The Panama Papers and a new international tax agenda set out by the Group of 20 and the Organization for Economic Cooperation and Development, saw international tax evasion and avoidance shoot up the list of reform issues for developing countries, and DfID has been keen to help – on the face of it with good reason.
Developing country governments are comparatively weak in identifying and enforcing tax liabilities, and are often no match for major multinational corporations and their legions of tax advisers, leading to a fear that developing country citizens are being exploited.
But what is the actual loss to developing countries from this kind of avoidance? In May 2015 the International Monetary Fund suggested the loss due to base erosion and profit shifting — or BEPS — was 1.3 percent of gross domestic product in developing countries. This is a tiny drop in the ocean of developing country undercollection of revenue.
In developing countries tax-GDP ratios are typically 8-20 percent, while developed country ratios are in the 30-45 percent range. Revenue loss from BEPS is clearly a low priority for developing countries, especially when the complexities of addressing it may be extremely challenging in low capacity environments.
So what are the high priorities?
A wealth of practical experience assisting developing countries with tax reform has revealed a set of constraints, more domestic in nature, that contribute significantly to the undercollection of tax. This includes a too-narrow tax base (the amount of taxes legally due), incomplete identification and registration of taxpayers, poor compliance by taxpayers, and weak enforcement against violators. Donors and developing countries should concentrate on resolving these problems to push tax-GDP ratios above 20 percent.
Turning first to the too-narrow tax base, a major concern is often “tax expenditures,” such as concessions, holidays and discounts given to sectors, markets, zones, groups of firms, groups of people, and even individuals. Tax reform programs in specific developing countries have identified that these tax expenditures can represent more than 5 percent of GDP.
The solution is a cost-benefit analysis and streamlining exercise, which will make sure tax expenditures are well-targeted and contribute to net benefit. This is a practical and achievable solution for developing country governments, and there are several examples where tax systems have been made simpler and more transparent, with more taxpayers brought into the tax net.
A broad-based consumption tax, such as VAT, is another major way to broaden the tax base. Exemptions, rates and thresholds should be in line with international best practice so that revenue mobilization is maximised while ensuring administrative simplicity and fairness for those on lower incomes.
The list goes on: earmarking certain taxes for expenditure on visible social service and infrastructure priorities; presumptive taxes for large numbers of small taxpayers; reducing the number of smaller “nuisance” taxes; withholding taxes on wages, rent, interest and dividends; combined withholding of wages and social security obligations; and taxing turnover rather than profits; these are all accessible tax policy reforms for developing countries.
Still, tax policy is only ever as good as its administration. Getting tax administration right is a huge challenge, which can take time and effort. Developing country tax administrations should focus on: understanding the political economy and cultural issues affecting the tax system; collecting known debts; assigning administrative resources to the riskiest areas where revenue potential is highest; enforcing against registered nonfilers, including through default assessments; better and more selective auditing of taxpayers who have filed; identifying unregistered taxpayers using all data (including third-party data) available; and implementing more efficient collection methods through better organization, processes, automation and management.
But impactful tax reform is not only a technical issue, the method and style of donor technical assistance is also critical. Very successful programs seem to be marked out by the way in which the reforms are implemented with beneficiary governments. Some of this sounds simple, but it is crucial. Technical assistance programmes should align program objectives with government and donor objectives and participate actively in cross-government processes.
Support should be provided hand-in-hand with government beneficiary counterparts on a day-to-day basis; have a genuine commitment to long-term capacity development alongside quicker wins; utilize local and native expertise and only the very best international experts; and provide comprehensive support and duty of care to the advisory team in the field, allowing team members to focus exclusively on technical problems and solutions.
While we should applaud co-ordinated efforts to tackle international tax evasion and avoidance as a matter of justice and fairness, we should be aware that the impact of this kind of evasion and avoidance on developing countries is minimal compared to other revenue loss. Developing country governments and those aiding them can collect much more revenue to finance development by focusing on the proven tax policy and administration reforms set out in this article.
If these reforms are implemented effectively, they will offer developing countries a route out of fiscal instability and donor dependence. The role of donors should be to help with the expert design and packaging of these high-impact reforms, and to make sure the method and style of implementation are right.
Join the Devex community and access more in-depth analysis, breaking news and business advice — and a host of other services — on international development, humanitarian aid and global health.
Paul Davies is Adam Smith International’s director of revenue reform and is responsible for all of Adam Smith International’s revenue reform work around the world. For the past 17 years he has managed multimillion, multiyear, multidisciplinary projects for a wide range of governments and donors in Africa, Asia, the Middle East and Eastern Europe. He was one of the first consultants to be active in Afghanistan in early 2002, and from 2004 directed DfID’s flagship program of reform and restructuring of the Revenue Department of the Ministry of Finance in Afghanistan.
Subscribe to Devex Newswire
Top international development headlines emailed to you every day