Revenue Policy and Administration Public Finance and Management Course, World Bank, May 1, 2006 Richard M. Bird

Overview  Revenue-expenditure linkages Macro – MTFF, stabilization, elasticity Micro – decentralization, earmarking, charges  Questions considered Who pays? How? What difference does it make?

Sources of Revenue  Charges and fees  Earnings – SOEs, etc.  Regulatory taxes  Seignorage  Inflation tax  Borrowing  General taxation

An Example: User Charges  Should use them if you can  But few do, for good reasons and bad: publicness, excludability, externalities, supply conditions, policy objectives  If you do charge, it’s important to do it right  But this too is seldom done: it’s not all that easy

It’s Not Just Pricing – It’s Marketing  Know the product  Know the data  Adjust data as necessary  Set the prices  Justify any subsidy clearly  Think through how to implement it  Sell the scheme to both clients and suppliers

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

The Tax Burden Tax Revenue as a Percentage of GDP by GDP/Capita Category,

Tax Capacity (2001)

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

Tax Instruments: Differences by Region over Time

Tax Instruments: Regional Differences in Reliance Latin America: Percentage of Total Tax Revenue,

Tax Instruments: Regional Differences in Reliance Africa: Percentage of Total Tax Revenue,

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

Trends in Tax Reform  Increased reliance on VAT  Increased pressure to reduce trade taxes  Increased tax competition for foreign investment  Reduction in top tax rates under individual income tax system  Reduction in top tax rates under business profits tax  Flat taxes?

Predictions for Future  Tax design will be largely dictated by domestic considerations  But no tax system can now be designed without regard to tax systems of other countries  Globalization will increase challenges in taxing income from capital  Possibly ….regional cooperation may lead to increased harmonization of tax systems

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

Competing Government Objectives  What considerations exist in choosing among the different objectives?  The real and perceived role of taxes in Encouraging economic growth Reducing disparity between the rich and the poor Reducing poverty Sharing the cost of government fairly Favoring the ‘good’, discouraging the ‘bad’ – walk very carefully in these treacherous grounds

Criteria for Evaluating Taxes  Revenue productivity  Efficiency  Fairness  Administrative feasibility  As an available policy instrument – Yes, but…..

The cost of collecting taxes  Costs of taxation Excess burden of taxes Excess burden of tax evasion Tax administration costs Compliance - and avoidance - costs. Psychic and social costs?

Efficiency  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  “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  Tax bases should be as broad as possible  Tax rates should be as low as possible  Careful attention must be paid to taxes on production  BBLR vs. interventionist strategy?

Fairness  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  Tax incidence  Actual vs. perceived fairness

Costs of Redistribution through Taxation  Trade-off of equity and efficiency  Costs of higher tax rates depends in part on the elasticity of wage supply – and on that of capital  Capital flight – into gray or black economy or out of the country

Tax Policy and Tax Administration  Tax policy + no administration = 0  No policy + administration = ‘policy’  Tax policy + administration = real policy

Task of Tax Administration  How much administration? – setting the budget: Lessons from history and experience?  How to administer? – organization (RA, LTO, etc.) and strategy  How far to push it? – choices at the margin

What Have We Learned?  Know the environment – economic, legal, ‘social capital’,  Keep it simple  Taxpayers as “clients” – the marketing problem of self-assessed systems

Tax Administration Reform  The willto do it – A Champion  Strategy – IT is not the answer (but it is usually part of it)  Matching the Task to Resources  Tax Architecture, Tax Engineering, and Tax Management

Facilitating Compliance  Identification – finding taxpayers  Assessment – determining tax bases  Collection – getting the revenue  Service – too often forgotten but a critical investment

What are Compliance Costs?  Citizen’s costs of meeting tax obligations  Excludes actual taxes paid and excess burdens.  Includes avoidance (“tax planning”) and evasion costs.  Includes costs of taxpayers, non-filers, third parties (banks, tax withholders, helping others)

Administration costs versus CCs  Substitutes  Other things equal, social cost considerations should dictate the choice between compliance requirements and administration responsibilities EG: Official versus self-assessment  Other things may not be equal… Documents enclosed with tax returns Desk versus field audits, etc.

International evidence: Business income taxes

Keeping Taxpayers Honest  Know the problem – know your clients; estimate tax gaps  Monitor closely – registration, filing, payment, appeal  Enforce – penalties, dispute settlement

Controlling Corruption  Incentives – C=M +D – A: limit opportunities, raise opportunity costs (positive and negative)  Training – professionalism  Organization – performance evaluation, etc.  Monitoring – internal audit, etc.

Taxes and Decentralization  Increasingly important to focus on assigning taxing and spending authority to lower levels of government  Decentralization may improve government service by increasing accountability  Not a panacea, but a potentially important linkage fostering ‘trust’

Earmarking: Good, Bad, and Symbolic  Good when good user charges  OK when benefit linkage  Sometimes useful for ‘trust’ building  Bad when none of the above

Varieties of Earmarking

Earmarking in Korea

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

Tax Reform: The Key Questions  What is to be done?  How is it to be done?  Who is to do it?  When is it to be done?  What will happen as a result?

Lessons from Developed Countries  Need for a Champion  Both Wrapping and Contents of Package Matter  Visible benefits essential  Adequate discussion – virtues and limitations (from tax reform perspective) of democracy

Lessons from Developing Countries  Timing, timing, timing  Simplify – don’t “complify”  Sequencing and Scope  Clarity (versus the political advantages of keeping tax matters in ‘decent obscurity’)  Details matter  Incrementalism  Politics…always and everywhere  There is No Such Thing as a ‘Politician-Proof Policy’: but should there be?

An Example: 30 Years of Reform in Colombia  Gradualism  Duration  Education  Did it Matter? The Question of ‘Fiscal Equilibrium’

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