4 ways low-income economies can boost tax revenue without hurting growth

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Achieving the Sustainable Development Goals requires a massive increase in investment over the next decade —each year, the equivalent of as much as 8.2% of national GDP for some developing countries. That’s a tall order for even the wealthiest of countries. For low-income countries, it’s a potentially crushing burden.

Most of these countries are already overextended: one-half of the poorest countries eligible to borrow from the World Bank’s International Development Association (IDA) are at high risk of debt distress or already in distress.  Many of them recognize that borrowing from foreign lenders will be a limited option going forward—that mobilizing domestic resources in the form of tax revenues will be critical to economic progress.

Today, more than a third of  IDA countries—and 70 percent of fragile and conflict-affected countries—collect taxes that amount to less than 15 percent of national GDP. That’s barely enough for governments to carry out the most basic state functions. Merely hiking tax rates would be counterproductive: it could aggravate poverty and slow growth. It takes a smarter approach to boost tax revenues in ways that are sustainable.

Here are four ways to do that:

  1. Build trust and provide proof

For taxation to work, citizens must trust their governments.  They need proof that their hard-earned resources are being used wisely, and that in the long run they will benefit from projects completed using taxpayer funds.

That requires transparency regarding government spending. Governments can start by implementing and publishing a medium-term revenue strategy so that all citizens can be informed about how their tax dollars are being used.

It also requires proof that taxpayers are getting bang for the buck. In countries with a large trust deficit, governments can commit new resources for specific projects that have visible benefits for the average citizen: The building of a new hospital or the construction of a new school can go a long way toward building trust. As trust in a country’s ability to provide good public services grows, governments could then move away from relating new tax revenues to particular projects. Better public services would enhance people’s trust in government, thus lowering tax evasion and increasing tax revenues further, which would sustain the level of government services, feeding a virtuous circle of trust and government services. 

  1. Keep it simple

Complex tax systems foster a culture of evasion and can create opportunities for corruption. Consider the example of Latin America: The average company can expect to spend 547 hours each year making 22 separate tax payments. Not surprisingly, countries in Latin America and the Caribbean lost $340 billion in 2015 to tax evasion.

A 2014 World Bank Group report found that a 10 percent reduction in both the number of payments and the time to comply with tax requirements can lower tax corruption by 9.64 percent. A simpler code can bring more small businesses into the taxable formal sector.  It also creates a more predictable environment for international investors, attracting investment and tax revenues in the process.

We are happy that countries see the benefit of making these changes and are taking action. Fifty economies now have just one tax per tax base. Over the past 13 years, 57 economies have merged or eliminated certain taxes.

  1. Go digital

The simpler a tax system is, the easier it is to enable electronic tax payments. 

More countries are moving in this direction, although progress is uneven. In Cote d’Ivoire, for example, the time to prepare and file taxes decreased in 2017 from 270 to 205 hours following the introduction of an e-filing system for corporations. But in Gabon, the time to prepare and file increased in 2017 despite the new availability of an e-filing system.

To make e-filing work across the board, many countries will have to overcome basic IT infrastructure hurdles. But once the basic elements are in place, countries can make progress by pairing digitized taxes with other innovative approaches such as digital identification, digital finance, online tracking of invoices and sales or auto-populating tax returns that citizens simply have to confirm. Kenya, for example, leveraged its ubiquitous money-transfer system, M-Pesa, to allow taxpayers to file and pay their taxes electronically through the platform.

  1. Find new sources of revenue

Property taxes, excise taxes, and carbon taxes are a potentially significant source of revenue in low-income countries—because they apply primarily to wealthier households. They can also deter unwanted behaviors, such as driving cars in already congested areas, smoking, or consuming unhealthy foods.

We are supporting the OECD-led global initiative to rethink how huge – and often digitized - multinational enterprises (MNEs) are taxed, which could have a big impact on developing countries. Currently, governments around the world miss out on anywhere from $100 billion to $600 billion in tax revenues due to legal forms of tax evasion and avoidance. The OECD proposal represents a turning point for international tax rules and, if done right, could reallocate more funds to developing country governments, as explained in a recent World Bank paper, International Tax Reform, Digitalization and Developing Economies.

Prerequisites for change

At the World Bank, we’re focused on helping countries mobilize the tax resources they’ll need for development. In Senegal, we’re helping the government launch a medium-term revenue strategy. In Mauritania and Cape Verde, we supported the government’s efforts to publish tax expenditures and to remove cost-ineffective taxes. In Uganda, we worked with authorities to identify possible areas for excise taxes.  And in Sierra Leone, we’re working with the government to modernize its Customs and Domestic Taxes Departments. During the first three months of 2019, revenues nearly doubled in year-on-year terms: to 211 billion leones from 127 billion leones in the same period of 2018.

These improvements aren’t easy to achieve. They depend on hard-to-wrangle fundamentals such as basic digital infrastructure and political will. Despite the challenges, I am hopeful. In the past decade countries have made hundreds of reforms to improve tax systems. With more work, we can mobilize more domestic resources to bridge the SDG financing gap. 

Authors

Marcello Estevão

Global Director, Macroeconomics, Trade & Investment

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