Death and Taxes May be Certain—But Taxes We Can Make Better

IMF Blog, October 15, 2013

Source details

IMF broad advice on the revenue side of consolidation:
- Before raising rates, broaden bases by scaling back exemptions and special treatments, and thereby getting more people and entities to pay taxes;
- Rely more on taxing consumption rather than labor;
- Strengthen property taxes; and
- Seize opportunities to raise revenue while correcting environmental and other distortions by, not least, carbon pricing (to address climate and other pollution challenges).
How advanced countries have performed relative to this advice:
- Increases in rates of value-added tax, or VAT, have been more evident than base broadening.
- Many countries have increased social contribution rates (linked to the financing of pensions and the like, but often affecting workers much like a tax).
- Effective carbon pricing remains largely unrealized.
Exceptions and specific measures:
- Portugal has managed significant VAT base broadening.
- "Thirteen or so" countries have adopted bank levies of the kind the Fund recommended in 2010.
Overall conclusion: countries have largely honored the advice "in the breach."

No single "right" size of government; revenue needs vary with country circumstances and social preferences.
Fiscal Monitor concept: "tax effort" — how well a country is doing at raising tax revenue compared with other similar countries (per capita income and other characteristics).
Interpretations from the Fiscal Monitor chart:
- A score of "1.0" on the horizontal axis means a country is raising pretty much the most one could expect.
- The vertical axis represents the additional effort needed in terms of garnering enough tax revenue to help meet half of their consolidation needs (as defined in the Fiscal Monitor).
- Several countries, including notably the United States, whose "effort" is relatively low could meet a good part of their consolidation needs by fairly modest increases.
Emerging markets and low-income countries:
- Estimated effort (not shown in the chart) is, on average, not especially low.
- Low-income countries with "effort" below their group median could raise "3.5 points of GDP" more by rising to that level.
Sources of unexploited revenue potential:
- In most advanced economies, flawed tax design is the predominant problem.
- Elsewhere, improving compliance (reducing avoidance and evasion) is the key.

Public acceptance of tax systems depends on perceived fairness.
Trends:
- Progressivity has fallen a lot over the last "three decades or so".
- Inequality has increased.
Analysis performed:
- Calculated the top rate of tax that would maximize revenue in advanced economies, presented as a range of percentages.
- Compared estimated revenue-maximizing top rates with current top marginal rates (see "Chart 2").
- In many cases, current top rates are below, or at the lower end of, the estimated range of revenue-maximizing rates.
Policy implication: Whether top rates should be raised depends on social judgments; the Fiscal Monitor clarifies considerations but leaves the decision to readers.

Experience shows hard economic times are generally not good for tax reform.
Lessons from the Fiscal Monitor:
- No silver bullet exists for tax reform.
- Transparency is critical but may not be sufficient.
- Effective communication is essential — public support requires persuasion that taxes are being raised fairly and will be put to good use.

Source: Death and Taxes May be Certain—But Taxes We Can Make Better, Michael Keen, October 15, 2013.