The Determinants of Tax Revenue in Malaysia
Undergraduate Research Project i Faculty of Business and Finance
DETERMINANTS OF TAX REVENUE IN MALAYSIA
BY
BEH KEAH KIANG
CHEAH HON CHIEW
CHEK WEN HAO
LIM YONG FOONG
A research project submitted in partial fulfillment of
requirement for the degree of
BACHELOR OF ECONOMICS (HONS) FINANCIAL
ECONOMICS
UNIVERSITI TUNKU ABDUL RAHMAN
FACULTY OF BUSINESS AND FINANCE
DEPARTMENT OF ECONOMICS
MAY 2021
The Determinants of Tax Revenue in Malaysia
Undergraduate Research Project ii Faculty of Business and Finance
Copyright @ 2021
ALL RIGHTS RESERVED. No part of this paper may be reproduced, stored in a retrieval
system, or transmitted in any form or by any means, graphic, electronic, mechanical,
photocopying, recording, scanning, or otherwise, without the prior consent of the authors.
The Determinants of Tax Revenue in Malaysia
Undergraduate Research Project iii Faculty of Business and Finance
DECLARATION
We hereby declare that:
1) This undergraduate Final Year Project (FYP) is the end result of our own work and
that due acknowledgement has been given in the references to ALL sources of
information be they printed, electronic, or personal.
2) No portion of this research project has been submitted in support of any application
for any other degree or qualification of this or any other university, or other institutes
of learning.
3) Equal contribution has been made by each group member in completing the research
project.
4) The word count of this research report is 13567.
Name of Student: Student ID: Signature
1. Beh Keah Kiang 17ABB02975 ___Beh____
2. Cheah Hon Chiew 17ABB00171 _ Cheah ___
3. Chek Wen Hao 18ABB05393 __________
4. Lim Yong Foong 17ABB02913 ___Lim____
Date: 26 March 2021
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ACKNOWLEDGEMENT
Throughout the process of completing the undergraduate project, we have gained a lot of
knowledge as well as experience on encountering difficulties in researching our project.
However, as our members putting effort and cooperating to each other this research project
has been successfully carried out. Therefore, we would like to extend our gratitude to all
whom providing their assistance to our journey.
First and foremost, we are grateful to have Prof. Choong Chee Keong as the supervisor of
this research project. Without his professional advice and guidance, we would not be able
to complete this project. We really appreciate his patient for supervising us as we always
took longer time in consultation for our research project.
After that, we feel thankful to our examiner, Ms. Koay Ying Yin for the valuable comments
and recommendation for us to amend the research project before the final submission date.
Her advice has guided us and enhance our performance of our research.
Finally, thanks to all the group mates together going through the joy as well as the
difficulties throughout the process of completing the project. Thank you for the effort to
finish the research and appreciate whoever provided assistance for this study.
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TABLE OF CONTENTS
Page
Copyright Page……………………………………………………………………………i i
Declaration…………………………………………………………………………… …. iii
Acknowledgement…………………………………………………………………… ….. iv
Table of Content……………………………………………………………………… …. v
List of Tables………………………………………………………………………… … viii
List of Figure………………………………………………………………………… ….. ix
List of Abbreviation………………………………………………………………… ……x
List of Appendix……………………………………………………………………… …xi
Abstract……………………………………………………………………………… … xii
CHAPTER 1 RESEARCH OVERVIEW .........................................................................1
1.0 Introduction ....................................................................................................1
1.1 Research Background…………………………………………………… ….2
1.1.1 The Tax System and Policy of Malaysia………………………… …..2
1.2 Problem Statement ……………………………………………………… …5
1.3 Objective of the Study……………………………………………………… 8
1.3.1 General Objective………………………………………………… ….8
1.3.2 Specific Objective…………………………………………………… .8
1.4 Significance of the Study…………………………………………………… 9
1.5 Chapter Layout………………………………………………………… …..10
1.6 Conclusion……………………………………………………………...… ..10
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CHAPTER 2 LITERATURE REVIEW…………………………………………… …...11
2.0 Introduction…………………………………………………………… ……11
