## Financing the SDGs, Incentives and Multilevel Governance: South-South examples and lessons for Indonesia (Ehtisham Ahmad)

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### Fiscal objectives and overarching revenue needs
- Fiscal objectives for SDGs in multilevel countries:
  - Generate adequate revenues to meet minimum SDGs.
  - At National, State and Local levels.
  - Meeting MDG/SDG targets.
  - Provide “own-source” revenue-handle for accountability.
  - And for sustainable access to credit for investment, particularly at the sub-national level.
  - Reduce the cost of doing business.
  - Enhance national competitive positions.
  - Generate incentives to use damaging or scarce resources effectively (e.g., carbon use and emissions).
  - Enhance equity.
  - Provide information to “stop_the_cheating”.
- How much revenue is needed:
  - The MDGs implicit requirement of around 18% tax/GDP ratio.
  - SDGs add a component for sustainable investment; likely need more than 18% tax/GDP target, conditional on:
    - a) the role and nature of the state (more in multilevel countries, e.g., Indonesia and Pakistan, than single-level unitary states such as Singapore); and
    - b) Whether public investment generates growth in a sustainable manner.
  - Any significant access to credit at sub-national levels, including borrowing and PPPs, must be linked to own-source revenue generation over time.
  - Avoid generating or aggravating economic crises (see Ahmad, Bordignon and Brosio, 2016).

### Elements of sustainable growth and investment priorities
- Public investment as cornerstone of SDGs and COP22.
- Investment and connectivity to raise overall potential and utilize comparative advantages; creation of clean urban “hubs”.
- Dynamic feedback: sustainable growth increases potential to finance additional infrastructure (Simonsen conditions).
- Must focus on income distribution and environmental considerations.
- Vulnerability to shocks: diversification critical; increasing reliance on primary/single commodity exports raises vulnerability.
- Debt context:
  - Some countries in difficulty at debt/GDP ratios below “rule_of_thumb” benchmarks (60% debt stock and 3% deficits): Argentina in 2000 (with debt stock under 50%); Spain and Ireland with debt/GDP ratio well below Maastricht levels.
  - Others with debt stock above the benchmark may have more room with faster and more stable growth.

### Tax and social policy under informality — cross-country project examples and lessons
- Mexico:
  - Santiago Levy (2008) thesis: Good intentions bad outcomes — universal benefits financed by taxes that fall on formal firms (payroll) encourage informality.
  - Recommended shift to general revenues and non-distorting VAT.
  - Non-oil taxes full of holes and stuck around 10% of GDP until reforms.
  - LSE-based research supported Hacienda for 2013 reforms, with lessons from Chinese reforms.
- Indonesia (LPEM with JICA support):
  - Incentives to evade contributions for health-care; low level of non-oil tax revenue.
  - Possible fiscal space for health care — role of different levels of government.
  - Lessons from Mexican failures and successes relevant.
- Pakistan:
  - Tax/GDP ratio around 10% (reported as 9.3% previously; NFC report: 9.5% in December 2016).
  - National Finance Commission Award (December 30, 2009) expected tax/GDP ratio to go to 15% by December 2015 from 9.3%, but major tax reforms did not happen.
  - Three national tax amnesties in the period; repeated amnesties ineffective.
  - Split VAT base and provincial focus on transaction and nuisance taxes turned spending assignments into unfunded mandates.
- Common problems:
  - Split bases (goods and services) create distortions and evasion opportunities.
  - Tax breaks and exemptions generate rent-seeking that becomes entrenched.
  - High effective corporate tax rates harm competitiveness.
  - Incomplete information on value-added chains incentivizes cheating and informality.

