THE EFFECTS OF EXCHANGE RATE DYNAMICS ON TAX REVENUE EFFORT: EVIDENCE FROM MALAWI 1990 to 2021

Abstract

Exchange rate dynamics are critical determinants of tax revenue efforts yet to be explored. A review of literature in Malawi and sub-Saharan countries shows that there needs to be more literature on the subject matter. The study’s primary objective was to analyze the extent to which exchange rate dynamics (devaluation policy and an exchange rate regime change) affect tax efforts. This study uses time series data from 1990-2021 using the Ordinary Least Squares (OLS) and Vector Autoregressive (VAR) estimation techniques to assess the effects of Exchange rate dynamics on tax revenue efforts. The study finds that factors such as Exchange rates, per capita Gross Domestic Product (GDP), agriculture share in GDP, and Trade openness significantly affect tax revenues in Malawi. The study also finds that changes in factors such as Exchange rates and Exchange rate regime Granger cause Tax revenues in Malawi, and the changes in exchange rates had a positive significant impact on tax revenue as there are traceable short-run effects of 2 to 4 years period. However, changes in the exchange rate regime had adverse significant effects on tax revenues for a short-run period of 0 to 2 years. The study further established the tax effort scores for Malawi and found that Malawi has been collecting taxes as expected from the economy’s structural characteristics. The study recommends that the government continue considering the Exchange rates as a policy instrument guiding demand for goods and services both domestically and internationally, as well. Specifically, consider tax reforms in the form of an increase in the value-added tax (VAT) to outweigh the effects of the nominal devaluation in the currency, which helps regain the competitiveness of domestically produced goods.