2.1 Literature Review……………………………………………………… …...11
2.1.1 Tax Revenue and GDP per Capita………………………………… ...11
2.1.2 Tax Revenue and Inflation………………………………………… ...13
2.1.3 Tax Revenue and Trade Openness………………………………… ...14
2.1.4 Tax Revenue and Share of Manufacturing in GDP………………… ..16
2.1.5 Tax Revenue and Public Debt to GDP……………………………… .17
2.1.6 Tax Revenue and inflow of Foreign Direct Investment (FDI)……….19
2.2 Hypotheses of Study……………………………………………………… ..21
2.3 Conclusion…………………………………………………………… ….....22
CHAPTER 3 METHODOLOGY…………………………………………………… …..23
3.0 Introduction…………………………………………………………………2 3
3.1 Research Design…………………………………………………………… .23
3.2 Sources of Data…………………………………………………………… ...23
3.3 Determinants of Tax Performance: Theoretical Issues…………………… …24
3.3.1 GDP per Capita……………………………………………………… ..24
3.3.2 Inflation……………………………………………………………… .25
3.3.3 Trade Openness……………………………………………………… .26
3.3.4 Share of Manufacturing……………………………………………… .27
3.3.5 Public Debt……………………………………………………………2 7
3.3.6 Foreign Direct Investment………………………………………........ .28
3.4 Estimation Model……………………………………………………………2 9
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3.5 Empirical Testing Methodology…………………………………………… ..31
3.5.1 Unit Root Test………………………………………………………… 31
3.5.2 ARDL Bounds Test…………………………………………………… 32
3.5.3 VECM Test……………………………………………………… ……33
3.6 Conclusion……………………………………………………………...…... 34
CHAPTER 4 RESEARCH RESULT AND INTERPRETATION ………………………3 5
4.0 Introduction…………………………………………………………… ……35
4.1 Unit Root Test……………………………………………………………… 35
4.2 ADRL Bound Test…………………………………………………….……3 7
4.3 Granger Causality Tests Based on VECM Estimation……………… ……...41
CHAPTER 5 DICSUSSION, CONSLUSION, AND IMPLICATION………………… 43
5.0 Introduction………………………………………………………………… 43
5.1 Discussion of Major Finding………………………………………….…… 43
5.2 Policy Implications of the Study…………………………………………… 45
5.3 Limitation of Study……………………………………………………. …..47
5.4 Recommendations for Future Research……………………………... ..……48
5.5 Conclusion…………………………………………………………….…… 49
References……………………………………………………………………………… 50
Appendices…………………………………………………………………………… ...58
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LIST OF TABLES
Page
Table 2.1: Hypotheses of Study………………………………………………………… 21
Table 3.1: Definition of Variable…………………………………… ………………… ..30
Table 4.1: Unit Root Test Results……………………………………………………… .35
Table 4.2: Cointegration…………………………………………………………………3 7
Table 4.3: Estimation Result of Long Run Relationship……………………………… ...37
Table 4.4: Goodness of fit & Diagnostic Checking…………………………………… ...38
Table 4.5: Granger Causality Tests Result……………………………………………… ..41
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LIST OF FIGURES
Page
Figure 1.1: Tax Revenue in Malaysia…………………………………………………… 3
Figure 1.2: Malaysia Budget Deficit (% GDP)………………………………………… ..4
Figure 4.1: Plot of the Cumulative Sum (CUSUM) and CUSUM of Squares Tests…….40
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LIST OF ABBREVIATIONS
ADF Augmented Dickey Fuller
PP Philip-Perron
ERSP Elliott Rothenberg Stock Point
ARDL Autoregressive-Distributed Lag
VECM Vector Error Correction Model
TAX Tax Revenue
GDP Gross Domestic Product
FDI Foreign Direct Investment
INF Inflation
XM Openness Level
MF Manufacturing
PD Public Debt
SST Sales and Service Tax
GST Goods and Services Tax
ARCH Autoregressive Conditional Heteroskedasticity
LM Lagrange Multiplier
ECT Error Correction Term
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LIST OF APPENDICIES
Page
Appendix I: Variables Data……………………………………………………………… 58
Appendix II: Empirical Result of Unit Root Test, ARDL Test, and VECM Test………..59
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ABSTRACT
The purpose of this research paper is to study the determinants of tax revenue of
Malaysia which are GDP per Capita, Inflation, Openness Level, Share of Manufacturing,
Public Debt, and Foreign Direct Investment. We are using the annual data from the year
1989 to the year 2018. After we conduct unit root tests, we found that all of our time series
data also have unit root (non-stationary) at their level form. Therefore, we use ARDL bound
test and VECM test to examine the long-run relationship and causality relationship between
our dependent variable and independent variables. The results show that there has a long-
run relationship between Malaysia’s tax revenue and determinants of tax revenue.
