This piece is co-published with the International Centre for Tax and Development.
Since its onset, governments the world over have responded to the COVID-19 pandemic by ramping up spending and providing tax relief to ailing families and businesses, even in the face of dwindling revenues. This has inevitably led to widened fiscal deficits and ballooning public debts. For a crisis of such large and unknown proportions, these extreme measures are more than justified.
What is not clear, however, is what will happen once the health emergency subsides, and governments are left with the task of returning public finances to a more stable and sustainable path. Will they decide to continue providing basic income support to people living in poverty and widening access to health services, or will the response turn to strict austerity measures? Can the crisis open up space for a more equitable and inclusive approach to fiscal policy, recognizing and addressing the inequalities that the pandemic has made ever starker and more apparent?
The answers depend in part on how governments approach tax policy. Raising additional revenues will be a necessity for governments as soon as the worst of the crisis is over. Proposals on how to ensure new revenues are collected in a more equitable and efficient way are already being put forward. Mick Moore and Wilson Prichard of the International Centre for Tax and Development (ICTD) laid out a particularly clear and comprehensive agenda pointing to tax reforms that reflect a new fiscal contract, prevent a further worsening of inequality and help to address other societal problems like climate change. In their view, the crisis presents an opportunity to promote a more fundamental shift in the ways in which governments collect revenues.
The real challenge lies in understanding how best to overcome the political opposition that tends to accompany large-scale reforms for more progressive and equitable tax systems. In many countries, political and economic elites are likely to resist new or increased taxes on wealth, while corporations and high-net-worth individuals are likely to use various tactics—including political pressure—to keep their tax bills low. In the immediate aftermath of the crisis, the targeting of wealthy individuals and businesses may face particular political resistance as these groups cite recent economic losses as justification for their inability or unwillingness to pay. At the same time, there is a risk that increased pressure for revenue will simply lead to greater revenue extraction from those that are less politically influential and more vulnerable, including individuals and businesses in the informal sector.
If we are serious about promoting more equitable and progressive taxation as part of post-COVID recovery strategies, we need to start thinking now about how to build the coalitions that can put pressure on governments to make better choices and withstand inevitable opposition.
How can civil society-led coalitions support politically challenging tax reforms?
What might these coalitions look like? And what role can citizens and civil society organizations (CSOs) play in them? An ongoing project at the International Budget Partnership’s new Tax Equity Initiative is looking at successful civil society engagements on tax reform across the world. While the case studies will only be finalized later in the year, IBP recently convened researchers and CSOs to discuss preliminary findings and emerging cross-country themes and lessons.
Evidence from the eight cases suggests at least four ways in which civil society-led coalitions can help shift popular perceptions of taxation and move the political needle on reforms:
Successful coalitions often go beyond the usual suspects to include a broad range of actors who support specific reforms: for example, parts of the business community supported tax reforms in Vietnam, Guatemala and Uganda. In the latter, civic actors and mobile money traders aligned against new taxes on mobile money transfers that would mostly hurt people living in poverty. In the United States, labor unions were critical to the success or partial success of so-called “millionaire taxes” (generally, income tax surcharges on high incomes) at the state level. CSOs therefore need to understand the interests of various groups, how interests may align in support of progressive tax reforms, and how messaging may be crafted to bring these groups into an effective coalition.
Promoting a narrative linking taxes to the services they are meant to fund can be effective in building public support for tax reforms. In the Philippines, broad support for so-called sin taxes—that is, taxes on products on tobacco and alcohol—was possible as the reform was framed as a health issue, not just a fiscal one, with revenues committed to financing public health care expenditures. Likewise, in the case of state-level “millionaire taxes” in the United States, framing tax increases around the education and infrastructure services new revenues would fund was critical to ensuring popular support for the reforms. In the wake of COVID-19, committing new tax revenues to health expenditures, food security or other recovery priorities may be a particularly effective strategy to gain initial widespread support.
Appeals to equity and fairness can also help ensure support for progressive reforms. Civic actors need to invest in learning more about how people think about fairness through surveys and focus groups where they can. This greater understanding of popular perceptions and expectations can help shape and strengthen public pressure campaigns. For example, when civil society organizations forced the tax administration to release details of the beneficiaries of tax amnesties in Mexico, data showed that well-known celebrities and large corporations were receiving generous tax relief without any clear need. This led to a public outcry and created political pressure on the government to stop these amnesties, which it eventually did. In France, the juxtaposition of cutting taxes on wealthy, urban elites while raising them on the rural working classes fueled impressions of unfairness that drove initial support for the Yellow Vests movement.
