The Causal Relationship between Sales Tax Revenue and Economic Growth in Jordan

Abstract

This study aims to examine the causal relationship between economic growth and General
sales tax revenue in Jordan using the Granger methodology in order to determine the
direction of relationship between the two variables during the period 1998-2015. We use the
Johansen cointegration technique proven to be superior to the Engle and Granger approach in
assessing the cointegrating of variables. Result of the test shows that there is cointegrating
relationship between General sales tax revenue and economic growth for Jordan data. Thus,
we find long-run relationship between General sales tax revenue and economic growth.
Furthermore, causality is going from the General sales tax revenue to economic growth, and
not vice versa. Based on the outcome of causality tests, changes in General sales tax revenue
help explain the changes that in economic growth

Full text

International Research Journal of Applied Finance
ISSN 2229 – 6891
Vol. VIII Issue – 3 March, 2017 www.irjaf.com
170
The Causal Relationship between Sales Tax Revenue and Economic
Growth in Jordan
Hanan A.D Al-Abbadi Shatha Abdul-Khaliq*
Abstract
This study aims to examine the causal relationship between economic growth and General
sales tax revenue in Jordan using the Granger methodology in order to determine the
direction of relationship between the two variables during the period 1998-2015.
We use the
Johansen cointegration technique proven to be superior to the Engle and Granger approach in
assessing the cointegrating of variables. Result of the test shows that there is cointegrating
relationship between General sales tax revenue and economic growth for Jordan data. Thus,
we find long-run relationship between General sales tax revenue and economic growth.
Furthermore, causality is going from the General sales tax revenue to economic growth, and
not vice versa. Based on the outcome of causality tests, changes in General sales tax revenue
help explain the changes that in economic growth
Keywords: The Causal Relationship, General Sales Tax Revenue, GDP, Granger, Co-
integration, Jordan, Economic Growth.
I. Introduction:
Economic growth is one of the most important determinants of economic welfare. The
relationship between tax revenue and economic growth is a frequent topic of discussion.
Also, tax is a sustainable source of revenue for government and a tool for fiscal policy and
macro-economic management. It is a potential tool for economic and social reform as it
pervades all aspect of the economy, individual, companies, citizens and foreigners (Eugene
and Abigail 2016).
As many of the developing countries including Jordan rely on foreign aids and loans to
finance their public expenditures, especially to cover the budget deficit and pay for debts. So,
in light of the effects of the global financial crisis and what ails the Arab countries seem that
Jordan and the other countries need to rely more on its own domestic revenues, particularly
taxes.
Structure of Domestic Revenues in the Budgetary Jordanian Government for the year 2015
consist of General Sales Tax by 47.0%, Taxes on Income & Profits by 14.5%, Taxes on
International Trade &Transactions by 5.6%, Other Tax Revenues by 2.2%, Revenues from
Selling Goods& Services by 14.4%, Pension Contributions by 0.3% and Other Revenues by
16.0% (Central Bank of Jordan, 2015). We find that General Sales Tax Revenues occupy
great importance in the Structure of Domestic Revenues of Jordan.
From the above, the importance of this study can be summarized in that it combines one of
the most important components Structure of Domestic Revenues to the Jordanian
Government (general sales tax revenues) and one of the most important economic goals
(economic growth).
The study aimed to examine the relationship between General sales tax revenue and
economic growth in a small developing Economy, Jordan. To achieve this, the study was
structured into 3 sections: section I deals with the Hypothesis and Previous studies; section II
discusses General sales tax revenue in Jordan; while methodology and analysis of results,
conclusion and recommendations are presented in section III.

