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MINISTRY OF EDUCATIONAL & TRAINING
UNIVERSITY OF ECONOMICS HO CHI MINH CITY
_________
NGUYEN PHUONG LIEN
PUBLIC FINANCE, GOVERNANCE AND
ECONOMIC GROWTH
DOCTORAL DISSERTATION

2
MINISTRY OF EDUCATIONAL & TRAINING
UNIVERSITY OF ECONOMICS HO CHI
MINH CITY
_________
NGUYEN PHUONG LIEN
PUBLIC FINANCE,
GOVERNANCE AND ECONOMIC
GROWTH
Specialization: Finance-Banking(Public Finance)
Specialization code: 9340201
DOCTORAL DISSERTATION
SUPERVISOR:
Prof. SU DINH THANH

Ho Chi Minh City - 2018

i
COMMITMENT
I commit that, throughout the whole process, I did this research based on
ethical rules and laws for academic scientific research, including creating research
ideas, conducting the literature review, collecting data, as well as the data analysis
and research interpretation. In addition, I commit that I conducted this study by
myself. The dissertation uses the data and analysis that I did by myself.
Committed by
PhD student

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ACKNOWLEDGEMENTS
First, I would like to express my deepest appreciation to my supervisor,
Professor Sử Đình Thành, for his lectures as well as coaching me while I performed
this research. Without his instructions and persistent support, this dissertation would
not have been possible.
Second, I would like to thank all UEH’s lecturers who instructed me in my
research methods courses during my time as a Ph. D. student in the University of
Economics, Ho Chi Minh City. Dr. Trần Thị Tuấn Anh’s expert guidance was
especially valuable for completing my research with clear and logical interpretations
of the methodology.
Third, I am also grateful to my parents, my young sisters, and my sons for
their encouragement in my life. I also wish to express my endless thanks to my love
for his sacrifice and daily care of me.
Finally, last but by no means least, thank you to all my colleagues who
shared with me their useful comments to help complete my publication.

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TABLE OF CONTENT
Table of Contents
COMMITMENT ........................................................................................................... i
ACKNOWLEDGEMENTS ........................................................................................ ii
TABLE OF CONTENT ............................................................................................. iii
ABBREVIATIONS................................................................................................... vii
LIST OF TABLES ..................................................................................................... ix
LIST OF FIGURES.................................................................................................... xi
CHAPTER 1 ................................................................................................................. 1
INTRODUCTION........................................................................................................ 1
1.1. Research background ...................................................................................... 1
1.1.1. An overview of the status of global economies in the period 1996–2016 . 1
1.1.2. The differences of public finance and growth between developed and
developing countries .............................................................................................. 5
1.2. Research motivation ..................................................................................... 10
1.3. Research objectives and research questions ................................................. 14
1.4. Research scope .............................................................................................. 15
1.5. Research methods ......................................................................................... 16
1.6. Research contribution ................................................................................... 18
1.7. Structure of dissertation ................................................................................ 21
CHAPTER 2:.............................................................................................................. 23
LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT ....................... 23
2.1. Introduction ...................................................................................................... 23
2.2. Some key concepts ........................................................................................... 24
2.2.1. Public finance ............................................................................................ 24
2.2.1.1 . Tax revenue ...................................................................................... 25
2.2.1.2 . Government expenditure .................................................................. 26
2.2.2. Governance and corruption ...................................................................... 27
2.2.2.1 Governance .............................................................................................. 27

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2.3 Theoretical literature on the relationship between public finance and
economic growth................................................................................................... 34
2.3.1 Public choice theory................................................................................. 34
2.3.2. Cost-benefit theory of taxation................................................................ 35
2.3.3. Governance theory .................................................................................. 38
2.3.4. Economic growth theory: Exogenous and endogenous growth theory... 40
2.4 Empirical literature on relationships among public finance, governance, and
economic growth................................................................................................... 42
2.4.1 Empirical literature on relationships between public finance, and economic
growth ................................................................................................................... 42
2.4.2. Relationship between tax revenue and government expenditures........... 47
2.5 Designing the analytical framework and building hypotheses....................... 54
2.6. Summary........................................................................................................ 58
CHAPTER 3............................................................................................................. 60
METHODS AND RESEARCH DATA................................................................... 60
3.1 Introduction..................................................................................................... 60
3.2. Research models ............................................................................................ 60
3.2.1 Long-term linkages between public finance, and economic growth ........ 60
3.2. 2 Tax revenue and expenditure relationship.............................................. 63
3.3 Research data and its source ........................................................................... 66
3.3.1. Determining appropriate variables and its sources................................ 66
3.3.2 Collecting secondary data........................................................................ 69
3. 4 Check balance and essential test.................................................................... 70
3. 5 Choose appropriate analytical methods......................................................... 71
3.7. Summary ........................................................................................................... 80
CHAPTER 4............................................................................................................. 81
PUBLIC FINANCE, GOVERNANCE, AND ECONOMIC GROWTH: A LONG
RUN ANALYSIS..................................................................................................... 81
4.1. Research data ................................................................................................. 81
4.2. Long-run relationship between public finance and economic growth .......... 85

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4.3. Linkage between tax revenue and government expenditure....................... 87
4.4. Results of examining role of governance in modifying effect between public
finance and economic growth............................................................................... 88
4.4.1 The role of governance in modifying effect between public finance and
economic growth in developing countries......................................................... 88
4.4.2 The role of governance in modifying effect between public finance and
economic growth in developed countries .......................................................... 91
CHAPTER 5:............................................................................................................ 96
CONCLUSION, IMPLICATION AND LIMITATION.......................................... 96
5.1. Conclusion ..................................................................................................... 96
5.2. Suggestion to policy makers.......................................................................... 98
5.3. Research limitation and future research ........................................................ 99
LIST OF AUTHOR’S PUBLICATION ................................................................ 100
REFERENCES....................................................................................................... 103
APPENDICIES .......................................................................................................... 1
Table Appendix A1................................................................................................. 1
List of studied countries.......................................................................................... 1
Table Appendix A2................................................................................................. 4
Table Appendix A3................................................................................................. 8
Table Appendix A4............................................................................................... 15
Table Appendix A5............................................................................................... 18
Table Appendix A6............................................................................................... 18
Results of variance inflation factor test (VIF) ...................................................... 18
Table Appendix A7............................................................................................... 20
Table Appendix A8............................................................................................... 21
1. Description of variables.............................................................................. 21
2. Correlation matrix ...................................................................................... 22
3. HT and IPS unit root test results (normal variables) ................................. 22
4. Results of co-integration test ...................................................................... 29
5. Granger test results..................................................................................... 34

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6. Results of verification of governance role in modifying economic growth by
SUR model......................................................................................................... 35
7. Results of verification of governance role in modifying economic growth by
SGMM................................................................................................................ 42
8. Robustness check with CPI ......................................................................... 47
9. Results of non-linear test ............................................................................ 58

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ABBREVIATIONS
Words
GDP
OECD
RGDP
LRGD
GEXgdp
TAXgdp
RE
FE
OLS
SGMM
GMM
SUR
EC
GLS
2SLS
HT
IPS
UEH
USA
US
UK
BI
ICRG
WB
IMF
Meanings
Gross Domestic Products
Organization for Economic Co-operation and
Development.
GDP per capita
Logarithm of GDP per capita
Government expenditure
Total Tax revenue
Random-Effects
Fixed Effects
Ordinary Least Square
System Generalized Method of Moments
Generalized Method of Moments
Seemingly Unrelated Regression
Error Correction
Generalized Least Square
Two-stage Least Square
Harris-Tzavalis (1999) test
Im-Pesaran-Shin (2003) test
University of Economics Ho Chi minh City
United States of America
United States
United Kingdom
Business International Corporation
International Countries Risk Guide
World Bank
International Moneytary Fund

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UNDP
WDI
WGI
WEO
HDI
CCI
CPI
ECM
TI
United Nations Development Programme
World Development Indicators
World Governance Indicator
World Economic Outlook
Human Development Index
Control of corruption indicator
Corruption perception index
Error correction mechanism model
Transparency International