Coalitions need to be ready to take advantage of political opportunities for change when they arise. When a corruption scandal in the tax administration agency rocked Guatemala and led to the dismissal and arrest of both the President and the Vice-President, a regional think tank, the Instituto Centroamericano de Estudios Fiscales (ICEFI), immediately called for an overhaul of tax administration and managed to get support from both business associations and peasant groups. ICEFI offered a roadmap which eventually led to a new law being passed to strengthen transparency and accountability in the Superintendency of Tax Administration (Superintendencia de Administración Tributaria). In Kenya, a progressive new constitution gave Tax Justice Network Africa (TJNA), a regional African coalition, an opportunity to challenge a double taxation agreement that the government had signed with Mauritius, eventually getting the courts to nullify it. Although the government then negotiated another similar treaty, TJNA successfully established a precedent that civic actors have legal standing to challenge tax policy decisions, creating the potential for more scrutiny around future deals across Africa.
*Paolo de Renzio and Jason Lakin are senior research fellows with the International Budget Partnership. Vanessa van den Boogaard is a research fellow with the International Centre for Tax and Development.
In response to the economic consequences of the coronavirus, the Government of Kenya (like other governments) has pursued important tax changes that deliver useful benefits to small businesses and formal-sector workers with lower incomes, but also provide poorly justified tax cuts for large businesses and individuals with higher incomes.
At this time of crisis, government policies should be focused on the population that is least able to fend for itself, rather than on providing relief to the most fortunate citizens. Because governments in low- and middle-income countries have less scope for borrowing and face greater risk of currency depreciation, they must also be more cautious about revenue-reducing measures that further exacerbate likely collapses in tax collection due to the economic slowdown and an already tenuous fiscal position. Targeted policies that benefit the most vulnerable are not only equitable: they ensure that limited resources are used well while continuing to collect revenue from those that can afford to pay.
Kenya’s parliament has acted to promote equitable tax policies…
Parliament plays an important oversight role in examining government’s pandemic response, and it has been sensitive to equity concerns when reviewing tax policy proposals in the country. For example, Parliament’s actions included:
Rejecting a proposed VAT increase on agricultural inputs like fertilizer and animal feeds, arguing it was inequitable and damaging to food security. According to latest Census numbers, 52 percent of Kenya’s 12.1 million households engage in farming (most in crop farming), and therefore, an increase in VAT on farm inputs would affect most Kenyans.
Rejecting a proposal to move essential items such as vaccines, medicines and veterinary medicines from a zero-rated category to tax exempt. (In the case of VAT exemption, producers could not reclaim input VAT and would have likely passed the cost onto consumers, leading to an increase in the cost of medicine in the middle of a pandemic.)
Increasing the proposed threshold for small businesses to start paying turnover tax from Ksh 500,000 to Ksh 1 million, to benefit more of the most vulnerable businesses in the country.
…but some policies deserved more debate
Unfortunately, some of the government’s tax measures have received less scrutiny and were not as targeted as they could have been. The individual income tax exemption (known in Kenya as personal relief) was increased by 70 percent in 2020, from Ksh 16,896 to Ksh 28,800 per year (from roughly US$157 to US$267 at current depreciated rates).
On the surface, this is a progressive policy, as it means that those in the lowest tier of income taxpayers will benefit the most. But these benefits will accrue primarily to a relatively limited low-wage formal sector workforce. The majority of Kenyans do not pay income tax. According to the Economic Survey 2019, over 80 percent of employment in Kenya is in the informal sector. Only about 20 percent of the nation’s 17.8 million workers filed returns in 2018, and many of these were nil returns (they paid no tax).
More importantly, the cut in income tax rates also reduced the top marginal rate from 30 percent to 25 percent. The logic of this move is somewhat unclear. While Kenya’s marginal income tax rate bands are compressed, such that the top rate kicks in at Ksh 688,000, just below the average annual wage level of Ksh 778,000, those with the highest wages will still benefit the most from this relief measure. For example, in sectors such as energy or finance, the average annual wage is close to Ksh 2 million a year. Higher income workers in these sectors have most of their income taxed at the top rate, and thus benefit more when it is dropped. A financial worker with an average annual income of Ksh 1.95 million, will save Ksh 63,000 in tax in 2020, or about 3 percent of gross income, while a worker that earns the average salary will save just Ksh 4,500, or less than 1 percent of gross income.
The government might have considered modifying the compressed marginal rate structure in Kenya to make it more progressive. For instance, one possibility would be to raise the threshold for the top bracket, so that those with the highest incomes would still face a 30 percent top rate. Or it could have introduced a solidarity surcharge on high-income filers, as recommended by the IMF. Workers who suffer the most are those who lose their jobs and see a drop in their income; in a well-structured income tax system, a worker with declining income will face declining marginal rates automatically. To the extent this is not the case in Kenya, this is again a good motivation for reform.
