How can taxation policy and administration promote economic growth and political legitimacy, while also mobilising revenue for the state? This article reviews the literature on the connection between taxation and governance and extracts seven principles for creating a statebuilding tax system. Drawing on evidence from DFID/World Bank projects in Sierra Leone, Yemen, and Vietnam, it argues that tax policy when effectively linked to political governance and economic growth can create mutually reinforcing statebuilding processes.
Recent research has focused the attention of the international development community on taxation as a fundamental process for constructing effective states and markets, necessary for ‘exit from aid’. An effective state requires a political settlement among elites to collect revenues. This agreement then enables a social contract between the state and its population to pay taxes in return for the delivery of basic freedoms and essential public goods. How the state collects taxes influences its relations with its citizens. The more effective the tax system is, the stronger its role is in developing the capability, prosperity and legitimacy of the state.
Seven principles for a statebuilding tax system can be identified. They are based on strengthening state legitimacy and the ‘fiscal social contract’:
- Political inclusion: Paying taxes gives citizens a powerful incentive to engage with government and the political process, creating a stronger democracy in states where a higher proportion of people pay taxes and vested interests do not ‘capture’ the state.
- Accountability and transparency: Use of tax revenues should be justified to taxpayers, who, in turn, can demand to know if tax revenues are properly used. Compliance rates go up when citizens and businesses know what they get for their taxes.
- Perceived fairness: Perceptions of unfairness, such as failure to address widespread tax exemptions or the informal economy, limit both revenue and ‘willingness to pay’.
- Effectiveness: Administrative capability translates increased public revenues into better public goods, more capable government, and increased political stability.
- Political commitment to shared prosperity: The tax-system component of the statebuilding effort must explicitly link to a national strategy for promoting economic growth.
- Legitimisation of social norms and economic interests: The state through tax policies can convey official recognition of social and economic institutions such as marriage and property rights, providing motivation for citizens to support the legitimacy of the state.
- Effective revenue-raising: Effective states need adequate resources for providing the physical security, property rights and effective contract enforcement needed to deliver economic growth. They also need resources to finance welfare systems that secure political stability.
In most developing countries where personal taxation is limited, the political development of the state depends on political and economic elites demonstrating a credible commitment to development outcomes. Harnessing this for statebuilding requires explicitly bringing tax policy and its administration together with political governance and economic growth, such that the state can be strengthened through the tax system. Policymakers need to:
- Engage with the political process around tax: Understand the historical/political context of taxation and strengthen the political rationale for broadening the tax base, explicitly encouraging citizen groups as taxpayers to seek political ‘voice’.
- Promote accountability and transparency: Work with parliaments, media, civil society and taxpayers’ associations to improve oversight, transparency, and public debate on tax issues.
- Build capacity: Support international networks of tax administrators to raise professional standards and ethics, while simplifying tax codes and regulations.
- Support fairness and equity: Broaden the tax base and reduce exemptions to increase the sense of justice, focusing particularly on direct taxation methods, such as income and property taxes.
