Is there a limit to taxation? Tax capacity and growth in the East African Community

Taxation is central to financing public goods and services, yet excessive taxation can stifle economic growth, making the determination of an optimal tax threshold a critical policy concern. The study seeks to estimate the tax capacity (TC) and tax effort of East African Community (EAC) countries using the true fixed effects time‐varying stochastic frontier model to estimate tax inefficiencies, effectively separating structural TC determinants from inefficiency effects over the 1995–2022 period. To identify the macroeconomic, institutional, and structural determinants of tax revenue (TR) performance across the EAC and to assess the non‐linear growth implications of taxation, by employing a fixed effects panel threshold regression model, accounting for heterogeneity and endogeneity in the tax‐growth nexus. The study finds that structural factors such as real GDP per capita, education, institutional quality, and trade openness enhance TR, whereas agricultural informality and digital disruption constrain it. The study identifies a threshold optimal TC estimated at 16.21% of GDP. These results underscore the importance of investing in institutional robustness, digital infrastructure, and formalizing key sectors to enhance revenue without impeding growth, offering vital policy direction for fiscal reforms in the EAC.