Moreover, public debt, openness level, and inflow of FDI have a positive impact on the tax
revenue of Malaysia, while GDP per capita, inflation, and manufacturing have a negative
impact on Malaysia’s tax revenue.
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Chapter 1: Research Overview
1.0 Introduction
Tax revenue is an important source of income that enables every country
government to conduct economic development activity to boost the country’s economic
growth. It has been always a hot topic to discuss what determinants are affecting the total
tax revenue collected by a country. Especially for a developing like Malaysia, taxation is
important for Malaysia in order for the government to implement new strategies to sustain
the country’s economic prosperity and keep the economic performance stable (Taha,
Colombage, & Malslyuk, 2010).
In Malaysia, the tax collection is uncertain because it can be upward and downward
according to the current economic performance. However, from Figure 1.1 we can see most
of the years Malaysia was obtaining an increasing amount of tax collection unless it faces
some serious economic crises. Malaysia’s federal government’s major source of income is
from the total tax revenue to support its government expenditure. Why taxation is important
for every country? It is because tax revenue is a foundation to support the government on
implementing their economic policies to improve the country’s development, without tax
revenue all the policies would not able to execute. Implementing an economic policy is
important for Malaysia to improve on Malaysia’s standings globally.
Researchers have been theoretically and empirically identified the relationship
between tax revenue and economic growth, and it was found a positive relationship
between each other (Taha, Colombage, & Malslyuk, 2010; Loganathan, Ahmad,
Subramaniam & Taha, 2020) Malaysia’s total government revenue is differentiated in two
categories, namely tax revenue, and non-tax revenue. For tax revenue, it is collected by the
three major departments which is Institutional Review Board and Royal Customs and
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Excise Department. For non-tax revenue is basically collect from the type of income. There
is two types of tax that collected for tax revenue, direct tax and indirect tax. The collection
of income tax from individuals, companies, and other personal consumption such as estate,
property is direct tax. Indirect tax is a tax that is not directly imposed to the tax payer but
the additional fees charged on the buyer such as sales and service tax (SST), and goods and
services tax (GST). Non-tax revenue is another source of income that the government
earned from the services provided by the government.
1.1 Research Background
This section will briefly discuss the history of Malaysia background, economic
development and tax system and policy of Malaysia.
1.1.1 The tax system and policy of Malaysia
Malaysia is one of the countries in Southeast Asia with a population of 34.2millions
in 2019 (World Bank, 2019). Malaysia has a total of 13 states from East Malaysia to West
Malaysia, and including three federal territories. Malaysia is located in between Thailand
and Singapore, West Malaysia sharing the same land with Thailand and East Malaysia
sharing with Brunei. Malaysia national capital is Kuala Lumpur and federal government
are working in Putrajaya.
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1.4 Significance of the study
One of the government's primary sources of revenue is taxation. For a developing
country such as Malaysia, the government needs to maintain good tax revenue every year.
The government uses tax revenue to execute projects and develop the country. This could
assist the country to stimulate economic growth (Dickinson & Paepe, 2014). However,
Malaysia's tax revenue to GDP has been declining over the years, the government needs to
implement a new policy to tackle the problem. Therefore, in this study, we like to look at
the relationship between tax revenue and various variables., namely GDP, Inflation,
Openness Level, Share of manufacturing, External Debt, and FDI. Many findings focus on
the independent variables except FDI. There are less studies investigated the relationship
between FDI and tax revenue. In Har, et al. (2008) study, it showed that FDI play a
significant role in Malaysia’s economy growth. Since FDI has a positive impact for the
economy growth, it should have contributed to the tax revenue as well based on Thomas &
Chaido (2005) findings. They proved the existence of causal link between marginal tax rate
and rate of economic growth. In short, Tax revenue should have a significant relationship
with FDI. However, we could not find any research regards FDI affects tax revenue in
Malaysia.