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LIST OF TABLES
1. Table 1.1: the global economic growth rebound .............................................. 1
2. Table 3.1: Variables………………………………………………………..68
3.Table 4.1: Description of variables ………………………………………. 81
4. Table 4.2: Correlation matrix ………………………………………………82
5. Table 4.3: Results of unit root test for a panel with normal data for the whole
sample in 1996-2016………………………………………………………….. 83
6. Table: 4.4: Results of unit root test for a panel with data of first different
values for the whole sample in 1996-2016…………………………………… 84
7. Table 4.5: Westerlund long-run cointegration test results (lrgdp)………… 85
8. table 4.6: Westerlund long-run cointegration test results (tax – exp)……... 86
9. table 4.7: Pairwise Granger test results……………………………………...87
10. Table 4.8: Westerlund long-run cointegration test results (lrgdp; Taxrev, and
Gexp)…………………………………………………………………………...89
11. Table 4.9: The results of verification influence of corruption on public
finance and economic growth in completely 82 developed and developing
countries……………………………………………………………………… 91
12. Table 4.10: The results of verification of the influence of corruption on
public finance and economic growth in 44 developing countries……………. 92
13. Table 4.11: The results of verification of the influence of corruption on
public finance and economic growth in 38 developed countries……………. 93
Appendicies
14. Table A1: List of studied countries…………………………………………1
15. Table A2: Summary of measurement of economic growth relating to tax
revenue and expenditure………………………………………………………4
16. Table A3: Summary of examination of hypotheses of tax revenue and
spending…………………………………………………………………………8
17. Table Appendix A4: Summary of measuring and evaluating effects of
corruption on public finance and economic
growth…………………………………………………………………………15
18. Table Appendix A5: Non-Linear correlation test results
…………………………………………………………………………………18

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19. Table Appendix A6: Results of variance inflation factor test
(VIF)…………………………………………………………………………..18
20. Table Appendix A7: Public choice timeline………………………………..20
21. Table Appendix A8: The analytical
results………………………………………………………………………….21

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LIST OF FIGURES
1. Figure 1.1: The line trend of global per capita income growth and ratio of tax
revenue and government spending in 1996 and 2016 in 38 developed
countries. ......................................................................................................... 2
2. Figure 1.2: the line trend of global per capita income growth and ratio of tax
revenue and government spending in 1996 and 2016 in 44 developing
countries .......................................................................................................... 4
3. Figure 1.3: the shrink frequency rate............................................................... 5
4. Figure 1.4: Line trend of tax revenue – government expenditure – GDP per
capita for whole sample in 1996-2016............................................................ 6
5. Figure 1.5: Line trend of tax revenue – government expenditure – GDP per
capita for 44 developing cuntries in 1996-2016.............................................. 6
6. Figure 1.6 : Line trend of tax revenue – government expenditure – GDP per
capita for 38 developed cuntries in 1996-2016............................................... 7
7. Figure 1.7: The control of corruption indicators in 38 developed countries in
1996 and 2016................................................................................................. 8
8. Figure 1.8: The control of corruption indicators in 44 developing countries in
1996 and 2016................................................................................................. 9
9. Figure 2.1: Public sector in the economy………………………………… 26
10.Figure 2.2: Analytical framework of correlation of public fiance, corruption
and economic growth. ………………………………………………… 57

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Abstract:
This dissertation runs a co-integration and Granger causality tests that
corroborate the existence of long-run co-integration linkages of public finance and
economic growth and a bi-directional causal correlation between tax revenue and
government expenditure. This finding suggests that to control deficits, a
government’s decisions on collecting taxes and government expenditure should be
simultaneous. To verify the effects of governance represented by control of
corruption on modifying the relationship between public finance and economic
growth, this study applies a seemingly unrelated regressions model for the dataset,
followed by a robustness check using a corruption perception index developed by
the Transparency International organization. Measuring public finance by two
factors: total tax revenue and general government expenditure helps this study to
confirm the results, which reveal that the governance has a positive role in the
economy. Additionally, the interaction between governance and tax revenue or
government expenditure affects economy diversely depending on the different
economic groups of developing and developed countries1
. For instance, in
developing countries, the interaction between public finance and governance always
becomes a beneficial factor for growth. While in developed countries, this
interaction does not have any meaning with taxation. Therefore, it may increase the
efficiency of government expenditure only. On the first side, the findings also
suggest that developing countries should focus on governance in anti-corruption to
increase the effectiveness of public finance and promote their economic growth. On
the other hand, developed countries should make the decision on collecting tax
separately with control of corruption.
1 In this study we call the “developed countries” are high-income countries, which were classified by World
bank and determined as those with a GNI per capita, computed using the World Bank Atlas method. On 1
July 2015, high-income countries gained more than $12,736. This study also calls the “developing countries”
are those countries were classified by World bank as seen as below. Low-income economies are determined
as those with a GNI per capita of $1,045 or less in 2014; Lower-middle-income economies are those with a
GNI per capita of more than $1,045 but less than $4, 125; and upper-middle-income economies are more than
$4,125 but less than $12,736.

xiii
Keywords: long-term economic growth, co-integration test, governance,
government expenditure, total tax revenue.
JEL Classifications: O40, C52, D73, H20

1
CHAPTER 1
INTRODUCTION
1.1. Research background
1.1.1. An overview of the status of global economies in the period 1996–
2016
During this period, the global economy witnessed the financial crisis
that arose when the real estate bubble exploded in the US in 2007, driving the
US financial crisis and influencing production and exports in numerous
developing countries. However, the World Bank’s report said that in 2016, the
economy’s growth recovery has rebounded (see table 1.1).
Table 1.1: the global economic growth rebound
Actual
2001- 2009- 201 201
2015 2016
08 12 3 4
World 4.20 3.30 3.30 3.40 3.10 3.60
Advanced economies 2.20 0.60 1.10 1.80 2.00 2.20
Emerging market and developing
6.50 5.50 5.00 4.60 4.00 4.50
countries
Commonwealth of independent
7.20 1.70 2.20 1.00 -2.70 0.50
States
Emerging and developing Asia 8.40 8.00 7.00 6.80 6.50 6.40
Emerging and developing
4.60 2.10 2.90 2.80 3.00 3.00
Europe
Middle East, North Africa,
5.40 4.10 2.30 2.70 2.50 3.90
Afghanistan, and Pakistan
Latin American and the
3.60 3.20 2.90 1.30 -0.30 0.80
Caribbean
Sub-Saharan Africa 6.10 5.00 5.20 5.00 3.80 4.30
Low-income developing
6.40 5.90 6.10 6.00 4.80 5.80
countries
Emerging market countries 6.50 5.50 4.90 4.50 3.90 4.40
Fragile States 5.00 6.60 4.90 1.30 1.40 6.30

Small States 5.50 2.40 1.60 2.30 1.40 2.80
Source: World Bank Group (2016)

2
Figure 1.1: The line trend of global per capita income growth and ratio of
tax revenue and government spending in 1996 and 2016 in 38
developedcountries.
Source: World bank’s database – WDI and IMF’s database – GFS.

3
From figure 1.1, we can see that there is a difference in income per
capita between 1996 and 2016 in developed countries. The maximum income
per capita is more than 13.8 times the minimum in 1996. By 2016, this gap has
declined to only 6.5 times. In 1996, Norway had the highest income per capita
at more than 73,626.16 US dollars. In contrast, Latvia had the lowest at almost
5,321.397 US dollars. In 2016, Norway still had the highest GDP per capita,
which was about 90,344.41 US dollars. However, the Seychelles had the
lowest income per capita (only 13,963.59 US dollars of GDP per capita).
Additionally, most developed countries collected more tax and spent less. In
1996, Norway’s tax revenue as a proportion of GDP was nearly 53.5 percent,
while its expenditure was only 47.5 percent. An interesting point is that
Latvia, with the lowest income per capita, also collected less tax (36.38%) and
spent more (37.03%). Norway continued to maintain its tax revenue
proportion at more than 53 percent of GDP in 2016.

4
Figure 1.2: the line trend of global per capita income growth and ratio of
tax revenue and government spending in 1996 and 2016 in 44
developingcountries
Source: World bank’s database – WDI and IMF’s database – GFS.
There is a large gap (152.43 times) between the highest and lowest
GDP per capita in developing countries in 1996. At about 30,333.74 US
dollars, Islamic Republic of Iran had the highest income per capita, while
Ethiopia remained at the bottom with only about 199.005 US Dollars. Islamic
Republic of Iran collected tax revenue of 20.165 percent of GDP and spent
more than 21.08 percent of GDP. In contrast, Ethiopia collected only 14.86
percent of GDP in tax revenue and spent 18.79 percent of GDP. In 2016, the
gap between the highest and lowest GDP per capita in developing countries is
lower than in 1996 at about 26.68 times. Russia remained at the top with about
11,099.17 US dollars per capita, while Madagascar had only 416.0027 US
dollars per capita. Russia increased their tax revenue proportion more than
1.02 percent compared with 1996, however this country spent lower than 1996
(see figure 1.2).