### Country-specific reform experiences and outcomes
- Singapore:
  - VAT introduced in 1994 to reduce a Corporate Income Tax (CIT) of 40% and taxes on assets.
  - VAT design principles: single low rate; no exemptions; no compensation.
  - Over time, CIT reduced to 17%, while VAT raised to 7%.
  - Relatively low tax/GDP ratio (less than 15%); education 22% of the budget.
- China:
  - Tax/GDP ratio dropped from 25% to 10% by 1992 following fiscal decentralization.
  - 1993/4 reforms: creation of a central tax function (SAT); VAT on goods shared with local governments; lump-sum guaranteed transfer (stop-loss provision).
  - Revenue returns created space for coastal “hubs”; major reduction in poverty (over 700m; 150m migrated to coastal hubs).
  - Further adjustments: completed integration of VAT on goods and services (May 2016), reduce cost of doing business, expand personal income tax beyond withholding, address failure of property tax, consider carbon tax, rationalize local government borrowing, and align own-source revenues with access to credit.
- Mexico (2007, 2010, 2013):
  - Prior erosion: non-oil tax/GDP ratio stagnated at around 10%; VAT efficiency ~25%.
  - 2007: introduction of IETU (minimum VAT-like tax) and rationalization of transfers with stop-loss; revenue impact ~0.5% of GDP but eroded politically.
  - 2010: failed VAT fixes; vehicle tax devolved to States and collection stopped due to competition; transfer system became “gap-filling”.
  - 2013 reforms (structure and intent):
    - Tax policy reforms across main taxes; eliminated special VAT provisions; rationalized CIT; abolished IETU; introduced a carbon tax (above a petroleum price set at world prices); excises on “bads”; integrated small taxpayer regime (RIF); mandatory electronic invoices; reversed segmentation of the tax base; reliance on basic social pension; CCT replaced by Prospera in 2014.
  - Revenue projections and performance:
    - Excises and carbon tax: initial benefits during 2014 (0.3% of GDP).
    - Non-oil tax/GDP ratio rose to around 14% in 2015 (+3.5% of GDP above 2012 level).
    - VAT revenue increase small initially (+0.5% of GDP to a total VAT of 4% of GDP in 2014).
    - Main impact on Income Tax: +1.7% of GDP in 2015 relative to 2012.
    - Carbon tax: +1.4% of GDP.
    - Actual revenue performance far exceeds projections (IMF, December 2016, Mexico Article IV staff report).

### Administrative weaknesses, evasion mechanisms, and anti-cheating measures
- Incentives to cheat driven by:
  - Split tax bases, REPECOS (small taxpayers regime below ~US$ 250k administered by states), and transfer designs that remove state incentives to chase taxpayers.
  - Evidence of bunching at lower end; 90%+ evasion by SAT assessment in some cases.
  - Mechanisms: carousel fraud, import fraud, use of split bases, VAT-free smuggling, special economic zones (maquiladoras) and lower border rates.
- Effective anti-cheating measures:
  - Integrate small taxpayer regimes (RIF in Mexico).
  - Mandatory electronic invoices and simple cash-based accounting packages.
  - Full value-added chain information (China’s Golden Tax Project): match all invoices to block cheating and facilitate efficient VAT refunds for exporters.

