Direct Tax, Indirect Tax and Economic Activities in Developing Countries: Empirical Evidence Based on Malaysia Data

Economists argued that macroeconomic activity will be affected differently whether through indirect taxes or direct taxes. Therefore, this paper aims to examine the causality relationship between two types of tax categories (direct tax and indirect tax) and major macroeconomic variables based on Malaysia data, namely consumption, investment, government expenditure and exports. In this paper, the bi-variate causality relationship between direct tax, indirect tax and the macroeconomic variables studied were examined using Granger causality tests that were proposed by Toda and Yamamoto. The data for the analysis consist of quarterly data covering the period from 1996 to 2013. The findings from the causality tests show that in the short run, direct tax in Malaysia causes household consumption and private investment, but not government expenditure and exports. Similarly, indirect tax also causes households consumption and private investment, but not the government expenditure and export. Both types of taxes do not causally affect the level of government expenditure in Malaysia.