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Taxes, States and Economic Growth: How can we better design and implement tax policy for development?

27-06-2011

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On a recent visit to Pakistan the UK Prime Minister, David Cameron, said that the Pakistanis would have to work on improving their tax system if they were to justify the 650m pounds aid package being offered. As the FT reported, “Mr Cameron admitted it was difficult to justify such aid when British taxpayer saw “waste” in a country where “too few people pay tax”. Although he importantly left out any mention of the role of UK and other developed country tax havens in depriving developing countries of much-needed revenues (something examined in detail in the recent book by Nicholas Shaxson, Treasure Islands), in the context of the recent financial crisis, continuing trade liberalisation, and with increasing scepticism about aid, the issue of domestic resource mobilisation through better taxation is climbing up the development agenda.

There is also growing support for the idea that tax systems are important for state-building. Based on a historical understanding of how representative states were formed in Western Europe, recent academic research suggests that state-building and taxation can be positively linked through a form of tax-revenue bargaining, or “social contract”, where citizens and the government agree on what they should pay and what should be received in return in the form of public goods and services.

Of course, this raises some important questions. While a historical understanding of taxes and state formation is useful for understanding the present, is it useful for formulating current tax policy advice to developing countries? Is it possible to move from the existing tax policy status quo, where government and private interests in a country may be satisfied and “demand” for greater state accountability is not yet heard? Are grand ideas of state-building even relevant in a context where the day-to-day pressure on revenue authorities is simply to achieve the revenue target stipulated by the Ministry of Finance, regardless of the potentially arbitrary way this target was established? Even the parallel government objective of promoting private sector development for job creation is often put under threat by this basic revenue necessity, so how can the more nebulous idea of “state-building” be addressed?

It was with these kinds of questions in mind that ECDPM recently attended the Annual Meeting of the International Centre for Taxation and Development (ICTD). A DfID-funded centre based at the Institute for Development Studies (IDS) in the UK, this has the objective of promoting policy-relevant research on tax issues, very much in this framework of using taxes to promote better governance. The meeting was an opportunity for tax practitioners and researchers from around the world to discuss issues, and to present research programmes to be carried out through the center.

The range of proposed case studies was interesting, reflecting the broad nature of the topic – tax policy and tax policy implementation relate importantly to the entire development agenda. However, an important point that was perhaps missing in some proposals was that while the state-building approach encourages a useful political economy analysis of tax reforms – an understanding of the stakeholders, the history, their incentives, their room for manoeuvre etc. – it nonetheless remains important that this be carried out as a complement to economic analysis. Taxes are highly political, but they also have economic effects. Tax reforms inevitable create distortions and perhaps lead to unexpected economic outcomes, something that can then inform a political economy analysis of the “real world”.

At ECDPM we are increasingly asked to provide assistance relating to tax issues. This relates in particular to the issue of how best to replace revenues lost through the process of trade liberalisation and EPAs in particular. This is important, given that trade-related tax revenues can account for 30-40 percent of government tax revenues in ACP countries. The pressure is further heightened by regional integration where countries are lowering their tariffs on neighbouring countries also, issues discussed in a forthcoming ECDPM Discussion Paper.

Further, with more and more attention paid to mineral extraction, the impact of foreign investment from emerging players such as the BRICS, and the need to facilitate business, it is fundamental that the tax system be better understood. As Richard Bird, author of the first book on Taxes and Development in 1962, and Head of the ICTD Advisory Group stated, “it’s not hard to collect taxes; it is hard to collect them the right way”. At ECDPM we look forward to engaging with governments and practitioners in getting closer to finding a better way…

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

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

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Economic Transformation and TradeDevelopment Finance and TaxationTaxPakistan