Tax, Governance and Development

1115 - 1300| Wednesday 30 November 2011

Tax, Governance and Development

Houses of Parliament, London

30 November 2011

SPEECH – Max Everest-Phillips

Director GIDD, Commonwealth Secretariat

Distinguished Participants, Guests, and Colleagues

For the last two decades the dominant development discourse has been that tax is a burden; although the state mattered, how it was funded was not an issue.

Why the aid community took this attitude is puzzling, when there existed a whole different approach to taxation.

Exactly 75 years ago, at Worcester Massachusetts in 1936, President Franklin D Roosevelt during the depth of the Great Depression turned his mind to addressing the topic of tax and democracy. Noting that Oliver Wendell Holmes had famously once remarked: "Taxes are the price we pay for civilized society", FDR continued:

Taxes, after all, are the dues that we pay for the privileges of membership in an organized society......

Taxes are the price we all pay collectively to get [ ] things done.

To divide fairly among the people the obligation to pay ..... has been a major part of our struggle to maintain democracy ....

FDR in other words, was asserting that Taxationis at the centre of good democratic governance;

Or, putting that another way, playing on concern about post-colonial donor dependency, The Kenyan Revenue authority has a nice slogan: ‘Pay your taxes and set your country free’

In less succinct and eloquent language, i will try to suggest this approach needs to enter the governance discourse in international development much more centrally for 3 reasons:

1. FIRST, THAT The perceived fairness of the tax system is crucial to building an effective state based on citizens’ consent.
2. SECOND THAT Willingness to pay taxes is a good indicator of the legitimacy of the state; AND
3. THIRD, THAT What citizens and governments are themselves prepared to pay for may be the best indication of genuine political ownership of development objectives.

In other words, if genuine commitment and an effective, legitimate state are crucial to the MDGs and other development outcomes, then aid cannot be allowed to continue to operate in a vacuum without reference to taxation.

The evidence that this matters is intimately enmeshed with the history of the building across the street.

The year1340 is not a date every schoolboy or MP would cite as being of great constitutional importance. Yet, i would suggest, that in its way it should be etched on our collective consciousness. Because it was in 1340, that the English Parliament for the first time explicitly linked its approval of the king’s demand for taxation to their requirement that the monarch redress public grievances over bad governance. In other words that was the first explicit manifestation of the social contract over tax, which allows Citizens-taxpayers, acting collectively, to play a key part in building the constitutional checks and balances over the executive.

But lets go back to basics

This is NOT REPEAT NOT about poor people or poor countries having to shoulder more of a tax ‘burden’; NOR is it a new ‘silver bullet’ quick fix to development challenges.

Rather its about recognising that, other than security, no governance challenge is as important as collecting taxes. Taxes supply the revenues to govern, and therefore establishing basic tax systems is a priority in even the most fragile contexts. Widespread corruption, tax avoidance and evasion by politically influential businesses and access to tax havens by wealthy taxpayers all undermine tax effort.

But the political challenge for development and building an effective state is not only what and how much to tax, but how to tax, who pays, and why (that is, what creates the relative degree of either taxpayer voluntary compliance, or taxpayer resistance and resulting coercion. Tax and governance are so interlinked that how the state is funded shapes the nature of the state: it is as much ‘No representation without taxation’as ‘No taxation without representation’.

All countries, even the very poorest and most aid dependent, need to collect taxes to fund the state. The tax ‘system’ comprises the laws and regulations that set out a country’s tax policy, combined with the administrative reality of how policy is actually applied. The shape of public finances – the mix of tax, debt and aid – matters because raising taxes well requires active state engagement with its citizens.

Tax systems should be economically efficient (raising most revenue with least cost and effort, without creating a significant disincentive to work or invest); effective (administratively capable of delivering the desired policy objectives at minimum administrative and compliance cost); and equitable (offering fair treatment of taxpayers and promoting social cohesion).

In other words, Sound and fair domestic taxation systems promote good governance because Not only does Raising taxes efficiently requires political effort to secure taxpayer consent, BUT also:

• First, Raising taxes effectively requires the development of a competent bureaucracy; and
• Second, Raising taxes equitably requires concern for the fair and equal treatment of citizens by the state.

Tax systems and individual taxes should be as predictable, simple and transparent as possible, be internally consistent, and be accepted as just.

