CHAPTER TWO

2. LITERATURE REVIEW

This chapter reviews related past theoretical and empirical literature on the impact of tax revenue
on economic development. The review is structured in six sub sections. The first section presents
theoretical perspectives (definition of tax revenue and economic development), which is
followed by a review of objective of taxation as a second section, the third section states the
good principles of taxation, the fourth section displays the relationships between tax revenue and
economic development indicators, the fifth section reviews empirical studies both globally and
country level. Finally, the sixth section presents conceptual frame work, concluding remarks and
the research gap observed by the researcher.
2.1 Theoretical perspectives
Tax is a compulsory payment by citizens to the government without the anticipation of a straight
and corresponding benefit from the government for the payment made by the taxpayers. Tax
revenues include both direct taxes and indirect taxes. Direct taxes are personal income tax,
property tax and corporate profit tax while value-added tax (VAT) , customs fees, excise and
Tariffs, are examples of indirect taxes. Tax revenue is critical to the long-term viability of
economies all over the world. According to Kesner-kreb & Kuli (2010), taxation is the central
foundation of income for every government in both developed and developing countries to
finance public expenditure.

2.1.1 Definition of Tax revenue and Economic Developments

Tax revenue is defined as the revenues collected from taxes levied on goods and services,
payroll taxes, taxes on the ownership and transfer of property, and other taxes. Total tax revenue
as a percentage of GDP indicates the share of a country's output that is collected by the
government through taxes. It can be regarded as one measure of the degree to which the
government controls the economy's resources.

The significance of tax policy is important for governments for several reasons; to generate
revenue as taxation which is most important source of government revenue, to discourage
purchases of certain products and promote desirable behaviors, to change distribution of income
and wealth.
Tax policy is defined as all the sets and main instructions that determine the structures of a tax
system and make it possible to finance public spending and support economic activity while, tax
reform is the process of changing the existing tax system or the current situation to a new level of
tax system so that the tax system can serve the main objective of financing government
expenditure and meet other objective in short and long run economic policies both in developed
and developing countries (Delesa, 2014; Dessalegn, 2014; Cliche, 2012).
The Oxford Advanced Learner’s Dictionary defines tax as: “Money that has to be paid to the
government so that it can pay for public services”. People pay tax according to their income and
businesses pay tax according to their profits, tax is often paid on goods and services. Tax is
restricted to compulsory, unreturned payments to general government. Taxes are unrequited in
the sense that benefits provided by government to taxpayers are not normally in proportion to
their payments. Tax is defined as a financial charge or levy imposed upon an individual or legal
entity by a state, to support government expenditure or defined tax as a monetary charge imposed
by the government on persons, entities, transactions or properties to yield revenue and can be
collected without any direct benefits attached with (William, and Andrew, 2014).
Economic development can be broadly defined as the structural transformation of an economy
through the introduction of more mechanized and updated technology to enhance labor
productivity, employment, income, and the population’s standard of living. Various
measurements of economic development have emerged as a result of the ambiguity of specific
definitions of economic development, such as structural changes in GDP, per capita income, full
employment, normative values, improvement in human status, physical quality of life index,
human development index, poverty index, and sustainable development.
Economic development: is all about improving living standards. Improved living standards refer
to higher levels of education and literacy, workers’ income, health, and lifespans. It is the
process in which an economy grows or changes and becomes more advanced, especially when
both economic and social conditions are improved. Economic development is the processes in
which people in a country become wealthier, healthier, better educated, and have greater access
to good quality housing (Behrman, 2017).
Economic development is related to an increase in output coupled with improvement in the
social and political welfare of people within a country while Economic growth deals only with
an increase in the level of output. Economic development refers to “a policy intervention effort
targeted at the economic and social wellbeing of people. The focus of economic development is
on improvement in the quality of life of people, introduction of new goods and services using
modern technological, mitigation of risk and dynamics of innovation and entrepreneurship”
(Hadjimchael, Kemeny & Lanadan, 2014).
Economic development is defined as a sustained improvement in material wellbeing of society.
Economic development is a wider concept than economic growth. Apart from growth of national
income, it includes changes of social, cultural, political as well as economic which contribute to
material progress. It contains changes in resource supplies, in the rate of capital formation, in
size and composition of population, in technology, skills and efficiency, in institutional and
organizational set-up. These changes fulfill the wider objectives of ensuring more equitable
income distribution, greater employment and poverty alleviation.
Economic development: is a process in which a nation is being improved in the sector of the
economic, political, and social well-being of its people (Krueger &Myint, 2019). Economic
development is the process by which emerging economies become advanced economies.
Economic development also refers to the process by which the overall health, well-being, and
academic level of the general population improves. During the development, there is a
population shift from agriculture to industry, and then to services. A longer average life
expectancy, for example, is one of the results of economic development. Improved productivity,
higher literacy rates, and better public education, are also consequences (Sen, 2019).