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I.1 Previous Studies
Several studies discuss the importance of tax revenue on economic growth. We summarize
some of these studies that addressed the issue of causality between tax revenue and economic
growth as follows:
Chigbu, et al., (2012) examined the causality between economic growth and taxation in
Nigeria for the period 1970-2009. The data were analyzed using relevant econometric models
such as Augmented Dickey-Fuller, Diagnostic Tests, Granger Causality and Johansen Co-
integration. The results from the econometric analysis revealed that taxation as an instrument
of fiscal policy affects the economic growth and taxation granger cause economic growth of
Nigeria. On the basis of the econometric result, the study concluded that taxation is a very
important instrument of fiscal policy that contributes to economic growth of any country. On
the basis of the conclusion useful recommendations were provided that will improve the
generation of revenue from taxation that would stimulate the economy of Nigeria positively.
Canicio and Zachary (2014) attempted demystify the mystery surrounding the belief that,
high tax revenue growth rates is a prima facie and a leading indicator for high standards of
living as a result of high economic growth rates engineered through the government
multiplier process. The effects of economic growth on government tax revenue growth were
investigated for Zimbabwe during the period of 1980-2012. Short-run and long-run
relationship between the tax revenue and economic growth in Zimbabwe were also
investigated. Theoretically and empirically it has been found that taxes affect the allocation of
resources and often distort the economic growth. The study applied the Granger Causality
test, Johansen’s Co- integration test and vector error correction model to serve the purpose.
This study clearly showed that there is an independence relationship between economic
growth and total government tax revenue with 30% speed of adjustment in the short run
towards equilibrium level in the long run. This implies that there is fiscal independence
between tax revenue and growth. The empirical analysis also provides the evidence of long-
run equilibrium relationship. Based on the findings, they highlighted some of major issues
that policymakers should consider for effective taxation policy formulation and
implementation in line with the complexity nature of the Zimbabwe economy. Therefore, the
outlook was that the economists and policy makers should suggests an ideal, efficient and
buoyant tax system so that gross tax revenue of the government would increase substantially
thereby leading to optimum mobilization of resources for higher economic growth of the
country. This can only be achieved through efficient allocation of collected tax revenue to
production sectors of the economy to try to achieve distributive principle through societal
welfare maximization.
Iriqat and Anabtawi (2016) aimed to investigate the causality relationship between Gross
Domestic Product and its components with Tax revenues in developing countries as a case
study Palestine during (1999 - 2014). The findings exposed mainly that the tax revenues does
not Granger Cause each of the Palestinian Gross Domestic Product, Government spending,
Consumption, Investment and Balance of trade. Moreover, results shows that the impact of
macro-economic variables on tax revenues and correlations between dependent and
independent variables was changing from one stage to other. The study concludes that the
Palestinian authority should motivate investment conditions and improve the tax collection
instruments and decrease the tax invasion. In addition, Palestinian government should
rationalize the government consumption spending and increase the government expenditure
for the development. In Munir and Sulatn (2016) study, an attempt has been made for
analyzing the impact of taxes on economic growth of Pakistan for the period 1976 to 2014.

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They had disaggregated taxes into direct and indirect tax. Indirect tax had further
disaggregated into five categories (excise duty, sales tax, surcharges, tax on international
trade and other taxes). By applying autoregressive distributive lag framework, study
confirmed the existence of long run relationship between taxes and real GDP of Pakistan.
Results indicate that in the long run direct tax, taxes on international trade, sales tax and other
indirect taxes had positive and significant impact on real GDP. However, in the short run
sales tax, tax on international trade and other tax had positive relationship, while excise duty
has negative relation with real GDP of Pakistan. The results confirmed that direct tax, sales
tax and tax on international trade are pro-growth taxes. Government should increase direct
taxes as they have positive and significant impact on economic growth in the long run.
I.2 Hypothesis
The first hypothesis: Assume that the changes in General sales tax revenue help explain the
changes that occur in the economic growth.
The second hypothesis: Assume that the changes in economic growth help explain the
changes that occur in the General sales tax revenue
II. General Sales Tax in Jordan
In Jordan the General sales tax started on a narrow scale as government tax in 1926 then
consumption tax and then sales tax in its first stage in 1994 which included the importer and
the manufacturer, the sales tax in its second stage which added the remaining trading
episodes in 2000, then developed into its current form as a sales tax which became into effect
on 1-1-2001 under Law No. (36) for the year 2000. Amendments were made to the law in the
year 2009 under Temporary Law No. (29) for the year 2009 (Ministry of Finance, Chapter :
1506).
The rates of General sales tax are:
• 16% as a general rate for goods and services
• 4% for specified agricultural products, fruits, meat, vegetables and live animals
• zero rate for a list of specified products like energy-saving products and pharmaceutical
industry inputs (Ministry of Finance, 2016).
A government initiative to promote industrial growth provides sales tax exemption and defers
the payment of the tax payable on goods and services at importation. Export sales and trading
within qualified Free Zones are sales tax exempted transactions in Jordan (PKF Worldwide
Tax Guide, 2013).
III. Data and Methodology
III.1Data
The data used for this study are basically time series data for Jordan covering the period
1998- 2015. The two economic variables included in this study are the General sales tax
revenue of goods and services GS and the Real Gross Domestic Product at Market Prices
(GDP) is an indicator to measure economic growth. Data were sourced from The Central
Bank of Jordan. It is worth mentioning that we used natural logarithm of the data.