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1.1.2. The differences of public finance and growth between developed
and developing countries
a) Growth rate and stability in economies
Figure 1.3 shows that in the high income countries, the economy has
been on the way becoming stability thoughout the years, whereas in the case
of meddilde income and low income countries, it has not been so.
Figure 1.3: the shrink frequency rate
Source: World Bank group (2017)
b) Tax revenue, government expenditure, and control of corruption
Tax revenue is an important component of revenue for most
governments. While most developing countries collected less in taxes than
developed countries, they spent more, and their economies grew more rapidly
from 1996 to 2016 (see figure 1.5 ).

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Figure 1.4: Line trend of tax revenue – government expenditure – GDP
per capita2
for whole sample (82 countries) in 1996-2016
Source: World bank’s database – WDI and IMF’s database - GFS.
Figure 1.4 shows the trend of spending more and fast trend of economic
growth in whole 82 countries.
Figure 1.5: Line trend of tax revenue – government expenditure – GDP
per capita for 44 developing cuntries in 1996-2016
Source: World bank’s database – WDI and IMF’s database - WEO.
Through figure 1.5, we can observe that the rapid economic growth
trend in developing economies is the same as that of the whole sample.
2 GDP per capita is gross domestic product divided by midyear population. The World Bank
considered that GDP is the sum of gross value added by all resident producers in the economy plus
any product taxes and minus any subsidies not included in the value of the products. This calculation
of GDP is without making deductions for depreciation of fabricated assets or for depletion and
degradation of natural resources. Data are in constant 2010 U.S. dollars.

7
However, beginning in 2010 these countries have attempted to spend more and
collect fewer taxes for rapid growth
Figure 1.6 : Line trend of tax revenue – government expenditure – GDP
per capita for 38 developed cuntries in 1996-2016.
Source: World bank’s database – WDI and IMF’s database - GFS.
In contrast, developed countries prefer to collect more taxes and spend
less to maintain a slow rate of growth in their economies (see figure 1.6). The
World Bank’s report shows that a large gap exists between developed and
developing countries in economic growth, as well as tax revenue. What is the
cause of the differences between two these groups of countries? Policy makers
around the world have been challenged in dealing with this question. In
summary, the global economy from 1996 to 2016 varies from year to year.
There is a large gap in income per capita between developed countries and
developing countries. There is also a large gap in the ratio of contribution to
global GDP growth. As mentioned by Spence (2011), the global monitoring
report 2015/2016 confirms that high-income countries contributed 60% to
global GDP growth in 2014, but their population was less than 15%.
Moreover, the World Bank estimated that income per capita in this period
might have increased more than it will in future periods. There are also large
differences between poor and rich countries in tax revenue, effectiveness of
government expenditure, and corruption, in this period. The maximum of GDP

8
per capita can be bigger than the minimum by 490 times. The largest gap
between the highest rate of tax revenue or expenditure and its lowest is 7
times. The highest indicator of control of corruption is 2.47, while the lowest
is only -1.53 (see table 4.1).
Control of corruption (1996) in 38
developed countries
2.5
2
1.5
1
0.5
0
-0.5
-1
Control of corruption (1996)
developed countries
2.5
2
1.5
1
0.5
0
-0.5
Figure 1.7: The control of corruption indicators in 38 developed
countries in 1996 and 2016
Source: World bank’s database –WGI.

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developing countries
1
0.5
0
-0.5
-1
-1.5
-2
BeninCo
te…Et
hiopiaIslamic…M
adagas…M
auri
tiusSout
h…Tunisia
Arme
niaCam
bodiaI
ndonesiaM
alaysiaNepalPhili
ppinesVNBel
iz
eBraz
ilCol
ombiaG
eo
rgiaJa
maicaPer
uRussia
1
0.5
0
-0.5
-1
-1.5
developing countries
Russia
Peru
Jamaica
Georgia
Colombia
Brazil
Belize
VN
Philippines
Nepal
Malaysia
Indonesia
Cambodia
Armenia
Tunisia
Africa
Mauritius
Madagascar
Islamic…
Ethiopia
d'Ivoire
Benin
South
Cote
Figure 1.8: The control of corruption indicators in 44 developing
countries in 1996 and 2016
Source: World bank’s database –WGI.
Through figure 1.7, we find that in 2016, with exception of Greece,
which maintained a negative index of control of corruption, most other
developed countries had a positive index of control of corruption. However,
figure 1.8 indicates that most developing countries showed a negative index of

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control of corruption, and a lower index of human development of around 0.26
to 0.7. In 1996, the developing country with the highest index of human
development is Bulgaria, and the lowest was Mali. This index improved; in
2016, the highest index is 0.8 and belongs to Russia, while Mali remained the
lowest (0.44). Georgia is a country that improved its corruption status too
rapidly. In 1996, this country had the lowest indicator of control of corruption
(-1.53), and Namibia had the highest score of about 0.81. In 2016, Georgia
became the country with the highest score of control of corruption (0.67),
while Cambodia was at the bottom with a -1.3 score of control of corruption.
The real situation of global economies requires us to answer the question:
How does public finance correlate with economic growth in long-term? Does
total tax revenue and government expenditure affect each other? How does
governance change the impact of public finance on economic growth
differently according to different economic groups?
1.2. Research motivation
First, public finance is a key source of government budget and its
effects are complicated. Holley (2011) argued that any change in public policy
could affect economic activities. However, until now a little research
examined the relationship between economic growth and public finance,
which measure by total tax revenue and general expenditure. Nevertheless,
government expenditure is a major source of public goods. Lump-sum taxes
for each person should guide government expenditure. In contrast, Barro’s
(1990) argument is too simple, because his assumption relates only to income
taxes. Tax revenue and government expenditure can demonstrate the full
effectiveness of government quality and capability. For instance, the
government can use the value from collecting taxes to develop labor force, to
supply the appropriate infrastructure, or to invest the new technologies.
Additionally, the labor force, infrastructure, and new technologies are key

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sources, which promote the production and ensure the safety society.
Furthermore, any taxes change can drive the investors and households to make
a different decision (Aghion and Howitt, 2009). The total tax revenue includes
sale tax, income tax, export-import tax, capital and environment taxes, etc. In
case if government increase or reduce any tax rate or expand the tax base, so
investor or households could change their behavior in investment or
consumption. As we may know that, these activities can affect the capital
stock, which is a major factor of the economic growth model. However, the
almost previous study argued the role of the subcomponent of taxes or
expenditure only. The question, therefore, is “How closely does public finance
correlate with the economy?” In the last two decades, the results seem to be
mixed and confusing. Most researchers have examined and evaluated the
growth effect of subcomponents of taxes, such as income taxes, sale taxes,
property taxes, or direct and indirect taxes. In contrast, a large body of
literature has considered the influence of the share of government expenditure
on economic growth. However, evaluating a government’s capabilities may
require considering the full meaning of public finance. Additionally, a few
studies have revealed that the linkages among the quality of governance, the
size of public sector and economic growth are ambiguous, and need to be
clarified (Dzhumashev, 2014.) That is why this study measures public finance
by the ratio between total tax revenue and GDP and total general government
expenditure per GDP rate and we try to examine the relationship between
these variables and economic growth to fill in the above gap.
Second, in the last two decades, both public choice theory and cost-
benefit theory posed the challenge for future research to determine the long-
term relationship of economic growth with public finance. In addition, short-
term effects of tax changes can be different from long-term effects because of
the elasticity of the demand curve. For planning future economic activities,
researchers should clarify these effects (Stiglitz, 2000 and Holley, 2011).

