Finding ways to increase tax revenue is critical if developing countries are to fund essential public services and reduce poverty. Global reforms to tackle tax evasion and policies to strengthen the capacity of national revenue authorities should be a top priority for development cooperation, argues Adam Parsons.
The issue of tax has never held such widespread public attention. Following the global financial crisis in 2008, tax issues that had been campaigned on at the margins for decades suddenly became the subject of high-level intergovernmental deliberations. Global tax regulation has turned into a priority in the G20 agenda, while global forms of tax are today the subject of major civil society campaigns. At the same time, direct action groups such as UK and US-UNCUT are taking the call for tax justice onto the high street. And now the billionaire investor Warren Buffett has forced the issue of tax code loopholes into the political mainstream. But there is another side to the not-so-gritty subject of taxation that lends itself less readily to the popular imagination, even though it remains critical to poverty eradication in developing countries – the issue of domestic tax collection.
Few people are likely to spend their spare time thinking about tax revenue authorities, but domestic tax collection could be equally as important for global justice advocates as issues of aid, trade or debt cancellation. In recent years, many civil society organisations have begun to highlight the imperative need for improved tax administration systems in the South. To begin with, tax is a vital source of revenue for governments to pay for essential services, infrastructure and social protection for their citizens. Tax systems play a fundamental role in redistributing wealth within an economy, and are central to reducing poverty and inequality, not least as it is the poor who depend more on publicly-funded services like health and education. Effective tax systems are about more than financing development, however; tax is also central to building the social contract between citizens and the state. There is now a wealth of research making the case that taxation generates stronger state-citizen relationships than money from other sources, such as aid or natural resources.
From almost any perspective, improved revenue collection is essential if developing countries are to end indebtedness in their own countries and finance poverty eradication from their own resources. In the longer term, a strong personal income tax collection system is clearly the best course of action for ending aid dependence in low-income countries. Yet the gap between where most developing countries’ tax levels stand today and where they quickly need to get to remains enormous. Countries such as Bangladesh and India, for example, gather less than 10 percent of national income from tax revenue, compared to well over 40 percent of GDP in some high-income countries such as France and Sweden. According to calculations by ActionAid for 2007, an extra US$198 billion could have been realised if all developing countries were able to turn at least 15 percent of their GDP into tax revenues (a commonly cited reasonable minimum for a developing country’s revenue-to-GDP ratio, although many countries could raise much more).
Instead, the overall trend of tax levels for governments in the South is going the other way. As a result of the recent financial crisis and ensuing recession, declining national income has led to a fall in tax revenue for most developing countries. At the same time, many rich countries are cutting back on their aid commitments, while falling investment and growing unemployment are placing a greater demand on government resources. The cost is inevitably being felt most by the poorest people, not least when social security systems are receiving the lowest level of support precisely when they are needed most. In this context, finding ways to increase tax revenue is critical if poor countries are to fill the funding gap needed to provide essential services and tackle poverty.
Plugging the holes
There are formidable challenges to overcome if developing countries are to ‘plug the holes’ where tax revenue is leaked out of the economy whilst also increasing the efficiency, capacity and jurisdiction of national tax authorities. On the domestic front, concrete steps can be taken to reduce the problems of corruption, mismanagement and weak administration. Concerning the illegal appropriation of public funds, for example, or the question of whether improved finances will actually be channeled into social services and public investments, the way forward lies in rendering the political process more democratic, accountable and transparent. Some countries have now started to experiment with alternative budget processes, such as participatory budgeting, to help ensure that government expenditures reflect the public interest. Many poor countries also face the challenge of a huge informal sector – generally untaxed, unregulated and growing in size - that can comprise well over 50 percent of the total labour force. Such a significant barrier to raising taxes requires governments to redesign incentive mechanisms that create legitimacy for the informal sector, and make sure that informal workers benefit from public services in exchange for tax.
