How to tax a fragile state

Tax evasion strips an estimated $250 billion to $300 billion from potential development funding. Photo by: eFile989 / CC BY-SA

While the development community rallies around a new post-2015 development agenda — set to launch in September — finance institutions, aid agencies, civil society groups and business leaders are trying to figure out how they’re going to pay for it.

One piece of the financing puzzle: stop tolerating a global financial system that allows private companies to evade and avoid tax obligations, stripping an estimated $250 billion to $300 billion from potential development funding.

That’s the message many development finance experts and pro-poor advocates hope will find its way to one of six high-level ministerial panels that will take place during the International Financing for Development Conference in Addis Ababa, Ethiopia, this July. Representatives will convene in the Ethiopian capital to hash out new commitments and partnerships aimed at closing the gap between the cost of the sustainable development goals and the money available to implement them.

“We’re not going to achieve the [SDGs] unless we actually tackle this question of domestic resource mobilization,” Ray Offenheiser, president of Oxfam America, told attendees at a panel on tax evasion during the World Bank spring meetings last week.

“The post-[2015] agenda is a 15-year project. If we finish that 15 years and we have not really built the institutional capacity to do tax work and have international tax cooperation we’re going to fail,” Offenheiser added.

The SDGs will likely include objectives to catalyze private sector involvement in developing and emerging markets in a way that the Millennium Development Goals largely did not. Public-private partnerships, global memorandums of understanding, shared value initiatives and other forms of partnership that seek to align private sector profits with development results have risen to the fore at the same time the transition from MDGs to SDGs has gotten underway.

The taxation challenge

But unmet tax obligations remain a basic, pivotal issue.

Villa Kulild, director general of the Norwegian Agency for Development Cooperation, described efforts to build confidence among developing country tax authorities, that it is their right to expect fair taxes from companies operating on their soil.

“When they meet companies ... bragging about their [corporate social responsibility] strategies, [I tell them to] just answer, ‘pay your taxes.’ That is a very important starting point,” she stressed.

The challenge of a transparent, effective tax system is particularly daunting in fragile and conflict-affected states, where public revenues are both desperately needed and desperately difficult to collect. Public institutions often don’t have the reach or capacity to manage a national tax collection program, and citizens of fragile states are often wary of — or politically marginalized from — their own governments.

At the same time these are the same countries where extreme poverty increasingly resides, and so any attempt to eradicate extreme poverty — a goal likely to find its way onto the SDG list — must confront sustainable development finance in fragile states.

That challenge led one attendee at the World Bank discussion to wonder whether the panel of experts might offer some recommendations for finance ministers operating under difficult conditions of state fragility, to help them begin the process of piecing a domestic resource mobilization system together.

“Do you have any particular advice to give to a minister of finance in such a country, who’s probably struggling with just creating their revenue authority, let alone getting on to the advanced stages?” asked Marcus Manuel, senior research associate at the Overseas Development Institute.

Start simple

Most panelists agreed on one particular point: Keep it simple.

“Don’t copy the advanced … tax systems from Denmark, U.S., whatever, but start on a simple base. Find the things that are easily taxable, that are easy to have full transparency on,” Benny Engelbrecht, Denmark’s minister of taxation, suggested.

Engelbrecht pointed in particular to a tax on tourism as one easy first step for countries looking to increase domestic resource mobilization to consider.

Kulild agreed with the minister’s appeal for simplicity in the early stages of a tax revenue authority, and she applied the message to taxation of extractive industries.

“If you’re in the extractive industry, don’t even start trying to deal with transfer pricing,” she said, referencing the challenges of attempting to regulate pricing when two subsidiaries of the same multinational company trade with each other, an extremely common form of transaction with a higher risk of price distortion and tax avoidance.

Even highly developed and highly experienced Norway has problems with this practice in the country’s oil sector, Kulild said.

“We have a big committee. … It’s very, very difficult,” she added, noting that Norway started with a gross taxation royalties system. “You just needed to measure how much was produced and how much was exported.”

Luis Miguel Castilla, Peru’s ambassador to the United States, advised finance ministers to do what they can to focus on risk areas and to stand up an effective deterrent against would-be tax evaders.

“To manage all of this is very costly, so risk management is something that we’re now trying to do,” Castilla said, adding that policymakers should look for “pockets of evasion” and then mitigate against the risks they pose. One way to do that is to establish “a very scary tax authority as a deterrent.”

“You have to really hate the tax authority and be afraid of it, and this really mobilizes taxpayers,” he added.

Create new bodies and structures?

Despite immense challenges that remain, many of the panelists saw reason for optimism in a global development conversation that has shifted away from development assistance funding and toward more discussion of the increased role that taxes and other domestic resources must play in securing the next generation of development goals.

Some participants speculated it might be necessary to create a new intergovernmental body, similar in shape to the World Trade Organization, with some degree of sanctioning power, but tasked with tax coordination.

“That’s exactly the conversation we should be having in Addis,” Offenheiser said. “If we lose the excitement about enforcement and the excitement about development that we have at the moment then we’ve really lost an enormous political opportunity and the political will that’s available to us right now.”

Others, like Engelbrecht, cautioned that designing new structures is less important than getting the system to work for developed and developing countries alike, including through initiatives already underway at the Organization for Economic Cooperation and Development and elsewhere.

Engelbrecht drew on a Danish saying to make his point.

“It’s not the color of the cat,” he said. “It’s whether it catches mice that’s important.”

With some reports estimating that more than 1 of every 6 taxable dollars is lost to evasion, that’s a lot of mice to catch.

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About the author

  • Igoe michael 1

    Michael Igoe

    Michael Igoe is a Senior Reporter with Devex, based in Washington, D.C. He covers U.S. foreign aid, global health, climate change, and development finance. Prior to joining Devex, Michael researched water management and climate change adaptation in post-Soviet Central Asia, where he also wrote for EurasiaNet. Michael earned his bachelor's degree from Bowdoin College, where he majored in Russian, and his master’s degree from the University of Montana, where he studied international conservation and development.