Institutional quality and government efficiency

Poorer countries have a much smaller public sector and correspondingly a smaller tax burden than richer countries, yet, their economic performance has not been necessarily better. Using a simple model, this paper suggests that the growth and welfare effects of taxation are mediated through institutional quality; consequently, optimal tax levels increase with improved institutional quality. The paper then employs firm-level perceptions on the quality of public services and on the tax burden to test some of the model's predictions. Consistent with these predictions, the paper finds that a higher level of institutional quality bolsters positive perceptions of the quality of public services while at the same time moderating the view of taxes as an obstacle to growth.