The Illomata International Journal of Management Ilomata International Journal of Tax & Accounting P-ISSN: 2714-9838; E-ISSN: 2714-9846 Volume 4, Issue 3 July 2023 Page No. 613-627 613 | Ilomata International Journal of Tax & Accounting https://www.ilomata.org/index.php/ijtc The Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Caribbean (LAC) Regions 2002-2019 Hendiva Tri Nugraha1, Suparna Wijaya2 1Politeknik Keuangan Negara STAN, Indonesia 2Universitas Pembangunan Nasional Veteran Jakarta, Indonesia Correspondent: hendivatri23@kemenkeu.go.id1 Received : May 19, 2023 Accepted : July 27, 2023 Published : July 31, 2023 Citation: Nugraha, H, T., Wijaya, S. (2023). Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Carribean (LAC) Region 2002- 2019. Ilomata International Journal of Tax and Accounting, 4(3),613-627. https://doi.org/10.52728/ijtc.v4i3.843 ABSTRACT: Tax revenue is one of the backbones of economy in almost every country in the world. There are several determinants that influence the amount of tax revenue in one country, one of which is international transaction activities. Such activities can partly be presented by three variables; Foreign Direct Investment (FDI), Trade Openness (TO), and External Debt. This study aims to acknowledge the effects of international transaction experienced by a country regarding its tax revenue. External Debt is used as a moderating variable to the effects of FDI and TO on tax revenue. The data source was taken from the World Bank within the period of 2002-2019 in 19 countries around LAC regions. The study implements an associative quantitative method with PCSE regression. The result showed that FDI affects tax revenue negatively, whereas trade openness and external debt affect tax revenue positively. External debt as a moderating variable strengthens the effect of FDI and weakens the effects of trade openness to tax revenue. Further research is expected to include all the LAC countries, add more variables relevant to the international transactions, and renew the research period. Keywords: Tax Revenue, Foreign Direct Investment, Trade Openness, External Debt, Latin America and Caribbean This is an open access article under the CC-BY 4.0 license. INTRODUCTION Almost all countries in the world rely on taxes to support the government’s economy. Taxation is the most practical system of raising government revenue to finance the spending on the goods and services demanded by the society” (Tanzi & Zee, 2001). The economic growth of one country depends on sustainable funding for programs such as social, health, education, and infrastructure to support the country in achieving its goals. Therefore, the aspect of taxation should be a major highlight in state affairs. A measurement to valuate the taxation performance is the proportion of tax revenue to a country's Gross Domestic Product (GDP). There are a number of factors affecting tax revenue, one of which is international transactions between countries. Latin America and Caribbean (LAC) regions refers to a composition of countries characterized by diverse international transaction activities. One of the largest countries in the region, Mexico, is https://www.ilomata.org/index.php/ijtc mailto:hendivatri23@kemenkeu.go.id https://doi.org/10.52728/ijtc.v4i3.843 Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Carribean (LAC) Region 2002-2019 Nugraha and Wijaya 614 | Ilomata International Journal of Tax & Accounting https://www.ilomata.org/index.php/ijtc considered a nation with the most open economy in the world, establishing 50 Free Trade Agreements (FTAs) with other countries(trade.gov, 2022), whereas the other two major countries in the region with the closest economies are Brazil and Argentina. Both countries have a proportion of international trade below 30% of GDP (O’neil, 2022). However, LAC is considered regions with the most exports, with an average trade to GDP of 67% in 2019 if compared to the percentage of 56% for the average country. The diversity across LAC countries is an interesting research topic, from which an investigation regarding how the region’s tax revenue is related to international transaction activities was conducted. As can be seen from Table 1, the tax revenue of countries in the LAC region varies with an average above the world’s revenue of 16.5%, whereas the average tax revenue