National revenue services
Broaden the base; close loopholes
How do you assess developing countries’ capacity to generate government revenues?
A lot has happened in the past 10 years. In many countries, the awareness has grown that development opportunities depend on the state’s ability to raise revenue successfully. The international buzzword is “domestic resource mobilisation”. Taxes matter very much in this context. Donor countries, by the way, agree that this issue deserves more attention and that more resources must be committed to it accordingly. The Addis Tax Initiative (ATI), in which both developing countries and donor countries committed to verifiable targets, was launched in the context of the UN Financing for Development summit in the Ethiopian capital in 2015.
What has been achieved?
Well, tax to gross domestic product (GDP) ratios have risen in Asia and Latin America in the past 10 to 15 years. Some countries have increased their revenues considerably. Moreover, international networks have emerged that promote the exchange of experience, capacity building and awareness raising. One example is the African Tax Administration Forum (ATAF). But it remains a huge challenge to mobilise domestic resources in the least developed countries, sub-Saharan Africa and fragile states.
What are the most important measures to improve the tax system?
It is essential to broaden the tax base, which means to include as many people as possible, but also to close loopholes. Moreover, the administration must be strengthened, and corruption must be fought. These priorities are obvious, but there is no blueprint for reform sequencing since the conditions differ from country to country.
Why is it difficult to raise taxes in developing countries?
There are various obstacles. Countries with low tax ratios are typically characterised by a big informal sector, which is hard to tax. These countries depend on the tax payments of a small number of very big private-sector companies. However, major multinational corporations are especially well versed in aggressive tax planning, and the revenue administrations of developing countries are often no match for the complex tax-minimisation strategies they adopt. Moreover, many governments and their tax administrations struggle to develop tax systems that strike a balance between efficiency, equity and administrative simplicity in a healthy way. Efficiency means to raise as much money as possible while intervening as little as possible in the economy. Finding the right mix of taxes, setting tax rates, defining the tax base and anticipating how the various rules will interact is a demanding task. Once that is done, law enforcement is the next challenge.
Are there typical pitfalls?
Yes, tax exemptions are an example. Many countries have a multitude of exemptions that were introduced for various reasons. The intention may have been to stimulate investments or to make life easier for poor people. The World Bank reckons that tax exemptions amount to up to six percent of GDP in some developing countries. Studies have shown, however, that tax exemptions often do not lead to the desired results, because loopholes often set the wrong incentives. Of course, tax exemptions reduce the size of the tax base. Nonetheless, it is very difficult in political terms to phase out tax exemptions. The people concerned feel entitled to them.
How can policymakers overcome such opposition?
Well, it can be helpful to estimate the amount of revenue that is lost because of the tax exemption, and to make these numbers public. The chances that phasing out exemptions will be accepted grow if such data become common knowledge – in the course of budget debates for example.
Are the revenue administrations up to task?
Every kind of legislation needs an agency of enforcement. The stronger a revenue administration is, and the better it is organised, the more it will be able to enforce the law. Merely identifying taxpayers and updating the tax register are serious challenges in many developing countries. Many tax registers include double entries, or they lists companies that no longer exist. Information concerning addresses or industry sectors is often flawed. Tax registers also tend to be incomplete because people who should pay taxes according to the law simply do not register. To keep the tax register up-to-date, the tax administration needs information from other government agencies, such as local trade offices or municipal registers of citizens. The capacities of those agencies, however, are often weak, and inter-agency cooperation typically leaves something to be desired. To detect tax fraud, moreover, the revenue administration can benefit from data of taxpayers’ banks and business partners, but all too often, such information is not available.
Doesn’t information technology (IT) help?
Yes, the potential is great. The optimisation of procedures can boost efficiency, and to the extent that interaction between officers and taxpayers is reduced, there are fewer opportunities for corruption. Analysing big data, moreover, increases the likelihood of detecting tax fraud. But to what extent IT really makes a difference, depends on many issues:
- Processes must be well defined.
- Officers must be competently trained for IT application.
- The IT system needs maintenance and regular updates.
- Power supply and internet connectivity must be reliable.
- Various functions and applications must be integrated.
These conditions are often not met. Sometimes, only some branches of the national revenue service use IT, but not all. It is also common for tax administrations to use various IT applications that are not compatible. Obviously, things like this limit efficiency gains and reduce the quality of tax data.
There are many different kinds of taxes, including income tax, sales and value added tax (VAT), corporate taxes and capital-gains taxes. Which taxes matter in particular for mobilising domestic resources in developing countries?
They all matter. The VAT is important because it is comparatively easy to raise in an efficient manner. But other kinds of taxes matter too, for the sake of social fairness for example. As the VAT is charged on consumer spending, it hits low-income groups harder than high-income groups. If policymakers do not want to compound social inequality, they need other kinds of taxes as well – plus a development-oriented expenditure policy that takes the needs of disadvantaged people into account. We must also consider that exports are normally exempted from sales taxes or VAT. The implication is that a commodity exporting country needs other kinds of taxes and levies if the state is to fiscally benefit from the country’s resource wealth.
It is sometimes said that the people of least developed countries (LDCs) are too poor to pay taxes. Do you agree?
LDCs can and should raise taxes. No country can develop without government revenues, and is not healthy to depend on official development assistance. Of course, it will not be feasible to tax all people in LDCs, but some are economically successful enough to pay taxes, and that includes some people in the informal sector, who are not taxed yet. Major agricultural producers or professionals like lawyers and physicians can obviously afford to pay taxes. The Africa 2016 Wealth Report was compiled by international financial firms, and it states that there are about 165,000 very rich people in Africa who, between them, own a fortune of about $ 860 billion. It would be fatal not to tax all of these people.
Political leaders normally belong to the elite that benefits from loopholes. Personally, they are probably more interested in tax evasion and tax avoidance than in the efficient enforcement of tax legislation. Is policymaking affected by such interests?
Well, such generalised statements are not helpful. Yes, some governments – with an eye to personal benefits or political advantages – dilute reforms or do not start them at all. On the other hand, we do see governments in some countries strive to improve the tax situation even though their members belong to the political, economic or educational elite. Consider Ghanaian President Nana Akufo-Addo for example. He is a member of the political elite; his father, his grandfather and his granduncle were influential policymakers. Now, he speaks of “Ghana beyond aid” and wants the state to generate the revenues it needs. His ambition is healthy. Improving government revenues is a complex challenge, however, and many different issues have a bearing on the success of reforms. The political and international environment keep changing. Whether President Akufo-Addo will achieve his goal – and if so, how fast – remains to be seen.
Germany’s Federal Government put the issue of international cooperation on taxes onto the agenda of the G20 summit in Hamburg this year. It was also discussed at previous summits. How does it relate to domestic resource mobilisation in developing countries?
In view of advancing globalisation, international cooperation on taxes is becoming ever more important. Increasingly, financial flows and business activities cross borders, and this trend poses challenges to national tax systems. Taxation is a matter of national legislation and national enforcement, but in the course of globalisation, multinational corporations and super rich individuals find it ever easier to bypass tax laws. National governments on their own cannot do anything about it, so the issue is on the agenda of intergovernmental policymaking. This debate is of great relevance to developing countries because the impact tax oases have on them are greater than those on advanced nations.
Stefanie Rauscher is an adviser on tax reform and plans projects in support of tax systems in developing and emerging markets on behalf of GIZ (Deutsche Gesellschaft für Internationale Zusammenarbeit) in Eschborn.