This week, world leaders are deliberating in Addis Ababa over how to pay for 17 sustainable development goals that include ending poverty, hunger and ensuring equitable education for all. With a lingering recovery from the financial crisis and a collapse in oil and mineral prices, financing such an ambitious agenda is a serious challenge.
The Addis Tax Initiative, committing both donor and recipient countries to strongly support tax reform in developing countries, is one outcome from the conference. It stems from a recognition that insufficient domestic revenue collection restricts a state’s ability to self-finance development goals. For example, non-oil tax collected by the Nigerian government is equivalent to just over 4% of its GDP, as opposed to 35% in the UK. This severely constrains Nigeria’s ability to self-finance poverty reduction efforts.
One significant obstacle in developing countries is self-made holes in their tax laws, known as tax expenditures. These expenditures consist of exemptions and deviations from a benchmark tax system, which prevent rates being applied across all taxpayers and all taxable income.
Tax expenditures often take the form of tax incentives aimed at attracting foreign investment, such as corporate tax holidays or exemption from custom duties. However, they can also serve social purposes such as not applying Value Added Tax (VAT) to food. Whatever the justifications, the effect on government revenues can be significant. According to one study, Sierra Leone’s custom duty and General Sales Tax exemptions in 2012 equalled over 50% of total revenue collected.
In popular debate, the concept of the tax base (the total amount of tax owed by all taxpayers) rarely gets the attention afforded to the tax rate, which can allow misguided policies, often benefitting particular sectional interests, to develop. An example would be corporate tax incentives, often introduced by developing countries despite World Bank evidence that suggests they are not a key factor influencing foreign direct investment. This means they unnecessarily risk the tax base of the country as well as often being to the disadvantage of local companies, who do not benefit from the tax incentive.
Unfortunately, analysis on the costs of tax expenditures in terms of revenue foregone by governments are rarely conducted, meaning decisions to award tax concessions don’t consider the costs of such concessions. Discretionary exemptions, such as presidential decrees benefitting particular companies often lack transparency with regard to both the beneficiaries and the costs of such exemptions.
The contrast between revenue and expenditure is stark. Accurately recording and accounting for how a government spends its budget has long been recognised as a basic component of good public financial management. However, when governments try to achieve policy objectives through tax expenditures, there is typically no equivalent transparency and accountability.
‘Tax expenditure statements’ which state the value of such tax expenditures can help overcome this anomaly. Just as budget statements allow parliamentarians and citizens to identify how much is spent on particular policies and priorities, tax expenditure statements record the value of revenue foregone in order to meet policy objectives. These allow such policies to be evaluated on a value for money basis, allowing policy makers to decide whether such concessions are worth their anticipated costs. They also reduce opportunities for political favouritism and corruption by identifying beneficiaries of tax expenditures.
Given the potential benefits in terms of increased revenues, reduced corruption and a more competitive business environment, tax expenditures could be a key focus in efforts to increase revenue in developing countries. The minimal effort involved in identifying and estimating tax expenditures mean it could be utilised as an important early step by many countries in bringing the Addis Tax Initiative to life.
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