Tax Matters for Developing Countries

By Carlo Cottarelli

You hear a lot these days—not least from me—about the fiscal problems of advanced economies. But let’s not forget the fiscal problems that low-income countries face, though they are of a different kind.

For all too many low-income countries, government tax revenues are far from enough to meet the needs of their people. Some have made good progress, and this helped them weather the crisis better than many advanced economies—but there is an underlying, quiet crisis of inadequately resourced governments.

Nor is it just the level of revenue that matters; tax design and implementation are also critical to the efficiency of economic activity, to fairness, and to the legitimacy of the state.

Sharing experiences

Supporting low-income countries’ efforts to strengthen their ability to raise revenue is an important part of the IMF’s role in helping them maintain stable and growing economies. How best to do this was the topic of two recent IMF conferences: one, in Nairobi, focused on sub-Saharan Africa; the other, with a global focus, in Washington DC earlier this week.

In both cases, I was impressed by just how candid and frank participants—government officials as well as civil society, donors, business and academics—were about what has and hasn’t worked for them. At both events, participants made very clear their view that the IMF’s technical support has, and is, helping their countries become better governed states that are responsive to the needs of the people. But they also made very clear that ultimately the solutions to these problems must be home-grown.

We want to hear your ideas too, on both our recent paper on this topic and the G-20’s request for major international and regional organizations (including the IMF) to advise them on what they could do to help. Please visit our comments page to weigh in.

More than “show me the money”

There was, of course, a lot of technical stuff at both events[i]. I now know much more about the details on which revenue mobilization ultimately depends, such as taxpayer segmentation, compliance management, production sharing agreements, transfer pricing, and small business taxation, among other critical issues.

But it is the broader issues that left the most powerful impressions. Four in particular stand out:

(i)  Strong Commitment

Many low-income countries have shown strong commitment to strengthen their revenue systems, through both administrative reforms and improved tax policies.

There is a lot still to do. In sheer revenue terms, an additional 4 percentage points of GDP or so was suggested needed in some low-income countries if they are meet the Millennium Development Goals. But there have also been notable successes: Tanzania, for instance, achieved a 5 percentage point increase in its revenue to GDP ratio in the decade after 2000. Such good results exemplify the need for a commitment to the reform process over the medium- to long-term; sustainable changes require continued effort, and, particularly, continued political support.

(ii)  Equity, fairness and good governance

Strengthening revenue systems is about much more than increasing revenue.

  • Effects on growth and efficiency clearly matter—the poor are not likely to be best served by tax systems that treat investment harshly, for instance.
  • But equity and fairness matter a great deal too, maybe even more. They matter in themselves: after all, a main reason that low-income countries need more revenue is to finance poverty-reducing measures. And equity and fairness also matter for the legitimacy and effectiveness of the tax system: taxes that are seen as unfair will be poorly complied with. And poor compliance leads itself to actual and perceived unfairness, as only some pay their fair share.
  • Then there are links between taxation and building modern, accountable and responsive governments overall. One reason we have long seen combating corruption in tax administrations as so critical, for instance, has been its potential value in spearheading wider improvements in public governance. Ensuring that elites are seen to pay a decent amount of tax is important in this context too.

(iii)  Avoiding exemptions and preferences

Exemptions and preferential treatments in tax systems are a pervasive source of revenue loss in many developing countries—as they are too, of course, in many advanced economies.

Discussions at the two recent conferences made clear again that many low-income countries fully understand the misallocation of resources and inequities these create.

They feel, though, largely powerless to do much about them because of both strong domestic interests and a perceived need to compete with neighboring countries for foreign investment. Increased transparency has an important role here, particularly in the form of analyzing the revenue losses associated with tax expenditures. So, perhaps, does stronger regional tax cooperation, so countries can avoid “beggar thy neighbor” tax policies.

(iv)  Political will

But addressing inappropriate tax policies, and improving revenue administration and enforcement, is ultimately an act of political will. The trouble is—and this is my final impression—that we still know very little about this ‘political will.’

We know it is needed in order to drive through tough policy changes. And that it matters to build and support firm, even-handed enforcement. But there are many hard questions, to which we don’t yet have the answers, about where political will comes from and how to create it.

Our best hope of finding the answers is by continuing the kind of dialogue we have had in Nairobi and Washington.


[i] You can find the presentations from the Washington event at www.imf.org/fadrmdc.

3 Responses

  1. [...] Cómo atraer la inversión sin sacrificar demasiados ingresos fiscales debido aincentivos tributarios costosos. [...]

  2. [...] to attract investment without sacrificing too much fiscal revenue through costly tax incentives; [...]

  3. If a developing nation is Monetarily Sovereign, it already has the unlimited ability to create its sovereign money, and so does not rely on taxes to fund spending.

    If a developing nation is monetarily non-sovereign it cannot rely on taxes alone. It must have money coming in from outside its borders, i.e. exports. This is a mathematical truth; taxes alone never can be sufficient to support a monetarily non-sovereign government. No amount of cost cutting or tax increasing will suffice.

    The solution for monetarily non-sovereign nation is either to have a positive balance of trade (a difficulty long-term strategy) or to become Monetarily Sovereign by divorcing its money from any other currency or physical product.

    Rodger Malcolm Mitchell

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