Monday, January 30, 2012

MDGs, taxes and where tax revenues come from...

As part of the build up to its 50th Anniversary, the OECD Development Centre has released a new report giving an updated estimate of the cost of meeting the MDGs. Entitled "Revisiting MDG Cost Estimates from a Domestic Resource Mobilisation Perspective" and financed by the Gates foundation, the report plays a valuable role in re-focusing minds towards the costs involved in meeting 6 of the MDGs by 2015, the target set back in 2000.

The paper also plays an important role by bringing a domestic resource mobilisation perspective. In these times of fiscal austerity and increasing attention on how developing countries can increase their own resources through taxation and savings, the report builds on the OECD’s own work on taxation in the 2010 Africa Economic Outlook to gauge the degree to which domestic resources might be used to fill the “financing gap”. By bringing the topics of MDGs and domestic resource mobilisation together,  the paper serves as a reminder that underlying many of the problems faced in developing countries is the need for strenger states and improved tax systems.

However, in bringing the two topics together, and despite the caveats given, it may oversimplify the  complexity of raising additional resources through taxation.    

A major element of the analysis of the scope for countries to cover MDG expenditures  domestic resources is based on an analysis of "tax effort". This measure comes from estimating the "average" tax performance across a group of countries, taking into account some of their characteristics such as income levels, the share of agriculture in the economy, and the level of trade. Countries with tax performance below what average performance would predict for them are considered to be capable of exerting more tax effort. Estimating tax effort therefore assumes that those are the only determinants that determine tax performance - that a country is gathering less or more than the average, based on the chosen country characteristics.

But tax performance also depends on a lot of other aspects. So can we really assume that the fact that some countries gather more revenue, even taking into account their income levels, means that other countries should be able to do so? For one thing, as the above brief explanation shows, the tax capacity predicted by the analysis will depend very much on the countries included in the analysis. Income per head may be correlated with a lot of characteristics that might affect tax performance, but other institutional and structural characteristics are also likely to be important so including EU countries, for example, may distort the prediction of what revenue levels are "feasible". Being resource rich also seems like a characteristic worth taking explicit account of in the analysis in this context, for example. Indeed, the 2010 African Economic Outlook report itself highlighted that a major part of the increase in domestic revenues across Africa has occurred in resource-rich countries. 

In addition to this, averages can be easily skewed by outliers. Countries such as Lesotho or Swaziland appear as having high tax effort, but in reality this is because (at least until recently) they receive a substantial part of their revenue through transfers from the SACU regional revenue sharing pool, largely financed by South Africa. So although they may be better placed to finance MDG-related expenditures, this is not necessarily related to tax effort or their taxation system. 

Although the estimation of the financing gap is explicitly recognised as a simplification, increased revenues are likely to be increased through increased economic growth. This is also overlooked by the study to some degree. To estimate the financing gap, the study estimates the additional resources required to achieve a growth rate that would  reduce poverty by 50 percent. This is then taken as the financial gap that must be filled to achieve this growth rate. But achieving the growth rate itself would imply economic activity, that itself generates tax revenues and potentially lowering the gap to be filled.

This highlights a borader point. The relation between taxation and the financing of the MDGs really needs to take account of where tax revenues actually come from and how they are collected. 

A gathering body of research, some of which was summarised in our recent Discussion Paper, highlights the institutional implications of tax policy and tax policy reform and their fundamental importance in determining how successful a country is in raising revenues. How the revenues are collected can then impact on growth through its influence on private sector behaviour. These are by no means simple issues to resolve. 

Further, on the specific question of how the MDG "gap" could be financed, increasing domestic resource mobilisation and increasing ODA are discussed as two substitutes. But as the (more critical) literature on the impacts of aid suggest, the institutional demands and implications of increased aid are very different to those of increased DRM. The timescales are clearly different too.

What this all highlights is the vital importance of paying more attention to the detail of how resources are and therefore can be raised. But of course, the analysis completely ignores the potential increased revenues form stemming capital flight. Only recently, Global Financial Integrity provided an updated estimate of capital flight in 2009, giving a figure of $600bn in 2009. Put in those terms, and given the estimated need for an additional $120m to meet the MDGs, maybe domestic resource mobilisation could do it after all....  

Nonetheless, highlighting the need for more resources to finance the MDGs is a good way to rally support and increase efforts in understanding the complex issue of raising domestic resources in developing countries.   

An edited version of this was posted at ECDPM's Talking Points here

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