in the world is 13.8%. There are three international transactions affecting a country's tax revenue, among others are Foreign Direct Investment (FDI), Trade Openness (TO), and External Debt (EXT or foreign debt). FDI or foreign direct investment is an international capital flow in which companies from other countries or multinational companies invest their capital either in the form of establishing or expanding their business in other countries (Obsfield, 1991). FDI is not only limited to the establishment of new corporate units, but also in the form of acquisitions of FDI recipient of companies in one country, to companies in others. As defined by the World Bank, TO or trade openness is the ratio between the amount of exports and the amount of imports either in a form of goods or services with other countries, calculated as a proportion of GDP. The EXT, in this case the government external debt is a debt owned by the central government, comprising bilateral and multilateral debts, export credit facilities, commercial debts, leasing, and some other kinds. Table 1 Tax Revenue (%GDP) of LAC Countries in 2019 Negara Tahun Tax Revenue (%GDP) Argentina 2019 10.64932467 Belize 2019 26.25967344 Bolivia 2019 24.61570104 Brazil 2019 13.73616364 Colombia 2019 15.07137014 Costa Rica 2019 13.47177923 Dominica 2019 24.14728928 Dominican Republic 2019 13.3027786 Ecuador 2019 14.35727421 El Salvador 2019 18.071017 Grenada 2019 21.558417 Guatemala 2019 10.45602392 Haiti 2019 12.83992672 Honduras 2019 18.70742178 Jamaica 2019 27.45394175 Mexico 2019 13.14822085 Nicaragua 2019 17.5430986 https://www.ilomata.org/index.php/ijtc Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Carribean (LAC) Region 2002-2019 Nugraha and Wijaya 615 | Ilomata International Journal of Tax & Accounting https://www.ilomata.org/index.php/ijtc Paraguay 2019 10.00060649 Peru 2019 14.5160313 source : worldbank There are several researches that examine how FDI affects tax revenue. Pratomo (2020) stated that FDI inflows have a positive effect on tax revenue in the developing countries. In addition, Camara (2023) argued that FDI inflows serve as a stimulus to increase tax revenue. However there is no connection with countries exporting the natural resources since tax revenues are not sensitive to FDI inflows. Nevertheless, Gaspareniene et al. (2022) stated the opposite. In European Union countries, FDI inflows have dampening implications for tax revenues. Their argument was FDI generates a reduction in tax revenue through tax incentives offered by the state in order to attract investors, for instance free trade zones where goods are exempt from duties and taxes. Similarly, other studies examining the relationship between trade openness and tax revenue have been conducted. A research by Kwaku et al. (2018) explained that trade openness has a positive effect on tax revenue, particularly the international trade tax. On the contrary, Shubita & Warrad (2018) emphasized that there is a negative relationship between trade openness and government revenue. It occurred as taxation is "forced" to compete, which ultimately reduces state revenue, a condition signaling economic openness (liberalization), Another research by Wijaya & Dewi (2022) pointed out that trade openness has no effect on tax revenue in Indonesia. (Khalid, 2016) stated further that aside from being related to tax revenue, trade openness has a direct effect on economic growth through international competitiveness, productivity, and other economic activities .These economic activities need funding, and if the government cannot rely on the revenue generation, it will be in debt. Eddine Salhi & El Aboudi (2021) conducted a study on the relationship between external debt and tax revenue. The results indicated that foreign debt affects the tax revenue and it was signified by currency devaluation. Furthermore, Saibum M.O. & Olatunbosun (2013) revealed that foreign debt in Nigeria erodes tax revenue. It directly affects not only the tax revenue, but also the relationship between the two other variables. External debt can influence government response to FDI inflows. The economic growth in countries with high levels of external debt differs from those with low external debt (Tanna et al., 2018). Pyeman et al. (2016) stated further that these two variables have a negative relationship, where