CESifo Seminar Series edited by Hans-Werner Sinn Economics and Psychology: A Promising New Field Bruno S. Frey and Alois Stutzer, editors Institutions and Norms in Economic Development Mark Gradstein and Kai A. Konrad, editors Pension Strategies in Europe and the United States Robert Fenge, Georges de Ménil, and Pierre Pestieau, editors Foreign Direct Investment and the Multinational Enterprise Steven Brakman and Harry Garretsen, editors Sustainability of Public Debt Reinhard Neck and Jan-Egbert Sturm, editors The Design of Climate Policy Roger Guesnerie and Henry Tulkens, editors Poverty, Inequality, and Policy in Latin America Stephan Klasen and Felicitas Nowak-Lehmann, editors Guns and Butter: The Economic Laws and Consequences of Conflict Gregory D. Hess, editor Institutional Microeconomics of Development Timothy Besley and Rajshri Jayaraman, editors
Dimensions of Competitiveness Paul DeGrauwe, editor Reforming Rules and Regulations Vivek Ghosal, editor Fertility and Public Policy Noriyuki Takayama and Martin Werding, editors Perspectives on the Performance of the Continental Economies Edmund S. Phelps and Hans-Werner Sinn, editors Industrial Policy for National Champions Oliver Falck, Christian Gollier, and Ludger Woessmann, editors Illicit Trade and the Global Economy Cláudia Costa Storti and Paul De Grauwe, editors The Continuing Evolution of Europe Thiess Buettner and Wolfgang Ochel, editors The Evolving Role of China in the Global Economy Yin-Wong Cheung and Jakob de Haan, editors Critical Issues in Taxation and Development Clemens Fuest and George R. Zodrow, editors
A list of the entire series is available at http://mitpress.mit.edu.
Critical Issues in Taxation and Development
edited by Clemens Fuest and George R. Zodrow
The MIT Press Cambridge, Massachusetts London, England
Includes bibliographical references and index. ISBN 978-0-262-01897-5 (hbk. : alk. paper) 1. Taxation—Developing countries. 2. Tax evasion—Developing countries. 3. Economic development—Developing countries. I. Fuest, Clemens, 1968– II. Zodrow, George R. HJ2319.C75 2013 336.200912'4—dc23 2012036427 10
Introduction 3 Clemens Fuest and George R. Zodrow
Taxation and Development—Again Michael Keen
Do Companies View Bribes as a Tax? Evidence on the Tradeoff between Corporate Taxes and Corruption in the Location of FDI 45 Timothy Goodspeed, Jorge Martinez-Vazquez, and Li Zhang
Do Corruption and Taxation Affect Corporate Investment in Developing Countries? 65 Clemens Fuest, Giorgia Maffini, and Nadine Riedel
Investment Treaties and Hydrocarbon Taxation in Developing Countries 83 Johannes Stroebel and Arthur van Benthem
The Effect of a Low Corporate Tax Rate on Payroll Tax Evasion 109 Boryana Madzharova
International Profit Shifting and Multinational Firms in Developing Countries 145 Clemens Fuest, Shafik Hebous, and Nadine Riedel
Too Low to Be True: The Use of Minimum Thresholds to Fight Tax Evasion 167 Mirco Tonin
Fiscal Federalism and Foreign Transfers: Does Interjurisdictional Competition Increase the Effectiveness of Foreign Aid? 189 Christian Lessmann and Gunther Markwardt
Taxation and Democracy in Developing Countries 217 Paola Profeta, Riccardo Puglisi, and Simona Scabrosetti List of Contributors Index 241
The CESifo Seminar Series aims to cover topical policy issues in economics from a largely European perspective. The books in the series are products of papers and intensive debates that took place during the seminars hosted by CESifo, an international research network of renowned economists organized jointly by the Center for Economic Studies at the Ludwig-Maximilians-Universität and the Ifo Institute for Economic Research. The publications in this series have been carefully selected and refereed by members of the CESifo research network.
