Researchers from the IGC have presented evidence to the Commons Select Committee on International Development emphasising the importance of effective tax collection for developing countries.
Tim Besley of the LSE and member of the IGC steering group, along with Adnan Khan, Acting Deputy Executive Director, submitted a paper on Tax in Developing Countries: Increasing Resources for Development to form part of the UK government’s review of its development policy. (The submission is available here and oral evidence is available here).
The paper focuses on how governments in developing countries can collect more taxes in order to provide the infrastructure and support needed for their countries to develop – such as building roads, schools and hospitals. But Besley and Khan point out that this is far from simple. While collecting taxes is essential for countries to grow, in order to do so governments need to spend money in the first place on monitoring people’s incomes, company profits, trade at ports, and so on. Without the tax revenue to do this, the process can be extremely difficult to kick-start. In the opening section of the evidence, they write:
“The inability to tax is both a symptom and a cause of underdevelopment. Difficulties in collecting taxes are generally a symptom of a weak economy and an ineffective government. And governments without tax revenues must rely on external sources of support to provide public services.”
This is part of the reason why richer countries tend to raise more tax revenue as a share of their national income than poorer countries. The paper highlights some of the underlying causes for this, which include:
- - Political stability: ‘Short-lived governments have little incentive to make changes [to the tax system] that will benefit future incumbents’.
- - Political institutions: ‘Those with strong legislative and judicial institutions, limit corruption and encourage public revenues to be spent on public services which benefit a broad segment of the population’. This in turn makes the general population more accepting of higher taxes and less determined to avoid and evade them.
- - Social interests: The paper argues that one of the major reasons for collecting taxes historically has been to fund wars, which at the time were considered in the common interest. Over time, the public interest in developed countries have moved to a desire for a more equal society, which requires tax to redistribute wealth.
But the paper notes: ‘Even if institutions are cohesive, translating demand for spending into fiscal capacity is muted when there are natural resource rents or aid dependence’. This is because governments have less need to set up effective tax systems when they receive revenues from the large mining or oil companies, for example. Adding, ‘the evidence on cash aid dependence is less clear cut but the basic argument is similar.’
For policymakers facing these problems, there is a limited amount of research and evidence to inform their decisions. The paper mentioned on-going IGC research that aims to plug this gap.
- - A study in Punjab, Pakistan by Ben Olken (MIT), Asim Khwaja (Harvard) and Adnan Khan (IGC LSE) aims to inform policy on revenue collection, corruption and how to improve the efficiency of tax collection. The researchers have worked closely with the government in designing and evaluating wage and incentive schemes for tax officers to see which are most effective. Pakistan has one of the lowest, and declining, tax-to-GDP ratios in the world.
- - A study together with the National Board of Revenue in Bangladesh being carried out by Raj Chetty (Harvard), Monica Singhal (Harvard), and Mushfiq Mobarak (Yale) is examining whether social rather than economic incentives can encourage tax compliance. In particular, they are exploring if concerns for social status can act as an incentive to pay more taxes.
- - Henrik Kleven (LSE) is currently working with the Federal Board of Revenue of Pakistan to look into people’s responses to their tax system (individual and corporate income tax, and VAT) with a view to reducing distortions and increasing the government’s tax revenue. Read the presentation from Growth Week 2011 here and a working paper is available here.
Besley and Khan conclude: ‘This kind of work is in its infancy but shows how a proper collaboration between research expertise and a revenue authority can potentially pay dividends’.
IDEAS FOR GROWTH
Besley and Khan point out that in the amount of tax being collected in poor countries as a share of their national income ‘does not look very different than the tax take 100 years ago in the now developed countries’. In other words, improving the ways that these countries collect taxes in one of the essential ingredients for an effective state, which in turn is vital for economic development. They conclude: ‘It is hard to divorce the creation of fiscal capacity from more general forces that shape state effectiveness and economic development’.
The evidence ends with a discussion of what donor countries, such as the UK, can do to encourage better tax policy in developing countries. They write: ‘Countries that have the underlying preconditions for growth and state effectiveness will tend to build effective fiscal systems along the way. Giving aid and support to such countries may accelerate this process but the case for external intervention is weak.’ It cites governments that are already developing their tax systems without encouragement, such as in China and India, and governments that in their current state have little incentive to improve their tax collection because they receive sufficient funds from natural resources or from international aid.
But within these countries, Besley and Khan conclude: ‘where there is a will to embrace reform, there is also scope to encourage governments to undertake more ambitious and innovative schemes for tax collection in collaboration with researchers that are both carefully conceptualised and scientifically evaluated. Since greater revenue mobilisation and improved public sector performance are among the top priorities of developing countries, the lessons from these studies are likely to broadly influence both the intellectual and policy debate on the topic.’