By far the greatest challenges to increasing tax revenue come from outside developing countries themselves. Beginning in the 1980s, the International Monetary Fund (IMF) and World Bank pressured governments to reform their tax systems in line with the so-called Washington Consensus policies. These fairly homogenous set of tax reforms aimed to make the economies of poor countries more compatible with the demands of global trade integration and financial liberalisation, at the expense of redistribution and the potential for tax to challenge inequality. In concert with their notorious Structural Adjustment Programmes, the IMF demanded that developing countries minimise the taxation of foreign investors, eliminate import barriers and reduce tariffs, even though trade taxes (those taxes levied at the border, mainly import tariffs and export duties) are one of the most important sources of income for countries in the South, particularly in Africa. According to the IMF’s theory, the losses in customs revenue would be compensated by the introduction or increase of other domestic taxes on purchases, such as value-added tax (VAT). Not only did this formula fail to bear fruit for the poorest countries who never managed to compensate for the losses in tariff revenue, but indirect or consumption taxes like VAT tend to be regressive, especially in countries with large informal economies – meaning that they have a disproportionate impact upon the poor, and negative welfare effects.
The IMF-led development model of the past few decades also enforced what is commonly known as the ‘tax consensus’ which has further deprived poor countries of vital tax revenues from multinational corporations (MNCs). In the global competition to attract foreign direct investment, governments are pressured to offer low tax rates and incentives to MNCs such as reduced corporate tax, tax holidays and subsidies. This is the ‘race to the bottom’ in which MNCs are able to play governments off each other in order to secure the biggest tax breaks, in return for the questionable benefits of increased productive investment in the host country. Special economic zones are frequently set up in developing countries – known in Latin America as the infamous ‘maquiladoros’ - which have different tax laws to the rest of the country, as well as poor worker rights, low environmental standards, and often disrespect for indigenous peoples who are displaced by land-grabbing companies. The true costs of these arrangements are ultimately borne by society in terms of lost tax revenue, which is likely to shift the tax burden onto domestic taxpayers or translate into less provision of public services. Research also questions whether tax competition attracts high-quality investment to developing countries, or creates the kind of jobs that would help permanently lift people out of poverty.
The other major obstacle on the international stage that deprives poor countries of tax revenue has now become an in vogue issue for campaigners - tax dodging by corporations and rich individuals. In recent years, a growing number of non-governmental organizations (NGOs) have begun campaigning on tax justice issues, pointing out the abject failure of the world’s tax systems that reward investors, MNCs and wealthy or corrupt elites at the expense of domestic economies and poor people. Many multinational groups of companies take advantage of secrecy jurisdictions, popularly known as tax havens, to shift profits and assets overseas and reduce their overall tax liability. Some companies take further advantage of the globalised system by manipulating the prices that are charged for goods and services within a company but across national borders, known as transfer mispricing.
Christian Aid has estimated that developing countries collectively lose US$160 billion in tax revenues as a result of international tax evasion practices by MNCs alone. According to the Tax Justice Network, tax evasion by high-net-worth-individuals costs governments worldwide a further $255 billion annually in lost revenues. International experts and NGOs have formulated comprehensive recommendations to reform a system of global finance built on secrecy, which inevitably requires new intergovernmental and multilateral rules and regulations, and cannot rely on the voluntary efforts of individual countries or corporations. One prominent solution favoured by the Tax Justice Network could be a ‘World Tax Authority’ that takes responsibility for tackling tax corruption, tax havens and profit laundering, although further progress on creating such a forum under the auspices of the United Nations remains pending.
For most if not all of the least developed countries, building effective tax systems to finance essential services and national development will be impossible without additional support from official development assistance (ODA). There are vast differences amongst tax levels between developing countries, as well as between countries of the Global North and South. This means that some poor countries have a far greater challenge than others to finance their development from domestic resources. At present, however, aid donors still tend to see taxation as a “dangerous idea” in development, and are far less likely to prioritise financing tax systems than other forms of aid. One of the reasons for this, according to UK tax expert Mick Moore, is that a focus on taxation in developing countries, or the lack of it, could in turn focus public attention on the lax rules that also characterise tax systems in donor nations. Currently, less than one thousandth of development aid is spent on helping countries improve their tax systems.
