Foreign direct investments, tax revenue, and economic growth in Sub-Saharan Africa: does maximum tax apply?

Abstract

Existing literature on economic growth often investigates the effects of foreign direct investments (FDIs) on economic growth while giving little significance to domestic resource mobilization in the form of taxes as a player in economic growth. This study contributes to literature in two unique ways: first, investigating the effects of FDIs and tax revenue on economic growth. Second, it examines the threshold of taxes that enhance economic growth. By using a fixed effect model, the study found that foreign direct investments significantly influence economic growth but tax revenue as a share of GDP does not. However, using dynamic threshold model, we found that tax revenue has an insignificant effect on economic growth because the average tax rate of the sampled countries falls below a level of taxes significant enough to stimulate economic growth. Again, the model indicates that below 15% of tax rate, economic growth is positively influenced by tax revenue but beyond this threshold, taxes become detrimental to economic growth. As a robustness check, the 43 sampled countries were grouped into central African countries (CA), eastern African countries (EA), northern African countries (NA), southern African countries (SA), and western African countries (WA). Given the findings, it is recommended that developing countries in Africa not only rely on foreign direct investments but also strengthen their tax systems which will then serve as a complement to FDIs in the economic growth of the country.