2.2 Objective of taxation

The primary goal of taxation is to generate income to cover government expenditures as well as
to redistribute wealth and control economic activities (Jhingan, 2004). According to Anyanwu
1993 and Nzotta 2007, taxes play a role in allocation, distribution, and stabilization. The
allocation function of taxes consists of determining the pattern of production, the items that
should be produced, who produces them, the connection between the private and public sectors,
and the social balance between the two sectors (Ojong et al., 2016). However, in this research
will focus on the following arguments as the main objectives of taxation;
Rising of Revenue: The main objective of tax system is the raising of the revenue required to
meet the expenditure. This income required to preserve the provision of goods and services
which members of privet sectors cannot provide such as defense, law and order and
infrastructural facilities.
Full Employment: Since the level of employment depends on effective demand, it is believed
that, if a country is willing to achieve the goal of full employment it must cut down the rate of
taxes. Consequently, disposable income will rise and hence demand for goods and services will
rise. Increased demand will motivate investment leading to a rise in income and employment
through the multiplier mechanism.
Economic Development: Economic development of any country is largely conditioned by the
growth of capital formation. It is said that capital formation is the principal of economic
development. But LDCs usually suffer from the shortage of capital. To overcome the scarcity of
capital, governments of these countries mobilize resources so that a rapid capital accumulation
takes place. To increase both public and private investment, government hits tax revenues
through proper tax planning; the ratio of savings to national income can be raised.
By raising the existing rate of taxes or by imposing new taxes, the process of capital formation
can be made smooth. One of the important elements of economic development is the raising of
savings- income ratio which can be effectively raised through taxation policy.

Economic Price Stability: taxation can be used to ensure price stability as a short run objective
of taxation. Taxes are considered as an effective means of controlling inflation. By raising the
rate of direct taxes, private spending can be controlled. Naturally, the pressure on the commodity
market is reduced. But indirect taxes imposed on commodities fuel inflationary tendencies. High
commodity prices, on the one hand, discourage consumption and encourage saving. Opposite
effect will occur when taxes are lowered down during deflation.
It has been said that the most fundamental reason a government has for taxing its citizens is to
provide a reasonable degree of price stability within the nation (summer field, et al, 1980). Most
spending by the public and private sectors without taxes generate high demand, which is
inflationary. In such a situation, the basic function of taxation is to reduce private expenditure in
order to allow governments spend without causing inflation. Thus, taxation is basically a
deflationary measure.
Control of Cyclical Fluctuations: control of cyclical fluctuations periods of boom and
depression is considered to be another objective of taxation. During depression, taxes are
lowered down while during boom taxes are increased so that cyclical fluctuations are controlled.
Reduction of BOP Difficulties: taxes like custom duties are also used to control imports of
certain goods with the objective of reducing the intensity of balance of payments difficulties and
encouraging domestic production of import substitutes.
Wealth Redistribution; the redistribution of wealth is a policy aiming to balance economic
disparities, often through taxes and welfare programs. It seeks to provide a safety net for the less
privileged and fund public services, promotion of a more equitable society. This has two quite
distinct forms.
o The first doctrine believes that taxation should be based on ability to pay and is
summarized by the saying that “The greatest burdens should be borne by the broadest
backs”.

o The second assumes that the present distribution is unjust and concluded that this should
therefore be undone. This second principle perceives elimination as legitimate objectives
of taxation.