More concerning is the government’s decrease in the corporate income tax rate from 30 to 25 percent. This is likely to benefit more established and wealthier companies, as well as wealthy citizens that have set up corporations to manage their wealth.
In addition to income tax, changes to business turnover tax deserve a second look
Another area that is not as progressive as it might initially appear concerns the turnover tax, where the government applied the same strategy as with income tax: a higher exemption, coupled with reduced rate at the top. A turnover tax on gross receipts is intended to facilitate tax payments for small companies that may find it challenging to file corporate income tax. The tradeoff with such taxes globally is that they charge a lower rate on revenue, as opposed to a higher rate on profits (which are more complex to calculate and document). Turnover tax is justified on the principle that it encourages gradual formalization of small and medium sized companies; it is intended as a kind of way station in scenarios of high informality and low administrative capacity in both the private and public sector.
Until the crisis, Kenya allowed small or medium-sized businesses with an annual turnover of less than Ksh 5 million (just under $50,000) to pay the turnover tax rather than filing corporate income tax. As part of the government’s COVID response, the threshold for turnover tax has been raised to Ksh 50 million, while those with turnover below Ksh 1 million are exempt (with the exemption increased by Parliament as noted above). The turnover tax rate was also reduced from 3 to 1 percent.
The higher exemption at the bottom seems reasonable and equitable: the vast majority of micro/small/medium enterprises in Kenya (those with less than 100 employees) had annual turnover of less than Ksh 1 million, according to a 2016 KNBS report. These companies are vulnerable to economic shocks, as they serve mainly individual consumers, and they provide a large share of Kenya’s total employment.
In contrast, the increase in the maximum threshold to Ksh 50 million directly undermines one of the goals of a turnover tax: it encourages companies who filed corporate income tax in 2019 with turnover between Ksh 5 and 50 million to revert to a presumptive tax. According to KNBS data from 2017, 40 percent of formal businesses in Kenya had turnover in this range. While the IMF recommends reducing taxes on small businesses during the crisis, it also recommends ensuring that larger business that can pay tax continue to do so. As with income tax, there is also an unfortunate result of the lack of bands: a company with turnover of Ksh 2 million pays the same rate of tax as a company with a turnover of Ksh 49 million. Once again, as with income tax, if a company’s turnover drops sharply, it will automatically pay less in tax. Companies that continue to maintain or increase their turnover should not necessarily receive tax relief.
How much revenue is at stake here? The Parliamentary Budget Office estimates that the reduction in income tax at the top will cost about Ksh 7 billion in 2019/20. The same report estimates a revenue loss for the reduction in turnover tax from 3 to 1 percent, but not for the increase in the threshold. A bigger revenue loss will come from the reduction in corporate income tax rate from 30 to 25 percent, which will cost Ksh 46 billion. While we lack full information about the cost of these measures, and indeed do not know how long they are likely to be in place, clearly reductions for wealthier income earners and larger businesses are an important source of revenue loss.
We have only examined a few areas of Kenya’s tax response to COVID-19 here, and a full assessment of the equity of the government’s response requires a comprehensive review of both revenue and spending policies, which is beyond the scope of this brief analysis. Nevertheless, our limited investigation raises important questions about the logic and equity of the government’s tax response. While we applaud useful exemptions at the bottom, these are coupled with reductions at the top that are less progressive and require further justification. Government might consider better targeted tax policies given limited resources.
This week over 170 policymakers, government officials, and members of academia, civil society, and international organisations will gather in Berlin to discuss the future of the Addis Tax Initiative (ATI). The overarching goal of the ATI is to improve domestic revenue mobilisation (DRM) in order to finance the Sustainable Development Goals (SDGs). More than 55 countries and regional and international organisations have joined the ATI, which commits donors to collectively double their assistance to DRM, developing countries to step up their tax collection efforts, and all members to ensure “policy coherence for development.” However, noticeably absent from the ATI’s progress monitoring is the issue of equity. Indeed, analysis by Oxfam finds that only 7% of DRM support reported by ATI donors in 2017 contained clear goals related to equity or fairness in revenue systems.
The importance of equity
If the primary goal of DRM projects and reforms is simply to collect more revenue, this can have negative consequences for development efforts. For example, revenue targets (like collecting 15% of GDP in tax) can create perverse incentives to collect wherever it is most feasible – which can harm those without political power such as the poor or women the most. Tax and transfer systems in low- and middle-income countries are, in general, far less effective than those in OECD countries at reducing poverty and inequality. In fact, research by the CEQ Institute shows that in 16 out of the 29 countries analysed, taxes and direct transfers to the poor actually increased income poverty. Of course, part of that pattern reflects the inadequacy of social spending, but it equally reflects the need for a greater focus on the equity implications of tax reforms.
