Taxation
Trust in the state
By Astrid Templin and Matthias Witt
Developing countries struggle with typical challenges when they try to tap their tax potential: illegal tax evasion (domestically and across borders) and legal tax avoidance thanks to national and international loopholes. International discussion in recent years has centred mainly on the international dimension.
Christian Aid, a British NGO, estimates that developing countries lose an annual € 100 billion because of international tax avoidance and tax flight. Berne Declaration, a Swiss NGO, calculates that developing countries would generate more than € 3 billion in additional revenue if all taxes were properly paid on foreign assets held in Switzerland. Obviously, no country can rise to these challenges on its own. International cooperation is required to make progress (see box).
Domestic enforcement of tax laws is challenging too. The larger the loopholes in tax law are, and the less reliable the tax authorities operate, the easier it becomes to evade taxes. The losses arising in developing countries are estimated at an annual € 190 billion. In comparison, international development aid only amounted to € 86 billion in 2010, according to OECD data.
On average, OECD nations collect about 35 % of GDP as taxes. In contrast, for most developing countries the share is below 15 %. Governments therefore lack funds to invest in infrastructure, education and healthcare, for instance.
What matters even more in the long turn, however, is that flawed tax systems erode citizens’ trust in the state. Studies show that willingness to pay taxes depends on whether citizens feel that they are treated in a fair manner. If some individuals succeed in getting around taxes, others’ willingness to pay is significantly diminished. The highest governance dividend can probably be expected when developing countries establish reliable and trustworthy tax procedures.
For many years, Germany has been providing assistance for appropriate reforms to partner countries. Four problems tend to arise again and again:
– the political will to implement reforms is lacking,
– tax authorities are unreliable and ineffective,
– tax authorities do not cooperate well with taxpayers, and
– trans-border tax problems can only be solved in international cooperation, not by countries acting on their own.
Lacking political will
The structure of a tax system is a highly political issue. It touches upon essential principles of the state and reflects balances of power because it defines the tax burdens various groups (businesspeople, landlords, salaried workers et cetera) have to bare in relation to their economic capacity according to the application of transparent rules for all citizens. “We are building the state”, is how one fiscal policymaker describes the effect of comprehensive tax reform.
This process of designing the tax system is likely to trigger intense political controversy. Every tax reform creates winners and losers. The allocation of tax burdens must reflect economic capacity, but the negotiating skills and political voice of the individual interest groups have an impact. To reform tax laws and enforcing authorities successfully requires an unconditional determination on the part of government and parliament.
Support for tax reforms can prove tricky for donor governments too. Often, revenue services in partner countries are granted police-like powers, allowing them to monitor compliance with tax laws. Unless, however, they are strictly supervised, they can abuse such powers to harass unpopular sections of the people. Aid can thus be abused or lead to undesired secondary effects.
Tax authorities essentially serve several basic functions. They register those liable to pay taxes (registration), they determine the tax amounts to be paid (assessment) and monitor incoming payments (collection). When taxes are not paid, they issue demand notes and claim penalty fines. If citizens know their rights and there is a reliable appeals procedure, the mistakes tax authorities make can be put right.
In many developing countries, the tax authorities do not understand these basic functions well, and such incompetence can have a strong impact on people’s attitudes towards the tax system in general. If entire occupational groups, for instance, are not registered, that will encourage members of other professions to dodge payments. In a similar sense, the impression that registered taxpayers are under heavy pressure to pay, while others, who would also be liable to pay, remain unknown to the tax authorities, will negatively affect attitudes towards taxes and, accordingly, government revenue too.
Focus on the major taxpayers
International organisations often recommend focussing on the biggest taxpayers initially, in order to collect large tax amounts quickly and cover administrative costs. In Tanzania, for example, 286 major taxpayers used to contribute almost 70 % of total tax revenue (see Odd-Helge Fjeldstad in D+C/E+Z 2007/5, p. 202 ff.)
However, it has negative implications when a government only turns to a few, particularly large taxpayers to collect money. Taxation that is perceived to be unjust becomes a motive for evasion. The small number of taxpayers, moreover, gains power and may become able to assert special interests. In an extreme case, the state becomes susceptible to blackmail.
In contrast, taxation that covers everyone boosts governmental accountability to all citizens. Those who pay taxes are inherently interested in the quality of government action. They are more likely to vote in elections and to get personally involved in politics than those who do not pay taxes. It therefore makes sense to widen the tax base to include as many citizens as possible.
Accordingly, designing reliable mechanisms deserves support – and so does reliable enforcement. The most effective option is to rely on standardised, reliable and automatic procedures. Even in the age of the internet, however, this cannot be taken for granted. Greek tax authorities only recently admitted that, for the most part, they did not rely on computerisation for processing tax assessments before 2010. Automatisation in itself, however, is only of limited use. Structures and procedures within the fiscal authorities need to be considered and reformed too.
Low honesty of taxpayers is an expression of citizens’ dissatisfaction with the state. In a survey of Latin America, 44.2 % of respondents indicated corruption as a motive for tax evasion. Action needs to be taken accordingly. There will be less tax evasion once tax laws are considered fair. No doubt, tax assessment procedures must also be fair, transparent and effective. Those who must pay taxes enjoy rights – and there must be a way to assert those rights reliably.
Starting points for donor action
There are several ways for donors to contribute to improving the effectiveness of tax systems in the developing world. First of all, they should leverage the political will that does exist. Opportunities for doing so typically arise after a government or even a political system changes. Donors must rise to opportunities and support appropriate reforms.
International debate, moreover, has neglected the important issue of unintended effects and unwelcome repercussions so far. Tax policy is always about the (re-)distribution of resources, and unjust results discredit not only the fiscal system but the state in general. Broad-based participation is essential, and government agencies must act in a cooperative manner.
To date, donor agencies have provided advice mainly to finance ministries and national authorities. In future, local tax authorities deserve more attention, because they play a crucial role in successful reforms. The local level is also the appropriate level for training staff.