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Table 1: GDP & General Sales Tax revenue in period 1998-2015
Year General Sales Taxes GDP
1998 350.3 5026.7
1999 372.5 5198.
2000 464.5 5998.6
2001 502.7 6363.7
2002 510.7 6794.
2003 596.3 7228.8
2004 827 8090.7
2005 1023.4 8925.4
2006 1219.1 10675.4
2007 1464.5 12131.4
2008 1671.6 15593.4
2009 1682.5 16912.2
2010 1987.3 18762.
2011 2033.2 20476.6
2012 2274.7 21965.5
2013 2532.9 23851.6
2014 2811.4 25437.1
2015 2780 26637.4
From Figure1 shows us that the General Sales Tax revenues have risen dramatically. Since
nineties with an average amount of 1395JD million as a result of the continuous changes
in the General Sales Tax law, which we mentioned earlier.
0
4,000
8,000
12,000
16,000
20,000
24,000
28,000
1998 2000 2002 2004 2006 2008 2010 2012 2014
GDP
General Taxes on Goods and Serv
Figure 1: General Taxes on Goods and Service & GDP
The total general sales tax revenues in 2015 amounted to 2780 JD million distributed as
follows: 1031.6 JD million from Sales Tax on Imported Goods, 598.6 JD million from Sales
Tax on Domestic Goods, 447.3 JD million from Sales Tax on Services and 702.5 JD million
from Sales Tax on Commercial Sector show figure 2

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SALES TAX ON
COMMERCIAL
SECTOR
25%
SALES TAX ON
DOMESTIC GOODS
22%
SALES TAX ON
IMPORTED GOODS
37%
SALES TAX ON
SERVICES
16%
Figure 2: General Taxes on Goods and Service in 2015
III.2 Descriptive analysis of the variables of the study
Table (2) shows descriptive statistics for the variables of the study, the table shows that the
variables do not far from the normal distribution using the test (Jarque-Bera), and to accept
the null hypothesis that the data follow a normal distribution. As shown us from the results of
the sprain values and through review of mean and median values, we find its close, so this
indicating the absence of sharp fluctuations in the fluctuation of the economic growth data. In
the other hand the general sales tax revenue is not normal distribution using the test Jarque-
Bera .
Table (2): Descriptive Analysis
GS GDP
Mean 1394.700 13670.47
Median 1341.800 11403.40
Maximum 2811.400 26637.40
Minimum 350.3000 5026.700
Std. Dev. 861.7938 7584.911
Skewness 0.284699 0.405698
Kurtosis 1.704543 1.664102
Jarque-Bera 1.501818 1.832241
Probability 0.471937 0.400068
Observations 18 18
III.3 Method
For the analysis of causal relationship between the General sales tax revenue and economic
growth we used the following steps, first, The Unit Root Test was tested by using the
Augmented Dickey-Fuller (ADF). Second, Cointegration was testing for the existence of a
long-run equilibrium relationship between General sales tax revenue and economic growth.
Third, Granger causality test was utilized to determine the directional causality between
variables.
III.4 The Unit Root Test
Macroeconomic time series data are generally characterized by a stochastic trend which can
be removed by differencing. Some variables are stationary on levels, others become