the amount of foreign debt of a country will affect investors' decisions regarding the location of investment and the type of investment. With TO, foreign debt has a positive relationship, since the higher the foreign debt, the more increased the export activities will be (Zakaria, 2012). Other studies however, revealed a negative relationship between these two variables. Mugasha (2007) argued that the debt problem in a developing country with stagnant economic conditions will be considered unfavorable for trade partners, which has implications for the decline in TO. The emergence of various opinions related to the influence of international transactions on tax revenue and the importance of taxes for a country's economy creates an urgency for further research on this matter. Furthermore, the diversity of international transactions in the LAC region signifies an interesting point of research. Therefore, this study aims to determine how FDI, TO, and foreign debt impact the tax revenue and how the role of foreign debt as a moderating variable on the effect of FDI and TO is on tax revenue in the LAC Regions within the periods of 2002- 2019. https://www.ilomata.org/index.php/ijtc Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Carribean (LAC) Region 2002-2019 Nugraha and Wijaya 616 | Ilomata International Journal of Tax & Accounting https://www.ilomata.org/index.php/ijtc METHODS The research method implemented is quantitative associative research, aiming to determine the influences between the independent variable and the dependent variable. The data of over an 18- year period from 2002 to 2019 in 19 Latin American and Caribbean (LAC) countries were used. The countries listed are Argentina, Belize, Bolivia, Brazil, Colombia, Costa Rica, Dominica, Dominican Republic, Ecuador, El Salvador, Grenada, Guatemala, Haiti, Honduras, Jamaica, Mexico, Nicaragua, Paraguay, and Peru. Whereas for the secondary data, the sources from the World Bank were added. The dependent, independent, moderating, and control variables used in this study are described in Table 2. Table 2 Research Variables Dependent Variables Unit Data Scale Data Transformation Tax Revenue (%GDP) Percent Ratio - Independent Variables Unit Data Scale Data Transformation Foreign Direct Investment (FDI) USD Ratio Natural Logarithm Trade Openness (%GDP) (TO) Percent Ratio - Moderating Variables Unit Data Scale Data Transformation External Debt (EXT) USD Ratio Natural Logarithm Control Variables Unit Data Scale Data Transformation CORR Index Ratio - EFF Index Ratio - LAW Index Ratio - Operationalization Variable Tax Revenue (%GDP) Tax revenue refers to mandatory transfers to the central government for public purposes. The mandatory transfers include fines, penalties, with the exclusion of most social security contributions. Refunds and corrections of erroneously collected tax revenues are treated as negative revenues. Trade Openness (%GDP) Trade openness is the total value of exports (+) and imports (-) of goods and services measured as a proportion of GDP. External Debt https://www.ilomata.org/index.php/ijtc Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Carribean (LAC) Region 2002-2019 Nugraha and Wijaya 617 | Ilomata International Journal of Tax & Accounting https://www.ilomata.org/index.php/ijtc External debt is a debt to a country that is repayable in currency, goods, and services. The analytical tool used is Multiple Linear Regression Analysis with panel data type. The data processing application implemented is Stata 17 as described in the following regression equation: 𝒀 = 𝜶 + 𝜷𝟏𝑭𝑫𝑰 + 𝜷𝟐𝑻𝑶 + 𝜷𝟑𝑬𝑿𝑻 + 𝜷𝟒𝑬𝑿𝑻. 𝑭𝑫𝑰 + 𝜷𝟓𝑬𝑿𝑻. 𝑻𝑹𝑫 + 𝜷𝟔𝑪𝑶𝑹𝑹 + 𝜷𝟕𝑬𝑭𝑭 + 𝜷𝟖𝑳𝑨𝑾 + 𝜺 where 𝑌 = 𝑇𝑎𝑥 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝛼 = 𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 𝛽1−8 = 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡 𝐹𝐷𝐼 = 𝐹𝑜𝑟𝑒𝑖𝑔𝑛 𝐷𝑖𝑟𝑒𝑐𝑡 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑇𝑂 = 𝑇𝑟𝑎𝑑𝑒 𝑂𝑝𝑒𝑛𝑛𝑒𝑠𝑠 𝐸𝑋𝑇 = 𝐸𝑥𝑡𝑒𝑟𝑛𝑎𝑙 𝐷𝑒𝑏𝑡 CORR = Corruption Control Level EFF = Government Effectiveness LAW = Quality of Law Enforcement 𝜀 = 𝑅𝑒𝑠𝑖𝑑𝑢𝑎l The classical assumption test is carried out before the hypothesis testing, in order to ascertain whether or not the model fulfills the econometrics model (Purba et al., 2021). The classical assumption tests are normality, heteroscedasticity , multicollinearity , and