Priority areas for increasing equity in DRM
Given that in low and middle-income countries taxes on consumption currently make up over 60% of revenues, there is a great deal of room for making tax systems more equitable at the national level. We suggest four priority areas for reform:
Strengthening taxation of income and wealth: OECD countries collect about 10% of GDP in personal income taxes, while non-OECD countries collect only slightly more than 2% of GDP on average. There is much developing countries can do to better tax professional incomes, increase the progressivity of income tax schedules, and tax inheritance and capital gains. When it comes to wealth, it remains largely undertaxed, despite a surge in ultra-high net worth individuals (especially in developing countries). An increasing amount of that wealth is being concentrated in real estate, yet property tax collection is similarly low. Non-OECD countries on average collect merely 0.5% of GDP from property taxes (compared to 2-3% in OECD countries). If low- and middle-income countries as a group could reach 1.5%, this would be equivalent to an additional $28.9 billion in government coffers annually: more than total combined aid disbursed by Canada, France, Netherlands, Norway, and Sweden in 2017.
Rationalising the use of tax incentives: Tax incentives to attract investment can play a legitimate role in economic policy. Unfortunately, studies suggest that tax incentives in developing countries frequently continue to be characterized by excessive discretion, poor monitoring, and little transparency. The result is reduced revenue and little new investment – in effect, a handout to corporations and wealthy interests. More transparent and accountable governance of tax incentives is needed.
Reducing the burden of consumption taxes and informal and nuisance taxes on the poor: While many assume that the poor do not pay much tax in low-income countries, they actually bear a heavy fiscal burden due to a wide array of consumption and informal taxes, small subnational taxes and levies, and formal and informal user fees to access essential services. In low- and middle-income countries, consumption taxes make a significant proportion of the poor poorer than they were before taxes and transfers. Unless the poor can be sufficiently compensated with transfers, exemptions for basic foodstuffs and other essential goods may thus be necessary. Studies from Sierra Leone and the DRC suggest that total formal and informal burdens of direct taxes, levies, and user fees make up as much as 10-20% of the incomes of poor households. Limiting these burdens should be given significantly greater priority.
Enhancing the participation of accountability stakeholders: Civil society organizations, academic institutions, women’s rights groups, and journalists have a critical role to play in monitoring and pressing for increased fairness in tax systems, voicing the concerns of the vulnerable, and advocating for the translation of tax revenues into public benefits. Nevertheless, in 2017, only 7% of DRM aid (reported to ATI) supported these actors.
Parallel action is also needed at the global level to make the ATI’s third commitment to “policy coherence” a reality:
Reforming the international tax system. While the BEPS Action Plan was a useful first step in trying to combat aggressive tax avoidance, it is not enough. Low-income countries continue to be disadvantaged by restrictive tax treaties and often still have little voice in global decisions that impact their taxing rights. All countries should be given the opportunity to raise their voice in the BEPS 2.0 negotiations, even if they are not members of the OECD Inclusive Framework – a situation that pertains to half of ATI partner countries. Meanwhile, existing international rules continue to be difficult to implement in lower-income countries, which are substantially more dependent on corporate tax revenues than OECD countries. A continued push for developing country taxing rights and priorities, including simplified approaches to enforcement, is needed.
Increasing cooperation on tackling offshore tax avoidance and evasion by wealthy individuals. It is estimated that Africans hold $500 billion in financial wealth alone offshore, which results in governments losing around $15 billion per year in unpaid taxes. Progress must be made to include developing countries effectively in automatic exchange of information processes and ensure effective collaboration in cases of tax evasion, while strengthening rules on beneficial ownership.
Continuing external support. In low-income countries, even the most substantial improvements in DRM will not generate enough revenue to finance adequate social protection and human development floors. External support such as aid will therefore remain critically important in pursuing equity at the global level.
In drawing that roadmap, we are calling on ATI members to focus more explicitly on equity and inclusion. Along with the priorities outlined above, we propose that members of the ATI:
Adopt specific indicators on revenue composition in monitoring progress on Commitment 2, in order to prioritize not only collecting more revenue, but from more progressive sources, like direct taxes on income and property, rather than indirect taxes on consumption.
