Taxation and development: a great new book

April 22, 2009

     By Duncan Green     

Finally finished an illuminating book on the link between taxation and development: (Taxation and state-building in Developing Countries), edited by Deborah Brautigam, Odd-Helge Fjeldstad and Mick Moore). Here are a few highlights – a bit long, but I’m trying to summarize a densely argued 260 page book, so bear with me.

Taxation is the new frontier for those concerned with state building in developing countries. The origins of representative government in Europe are intimately bound up with the evolution of taxation. The oft-told narrative begins with war: the costs of warfare led European monarchs to increase direct taxation, which they were only able to do through bargaining with their societies’ elites. This had two political outcomes: it prompted the rise of parliaments, and it led to larger, more capable, and more professional state bureaucracies.

Less familiar is the argument about taxation and state capacity: the demands for increased revenue prompted reform of tax systems, shifting from ‘tax farming’ to permanent, modern bureaucracies. These set the standard for the evolution of bureaucratic structures in Europe’s new states.

Since then, most industrialized countries have succeeded in creating high levels of both capacity and consent. Their governance rests on fiscal systems that are the subject of policy debate, but are rarely thrown into fundamental question or doubt. Developing countries are more diverse and, in most cases, in a far less happy situation. Their tax systems are often regressive and distortionary. Tax administration is usually weak and characterized by extensive evasion and corruption. Coercive modes of taxation are common. In many cases overall tax levels are low, and large sectors of the informal economy escape the tax net entirely. In Tanzania, with a total population of more than 35 million people, 286 large taxpayers pay almost 70% of the domestic taxes. Fewer than 1% of the taxpayers pay more than 85% of the direct takes levied in Peru.

Natural resource dependence is one of the key differences between poor countries today and historical Europe. Taxing resources allows governments to bypass bargaining with citizens, undermining the development of the social contract between citizens and state. For example in Saudi Arabia and Yemen, with the rise of a ‘rentier economy’ in the 1970s (based on petroleum in the case of Saudi Arabia, and on aid and labour remittances, in the case of Yemen), state building took a drastic step backward. Yemen jettisoned its extractive bureaucracy and Saudi Arabia dismantled its tax agency.

So what’s been happening more recently? The answer is an awful lot of tax reform. To the worm’s eye, tax reform has been a continuous stream of small, technical modifications to law and procedure. The bird’s eye view is very different: there are global patterns of tax reform. Governments borrow ideas from each other much more on tax than on e.g. essential services or social welfare. National tax systems, like central banks, seem more like members of a distinct global family.

That global family, presided over by the IMF and driven by an ‘increasingly organized epistemic community of tax professionals’, has three basic tenets:
1. The introduction of broad-based consumption taxes
2. Simplified tax design
3. Improved tax administration, often through setting up autonomous revenue authorities

Given a relatively united front between the tax professionals, the IMF and other international financial institutions, and the tax economists, much tax reform passes as necessary modernization of an essentially technical character. There is a big contrast between the contentiousness of the overall neoliberal (or Washington Consensus) economic reform agenda and the fact that its tax policy components have been widely adopted with little protest or overt debate.

How far has this global wave of tax reform contributed to state-building? The contemporary global tax reform agenda (GTRA) is least appropriate to those countries most in need of the state-building to which the taxation process has contributed at other places and times.

Between 1975-2000 tax take (as a % of GDP) increased steadily in the high income group of countries, declined very slightly in the middle income group and declined more markedly in the low income group. Why? Because countries scrapped trade taxes, often at the urging of the IMF or World Bank, or as a requirement for signing regional trade agreements. But they have struggled to replace the lost income from trade taxes with other sources. The authors conclude that ‘in respect of total government revenues, the GTRA has failed the poorer countries’.

Elsewhere, the story is more one of lost opportunity than actual harm (for example , the authors cite research findings that there is no evidence that overall, the GTRA has shifted the tax burden to the poor, which surprised me). The authors identify three big missed opportunities:

1. Taxing the informal sector (I’ll blog on that separately)
2. Taxing urban property (perhaps neglected because the IMF mainly cares about national government finances, and property taxes are often local. This is a particularly unfortunate oversight because local taxes are often the most coercive and unfair and in dire need of reform.)
3. Taxing aid flows.

Their conclusion? ‘The GTRA has been effective in part at least because its proponents have been consciously anti-political. They have not generally wished to engage citizens over taxation issues and have certainly tried to exclude most politicians. These are all understandable strategies. However, … they are unlikely to contribute to the construction of effective and accountable sates, and might even on occasion be undermining that goal.’