2.3 The Principles of good taxation

Given the many levels of taxation (Federal and Regional states) the main purpose of the
government is to increase revenue collection, while most of tax payers argue; tax laws vary
constantly, lack of awareness on the rate of tax to pay, when to pay, where to pay and to whom
to pay. To this end, economists forwarded as the principles of good taxations should be;
Efficient - A tax system should raise enough revenue such that government projects can be
efficiently sponsored, without burdening the economy too much (tax payers), as not to become a
discouragement for their performance.
Equitable - Taxation should be governed by people's ability to pay, that is, wealthier individuals
or firms with greater incomes should pay more in tax while those with lower incomes should pay
comparatively less.
Certainty – tax rules should be clearly specified when and how a tax is to be paid and how the
amount will be determined. Certainty may be viewed as the level of confidence a person has that
a tax is being calculated correctly.
Simplicity – tax payers should be able to understand the rule and obey with them correctly. A
simple tax system better enables tax payers to understand the tax consequences of their actual
and planned transactions, reduces errors and increases respect for that system.
Neutrality – the tax law’s effect on a tax payer’s decision whether or how to carry out a
particular transaction should be kept to a minimum.
Transparency – taxpayers should know that a tax exists, and how and when it is imposed on
them or others. Taxpayers should be able to easily determine the true cost of transactions and
when a tax is being evaluated or paid, and on whom or where.
Minimum Tax Gap – a tax should be structured to minimize negation. The tax gap is the amount
of tax allocated less the amount collected. To gain an acceptable level of Agreement, rules are
needed. However, a balance must be set between the desired level of agreement and the tax
system’s cost of performance and the level of unacceptability.
Convenience – a tax should be due at a time or in a manner most likely to be convenient to the
tax payer that helps to insure compliance. Taxes should be collected at a time convenient for the
Taxpayers. For example, the pay as you earn income tax on salaries and wages deducted weekly
or monthly as the case may be as income is received, is a good example of the principle of
convenience. Convenience as a principle of taxation has to do with the enforcement of tax and
administration.
Eckeston (1983) has said that a good tax should not impose taxes that are impossible to enforce
even when people comply to tax laws voluntary, the government should verify the tax payments,
if not the tax becomes an invitation to break the law. Adam (1910) has pointed out that every tax
ought to be levied at the time or in the manner in which it is likely to be convenient for the
contributor to pay it.
Using this principle as a researcher argue that the convenient time for tax payments in Somali
region is; for income tax of employees/workers to be at the end of each month, while the profit
tax for business organizations/companies to be the end of each fiscal year, whereas, pastoralists
and agro pastoralists resides in rural areas could be after the harvest time and tax administers
should impose to taxpayers legal and logical payable amount of tax based on their ability to pay.
2.4 Tax revenue and Economic Development Indicators

2.4.1 Relationship between tax revenue and infrastructure development

The relationship between tax revenue and infrastructure development in the Somali region of
Ethiopia, or any other region for this matter, is complex and multidimensional. Development
economists have considered physical infrastructure to be a precondition for industrialization and
economic development, where physical infrastructure, in general, consists of two parts:
economic infrastructure such as telecommunications, roads, irrigation, and electricity; and social
infrastructure such as water supply, sewage systems, hospitals, and school facilities (Murphy,
Shleifer, and Vishny 1989).
It has been demonstrated that physical infrastructure development improves the long-term
production and income levels of an economy in both the macroeconomic endogenous growth
literature (Barro 1990; Futagami, Morita, and Shibata 1993) Moreover, a number of micro
studies have shown that development of infrastructure is one of the indispensable components of
poverty reduction (Van de Walle 1996; Lokshin and Yemtsov 2005; Jalan and Ravallion 2003;
Jacoby 2000; Gibson and Rozelle 2003).
Infrastructure is typically thought of as those fundamental and necessary services that must exist
before development can take place. Infrastructure can also be used to refer to the physical
structures needed for civilization to function. Infrastructure refers to the fundamental physical
and institutional components that make up a society, such as its industries, buildings, roads,
bridges, health services, government, and so forth while transportation (road, rail, ocean, air, and
pipeline), telecommunication, and power are examples of infrastructure components or elements.
Infrastructure refers to activities that are considered "social overhead capital" and have two key
characteristics: economies of scale in production and spillover effects from users to non-users. It
is business, or the goods, services, and conveniences needed for an economy to run .
According to Todaro and Smith (2011), the presence of physical, social, and economic
infrastructures can support and expedite the development of infrastructural systems. Access to
infrastructure not only increases household income directly by improving production; it also has
indirect effects, such as changing consumption, saving, and investment decisions as well as
facilitating accumulation of social capital.
According to Dasgupta and Serageldin 2000; Durlauf and Fafchamps 2005; Hayami 2009), wide
variety of infrastructure evaluation results using either experimental or no experimental methods,
infrastructure’s role should be regarded as a facilitator of strengthening mutual matches between
market, state, and community mechanisms, as community mechanisms play a critical role in
correcting both market and government failures.