### Design and implementation recommendations for tax and sectoral reform (policy prescriptions)
- VAT and tax design:
  - Clean, simple VAT to raise revenues and provide information; exemption only for non-processed food (as extreme case referenced for Timor-Leste).
  - Single low VAT rate, no exemptions where practicable; revisit thresholds for VAT/small taxpayer regimes.
  - Stop cheating in income taxes; avoid expectations of future amnesties.
  - Implement tax reforms in parallel with adjustments in energy prices/carbon tax in a multilevel context.
  - Consider piggy-backing on income tax to address PIT base and spatial/interpersonal issues.
- Energy, carbon, and subsidies:
  - Reduce implicit and explicit energy subsidies; consider a positive carbon tax.
  - Use subsidy reduction to partially finance universal health coverage—more efficient than CCTs in some contexts.
  - Design carbon tax with possible local piggy-back to permit higher marginal rates in more polluted/congested areas, with a national minimum to prevent a race to the bottom.
- Health and social transfers:
  - Prefer financing universal health coverage from general revenues rather than relying solely on employer contributions that create evasion incentives.
  - CCTs (e.g., Oportunidades) can mis-target or create dependency; evaluate gainers and losers across regions before compensatory measures.
  - Local basic functions—sanitation, preventive public health, mother and infant clinics, nutrition and vaccinations—are key to containing health expenditures.
  - Use “special purpose transfers” cautiously where preventive functions are national priorities.
- Sub-national finance, property taxes, and local accountability:
  - Own-source revenues and clear delineation of functions are necessary for accountability and access to credit.
  - Property taxes typically fail in emerging markets; potential tools include linkage to service delivery, electronic property registers, satellite imagery, and legislated maximum/minimum bands with local rate-setting.
  - Avoid “gap-filling” transfers that override incentives to raise local revenue.
- Political economy and sequencing:
  - Bundle reforms to offset opposition; provide minimum compensation where needed.
  - Focus administrative capacity: integrate invoice matching, digitalization, and targeting to reduce evasion and lower cost of doing business.
  - Tailor non-standard recommendations in presence of informality: integrate small taxpayers while keeping focus on largest firms to preserve enforcement feasibility.

### Empirical and regional observations
- Asian education performance (PISA, OECD, December 2016):
  - Top global PISA rankings: (1) Singapore; (2) Japan; (4) China Taipei; (6) China Macau; (7) Viet Nam; (8) China_Hong Kong; (9) China_Beijing-Shanghai-Jiangsu-Guangdong.
  - China_Shanghai topped previous PISA rankings.
  - European comparators: (3) Estonia and (5) Finland.
- Asian revenue envelopes:
  - China and India raised overall tax/GDP ratio for general government to around 18% (China from 10% in 1992/3).
  - China completed integration of VAT on goods and services in May 2015 (noting Section 2 references completion in May 2016 for replacing local business tax on services).
  - Pakistan reported tax/GDP ratio at 9.5% in December 2016 (NFC report to Parliament); expected increases from NFC awards did not materialize.
- Industrial/regional development in Mexico:
  - New clean “hubs” supported by federal public investment: Querétaro attracted Aerospace ($1.5 bn) and BMW ($1.3 bn).
  - State and local investment in services required to link hubs to national grids; state/local incentives remain problematic.

### Key lessons (summary)
1. Raise revenues efficiently for sustainable growth and job creation:
   - Use taxes that do not add to the cost of doing business.
   - Provide a basis for addressing inequalities and financing clean cities or sustainable “hubs”.
2. Appropriately design tax and social policies that generate sustainable growth:
   - Avoid distorting benefits that create a “poverty trap”.
3. Attend to institutions and incentives to cheat at each level of administration:
   - Administrative integration, digital invoicing, and full value-added chain information are central to stopping cheating and improving competitiveness.

*Conference presentation: Ehtisham Ahmad, IMF-JICA High Level Forum, Tokyo, February 2017.*

### Section 1

### Financing the SDGs, Incentives and Multilevel Governance: South-South examples and lessons for Indonesia

### Fiscal objectives for SDGs in multilevel countries
- Generate adequate revenues to meet minimum SDGs.
- At National, State and Local levels.
- Meeting MDG/SDG targets.
- Provide “own-source” revenue-handle for accountability.
- And for sustainable access to credit for investment, particularly at the sub-national level.
- Reduce the cost of doing business.
- Enhance national competitive positions.
- Generate incentives to use damaging or scarce resources effectively (e.g., carbon use and emissions).
- Enhance equity.
- Provide information to “stop_the_cheating”.

### Tax and social policy in the presence of informality (project examples: Mexico and Indonesia)
- Santiago Levy (2008) thesis: Good intentions bad outcomes.
- Mexico: universal benefits financed by taxes that fall on formal firms (payroll) encourage informality (cheating).
  - Recommended shift to general revenues and non-distorting VAT.
  - Non-oil taxes full of holes and stuck around 10% of GDP.
  - LSE-based research working with Hacienda (MOF) provided background analyses for 2013 reforms—with lessons from Chinese reforms.
  - Strengthened revenue and competitive position will be critical amid turbulence in trade within the continent—better integration with rest of the world possible.
- Indonesia (LPEM with support from JICA):
  - Incentives to evade contributions for health-care; plus low level of non-oil tax revenue.
  - Possible fiscal space for health care—role of different levels of government.
  - Lessons from Mexican failures and successes.