These objectives frequently conflict: a simple tax system is unlikely to be fair; an efficient system may be inequitable. A weak or corrupt tax administration may undermine an otherwise effective tax policy, and can be used to harass the political opposition.Declines in public revenues have frequently triggered political violence and reflect state failure.

Tax policy and its administration needs to be understood as a coherent system. Different components combine to shape and reflect the political process for balancing the demands for raising revenue, promoting economic growth and delivering social cohesion by funding adequate public services and welfare.

Good tax systems fund public services and promote better governance and more sustainable economic growth on which long-term poverty reduction depends. Poor tax systems undermine development aspolitical choices about raising and spending tax both reflect and shape the nature of the relationship between the state and its citizens.

Therefore Political equality and economic efficiency cannot be addressed solely through public expenditure provision of public goods like security and public services like health and education.

To deliver better governance and more sustainable growth, tax policy and its administration in many developing countries needs to be improved. In Yemen, for example, only 7% of GDP is raised in taxes and the tax authority collects no more than 20-25% of taxes due. In Pakistan the tax administration is characterised, according to a recent study, by QUOTE pervasive rent-seeking UNQOTE; in Nigeria the federal government in 2004 collected only around 10% of taxes due, and then half the revenue collected was believed to have been subsequently lost or embezzled.

Losses stem not only from corruption and ineffective revenue collection. Tax evasion and avoidance have been calculated to cost developing countries many times total international development aid. The accuracy of these figures can be challenged, but the general point cannot.

These problems however highlight that a good tax system also requires ‘rule of law’ institutions and taxpayer rights. Tax avoidance is legal (tax planning) rather than illegal (tax evasion). In many developing countries this clear distinction is inadequately institutionalised and taxpayers have few well-defined legal rights.

Behind a good tax system are two very basic ideas: that its Fairness is key for its Legitimacy, and the perceived legitimacy of the state strongly influences citizens’ willingness to pay tax.

The goal of development work on Governance is to help to build the democratic legitimacy, effective public authority and responsive public administration that together promote development, political stability and economic growth.

To achieve such ambitious ends we need to remember the overwhelming body of research findings, as well as experience, that suggests that the quality of government that most appears to create trust in government and build the legitimacy of the state is not in fact democracy, the rule of law, or state efficiency. Rather what seems to matter above all else is the perception of citizens about the impartiality of public institutions that exercise government authority.

Public trust in the state depends, in other words, above all else, on public administration being, and appearing to be impartial – that is, fair, equitable, honest and just. Fairness arises from and reinforces a public service ethos that motivates officials to deliver public services in the public interest. People’s perceptions of that ethic in public administration strongly influence satisfaction with services, trust in government, and citizens' views of politics.

As a result, fairness in public administrationhas very concrete outcomes: research associates this quality of government with less corruption, higher levels of citizens’ general well-being, and a reduced likelihood of civil war. Through promoting trust, fairness in tax policy and administrationresults in comparatively higher levels of tax compliance. It is indeed difficult to raise taxes without the tax system being perceived as fair, effective and efficient, and its enforcement as a legitimate exercise of state power in the eyes of citizens and the private sector.

The year 1344, like 1340, is again not a date every MP would know or cite as being of great constitutional importance. Yet, i would suggest, that in its way it too marks a key moment, whenParliament first achieved perceived fairness of the tax system through the introduction of a standardised and regularised system of assessment of taxation.

State legitimacy emerges from the quality of governance institutions and the extent to which they deliver political stability, accountability, rule of law, the absence of violence, regulatory quality and control of corruption. Trust in the government, in the justice system and in the legislature helps citizens’ confidence that that government will spend tax revenues wisely and efficiently. This increases tax compliance, which in turn increases the efficiency of tax collection.

So creating a high tax ‘morale’ (citizens’ intrinsic willingness to pay taxes based on acceptance of the legitimacy and effectiveness of the state) requires governments not just to be able to compel but also to persuade - it is hard to raise tax efficiently without ‘bargaining’ with citizens and building up their trust in government.

So, where governments must finance themselves by persuading rather than coercing their citizens, they are more likely to rule democratically and to spend money providing services to citizens. As a result, increases in the tax burden can, depending on country circumstances, predict increases in the degree of democracy and constraints on state authority. Progress will be most readily realised where there is a ‘fiscal social contract’ – that is, the implicit agreement between the state and its citizens that taxes are paid in return for good governance.