In this paper, we tend to contribute to find the determinants of tax revenue. We have
noticed that government expenditure is very high. Tax revenue is important to cover
government expenditure and reduce the budget deficit. Hence, we tend to provide a
trustworthy result for the policymakers to improve the country's fiscal policy. Our
contribution of the research is to supplement the existing literature and develop an
understanding of the determinants of tax revenue in Malaysia.
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1.5 Chapter Layout
This research is divided into five chapters. The first chapter provides an overview
of our topic, research background, problem statement, research objective, and significance
of the study. Chapter 2 provide a brief literature review based on previous empirical studies.
Besides that, Chapter 3 describes the source of data, conceptual framework, and the
selected methodologies (diagnostic testing) for the study. Meanwhile, results and
interpretation are discussed in Chapter 4. Lastly, Chapter 5 summarises the main findings
of the study, policy implications, recommendations, and the limitations of the study.
1.6 Conclusion
Tax revenue is introduced and discussed as the dependent variable in this research.
We have included six determinants of tax revenue which are GDP, inflation rate, trade
openness, share of manufacturing, public debt, and FDI. Researchers also determine the
objectives to find out the determinants of Malaysia’s tax revenue to improve its collection
performance. After that, researchers also provide a better understanding of the factors that
will affect the tax revenue. However, researchers will further discuss the literature review
in the next chapter.
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CHAPTER 2: LITERATURE REVIEW
2.0 Introduction
In Chapter 1, we focus on the research background which raises some issues
regarding the tax revenue in Malaysia. In this chapter, we will be reviewing the past
literature. We are going to discuss some findings regard to the tax revenue and independent
variables namely, GDP, Inflation, Openness Level, Share of Manufacturing, External Debt,
and FDI. We will discuss the methods and studies of the past researcher used. Other than
that, we will also state the relationship between the predicted variable and explanatory
variables from the literature.
2.1 Review of Literature
2.1.1 Tax revenue and GDP per capita
Based on the previous literature, some variables have been found to be important
determinants of tax revenue, such as real GDP growth, GDP per capita and Gross domestic
product (GDP). These are commonly used to measure market size and growth. The size of
the host country's market also reflects the country's economic situation. Basically, a good
country’s economic situation indicates more tax revenue can be generated.
According to the empirical evidence of Ayenew (2016), there will be a positive
correlation to real GDP per capita and tax revenue. Since a higher GDP per capita implies
a higher level of development, it indicates a higher ability to reimburse taxes. Hence, a
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higher ability for government to collect tax revenue. Similarly, according to Hung (2019)
's regression and correlation analysis, the results reveal that the GDP per capita on personal
income tax is positive and significant. Therefore, the more income tax that can be collected,
the higher the tax will be.
In addition, according to the Sinbo and Miubo (2013), the growth rate of economic
activity will influence on the tax revenue positively and significantly in Nigeria. Also, the
researchers Terefe and Teera (2018) used the Error Correction Model and Augmented
Dickey Fuller also found out the same positive result between GDP per capita and inflation.
They pointed out that when a country's economy grows, its tax base grows in proportion to
its income.
Besides that, the research for Gorbachev, Debela, Shibiru (2017) found that there was
a positive correlation between GDP per capita to tax revenue in Ethiopia. The tax system
in Ethiopia is progressive which means that people who earn high incomes will pay high
taxes on different tax arrangements such as rental income tax, personal income tax,
corporate income tax and business income tax etc. Thus, an increase in per capita income
will result in high tax revenue in their country.
Normally the previous researchers’ empirical evidence found out that there is a
positive relationship for GDP per capita and tax revenue. However, the last findings from
Pakistan have shown a negative relationship between the GDP per capita and tax revenue
in their regression. In other words, it indicates that tax revenue decreases with the increase
in GDP per capita. This is due to the poor tax system and high tax evasion for Pakistan
(Chaudhry and Munir,2010).