Regularly assess, under Commitment 3, tax spillovers and the distributional impact of tax policy reforms. ATI donor countries should conduct tax spillover analyses to ensure that their own corporate tax rules and practices, and tax treaties, are not undermining their DRM support. ATI partner countries should conduct distributional impact assessments in order to ensure the drive for more revenue does not come at the expense of achieving the SDGs, particularly on inequality and poverty.
Make a collective commitment to increase tax transparency. All government ATI members should commit to transparency on data about tax collection, tax policy decisions, administrative practices, and the amount of revenue raised from each type of source. In addition, all ATI members should commit to encouraging and facilitating the engagement of accountability stakeholders, and to support the effective representation of developing countries in international policymaking forums.
Wilson Prichard, Research Director, International Centre for Tax and Development (ICTD) and Associate Professor of Global Affairs, University of Toronto
Nora Lustig, Samuel Z. Stone Professor of Latin American Economics and Director of Commitment to Equity (CEQ) Institute, Tulane University
Sanjeev Gupta, Senior Policy Fellow, Center for Global Development
Warren Krafchik, Executive Director, International Budget Partnership (IBP)
Ian Gary, Director, Power and Money, Oxfam
Brahima Coulibaly, Senior Fellow and Director of the Africa Growth Initiative, Brookings Institution
Also contributing to this piece: Rhiannon McCluskey (ICTD), Paolo de Renzio (IBP), Nathan Coplin (Oxfam), and Ludovico Feoli (CEQ)
Governments are engaged in a race to the bottom on corporate taxation. Tax rates are falling and tax incentives are multiplying. This is bad news when it comes to financing development. Citizens must demand transparency and accountability regarding tax incentives, and regional and global cooperation to set a floor under corporate tax rates.
The Sustainable Development Goals call for trillions of dollars of new investments in health care, education, agriculture, climate change adaptation, and more. Most of that funding is supposed to come from domestic resources. The corporate income tax represents a major source of domestic revenue for low-income countries – around 20% of their total government revenue.
Yet corporate tax rates are trending downwards. Last year the world’s largest economy, the United States, dramatically cut its rate from one of the highest (35%) to just below the average of rich countries (21%). The IMF estimates that U.S. tax reform will spill over onto other countries, cutting their revenue from multinational companies by up to 5% if they maintain their current policies, or by as much as 13% if they respond by decreasing their own tax rates in line with current trends.
In addition to lowering the rate for all companies, many countries shoot themselves in the foot by granting tax incentives to specific industries or individual companies. Incentives include tax holidays (i.e., temporary tax exemptions), special economic zones (i.e., tax-free geographic areas), or reduced tax rates. Governments are desperate for foreign investment and use such incentives to lure multinational companies into investing in their country instead of their neighbors.
Foreign investment is important. But study after study shows that tax incentives are not very effective at attracting it. This is particularly true for extractive industries, where investments are tied to the location of resources, as well as for services like telecoms or tourism, where investments are tied to where customers are. These sectors account for the lion’s share of foreign investment in low-income countries.
Business surveys confirm that taxes are low on companies’ criteria to choose investment locations. The vast majority – 93% in four low-income African countries – of investments that benefited from tax incentives would have been made without them anyway.
Developing countries’ governments forego billions of dollars to tax incentives, often several percentage points of their GDP. That means funding for poverty alleviation programs is cut. It also shifts the tax effort onto workers and consumers. Poor people are hit by a triple whammy.
Why on earth do governments continue to waste money on such corporate giveaways?
Governments uniformly proclaim that they have no choice but to grant corporate tax incentives and reduce rates because their neighbors have done it.
That is not good enough. Perhaps it is just a matter of time and education for the evidence to sink in? After all, the neoliberal ideology has prevailed for years and continues to be hammered in through competitiveness indices like the World Bank’s Doing Business Index or the Tax Foundation’s International Tax Competitiveness Index. Still, mainstream opinion has started shifting.
Tax incentives must be justified based on the national development strategy
Tax incentives must be transparent and quantified in the budget
Tax incentives must be based in law approved by parliament
Tax incentives must be subject to cost-benefit analyses
Tax incentives must be available on a level-playing field to all similar companies
National tax justice alliances have emerged to campaign on this agenda in many countries from Uganda to Pakistan. They need help. Any civil society organization that demands government spend more money on anything – from health care to agriculture – should join them, because there is not going to be more government spending without more government revenue. Tax justice alliances should work more closely with NGOs of different sectors to show the human cost of tax incentives and low corporate tax rates. Tax competition is a unifying theme that civil society could push during electoral campaigns. The global Fight Inequality Alliance has been successful at weaving links among groups, telling stories, and mobilizing the public on issues like taxation.
