7/29/2019 Enhancing Tax Revenues (1)

1/3

COMMENTARY

january 19, 2013 vol xlviii no 3 EPW Economic & Political Weekly18

Enhancing Tax RevenuesA Global Priority

Jomo Kwame Sundaram

Jomo Kwame Sundaram (jomoks@yahoo.com)

is UN Assistant Director-General, Economic

and Social Development Department, Foodand Agriculture Organisation of the United

Nations, headquartered in Rome.

Drawing on global experiences

and comparisons, this article

argues for the need to increase

cooperation between countries

to plug tax loopholes and bring

in systems which enhance the

tax to GDP ratio without hurting

investments. Increasing this

ratio is the only way to improve

development spending while

avoiding fiscal difficulties.

The ability to pursue developmental

policies depends crucially on avail-

able fiscal space, which relies

mostly on domestic revenues, especially

taxes. However, tax revenues in most low

and middle income developing countries

are low. The average tax-GDP (gross

domestic product) ratios in low-income

and lower-middle income countries are

around 15% and 19%, respectively.

Although non-tax revenues may add

significantly to total revenues in some

countries, these ratios are typically low

compared to the Organisation for Econom-

ic Cooperation and Development (OECD)

average of over 35%. Low- and lower-

middle income countries should take steps

to increase their revenues after consider-

ing various options for doing so.

This is necessary because the main

approach in recent decades has been to

increase tax rates only if unavoidable. It

was presumed that lower rates wouldensure better compliance with tax laws,

and thus raise revenue as the tax to GDP

ratio was supposed to rise.

The prevailing tax wisdom also favo-

ured broadening the tax base even when

revenue collection capacities are modest.

Thus, indirect taxation has tended to

increase while direct taxation of corpo-

rations and individuals has tended to

decline. The latter was supposed to be

good for investment and growth although

the empirical basis for this presumption

is dubious.

In the vast majority of countries in

sub-Saharan Africa and Latin America,

the tax to GDP ratio has actually stagnated

or declined (Mehrotra 1996), as inter-

national trade taxes accounted for the

largest share of tax revenue. As tariffs

and export duties declined with trade

liberalisation, the share of trade taxes

was bound to fall.

Unfortunately, other taxes have notgrown to compensate for the falling contri-

bution of trade taxes. India experienced

a 2% decline in the central governments

tax to GDP ratio in the 1990s after the

economic reforms due to lower trade

taxes alone (Rao 2000). There is an

urgent need to reverse this trend, with

greater commitment to revenue genera-

tion in order to improve social protection,

create employment and otherwise con-tribute to sustained economic recovery.

For many developing countries, total tax

revenues were mainly derived from three

sources: domestic taxes on goods and

services (general sales tax, excises), foreign

trade taxes (mostly import duties), and

direct taxes (mostly from corporations,

rather than individuals).1 Wealth/prop-

erty taxes and social security contributions

continue to make modest contributions.

For rich countries, however, income

taxes (mostly from individuals) make the

largest contribution (around 36%), with

domestic taxes on goods and services

and social security contributions ac-

counting for slightly over a quarter each

of total tax revenue, and trade taxes

quite insignificant.

With different economic circumstances,

it does not make sense for developing

countries to simply mimic developed

economies in trying to generate revenue.

Even among developing countries, thereis no one size that fits all. And certainly not

for all time, as tax systems must evolve

with changing economic circumstances.

A key question is: which taxes are most

likely to meet the requirements of imple-

mentability, buoyancy and stability?

Domestic Taxes: Direct or Indirect?

Inter alia, the revenue to GDP ratio can

rise in the following ways: the tax base

is widened; tax avoidance and evasion

are reduced; and new sources of inter-

national taxation are found.

According to the International Mone-

tary Fund (IMF), In view of the high share

of agriculture and informal economic

activity in many countries, corporate and

personal income taxes are unlikely to be

a major source of domestic revenues in

the short to medium term (IMF 2004).

But there is no reason to be overly pessi-

mistic about direct taxation as tax reform

has significantly improved the contribu-tion of direct taxes to overall revenue in

many countries (Burgess and Stern 1993).

7/29/2019 Enhancing Tax Revenues (1)

2/3

COMMENTARY

Economic & Political Weekly EPW january 19, 2013 vol xlviii no 3 19

It is certainly possible to enhance tax

revenues by increasing the share of

direct taxation of the wealthy through

more progressive income taxes in devel-

oping countries. However, greater effort

should also be given to increase govern-

ment revenue substantially by ensuring

better compliance with, and higher col-lection of, existing taxes.

For instance, as part of a comprehensive

reform of its tax administration during

1988-92, the Mexican system awarded

generous bonuses to collectors. As a result

the number of, and yield from, audits

increased almost overnight. The share

of additional revenue due to these

audits increased from 38% in 1988 to

90% in 1990.

Limiting the discretionary authority

of tax officials could also help improve

compliance and reduce evasion. Compu-

terisation of tax administration can

help limit corruption, as it makes it

harder to tamper with records.2 Improved

tax administration also increased the

share of personal income tax in total tax

revenue. A number of innovations ac-

counted for this shift. Expansion of the

scope of tax deduction at source has been

very effective in reaching the hard-to-

tax group. Moreover, every individualliving in large cities who is a house

owner, vehicle owner, club member,

credit card holder, passport, driving

licence or identity card holder and tele-

phone subscriber can be required to file

a tax return.

Excise taxes are another important

source of revenue in developing coun-

tries. They are particularly levied on a

few products such as alcohol, tobacco,

petroleum, vehicles and spare parts. From

a revenue perspective, they are convenient,

involving few producers, large sales vol-

umes, relatively inelastic demand and

easy observability. Excises may be levied

on quantities leaving the factory or

arriving at ports, thus simplifying meas-

urement and collection, ensuring cover-

age, limiting evasion and improving

monitoring. Excise taxes currently amount

to less than 2% of GDP in low-income

countries, compared to about 3% in

high-income countries. They have abuoyant base and can be administered

at low cost.