In conclusion, based on our literature review, most of the previous research stated that
GDP per capita has a positive relationship to the tax revenue. Although there is one
researcher from Pakistan shown there is a negative relationship because of the high tax
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evasion and different tax system over there. Therefore, we expected that GDP per capita
income has a positive impact on tax revenue.
2.1.2 Tax revenue and Inflation
Inflation is an increase in the price of every good and service which reduces the
purchasing power of money (Suleka, Mary and Tharmalingam, 2019). The reducing power
of money might give impact on the tax revenue. Therefore, there are several researches
have discussed on the impact of inflation on the tax revenue.
There are several researchers has investigated that inflation has negative
relationship to tax revenue. According to the to Ayenew (2012), he has used inflation in
analyzing the data of tax revenue in Ethophia in the period 1975-2013 concluded that the
inflation has impact to tax revenue negatively and significantly. Also, Mahdavi (2008)’
study stated that inflation was associated with lower tax revenues as a percentage of GDP
in developing countries. The researchers mentioned that inflation will reduce the
purchasing power of society and thus the ability of taxpayers to pay taxes will be reduced
as well. In other words, inflation will lead to citizens reduce the consumption and the profit
for businesses and companies will be lower result in lower tax revenue.
Similarly, Terefe and Teera (2018) proved that inflation is negatively correlated
and significant impact with tax revenue in East Africa, with a correlation coefficient of -
0.103. They stated abnormal rise in the price of goods and services will harm the welfare
of the whole society result in lower tax revenue. Additionally, Crane and Nourzad (2013)
also pointed out that inflation has a negative impact on tax revenue. The researchers stated
that the higher the inflation rate, the higher the likelihood of tax evasion. This is because
higher price levels will lead taxpayers to engage in more informal or shadow economic
activity, reducing tax revenues.
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However, based on the research of QadirPatoli and Zarif (2018), they found out that
there is a positive and direct relationship between inflation and the taxes in Pakistan. They
stated that developing countries tend to increase tax rates in order to reduce high inflation.
Therefore, any increase (decrease) in inflation will cause to an increase (decrease) in tax
revenues.
To sum up, most of the previous studies believed that inflation was negatively and
significantly correlated with tax revenue, this is because inflation would reduce the
purchasing power, leading to the decrease of taxpayers' income and tax revenue. Therefore,
this study expects inflation to have a negative impact on tax revenue.
2.1.3 Tax revenue and trade openness
Trade openness playing an important role that determinants tax revenue.
International trade taxes have become the main source of revenue for many developing
countries (Hisali, 2018). There are some researchers argued whether trade openness is
important for a country economic development. This is mainly because of the function of
trade between countries in long run will be significantly increase the productivity, for the
countries that are more actively on trading will be more productive (Kim, 2013; Shahbaz,
2012; Dong, 2014). Shubati and Warrad (2018) found there is two argument form a positive
relationship and a negative relationship between trade openness and tax revenue.
From the positive argument side, there are some researchers’ studies aimed to
identify the factors that can influence better tax revenue inflows (Bornhorst, 2009;
Drummond et al., 2012; Stotsky and Woldemariam, 1997). Consequently, their research
obtained the same result from the empirical evidence that showing the trade openness
having a positive relationship to the tax revenue and they explained it by the increase of
productivity of output and enhance the economic growth, therefore increase the tax revenue
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as well. Mushtaq (2012) also indicated international trade openness is positively correlated
on tax revenue by identifying the determinants of tax revenue of Pakistan from 1975 to
2010. Through their research, there are many variables that determinants the tax revenue
such as exchange rate, gross domestic product. However, the study claimed that by
comparing to all the variables trade openness is found to be more significant to the tax
revenue of Pakistan.
Gnangnon (2017) also supported trade openness has a positive relationship on tax
revenue in the long run from his research. The research is based on panel data of 169
countries for the period of 1995 to 2013 by identifying the impact of trade openness to tax
revenue, then the study obtained a positive relationship of trade openness and tax revenue.