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Additionally, determining the long-term economic relationship between tax
revenue and expenditure supports policymakers worldwide in designing
appropriate policies for taxes and spending, as well as avoiding deficits.
However, until now, the results of empirical research seem to be mixed and
confusing. Moreover, tax revenue and expenditure are two major components
in the creation of a government budget (Holley, 2011 and Hillman, 2009).
Governments will face a deficit if they spend more, or collect less in taxes.
Currently, the long-term relationship among tax revenue, expenditure, and
economic growth is an important challenge, attracting more research to aid
policymakers in developing appropriate fiscal policies for operating their
economies, and handling future deficits. That is why this study tries to confirm
the persistence of this relationship in the long term (See Lien and Thanh,
2017). In addition, to help the government to handle the deficit, policymakers
should understand the direction of links between tax revenue and expenditure.
This research continues to identify the direction between two major parts of
public finance: tax revenue and expenditure.
Third, the effects of corruption on economic activities and outcomes
are ambiguous and diverse. In the last decades, the results in the literature
about the role of corruption in economies are unclear. As we may know that,
each economy has both sides of the private sector and public sector. However,
public finance is a major factor that led to both private and public activities
depending on governance and its quality. Until now, governance theory
continues to argue the role of corruption and government in affecting the
relationship between economic growth and public finance. There are
numerous debates about the complicated role of corruption in economic
growth. Some previous researchers have said that corruption has a “greasing”
role and a “salting” role in the wheels of an economy, depending on different
groups of countries. Méon and Weill (2010) confirmed the hypothesis that
corruption is “efficient grease” in extremely inefficient countries and it is less

13
damaging to efficiency in countries with less institutional quality. Through
this research, we do not know how corruption does affect public finance and
under effects of anti-corruption how public finance does promote the
economy. Bird et al. (2008) considered the tax revenue as a share of GDP and
could represent the tax effort or tax capacity of a country. They said that
control of corruption positively promotes tax revenue. Belkaoui (2008) used
the data of control of corruption following Kaufman (2004) for 30 developed
and developing countries and indicated that control of corruption has a
significantly positive effect on both tax compliance and tax expenditure in
both developed and developing countries. Nevertheless, two above studies did
not verify the influence of control of corruption on expenditure and growth.
Dzhumashev (2014) also showed that corruption forces government spending
to be more effective. He suggested that increasing levels of corruption may
improve economic growth in less developed countries, but it should be
detrimental in developed countries due to higher costs of private production.
d’Agostino et al. (2012) and Ugur (2014) indicated that corruption suggests
weakness of institutional quality, and has a potentially harmful effect on
economic growth. Moreover, d’Agostino et al. (2016) revealed that, although
corruption does not directly affect the growth of economies, its interaction
with spending on investment and military negatively affects economic growth.
In summary, only those countries that maintain a low corruption index achieve
high tax revenue, spend less, and maintain stable growth of their economy. In
the last decades, most previous scholars who assessed the crucial role of
corruption noted the “greasing or salting” of the wheels of an economy,
depending on the different groups of countries. There is little literature that
evaluates the way corruption modifies public finance before its direct effects
on economic activities. Furthermore, the relationship between anti-corruption
and other macroeconomic variables are complicated. The role of corruption in
an economy depends on government size, as well as the quality of governance,

14
and need to be clarified (Méon and Weill, 2010; Dzhumashev, 2014 and Ugur
2014). Until now, the question: “How governance in anti-corruption does lead
the public finance and economic growth?” The answer to this question
becomes challenged the economist in over the world.
1.3. Research objectives and research questions
1.3.1 Research objectives
This dissertation attempts to obtain the three below research objectives:
First, this study investigates the long-run linkages between public
finance and economic growth. Examining the long-term relationships
between public finance and economic growth, encourages policymakers to
show greater diligence when issuing policies related to public finance and
growth, owing to the persistence of these variables.
Second, to expand on the “tax and spend” hypothesis, this thesis
identifies the direction of causal linkage between tax revenue and
expenditure. The results may help governments balance spending and tax
collection in the future to control deficit. The research findings may aid
policymakers in better understanding the impact of these linkages, enabling
them to avoid risk factors in planning.
Third, to contribute to the quality of governance theory and the
endogenous growth theory, this research evaluates the influence of
governance on the modifying effects of public finance on economic growth
differently according to different group countries. With this objective, the
study aims to help policymakers in both developed and developing countries
understand the role of corruption and public finance policy, so that they can
develop appropriate strategies in future.

15
1.3.2. Research questions
This study endeavors to answer the following questions to meet these
research objectives:
How closely does public finance correlate with the economy in the long
run?
Do tax revenue and government expenditure cause each other?
How does governance modify the effects of public finance on economic
growth differently according to different group countries?
As the research scope plays a crucial role in the research approach, the
next section will introduce the research scope.
1.4. Research scope
The study investigates linkages among government expenditures, tax
revenue, and economic growth for the whole sample (82 developed and
developing countries) in 21-year period 1996-2016.
The reasons for choosing research objects and research period are:
First, government expenditures and tax revenue are the key factors to
create and maintain a government budget. They also help policy makers
control deficits to maintain a stable economy.
Second, control of corruption plays a crucial role in governance, which
says about cause of difference of rich and poor countries.
Third, in the period 1996–2016, the global economy witnessed the post-
Asian financial crisis, which began in Thailand in 1997 and then affected the
stock markets of Asian countries such as Malaysia, Taiwan, and others. The

16
second financial crisis rose when the real estate bubble exploded in the US in
2007, driving the US financial crisis and influencing production and exports in
numerous developing countries. First, for the less data bias from these crises,
this study used the annual inflation rate as a control variable in the estimating
model. Second, for solving the spillover effects of macroeconomic variables in
their relationship with economic growth as well as deeper effects of two
financial crises, this research applied the SUR model for estimation effect of
public finance and control of corruption. Additionally, SUR model helps
researchers gain more efficiency than a single equation.
Fourth, the differences of collection taxes, spending status, GDP per
capita and governance showed a big gap between developed economies and
developing economies, which attracts a large of literature and needs to be
clarified. Developing countries obtain the more than 60% of population of the
world, but contribute less than 30% to global GDP (Spence, 2011).
1.5. Research methods
1.5.1. Research methods
First, for the first research question, this study employs a co-integration
test to examine the long-run relationships among variables. As we may know
that, an co-integration test is often applied to investigate the long-run
relationships between stationary variables (Ojede and Yamarik, 2012).
Additionally, the existence of co-integration among nonstationary variables
could avoid spurious regression (Gujarati, 2004 and Persyn and Westerlund,
2008). There are numerous researchers who have designed co-integration tests
to prevent spurious regression, such as McCoskey and Kao (1999), Bai and Ng
(2004), Pedroni (2004), Breitung and Pesaran (2005), Westerlund and
Edgerton (2008), and Persyn and Westerlund (2008). We follow Persyn and
Westerlund’s (2008) test to identify the existence of co-integration linkages

17
among the variables in this study. This test is very flexible technique and
allows for an almost completely heterogeneous specification of the long-run
portions of the error correction model, where the latter can be determined from
the data. For checking the robustness of co-integration test, this dissertation
also applies the other test such as Kao, Pedroni and Westerlund test.
Next, the Granger test result helps this thesis to answer the research
question 2. The Granger’s techniques could support this study to identify the
direction of the link between tax revenue and expenditure.
Furthermore, to reduce bias from extracting data in the period, which
witnessed two financial crises and to ensure the efficient result of estimation
from the system equations, this study employs a SUR model and two-step
SGMM to estimate the role of governance in modifying the effect of public
finance on economic growth.
1.5.2. The research data
This study uses the strongly balanced panel data for 82 developed and
developing countries from 1996 to 2016 (see table appendix A1). We extracted
the data of GDP per capita, inflation rate and the ratio between foreign direct
net inflow and GDP from World Banks’ database - World Development
Indicators (WDI). To measure the role of governance, this study collects the
“control of corruption indicators3
” from World Bank’s database - World
Governance Indicators (WGI). In this study, the public finance variable was
presented by the ratio between total tax revenue and GDP and the rate of total
government expenditure and GDP, which were selected from International
Monetary Fund (IMF)’s database - Government finance statistic (GFS). In
addition, tries to investigate the role of human capital, this research
3
Control of Corruption captures perceptions of the extent to which public power is exercised for private gain, including both
petty and grand forms of corruption, as well as "capture" of the state by elites and private interests. Estimate gives the country's
score on aggregate indicator, in units of a standard normal distribution, i.e. ranging from approximately -2.5 to 2.5.

18
collect the data of human development index (HDI4
) from United Nations
Development Program (UNDP).
Additionally, the control of corruption indicator denotes a perception of
private, elite governors and foreign investors about the public powers
exercising for the private firms only. For a robustness check of the role of
governance, this study continues to explore the corruption perception index
(CPI)5
of business developed by Transparency International website (TI). The
results may support this research’s contribution toward determining the role of
governance in an economy.
1.6. Research contribution
Contribution to public choice and cost-benefit theories
This thesis examines the long run relationship between public finance,
governance and economic growth in developed and developing countries over
the period 1996–2016. Furthermore, this thesis also evaluates the role of
governance in modifying the influences of public finance on economic
growth.
The first research objective is to verify the persistence of a long-run
relationship between public finance and economic growth in both developed
and developing economies. The finding supports the long run relationship
between public finance and economic growth. By adding the ratio between
total tax revenue and GDP as well as the rate of government expenditure to
GDP into economic growth model, this study enlarges the generation of
economic growth by public finance’s factors. Furthermore, this finding also
supports the policymakers to concentrate on the relationship between public
4
HDI is human development index, is an index composed of four country variables: life expectancy, adult literacy, combined
primary, secondary and tertiary gross enrollment and extracted from United Nations Development Program (UNDP)
5
The Transparency International organization focuses on bribery, measuring the perception of corruption in different countries
From 1996 to 2011, the TI computed the maximum index of CPI is ten, however, from 2012, this CPI was changed the
computation method, and the highest index is 100, which represents the area, where corruption is free.

