Multilateral affairs

“Tax holidays are counter-productive”

In Addis Ababa in July, the UN will hold the third global conference on financing for development. The previous conferences took place in Monterrey, Mexico, in 2002 and Doha, Qatar, in 2008. At stake is how countries will fund their development. In an interview, Erik Solheim of the Organisation for Economic Cooperation and Development (OECD), to which all established donor nations belong, told Hans Dembowski what to expect.
With three times more tax revenues, Guatemala could spend more on health care. Sean Sprague/Lineair With three times more tax revenues, Guatemala could spend more on health care.

What sources of development finance will be discussed in Addis?
There are basically three main sources: aid, private investment and domestic tax revenues. There is no contradiction between them. They can be used in ways that support one another.

Let’s start with aid. The advanced nations have been promising for decades that they will raise their official development assistance (ODA) to 0.7 % of their gross national income, but they have not done so. Will this issue be on the agenda?
Yes, it will be a focus point in Addis. The clear expectation of developing countries is that there must be a recommitment to the 0.7 %. Moreover, there must be well-defined pathways that indicate how the advanced nations intend to fulfil that recommitment. Currently, only five member countries of the OECD are living up to their promise: Britain, Denmark, Norway, Sweden and Luxembourg.

Ten years ago, the EU adopted a plan to step up ODA and reach the 0.7 % by 2015. The plan failed. Are promises of this kind credible at all any more?
Well, let me say three things:

  • First of all, it is important to see that global ODA did increase considerably. The current level is 60 % above the level of 2000. We are below target, but one should appreciate that we have achieved a lot nonetheless.
  • Second, the main reason for the failure was the global financial crisis. Many donor governments found their budgets constrained. But many countries are now moving out of the crisis, so there is new scope for increasing aid.
  • Finally, Britain has set a very good example. In spite of being hit hard by the  crisis, the British government ring-fenced the aid budget and stuck to the 0.7 % promise. And if Britain can do that, other countries can do more too.

What do you expect regarding private investment? Addis is basically a conference of governments, and private investments are not made by governments, but by private investors.
Governments can do a lot to facilitate private investments. It is important to get the legal framework right. Governments can reduce risks for private-sector businesses. Asia and Latin America have set examples that least-developed countries, not only, but particularly in sub-Saharan Africa, should follow. It makes sense to use ODA money to improve the investment climate.

As you mentioned, the third relevant source of finance is taxes – but can poor countries really raise enough taxes to drive development?
Yes, they can – and they must. Otherwise, development will not happen. And once more, it makes sense to use ODA to improve matters. Taxes are crucial for funding the health and education sectors. They are needed to build infrastructure. Even today, 98 % of all education spending in developing countries is covered with domestic resources, especially tax money. If all developing countries managed to increase their tax revenues by a little more than one percent, that sum would be equal to a doubling of global ODA. I’ve recently been to Guatemala, a country with a small, but very rich elite. Guatemala only collects 11 % of GNI in taxes. The international standard is 34 %, almost exactly three times more. That is what Guatemala could be spending on social services and infrastructure. Domestic taxation is absolutely essential.

But won’t taxation frighten off investors? They want to make profits, not pay taxes.
Taxes are not the main issue for investors. Experience from many countries shows that other things are more important. Investors want rule of law, a reliable legal framework, fair and orderly judicial reso­lution of disputes. Moreover, they want a literate and healthy workforce, roads, sustained power and water supply and so on. Tax holidays are actually counterproductive. Governments that grant them are not able to do their jobs properly.

Should developing countries raise their tax rates, or should they improve the way they enforce their tax legislation?
Enforcement is what really matters. The tax rates of many developing countries are actually quite high on paper, but the money is never paid. That must change. Tax evasion, capital flight and illicit financial flows in general must be stopped.

Illicit financial flows are a cross-border phenomenon. What progress is the international community making in fighting such flows?
We are moving ahead. In the financial crisis, many governments became aware of how important this issue is. The G20 are dealing with it, and so is the OECD. The OECD has been focussing on two aspects. The first is profit shifting within large multinational corporations. They have a tendency to declare profits in places with particularly low tax-rates, no matter where they actually earned the money. Accounting must become more transparent. The second aspect is the exchange of tax data, with governments sharing information on who has paid what. These are important steps in the right direction, but it will be a long-term struggle.

My impression is that both approaches do more to improve government revenues in rich nations because least-developed countries probably do not have the capacities needed to engage in this kind of cooperation.
Yes, this is a very real issue. As you can imagine, data sharing between Switzerland and Germany is more effective than data sharing between Switzerland and Guinea-Conakry. And this is precisely why I am saying that we must use ODA to improve countries’ inland revenue services and boost audit offices to strengthen the enforcement of tax legislation. Governments need adequate capacities so they can operate in a satisfying manner.

Will aid modalities be on the agenda in Addis?
Well, one important issue is that aid to least-developed countries must increase. Recently, we have seen a rise in ODA in general, but a decrease for the poorest countries. That trend must be reversed. OECD ministers have promised to do that. Now they must live up to that promise. Middle-income countries must not be the main beneficiaries of rising ODA.

In your eyes, what would be a good result in Addis?
We need progress on three fronts:

  • ODA to least-developed countries must be stepped up,
  • private finance must be stepped up and
  • ODA to improve tax collection must be stepped up.

Don’t developing countries need ODA for social issues and the Sustainable Development Goals, that the UN will decide as the follow-up agenda to the Millennium Development Goals?
Sustainability definitely matters in every dimension – ecologically, economically and socially. The title of the conference in Addis should be finance for sustainable development. It does not make sense to pit environment against development, both must be tackled in a holistic way. But that also means that there must not be one particular way of funding for every single SDG. It is important that as many countries as possible become able to rise to the challenges they face, relying on their domestic resources and capacities. Consider Singapore: 50 years ago, this was one of the poorest places on earth. Today, it is among the most prosperous. It has benefited from a determined leader, Lee Kwan Yew, who built a capable state. Ultimately, we need least-developed countries to become successful states like Singapore. ODA must play its role, but it is not the solution.

How does climate-finance relate to ODA? At the climate summit in Copenhagen, the rich nations promised to make available an annual $ 100 billion to developing countries for miti­gation of and adaptation to climate change. The developing countries expect that money to flow on top of ODA, but donor governments are increasingly listing climate-related spending as ODA.
There is no meaningful way to distinguish between climate and development. All climate finance for developing nations today is registered as ODA. Whether it is solar energy in Mali, flood prevention in Bangladesh or new drought resilient seeds for Ethiopia – it is all environment as well as development. But we need to substantially step up the spending.

Erik Solheim is the chair of the Development Assistance Committee of the Organisation for Economic Co-operation and Development (OECD).

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