2.4.2 Relationship between tax revenue and Job Creation

The relationship between tax revenue and job creation is a genuinely debated in economic and
political issue. Some analysts claim that higher taxes lead to lower employment, by reducing the
availability of capital to be invested in job-creating enterprises, or by reducing the amount of
money available for consumers to use to purchase goods and services, thereby causing a loss of
business for broadcasters of those goods and services.
Other commentators claim that higher taxes lead to higher employment, because governments
use those tax revenues to employ government workers, who then purchase goods and services
from private businesses and because governments themselves may act as consumers of goods
and services. Higher taxes have also been claimed to increase the confidence of outside investors
in the stability of the government, and in the government's willingness and ability to pay debts.
On local scales, it has also been claimed that higher taxes in one area (region, or country) will
motivate businesses to move their operations to other areas with lower taxes. However, it has
conversely been claimed that some authority with relatively high tax burdens experience higher
employment than some authority with relatively low tax burdens, based on the infrastructure and
government services that may be provided to businesses operating in that authority.
Nevertheless, the impact of taxation on job creation and employment is a controversial topic
among economists and policymakers. Some argue that high taxes can restrict economic growth
and discourage businesses from expanding and hiring new employees. Others contend that tax
revenue can be used to fund public investments and social programs that stimulate job creation.
In examining the effect of taxation on job creation and employment,
In 2023, the unemployment rate in Ethiopia remained nearly unchanged at around 3.5 percent.
The unemployment rate of a country or region refers to the share of the total workforce that is
currently without work, but actively searching for employment. It does not include economically
inactive persons, such as children, retirees, or the long-term unemployed.
Finally, to promote job creation, this research proposes to consider various perspectives and
assess the potential benefits and drawbacks specified the following paragraphs.
Tax incentives for businesses; One approach to promote job creation is by using tax incentives
for businesses. These incentives can take various forms, such as tax credits, deductions, or lower
tax rates for certain companies or businesses. Supporters of this approach, argue that these
measures encourage businesses to invest in expansion and hiring additional employees as they
reduce the overall tax burden. For instance, a government may offer a tax credit to businesses
that hire a certain number of new employees within a specified period. This motivates companies
to increase their workforce and contribute to employment growth.
Taxation policy on small businesses; Taxation policies can have a significant impact on small
businesses, which are often considered the backbone of many economies. High taxes can place a
heavy burden on small businesses, limiting their ability to expand and create jobs. Conversely,
reducing tax rates for small businesses can provide them with the necessary resources to invest in
growth and employment. This can be particularly beneficial in sectors that heavily rely on small
businesses, such as retailers, small & new businesses and services. By alleviating the tax burden
on these enterprises, governments can raise job creation and support local economies. For
example, lowering tax encourage a number of small businesses which in turn hire a number of
employees that may increase job creation of the societies and increase formal business with TIN
numbers.
Tax revenue allocation & utilization; another aspect to consider is how tax revenue is allocated
and utilized by the government. Some argue that higher taxes can be justified if the funds are
used to invest in infrastructure, education, or research and development. These public
investments can create a favorable environment for businesses, leading to job creation in the long
run. For example, improving transportation infrastructure can attract new businesses to an area
and create employment opportunities. However, it is vital for governments to ensure efficient
and effective allocation and utilization of tax revenue to maximize the positive impact on job
creation.
International competitiveness; Taxation policies can also influence a country's international
competitiveness and attractiveness for businesses. High corporate tax rates, for instance, may
discourage foreign direct investment and cause companies to relocate to authorities with more
favorable tax regimes. This can result in job losses and reduced employment opportunities
domestically. Therefore, policymakers need to slowdown a balance between generating tax
revenue and maintaining a competitive business environment. Lowering corporate tax rates or
implementing tax reforms that incentivize investment and job creation can help countries remain
attractive to businesses while supporting employment opportunities.
A balanced Approach; Even though there are opposing views on the effect of taxation on job
creation and employment, a balanced approach is often considered the best option. This involves
implementing tax policies that walkout a balance between generating revenue for public
investments and supporting businesses' ability to expand and create jobs.
I, as a researcher argue that a combination of tax incentives for companies, targeted support for
small businesses, efficient allocation of tax revenue, and maintaining international
competitiveness can contribute to job creation and economic development.

2.4.3 Relationship between tax revenue and public Expenditure

Public expenditure refers to the government expenditure. It is incurred by central and Regional
state governments in Ethiopian context. The public expenditure is incurred on various activities
for the welfare of the people and also for the economic development, especially in developing
countries. In other words, the expenditure incurred by public authorities like central, state and
local government to satisfy the collective social wants of the people is known as public
expenditure Akrani (2010).
Public expenditure is a pre-requisite of economic development. The public sector initially
provides economic infrastructures such as roads, railways, water supply and sanitation. As
economic growth take place, the balance of public investment shift towards human capital
development through increase spending on education, health and welfare services. In this model,
the state is assumed to grow like an organism making decision on behalf of the citizens. Society
demand for infrastructural facilities such as education, health, electricity, transport etc. grow
faster than per capita income.
Types of public expenditure

• Current expenditure or Government final consumption expenditure on goods and

services, for current use to directly satisfy individual or collective needs of the members
of community.
 • Capital expenditure or fixed capital formation (or government investment) government
spending on goods and services intended to create future benefits, such as infrastructure,
investment in transport (roads, railways and airports) health (water collection and
distribution, sewage systems, communication (telephone, radio, and tv) and research
assessments spending topics.
• Transfer payment; spending that does not involve transaction of goods and services, but
instead represent transfer of money, such as social security payments, pensions and
unemployment benefits.