19
finance and economic growth in the long-run for their developing appropriate
fiscal policies in future.
The second research objective is to confirm the taxation and spending
hypothesis of a bi-directional causal linkage between total tax revenue and
general government spending. This result supports the thesis to prove the
fiscal synchronization hypothesis. Furthermore, following the cost-benefit
theory, we know that a deficit is a harmful factor that can hinder the creating
budget of an economy (McGee, 2008). The finding suggests that policymakers
in both developed and developing countries should focus on the role of every
type of tax rate, tax base and the whole objectives of the government
expenditure simultaneously to promote economies and handle the deficit.
The findings of the first and second research objectives help this study
become one of a few studies, which provide the evidence to prove the long run
theory of the links among total tax revenue and general government
expenditure that represent the quality and quantity of capacity of the
government and economic growth. Thoroughly understanding this link, the
government can give a better fiscal policy, which suits different economic
groups for handling a deficit and promote growth in an economy well.
Evaluating the influences of governance in modifying public finance and
promoting economic growth differently according to different economic
groups is the third research objective. Firstly, investigating the effects of
governance and public finance on economic growth helps this study to
indicate that public finance differently affects economic growth depending on
total government taxes or spending. Secondly, the effect of interaction
between the control of corruption and public finance makes government
expenditure become a beneficial factor for economic growth in both
developing and developed countries. The finding shows that corruption is a
big obstacle that hinders raising an economy over the World. Thirdly, when

20
control of corruption interacts with collecting taxes it has a positive effect on
economic growth in developing countries, whereas in the case of developed
countries it has not been so. These findings provide strong evidence
supporting the theory of quality of government that affects differently in
different groups of countries.
Contribution to empirical study
Up to now, both the public choice theory and cost-benefit theory posed
big challenges to academic researchers in examining the role of public finance
and governance on economic growth. Few previous studies argued about the
role of the subcomponent of tax revenue and each part of government
expenditure on economic growth in the short run. By applying the co-
integration test and Granger test for a panel data of 82 developed and
developing countries over the period 1996 - 2015, which witnessed the two
financial crises, this thesis bridges the gap in understanding the long run
relationship among public finance, governance, and economic growth.
Additionally, this result also supports that the long-run relationship between
public finance and economic growth has existed during the crucial time.
Overmore, evaluating public finance by total tax revenue and general
expenditure, this dissertation can bridge the gaps of lacking verification of the
role of the whole capacity of government size in increasing an economy
during a period of a long time.
Verifying the role of governance in modifying the effect of public
finance on economic growth helps this thesis to confirm that the government
with a high indicator of control of corruption can make public spending
become a beneficial factor for raising an economy in both developed and
developing countries. The finding noted that the anti-corruption is big
challenges for the government in the worldwide. While observing the

21
interaction between anti-corruption and collecting taxes, this dissertation
shows that the developing countries, which will handle a corruption can get a
higher collection of taxes, whereas, in the case of developed countries, it has
not been so. These results suggest that anti-corruption in collecting taxes
should be concentered in developing countries, while its assignment may not
concern the collecting taxes in developed countries.
1.7. Structure of dissertation
This thesis is presented in the following structure. After the abstract,
the key sections are:
Chapter 1: Introduction
First, this chapter provides an overview of the theoretical and empirical
background related to government expenditure, tax revenue, corruption, and
economic growth. Second, this chapter also presents a summary and outline of
the research. Last, this chapter provides the evidences of research gaps.
Chapter 2: Literature review, and hypotheses development
This chapter introduces the critical literature review of the growth
effects of government expenditure, tax revenue, and control of corruption. It
presents the methodology used by previous researchers to analyze research
data. Moreover, this chapter also interprets the impact of the regimes under
which the research variables affect economic growth.
Chapter 3: methods and research data
Chapter 3 introduces the methods that this research applies to achieve
the research objectives; for instance, Granger causality, co-integration tests,
SUR and two-step SGMM models. Base on the characteristic of these
methods, this chapter also presents the research data and sources from which

22
the data were extracted, such as the WDI and WGI from the World Bank’s
database, the WEO from the IMF’s database, and corruption perception index
of business (CPI) from the Transparency International (TI)’s database.
Chapter 4: Public finance, governance and economic growth: A long-run
analysis
Chapter 4 interprets the empirical research results that introduce the
confirmation of a long-run economic relationship with two factors of public
finance: tax revenue and government expenditure. The research findings in
this chapter also confirm the direction of the causal linkage between tax
revenue and government expenditure, which supports the fiscal
synchronization hypothesis and suggests that policy makers implement joint
decision making for taxes and spending.
Chapter 4 also presents the means through which control of corruption
affects the influences between public finance and economic growth depending
on the economic group.
Chapter 5: Conclusions, implications, and limitations:
This chapter first summarizes the research results in general. Second,
based on the major research results, chapter 5 makes recommendations to help
policy makers and governments design appropriate policies for improving
their economies, as well as for handling corruption. Furthermore, this chapter
discusses the study’s limitations and opportunities for future research.

23
CHAPTER 2:
LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT
2.1. Introduction
Public finance and governance play a crucial role in economic
activities. Answering the question “How does this factor affect economic
outcomes?” may help governments issue appropriate policies, and enable their
society and economy to become more stable. First, this chapter sheds light on
the literature regarding the relationships among public finance, and economic
growth in long-term and in both developed and developing countries. Second,
this chapter continues to review the literature related to the role of governance
in anti-corruption and leading public finance to promote their economy. This
summary in literature helps this chapter to identify research gaps and to apply
the theories related to public finance, governance, and economic growth to the
development of an analytical framework.
In addition to the introduction, section 2.2 summarizes the key concepts
used in this thesis. In section 2.3, this study presents the theoretical literature
on the relationship between public finance and economic growth. First, it
describes the previous theoretical arguments on the linkage between public
finance and economic growth. Second, this section shows the means through
which corruption affects public finance and economic growth in an economy.
The literature on empirical research that aims to verify the relationship
between public finance and economic growth as well as the role of corruption
in modifying the growth effects of public finance is discussed in section 2.4.
Section 2.5 presents the process used to develop the analytical framework and
research hypotheses. The final section is a summary of this chapter.

24
2.2. Some key concepts
2.2.1. Public finance
Public finance influences economic activities daily because of the
relationship between government expenditure in providing public goods and
the capacity of tax collection (Philips, 1957). Wagner (1883) noted that the
science of public finance understands the nature of a fiscal economy; this
addresses the two specific characteristics of a state, consumption and income,
which should be understood as government expenditure and tax revenue.
According to the traditional approach to public finance, we learn that
public finance is a subcomponent in classical, neo-classical, and Keynesian
economics. Taxes and expenditure are two factors that have been studied to
identify their effect on the activities of firms, families, and individuals. People
always make choices that will result in their highest utility, so any change
related to public policy or public finance could affect the benefits of all
partners in society (Buchanan, 1999.)
Hillman (2009) indicated that government has three major duties:
preserving microeconomic stability, reducing unemployment and inflation,
and maintaining the stability of banking and financial systems through public
finance and public policy.
Gruber (2011) shed light on how public finance enables governments to
deal with economic crises. On the expenditure side of public finance,
governments should decide what kinds of goods or services it could provide.
On the taxes side, governments should answer the question: “How much
should a government tax its citizens?”

