Broadening the base

[ By Odd-Helge Fjeldstad ]

As Mick Moore (2007) recently argued in this journal, the role of taxation for the evolution of democratic governance in Western countries holds lessons for developing countries. His key argument is that the more a state depends on tax collection, the more it will need to reach reciprocal arrangements with the citizens on provision of services and political representation in exchange for tax contributions. If correct – as I believe it is – this proposition has consequences for designing tax reforms in aid-dependent countries.

For taxation to have a positive effect on governmental accountability in general, a majority of citizens must “feel” taxation. Otherwise, only minorities will demand participation and better services. Taxes, therefore, must not be confined to small numbers of companies and rich people. They should affect the public at large. This requires that taxes should be levied as consensually and as transparently as possible. Moreover, the process will have to be a predictable, negotiated one, in which the taxpayer has the option of appealing to the judiciary in case of unjust treatment.

It makes sense to consider the tax-reform agenda in the context of governance. For the past ten to 15 years, three features have dominated international debate:
– simplification of tax structures and procedures,
– broadening of the tax base, and
– administrative reforms.

The focus, so far, was predominantly on how these features might contribute to increasing governmental revenue. That topic is, no doubt, important – but so is how these features relate to the interaction of state and society (Fjeldstad and Moore, 2007).

Revisiting tax reform

In most developing countries, tax structures have been simplified considerably in recent years. The numbers of income tax bands, customs duties, excisable goods et cetera have been reduced. Rwanda and Zambia, for instance, today report substantially lower “tax-compliance time” for businesses than is the OECD-average, with the result of fewer incentives and fewer opportunities for bribery. Furthermore, simplifying complex tax codes and revenue procedures make the systems more transparent and accessible to ordinary citizens, which, in itself, is likely to encourage political mobilisation around tax issues.

For instance, Tanzania’s government and the business community are increasingly engaged in a constructive dialogue, and increasingly willing to compromise. This amounts to significant progress in a country where the private sector was completely shunned by government until recently, and where bribery and private deals played a major role in shaping tax assessments. In a similar sense, it is a healthy development that corporate taxpayers in Tanzania have started to mobilise the judiciary in the case of tax grievances. Rule-bound administrations, after all, are checked by the legal system.

Generally speaking, however, tax codes and administrative procedures are still too complex and take too much time in most of Africa. In South Africa and Lesotho, firms on average spend 350 hours per year dealing with tax liabilities, compared with an OECD average of 200 hours (World Bank/IFC 2006). Obviously, cumbersome and unpredictable procedures facilitate arbitrary assessment and, therefore, extortion by corrupt tax officers.

Tax reforms in Africa have so far been marked by an emphasis on not including marginal payers in the tax base. Indeed, the number of tax payers probably even went down in some countries. In Rwanda in 2005, 13 large companies contributed 80 % of the total tax revenue. In Tanzania, a country of some 35 million people, 286 large taxpayers contributed almost 70 %. To some extent, this approach makes sense because it reduces administrative costs and avoids placing financial burdens on economically-weak people. To tax collectors, it will always seem easier, both in institutional and personal terms, to extract more revenue from an existing, registered tax base than to bring many more smaller enterprises and individuals into the net. Nonetheless, there are good reasons for broadening the tax base, and they are not only about raising money.

Including informal businesses and small-scale agriculture in the tax base is technically difficult and politically controversial. While there are fewer precautions against taxing professionals such as lawyers, doctors and private consultants, doing so is technically quite tricky nonetheless. As a result, it is mostly the corporate sector that feels the tax burden – with some perverse results.

For instance, there tends to be a politically-driven proliferation of tax exemptions, reducing governmental revenue on the one hand and exacerbating problems of legitimacy on the other. Discretionary exemptions create room for bribery, distort competition and generate demand for yet more exemptions. Moreover, they cement the widespread perception that the tax system is unfair, making evasion and the search for loopholes seem legitimate. Nasty effects of tax exemptions became evident in Zambia (von Soest 2007), for instance. During the terms in office of President Frederick Chiluba, tax exemptions were widely applied to favour political supporters, while tax audits and harassment were used against opponents.

