Value added tax, ethnic fragmentation and income inequality in sub-Saharan Africa

Abstract

Background: The persistent and high levels of inequality in sub-Saharan Africa (SSA) pose significant challenges to achieving Sustainable Development Goal (SDG) 10, which aims to reduce inequality.Aim: This study examines the combined effect of effective VAT (calculated as total VAT revenues divided by final consumption, reflecting the economic incidence of the tax) and ethnic fragmentation on income inequality in SSA.Setting: The analysis covers 35 SSA countries from 1995 to 2021, based on Kripfganz and Schwarz’s (2019) dynamic panel estimator of time-invariant effects.Method: This study utilises the system generalised method of moments (SGMM) estimation to achieve its objective. The analysis covers 35 SSA countries from 1995 to 2021, based on Kripfganz and Schwarz’s (2019) dynamic panel estimator of time-invariant effects.Results: The findings indicate that effective VAT increases income disparity in both the short and long-run, with the long-run effect being more pronounced. Additionally, the findings suggest that ethnic-fragmentation amplifies the positive impact of effective VAT on income inequality over both time horizons, with a stronger effect in the long run. This suggests that ethnic-fragmentation hinders the ability of effective VAT to lower income disparity in SSA.Conclusion: This study suggests that prioritizing policies to strengthen the tax system and enhance social cohesion should be a focus in Sub-Saharan Africa (SSA).Contribution: This study adds significant value to the literature by demonstrating the role of effective VAT on the relationship between ethnic fragmentation and income inequality in SSA. To solve the endogeneity issues, this study uses SGMM, incorporating forward orthogonal deviations, which distinguishes it from the traditional SGMM approach that does not account for these deviations (Roodman 2009a).