Should governments outsource revenue collection?

In order to improve the efficiency of tax collection, local governments in many developing cities are looking to outsourcing tax collection to private companies. This is seen across a number of different revenue sources, including property taxes, parking fees and market fees. In Mwanza, Tanzania, for example, over a third of council revenues in 2006 were privately collected 7.

There are a number of potential advantages to local governments to outsourcing tax collection to private companies. Private managers are likely to have greater incentives and potential means with which to motivate tax collectors to expand tax revenues. If private firms have higher staffing and financial capacity than local governments, this can also expand their tax collection potential. Where tax collection is implemented under ‘tax farming’ contracts, which specify a particular level of revenue to be paid to governments by private partners each month regardless of actual collection revenues, outsourcing collection also comes with more predictable streams of revenue for governments.

However, privatising tax collection also comes with significant potential disadvantages. These include:

  • Local governments can face inflated or uncompetitive costs of private collection, particularly if there are significant sunk costs associated with switching to new systems of collection, or if private collectors have a strong monopoly position in providing collection services.
  • Private firms also charge a private premium on collection in the form of retained revenues, which can far exceed costs.
  • Private collection can undermine the legitimacy of local government and damage the necessary social compact between citizen and state for tax compliance.

As such, for private outsourcing of collection to be effective in expanding local government revenues and enhancing tax compliance requires very specific conditions:

  • Competitive and transparent tendering processes to reduce opportunities for corruption.
  • Investments in detailed revenue projections to reduce private premiums.
  • Shorter term, smaller scale and enforceable collection contracts to encourage competitive performance.
  • Monitoring systems to prevent overzealous collection, inefficiency and corruption of private collection.

Without these enabling conditions, capacity development to facilitate internal tax collection by government departments may be the best option for developing cities.

An extended Cities that Work synthesis paper on private vs. public revenue collection is available here.

Footnotes

  • 7 Fjeldstad, Katera, and Ngalewa, “Outsourcing Revenue Collection: Experiences from Local Government Authorities in Tanzania.”