The Impact of Trade Openness on Economic Activity and Tax Revenue in Developing Countries: Panel Evidence from the MENA Region

Abstract

This paper examines the effect of trade openness on corporate tax revenue in the Middle East and North Africa (MENA) region, where increased economic integration might incite more business activity and expand taxable corporate income but also intensify losses due to practices such as profit shifting. The study follows a quantitative empirical approach and applies a panel ARDL model to secondary data collected from international databases (World Bank and IMF), such as GDP, trade openness (exports and imports as % of GDP), inflation, corporate tax revenues, foreign direct investment inflows and tax evasion via informal economies, for a sample of ten developing countries from the MENA region, including Morocco, Tunisia, Egypt, Jordan, Lebanon, Algeria, Saudi Arabia, Oman, the United Arab Emirates, and Bahrain, over the period 2010–2023. We employ a PMG ARDL model to study our panel data, allowing the analysis of both short-run and long-run effects to investigate the relationship between trade openness and tax revenues. Our results show that in the long run, export-driven economies generate higher corporate tax revenues by expanding profitability and the tax base, and imports also positively affect revenues, indicating that trade openness stimulates economic activity. Conversely, FDI inflows reduce corporate tax revenues, consistent with profit shifting and tax incentives in developing countries. GDP growth does not necessarily increase tax receipts, likely due to tax elasticity effects and growth-oriented tax structures. Also, tax evasion appears to decline, likely reflecting improved compliance, and no significant short-run effects are observed. The results contribute to the literature on tax compliance and economic integration in the case of open economies in developing countries. From a practical perspective, our findings have implications for policymakers and tax regulators in the MENA region, as they highlight the dual nature of globalization for developing countries and their tax systems and underscore the need for effective compliance measures in trade and investment policies.