Revenue losses due to globalisation

need to be addressed. There are three main

reasons for revenue losses: first, capital

movements increase opportunities for

tax evasion because of the limited capa-

city that any tax authority has to check

the overseas incomes of its residents;

evasion is enabled as some governmentsand financial institutions systematically

conceal relevant information.

International Tax Evasion

Where dividends, interest payments,

royalties, and management fees are not

taxed in the country in which they are

paid, they more easily escape notice in

the countries where they live. There

have been large non-resident aliens

bank deposits in some countries like the

United States that impose no taxes on

interest from such deposits.3

Second, avoidance (not evasion) may

increase, given the international differ-

ences in tax rules and rates, because of

the choice of tax regime that inter-

national tax treatment of enterprise

income commonly offers. This is more

likely for taxation of profits from corpo-

rations international operations. Transfer

pricing for goods, services and resources

moving among branches or subsidiariesof a company provides opportunities for

shifting income to minimise tax liability.4

Third, international competition for

inward foreign direct investment may

lead governments to reduce tax rates and

increase concessions for foreign investors.

Income tax rates have fallen sharply since

the late 1970s. There is evidence of sudden

capital outflows in response to certain

tax policy changes (Tanzi 1996).

The tax rates governments can impose

are thus constrained by international

competition. Hence, they are reluctant

to raise rates or to tax dividend and

interest income for fear of capital flight.

Yet, it has long been known that direct

tax concessions have little or no effect in

diverting international investment, let

alone in attracting such flows. Hence,

such tax concessions constitute an un-

necessary loss of revenue.

Beggar-thy-neighbour policies will lead

to losses of revenue for all developingcountries in a larger race-to-the-bottom,

also involving labour and environmental

standards and conditions. This also un-

dermines the possibility of balanced, in-

clusive and sustainable development.

Finance ministries and tax authorities

in developing countries need to cooper-

ate among themselves and with their

counterparts in the OECD economies to

learn from one another and to close ex-isting loopholes in their mutual interest.

With the huge and growing size of public

debts and the real and imagined fiscal

constraints to sustained global economic

recovery, such cooperation is more urgent

than ever.

Notes

1 IMF (2004) notes that lower income countries (LICs) 14% tax to GDP ratio is accounted for byforeign trade taxes (4.2%), excises (1.8%), gen-

eral sales tax (3.1%), and social security (1.8%).For lower-middle income countries (LMICs),their 18.5% tax/GDP ratio is accounted for by alower share for foreign trade (3.4%), and highershares of excises (2.3%), general sales tax(4.9%), and social security taxes (3.7%). Forupper-middle income countries (UMICs), their23% tax/GDP ratio has even lower shares forforeign trade taxes (3.1%), and higher sharesfor excises (2.5%), general sales tax (5 .9%) andsocial security (6.4%).

2 In developing countries, a large proportion ofthose not in organised formal manufacturingactivities are in agriculture and the informalsector. However, tax administration in manycountries is either unable or unwilling to cope

with this sector of largely untaxed incomes.

There is also a need to motivate high-level offi-cials to evaluate the performance of their sub-ordinates. Autonomy over budgets, personnel,and controlled increases in tax administrationreforms in Argentina, Colombia, Ghana, Jamaica,and Peru. In some cases, budgets have beenlinked to revenues collected while some coun-tries have contracted out tax collection opera-tions to the private sector (Das-Gupta andMookherjee 1997)

3 Some suggest ions based on the following prin-ciples have been made to deal with theseproblems. First, withholding-taxes on interest,dividends, royalties and management fees,if these payments are to cross borders, shouldbe collected universally, at uniform rates agreedto internationally. Second, there should be a

single international code system for identify-ing payers of individual and corporate incometax, so that tax authorities can share informa-tion about taxpayers without revealing theinformation to others. Third, a tax-return toany tax authority of the income of a corpora-tion or other enterprise should be requiredto give information relating to its total worldincome.

4 Tax havens provide the possibil ity of avoidanceby forming holding companies and shiftingostensible residence (Tanzi 1995).

References

Burgess, R and Nicholas Stern (1993): Taxationand Development,Journal of Economic Litera-ture, 31 (2): 762-830.

Das-Gupta, A and D Mookherjee (1997): Designand Enforcement of Personal Income Taxes in

7/29/2019 Enhancing Tax Revenues (1)

3/3

COMMENTARY

january 19, 2013 vol xlviii no 3 EPW Economic & Political Weekly20

India in Das-Gupta and Mookherjee (1998),Incentives and Institutional Reform in TaxEnforcement: An Analysis of Developing Countr yExper ience (New Delhi: Oxford UniversityPress).

IMF (2004): Global Monitoring Report 2004, Inter-national Monetary Fund, Washington DC,available at www.imf.org/external/np/pdr/

gmr/eng/2004/041604.pdf, accessed on 3 Jan-uary 2013.

Mehrotra, Santosh (1996): Domestic Liberalisa-tion Policies and Public Finance: Poverty Impli-cations in UNCTAD, Globalisation and Liber-alisation: Effects of International Economic Re-lations on Poverty, Geneva.

Rao, Govinda (2000): Fiscal Decentralisation in

Indian Federalism, processed, Institute ofEconomic and Social Change, Bangalore.

Tanzi, Vito (1995): Taxation in an Integrating World(Washington DC: Brookings Institution).

(1996): Is There a Need for a World TaxOrganisation?, paper at the 52nd Congress ofthe International Institute of Public Finance,Israel.