A modern ‘fiscal social contract’ has two components: a high level of routine, institutionalised process for citizens to be engaged in decisions about how public revenues are raised and spent; and general acceptance that obligations to pay taxes (‘contributive justice’) and entitlements to the benefits of public expenditure (‘distributive justice’) are important components of citizenship.

Domestic accountability then matters: Parliaments, audit agencies and other oversight institutions, business associations and the media can then scrutinise government revenues and expenditures. For example, taxation appears to be driving the emergence of political ‘voice’ within the business communities in Tanzania, Uganda and Zambia.

Better political representation, stronger civil society ‘voice’, and a more effective bureaucracy mean people are more likely to be better served by the government. The role of effective tax systems is reflected in two leading development successes in Africa, Mauritius and Botswana.

Taxation has always acted as a key incentive for states to create competent administration. Effective taxes require collecting enormous amounts of information efficiently: for example, this process occurred in England through the compilation of a complete register in the Domesday Book of all taxable assets in 1086. This ‘Domesday Book dynamic’ has happened not just in Western Europe but also in recent examples of successful developmental states such as in East Asia’s ‘tiger’ economies.

Revenue authorities in all countries have considerable power and discretion. But in many developing countries without effective institutional checks and balances it is difficult to ensure that discretionary authority is used fairly and transparently. As a result, allegations of tax evasion are often used as a political instrument to harass opponents of the regime; or at a petty level to extract bribes from taxpayers and businesses. Tax authorities are also often under enormous political pressure to raise revenues, creating widespread undermining of due process and taxpayer rights. Introducing greater transparency and external oversight, and reducing the scope of discretion [and so also corruption] is therefore a priority.

Tax is always highly political: Taxes both fund public goods and also help to entrench political authority. In democracies there is always a tension over fiscal discipline between citizens’ interests as voters or citizens’ concerns as taxpayers. In developing countries this relationship between the citizen as taxpayer or as voter is particularly difficult since most voters do not pay tax.

The ‘social contract’ is also needed with the private sector. The informal sector is a major part of the economy in many developing countries in part because of low ‘tax morale’ (intrinsic willingness to pay taxes). Business owners like all citizens do not want to pay taxes unless they feel the tax is legitimate, services will be delivered, and others are also paying their fair share.

To close may i offer a few recommendations for actions that can be taken by parliamentarians to contribute to tax reform when you return to your own countries.

Broadening the sources of tax revenue and widening the tax base on individual taxes is a priority for developing countries. Reforms need to be carefully crafted according to each country’s context. This also applies to tax administration.

A modern tax system aspires to promote voluntary compliance through the following desirable features:

• Clear and simple laws, better information and taxpayer services to minimize taxpayer effort and compliance costs.
• Efficient collection systems and procedures.
• Adequate enforcement power of tax administration.
• Better Risk analysis.
• Automation
• Focus on taxpayers by their revenue potential.
• Human resource management professionalism:

Be wary of those who simply argue for tax cuts alone as the way to promote a better investment climate – remember that much higher rates of taxation in 18th century England than in other countries did not stifle the industrial revolution.

But most importantly, please seize ownership of development by insisting on talking about tax. Despite Paris, Accra and now Busan, the development discourse in developing countries remains far too much the government responding to thedemands of the World Bank and DFID, not tothe demands of taxpayers.

You must therefore articulate the fact that Tax effort requires the political ambition for constructing an effective state that is genuinely supported by citizens’ and the private sector’s willingness to pay tax.

Explicitly recognise that accountability runs both ways: an effective state has to be paid for by a tax system that is generally perceived to be fair; and that, of course, in turn creates strong political pressure from taxpayers to ensure their taxes are not wasted.The political will for ‘elites to pay taxes’ is, however, weak in many developing countries: in other words, if politically powerful people are not be prepared to pay their fair share of the taxes required to improve the effectiveness of the state, donors must ask whether delivery of development goals is really likely to happen because, as over2 centuriesago the great Parliamentarian Edmund Burke put it: ‘Revenue is the chief preoccupation of the state. Nay more, it is the state’.

THANK YOU

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