Financing public goods and services are essential for the functioning of society and include
infrastructure, education, healthcare, defense, law enforcement, and social welfare programs. The
efficient use of tax revenue in public expenditure is also critical for economic development.
A study by Gupta, Davoodi, and Tiongson (2002) investigated the impact of public expenditure
efficiency on economic growth in developing countries. The findings indicated that countries
with more efficient public expenditure systems achieved higher economic growth rates.
 Tax revenue could be used to finance public goods and services as follows:

Infrastructure: Tax revenue is often allocated to fund the construction, maintenance, and
improvement of infrastructures (roads, bridges, airports, railways, and public transportation
systems). These investments are necessary for economic development and facilitate the
movement of goods, services, and people.
Education: Tax revenue is used to support public schools, colleges, and universities. It covers
expenses like teacher’s salaries, school furniture facilities, textbooks, and educational resources.
By funding education, governments aim to provide equal opportunities for all citizens and
promote human capital development.
Healthcare: Tax revenue is allocated to healthcare systems to ensure access to quality medical
services for the population. It funds public hospitals, clinics, vaccination programs, public health
initiatives, and research. The goal is to promote public health, prevent diseases, and provide
medical cares to those are in need of.
Defense and Security: Governments allocate tax revenue to national defense and security
agencies to protect the country's sovereignty, borders, and citizens. It funds armed forces,
intelligence agencies, law enforcement departments, and emergency services. These expenditures
help maintain peace, security, and stability within the country.
Social Welfare Programs: Tax revenue is also used to finance social welfare initiatives like
social security, unemployment benefits, disability benefits, and public assistance programs.
These programs aim to provide a safety net for vulnerable populations, alleviate poverty, and
ensure a basic standard of living for all citizens.
Purpose of Public Expenditure: Government spends money for a variety of reasons, including
• To supply goods and services that private sector would fail to do, such as public goods,
including defense, roads and bridges, merit goods such as hospital and schools, and
welfare payments, including unemployment and disability benefit.

• To achieve supply-side improvements in the macro- economy, such as spending on

education and training to improve labor productivity.

• To reduce the negative effect of externalities, such as pollution controls.

• To help the redistribution of income and achieve more equity.
• To inject extra spending into macron-economy, to help achieve increases in aggregate
demand and economic activity.

Challenges of Public Expenditures.

• Corruption and inefficiency for the implementers  Inadequate resource and time
allocation from government

• Donor funding is not reliable, or might not be given on time.

• People evade taxes or even fail to declare wealth.
• Lack of awareness for both Tax collectors and taxpayers.

The causal relationship between government revenue and government expenditure is an issue
that has generated excited debate globally, over the years, among economists and policy analysts.
An understanding of this relationship is critical in the formulation of a sound or excellent fiscal
policy to prevent or reduce unsustainable fiscal deficits.
2.4.4 Relationship between tax revenue and Social welfare program