Introduction Clemens Fuest and George R. Zodrow
The ability of governments to raise taxes in order to finance public goods is essential to achieving economic development and growth. Many developing countries find it very difficult to raise the revenue required to provide basic public services such as infrastructure or schools. Improving the revenue-raising capacity of the public sector without crippling the growth prospects of a developing economy is a difficult policy challenge. Moreover, many of the central themes of ongoing debates regarding tax reform in developing countries—such as the mix of direct and indirect taxation and the details of the tax rates and tax base under the income tax—are less important in a developing country, where issues such as dealing with widespread corruption, erosion of the tax base due to evasion and avoidance (including the pervasive phenomenon of income shifting by multinational corporations), the importance of resource taxes (and their variability due to often dramatic fluctuations in the prices of resources), and ineffective political structures dominate discussions of tax reform. This volume brings together nine studies in which leading researchers in the field investigate various aspects of the challenge of effectively raising tax revenue in developing countries, focusing on specific issues that are highly relevant to reforms of their tax structures. Earlier versions of these studies were presented and discussed at the conference on Taxation in Developing Countries held during the CESifo Venice Summer Institute at the Venice International University in July of 2010. In particular, this book takes a unique approach to the difficult issue of raising revenue in developing countries. The approach falls somewhere between an overarching treatment of virtually all tax issues facing developing countries and all types of taxes (as in Bird and Oldman 1990 or Alm, Martinez-Vazquez, and Rider 2006) and the treatments found in volumes that are either tax-specific (e.g., Bird and
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Gendron 2007; Ebrill, Keen, Bodin, and Summers 2001; Daniel, Keen, and McPherson 2010) or country-specific (e.g., Thirsk 1997; Gordon 2010). Instead, apart from Michael Keen’s comprehensive and insightful overview of current issues in taxation and development in chapter 2, each chapter in this book focuses on one fairly narrowly defined issue that is a critical element of a complete understanding of the effects of taxes on development, and uses modern empirical methods to comprehensively address that issue. A wide variety of topics are covered in this context, including various ways in which business taxation affects development; corruption, tax evasion, and tax avoidance; and how political structure bears on the effectiveness of aid and on the nature of the tax systems in developing countries. Emphasis is also placed on issues that have received relatively little attention in the literature, rather than on often-examined topics such as value-added taxes and personal income taxes (see the references cited above) or consumption-based direct tax reforms (see, e.g., Zodrow and McLure 1991). Most of the chapters investigate empirical regularities across developing countries, although a few utilize a country-study approach. In our view, these highly focused and carefully executed studies provide a wealth of information that will be useful to experts in the academic and development communities, including the staffs of the various multilateral development organizations, policy makers in both developed and the developing countries, and indeed anyone with an interest in economic development. The chapters are grouped in four parts. Part I, which gives an overview of the issues, includes this introduction and chapter 2, in which Michael Keen observes that interest in taxation and domestic resource mobilization in developing countries has waxed and waned over the years and now appears to be resurgent. Keen focuses on four issues that arise in evaluating the practical advice that developing countries are commonly given on tax matters, with the general theme that oversimplification should be avoided in dealing with issues involving taxation and development. The first issue is the importance of differences across developing countries and between them and the developed countries. Keen notes that geographical characteristics, especially the presence of natural resources, colonial histories, and political structures, vary considerably across developing countries. Nevertheless, Keen argues, many general guiding tax principles are still applicable in the developing countries, and we should not assume that broad commonalities of tax design and advice are necessarily inappropriate.