autocorrelation tests with details in Table 3. Table 3 Classical Assumption Test Test H0 H1 Skewness and Kurtosis Tests Data is normally distributed Data is not normally distributed Breusch–Pagan/Cook– Weisberg test Homoskedastic data variance Heteroscedastic data variance Breusch–Godfrey LM test Model is not autocorrelated Model is autocorrelated <10 ≥10 Variance Inflation Factor (VIF) Data is not multicollienar Data with multicollienar problem After ensuring that the model meets the classical assumption test, the goodness-of-fit (GOF) test was proceeded. The GOF of a model describes how well the model fits a set of observations(Alberto & Forero, 2010). The GOF test was conducted with an alpha level = 5% as in Table 4 below. Table 4 Goodness of Fit Test GOF Test H0 H1 https://www.ilomata.org/index.php/ijtc Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Carribean (LAC) Region 2002-2019 Nugraha and Wijaya 618 | Ilomata International Journal of Tax & Accounting https://www.ilomata.org/index.php/ijtc T Test Independent variables partially have no effect Independent variables partially affect F Test All independent variables simultaneously have no effect All independent variables simultaneously affect Strong Moderate Weak Adjusted R-Squared >0.67 0.67 chi2 Interpretation Skewness and Kurtosis Tests 0.0001 Not normally distributed Breusch–Pagan/Cook–Weisberg test 0.0013 Heteroskedastic Autocorrelation Woolridge test 0.0187 Autocorrelated VIF Interpretation Variance Inflation Factor (VIF) 186.39 Multicollinear Problem Next is the PCSE regression results described in table 7. From the results obtained, the F Test value (Prob> F) is below the alpha value of 0.000, which means that all variables simultaneously and significantly affect the Tax Revenue in 18 countries. The R-Squared value obtained is 0.2973 or 30% which means that the dependent variable is influenced by 30% of the independent variables used in the study, thus the remaining 70% is the impact of other variables not being tested. According to (Chin & Marcoulides, 1998) the R-Squared value below 33% indicates a weak category, which means that the ability of the independent variables to explain the dependent variable is considered insufficient (Ghozali, 2016). Moreover, the partial tests show that FDI and Trade Openness have a significant effect on Tax Revenue, even after being moderated by the External Debt variable. Table 7 PCSE Regression Results Variables Coefficient Prob Cons -42.3263 0.000 Foreign Direct Investment (FDI) -3.1239 0.057 Trade Openness (TO) 1.4895 0.000 External Debt(EXT) 2.3872 0.000 FDI.EXT 0.1301 0.064 TO.EXT -0.0627 0.000 CORR 3.197 0.001 EFF 3.776 0.000 LAW -5.304 0.000 R-Squared 0.2973 Prob > F 0.0000 https://www.ilomata.org/index.php/ijtc Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Carribean (LAC) Region 2002-2019 Nugraha and Wijaya 621 | Ilomata International Journal of Tax & Accounting https://www.ilomata.org/index.php/ijtc The Effects of FDI on Tax Revenue The results of partial tests conducted on FDI indicate that FDI has a negative effect on tax revenue. It contradicts the research by Pratomo (2020) which states that the increase in FDI has a positive relationship with the total tax revenue, alongside with the corporate, the personal, and the value added taxes in the developing countries. The study states further that the type of FDI shows its effects on the tax revenue. FDI inflow is divided into two types, greenfield and brownfield. Greenfield FDI is FDI in the form of construction of new production units by multinational companies in the recipient country, whereas Brownfield FDI is FDI in the form of acquisitions or mergers of domestic companies in the recipient country, carried out by multinational companies (Takayama, 2023). It is apparent that Greenfield FDI has a positive effect on tax revenue while Brownfield FDI tends to dampen the revenue. Referring to Pratomo's research, Latin American and Caribbean countries are prone to accept Brownfield FDI (on the ground that FDI has a negative impact on tax revenue). One of the recent investment issues of Latin America and the Caribbean with other countries is its cooperation with China, channeled through the China and the Community of Latin America and Caribbean States (CELAC) meeting. Since 2015, Chinese investment in Latin America and the Caribbean has