Especially in long run, a higher level real GDP of the country will increase the positive
impact of trade openness of tax revenue. Based on Lutfunnahar’s (2007) study also
identifying the determinants of tax revenue in Bangladesh. From the study result, he
claimed that for Bangladesh the increasing trade openness will also increase the tax revenue.
Piancastelli (2001) sampling 75 countries for the period 1985-1995, his study finds
trade openness having a positive relationship to tax revenue. According to Bahl (2003)
study, the data of OECD and developing countries found trade openness is positively
correlated to tax revenue. Therefore, most of the previous research that study on the
determinants of tax revenue support trade openness positively correlated to tax revenue.
However, there are also few researchers who argued there is a negative relationship
between trade openness and tax revenue. According to Khattry and Rao (2002), they argued
the trade liberalization can lead in decrease in government revenue. They explained it
because indirect tax revenue is the major income for developing countries such as the taxes
collected from import tariffs. Thus, when the degree of trade openness is higher it will
cause a reduction in the restriction of import tariff and hence, it decreases the tax revenue.
Cage and Gadenme (2014) also indicated trade openness is having a negative impact on
developing countries. Based on Shubati and Warrad (2018) by using panel fully modified
OLS to estimate the relationship between trade openness and government revenue and
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found negatively correlated. Johnson, Hammed and Odunsi (2018) also conducted the
Augmented Dicky-Fuller Unit Root test to identify the relationship of trade openness and
tax revenue and found negatively correlated to each other.
2.1.4 Tax Revenue and Share of manufacturing in GDP
Many scholars discuss the contribution of manufacturing to tax revenue. According
to Teera (2003), she concluded that manufacturing enterprises are typically contributed to
tax revenue. She stated that typically manufacturing enterprises keep better books of
accounts and records than other industries such as agriculture. Well recorded accounts are
easier to tax. In the research of Uganda, the results proved that the theory of manufacturing
has significant effects on total tax revenue. However, there are certain researches believe
in the theory that manufacturing positively affects tax revenue but the empirical results
were insignificant. According to Chaudhry and Munir (2010), their finding also showed
that manufacturers are having better bookkeeping skills in general but the effect of
manufacturing value-added in Pakistan is insignificant due to lower manufacturing volume.
They also mentioned that tax incentives in Pakistan are only given to large enterprises that
contribute to low tax revenue. This indicates that small manufacturing volume could not
significantly affect the tax revenue.
In other findings, we have discovered that a wider manufacturing market is easier
to track and tax., a larger share of manufacturing in GDP contributes to economic
development. However, not every country has the same empirical results. The study
showed that manufacturing imports have a negative relationship in the lower-income
country (Morrisey, et al., 2016). The relationship between tax revenue and manufacturing
activities are depended on the nature of the country. Morrisey specifically mentioned that
lower-income, non-resource rich, and non-democracies countries will have a negative
relationship, based on the empirical results. The researchers explained that poorer counties
usually maintain a low tax rate for the manufacturing enterprise to sustain their
international competitiveness. By considering that poor countries have a lower
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manufacturing volume and low tax rate, the contribution of tax revenue from
manufacturing activities will be insignificant.
Furthermore, a study of Iran also showed a positive relationship between tax
revenue and industry activities. According to Basirat, Aboodi, and Ahangari, as the
industrialization of a country increase, economic activities are exploited in larger scales,
hence encourage further taxation. The more the country develops economically, the more
the domestic consumption and import increase, the industry activities will increase and
ultimately increase the tax revenue to increase.
Therefore, whether the share of manufacturing in GDP increase or decrease tax
revenue is an ambiguous question. The relationship is depending on the nature of the
country (Morrisey, et al., 2016). In this study, we are using manufacturing in GDP as a
determinant that increases the tax revenue mainly because the share of manufacturing as a
percent of GDP in Malaysia is more than 20% since 1988 (The World Bank, 2019).
Manufacturing operations have a huge economic effect. Nonetheless, most of the
manufacturing firms have better recording accounts than other sector firms, this will
increase the tax capacity of Malaysia. As the volume of manufacturing increases, the tax
revenue is increased.
