Why do the governments of low income countries not raise more tax revenues? Two different but complementary approaches are used to answer it. The first approach is comparisons: among countries today, and within countries over time. This approach tends to generate relatively conservative answers to the central question. It leads to an emphasis on the ‘sticky’ nature of the taxation.
For any individual country in ‘normal times’ – i.e. excluding situations of war, major internal conflict, the collapse or rapid reconstruction of state power – revenue collections, measured as a proportion of GDP, do not change much from year to year. This is partly because effective taxation systems require a great deal of coordination and cooperation between revenue agencies and other organisations, both inside and outside the public sector. It is hard quickly to improve the effectiveness of a complex organisational network.
The ‘stickiness’ of tax collections also reflects the fact that the overall tax take – i.e. the proportion of GDP raised as public revenue – is to a significant degree determined by the structure of national economies. For logistical reasons, it is much easier to raise revenue from economies (a) that are high income, urban and non-agricultural and (b) where the ratio of international trade to GDP is high. The government of the average low income country raises less than 20 per cent of GDP in revenue. It makes no sense for such governments to aim to match OECD tax takes of 30-45 per cent of GDP.
The comparative and historical approach also draws attention to the political constraints on the capacity of governments to raise more revenues. These political constraints are quite variable across time and space. The most familiar is the capacity of wealthy people and companies to influence opaque processes of tax policy formulation and administration to ensure that they pay less in taxes than most other people would consider reasonable. But this kind of interest group politics is only one of the sets of political phenomena we need to take into account.
Another is that the organisations that collect taxes often engage in a considerable amount of rent-taking. They make money illegally for their own staff, often handing over some of it to their political masters. In the process of making money illegally, they often cut deals with taxpayers, to the double detriment of the public treasury. These practices tend to bring tax collection into disrepute, and decrease overall willingness to pay.
The tax system also serves another political purpose. The ability of governments to grant tax exemptions – i.e. to exclude specific companies, industries or individuals from tax entirely, typically on the grounds that this is an ‘incentive’ to bring in more investment – is in some countries a significant instrument through which governments command support and political financing. The tax losses are enormous.
Finally, the design of a country’s political and government institutions can sometimes have a significant effect on its capacity to tax. In particular, if the authority to raise taxes is institutionally and politically very separate from the authority to spend public money, the political capacity to raise revenues is likely to be reduced.
The second approach to answering the central question of this paper is to examine the potential benefits of reforms in tax policy and administration. This generates more optimism about the possibilities of raising additional revenues.
The paper deals in particular with three reform issues. The first is the scope for the governments of low income countries to obtain more revenue by better taxing transnational economic transactions, above all those involving large transnational companies. The picture here is very unclear, not least because attitudes, understanding and policies are changing quite rapidly at the global level. Low income countries might benefit from a wide range of reforms now on global policy agendas. But they would be unwise to rely heavily on such an outcome.
The second issue concerns the scope to adopt more widely a bundle of what I term ‘advanced tax administration practices’. Although they originate mainly in OECD countries, these ‘advanced tax administration practices’ have already had a significant impact in many low income countries, and are not intrinsically inappropriate to their circumstances.
But in one respect they do not address the needs of low income countries: they do not tackle the problem of the gross under-taxation of land and property. This is the third policy reform area. The case for substantial taxes on land and property is compelling. The obstacles are both political and institutional.
If we look for specific ‘revenue gaps’ in low income countries, the most evident are: the large amounts of potential tax that are given away routinely by governments in the form of unjustified ‘tax incentives’; the under-taxation of land and property; evasion by those transnational corporations that use transfer mispricing to relocate their profits to the places in the world where they pay little or no tax; the under-taxation of the profits of mining companies (at least when we take into account the prices for minerals over the past decade); and the under-taxation of the wealth and incomes of very rich individuals.
But the more visible revenue gaps are not always the most important. The productivity of VAT in some countries is low because the system is poorly designed. The easiest way to raise more revenue might be to make a series of apparently highly technical changes to the VAT.
And even the visible revenue gaps might not always be best tackled frontally. There will be moments when that seems right. But a frontal assault is not always the best way to win a tax war. Effective tax reform typically requires large doses of political cunning, and may best be wrapped in the soothing – or even soporific – language of ‘tax administration improvements’. If employed intelligently, the obscure concept of ‘broadening the tax base’ could be used in many countries significantly to narrow the five big ‘revenue gaps’ listed above.
Tax is simultaneously both a highly political and a highly technical issue. It is not useful to make advance judgements about how technical knowledge and politics might best be combined to raise more revenue in any specific context.