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How could taxation help to achieve the MDGs? – A reaction to OECD research

27-01-2012

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Financing the Millennium Development Goals (MDGs) remains a major challenge. It is becoming clear that Official Development Assistance from donor countries will not be sufficient to fill the existing finance gap. A new OECD Working Paper zooms into domestic resource mobilisation – savings generated from domestic resources – as potential source of finance, and gives an updated estimate of the cost of meeting the MDGs. This article takes a closer looks at some details of the report.

OECD’s research plays a valuable role in re-focusing minds towards the costs involved in meeting six of the MDGs by 2015, the target set back in 2000, and brings a domestic resource mobilization perspective to this question. In these times of fiscal austerity in donor countries increasing attention is given to how developing countries can increase their own resources through taxation and savings. OECD’s report builds on its previous work on taxation in the 2010 Africa Economic Outlook to gauge the degree to which domestic resources might be used to fill the “financing gap”. By bringing the topics of MDGs and domestic resource mobilisation together, the paper serves as a reminder that underlying many of the problems faced in developing countries is the need for more effective states and improved tax systems.

However, in bringing the two topics together, and despite the caveats given by the authors, it may oversimplify the complexity of raising additional resources through taxation.

More taxes, is it that simple?

A major element of the analysis focuses on the scope for countries to cover MDG expenditures through improving collection of domestic resources. This is based on an analysis of “tax effort”. The tax effort measure comes from estimating the “average” tax performance across a group of countries, taking into account some of their characteristics such as income levels, the share of agriculture in the economy, and the level of trade. On this basis, countries with tax performance below what average performance would predict for them are considered to be capable of exerting more tax effort. The tax effort estimate therefore assumes that the income levels, the agricultural share and trade openness are the only determinants that determine ‘feasible” tax performance.

But tax performance also depends on a lot of other aspects. So can we really assume that the fact that some countries gather more revenue, even taking into account some country characteristics, means that other countries should be able to do the same?

For one thing, as the above brief explanation shows, the tax capacity predicted by the analysis will depend very much on the countries included in the analysis. Income per head may be correlated with tax performance, but other institutional and structural characteristics are also likely to be important. This could be the tax authorities’ capacities to raise tax revenues, for instance. Being resource rich also seems like a characteristic worth taking explicit account of in the analysis in this context. Indeed, the 2010 African Economic Outlook report itself highlighted that a major part of the increase in domestic revenues across Africa has occurred in resource-rich countries. Thus including developed countries along with developing countries, for example, may distort the prediction of what revenue levels are “feasible”.

Further, outliers can easily skew averages. While countries such as Lesotho or Swaziland may appear to exert high tax effort, in reality this is because (at least until recently) they receive a substantial part of their revenue through transfers from the Southern Africa Customs Union regional revenue sharing pool, largely financed by South Africa. So although they may be better placed to finance MDG-related expenditures, this is not necessarily related to tax effort or their national taxation system.

This perhaps highlights a broader point. The relation between taxation and the financing of the MDGs really needs to take account of where tax revenues actually come from and how they are collected.

Details of the bigger picture

Tax revenues are likely to be increased through increased economic growth. While the OECD report recognises that an assessment of the MDG financing gap is a simplification, it estimates the additional resources required to achieve a growth rate that could reduce poverty by 50 percent. This figure is then taken as the financial gap that must be filled to achieve this growth rate. But achieving the growth rate itself would imply some economic activity, that itself generates tax revenues and thus potentially distorts the estimated financing gap.

A gathering body of research also highlights the institutional implications of tax policy and tax policy reform and their fundamental importance in determining how successful a country is in raising revenues. My colleague Melissa Dalleau and I summarized some of this in a recent ECDPM Discussion Paper. How the revenues are collected, the institutional relations around tax policy design and its implementation can impact on growth through its influence on private sector behaviour. These are by no means simple issues to resolve.

Further, on the specific question of how the MDG “financing gap” could be funded, increasing domestic resource mobilisation and increasing Official Development Assistance from donors are discussed as two substitutes. But as the (more critical) literature on the impacts of aid suggest, the institutional demands and implications of increased aid are very different to those of increased domestic resource mobilization

Another major factor to take into consideration is the loss of revenues due to illicit capital flight. Only recently, Global Financial Integrity provided an updated estimate of illicit capital flows in 2009, giving a figure of $ 600bn. Put in those terms, and given the estimated need for an additional $120 bn to meet the MDGs, maybe domestic resource mobilisation could do it after all….  But here, more coordinated international action is needed so money leaving developing countries illicitly no longer can be stored in safe heavens, which mostly are located in donor countries.

From all this, the importance of paying attention to the questions of how resources are raised and where they come from becomes clear. Nonetheless, highlighting the options for financing the MDGs, as the OECD report does, is a good way to rally support and increase efforts in understanding the complex issue of raising domestic resources in developing countries.

Bruce Byiers is Policy Officer Political Economy of Reforms and Development at ECDPM.

This blog post features the author’s personal views and does not represent the view of ECDPM.

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Economic Transformation and TradeDevelopment Finance and TaxationMillennium Development Goals (MDGs)Tax