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Public Finance

Simple, low and fair

Germany helps developing countries reform their tax systems by giving support both bilaterally and through multilateral channels. Dirk Niebel, Germany’s minister for economic cooperation and development, explains his policy.

By Dirk Niebel

When I recently visited Ghana, I inspected projects and talked to government representatives. One of the issues Germany advises Ghana on is drafting medium to long-term fiscal policy with an eye to reducing poverty and promoting targeted economic growth. Our advice on organising revenue collection has already contributed to standardising administrative procedures, identifying potentials to reduce costs and defining indicators for monitoring performance at all levels of fiscal management. Consultation on IT services, moreover, has led to the gradual automation of internal operations as well as better communication with taxpayers. In the future, advice on human resource management is expected to help to modernise training and personnel development programmes and boost the efficiency of staff recruitment.

The Ghanaian project is a success. It shows that transparent and efficient public finance systems are a core requirement for reducing poverty and facilitating development. A sound policy on government revenue and expenditure, moreover, promotes ­people’s identification with the state and thus increases the state’s legitimacy. When a government has adequate resources, it can shape an adequate environment for private-sector engagement. It can invest in schools and healthcare facilities for instance. For such reasons, partner countries’ mobilisation of local resources is high on the agenda of all relevant international bodies, from the United Nations and OECD to the G8 and G20.

Basis for action

Levying taxes is one of the core functions of the state and a vital requirement for the dynamic and effective discharge of a government’s primary responsibilities. Recently, the International Monetary Fund (IMF) praised Germany for its budget policy and low net new borrowings this year. Stable tax revenues, of course, are of crucial relevance in this context. In developing countries, however, the national tax base tends to be small. Many countries are highly depen­dent on donor funding. If they really want to shape their own future, they will have to develop the capacity to generate sufficient revenues themselves.

In regard to development, taxation matters for more than merely financial reasons however. Yes, fair and efficient tax systems sustainably deliver the funds governments need to finance their core tasks, but they also serve public accountability. Free and self-confident tax-paying citizens will demand information – which, in itself, is a significant contribution to state building.

The international donor community was slow to rise to the developmental challenge of taxation. In 2002, the heads of state and government who adopted the Monterrey Consensus stated that an increase in developing countries’ domestic financial re­sources was a fundamental requirement for attaining the Millennium Development Goals.

Another milestone was the Paris Declaration on Aid Effectiveness in 2005. Donor and partner countries signed up to a set of basic principles for development cooperation. While donors agreed to align assistance to partner countries’ institutions, procedures and development strategies, the partner countries pledged to strengthen their own systems and generate more domestic resources.

At the follow-up conference on financing for development at Doha in 2008, Germany and other donors again emphasised that domestic resources are key to poverty reduction and sustainable development.

Engagement at many levels

Germany has long supported developing countries’ efforts to reform tax systems. We have helped to draft fiscal policies, streamline administrative procedures and harmonise tax systems across regional eco­nomic blocs. German support has been channelled through multilateral agencies and provided in bilateral projects. In Latin America, for example, we have engaged in bilateral cooperation on fiscal decentralisation, budgetary control, public procurement and corruption prevention in a large number of countries, including the Dominican Republic, Ecuador, Guatemala, Colombia, Nicaragua and Peru.

A special challenge consists in revenue losses due to tax evasion and tax avoidance. This does not only happen in the domestic context, but also across borders when wealthy individuals or multinational companies fail to meet local fiscal obligations. Experts reckon that some countries lose as much as two-thirds of their tax revenues this way. In Germany, tax evasion deprives the state of billions of euros every year.

Industrial and developing countries both face this challenge, but developing countries are hit harder. Their tax revenues are lower to begin with, and they lack effective control systems to check tax evasion and avoidance. In the past, too little attention was paid to this issue.

International Tax Compact

For this reason, the International Tax Compact (ITC) was launched. Germany’s Federal Ministry for Economic Cooperation and Development started it as an informal platform for exchange between partner countries and international organisations. The idea is to help developing countries reform their tax systems and combat tax evasion as well as avoidance.

The ITC aims to harmonise donor activities and to include all relevant actors in discussions: not just aid agencies, but government officials and civil ­society representatives from partner countries as well. We hope to strengthen developing countries’ domestic resources. The ITC is, however, but one of the many approaches taken by Germany to contribute effectively to poverty reduction, better governance and the achievement of the Millennium De­velopment Goals.

The first tangible results of coordinated cooperation in the ITC include a review and analysis of donor activities in the fiscal sector. It was performed in conjunction with the OECD. Another result is an analysis conducted in cooperation with the European Commission on the phenomenon of international transfer pricing. Such pricing can be abused to shift profits from developing countries to places where taxes are low.

Germany is well placed to support fiscal reform in developing countries – not just because of the ITC. We also have two highly effective agencies that help to reform partner countries’ tax systems all over the world: KfW Entwicklungsbank and Deutsche Gesell­schaft für Internationale Zusammenarbeit (GIZ). Apart from the “big two”, we rely on cooperation with academic institutes and non-governmental organisations to provide our partner countries with the best possible support. In all these activities, we emphasise cooperative relationships with other organisations and donors.

Germany is not only active at the bilateral level, but involved in multilateral initiatives too. Thanks to years of experience in the field of fiscal reform, especially with local partners, we can make valid contributions to international forums and actively help to shape ongoing processes. The issue of taxation has recently been getting more – and significant – attention. The IMF has set up a Multi Donor Trust Fund to support tax reforms in developing countries, flanking its regional training centres. Germany is one of the countries that contributes to this fund, which will become operational from May 2011 on.

The EU is also devoting increasing attention to how development cooperation can help to boost the efficiency of fiscal systems.

At the OECD, significant progress has also been made. There is a wealth of experience amassed by member countries – not all of which is positive (Germany’s tax system, for instance, is too complex). Such knowledge is being harnessed to enable partners to find their own solutions for rising to the challenges they face.

Partners’ immediate responsibility

At the partner level, taxation has similarly become an issue of growing relevance. In 2008, the foundation stone was laid for the African Tax Administration Forum (ATAF), a platform for exchange among ­African tax authorities. It now has 30 member countries. The ATAF is an excellent and auspicious example of an African initiative for developing context specific solutions. Germany is supporting that initiative in a variety of ways – including through a German development cooperation project that gives advice to the ATAF.

Success, of course, will depend on partner countries accepting their responsibilities and applying home-grown solutions. Both are important criteria for our support. Taxation, moreover, is an increasingly important issue for a number of regional organisations in Africa. For instance, we are advising the East African Community (EAC) on issues such as information exchange, double taxation and the harmonisation of excise taxes.

The challenges, you see, are as complex as the forms of support. Taxation will remain a major development issue for quite some time. This has also become evident in the G20. Tax reform is one of nine points on its developmental agenda. An efficient and transparent system of simple, low and fair taxes sets guidelines for both the public and private sectors and, at the same time, grants scope for medium and long-range planning. It is, moreover, the basis for a country’s sustainable development in social, economic and environmental terms. Germany is ready to go down this road with our partners. The ministry I head will ensure that the issue of taxation stays high on the agenda.

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