Tax structure and public sector efficiency: new evidence for developing countries

Abstract This paper investigates how tax structure compositions influence public sector efficiency on developing countries using a combined framework of data envelopment analysis (DEA), instrumental-variable estimation and dynamic productivity analysis based on the Malmquist index. We first construct composite indicators of public sector performance (PSP) and employ them as outputs to compute efficiency scores under alternative orientations, allowing a distinction between cost efficiency and service effectiveness. Adopting a general-to-specific approach, we identify the main determinants and assess the role of different tax categories in shaping government efficiency through panel analysis. Results show that the orientation of DEA scores significantly matters and that the tax structure plays a decisive role to public efficiency. Consumption taxes consistently reduce cost efficiency and hinder economic performance, while income and corporate taxes generate a trade-off between equity and efficiency, worsening cost efficiency but often improving redistributive and stabilizing performances. Property taxes emerge as the friendliest instrument across static and dynamic specifications. Overall, results highlight that tax policy affects not only contemporaneous public sector efficiency, but also long-run productivity dynamics, with potential implications for fiscal design and decentralization.