The debt crises that are looming over several countries offer another opportunity for change. Governments typically restore fiscal balance with “turn-key” reforms, like increasing the VAT rate or freezing civil servants’ salaries. Such measures hurt the poor and sometimes trigger large-scale protests. Tax justice alliances should be ready to seize such moments to demand the elimination or reduction of tax incentives for multinational corporations, which can in some cases be implemented quickly.
Emulating ICIJ’s work on tax avoidance, investigative research on emblematic cases of wasteful tax incentives would be helpful generate media attention. Regional scorecards ranking governments in terms of the transparency, governance, and design of their tax incentives could inform the debate as well.
Tax justice alliances could also create forums for dialogue with government officials and business leaders who accept they have a social responsibility regarding taxation. Such dialogue could help share knowledge and build consensus over the right approach to tax incentives.
Such forums should best be held at the regional level, where most tax competition takes place. Although tax is not near the top consideration to locate foreign investment, it is not completely irrelevant. That is especially true in manufacturing, which might explain why corporate tax rates have been falling faster in Asia than in other regions.
National tax justice coalitions should join forces to put tax competition on the agenda of regional institutions. Ultimately governments should gang up and set a floor under corporate tax rates and adopt a joint mechanism to monitor tax incentives.
Recent years have seen surging international interest in strengthening tax collection in order to finance national development programs. Yet, despite evidence of high and frequently rising inequality across much of the developing world, strengthening the equity of tax systems has usually been low on the agenda. This in part reflects a technical debate: if the ultimate goal is redistribution, is it best achieved through progressive taxation, or through effective and relatively neutral taxation paired with progressive public spending? It also reflects a technical and political constraint: building more progressive tax systems in developing countries is stubbornly difficult, owing to the combination of political resistance by national elites, technical complexity, and an international tax system poorly suited to the needs of developing countries.
Despite these debates and challenges there is a persuasive argument that civil society actors should place a significant advocacy focus on improving the overall equity of tax systems. This is true for technical, political, and strategic reasons. Technically, there is enormous scope for strengthening the progressivity of tax systems, and an urgent need. Politically, building popular trust in tax systems, and in broader state legitimacy, is likely to depend at least in part on being able to demonstrate that even the wealthy are paying their “fair share” – an important goal that also offers a way of “selling” this kind of reform to governments. Strategically, a focus on equity offers an entry point for civil society to build stronger ties to local communities in building grassroots power to push for equity, fairness, and accountability in taxation.
Inequity in Existing Tax Systems
Although we lack the data to precisely estimate patterns of tax incidence – and thus the overall progressivity of tax systems – in lower-income countries, the key message is clear: tax systems are dramatically less progressive than in Organisation for Economic Co-operation and Development (OECD) member countries. This reflects three broad features of tax systems in lower-income countries:
Taxes on high income individuals are frequently highly ineffective. In lower-income countries, personal income tax collection is generally only about a quarter of the levels achieved in OECD countries, while taxation of non-salary incomes – which are central to the incomes of the wealthiest – is particularly ineffective. Property taxes are also poorly collected, thus squandering the possibility of capturing and redistributing rapid increases in property values in many capital cities.
Direct tax burdens on low-income groups appear to be much larger than is suggested by official data. In most low-income countries the majority of citizens escape personal income taxation at the national level due to a combination of low incomes, weak administrative capacity, and informality. This can give the impression that the poor “don’t pay direct taxes.” However, the burdens on poor households may nonetheless be large due in part to subnational taxes, or by payments that often fall outside of government budgets but are necessary to access government services. Examples include formal and informal user fees (or reliance on private alternatives to unavailable public services), payments to state officials that do not reach the government budget (‘bribes’, ‘acceleration payments’, ‘revenue leakage’, etc.), and quasi-voluntary payments to community development associations, traditional authorities, religious institutions, and the like. These are increasingly collectively captured under the umbrella term “informal taxation,” with estimates in Sierra Leone and the DRC suggesting these payments may be as large as 10%-20% of the incomes of poor households.
The Value-Added tax (VAT) is the primary source of tax revenue but imposes a significant burden on low-income groups. In principle, the VAT can be a key part of progressive fiscal systems by raising revenue to support progressive public spending. However, a growing body of research suggests that VATs impose a significant and immediate burden on the incomes of poor households – and in many low-income countries this burden is not offset by effective transfer programs. VATs may thus increase “cash poverty,” while the overall quality of service provision for low-income groups remains questionable.
What are the right targets for reform?
Historically, much of the advocacy focused on increasing the equity of tax systems in developing countries has been centered on an anti-VAT platform. The argument is straightforward: the VAT is generally a more or less neutral, rather than progressive, tax, and represents a significant burden on the poor through the increased cost of the goods they consume.
