The Role of Taxation in Driving GDP Growth in Sri Lanka: An ARDL Bounding Testing Approach

Abstract

This study examines the impact of taxation on economic growth in Sri Lanka using annual time series data from 1990 to 2023 within an ARDL Bounds Testing framework. GDP growth is analyzed alongside tax revenue, inflation, money supply, and trade openness to assess short-run and long-run dynamics. Descriptive statistics indicate Sri Lanka’s GDP growth averages 4.30% with moderate variability, while inflation shows high volatility. The ADF unit root tests confirm a mixed order of integration, validating ARDL applicability. The bounds test confirms a stable long-run equilibrium relationship among variables. In the long run, tax revenue significantly and positively impacts GDP growth, suggesting higher tax revenue supports growth through productive public investment. Inflation and money supply lagged exhibit significant negative effects, indicating that price instability and excessive monetary expansion harm growth. Trade openness displays a weak but positive influence. Short-run analysis reveals that changes in money supply and trade openness significantly affect GDP growth, with the error correction term indicating that 95% of disequilibrium adjusts within one year, confirming rapid convergence to the long-run path. Diagnostic tests confirm model reliability, with no evidence of heteroscedasticity, serial correlation, or significant non-normality in residuals. CUSUM and CUSUMSQ tests further validate structural stability. The findings highlight the role of tax revenue in driving Sri Lanka’s GDP growth while emphasizing the need for effective monetary policy to control inflation and manage money supply. The study recommends reforming the tax system to focus on growth-friendly instruments, strengthening tax administration, ensuring price stability, and promoting trade openness to support sustainable economic growth in Sri Lanka.