### Plan of presentation (key questions)
- What revenue envelope is needed for sustainable growth?
- Success stories and failures: Singapore; Lessons from China’s 1993/4 reforms; Mexico, 2007 and 2013.
- Lessons for efficient energy-use and health care in Indonesia.
- Improving governance: Institutions, incentives and generation and management of information.
- Clean cities and multilevel finance—importance of tax-benefit links to align incentives.

### How much revenue is needed for the SDGs? (overall envelope)
- The MDGs implicit requirement of around 18% tax/GDP ratio.
- SDGs, in addition include a component for sustainable investment.
- Significant unmet needs in all parts of the world, including Asia.
- There also has to be access to private financing, in a fiscally sustainable manner, especially at the sub-national levels.
- Avoid generating or aggravating economic crises, such as in post-2007 Europe (see Ahmad Bordignon and Brosio 2016).
- Any significant access to credit at sub-national levels, including borrowing and PPPs, has to be linked to own-source revenue generation over time (i.e., over which a jurisdiction has control at the margin).
- Consequently, likely need more than 18% for tax/GDP target, but much depends on:
  a) the role and nature of the state (more in multilevel countries, (e.g., Indonesia and Pakistan, than small single level unitary states such as Singapore) and
  b) Whether or not public investment generates growth in a sustainable manner.

### Elements of sustainable growth
- Public investment cornerstone of sustainable development agenda, SDGs and COP22.
- Critical in the international context, e.g., in China and the EU.
- Reformulation of investment needed for sustainability (in the WB’s best case scenario: “Chile”, see Ahmad and Viscarra, 2016 IADB).
- Investment and connectivity not always sufficient (e.g., EU — Ahmad, Bordignon and Brosio, 2016).
- Sustainability linked to new clean urban “hubs”, to enhance overall production possibility frontier.
- Investment, including cross-border connectivity to raise overall potential, and better utilization of comparative advantages.
- Dynamic effects: as sustainable growth rises, so does the potential to finance additional infrastructure (formally, the Simonsen conditions).
- Must focus on income distribution as well as environmental considerations.
- Vulnerability to shocks: diversification critical.
  - Some countries have had high growth but become more dependent on primary exports (Chile), and become more vulnerable to shifts in trading patterns.
- Feedback effects from sustainable public investments and growth to ability to finance investment.
- Subject to the minimum requirements for investment in local public goods and services, to supplement connectivity infrastructure.
- Then Simonsen conditions apply to the risk management issues.
- Increased reliance on primary/single commodity exports (reduced complexity) increases vulnerability.
- Some countries in difficulty at debt/GDP ratios below the “rule_of_thumb” benchmarks (60% debt stock and 3% deficits).
  - Argentina in 2000 (with debt stock under 50%).
  - Spain and Ireland with debt/GDP ratio well below Maastricht levels, Germany and France above, but the former group was more vulnerable (see Ahmad, Bordignon, Brosio, 2016, Multilevel Finance and the Eurocrisis, Elgar).
  - Others with debt stock above the benchmark may have more room with faster and more stable growth.

### Empirical question: Is 18% tax/GDP enough?
- Cited source: IMF (2013), India 2013 Article IV Consultation, based on World Economic Outlook — General Government Revenue and GDP per Capita, 2012 (excluding oil-exporters and microstates).

