Introduction to Tax Policy Design and Development Richard M. Bird and Arindam Das-Gupta March 2004

Course Objective n How can developing countries best design and develop their tax systems? –Given political objectives –Given economic and political constraints –Given tax administration capabilities

Key Questions n How do tax systems differ across countries? n What can, or should, taxes do? n What criteria are useful in thinking about the design and operation of tax systems? n What constraints may limit the tax policy options available in a particular country?

Discussion in Context n This Module serves as a general introduction to much of the material covered this week. n No magic blueprint; no system or structure that makes sense for all countries n Taxes just one tool available to governments. It is important to consider other government programs, especially, government expenditure programs, in designing and evaluating government activity.

Comparison of Tax Systems n Types of taxes n Tax levels (overall tax burden) n Tax structure n Developed vs. developing countries n Recent trends n Predictions for future

Different Types of Taxes n Taxes on consumption –Turnover, VAT, excise, import duties and export taxes n Taxes on labor income –Wage taxes and social security taxes n Taxes on business and investment income n Wealth and inheritance taxes n Property and land taxes

Aggregate level of taxes n Differences between developed countries (38% of GDP) and developing countries (18% of GDP) n Relationship between tax level and per capita income n Estimates of tax capacity –Hypothetical tax to GDP ratio –VAT productivity

Relative Use of Different Tax Instruments... n Factors influencing relative mix of different tax instruments –Revenue considerations –Administrative considerations –Fairness considerations –Transition and political considerations

…and Non-Tax Instruments n Includes royalties, user charges, sale of goods and services, fees, penalties n Relatively neglected (  15% except oil producers and Singapore: 40%) n Great potential n Potentially fairer than broad based taxes

Differences Between Developed and Developing Countries n Relative use of trade taxes n Relative use of income and consumption taxes n Relative proportion of income taxes between individual and corporate income taxes

Tax-GSDP ratios and Per Capita GSDP: c: 2001

Taxes as a % of Current Revenue by Region

Revenue Structures in SAR and EAP Countries

What explains differences? n Different demands and tastes for government services n Different capacities to tax –Level of economic development –Size of informal economy n Different abilities to impose and collect taxes n Other revenue sources

Trends in Tax Reform n Increased reliance on VAT n Increased pressure to reduce trade taxes n Increased tax competition for foreign direct and portfolio investment n Reduction in top tax rates under individual income tax system n Reduction in top tax rates under business profits tax

What Can Taxes Do? n Raise revenue to fund government operations n Assist in redistribution of wealth or income n Encourage or discourage certain activities n At a cost in terms of efficiency and growth

Competing Government Objectives n What considerations exist in choosing among the different objectives? n The role of taxes in –Encouraging economic growth –Reducing disparity between the rich and the poor –Reducing poverty

Criteria for Evaluating Taxes n Revenue productivity n Efficiency n Fairness n Administrative feasibility

Raise Revenue n Match budgeted expenditures with estimates of likely revenue receipts n Income tax elasticity –Growth of tax revenues relative to growth in the economy n Effect on tax revenue from economic recessions and expansions –Total tax revenues –Revenues from specific tax instruments

Efficiency n Taxes influence behavior –Work vs. leisure –Save vs. spend –Choice of products –Operate in formal economy vs. operate in informal economy –Choice of location for investment n Reduce “deadweight” or “distortion” costs –Almost all taxes distort –Costs are real costs—especially for economies where resources are scarce –Focus on minimizing tax costs

Minimize Deadweight Costs of Taxation n Tax bases should be as broad as possible n Tax rates should be as low as possible n Careful attention must be paid to taxes on production

Fairness n Different ways to think about fairness –Horizontal and vertical equity –Focus on single tax provision, single tax, or tax system as a whole –Focus on government activity as a whole n Tax incidence n Actual vs. perceived fairness

Tax Incidence n Distinguish between who has liability to pay tax and who suffers the economic burden of taxation n People pay taxes—in role of consumer, producer or factor supplier n Tax incidence depends on market conditions (ability to shift taxes to others) n Economic conditions vary among countries—hard to predict tax incidence, especially in developing countries

Administrative Feasibility n Cost of collection n Cost of compliance –To taxpayers –To third-parties n Cost of enforcement n Designing rules and regulations n Challenges to tax administration

How To Choose Among Competing Criteria? n What factors to consider in choosing among the different criteria? n Why do countries make different choices among each other and over time?

Taxation and Growth n Does economic growth mean greater inequality? n Is there a relationship between level of tax rates and rates of economic growth? n Bad tax systems can stifle economic growth; unclear whether good tax systems can substantially increase economic growth

Taxes and Decentralization n Increasingly important to focus on assigning taxing and spending authority to lower levels of government n Notion that decentralization may improve government service by increasing accountability

India: Centre vs state revenues vs

Tax Decentralization n Ownership of tax revenues n Choice of tax base n Choice of tax rate n Responsibility and coordination of tax administration

Taxes and Globalization n Increased pressure to reduce trade taxes n Increased pressure on corporate tax revenue –Tax competition –Intra-company trade increases opportunity for tax evasion n Increased pressure on individual tax revenues –Easier to work or invest outside of country of residence n Increased pressure on VAT revenue –Services and intangibles larger part of value- added –Digitized products

Predictions for Future n Tax design will still be largely dictated by domestic considerations n However, increased cross-border activity means tax system can no longer be designed without regard to tax systems of other countries n Globalization will increase challenges in taxing income from capital n Regional cooperation may lead to increased harmonization of tax systems

Conclusion n ‘To tax and be loved is not possible’ n ‘‘Taxes are the price we pay for civilized society’ n Above all, do no harm – or at least as little as possible’