THE EFFECT OF ECONOMIC
FACTORS ON THE TAX RATIO IN
TRINIDAD AND TOBAGO
The University of the West Indies, Trinidad and Tobago
Loughborough University, U.K.
We focus on the potential economic factors of tax revenue in Trinidad and Tobago and present
cointegration test statistics for a second order VAR(2) based on Johansen’s maximum
likelihood approach. Our results suggest a positive relationship between the level of income
and the tax ratio and also that external debt and inflation impede the collection of taxes.
Additionally, we find that the degree of openness exerts an insignificant impact on the tax
ratio. Our study recommends potential areas that may be targeted in order to raise tax revenues
and which may also raise the consciousness that tax reform is a very important subject matter.
JEL Classifications: H2, C22, O54
Keywords: tax ratio, economic policy, cointegration, weak exogeneity, Trinidad and Tobago
Corresponding Author’s Email Address: Sandra.Sookram@sta.uwi.edu
The adoption of effective and efficient tax policy in developing counties is a
formidable challenge and has been the subject of theoretical and empirical study
worldwide (see Burgess and Stern, 1993). Tax shares in developing countries
continue to be much lower than in developed countries, which make this research a
very important and still timely policy issue1. Studies increasingly highlight the
importance of tax revenues as an instrument for economic growth and development.
This study examines the Trinidad and Tobago context using time-series analysis.
This type of econometric investigation may be more useful from a policy perspective
since it allows for the consideration of the country-specific economic environment.
The World Bank classifies Trinidad and Tobago as upper middle-income
(World Bank List of Economies, 2005), but it still has a substantial hidden economy2,
high degree of poverty3 and is considered a developing economy. Nevertheless,
Trinidad and Tobago presents a unique case because, although it is an oil-rich
country, its tax revenue composition has not changed much from the 1960s and still
remains structurally similar to other developing countries. Developing countries tend
to lack diversification and most are characterised by one dominant sector in the
economy, in many circumstances the agricultural sector, and in examining the tax
ratio it is quite common to include at least one influential sector of the economy in
the set of independent variables in the specification. In the case of Trinidad and
Tobago the energy sector dominates and the government relies heavily on the energy
sector to finance expenditures. But, even so the energy sector