### Asian experiences with SDGs — education
- Asia has some of the best performing countries/regions in the world.
- PISA (OECD, December 2016): 7 Asian countries in the top 10 global rankings:
  - (1) Singapore; (2) Japan; (4) China Taipei; (6) China Macau; (7) Viet Nam; (8) China_Hong Kong; (9) China_Beijing-Shanghai-Jiangsu-Guangdong.
- China_Shanghai was top of the previous PISA rankings.
- European countries: (3) Estonia and (5) Finland; overtaken by Asia.
- But also some laggards:
  - Pakistan continues to struggle with literacy, basic services.
  - Spending on education has declined over the past decade despite a vigorous attempt to eliminate overlapping responsibilities (18th Amendment to the Constitution, 2011).
  - Additional share given to provinces in December 2010 National Finance Commission Award.
  - Largely linked to failure in the domestic-resource mobilization agenda.

### Asian experiences — revenue envelopes
- China and India have raised overall tax/GDP ratio for general government to around 18% (China from 10% in 1992/3).
- But not enough as spending and investment needs are great.
- Split VAT base causes distortions and adds to cost of doing business.
- China completed integration of VAT on goods and services in May 2015.
- India: Constitutional Amendment for integration of the VAT base.
- Pakistan lagging (around 10%): provisions and gaps/exemptions and split bases in virtually all major taxes.
  - National Finance Commission Award (December 30, 2009) expected tax/GDP ratio to go to 15% by December 2015 from 9.3%.
  - Major tax reforms did not happen; instead VAT base was split between goods and services (latter assigned to provinces revenues).
  - Major revenue effort at provincial level largely focused on transaction and nuisance taxes that did not stem revenue haemorrhage.
  - Three national tax amnesties in this period.
  - Tax/GDP ratio stood at 9.5% in December 2016 ((NFC report to Parliament).
  - Turned the spending assignments into unfunded mandates.

### Pakistan: ineffective tax-benefit linkages?
- For IMF SBA in 2008, authorities promised to revamp the VAT and eliminate loopholes, along with energy price reforms to close revenue-gaps.
- Conditional Cash Transfer (CCT) — the Benazir Income Support Program, modelled on Mexican Oportunidades — to be introduced (with WB and bilateral financing) to compensate “losers” and gain political acceptability.
- However:
  - CCT correctly went to poorest rural households, while most of the “losers” were fixed and low income people in urban areas.
  - CCT was implemented, but the tax reform was not.
  - Tax/GDP ratio remains below 10%, despite new WB loan of $300m for new tax administrations.
  - Repeated amnesties without credible sanctions or improved plugging of hole ineffective in raising revenues.
  - Create incentives to wait until the next amnesty.

### Ineffective taxes and rent-seeking: why some countries are stuck
- Similarities between Pakistan and Mexico (before 2013).
- Split bases (goods and services) problematic.
- Tax breaks for distributional objectives, or encouraging sectors, generate rent-seeking behaviour that becomes entrenched over time.
- Harms competitiveness (e.g., vis a vis competitor countries).
- Insufficient financing for basic services.
- Incomplete information on value added chain leads to incentives to cheat and informality, compounding problems.
- High effective corporate tax rates a major disadvantage.
- But first some success stories in Asia (Singapore and China).

### Singapore: tax and spending design to encourage investment and human capital
- PISA leader, with low, but efficient and effective tax/spending system.
- VAT introduced in 1994 to reduce the Corporate Income Tax of 40%, as well as taxes on assets that added to the cost of doing business.
- VAT design principles:
  - Single low rate.
  - No exemptions.
  - No compensation; idea is to create investment and full employment.
- Over time, CIT reduced to 17%, while VAT raised to 7%.
- Relatively low tax/GDP ratio (less than 15%).
- Most efficient tax administration, and well-prioritized public spending (education 22% of the budget).