The relationship between welfare and taxes is that taxes are a key source of revenue for the
government to fund welfare programs. Welfare programs are designed to provide financial and
social assistance to individuals and families who are in need of support due to poverty,
unemployment, disability, or other factors.
However, the impact of tax revenue on these programs is a complex and multidimensional issue,
with different perspectives and considerations to take into account.
Funding Adequacy: One of the key factors to consider when examining the impact of tax
revenue on social welfare programs is the adequacy of funding. Adequate funding is essential to
ensure that these programs can effectively address the needs of the target population. Insufficient
tax revenue can result in underfunded programs, leading to limited resources and services
available to those who rely on them. On the other hand, excessive tax revenue may lead to the
misallocation of funds and inefficiencies in program implementation.
Balancing Priorities: Governments face the challenge of balancing competing priorities when
allocating tax revenue to social welfare programs. They must consider the needs of various
segments of society, such as healthcare, education, housing, and unemployment benefits, among
others. Each program requires a different level of funding, and striking the right balance is
crucial. For instance, a government may need to prioritize investing in education to ensure a
skilled workforce for future economic growth while also providing adequate support for those in
immediate need.
Equity and Fairness: Another critical aspect to consider is the equitable distribution of tax
revenue among different social welfare programs. Governments must ensure that their allocation
decisions are fair and just, taking into account the diverse needs and circumstances of their
citizens. For example, a progressive tax system that imposes higher tax rates on the wealthy and
lower rates on lower-income individuals can help promote a more equitable distribution of
resources to fund these programs.
Effectiveness and Efficiency: The impact of tax revenue on social welfare programs also
depends on the effectiveness and efficiency of their implementation. It is crucial to evaluate the
outcomes and impact of these programs to determine whether they are achieving their intended
goals. Governments should regularly assess program performance, identify areas for
improvement, and ensure that tax revenue is being used efficiently to maximize the benefits for
the target population.
Balancing Economic growth; While social welfare programs are essential for addressing
societal needs, it is vital to strike a balance with the broader goal of promoting economic
growth.. Excessive taxation can have negative effects on economic activity, investment, and job
creation. Therefore, governments must consider the potential impact of tax revenue on economic
growth when allocating funds to social welfare programs. This requires careful analysis and
consideration of the trade-offs involved.
Overall, tax revenue plays a critical role in funding social welfare programs and maintaining a
balanced budget. Adequate funding, balancing competing priorities, equity and fairness,
effectiveness and efficiency, and balancing economic growth are all important considerations
when evaluating the impact of tax revenue on these programs. Striking the right balance is
crucial to ensure that funds are allocated effectively, benefiting the target population while also
fostering economic growth.
 Types of funding for social welfare programs

Government funding;- Government is one of the primary source of funding for social welfare
programs. This type of funding includes grants, subsidies, and other forms of financial support
provided by the government to non-profit organizations, charities, and other entities that work
towards the betterment of society. For example, in Ethiopian country, some of the schools are
given school grant, school feeding food while some teachers are given housing assistance..
Private Funding - Private funding is another significant source of funding for social welfare
programs. This type of funding includes donations and grants from private individuals,
corporations, and foundations. Private funding can be used to support a wide range of social
welfare programs, including education, healthcare, and housing. For example, the Bill and
Melinda Gates Foundation provide funding for education programs in developing countries.
Community Funding: Community funding refers to funding that is raised by local communities
to support social welfare programs. This type of funding can be used to support a variety of
programs, including food banks, homeless shelters, and community centers. Community funding
can be raised through donations, fundraising events, and other initiatives.
Therefore, there are several types of funding available for social welfare programs, each with its
own benefits and drawbacks. While government funding provides a stable source of financial
support, private and community funding can provide more flexibility and innovation in program
design and implementation. Ultimately, a combination of these funding sources may be
necessary to ensure the success and sustainability of social welfare programs.
Challenges of funding of Social Welfare

Limited Government Budgets: One of the primary challenges in funding social welfare program
is the limited availability of government budgets. Governments around the world have to allocate
funds to various sectors, such as education, healthcare, defense, and infrastructure, in addition to
social welfare programs. With a finite amount of resources, it becomes challenging to adequately
fund all social welfare initiatives, resulting in tough choices and trade-offs. For example, a
government may need to prioritize funding for primary education over expanding health care
services.
Economic Downturns: during periods of economic downturns, funding for social welfare
programs often takes a hit. As governments face decreased revenue and increased demands on
their budgets, they may be forced to make budget cuts in various areas, including social welfare
programs. For instance, when a recession occurs, governments may need to reduce spending on
unemployment benefits or job training programs due to fiscal constraints..
Complexity of program implementation; the implementation of social welfare programs can be
complex and resource-intensive. From designing effective policies to establishing distribution
mechanisms, there are numerous steps involved in setting up successful social welfare initiatives.
Unfortunately, this complexity can also lead to higher costs and inefficiencies in funding the
programs effectively. For example, administering means-tested benefits, such as income support
or housing assistance, requires extensive administrative infrastructure and can be costly to
maintain.
Changing Demographics; changing demographics attitude a challenge in funding social welfare
programs. As populations age or migrate, the demands for specific services may evolve,
requiring adjustments in funding allocations. For instance, a country with an aging population
may face increased demands for healthcare services or elderly care, necessitating additional
funding to meet the changing needs of its citizens. Failure to recognize and adapt to changing
demographics can strain social welfare programs, this type is not common in Ethiopia..
Political Priorities and Partisanship; Political priorities and partisanship can significantly
influence the funding of social welfare programs. Different political parties often have varying
perspectives on the role of the government in providing social welfare, resulting in variations in
funding levels and priorities. Changes in government leadership or shifts in political ideologies
can impact the financial support for these programs. This can lead to fluctuations in funding,
causing disruptions or inconsistencies in service delivery. For example, a change in government
may result in reduced funding for certain social welfare programs that were deemed crucial by
the previous administration.
Finally, funding social welfare programs faces multiple challenges, including limited
government budgets, economic downturns, program implementation complexities, changing
demographics, and political priorities. Recognizing these challenges are crucial to finding
innovative solutions and ensuring the effective delivery of social welfare services to those in
need.

