Revenue Policy and Administration

Public Finance and Management Course, World Bank, May 1,

2006Richard 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?

Tax revenue (% of GDP)

0

5

10

15

20

25

30

35

40

45

50

0 5000 10000 15000 20000 25000 30000 35000 40000

Per capita GDP (PPP)

The Tax Burden

18.3%

22.5%

29.4%

23.2%

0%

5%

10%

15%

20%

25%

30%

35%

Low Middle High Total$0 - $4999 $5000 - $19999 $20000 +

Tax Revenue as a Percentage of GDP by GDP/Capita Category, 1999-2001

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

Total Individual CorporateSocial

Security TotalGeneral

Consumption ExcisesInternational

Trade

North America

1975-1980 61.0% 44.3% 15.9% 21.4% 11.7% 6.0% 5.1% 5.2%

1986-1992 57.3% 46.2% 10.5% 26.8% 12.4% 7.1% 4.6% 3.1%

1996-2002 82.4% 65.6% 15.7% 41.2% 14.7% 8.7% 5.1% 1.8%

Latin America

1975-1980 25.9% 8.8% 13.9% 21.3% 32.0% 13.6% 15.3% 21.2%

1986-1992 25.3% 7.0% 14.4% 18.6% 38.5% 17.0% 17.1% 17.5%

1996-2002 29.2% 5.9% 17.8% 24.9% 54.0% 32.6% 15.5% 12.8%

Western Europe

1975-1980 27.5% 21.4% 5.5% 30.8% 32.6% 18.4% 10.6% 4.3%

1986-1992 28.0% 21.3% 6.0% 31.2% 34.4% 21.6% 9.6% 2.1%

1996-2002 44.4% 30.8% 12.2% 50.1% 49.3% 29.8% 14.1% 0.3%

Asia

1975-1980 37.2% 22.0% 19.7% 0.1% 35.7% 13.7% 17.6% 23.1%

1986-1992 37.2% 19.7% 18.2% 0.4% 37.4% 16.4% 15.8% 20.1%

1996-2002 44.6% 23.0% 20.3% 3.7% 38.2% 18.6% 14.5% 12.3%

Africa

1975-1980 28.9% 13.2% 14.5% 6.5% 26.7% 16.6% 12.1% 34.4%

1986-1992 24.7% 13.2% 10.3% 5.9% 28.8% 16.5% 10.7% 36.7%

1996-2002 29.6% 17.1% 11.2% 6.2% 35.0% 21.1% 10.9% 32.0%

CEEME

1975-1980 -- -- -- -- -- -- -- --

1986-1992 34.9% 10.1% 23.1% 20.9% 30.6% 23.3% 6.1% 11.3%

1996-2002 29.0% 13.9% 14.8% 40.2% 52.1% 31.8% 14.3% 14.2%

Income Tax Domestic Goods and Services

Tax Instruments:Regional Differences in Reliance

Latin America: Percentage of Total Tax Revenue, 1975-2002

0%

10%

20%

30%

40%

50%

60%

1975-1980 1986-1992 1996-2002

IncomeDomestic ConsumptionInternational TradeSocial Security

Tax Instruments:Regional Differences in Reliance

Africa: Percentage of Total Tax Revenue, 1975-2002

0%

5%

10%

15%

20%

25%

30%

35%

40%

1975-1980 1986-1992 1996-2002

Income Domestic ConsumptionInternational Trade Social Security

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 will to 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 EarmarkingTable 1. Varieties of Earmarking

Variety Expenditure Linkage Rationale Example

A Specific Tight Benefit Public enterprise

B Specific Loose Benefit Gasoline tax and road finance

C Broad Tight Benefit Social security

D Broad Loose Benefit Tobacco tax and health finance

E Specific Tight None Environmental taxes and clean-up programs

F Specific Loose None Payroll tax and health finance

G Broad Tight None Revenue sharing to localities

H Broad Loose None Lottery revenues to health

Earmarking in KoreaTable 9. Characteristics of Earmarking in Korea

Tax Expenditure Linkage Rationale

Transportation tax Loose Mixed (85.8%) Specific (Road, railroad, port, etc.) (14.2%) Specific (Environment, from 2005)

Rural development tax Broad (Variety of uses) Tight? None

Education taxes Specific (Education) Loose None

Liquor tax Broad (Local expenditure) Loose None

Tobacco tax (45%) Specific (Education) Loose None

Special excise tax on automobiles Loose Mixed (72%) Specific (Road) (28%) Broad (Local expenditure)

Internal taxes Loose None (15%) Broad (Local expenditure) (13%) Specific (Education)

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’