become more massive, with the proportion of brownfield FDI or mergers and acquisitions (M&A) amounting to 35% from the total investment (Abdenur, 2017). Figure 2 the accumulated Chinese FDI Outflows to the LAC Region in Billion USD 2000-2001, source : European Parliament Over the years, the trend of Chinese Brownfield FDI into LAC has been increasing, with the average share of Chinese FDI deals from 2015-2021, thus the M&A (Merger and Acquisitions) was 47%. Even in 2019 (12 out of 19 deals were M&A) and 2020 (13 out of 20 deals were M&A), M&A transactions exceeded greenfield FDI. In terms of numbers, M&A transactions were recorded at 66.45 billion USD while greenfield reached only 22.68 billion USD. This trend can be attributed to the opposition and social conflicts associated with greenfield investments in LAC https://www.ilomata.org/index.php/ijtc Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Carribean (LAC) Region 2002-2019 Nugraha and Wijaya 622 | Ilomata International Journal of Tax & Accounting https://www.ilomata.org/index.php/ijtc (Raza & GROHS, 2022). However, M&A is only limited to change of ownership of existing companies/projects. The Effects of Trade Openness on Tax Revenue Partial tests conducted on trade openness indicate that trade openness has a positive effect on tax revenue. The result is in line with a study by Gnangnon & Brun (2019) which stated that through tax reform, developing countries which become more open to international trade receive more positive impacts on tax revenue than countries with closed economies. Similarly, another research by Kwaku et al (2018) examined the effect of trade openness on trade tax revenue in Ghana. The results obtained are that trade openness has a positive effect on tax revenue in the international trade sector (import / export taxes, import / export duties) both in the short and long terms. In LAC, a country with the highest level of trade openness is Honduras and its biggest exported product is coffee reaching a value of 1.35 Billion USD (this marks Honduras the seventh largest coffee exporting country in the world) with the United States as its largest export market (OECD, 2023). The driving factor is the fiscal policies that intersect with the coffee production sector in Honduras. An annual report on the Honduran coffee sector published by the United Stated Department of Agriculture Foreign Agricultural Service (USDA) reported that in 2022, the Honduran government passed a regulation that excludes the imposition of a 12% sales tax on the country’s coffee production. The policy is estimated to generate USD 183 million in fiscal relief which will reduce the cost of coffee production and increase the competitiveness of the Honduran coffee sector, including the export policy (Fiallos, 2022). With a reference to the research results described, it can be concluded that the implementation of tax relief policies in leading export sectors will increase exports of these products, trade openness rates, and tax revenues. The Effects of Foreign Debt on Tax Revenue as a Moderating Variable Partial tests conducted on foreign debt revealed that a foreign debt borne by the government has a positive effect on tax revenue. A research by Eddine Salhi and El Aboudi (2021) indicated a similar result: a foreign debt has a positive effect on the tax revenue. The study measures foreign debt associated with currency devaluation (it relates to foreign debt payments and the exchange rates) against tax revenue. Basically, devaluation is a factor that makes the government fails to pay foreign debt. Therefore, the government is encouraged to continue seeking for more state revenue, one of which is by increasing tax revenue. However, foreign debt management must be implemented with the right strategy. Accumulating economic growth through debt proposals is not the right strategy to implement, since reducing high debt levels will benefit the country's economic performance (Chien et al., 2022). The foreign debt variable as moderation of FDI (Foreign Direct Investment) strengthens the effect of FDI on tax revenue, from the initial coefficient value of -3.1239 to 0.1301 after moderation. The relationship between foreign debt and FDI in a country can be stated in an analogy : a country with high foreign debt will try to find more revenue to pay its debts, one of