2.5.1 Empirical Studies on tax and economic development in case of global studies

Empirical studies on taxes and economic development in developing and developed countries
fiscal policies can affect economic growth and economic development. Policies such as
increasing public spending on healthcare and education or reducing tax rates can positively
influence the stock of human capital and support economic growth in the short term and
economic development in the long term. Many scholars and researchers are interested in
analyzing the relationship between fiscal policy and economic growth in developing and
developed countries. The interest sparked because of the necessity to stimulate the rate of
economic growth and to reduce the budget deficits because of inefficient government spending..
Past literature has recognized conflicting findings on the impact of taxation towards economic
development in developed and developing countries. Research about taxes and economic growth
in developing countries is enormous but concentrated to Africa and Middle East. In South Africa,
Ocran (2011) examined the effect of fiscal policy variables, including government gross fixed
capital formation (GFCF), tax and government consumption expenditure, and budget deficit on
economic growth from 1990 to 2004. He used quarterly data in the estimation with the aid of the
vector regressive modeling technique and impulse response functions. The findings indicated
that government consumption expenditure, GFCF from the government, and tax receipts
positively affect output growth.
Similarly, Eugene and Abigail (2016) studied the impact of taxation policies on the overall
economic growth from 1994 to 2013 using the OLS method. The results confirmed the positive
impact of a tax on Nigerian economic growth. Babatunde et al. (2017) investigated the impact of
taxation on economic growth from 2004 to 2013 in 16 African states using the panel data. They
found a significant and positive relationship between tax revenues and GDP, which suggests that
tax revenues accelerate the economic growth of African states.
In Nigeria, Ojong et al. (2016) examined the impact of tax revenue on the Nigerian economy
from 1986 to 2010. They examined the impact of company income tax and the effectiveness of
non-oil revenue on the Nigerian economy. Ordinary least square (OLS) of multiple regression
models were used to test the relationship between dependent and independent variables. Their
finding reveals a significant relationship between petroleum profit tax and the growth of the
Nigerian economy. However, no significant relationship is found between company income tax
and the growth of the Nigerian economy. A number of studies in developing countries have
found, however, that taxes do not significantly affect economic growth.
Meanwhile, in Pakistan, Ahmad and Sial (2016) examined the relationship between total tax
revenues and economic growth using annual time series data from 1974 to 2010. The
autoregressive distributed lag (ARDL) bounds testing approach for co-integration was applied to
estimate the long-run and short-run relationship among the variables. The results show that total
tax revenues have a negative and significant effect on economic growth in the long run. The
finding suggests that a 1% upsurge in total taxes would reduce the economic growth by 1.25%.
In their research on developing countries,. Korkmaz et al. (2019), observed similar findings in
their research of the Turkish economy where taxes are significantly and negatively associated
with economic growth.
Widmalm (2001) found a negative relationship between direct income taxes and economic
growth. However, the adverse effects of indirect taxes on economic growth are not confirmed.
The finding is later supported by the latest study in Tanzania (Maganya, 2020). Mdanat et al.
(2018) analyzed the Jordan tax structure and its implications on economic growth between 1980
and 2015 by using error correction techniques. Their study provided empirical evidence, which
entails that direct and indirect tax structure is insufficient to help improve the economic growth
of Jordan, particularly when the country faces poor fiscal performance. In addition, Jordan has an
inefficient fiscal structure that should determine politicians within their politics to focus more on
increasing the GDP per capita by addressing the importance of consumption taxes and customs
duties. They believed that sustainable economic growth could only be achieved if poverty and
inequalities are to be reduced and living conditions are to be improved.
Research in developed countries also produces mixed findings. Poulson and Kaplan (2008)
explored the impact of tax policy on economic growth in the US within the framework of an
endogenous growth model. They conducted the regression analysis to estimate the impact of
taxes on economic growth from 1964 to 2004. The analysis showed a significant negative impact
of higher marginal tax rates on economic growth. This evidence suggests that taxes can
significantly impact economic growth. The government has a choice of direct1 and indirect2
taxes to determine the efficiency of the allocation of resources, either through tax revenue or
improvement of economic growth.
Numerous factors can also have an impact on economic growth. From the European Union
countries, Armeanu et al. (2018) conducted an empirical study on the sustainability factors of
economic growth rate in the EU-28 member countries by using data panel regression models and
by applying fixed and RE and the generalized method of moments. They include sustainability
factors, such as the high level of education, the economic and business environment of a country,
technology, infrastructure, communications, people’s lifestyle, media, and demographic changes
in measuring the real growth rate of the GDP. They highlighted a positive connection between
the economic growth and the level of the expenses for the education of the students between the
ages of 18 and 26 years and the expenses for the research and development and the degree of
employment of the fresh graduates. They also found that the indicator regarding the perception
of corruption is negatively associated with economic development. Research that makes a
comparison between developed and developing countries using panel data also found conflicting
results..
Additionally, Indirect taxes have a positive link with economic growth in selected developed and
developing countries, according to Hakim (2020). Similar to this, studies conducted in
developing economies have shown that indirect taxes have a favorable impact on economic
growth (Korkmaz et al., 2019; Nguyen, 2019). Tariffs and domestic goods and services taxes are
two additional tax forms that have a direct impact on the economic growth of countries
(Maganya, 2020; Mdanat et al., 2018). It is undeniable how taxes affect other aspects of the
economy, like investment and unemployment.
Numerous research has produced contradictory results regarding how taxes affect investment.
Taxes have a significant impact on investment, according to studies by Abdioglu et al. (2016),
0proved that FDI in developed nations is responsive to host country taxation, but not in
developing countries. The existing literature revealed that taxes significantly impact the
unemployment rate. In developed nations, the unemployment rate rises when the tax rate on
labor is high, according to studies by Disney (2000) and Seward (2008). Similarly, Nikolka’s
(2016) report on taxes and the female labor force supports the claim.
The discussion in the above literature review identifies several gaps. There seem to be
inconclusive results of the impact of taxes on economic development, either in developed or
developing countries. Next, this study does not only examine the impact of direct and indirect
taxes on GDP but also on other indicators of economic development, namely infrastructure and
job creations, which limited study has done so far. This study focuses more on the impact of tax
revenue on economic development indicators that may produce interesting results compared to
prior studies.