Yet a focus on anti-VAT advocacy may be misplaced in most cases, for both conceptual and strategic reasons. Conceptually, the problem is not so much that the VAT is bad, but that other taxes might be better. And there is not yet any compelling evidence that strong VATs substantially discourage collection of more progressive taxes. Strategically, there seems no possibility of governments moving significantly away from the VAT, or even significantly reducing rates, given that it is generally the backbone of public revenues. As such, a simple anti-VAT stance may miss more important targets and spend resources on an objective with little chance of success.
A more appropriate focus may lie in targeting proactive strategies to make tax systems both more progressive and more productive. Some immediate possibilities:
Strengthen personal income taxes – and not only on wages. Personal income taxes are the most likely source of tax progressivity, and poor collection is the most glaring weakness of developing country tax systems. Plus there appear to be significant, and relatively simple, steps that many countries could take immediately to improve personal income tax collection given adequate political support, or political pressure.
Improve property taxation, emphasizing simplicity. Like personal income taxes, property taxes in developing countries are poorly collected but offer relatively straightforward pathways to reform where political support exists. Improving collections in this area can be critical to improving subnational service delivery, which is often particularly important to low-income groups.
Better VATs. While VATs will remain a key part of broader fiscal systems, there seems to be a strong case for seeking to avoid taxation of essential goods consumed by low-income households through careful zero rating.
Transparency around tax exemptions. The International Monetary Fund and others have long called for greater transparency around tax exemptions, which are frequently poorly targeted and amount to tax giveaways to large corporations and wealthy individuals.
Improved taxation of multinational corporations (MNCs). There remain important debates about the extent of potential revenue benefits, but there is little question that substantial revenues could be secured through relatively straightforward reforms and audits, particularly in the extractives sector.
Reduce opportunities and incentives for ‘informal taxation’. Curbing regressive informal taxation will require reducing both opportunities and incentives for more predatory and regressive payments through measures including simplification of local tax systems, improved funding of frontline service provision, and improved monitoring (by both government and civil society).
It is important to remember that the greatest opportunities for ensuring the overall progressivity of the fiscal system likely lies in improving the quality and progressivity of public spending. Here tax advocacy remains relevant: there is now growing evidence that debates about taxation can serve as a catalyzing tool for mobilizing public engagement in broader debates about budgets and public spending, organized around the message to taxpayers that public revenues are, in fact, “your money.”
The agriculture, forestry, plantation, and marine fisheries sectors provide livelihoods for a significant fraction of the Indonesian population, yet contribute less than one out of every ten dollars of revenue received by the provincial and the national governments. In many resource-rich regions, poverty rates are high and local residents receive little or no benefit from the exploitation of the country’s abundant natural wealth. Two Indonesian civil society organizations – Perkumpalan Inisiatif and Seknas FITRA – hypothesized that weak administration and corruption contributed to weak revenue collections and designed an ambitious research project to test this hypothesis and develop recommendations for improving revenue collections and resource management.
While both Inisiatif and FITRA brought a strong background in spending-side budget analysis to the table, this effort was the first by each organization to address the revenue side of public budgets. The basic analytic approach – review of public documents, budgets, laws, and data sources – largely drew on the same skills used in budget analysis. But the project differed from traditional budget analysis in its focus on potentially sensitive subject matter – corruption – and its reliance on key informant interviews. The focus on non-extractive natural resources also distinguished this project from prior efforts in Indonesia and in other resource-rich countries.
Project design and results
With support from the International Budget Partnership, project organizers developed a three-step plan designed to build the knowledge base and support needed for future advocacy efforts. The first phase of this project focused on four non-extractive natural resource sectors – forestry, agriculture, plantations, and marine fisheries – and involved:
Researching the policies and practices governing national and sub-national revenues in these sectors.
Mapping the actors involved in managing and advocating for better management of each of these sectors – including their capacity and the relationships among the various individuals and institutions.
Engaging a wide array of stakeholders to develop a common agenda for improving sectoral governance.
The project relied on extensive field work – “revenue sniffing” – conducted by members, staff, and leaders of the two organizations. The sniffing process deployed detailed interview protocols tailored for each sector, designed to identify evidence of tax evasion, permitting violations, or other forms of corruption and mismanagement. Field researchers interviewed a range of actors including government officials, workers, and others that might have knowledge of practices affecting revenue collections. The field interviews also sought to inform the development of recommendations for improving revenue collections and resource management. Perhaps more importantly, the revenue sniffing process was also key to the project’s advocacy strategy and was designed to prepare the field researchers to become leaders in subsequent advocacy activities.