which is from FDI entering the country. Similarly, a research by Tanna et al. (2018) emphasized that FDI-based economic growth depends on the level of foreign debt owned by a country. When a country has a high level of foreign debt (high indebtedness), the economic growth from FDI can no longer be https://www.ilomata.org/index.php/ijtc Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Carribean (LAC) Region 2002-2019 Nugraha and Wijaya 623 | Ilomata International Journal of Tax & Accounting https://www.ilomata.org/index.php/ijtc generated since the country will focus more on paying off its foreign debt. One of the steps taken by the state in response to this case is to improve its international tax competitiveness strategy to help increase foreign investment. If a country's domestic tax base tends to be higher than other countries, investors will move their operations to countries with a smaller tax base, and this will result in FDI outflows (Gropp & Kostial, 2001). Foreign debt variable as moderation of trade openness weakens its effect on tax revenue, from the initial coefficient value of 1.4898 to -0.0627 after moderation. A number of studies indicate a positive relationship between foreign debt and trade openness. A research by Zakaria (2012) that trade openness has a significant positive effect on Pakistan's foreign debt. It is proven that the country's economic openness is one of the stimuli for the growth of its foreign debt. A similar relationship is shown in a study by Casares (2015) which indicated an increase in the proportion of foreign debt to GDP and a decrease in the currency exchange rate, thus it results in a relative price decrease of non-tradable good. Non-tradable goods are goods which are not offered to international market, such as electricity, water, or goods with high accommodation costs or specialized commodities, including the public service sectors like hotels, construction, real estate, and some others (Jenkins et al., 2011). Figure 3 Service Sector Contribution to GDP in LAC in 2019, source : Worldbank From the previous explanation given, it can be emphasized that countries in LAC tend to have a high contribution to GDP from the services sectors as shown in Figure 3. The implication is that the decline in the relative price of the services sector in LAC countries affects a decrease in tax revenue. As for the tax calculations, when the nominal transaction on which the tax base decreases, the tax imposed by the state will proportionally become lower. Therefore, it can be stated that a foreign debt will affect the trade openness on tax revenue through a decrease in the tax base of non-tradable goods, particularly the service sectors. https://www.ilomata.org/index.php/ijtc Determinants of Tax Revenue in the Context of International Transactions in the Latin America and Carribean (LAC) Region 2002-2019 Nugraha and Wijaya 624 | Ilomata International Journal of Tax & Accounting https://www.ilomata.org/index.php/ijtc CONCLUSIONS Tax revenue serves as the backbone of the economy in almost every country in the world. Factors affecting the amount of tax revenue generated by the state include international transaction activities. The activities can partially be represented by three variables, FDI, TO, and foreign debt. The results of the study using regression model suggest that FDI has a negative effect on tax revenue in LAC. This occurs since brownfield FDI dominates FDI transactions in the LAC region, particularly from China. TO has a positive effect on tax revenue, on the grounds that exports of Honduras' main product, coffee beans, are given tax incentives to stimulate growth in the sector. As a result, the export activities become better, the international trade increases, and so does the tax revenue. Furthermore, foreign debt has a positive effect on tax revenue. This is explained an analogy, that if a country is indebted, it will try to increase its state revenue, one of which is from taxes. Foreign debt as a moderating variable of FDI is able to strengthen the influence of FDI on tax revenue through a tax competitiveness strategy for the purposes of attracting investors to come and encouraging tax revenue to increase. Conversely, foreign debt as a moderating variable of TO, weakens its influence on tax revenue. 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