Second, Keen notes that the record of success of many “big ideas” that were originally seen as potentially critical to sustained improvement of performance—including direct taxes, the value-added tax, quasiindependent revenue agencies, and large taxpayer offices—is mixed, with the VAT the most successful innovation. He emphasizes that focusing on grand innovations risks distracting from less dramatic but important reforms that might yield significant progress. Third, Keen observes that, although it is well known that informal or “hard-to-tax” sectors are prevalent in developing countries, it is necessary to consider more precisely how their existence affects tax design and implementation. Finally, Keen addresses the topical issue of the relationship between taxation and state building. He notes the need for greater transparency in linking revenues and expenditures (raising the controversial issues of whether there should be a greater role for earmarked taxes) and the importance of the tax treatment of small and micro enterprises. Keen’s conclusions emphasize the potential for microdatabased analyses (of which this volume provides several examples) to transform tax analysis for developing countries as it already has for advanced countries. The chapters in part II focus on the role of business taxation and other economic variables in investment in the developing countries. They emphasize that factors such as corruption and the possibility of government expropriation of private resources play a larger role in determining the interaction between taxes and investment in the developing countries than in more developed countries. In chapter 3, Timothy Goodspeed, Jorge Martinez-Vazquez, and Li Zhang note that, in contrast with the literature on taxes and investment in the developed countries, the results of existing studies are mixed as to whether high corporate taxes in host countries deter foreign direct investment (FDI) in developing countries. Goodspeed et al. investigate one possible reason for this difference: the presence of a tradeoff between taxes and good governance. Their empirical analysis indicates that the effect of taxes on FDI is lessened when corruption is present. They suggest that this is because taxes and corruption in the form of bribery to tax officials are substitutes, so that the presence of corruption should be expected to weaken the importance of formal taxation in determining the location of FDI. Moreover, corruption is more likely in a high-tax environment, as it is a response to the desire of multinationals to avoid excessive taxation. Since corruption tends to be more prevalent and tax administration weaker in developing
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countries, this helps explain why in general corporate taxes are less relevant in explaining FDI location in the developing countries. Goodspeed et al. conclude by noting that, from the viewpoint of political economy, their results may help explain why the tax codes of many developing countries are still characterized by high statutory corporate tax rates: high rates may protect the interests of corrupt tax officials by allowing them to solicit bribes from foreign and domestic investors. The interaction between corruption and corporate taxation in determining the level of business investment in developing countries is also investigated in chapter 4, in which Clemens Fuest, Nadine Riedel, and Giorgia Maffini investigate the effects of corruption and corporate taxation on business investment. Their starting point is the debate about how corruption affects economic development. While international development organizations and most governments undertake considerable efforts to limit corrupt practices, views on the economic effects of corruption are divided. Clearly, corruption can be bad for economic development because it undermines state capacity, creates uncertainty and may be accompanied by extortion of firms and consumers. However, corruption may also have other effects. According to the “corruption as grease” hypothesis, corruption may facilitate economic activity by allowing entrepreneurs and other economic agents to circumvent inefficient regulations and taxes. Using panel data for firms in 16 developing countries, Fuest et al. investigate how public-sector corruption and corporate taxation affect the capital stock of firms operating in these countries. Most of the specifications in chapter 4 suggest that corruption is linked to a lower capital stock. In the same direction, a high corporate tax burden tends to exert a negative effect on firms’ total assets. The findings thus support the view that high taxes may deter investment. At the same time, they cast some doubt on the “corruption as grease” hypothesis. Fuest et al. also investigate whether the effects of corruption and taxation on multinational firms differ from the effects on purely national firms. They find that the negative effect of corruption on investment is larger for multinational firms but that the reaction to taxes is not significantly different. This result suggests that corruption is a burden on economic activity and that multinational firms, possibly because of their higher mobility, find it easier to reduce the exposure of their assets to corrupt environments or to avoid doing business in corrupt countries. Another possible interpretation is that smaller, national