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stationary after one differentiation, and some may become stationary by more than one
differentiation. To test for the stationary of the variables, the Augmented Dickey-Fuller
(ADF) technique was utilized. The ADF equation was performed for the case when it
includes intercept only in addition to the case when it includes both intercept and time trend.
Table 3 reports the results of the unit root tests. The results indicate that both variables,
ln(GS) and ln(GDP), are not stationary on their levels. In other words, they have a unit root.
Then, we repeated the unit root test for the first difference for both variables. The results
point out that the ln(GS) and ln(GDP) became stationary after the first difference .Since the
computed absolute values are greater than the critical absolute values at a 5% level of
significance, the null hypothesis of nonstationary variable can be rejected. This implies that
these variables are integrated of order one or I(1),
Table 3: Augmented Dickey-Fuller Test (with intercept only)
III.5 Cointegration
If the time series (variables) are non-stationary in their levels, they can be integrated with
integration order 1, when their first differences are stationary. These variables can be
cointegrated as well, if there are one or more linear combinations among the variables that are
stationary. If these variables are being cointegrated, then there is a constant long-run linear
relationship among them (Anastassiou, 2005). The Johansen cointegration test is used and the
results are as presented below.
Table 4: Johnson Cointegration Test
The findings for trace and maximum Eigen value cointegration tests are presented in Table 4.
These findings show both trace statistic and maximum Eigen value statistic indicated there is
cointegration at the 1% level of significance, suggesting that there is long run relationship
between General sales tax revenue and Economic Growth. Since the null hypothesis was
rejected, we can examine the causality between variables.
III.6 Granger Causality Test
The Granger causality test was developed by Granger and according to him, a variable (in
this case General sales tax revenue) is said to Granger cause another variable (GDP) if past
and present values of sales tax revenue help to predict GDP.
A simple Granger causality test involving two variables, General sales tax revenue and GDP
is written as:
First difference Level Variable
ADF ADF Critical values %5 Critical values 1%
-3.45 -0.3 -3.05 -3.8 ln(GDP)
-2.98 -1.3 -3.06 -3.9 ln(GS)
Unrestricted Cointegration Rank Test (Trace)
Hypothesized Trace 0.05
No. of CE(s) Eigenvalue Statistic Critical Value Prob.**
None * 0.768415 28.26245 20.26184 0.0032
At most 1 0.261841 4.857546 9.164546 0.2994

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tjt
n
j
jit
n
i
it
tjtj
n
j
n
i
itt
UGDPGSGS
UGDPBaiGSGDP
2
12
1
12
.
++=
++=
−
=
−
=
−
==
−
∑∑
∑∑
δη
Testing null hypothesis: H0: α= 0, this hypothesis mean that General sales tax revenue does
not Granger cause economic growth against the alternative hypothesis H1: α ≠ 0, this
hypothesis mean that General sales tax revenue does Granger cause economic growth.
Similarly, testing H0:
δ
= 0, this hypothesis means that economic growth does not Granger
cause General sales tax revenue against H1:
δ
≠ 0, which means that GDP does Granger
cause GS.
The below table show that there is a causal relationship between General sales tax revenue
and economic growth but in one direction so that changes in General sales tax revenue have
effects on economic growth and not vice versa, where tests showed causal there was no effect
of changes in economic growth on General sales tax revenue.
Table 5 Granger Causality Test
This means that an increase or a decrease in the General sales tax revenue can affect and
causes economic growth at 1% significant level. On the other hand, economic growth does
not seem to Granger Cause General sales tax revenue. This suggests that information about
economic growth in past periods cannot explain the behavior of General sales tax revenue in
the present time.
IV. Conclusion
This paper has examined the role of General sales tax revenue in the economic growth
process in Jordan using causality tests for data over the period 1998 to 2015. Granger
causality was applied to test the causal relationship between General sales tax revenue and
economic growth. The results show that there is evidence of uni-directional causality between
General sales tax revenue and economic growth in Jordan and the direction of causality runs
strictly from General sales tax revenue to economic growth. Finally, for the case of Jordan
this paper lifts a suggestion for policy makers that the general sales tax substantially affect
the economic growth and must do more detailed studies on the relationship between the
General Sales Tax rates and economic growth in Jordan.
References
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Government Tax Revenue Growth and Economic Growth: A Case of Zimbabwe (1980-
2012). Journal of Economics and Sustainable Development 5(17): 10-21.
Null Hypothesis: Obs F-Statistic Prob.
GDP does not Granger Cause GS 16 1.23785 0.3274
GS does not Granger Cause GDP 10.3620 0.0030

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Authors
Hanan A.D Al-Abbadi
Lecturer of Economics, Faculty of Business, Al-Balqa Applied University, As Salt, Jordan,
hanan.abbadi@yahoo.com
Shatha Abdul-Khaliq*
Associate Professor, Al Zaytoonah Private University of Jordan, Amman Jordan
*corresponding author