How can taxation policy help to improve governance and accountability in developing countries? This paper from the OECD’s DAC guidelines and reference series argues that taxation systems contribute significantly to shaping accountability relationships and strengthening state capacities. Further coordinated efforts from both developing countries and donors are needed to secure larger tax bases, better tax compliance, and comprehensive tax reform in order to improve state responsiveness and accountability. Donors should combine high-level international efforts with work to improve the enabling environment and with more direct support to organisational changes.
Historically, the formation of accountable and effective states has been closely bound up with the emergence of taxation. In many developing countries, however, states have grown reliant on revenue from foreign aid and natural resource rents. As a result, there is little bargaining between governments and citizens and little incentive for governments to be accountable, responsive, or efficient. This limited state dependence on taxes has been shown to lead to bad governance outcomes.
While the negative impact of resource rent reliance has been well-documented, the effect of aid inflows is less certain. Reliance on aid for state revenues can create perverse incentives for governments and free them from some pressures of accountability, but it is thought that the ‘purposive’ nature of aid, as well as its accompanying expertise and scrutiny, help to counteract its negative influences. Nevertheless, donors should match their focus on resource revenue transparency initiatives with a renewed focus on the positive drivers of enhanced domestic accountability.
The challenge for poor countries is to tax a larger number of citizens and enterprises more consensually. While evidence suggests that, due to large informal sectors, tax coverage and compliance is low, recent experience suggests that taxpayers’ behaviour can be transformed by reforming the tax system. A further difficulty facing governments and donors alike is the need to avoid taxes that are perceived to be unfair or collected in unfair ways. Finding equitable and efficient taxation solutions will require moving beyond the national level and engaging with local and regional governments. There may be limited government interest in reform at first, but small changes can tip the balance of incentives and begin to create virtuous circles of change.
Donors must do more to support revenue-raising efforts in partner countries in ways that are likely to improve governance. Areas for intervention include the following:
- Follow up on the 2002 Monterrey Consensus to provide more, and more predictable, aid to partner countries, with the commitment from partner countries to enhance domestic resource mobilisation
- Negotiate and implement tax treaties with developing countries to ensure that multinational enterprises pay a fair share of taxes, and do more to address the problem of tax havens where illegally acquired funds from the developing world often end up
- Take account of political economy aspects of and political incentives for taxation and the impact of different aid modalities on domestic accountability and tax
- Develop a consensus on key technical elements of tax reform and provide more harmonised support around these programmes
- Give priority to regional initiatives and South-South learning on tax reform
- Identify and support civil society partners with strong links to the revenue side of public policy