firms have adapted or learned to deal with corruption while multinational firms have done so to a lesser degree. In any case, the results of chapter 4 are compatible with the findings of chapter 3, according to which good governance seems to be a major factor in attracting international investment. A different angle on business taxation and economic development is taken in chapter 5, in which Johannes Stroebel and Arthur van Benthem focus on the problem of resource taxation applied to independent oil companies (IOCs)—something that is crucially important for many developing countries. Specifically, Stroebel and van Benthem examine how bilateral and multilateral investment treaties affect the structure of tax contracts between resource-rich host countries and IOCs. Resource-rich countries typically derive a large fraction of their revenues from resource taxes, and need to insulate their revenue flows from the severe price fluctuations that often characterize resource markets. They can obtain such price insurance by using tax structures that shift price risk to IOCs, taxing a larger share of IOC revenues when resource prices are low and a smaller share when prices are high. However, because political pressures to enact windfall-profit taxes or to expropriate resources are high in the latter case, it is difficult for governments to credibly commit to such tax structures. Stroebel and van Benthem emphasize that bilateral and multilateral treaties can increase the avenues of recourse available to foreign investors in the case of a breach of contract by host governments; they can thus significantly increase the cost of expropriation, and enhance the ability of developing countries to make credible commitments to avoid windfall profits taxes and expropriation. They first construct a theoretical tax contract model and show that the amount of price insurance in such contracts increases with the cost of expropriation to the host country. They then use an extensive data set on the fiscal terms of 2,466 tax contracts with resource firms in 38 countries to analyze the degree of price risk borne by the government through the tax structure. They show that the presence of bilateral and multilateral investment treaties is associated with tax contracts that allow host countries to shift more price risk to foreign investors. Part III includes three studies of corruption, tax avoidance, and tax evasion, issues that again are more important in most developing and emerging economies than in the more developed countries. The chapters in this part examine particular avenues for corruption, evasion, and avoidance that are specific to developing countries. It is a
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commonly held view that the widespread policy of cutting the corporate income tax has a positive effect on taxable income through decreasing firms’ incentive to hide profits. A neglected side of this policy, however, is its potential to trigger more evasion in another tax base, namely the social security base, especially if the corporate income tax is very low relative to the contribution rate. In chapter 6, Boryana Madzharova develops a model in which employers and employees cooperate in declaring lower wages to the tax authorities in order to evade payroll contributions. Since wages and payroll taxes are deductible expenses, a lower reported wage translates into higher corporate profits on paper and, hence, a shifting of tax liability out of the social security tax base into the corporate tax base. Using firm-level panel data for Bulgaria, where the problem of contribution evasion is especially severe, Madzharova finds that a 10 percent increase in the difference between the payroll rate and the corporate income tax will translate into a 0.86 percent decrease in reported wages and a 0.6 percent rise in reported taxable income. The reported wage bill of big taxpayers appears to be more responsive to changes in the difference between the payroll and the corporate income tax rates, but these firms do not tend to overpay corporate profit taxes stemming from payroll evasion. These results suggest that while wages paid by smaller taxable income firms are less sensitive to the tax gap, it is small businesses who mostly shift income between the bases. In chapter 7, Clemens Fuest, Nadine Riedel, and Shafik Hebous turn to corporate income tax avoidance by large firms—an issue that is common to both developing and developed countries but is especially problematic in the former because of their limited administrative capabilities. The analysis uses microdata on German multinational firms and their subsidiaries and branches in industrialized and developing countries. These data include information on intra-company loans— that is, loans between different entities of the same multinational group, as opposed to loans from third parties such as banks. Intra-company loans are particularly suited for tax avoidance because, owing to the deductibility of interest payments, these loans allow multinational firms to shift profits from high-tax countries to low-tax countries. Fuest et al. find a positive and significant relationship between the host country’s tax rate and the level of intra-firm debt financing. This is in line with the hypothesis that firms use intra-group loans to reduce their tax burden. This effect is stronger in developing countries, suggesting that developing countries are more vulnerable to profit shifting than devel-
oped countries. Fuest et al. also investigate whether firms with affiliates in tax havens react more sensitively to tax differences than firms with no links to tax havens. Perhaps surprisingly, the data do not support this hypothesis. Overall, chapter 7 is consistent with the view that developing countries face greater difficulties than developed countries in dealing with sophisticated tax planning strategies of multinational firms. In chapter 8, Mirko Tonin focuses on the role of the administrative instrument of minimum thresholds for fighting the tax evasion and tax avoidance that are the topics of the previous two chapters. Such “presumptive” rules for taxation are common in developing countries that are administratively unable to effectively enforce taxes on business and personal income. Tonin looks at minimum thresholds that prevent taxpayers from declaring an income below a certain amount or, alternatively, make them subject to a higher probability of an audit if they decide to do so. First, he models the effect of minimum thresholds by explicitly taking into account low administrative