### China: reforms since 1993/4 and structural change
- Fiscal responsibility system had reduced the tax on SOEs; tax/GDP ratio dropped sharply from 25% to 10% by 1992.
- Central share fell from 50% to 25%, as local governments prioritized their own spending before sharing revenues upward.
- By 1992/3 central government ability to conduct macroeconomic policy, redistribution or investment severely curtailed.
- 1993/4 reforms: creation of a central tax function (SAT) and a new tax: VAT on goods to be shared with local governments.
- Lump-sum guaranteed transfer to ensure no province lost (stop-loss provision, used in Mexico’s 2007 reform).
- Revenue-share from VAT and income taxes benefited rich provinces.
- Equalization system provided an inducement for poor provinces.
- Revenue returned: created space for investment for coastal “hubs”, critical for sustained growth over the next two decades.
- No individual compensation—but maintenance of full employment.
- Major reduction in poverty (over 700m; as 150m migrated to coastal hubs).

### China: further needs and policy adjustments
- Integration of the VAT on goods and services—replacing local business tax (on services) completed in May 2016.
- Reduce cost of doing business.
- But removes last tax handle in the hands of local governments.
- Address problems of success:
  - Increasing inequalities.
  - Need to expand personal income tax beyond withholding on wages; e.g., piggy back on central base.
  - Address failure of property tax.
  - Congestion and pollution.
  - Adjustments in energy prices and creation of a carbon tax.
  - Own-source revenues at local level as basis for access to credit.
  - Rationalization of local government borrowing.
  - Lay basis for new internal hubs to supplement national investments in cross-border connectivity (One Belt One Road), links with SE Asia (Indonesia), Central and South Asia, Europe.

### Mexican reforms (2007 and 2010): mixed success and political economy lessons
- Creeping erosion of tax bases in Mexico:
  - Non-competitive trading regime caused preferences and exemptions for income taxes and VAT.
  - SEZs (maquiladoras) exempt from income tax and VAT; lower VAT rates in border regions.
  - Preferences remained after NAFTA—hard to remove once bestowed.
  - Successive Finance Ministers tried reforms; strong vested interests prevented reform.
  - Non-oil tax/GDP ratio stagnated at around 10%, VAT efficiency of 25% — close parallels with Pakistan.
- 2007: introduction of IETU to “partially” close loopholes in the CIT.
  - GAT (Gross Assets Tax) replaced by unique enterprise-based minimum VAT-like tax, IETU credited towards the CIT.
  - Introduction of IETU based on principles used in the 1993/4 Chinese reforms.
  - Rationalization of the transfer system, greater clarity in untied revenue-sharing arrangements, and special purpose transfers.
  - Stop-loss provision so that no state would lose as a result of the reform.
  - Revenue impact was small, half percent of GDP, and began to erode as political pressure was applied.
- 2010 attempts to fix the VAT failed:
  - Attempt to add additional amounts paid to recipients of the CCT (Oportunidades) as compensation did not address main losers from the VAT reform.
  - Vehicle tax, tenencía, fully devolved to the States; collection stopped due to competition across states and access to MOF transfers at year-end.
  - Transfer system had become “gap-filling”; states had no incentives to raise own-source revenues or manage spending efficiently.
  - States refused to avail of a piggy-back on the PIT that was available to them.
  - Main source of financing for states remained the nomina, or payroll tax.
  - Federal Government carried the political burden, as it also covered social benefits at the national level.

### Good intentions, bad outcomes (informality and tax design)
- Santiago Levy (2008) argued:
  - Universal benefits financed by “distortive taxes” that add to the cost of doing business lead to informality.
  - Not all informality is bad or illegal (Kanbur and Keen), e.g., in rural areas.
  - “Informality” as evading the payment of taxes or social contributions applies to firms of all sizes and to workers hiding wages via short-term contracts.
  - Leads to less efficient use of resources, and lower growth potential.
  - Recommendation: reduce high social contributions and shift to VAT that does not add to the cost of doing business.

_Conference presentation: Ehtisham Ahmad, IMF-JICA High Level Forum, Tokyo, February 2017._

### Section 2

### Section 2 — Ehtisham Ahmad

### Fiscal design and "fiscal devaluation"
- In post-crisis Europe, where exchange rate adjustments are not possible, a shift from high social contribution to VAT is framed as “fiscal devaluation.”
- The “Swiss cheese” approach to VAT or CIT is not feasible in Mexico.

