Taxes matter. People talk about them and try to avoid them. Businesses react to taxes in how they organise their activities and in where they carry them out. This study from the World Bank looks at the issues and asks one key question: How can developing countries best design and develop tax policies to achieve their policy objectives, given the complex economic and political environments they face?
Developing countries face a difficult task in designing and implementing suitable tax systems. In practice, countries have often relied heavily on taxes on international trade, but this tax base is also becoming increasingly hard to implement in the face of pressures for trade liberalisation. As countries develop, the mass modern production and consumption activities (on which the tax systems of developed countries rest) are expanding and need to be brought into the tax base without overstraining administrative capacity. Economic growth is often encouraged by, and results in, closer involvement with the international economy, but such “globalisation” simultaneously may cause fiscal problems. Life is not easy for tax people in developing countries, and is becoming increasingly difficult. The problems are potentially greatly exacerbated by the political economy context within which taxation must be designed and implemented:
- Tax policy decisions are not made in a vacuum. Nor are they made, as is often assumed in economic discussion, by a “benevolent” government.
- Taxation is not simply a means of financing government but one of the most visible parts of the social contract underlying the state.
- Unless states are accepted as legitimate, they will not be capable of securing sufficient resources to govern or to develop.
- The success of tax reform clearly depends on the way in which different political groups perceive the reform and how they react to their perception.
- Tax reform is “an exercise in political legitimation”. Those who will have to pay more must be convinced that they will get something worthwhile for their money.
- Those who will not pay more must also get behind a reform if it is to succeed. The bureaucracy must also support it, or at least not actively oppose it.
In these and other ways, the eternal problems of designing and implementing a good tax system continue to be complicated by the changing world within which such decisions are made. Countries no longer have the luxury to design their tax systems in isolation. There is increased pressure:
- On trade taxes. World Trade Organisation membership requires significant reductions in import and export taxes. This has different consequences in different parts of the world.
- On corporate income tax revenue, which is a larger portion of tax revenue for developing countries as compared to developed countries.
- On individual tax revenue. Increased mobility of capital makes it harder to tax income. It may also be harder to tax labour income, as labour becomes more mobile.
- On VAT revenue. Improvements in technology allow increased sales without the seller having a physical presence in a country, as well as increased use of digitised products that make collecting taxes on such products more difficult.