In the past 15 years, many African countries have undertaken reforms in tax-administration, establishing semi-autonomous revenue authorities outside the finance ministries (Fjeldstad 2006). The purpose has been to limit political interference in the day-to-day operations of the revenue authority, and to loosen the constraints of civil-service rules on hiring and firing as well as remuneration for the sake of attracting and retaining qualified staff. Typically, the senior management has been replaced and so have many lower-level officers too. It was assumed that these steps would lead to greater job motivation and less corruption.

In some respects, these reforms have succeeded. In nominal terms at least, tax revenues have grown. However, tax-to-GDP ratios have not increased as expected. More depressingly still, accountability towards taxpayers has not made much progress in several cases. Two factors are particularly relevant for explaining this trend.
In spite of relatively high wages and good working conditions, corruption may continue to thrive. If there is high demand for corrupt services from the business community, sometimes due to cumbersome procedures, it is unrealistic to provide tax officers with pay rates to compensate for the amounts gained through bribery. Without extensive and effective monitoring, wage increases may simply result in better paid but still highly corrupt tax administration. Hiring and firing procedures may also lead to more corruption, if those dismissed operate in networks with officers still in service. For instance, they may be hired as “tax experts” by the private sector, as has happened in Tanzania (Fjeldstad 2003).
Second, many African governments are under strong pressure from the IMF and donors to meet revenue targets. The tax administrations respond with some combination of an even tighter squeeze on registered taxpayers and quasi-military ‘raids’ on other businesses on which they do not have detailed information. In Uganda, operations against smuggling and tax evasion have even been staffed by army personnel. Attempts to meet externally set tax-to-GDP targets may undermine democratic accountability if legal processes and taxpayers’ rights are set aside in response. Of course, blame for such behaviour should be widely shared, and does not lie solely with the IMF. The point is that a purely economistic approach to tax policy may have perverse results, for both polity and economy.

The way forward

Three broad policy recommendations can be drawn from these experiences of the past 15 years:
– First, the debate on taxes and development needs to be put on a broader base, considering more aspects than merely economic ones.
– Second, a clearer understanding of what makes taxpayers comply with regulations is necessary.
– Third, measures are required to enhance citizens’ engagement with public finance.

So far, the IMF and the World Bank have dominated the tax-reform debate. While their input has been important, they tend to ignore important social and political dimensions. Their approach is not conducive to establishing constructive state-society relations based on taxation. Moreover, the IMF/World Bank-agenda has almost exclusively focused on central governments and their revenues. To a large degree, however, sub-national tax systems have been ignored, although they commonly affect a much larger number of citizens. Thus, interrelations between the central and sub-national levels also need to be addressed.

Taxpayers’ compliance is not only an issue of strictly enforcing laws and punishing evaders. It is also about whether tax practices are considered fair and reasonable by the majority of citizens. In this sense, taxpayers’ rights require more attention. Highly coercive methods of revenue raising as practiced by tax administrations in some parts of Africa should be discontinued. Moreover, it is essential to address tax holidays and exemptions as both are prone to undermine tax morale as well as to erode the revenue base.

This is one reason why donors should consider starting to pay taxes themselves. Doing so will not directly add money to the national budgets of developing countries, but it will boost the credibility of the national governments along with that of the donors themselves. Over time, the budgets of developing countries should benefit from tighter controls, more transparency and fairer resource allocation. The International Tax Dialogue has initiated a discussion to eliminate tax exemptions related to bilateral and multilateral assistance, but consensus among the stakeholders has yet to be reached.

Finally, citizens’ right and access to information on fiscal issues must be emphasised. Therefore, continued and strengthened support to building capacity on tax issues among legislators, business associations and business journalists remains important. Institutions depend and thrive on popular trust – and that is true of tax systems too.