25
McGee (2013) suggests that to understand public finance, we should try
to answer the question “What should government do to provide its services
and lead private firms as well as individuals to agree to pay taxes?”
Furthermore, Su Dinh Thanh (2014) also used the government size to
evaluate the Vietnamese public finance variable. In this case, government size
covering two subcomponent factors: government expenditure and government
revenue.
In summary, in last two decades, most authors have considered public
finance as a tool that supports governments in determining the level of
spending for providing public goods or services to society. Furthermore,
public finance is a technique that can help governments make decisions
regarding the level of taxes to charge its citizens for better provision of public
goods in the future, as well as a means through which governments can control
deficits. Two major components of public finance are tax revenue and
government expenditure, as documented by Buchanan (1999), Wellisch
(2004), Kaul and Conceição (2006), and McGee (2013).
2.2.1.1 . Tax revenue
Hillman (2009) considered that tax revenue includes different types of
taxes and is a major source for financing government spending. Moreover, tax
revenue can be changed when tax rates are increased. Wellisch (2004)
suggested that the countries that produce products should collect the tax
revenue, shifting the tax burden to residents of the countries where the goods
are consumed.
McGee (2008) described tax revenue as a tool, which evaluates the
capacity of a country to enhance its tax efforts. Furthermore, tax revenue as a
percentage of GDP represents the variable for fiscal freedom. As measured by

26
the ratio of tax revenue to GDP, most developing countries collect only two-
thirds of the amount collected by high-income countries (Rizvi, Bacha, and
Mirakhor, 2016)
2.2.1.2 . Government expenditure
Holley (2011) confirmed that governments spending tax
revenue to promote production and consumption is called tax expenditure. In
less developed countries, governments always face the pressure of economic
development; thus, they should increase expenditure as well as enhance tax
revenue to help them to generate more money (Philips, 1957).
In summary, we can apply the geometric shape shown in figure 2.1 to
describe the flow of creating a government budget.
Figure 2.1: Public sector in the economy
Source: Musgrave and Musgrave (1989, p.16)

27
In figure 2.1, the solid lines represent income and spending in the
private sector. The broken lines indicate the public sector. First, we suppose
that there is no public sector in the market. Household income comes from
sales (line 1), which is then spent (line 4) or saved (line 5). Using savings,
households can finance (line 6). Lines 6 and 4 combine the purchase of
products in product markets. When a government exists in the market, it can
spend on public factors (line 2) or private products (line 7), and then payments
are transferred (line 8). Additionally, governments could obtain revenue from
the collection of taxes (line 9) and from borrowing (line 10).
This figure provides a simplified view of the interaction between public
and private sectors in an economy. Figure 2.1 also indicates those whole
objectives of government expenditure should affect the all of activities in the
economy.
2.2.2. Governance and corruption
2.2.2.1 Governance
Stoker (1998) noted that governance plays five positions in a society
for setting up institutions that lead social activities, identifying and operating
their economy for protecting the countries' boundaries well. The government
also recognizes the capacity for locating the resources in an economy. Based
on UNDP principles, Brunet and Aubry (2016) indicated that the value of
these criteria: legitimacy, efficiency, and accountability could be valuable for
evaluating good governance.
Hague and Martin (2004) confirmed that governance stands for the
activities of making collective decisions. Therefore, these authors argued that
the government’s decisions depend on the authority, who is the right to act,
rather than the power to do. However, an authority creates its own power so
long as people accept that the authority figure has the right to make decisions,

28
so control of corruption or corruption may have an important role in the
process of governance.
2.2.2.2. Corruption
Additionally, Dzhumashev (2014) argued that corruption represents the
quality of governance and influences an economy’s private and public
production through its impact on the effectiveness of government spending as
well as the control of production costs. In comparison, Ugur (2014) debated
that corruption stands for institutional quality and has diverse effects on the
income per capita of an economy.
A substantial amount of literature in recent decades has introduced
the concept of corruption. Cintra et al. (2017) confirmed that the concept of
corruption is somewhat diverse, and that it was the most cited concept in
articles in Scopus from 2000 to 2010. Corruption primarily injures the poor,
and it can subvert public support by creating an incorrect perception that
corruption affects all progress. Furthermore, corruption impedes the access of
developing countries to private capital (World Bank, 1997). Jain (2001)
identified three types of corruption. First, “grand corruption” refers to issuance
of economic policies based on the power of politicians. Second, “bureaucratic
corruption” is a petty form of corruption and refers to acts of a bureaucrat
when dealing with others and using their power to accomplish a task; the third
is corruption in making laws or voting for something. Through this literature,
we can see that corruption is a complex phenomenon that has a complicated
effect on economic activities. Grossman (2003) noted that government
corruption is disloyalty of an officer, which may be one of the following
behaviors: bribery, fraud, graft, extortion, embezzlement, influence peddling,
ticket fixing, or nepotism. He also argued that political corruption has four
definitions. First, corruption is an illegal behavior, such as bribery. The second
meaning involves an unethical benefaction. Third, corruption may be a

29
conflict of interest on the part of a government officer. Finally, corruption can
be related to political behavior that is a nonresponse to the public interest.
Capasso and Santoro (2017) divided corruption into two groups: active
corruption and passive corruption. Government officials using their power to
demand benefits or money in dealing with private suppliers that provide public
goods is an example of active corruption. People or private firms who want to
give money or some other benefit to obtain a major agreement are engaged in
passive corruption. They also conducted an empirical study using Italian data
and noted that active and passive corruption has different effects on
government expenditure. In most cases, the corruption that was pointed out
involved public officials using their position to maximize their income by
employing market mechanisms to make business decisions (Cintra et al., 2017;
Brianzoni, Campisi, & Russo, 2017.)
Jain (2001) and Cintra et al. (2017) confirmed that not only is the
definition of corruption complex, but that corruption can also be difficult to
measure. A few ways of measuring corruption are described below.
First, Business International Corporation (BI), which merged with the
Economist Intelligence Unit, previously published ratings assessing corruption
by collecting and analyzing network data around the world. The ratings were
first published for the period 1981–1983; Mauro (1995) may have been the
first author to use this data.
Second, Political Risk Services, Inc. publishes an annual report called
the “International Country Risk Guide” (ICRG), which includes a corruption
index.

30
Third, the World Economic Forum in Switzerland has published the
Global Competitiveness Report since 1989, which reports the minimum
degree of care in academic research as corruption.
Fourth, the Transparency International organization focuses on bribery,
measuring the perception of corruption in different countries, and created a
“Bribe Payers Index” in 1999.
A group of researchers lead by Kaufmann, Kraay, and Mastruzzi (2011)
created six world government indicators that include a control of corruption
index.
Furthermore, previous empirical studies have often measured
corruption at the country level using summary indexes (e.g., Transparency
International’s Corruption Perceptions Index (CPI) or the World Bank’s
Worldwide Governance Indicators (WGI)) (Nguyen et al., 2016). This
supports using both CPI and WGI in this study to verify the role of governance
in control of corruption.
To understand the regime of corruption that affects other activities,
previous authors designed two major models. First, the agency model uses the
equilibrium equation to balance the interests of officials and their elected
power and explain the existence of corruption and its influence on economic
activities (Barro, 1973; Mauro, 1995; Bird, Martinez-Vazquez and Torgler,
2008; Beekman, Bulte and Nillesen, 2013; Angelucci and Russo, 2015;
Aghion et al., 2016). Second, the resource allocation model applied and
expanded the production function to show the causes of corruption and its
impact on economic outcomes (Ajaz and Ahmad, 2010; Brianzoni, Campisi
and Russo, 2017.) Qiao and Shah (2006) noted that in China, the tax revenue
task gives government officials the opportunity to engage in corruption and
rent seeking. Acemoglu (2008) emphasized that when governments in poor

31
countries make decisions, it leads to distorted incentives in the marketplace
and increases corruption. Hillman (2009) defined governance is the
performance of activities exercised by government officials. Good governance
is a government that serves its taxpayers well. In contrast, bad or inadequate
governance is a government that has the authority to serve taxpayers in ways
that obtain more benefits for government officials’ families and friends than
for taxpayers or voters.
Folow Dzhumashev (2014) and Ugur (2014)s’ argument, this study
uses control of corruption indicator extracted from the World Bank’s database
to evaluate the quality of governance. However, this indicator represents the
perception of private, elite governors and foreign investors about the public
powers exercising for private firms only. Owing to the limitation of the
indicator of control of corruption that is a reason to promote this study by
applying the other indicator, for example, corruption perception index - CPI to
confirm the reliable results of evaluating the effects of governance. According
to the Transparency International, we know that this organization collected
CPI from two different types of source: business people’s opinion survey and
assessment scores of a country’s performance provided by a group countries’
expert analysis. In addition, both indicators have the same meaning. In the
country gained a higher index, the area obtained the free of corruption. The
control of corruption (CCI) range lies from -2.5 to 2.5, the higher point is an
area, where control the corruption well. The corruption perception index stays
from 1 to 100 score, where 0 is high corrupt and 100 is free of corruption.
2.2.3 Economic growth
Economic growth plays a crucial role in society and determines the living
conditions of people around the world. There is a great deal of literature on
economic growth. First, classical economists posited that economic growth
depends only on population (labor force) and physical capital (Smith, 1776;

