Seizing the opportunity for tax administration reform

In today’s post-COVID world, countries are facing reduced fiscal space, due to the combined impact of expenses linked to the pandemic response, rising interest rates, and increasing energy prices.

Typically, governments employ a combination of three approaches to increase fiscal space: budget cuts, tax policy reforms, and tax administration reforms. The first two have been the preferred options for a while. However, they tend to be unpopular during election cycles. Not surprisingly, in 2024, a year in which more than 70 countries held national elections, a number of countries started to focus more deeply on tax administration reforms, the impacts of which tend to be felt by a small percentage of the population—those evading taxes—and are generally perceived to be fair. 

The quest to improve tax administration is not a new one.  And the upsides are very relevant. Tax collection in the developing world is relatively low. Many countries remain below the 15% to GDP threshold which is considered the minimum needed for countries to be able to effectively provide essential services. In addition to providing resources needed to deliver services to the population, it is only fair that everyone who is supposed to pay taxes actually pays them. 

A 2023 IMF study estimated that low-income developing countries (LIDCs), could raise a substantial amount of additional revenues through a combination of tax system reform and strengthening their institutions to the level of emerging market economies. More generally, comparing countries by development level, two important features stand out from that study.  First, the higher a country’s level of development, the higher the level of tax potential—advanced economies, 26% of GDP; emerging market economies, 22.5%; and low-income developing economies, 22.2%.  And second, advanced economies are very close to their potential, with few untapped resources (See figure below).  

Source: Benitez et. al. (2023). Building Tax Capacity in Developing Countries. IMF Staff Discussion Notes. Available at https://www.imf.org/-/media/Files/Publications/SDN/2023/English/SDNEA2023006.ashx 

What do tax administrations—particularly in developing economies—need to do to access these untapped potential resources?  An important step is strengthening institutions, as shown by  a World Bank paper which finds that stronger institutions lead to higher revenue mobilization, irrespective of the income level of a country. 

But what does this mean in concrete terms?

We think the following six trends hold a strong potential to improve tax administrations:

• The first, which has been ongoing for many years, relates to strengthening tax administrations’ business processes and deploying IT systems. Looking ahead, strengthening their processes and systems will continue to be a priority for many countries. 
• Many tax administrations have integrated tax and customs systems, which can make tax administration more efficient by exploiting synergies such as common HR and IT systems and data sharing platforms. At the same time, the process of integration is not easy given the different organizational cultures of tax and customs administrations.
• Third, the introduction of new IT systems to support tax administration, which are intended to automatize and systemize tax administration data. A wealth of administrative data can now be utilized to analyze and identify tax evasion patterns, using sophisticated data analytics programs. Advanced and middle-income countries have been doing this more in recent years; this is something that lower income countries need to focus on more.  According to ISORA data, while 85 percent of advanced economies are currently using these innovative tools in their tax administrations; that number falls to 25 percent in lower middle-income countries, and only 10 percent in low-income countries (See figure below). 
• Another point is the strengthening of human resources. In some cases, this means simply bringing more people to carry out targeted tax audits—for example, the introduction of a mid-size taxpayers office. It can also mean hiring staff with new skills—statisticians, data scientists, economists, etc.—to more fully exploit the informational value of newly available administrative data. 
• Fifth is the implementation of the findings of research in behavioral economics which focuses on interventions for voluntary compliance.
• And, at the frontier of where we are now is the use of cutting-edge innovative technologies, such as artificial intelligence (AI) and machine learning (ML), in tax administration. This last step builds upon previous reforms, uses large amounts of administrative data (both related to taxes and beyond), and is particularly efficient in picking up otherwise undetected patterns in tax evasion. However, there is a limited use of these innovative tools in low and lower middle-income countries compared to advanced economies (See figure below).  

We are presently at a timely juncture in which the need to reform tax administrations, the political commitment, and the solutions are all available. Let’s make the most of this opportunity.