Day 1: Framework Session – Taxation and Development

The Taxation and Development session was chaired by Professor Sultan Hafeez Rahman. Professor Henrik Kleven (Professor of Economics, LSE) and Professor Asim Khwaja (Professor of Public Policy, Harvard Kennedy School) were the speakers. Professor Rahman said that the taxation is a crucial development issue and there is increasing policy interest in the taxation around the world.

Professor Henrik Kleven (Professor of Economics, LSE) presented first and described two current approaches to study public finance and taxation. The first approach is the big- picture – trying to study macro issues and answer questions like how does a government go from raising around 10% of GDP taxes to raising around 40%. The second approach is the nitty gritty or micro approach that focuses on tax administration, tax policy and other micro issues.

He then said that both him and his co-presenter Professor Asim Khwaja focus on the micro- nitty gritty approach in this presentation.

Professor Kleven covered two aspects of the micro approach of studying public finances- (a) enforcement and (b) tax policy.

While speaking about tax enforcement- he described four key components of the tax enforcement- they are (a) audits (b) penalties (c) third party information reporting and (d) other verifiable information trails. All these components are weak in developing countries. He also said that there is a negative relationship between theĀ self employed population and tax to GDP ratio of countries that affect tax enforcement capacity of the developing countries. He presented an example of Denmark, a developed country that has the record tax to GDP ratio in the world and said that the reason behind such high tax GDP ratio is the tax information reporting system of the country. In this background, he said, the Policy lesson for developing countries is not to try and replicate the Danish information reporting system as the success of the system is based on many context specific factors are like tax administration, self- employment, industrial composition, firm size and complexity, financial sector, scope for evasion substitution.

While speaking about Tax policy, he said that the two most important recommendations from literature are to use progressive income taxes and VAT and do not use capital tax, differentiated consumption taxes (except for externalities) and taxes on turnover. Even for the tax policy, he said, the recommendation for IGC countries is not to replicate policies from high income countries but to consider the specific context.

The next speaker, Professor Asim Khwaja (Professor of Public Policy, Harvard Kennedy School) started his presentation with three important points about taxation. (a) people matter – both the tax staff and citizens matter for taxation (b) people (generally) act in their self-interest and (c) policies/systems work better when designed to account for the fact that people act in their self-interest.

He then spoke about specific tax administration issues in developing counties and presented broader civil service reform issues related to tax services in developing counties like low payments to tax authorities and lack of career development opportunities for them. He then presented results from his empirical study from Pakistan which shows that there is a substantial increase in the total revenue collection if the tax administration people are paid based on their performance.

He concluded his remarks with policy recommendations for developing countries and said that- rather than relying on transplanting developed country solutions/tax codes/ procedures, developing counties should take more a nitty-gritty micro approach grounded in the specific context and constraints of the country in question. It’s hard but doable.

By Vikas Dimble, Country Economist, IGC India-Central