Ideas for growth session 10: State capabilities

Chaired by Oriana Bandiera (LSE; IGC), the session on State Capabilities was opened by Karthik Muralidharan (USCD) who presented India-based research on the fiscal costs of weak governance. India has ~200 million school-age children, but on any given day 25% of teachers are absent. The government has increased school spending; this research uses panel data to ask to what extend these investments have improved education quality in rural India. Results indicate considerable improvement in school infrastructure & pupil-teacher ratios but much less progress in reducing teacher absence. A key research finding is that changes in teacher absence are more significantly correlated with outcomes (enrolment, attendance, test scores) than changes in infrastructure. Increasing governance through inspections to reduce teacher absence would, on the margin, save approximately 10 times the cost in terms of salary cost of teacher absence.

Eric Verhoogen (Columbia) presented research examining payroll tax compliance in Mexico. Difficulty in raising taxes from firms to fund public goods is a major growth constraint. Most research in this area examines the failure of firms to register, but this research examines the under-appreciated area of under-reporting of wages. Using a difference-in-difference method and using pension data, Verhoogen finds that substantial evasion exists. The implications are that the administrative costs of collecting taxes need to be taken into account in designing tax systems, and specifically, in low-enforcement settings, giving employees an incentive to monitor employers can be effective in improving compliance.

Dina Pomeranz (Harvard) presented further research on firms’ tax compliance, focusing in this case on Latin America and using a method whereby firms are notified that the tax authority will cross-check tax declarations. A Chilean-based experiment tested whether increased tax enforcement has a smaller impact where self-enforcement is present and found a strong response to the message of increased audit probability, with a VAT paper trail acting as a substitute for increased audit risk. The receipt trail inherent to VAT has important self-enforcing properties. New research in Ecuador dives deeper into the micro-economics of tax evasion and asks about the ways in which firms can manipulate information. An initial conclusion is that a paper trail and third-party reporting are crucial tools for tax enforcement.

Discussant Nasiruddin Ahmed (National Board of Revenue, Bangladesh) noted that, as a policy-maker, the research presented was of direct interest, particularly the issue of voluntary tax compliance. Ahmed commented that informality is an important issue for Bangladesh, and informed the audience that Bangladesh has begun to implement some incentive-based tax systems which attempt to involve employees more directly and increase tax transparency.