes. This includes designing more progressive tax structure that emphasize direct taxes while reducing reliance on regressive indirect taxes, which disproportionately burden low-income households. Key measures include enhancing transparency, adopting digital tools to minimize human intervention in tax administration, building capacity among tax officials, and ensuring transparent use of tax revenues. These actions will boost revenue collection, foster public trust, encourage compliance, and promote a tax structure that relies more on direct taxes for greater equity and fairness.