Effective tax enforcement is central to a government’s ability to fund infrastructure and public service delivery. Ineffectual tax policies contribute to higher levels of corruption, evasion, and ineffective political structures. Barriers to effective tax collection, enforcement, morale and administration all constrain the fiscal capacity of developing country governments to finance the expenditures on services and infrastructure needed to spur growth. Public finance reform is, however, only one piece of a larger growth puzzle. For increased tax revenues to translate into meaningful and transformative growth, broader reforms to procurement and public sector practices are needed alongside improvements in accountability and transparency.
Characterised by higher informality and selfreported income, developing countries often lack the enforcement capacity needed to effectively wield modern tax instruments. Modern tax systems require third-party verifiable information trails generated through widespread monitoring and reporting of financial flows. Without this, evasion increases and revenues decrease.
Historically recommended reforms centred on secondbest approaches, champion production efficiency above all else. These ignore the enforcement challenges experienced by most developing countries. A new wave of third-best policies, prioritising revenue efficiency, illustrate that higher revenues, generated by tax policies accounting for capacity constraints, may outweigh lost production efficiency.
This brief provides four key recommendations for policymakers striving to increase tax revenues:
- Strategies for increasing tax revenues must account for a country’s local context and its particular constraints. Developing countries tend to have weaker tax collection and enforcement systems; even incremental improvements could increase much-needed revenues.
- Policies for developing country governments may need to shift away from production efficiency in favour of revenue efficiency. Policy design must account for higher tax evasion rates and invest in third-party reporting systems.
- Leveraging incentives and social pressures on taxpayers could improve tax compliance. Social recognition schemes show promise in raising tax compliance. However, better evidence is needed to understand how to harness citizen tax morale.
- Incentives to improve tax administration are vital in addressing challenges to tax enforcement. Implementing simple and objective performance-based pay schemes can incentivise tax collectors in developing countries, offering an escape from cycles of low pay, low motivation, and low productivity. Incentives must be balanced against abusive over-taxation.