32
Ricardo, 1821; Schumpeter, 1942.) The simple Cobb-Douglas production function ( = ( , ))
was a popular function used in early research to examine economic growth.
Neo-classical scholars indicated that growth in economies is created by
increasing output or changing GDP per worker (Samuelson, 1954; Solow,
1956; Swan, 1956.) They explained the differences in economic outcomes by
applying external factors: human capital, physical capital, and transforming
technologies. They designed an economic model, = 1− , where Y is
productivity, A denotes technology process, and K and L are physical capital
and human capital, respectively.
The limitation of both the classical and neo-classical models, as most
scholars have explained, is that in the long run, growth in GDP per capita is
driven by exogenous technological change. These theorists did not consider
the potential accumulation or dissipation of physical and human capital in the
long run.
Barro (1991) and Mankiw et al. (1992) developed the growth equation
following Solow’s style:
( , ) − ( ,0) = ( ,0) + + + , where ( , )
stands for logarithm of economic growth of country i at time t, is a matrix
vector of independent variables, denotes the vectors of control variables and
indicates the vector of unobserved error term. Furthermore, Islam (1995) put
the growth model in context of dynamic panel data and designed this above
equation as seen as below:
( , ) = ( , −1) + + + + + , ,
=(1+ )→ =( −1)

33
Barro and Sala-i-Martin (2004, P.221) supposed that government finances
its expenditure for public goods and service with lump-sum taxes and they
designed the new production function to measure the income as seen as below:
= 1− , where G stands for quantity of public goods
These authors also argued that the total tax revenue collected is so the growth
account will be: = . + . + . , where is average of tax rate between +
This argument supports that tax revenue and government expenditure give
direct effects on both major input factors: physical capital and labor’s capital
(K & L in the above equation) of production function only. These factors also
have an indirect influence on technology (A). The debate shows the
complicated path of indirect impact of taxes and expenditure on economic
income and needs to be clarified. However, these researchers considered the
relationship between direct taxes, each objective of government expenditure,
and economic growth only. Furthermore, the benefits of an economy that
affect the structure and status of a society depend on its budget and the way
the government spends its total tax revenue. Based on this debate, in each
society, we should examine the links among total tax revenue, general
government expenditure that present the quality and quantity of a government
and economic growth to support policymakers to develop the fiscal policies,
which suit different economic groups.
Martínez-Vázquez, Vulovic, and Moreno-Dodson (2012) defined
economic growth by GINI coefficient and designed the below equation to
measure economic growth:
, = , −1 + , + , + + , , i=1,….n and t=1,…T where
, stands for gini coefficient of a country i at time t, while , −1

34
represents its value at time t-1. , is a vector of fiscal variables saying about the component of taxes such as personal
income tax (PIT), companies’ income tax (CIT), social security contribution (SSC), payroll taxes, general sales tax
(GST) and custom duties. , indicates the vector of control variables: population growth, age dependency, the level of
globalization, GDP per capita growth, unemployment, the corruption, education level, and the size of government. ,
present the unobserved and observed error term.
In addition, a small group of authors computed the average or five-year
average of the GDP per capita growth rate to evaluate the growth level of the
economy (Kormendi, 1985; Landau, 1985; Grier & Tullock, 1989; Devarajan
et al., 1996; Kneller et al., 1999). However, Barro (1991) argued that this rate
might provide the bias data after calculation. In general, most researchers have
evaluated economic growth using GDP per capita (see Barro, 1991; Acemoglu
et al., 2003, 2008; Johansson et al., 2008 ; Romero-Ávila and Strauch, 2008;
Ojede and Yamarik, 2012; d'Agostino et al., 2016). This variable indicates the
full meaning of capability of an economy, which considered the quantity of
human resource. That is a reason why this research uses GDP per capita to
measure economic growth.
2.3 Theoretical literature on the relationship between public finance and
economic growth
2.3.1 Public choice theory
The public choice theory explains how government and politicians
work using the methods and tools of economics. This theory also provides a
mechanism for allocating resources (Buchanan, 1999; Stiglitz, 2000). There
are two sides to the argument in public choice theory. On the one hand, some
researchers have indicated that the government is not concerned with the
trade-off theory; therefore, they may be willing to collect more tax or cut

35
spending to reduce the deficit. On the other hand, if the government confirms
the role of the trade-off theory, it always tries to grow and will attempt to
collect more tax and spend less. At present, we do not clearly know which
argument is more helpful for policymakers. Furthermore, Stiglitz (2000)
indicated that governments always think that increasing public expenditure
will make their countries richer. The evidence of government spending in
developing countries from 1996 to 2016 supports this argument (see figure
1.5). Additionally, developing countries try to grow, inevitably trading off
their expenditure or land to develop infrastructure, agriculture, and human
capital (Kanter et al., 2016; Liu, 2017; Beauchamp, Clements and Milner-
Gulland, 2018.) All we may know that tax revenue decides the cost of public
goods and services. Therefore, political making decision is a complex process.
The fiscal process always poses a double choice: one choice or decision
related to a size of public spending and the other a choice or decision on the
rates of taxes (Buchanan, 1999.)
Furthermore, this theory also poses a challenge for future research due
to the persistence of the link between tax revenue and government
expenditure. Each individual has a different preferred level of public spending.
Additionally, total tax revenue is based on multipliers between the total type of
tax base and tax rates, which may drive the activities of all people in an
economy. Furthermore, the popular government often refers to what people
want to make decisions. How does the government make its decision since
different people prefer different things (Buchanan, 2009; Kaul and Conceição,
2006; Stiglitz, 2000)? Until now, the public choice theory may not fix this
issue. That is why we should try to analyze the long-run relationship between
total tax revenue and government expenditure as well as the correlation
between public finance and economic growth.
2.3.2. Cost-benefit theory of taxation

36
Dasgupta and Pearce (1972) noted that cost-benefit analysis (CBA)
relates to the term of social gains and losses. However, real benefits and costs
may be both direct and indirect. Direct costs and benefits are those related to
project objectives, whereas indirect benefits and costs reflect the nature of
products (Musgrave and Musgrave, 1989). Schmid (2004) indicated that cost-
benefit analysis is a set of economic tools for evaluating budget size, public
spending, and regulation. Following cost-benefit analysis, we know that a
deficit may be a big challenge, which hinders creating a budget (McGee,
2008). To better handle a deficit, government should thoroughly understand
the relationship between tax revenue and government spending. Meltzer and
Richard (1981) assumed that in an economy, people have different choices of
work or leisure and consumption. These activities affect wages, income tax,
and the way government pays for public goods, so they showed that
government should balance the amount of government spending and the
collection of taxes. However, this study evaluated only the relationships
among individuals’ labour choices, income tax, and government expenditure.
To evaluate the full capacity of government, we should investigate total tax
revenue and total expenditure.
Based on cost-benefit theory, there is a large body of theoretical research on the
relationship between government expenditure and growth of economies, but the arguments are
too complicated. Barro (1990) debated that the source of government spending is equal to tax
revenue: = = . = . . ∅( ), where g is government spending, T denotes tax revenue, and is the
income tax rate. However, governments create budgets from tax revenue based on government
expenditure and household spending, so = ( . + . ℎ) , where h is household expenditures. Based
on Barro’s argument, the confusion is that government expenditure depends on tax revenue, but
we can collect tax revenue after the government and households make expenditures.

37
This debate is a reason for future research, which more clearly defines his idea
and to answer the question: “How do tax revenue, expenditure, and the
economy relate to each other?"
In addition, Barro Sala-i-Martin (1992) confirmed that in an
endogenous growth model ( = 1− , where G is government purchase). The
government’s selection of tax rates and expenditure level is a key cause of
different long-term growth. Based on their argument, investors are sensitive to
the tax rate. Investment is a crucial element in a growth model. This study
argued the role of government in leading private investment as well as
providing public goods or services through its spending and taxes. However,
Barro and Sala-i-Martin (1992), and Johansson et al. (2008) verified only a
part of taxes. Additionally, government spending affects both consumption
and production markets. Taxes, which include both direct and indirect taxes,
are known to be an effective tool used to finance public goods. When people
earn income, they pay a direct tax. When people spend their income, they pay
indirect taxes (Hillman, 2009). He also indicated that tax revenue is a
multiplier between the tax rate and tax base. Based on his argument, we know
that politicians are sensitive to the Laffer curve, so tax rates or tax bases
depend on their preference. If a politician prefers to spend more, he will
increase the tax rate, while other politicians who want to increase revenue
should reduce the tax rate or expand the tax base. A lower tax rate attracts
investors because they understand that when investment grows, tax revenue
will also rise. There is much literature on the role of public spending, and it is
also ambiguous (Dzhumashev 2014). In more detail, Samuelson (1954)
disputed that in each economy, there are two types of goods: private
consumption goods and collective consumption goods. If individuals prefer
both types of goods, then each individual tries to maximize his or her utility.
The government expenditure affects gross domestic economic growth
depending on the way those expenditures are made. Most research showed the

