Tax Matters for Developing Countries

IMF Blog, April 22, 2011

Source details

Author: Carlo Cottarelli
Date: April 22, 2011
Context: Reflections on fiscal challenges in low-income countries and lessons from two IMF conferences (one in Nairobi focused on sub-Saharan Africa; one global conference in Washington DC).

Many low-income countries face a "quiet crisis" of inadequately resourced governments: tax revenues are often insufficient to meet public needs.
Revenue levels matter, but tax design and implementation are equally critical for efficiency, fairness, and state legitimacy.
Strengthening revenue systems is an important part of the IMF’s role in helping low-income countries maintain stable and growing economies, but solutions must ultimately be home-grown.

Strong Commitment
- Many low-income countries have shown strong commitment to strengthen their revenue systems through administrative reforms and improved tax policies.
- In sheer revenue terms, "an additional 4 percentage points of GDP or so" was suggested as needed in some low-income countries to meet the Millennium Development Goals.
- Tanzania achieved "a 5 percentage point increase in its revenue to GDP ratio in the decade after 2000", illustrating the potential of medium- to long-term reform and sustained political support.

Equity, fairness and good governance
- Strengthening revenue systems concerns growth and efficiency (for example, avoiding tax systems that treat investment harshly) and matters deeply for equity and fairness.
- Equity and fairness are essential both to finance poverty-reducing measures and to ensure legitimacy and compliance; taxes perceived as unfair yield poor compliance and perceived unfairness.
- Combating corruption in tax administrations can spearhead wider improvements in public governance; ensuring elites pay a decent share of taxes is important for legitimacy.

Avoiding exemptions and preferences
- Exemptions and preferential treatments are a pervasive source of revenue loss in many developing countries.
- Countries recognize the misallocation and inequities created by tax expenditures but often feel constrained by strong domestic interests and perceived competition with neighbors for foreign investment.
- Increased transparency (including analysis of revenue losses from tax expenditures) and stronger regional tax cooperation can help avoid "beggar thy neighbor" tax policies.

Political will
- Improving tax policy, administration, and enforcement ultimately requires political will.
- There is limited understanding of where political will comes from and how to create it, yet it is necessary to drive tough policy changes and to support firm, even-handed enforcement.
- Continued dialogue (as in Nairobi and Washington) is the best hope for finding answers.

Technical topics highlighted at the conferences included: taxpayer segmentation, compliance management, production sharing agreements, transfer pricing, and small business taxation.
Participants—government officials, civil society, donors, business and academics—were candid about what has and hasn’t worked, and reported that IMF technical support has helped countries become better governed and more responsive to people’s needs.

Sustain medium- to long-term commitment to revenue reform, supported by continued political backing.
Prioritize equity and fairness to strengthen legitimacy and compliance of tax systems.
Reduce exemptions and preferential treatments; improve transparency by analyzing tax expenditures and revenue losses.
Explore stronger regional tax cooperation to limit harmful tax competition.
Support technical assistance but emphasize that reforms must be domestically owned; foster dialogue to better understand and build political will.

The author invites ideas and comments on the IMF’s recent paper on revenue mobilization and on the G-20 request for advice from major international and regional organizations, directing readers to the IMF comments page for input.

Source: Carlo Cottarelli, "Tax Matters for Developing Countries", April 22, 2011.