Aiding the South
There are some signs that this trend is shifting as some international donors have begun to provide funds and technical assistance for tax-related projects. The UK Department for International Development (Dfid) has set an example by funding 181 tax-related projects between 2001 and 2006, and recently supporting a new research consortium on tax system issues in low-income and fragile countries called The International Centre for Taxation and Development (ICTD). Many case studies illustrate the positive gains that investments in tax systems can generate. For example Ghana, with help from the German government, increased its corporation tax revenues by 44 percent in real terms, and direct taxation by 22 percent between 2003 and 2005. Similarly, Rwanda was able to quadruple its level of tax collection between 1998 and 2006, while Uganda also nearly doubled its tax-to-GDP ratio between 1993 and 2003 with the help of aid donors. But there is still considerable scope for rich-country governments and international donors to increase funding for poorer countries to strengthen their tax systems, increase surveillance and tackle illicit flows of capital.
Domestic taxation, previously referred to as the Cinderella in debates about financing for development, is emerging from the shadows as one of the most important issues for civil society to get behind and influence. If we want to advocate for a fairer sharing of world resources, tax policy is fundamental to narrowing the gap between rich and poor, and ensuring the availability of funds for vital social programmes. There is a clear understanding of what developing countries should aim towards: broad-based tax systems that redistribute wealth by seeking to levy more taxation on those with a greater ability to pay, including rich individuals and landowners; the taxing of capital and resource consumption, rather than applying more regressive taxes such as VAT; and the effective taxation of multinational corporations. These are the essential prerequisites for more just and equal societies in rich and poor countries alike, and should be actively supported through development cooperation to strengthen the capacity of national revenue authorities.
Of course, the massive redistribution of resources from rich to poor that is needed to end poverty will never happen without a reformed architecture of global governance, a shift in power relations from North to South, and major political-institutional changes in the global economy. The most powerful industrialised countries and the institutions they dominate – namely the IMF, World Bank and World Trade Organisation – are in large measure responsible for the loss of tax revenue in the South resulting from forced tariff reductions, unjust trade policies and odious debt repayments. An unprecedented level of international cooperation is also needed to effectively tax multinational corporations, close down tax havens and fight corruption, bribery and the embezzlement of stolen money to foreign bank accounts. But domestic tax policy is inseparably bound up with all these issues, for without a fair and efficient system of tax collection and income redistribution there can be no lasting improvement in the poverty situation of developing countries. The entrenched opposition to progressive reforms from those who benefit from the status quo, such as wealthy or corrupt elites and profit-driven investors, only reinforces the responsibility of civil society to push for a drastic increase in public revenues through international tax justice.
 ActionAid, Accounting for Poverty: How international tax rules keep people poor, September 2009, table on p. 13.
 United Nations Research Institute for Social Development, Combating Poverty and Inequality: Structural Change, Social Policy and Politics, September 2010. See chapter 8.
 Friedrich Schneider, Andreas Buehn and Claudio E. Montenegro, Shadow Economies All over the World: New Estimates for 162 Countries from 1999 to 2007, The World Bank, July 2010.
 Oxfam, 21st Century Aid: Recognising Success And Tackling Failure, May 2010, p. 39.
 lledo, V., Schneider, A. and Moore, M., Governance, Taxes and Tax Reform in Latin America, IDS working paper, 1st January 2004.
 Jens Martens, The Precarious State of Public Finance Tax evasion, capital flight and the misuse of public money in developing countries – and what can be done about it, Global Policy Forum, 2007, p. 21.
 M. Shahe Emran and Joseph Stiglitz, On selective Indirect Tax Reform in Developing Countries, Stanford University / Columbia University, 2002.
 Christian Aid, Tax justice advocacy toolkit: a toolkit for civil society, January 2011, p. 12. See the studies listed on reference 34.
 Christian Aid. Death and taxes: the true toll of tax dodging, London, 2008.
 Tax Justice Network. The price of offshore, TJN, 2005.
 ‘Dangerous Ideas in Development - Why are Aid Donors Frightened of Taxation?’, event held by the Institute of Development Studies at Westminster, London, on 24th April 2007, with Mick Moore And John Christensen.
 ‘Tax for Development’, OECD Observer, December 2009, quoted in Nicholas Shaxson, Treasure Islands: Tax Havens and the Men Who Stole the World, The Bodley Head, London, 2011, p. 282.
 ActionAid, Accounting for Poverty, op cit, p. 45.
 Ibid, p. 13.
 Nicholas Shaxson, Treasure Islands, op cit.