Terms of trade shocks and taxation in developing countries

We find evidence suggesting that economies with a tax structure more oriented toward indirect taxes –rather than direct taxes– tend to mitigate the effect of terms of trade shocks on output fluctuations. This finding might be particularly important for lower-income countries since the negative welfare effects caused by macroeconomic volatility in the absence of consumption-smoothing mechanisms are more severe in developing economies exposed to external shocks. Additionally, some of these economies are attempting to reorient their tax structure toward more direct taxes following the standards in advanced economies.