In recent decades, many developing countries have experienced declines in fiscal revenue as a share of national income. There is an urgent need to reverse this trend, with greater revenue collection to finance the realization of developing countries’ developmental aspirations.
The pursuit of development objectives depends crucially on government spending which, in turn, is constrained by fiscal revenues, especially taxes. But tax revenues in most developing countries are typically low, much lower than in developed countries, Jomo Kwame Sundaram wrote for IPS.
In many sub-Saharan African and Latin American countries, the tax to gross domestic product ratio has actually declined, with declining tax revenues from import tariffs and, less often, export duties. Taxes on international trade have long been the easiest taxes for governments to collect.
Such revenue, indeed the share of trade taxes, has fallen with trade liberalization in recent decades, often encouraged, if not required, by the Washington-based international financial institutions. Typically, other taxes have not grown enough to compensate for lower trade taxes.
Tax revenues are mainly from three sources in most developing countries: domestic taxes on goods and services (general sales tax, excises), foreign trade taxes (mostly import duties) and direct taxes, mainly income taxes, as estate duties and other such taxes have declined in significance.
In most developed countries, income taxes (mostly from individuals rather than corporations) and consumption taxes make the largest contributions (around a third each on average), while social insurance contributions account for about a quarter of total tax revenue on average, with trade taxes quite insignificant.
Generating Tax Revenue
Although there is growing trend towards standardizing tax practices, varying circumstances and hence revenue potential suggest that developing countries should not seek to emulate developed economies in trying to generate tax revenue. No one size fits all, even among developing countries, and certainly not for all time.
Tax systems should evolve with economic conditions and circumstances. For most revenue authorities, nonetheless, a key consideration is to ensure effective, regular and adequate tax collection.
There has also been a push to broaden or diversify the national tax base, posing dilemmas for countries with limited revenue collection capacities.
Non-tax revenues have mainly been important for petroleum renter states and the few countries with large, well-run state owned enterprises. Such ratios are typically low, even in countries with considerable non-petroleum mineral resource extraction activities, typically to minimize or even avoid corruption.
Improved Tax Administration
Hence, it is imperative for developing countries to take steps to increase their revenues after considering various relevant options for doing so. In recent decades, most developing country governments have been advised to lower, rather than to increase tax rates.
The presumption was that lower rates would ensure better compliance and also encourage greater investment, thus resulting in higher tax revenues.
Tax revenue can be increased in several main ways: widening the domestic tax base; reducing tax avoidance and evasion; and securing new sources of international taxation.
Improved tax administration can increase the contribution of personal income taxes to total revenue. Every individual who is a house owner, vehicle owner, club member, credit card holder, passport, driving license or identity card holder and telephone subscriber can be required to file a tax return. Expanding the scope for tax deduction at source has been very effective in taxing those otherwise hard to reach.
VAT revenue has been much less than expected at the time of its introduction in developing countries owing to their generally larger informal sectors. Aggressively widening the VAT base would hurt the poor who are typically more engaged in the informal sector, both as consumers and producers. The administrative costs of having multiple VAT rates and exemptions are also higher in developing countries.
Excise taxes are another important source of revenue in developing countries as they have a buoyant base and can be administered at low cost. They are typically levied on products such as tobacco, petroleum, vehicles and spare parts. From a revenue perspective, they are convenient, involving few producers, large sales volumes, relatively inelastic demand and easy observability.
Excises may be levied on quantities leaving the factory or arriving at ports, thus simplifying measurement and collection, ensuring coverage, limiting evasion and improving monitoring. Excise taxes currently amount to less than 2% of GDP in low-income countries, compared to about 3% in high-income countries.