2.6 Conceptual Framework

Conceptual framework is a written or graphic presentation that “explains either graphically, or in
narrative form. The main things to be studied, the key factors, concepts or variables and the
presumed relationship among them and it can also be defined as a set of broad ideas and
principles taken from applicable fields of investigation and used to structure a subsequent
presentation and the relationship between independent variable and the dependent variable. The
conceptual framework provides a structure for understanding the impact of tax revenue on
economic development in the Somali Region of Ethiopia. The framework outlines the key
variables and relationships that need to be considered when examining the impact of tax revenue
on economic development.

MEDIATING VARIABLE
INDEPENDENT VARIABLE DEPENDENT VARIABLE
Public Goods & Services (pbg&s) &
[TAX REVENUE] [ECON- DEVEL’T]
Tax Policy & administration (tb&ad)
 Income tax (IT )  Infrastructure

 Sales Tax (ST )  Job creation

 Property Tax (PT )  Public

 Administrative Expenditure
MODERATING VARIABLES
Tax ( AT )  Social Welfare
Institutional Factors (If) &

Socioeconomic factors (Sef)

DEPENDENT VARIABLE: Economic Development: This refers to the overall growth and
improvement of the Somali Region's economic indicators like; infrastructure development, job
creation, provision of public goods and services and social welfare.
INDEPENDENT-VARIABLE: Tax Revenue: This represents the total amount of revenue
collected by the government through taxation in the Somali Region. Types of taxes include;
income tax, sales tax, property tax, and corporate tax and administrative tax.
Mediating-variables: Public Expenditure: The amount of government spending in the Somali
Region, which includes investments in infrastructure, healthcare, and other sectors can influence
economic development through its impact on the provision of public goods and services.
o Tax Policy and Administration: The design and implementation of tax policies, tax rates,
tax incentives, and the efficiency of tax administration. Effective tax policies and
administration can encourage compliance, minimize tax evasion, and optimize the
revenue collection process.
Moderating-variables:

o Institutional Factors: The quality of governance, rule of law, and effectiveness of

institutions in the Somali Region. Strong institutions can enhance tax compliance, reduce
corruption, and provide a better environment for economic development.
o Socioeconomic Factors: Factors such as education levels, income distribution,
employment rates, and social welfare programs. These factors can influence tax
compliance, revenue collection, and the redistribution of tax revenue for development
purposes.