38
method of growth affects public finance and governance quality through
aggregate demand or supply. Based on utility function, previous researchers
have argued that public finance or governance quality impacts individual
consumption of public and private goods, and these independent variables
continue to affect the aggregated outcome of the economy.
In short, until now, cost-benefit theory has posed a challenge to
academic researchers, who are interested in verifying the relationship between
tax revenue and expenditure. Most previous studies did not clearly confirm the
hypotheses of relationship between total tax revenue and general government
expenditure in both developed and developing countries. Therefore, these are
also key tools to support government control of deficits to maintain stable
economies.
2.3.3. Governance theory
Governments play an important role in the organization of society and
law, as well as increasing economic growth. However, attaining a balance
between income and spending always constitutes a big challenge for them.
Stiglitz (2000) indicated that the government is concerned with all economic
activities and devises and maintains a legal framework that covers all
transactions within an economy. Hillman (2004) reviewed the existing studies,
and revealed that public finance is a tool that helps government in low-income
countries increase economic growth and reduces poverty. He proved that
corruption in these countries makes governments ineffective in spending and
in collecting taxes. He also indicated that corruption might come from
government regulation, taxation, procurement, and public spending for private
benefit. Nevertheless, this research tries to describe the way that corruption
affects society and economies. First, corruption has an inverse link with low
wages for government officials. Second, corruption is a means of helping
leaders or rulers support their authority. Third, rent seeking and corruption

39
make distribution of natural resources more distorted. Fourth, corruption
inhibits economic development because it reduces the effectiveness of private
investment and discriminates against small enterprises or start-up companies.
Fifth, corruption reduces tax revenue and makes public spending ineffective.
Sixth, he also posed the argument that there may be more or less corruption in
fiscal decentralization, which is a debate that should be further investigated in
future research. Seventh, corruption shows the inequality in income
distribution and affects taxation. Last, he also confirmed that governments in
transition economies should reform their policies to reduce the corruption
perception index to improve their governance. In summary, this study revealed
that the role of corruption in the effectiveness of public finance and inhibition
of economic development in developing countries needs to be verified in
future research.
Dzhumashev (2014) performed theoretical research on both sides of
corruption, such as households and politicians, and mentioned that corruption
has a close relationship to the quality of governance. Corruption can shift the
difference of the optimal size of government and become a useful factor to
enhance economic growth. Countries with poor governance could spend more
than the optimal level, so corruption can support them in developing their
economy. This finding shows the limitation of research that studies the role of
corruption in an economy without the linkage between quality of governance
and government size with corruption.
Applying the Nash equilibrium to analyze the Greek economy, Litina
and Palivos (2016) noted that a good way to keep a unique equilibrium is to
impose a strong moral cost on corrupt politicians and tax evaders, two agents
who try to gain more individual benefits.
Célimène et al. (2016) indicated a different way that households and
politicians used refunds from tax evasion. Private investors can re-invest their

40
gains from tax evasion to develop production, which can increase the
economy. However, the benefits gained by politicians from household bribes
can be used only for individual purposes. From this debate, we can learn that
corruption has different effects depending on how transactions of corruption
benefit both politicians and households in a society.
In summary, governance theory confirm the linkage between quality of
governance, government size, and corruption, so to verify the role of
corruption in economic growth, researchers should care about both sides of an
economy; in other words, the private sector and politicians. In addition,
corruption and quality of governance also lead to activities in the private
sector as well as the public sector, like tax revenue and government
expenditure. Until now, these theories have only considered the role of
corruption and governance in an economy, or in the composition of taxes or
spending. However, total tax revenue and spending are two major factors in
creating government budget and in establishing inputs for production. These
factors also represent the full capability of government, and the relationship
between them and economic growth in the presence of corruption and
governance needs to be clarified.
2.3.4. Economic growth theory: Exogenous and endogenous growth theory
Barro and Sala-i-Martin (2004) confirmed that a small rate of
economic growth plays an important role in increasing standards of living;
however, the way governments choose policies could affect long-term growth
rates. These authors also indicated that in the mid-1980s, due to the complex
definition of capital, the neoclassical or exogenous theories become
unsatisfactory tools for determining long-run growth. This study also
considers that economic activities depend on the actions of firms and
government decisions in creating budgets and spending. Furthermore, these
decisions may affect standards of living, which affect the quality of human

41
capital as well as technological capital. These two capital resources can
increase or reduce aggregated total productivity in a society. Based on this
argument, endogenous growth theory can help researchers explain growth
better than exogenous theories.
Acemoglu (2009) mentioned that the differences in growth rates many
times make a country become richer than other countries. Therefore,
understanding growth theory is necessary for today’s policy makers to
increase income per capita. Acemoglu (2009) also revealed that previous
researchers emphasized that specific characteristics of a country may relate to
economic growth, such as investment, physical and human capital,
technology, policies, culture, and exogenous environmental factors.
Aghion and Howitt (2009) also argued that economic growth was
measured by GDP per capita, so neoclassical theory did not explain the
changed rate of technological progress. The endogenous growth model can
enable researchers to correct this issue and determine growth in a long-run
relationship with endogenous factors. These researchers presented the AK
model, which adds more explanation of the accumulation of knowledge of
human capital in determining the growth of an economy.
In addition, tax revenue steers the provision of public goods, which
drives economic growth more than capital accumulation (Cerqueti and
Coppier, 2011.)
Furthermore, Aghion et al. (2016) proved that the less effective
governance reduces the positive impact of taxes on growth. The effectiveness
of governance also increases tax rates, which has a U-shaped effect on growth
equilibrium.

42
Célimène et al. (2016) explained that tax evasion and tax corruption
affect private capital and public spending, which are two inputs in the
production function. This argument supports the role of taxes and corruption
in driving economic growth.
Additionally, tax revenue and public expenditure are two major factors
in the production function. Total tax revenue and total expenditure can
indicate the capacity of a government. Currently, endogenous growth theory
continues to require more verification of the relationships among tax revenue,
government expenditure, and economic growth.
2.4 Empirical literature on relationships among public finance,
governance, and economic growth
2.4.1 Empirical literature on relationships between public finance, and
economic growth
According to Barro’s (1990) perspective, which explained the role of
the interaction between government expenditure and taxes in household
spending and income, we know that this might be a too simple social regime,
where governments only collect taxes from income and property. The
limitation of this research is that it does not evaluate the relationship between
total tax revenue and total public spending, which articulates government
capability.
In recent decades, two stances have emerged for evaluating the
relationship between public finance and economic growth. First, a few
scholars applied causality and co-integration tests to confirm the correlation
between economic growth and tax structure or share of expenditure only (Ray,
Pal and Ray, 2012; Azam et al., 2015.) Second, a group of researchers adopted
the endogenous growth model to examine the linkage between a part

43
of tax revenue or share of government expenditure and economic only. For
instance: Landau (1983, 1985), Grier & Tullock (1989), Barro (1990, 1991),
Hitiris and Posnett (1992), Mankiw et al. (1992), Devarajan et al. (1996),
Fölster and Henrekson (2001), Bassanini and Scarpetta (2002), Lee and
Gordon (2005), Aizenman and Glick (2006), Arnold (2008), Romero- Ávila
and Strauch (2008), Cooray (2009), Baltagi and Moscone (2010), Mercan et
al. (2010), Ojede and Yamarik (2012), Azam et al. (2015) d'Agostino et al.
(2016), Stoilova (2017), Ramírez, Díaz and Bedoya (2017).
In some previous studies, the income tax, sale tax, or property tax are
very significant in reducing economic results in both developing and
developed economies (Lee & Gordon, 2005; Ojede and Yamarik, 2012; Amir
et al., 2013; Adkisson & Mohammed, 2014). In addition, Bujang et al. (2013)
employed Kao’s co-integration test for a panel dataset of 24 developing and 24
developed countries over a 10-year period and found that tax structure and
GDP in developing countries do not have a long-run co-integrating
relationship, which only exist in developed countries. Furthermore, Easterly
and Rebelo (1993) revealed that taxes that come from the income of any
person or organization can make an economy to grow, while import or export
tax may reduce it.
Other earlier authors also confirmed the mixed growth effect of
government expenditure and tax revenue. By performing an empirical study of
98 countries from 1960 to 1985, Barro (1991) indicated that the relationship
between public spending and economic growth is negative. Furthermore,
Hitiris and Posnett (1992) analyzed the data of 20 OECD countries over a 28-
year period and found that when a government uses expense for caring their
peoples’ health, this spending can increase the country’s income per head.
Applying OLS, fixed effects (FE), and pooled OLS techniques; Kneller et al.
(1999) performed an analysis of a dataset of 22 developed countries between

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