### Incentives to cheat and administrative weaknesses
- Split bases for VAT and Income taxes created opportunities for evasion.
- REPECOS (small taxpayers regime, below ~US$ 250k, administered by states) provided a convenient shelter from SAT audit.
- No incentive for states to chase taxpayers, given transfer design (year-end gap-filling exercise).
- Evidence of bunching at the lower end—minimum required to keep SAT at bay.
- 90% + evasion (SAT assessment).
- Mechanism convenient even for larger firms to “hide” production.
- Progressive deductions and exemptions erode the tax base via:
  1. Temptation effect (generates incentives to cheat).
  2. Information gaps (limits possibilities of offsetting cheating).

### Mechanisms and channels of cheating
- Mechanisms include carousel fraud, import fraud, and use of split bases.
- Special Economic Zones (Maquiladoras) and lower border rates exacerbated cheating by shifting tax liabilities and facilitating fraud.
- VAT-free goods smuggled into Mexico created problems for domestic manufacturers.
- Net effect: lost revenues and economic distortions.

### The 2013 package of reforms: structure and intent
- The 2013 “package” of reforms was meant to affect structural change, not revenues.
- Measures included:
  - Tax policy reforms across main taxes previously untouchable.
  - Eliminated the special provisions in the VAT.
  - Rationalized the CIT.
  - Abolished the Minimum asset tax (IETU).
  - Introduced a carbon tax, above a petroleum price set at world prices.
  - Excises on “bads”.
  - Blocked the ability to cheat by integrating the small taxpayer regime (RIF).
  - Issued simple cash-based accounting packages by SAT to taxpayers.
  - Mandatory issuance of electronic invoices.
  - Reversed segmentation of the tax base—all firms subject to SAT audit.
  - Reliance only on basic (social) pension for those without occupational pension.
  - CCT: Oportunidad not used, replaced in 2014 by Prospera to encourage small businesses and employment.

### Revenue projections and actual performance
- Excises and carbon tax: initial benefits during 2014 (0.3% of GDP).
- Additional revenues pushed non-oil tax/GDP ratio to around 14% in 2015 (+3.5% of GDP above 2012 level).
- VAT revenue increase was small initially (+ 0.5% of GDP to a total VAT of 4% of GDP in 2014).
- Main impact was on the Income Tax: +1.7% of GDP in 2015 relative to 2012.
- Carbon tax: + 1.4% of GDP.
- Actual revenue performance far exceeds projections (IMF, December 2016, Mexico Article IV staff report).
- Political pressure to further increases could be diffused by adopting the piggy-back approach, together with an equalization framework.

### Industrial and regional development implications
- Ambition to turn large parts of Mexico into a Free Trade Zone; Ford cancelled the Cruze plant in January 2017 under pressure.
- Creation of new clean “hubs” for sustainable development supported by Federal public investment:
  - New Capital airport at Querétaro; small university town with attractive environment.
  - Attracted Aerospace ($1.5 bn) and BMW ($1.3 bn).
  - Good local infrastructure, but additional urban hubs require state and local investment in services and smaller investments to link to national grids.
- State and local incentives remain problematic.

### State and local fiscal challenges and reforms needed
- Payroll tax (nómina) remains at the state level; Santiago Levy critique has not been addressed.
- Disincentives to implement own-source revenues linked to transfer design.
- Need to implement vehicle tax and piggy-back on carbon tax (opposed by states).
- Consider piggy-backing on income tax to address PIT base and more effectively address spatial and interpersonal issues.
- Property tax is dysfunctional.
- Problems with state-level services, particularly education.
- Oportunidades generated a poverty trap in Chiapas (poverty increased since late 90s, despite 75% of population receiving CCT), entitlement, diversion of funds in some states.
- Education: problematic assignment and shared responsibilities needing revisitation.
- Own-source revenues together with Equalization Transfers needed, with clearer delineation of functions.
- Indonesian experience will be useful.

