How can tax reform enhance citizen-state relations? This report examines the role of taxation in building more responsive and accountable government, and in expanding state capacity. It finds that the specific character of tax systems and of tax reform is very important to strengthening connections between taxation and broader governance gains. Governments and donors can strengthen tax-governance links through three types of actions: 1) specific measures to enhance and re-orient the dominant tax reform agenda; 2) support for civil society actors to engage in debates about tax issues; and 3) managing the provision of aid in ways that maximise positive revenue-raising incentives and local accountability.
One of the ways in which taxation can improve governance is by developing the state apparatus. Improvements in tax administration can lead to broader improvements in state capacity by means of: administrative innovations that can spread through the civil service; pressure for improvements in other agencies; an enhanced government presence in remote areas; and by providing data and information essential to other government activities. In order to improve the state’s administrative systems, a supportive tax reform agenda should focus on:
- Links between the tax administration and other areas of government: System-wide gains are more likely where links are strong.
- Data gathering and transparency: This can help improve government performance in areas such as industrial policy, land management and law enforcement.
- Reforms that are also relevant for other departments: These might include citizen outreach, incremental information technology reform, or experimenting with different salary scales.
- Local tax administration: Strengthening local systems, and their links to the national tax system, might encourage broader improvements in local government performance.
Taxation can also improve governance by developing responsiveness and accountability. Governments that rely on taxes engage in a ‘tax bargain’ with citizens. This process engages taxpayer-citizens in politics: citizens comply with taxes in exchange for government providing effective services, the rule of law and accountability. However, in many countries taxpayers have little faith in the system, which remains essentially coercive and offers benefits and exemptions for elites.
Research indicates that a consensual tax bargain is more likely where taxpayer awareness and education are high; the tax system is transparent and highlights tax-expenditure linkages; taxpayers have shared interests and a high level of mutual trust; there is adequate trust in the integrity of the tax system; taxpayers are organised politically; and voluntary compliance is emphasised. Reform should therefore aim to improve responsiveness and accountability by: 1) improving equity in tax enforcement and administration; 2) improving public awareness, transparency and taxpayer services; 3) broadening and improving direct taxation; and 4) strengthening civil society engagement with tax issues.
It is also important to consider the impact of aid on taxation – on levels of tax collection, on how taxes are collected, and on government dependence on tax revenue as a share of total revenue:
- Aid does not consistently lead to lower levels of tax collection: aid creates both incentives and disincentives for revenue generation, and the relative strength of these in each case is likely to be context specific.
- While donor conditionality in relation to tax revenue increases tax collection, it is also likely to promote coercive and short-term technical collection measures (at the expense of long-term ‘soft’ requirements such as national dialogue on taxation).
- Aid seems likely to reduce the potential for tax bargaining through its impact on levels of government dependence on tax revenue. Aid is likely to affect dependence levels by: a) reducing government willingness to make concessions to taxpayers in order to secure tax revenue; b) reducing the likelihood that taxpayers will engage in collective action to make demands on government; and c) making governments more responsive to donors than to their citizens, contributing to a sense of disempowerment among citizen groups. More research is needed to test these ideas.
Two, more speculative, insights emerge from recent research on taxation and state building. In order to support increased accountability in recipient countries donors could:
- Make revenue-raising processes an entry point for efforts to strengthen domestic institutions of accountability, particularly in states recovering from conflict
- Support downward accountability to citizens for aid funds, emphasising transparency and consultation at national and local levels, instead of relying on upward accountability to donors.