2.1.5 Tax revenue and public debt to GDP
Public debt to GDP is normally used to indicate the government’s ability to meet
its future obligations, which will influence fiscal policy decisions. Therefore, public debt
is an important factor in determining the taxation in a country. A research paper described
that after they apply the annual balance panel data and study on selected 22 OECD
countries, there is a significant positive relationship between government debt and tax
revenue (Ong et al., 2014). In other words, when a country’s public debt increases, it will
lead to an increase in the country’s tax revenue. On the other side, Alawneh have found a
significant positive relationship between tax revenue and public debt in Jordan (Alawneh,
2017). This research paper not only has separated the public debt into external debt and
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internal debt as two independent variables but also added capital and current public
expenditure as another two independent variables to explain the tax revenue in Jordan. Both
of these four variables also show the significant positive related to tax revenue in Jordan.
However, a small group of economists found that the relationship between public
debt and tax revenue can be significantly negative in some countries or regions. For
instance, Republic (2018) has pointed out government debt and tax revenue is a significant
negative relationship in 23 selected countries. Besides that, Ismail et al. (2019) found that
the relationship between public debt and economic growth is ambiguous and also stated
that if the borrowing is used for productive purposes, the negative relationship will turn to
positive. Simply put, if the government makes good use of the borrowed money to develop
the country, the national economy will rise. On the contrary, if the government does not
make good use of the borrowed money to develop the country, the higher the country’s
debt, the greater the slowing down of the country’s development. As we mentioned above,
there has a significant positive relationship between tax revenue and economic growth.
Therefore, it’s not difficult for us to understand why some studies show a negative
relationship between public debt and tax revenue in certain countries.
On the other hand, Krogstrup (2002) pointed out the taxes of EU countries with
high-debt normally higher than EU countries with low-debt. In other words, it’s indicated
that the higher debt of a country, the higher the country’s tax revenue (the positive
relationship between tax revenue and public debt). In a subsequent study, Eltony (2002)
found that outstanding foreign debt is significantly positive related to the tax revenue in 16
selected Arab developing countries. In addition, they claimed that Arab countries will raise
the tax rate in order to reduce government debt, which leads the public debt to have a
positive relationship related to the tax revenue.
In conclusion, bases on previous empirical review, the impact of public debt on tax
revenue is ambiguous, it has to depend on the nature of the country. However, we believe
public debt is an important determinant of tax revenue in a country because public debt
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able to influence the government’s fiscal policy decision. Therefore, we selected public
debt as an independent variable to explain Malaysia’s tax revenue in our research.
2.1.6 Tax revenue and inflow of Foreign Direct Investment
Foreign direct investment (FDI) is where individuals or companies from one country
invest in another country (Boyce, 2020). FDI is an important factor in determining tax
revenue indirectly through economic growth. According to a research paper of
“Determinants of Tax Revenue in Ethiopia”, there have a positive relationship between tax
revenue and the net inflow of foreign direct investment and statically significant in Ethiopia
(Gobachew, Debela, and Shibiru, 2017). Hence, when the country’s net inflow of FDI
increases, the country’s tax revenue will increase. After that, based on the research paper
“Long Run Effect of FDI on Tax Revenue” shows that the inflow of FDI has a positive
impact on tax revenues in developing countries excluding resource exporting countries in
the long run (Camara, 2019). On the other hand, the result of this research paper also
indicates that the impact of FDI inflows on tax revenue is positive, but there was no
statistical significance at the conventional level of significance in the short term.
Besides that, Grop, and Costial (2000) have pointed out the inflow of FDI can
indirectly have a positive impact on the total tax revenue by promoting economic growth
and employment. Simply put, the increase in FDI inflows can increase the country’s
employment rate and promote economic growth. After that, economic growth is the main
driver of taxation levels. In an era of increasing taxes, the economy is performing well
(Lundeen,2017). On the other hand, the benefits of FDI inflow include job creation and
increased government tax revenue (Abbas, & Xifeng, 2016). In other words, this shows the
positive relationship between FDI inflow and employment rate as well as employment rate
and total tax revenue. Therefore, there has an indirect positive relationship between FDI
inflow and the tax revenue.
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Appendix II: Empirical Result of Unit Root Test, ARDL Test, and VECM Test
Unit Root Test: ADF
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Ng-Perron
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ERSP
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VECM Test
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