COMMENTARY

Enhancing Tax Revenues

A Global Priority
Jomo Kwame Sundaram

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 scal difculties.

Jomo Kwame Sundaram (jomoks@yahoo.com) is UN Assistant Director-General, Economic and Social Development Department, Food and Agriculture Organisation of the United Nations, headquartered in Rome.

he ability to pursue developmental policies depends crucially on available scal 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 signicantly to total revenues in some countries, these ratios are typically low compared to the Organisation for Economic Cooperation and Development (OECD) average of over 35%. Low- and lowermiddle income countries should take steps to increase their revenues after considering 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 would ensure better compliance with tax laws, and thus raise revenue as the tax to GDP ratio was supposed to rise. The prevailing tax wisdom also favoured broadening the tax base even when revenue collection capacities are modest. Thus, indirect taxation has tended to increase while direct taxation of corporations 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 international 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 not grown to compensate for the falling contribution of trade taxes. India experienced
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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 generation in order to improve social protection, create employment and other wise contribute 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/property 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 ser vices and social security contributions accounting for slightly over a quarter each of total tax revenue, and trade taxes quite insignicant. 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, there is no one size that ts 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 implementability, 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 international taxation are found. According to the International Monetary 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 pessimistic about direct taxation as tax reform has signicantly improved the contribution of direct taxes to overall revenue in many countries (Burgess and Stern 1993).
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It is certainly possible to enhance tax revenues by increasing the share of direct taxation of the wealthy through more progressive income taxes in developing countries. However, greater effort should also be given to increase government revenue substantially by ensuring better compliance with, and higher collection 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 ofcials could also help improve compliance and reduce evasion. Computerisation 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 accounted for this shift. Expansion of the scope of tax deduction at source has been very effective in reaching the hard-totax group. Moreover, every individual living in large cities who is a house owner, vehicle owner, club member, credit card holder, passport, driving licence or identity card holder and telephone subscriber can be required to le a tax return. Excise taxes are another important source of revenue in developing countries. 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 volumes, relatively inelastic demand and easy observability. Excises may be levied on quantities leaving the factory or arriving at ports, thus simplifying measurement and collection, ensuring coverage, 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 a buoyant base and can be administered at low cost.
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Revenue losses due to globalisation need to be addressed. There are three main reasons for revenue losses: rst, capital movements increase opportunities for tax evasion because of the limited capacity that any tax authority has to check the overseas incomes of its residents; evasion is enabled as some governments and nancial 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 differences in tax rules and rates, because of the choice of tax regime that international tax treatment of enterprise income commonly offers. This is more likely for taxation of prots from corporations international operations. Transfer pricing for goods, services and resources moving among branches or subsidiaries of 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 outows 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 ight. Yet, it has long been known that direct tax concessions have little or no effect in diverting international investment, let alone in attracting such ows. Hence, such tax concessions constitute an unnecessary loss of revenue. Beggar-thy-neighbour policies will lead to losses of revenue for all developing countries in a larger race-to-the-bottom, also involving labour and environmental
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standards and conditions. This also undermines the possibility of balanced, inclusive and sustainable development. Finance ministries and tax authorities in developing countries need to cooperate among themselves and with their counterparts in the OECD economies to learn from one another and to close existing loopholes in their mutual interest. With the huge and growing size of public debts and the real and imagined scal 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 by foreign trade taxes (4.2%), excises (1.8%), general 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 a lower share for foreign trade (3.4%), and higher shares of excises (2.3%), general sales tax (4.9%), and social security taxes (3.7%). For upper-middle income countries (UMICs), their 23% tax/GDP ratio has even lower shares for foreign trade taxes (3.1%), and higher shares for excises (2.5%), general sales tax (5.9%) and social security (6.4%). In developing countries, a large proportion of those not in organised formal manufacturing activities are in agriculture and the informal sector. However, tax administration in many countries is either unable or unwilling to cope with this sector of largely untaxed incomes. There is also a need to motivate high-level ofcials to evaluate the performance of their subordinates. Autonomy over budgets, personnel, and controlled increases in tax administration reforms in Argentina, Colombia, Ghana, Jamaica, and Peru. In some cases, budgets have been linked to revenues collected while some countries have contracted out tax collection operations to the private sector (Das-Gupta and Mookherjee 1997) Some suggestions based on the following principles have been made to deal with these problems. First, withholding-taxes on interest, dividends, royalties and management fees, if these payments are to cross borders, should be collected universally, at uniform rates agreed to internationally. Second, there should be a single international code system for identifying payers of individual and corporate income tax, so that tax authorities can share information about taxpayers without revealing the information to others. Third, a tax-return to any tax authority of the income of a corporation or other enterprise should be required to give information relating to its total world income. Tax havens provide the possibility of avoidance by forming holding companies and shifting ostensible residence (Tanzi 1995).

References
Burgess, R and Nicholas Stern (1993): Taxation and Development, Journal of Economic Literature, 31 (2): 762-830. Das-Gupta, A and D Mookherjee (1997): Design and Enforcement of Personal Income Taxes in

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India in Das-Gupta and Mookherjee (1998), Incentives and Institutional Reform in Tax Enforcement: An Analysis of Developing Country Experience (New Delhi: Oxford University Press). IMF (2004): Global Monitoring Report 2004, International Monetary Fund, Washington DC, available at www.imf.org/external/np/pdr/ gmr/eng/2004/041604.pdf, accessed on 3 January 2013. Mehrotra, Santosh (1996): Domestic Liberalisation Policies and Public Finance: Poverty Implications in UNCTAD, Globalisation and Liberalisation: Effects of International Economic Relations on Poverty, Geneva. Rao, Govinda (2000): Fiscal Decentralisation in Indian Federalism, processed, Institute of Economic and Social Change, Bangalore. Tanzi, Vito (1995): Taxation in an Integrating World (Washington DC: Brookings Institution). (1996): Is There a Need for a World Tax Organisation?, paper at the 52nd Congress of the International Institute of Public Finance, Israel.

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