Informal Economy and Governance Quality Impact on Tax Revenue in African Countries

The study uses an empirical panel dataset from 43 African countries from 1996 to 2018 to investigate how taxation is affected by the extent of the informal economy and the quality of governance. The dependent variables of the model for the relationship between size of informal economy, governance quality and taxation is the tax to GDP ratio for countries in the sample. Governance indicator in this research is composite from the six governance indicators(WWGI), including voice and accountability, political stability and absence of violence, rule of law, regulatory quality, government effectiveness and corruption control, generated by using Principal Component Analysis (PCA). Quantile Regression is the primary estimation method employed, supplemented by the General Least Square Model. Quantile regressions are estimated at 10, 25, 50, 75, and 90% by applying the simultaneous quantile estimation techniques. This approach is chosen because it is believed that the influence of the size of the informal economy and governance quality varies depending on the current level of taxation. Countries with low, middle, and high taxation levels should have diverse approaches to effective economic formalization, governance, and taxation. The following are the main conclusions: First, while the scale of the informal economy has a negative impact on tax revenue mobilization, improvements in governance institutions lead to higher taxes. Second, in the upper quantiles of the taxation distributions, the effects of both the informal economy’s size and the quality of governance are typically more noticeable. Third, direct taxes are affected more than indirect taxes due to the extent of the informal economy and the quality of government. The outcomes hold up well when compared to other econometric estimate methods.