Weak administration undermined revenue collections, opened the door to corruption
The problems identified by the research were largely consistent across the four focus sectors. Each of the sectors suffered from a general lack of transparency and accountability. Permit and licensing processes were complicated, which created opportunities for corruption and made it difficult for legitimate businesses to operate. Revenue administration was weak, leading to poor compliance and opening the door to corruption. Affected communities understood that they often did not benefit from the exploitation of natural resources, but lacked the knowledge on how to respond in a manner that could achieve results. The lack of comprehensive and consistent data contributed to inadequate oversight and poor compliance. Researchers concluded that improved governance would present a “win-win” opportunity for increasing revenues and improving the plight of local residents that depend on natural resources for their livelihoods.
Even for two experienced organizations to tackle together, this project was large and complicated. The scale, scope, and innovative focus of the project generated a number of “lessons learned.” Among the most important are:
The scope of the project. Researching four sectors in 11 Indonesian provinces simultaneously was challenging. In retrospect, the project organizers say they would have started with one or two sectors, rather than four. This would have enabled them to apply lessons learned in one sector to work on other sectors. Based on this experience, the next phase of the project was narrowed to two strategically important sectors – forestry and plantations – and only examined four provinces, providing a more manageable target.
The experience level of field researchers. The project model assumed that the field researchers, or assessors, would become leaders in future governance reform efforts. While the organizers remain committed to this model, making this work has proved to be more challenging than they had initially expected. A number of the assessors came from people’s organizations and had little background in budget analysis. The diversity of backgrounds – some assessors were college educated, others only graduated from secondary school; some were experienced budget activists, while others were just beginners – made it difficult to target training workshops at an appropriate level. Based on this experience, subsequent training sessions have been redesigned to provide additional background on budgets, the importance of citizen participation in the budget process, and on the potential for generating additional revenues from natural resource sectors. Participants in the most recent training were also chosen based on their background in a specific sector and past engagement around sectoral management issues.
The importance of local knowledge. The original project design relied on researchers drawn from the two national organizations. As the project progressed, it became clear that familiarity with the local context, the ability to fit in, and the knowledge of local dialects and languages would be critical to the project’s success. This affected the selection of assessors and also led to the selection of assessors with more limited experience in budget activism. Assessors also needed a degree of “street savvy.” The sensitive nature of the research – sniffing out possible corruption – generated suspicion. Assessors from local people’s movement organizations were generally better able to respond to potentially dangerous situations and were more adept at cultivating key informants than outsiders who were not from the area.
Evolution of the project design. The initial research design focused on the role of provincial governance and revenue collections. Through an initial test of the interview protocol, the project organizers discovered that local revenues and local regulations were more important and that the primary role of resource management at the provincial level was to aggregate data and the decisions made locally. In response to this discovery, the organizers restructured the research plan to collect local data in one or two districts within each province. The scope and focus of the project changed during the field research and as the researchers learned more about how things actually worked on the ground. The evolution of the project design underscores the need for flexibility and the importance of learning and adapting during a lengthy research project.
Some questions were too difficult to answer. The project’s initial research design was extremely ambitious. As the project progressed, researchers learned that some questions they’d hoped to resolve were beyond the scope of civil society to answer. Researchers repeatedly found, for example, conflicts in data that couldn’t be reconciled. They also discovered that one of the primary questions they’d set out to answer – how much revenue was lost due to “leakage” – was beyond their ability to accurately answer. They did learn, however, that they could identify evidence of potential corruption that they could report to state investigators for follow up.
Everything takes longer than you think. The initial project timeline proved overly ambitious. Nearly every step in the project – from the time needed to conduct an interview to the time needed to write a research report – took longer than expected. Delays in the early part of the project – such as the need to substantially revise the interview tool and provide additional training to field researchers – compounded as the project progressed and required a number of activities to be shortened – such as the time researchers spent in the field – and led to a delay in the production of final reports. In retrospect, the additional time led to improved results. The project leads note, for example, that the lessons learned during the test of the draft research tools enabled them to be more realistic with their assessment of what could be accomplished during a given period of field research.
For Inisiatif and FITRA, the project was largely a success. The two organizations’ history of collaboration established the trust needed to respond to unanticipated challenges. As problems or foreseen issues arose, the project team learned to “slow down a little, discuss, and learn.” Working together, they developed a compelling body of evidence documenting systematic problems that prevent the full realization of state revenues from four key sectors in the Indonesian economy, recommended solutions for improving revenue generation and governance, and engaged key stakeholders to increase awareness of the importance of these issues and help ensure that governments have the resources they need to support public services and develop policies that advance the well-being of citizens and communities.