Effect of import and income tax dependence on economic growth in Uganda

Abstract

The Government of Uganda implemented tax reforms in the 1990s that resulted in a modest increase in revenue from 7 % of GDP in 1991 to around 26 % in 2005. Uganda faces the problem of raising revenues for ever growing public expenditure needs. This task is affected by the reliance on a very narrow tax base. Uganda has in the past relied heavily more on import duties than income taxes although this is slowly changing. Empirical evidence shows that countries that rely on international trade taxes do not perform as well as those countries that rely on taxing incomes and profits. Import tariffs may bring in badly needed revenue in the medium term but heavy reliance on them can create imbalances and distortions in the economic choices and ultimately reduce welfare. With the reduction in the rates of import duties there needs to be an alternative source of revenue to generate income to meet public expenditure needs and reduce on the budget deficit.

In otherwords, this study has tried to establish the factors that affect the degree of reliance on import taxes. In addition, the study examines the factors affecting the share of income tax in total revenue. This study goes further to establish the importance of income taxes versus import taxes in the economic growth of a developing country such as Uganda and tries to answer the following question which of the two tax types is more useful to the economy relative to the other? That is which of the two tax types should government rely on most? Therefore, this study determines the factors that affect the share of import and income taxes in total revenue for Uganda. In addition, the study compares the impact of the share of import and income taxes on the economy. Import tax share is affected by foreign debt obligations and Tax reform in the form of VAT which are found to be significant. This shows that government is relies on import tariffs to meet its debt obligations. However, tax reform episodes result in reduction of the import tax share. Evidence of this is provided by the introduction of VAT which has led to a reduction in import tax share in total revenue. Income tax share is positively affected by government foreign debt payments, level of manufacturing (growth informal sector employment) and negatively by growth of agricultural sector (informal sector growth).

The effect of import tax share in total revenue and income tax share in total revenue on economic growth has been found to be positive and significant in both cases. However the impact of increasing the share of income tax is larger than that of increasing import tax share. The results provide support for the hypothesis that the effect of income tax shares on GDP is greater than that of import tax share. In conclusion increasing reliance on income taxes share is more beneficial to economic growth than reliance on import taxes. However, increased reliance on income taxes will require improvements in the efficiency of the administrative capabilities of the tax collection authority that is URA in order to make significant improvements in the amount of income tax collected.