### Lessons for Indonesia: energy, health, and tax reform
- Reducing implicit and explicit energy subsidies is sensible—if not an outright positive carbon tax.
- Using subsidy reduction to partially finance universal health coverage is a more efficient compensation mechanism than CCTs.
- Experience of Mexico with the basic pension and the carbon tax is relevant.
- CCT already tried in Indonesia.
- Disincentives for (large) firms to pay employer contributions suggest a significant financing gap will have to be covered by general revenues.
- Illustration of the Levy “good intentions” problem.
- Indonesia, like Mexico, faces a low non-oil tax/GDP ratio and a dysfunctional VAT.

### Design and implementation recommendations for national tax reform
- Clean, simple VAT as a mechanism to both raise revenues and provide information, with exemption only for non-processed food (see estimates for Timor-Leste, as extreme case).
- Revisit the threshold for VAT/small taxpayer regimes.
- Stop cheating in the income taxes; avoid creating expectations of future tax amnesties (the “Pakistan possibility” of “waiting for the next amnesty”).
- Implement tax reforms in parallel with adjustments in energy prices/carbon tax in a multilevel context.
- More research needed for Indonesia (see Ahmad and Stern 2011 for India).
- Evaluate gainers and losers to ensure no major shifts in resources across regions.

### Containing health expenditures through local actions
- Key basic functions at the local level include sanitation; public health and education including nutritional advice; mother and infant/child clinics for preventive care, nutrition and vaccinations.
- Preventive functions may be in national interest; “Special purpose transfers” may be in use.
- With imperfect information on spending and budgets, no certainty funds will be used effectively and not diverted (as with Oportunidades in some Mexican states).
- Local incentives need close alignment, dependent on clarity of responsibilities and own-source revenues for accountability.
- Consider designing taxes (e.g., carbon tax) with a local piggy-back to permit higher marginal rates in more polluted/congested areas, but with a national minimum to prevent a race to the bottom.
- “Gap-filling” transfers, or use of “actual” factors in equalizing systems, can override incentives to use local tax handles even if they exist.

### Property taxes, local credit access, and clean cities
- Typical failures with property taxes in emerging markets (Latin America including Mexico, many Asian countries).
- US-type model based on ownership and valuation is hard to implement—abandoned in the UK.
- Self-assessment option (e.g., Bogotá) may be subject to abuse.
- Presumptive approaches did not work in Delhi or Pune, and are problematic in Bangalore.
- Linkage with service delivery (Marshallian principles) can overcome resistance (Ahmad, Brosio, Pöschl (2015) and (2017 on Mexico)).
- Focus on service delivery enhances accountability.
- Maximum and minimum “bands” legislated in unitary countries; local rate setting for accountability while avoiding race to the bottom.
- Scope for electronic property registers and satellite imagery (arms’ length administration to reduce scope for corruption).

### Political economy, administration, and broader lessons for emerging markets
- Political economy and institutions are critical.
- Non-standard recommendations may be needed in the presence of informality.
- Lower effective threshold may be needed by integrating small taxpayers while keeping focus on the largest.
- Full value-added chain essential to generate information, stop cheating and base shifting.
- Chinese administrative approach: match all invoices (Golden Tax Project) to block cheating and facilitate efficient and accurate VAT refunds for exporters.
- Reduced cost of business and enhanced competitive position can follow from better administration.
- Political economy strategy: offset opposition to each main tax by putting reforms together, with minimum compensation needed.
- Work on sub-national taxes and transfers remains necessary.

### Key lessons
1. Raise revenues efficiently for sustainable growth and job creation
   - Taxes that do not add to the cost of doing business.
   - Basis for addressing inequalities and financing clean cities or sustainable “hubs”.
2. Appropriately design tax and social policies that generate sustainable growth
   - Avoid distorting benefits that create a “poverty trap”.
3. Attention to institutions and incentives to cheat at each level of administration

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_Source: https://www.imf.org/-/media/files/news/seminars/2a3_presenter_-ehtisham-ahmad.pdf_