capacity. The model shows that introducing a threshold creates a spike and a “missing middle” in the distribution of declared incomes and highlights under which conditions a threshold is likely to increase net revenues. Tonin then analyzes two policies used to fight underreporting: the Italian “Business Sector Analysis” and the Bulgarian “Minimum Social Insurance Thresholds.” The Italian tax authority infers “normal” revenues and compensations by small and medium enterprises, self-employed individuals, and professionals from indicators that are difficult to conceal or manipulate. If the taxpayer decides to declare less than the “normal” level, the probability of an audit increases and the burden of proof is reversed. Bulgaria has established a system of differentiated minimum social insurance thresholds depending on sector and profession, which put differing floors under social security contributions. In conclusion, Tonin appraises the applicability of these two systems in other countries. The chapters in part IV address issues related to political structure and economic development. In chapter 9, Christian Lessmann and Günther Markwardt examine the importance of the extent of fiscal decentralization and interjurisdictional tax competition for the effectiveness of development aid. Using measures of expenditure decentralization and tax decentralization, they analyze a panel data set that includes 41 developing countries to investigate how decentralization and interjurisdictional competition affect effectiveness of aid. The
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analysis shows that the degree of expenditure decentralization has a negative effect on foreign aid’s effectiveness. Aid may contribute to economic growth in centralized countries, but it significantly harms growth in decentralized ones. Interjurisdictional competition, as reflected by the degree of tax-revenue decentralization, has a negative effect on foreign aid effectiveness in general. Lessmann and Markwardt’s study has important implications for the design of anti-poverty programs. Since decentralization and interjurisdictional competition undermine foreign aid’s effectiveness, they conclude that aid should be allocated to more centralized countries. At least, development aid to decentralized countries should take into account the limited effectiveness of aid observed in the past and develop strategies to improve the outcomes. Finally, in chapter 10, Paola Profeta, Ricardo Puglisi, and Simona Scabrosetti consider the relationship between political structure and the nature of taxation in developing countries. Their empirical analysis focuses on the relationship between democracy and taxation in three areas of the world—Asia, Latin America, and the new members of the European Union—that have recently experienced democratic as well as economic transitions. Profeta et al. focus on two aspects of democratic political regimes that may be present to different degrees and may play independent roles in determining the level and the composition of taxation: existence of democratic institutions and guarantees of civil liberties. To examine these issues empirically, Profeta et al. construct a new data set of fiscal, socio-economic, and political variables for 39 low-income developing countries over the period 1990–2005. They find some correlations between political variables and tax factors when using standard cross-country pooled ordinary least-squares regressions with region fixed effects. However, once they control for country fixed effects, tax revenues and tax composition in general are not significantly correlated with indices of the strength of democratic institutions and of the protection of civil liberties. The only exceptions are (1) a positive and significant relationship between the democracy index and the share of trade taxes and (2) a negative correlation between protection of civil liberties and property taxation. Profeta et al. provide some plausible explanations for these two results, but note that the links between democracy and the level and composition of taxation are complex phenomena that require careful investigation. They conclude by suggesting that further research is needed to determine through what channels political institutions affect economic outcomes.
Recent years have seen increasing interest in the need to improve economic conditions in developing countries. Although the problems of developing countries are multi-faceted, the existence of an effective revenue system to finance the provision of essential public services is essential to fostering development. The studies presented in this volume examine numerous issues in taxation and development from a wide variety of theoretical, applied, and empirical perspectives. Together they provide a wealth of knowledge on how tax policies should be reformed to foster economic development and thus help solve one of the most critical issues of our time. References Alm, James, Jorge Martinez-Vazquez, and Mark Rider. 2006. The Challenges of Tax Reform in a Global Economy. Springer. Bird, Richard M., and Pierre-Pascal Gendron. 2007. The VAT in Developing and Transitional Countries. Cambridge University Press. Bird, Richard M., and Oliver Oldman. 1990. Taxation in Developing Countries. Johns Hopkins University Press. Daniel, Philip, Michael Keen, and Charles McPherson, eds. 2010. The Taxation of Petroleum and Minerals. Routledge. Ebrill, Liam, Michael Keen, Jean-Paul Bodin, and Victoria Summers. 2001. The Modern VAT. International Monetary Fund. Gordon, Roger H. 2010. Taxation in Developing Countries: Six Case Studies and Policy Implications. Columbia University Press. Thirsk, Wayne. 1997. Tax Reform in Developing Countries. World Bank. Zodrow, George R., and Charles E. McLure Jr. 1991. Implementing direct consumption taxes in developing countries. Tax Law Review 46 (4): 405–487.
Taxation and Development—Again Michael Keen
Interest in issues of taxation and development comes and goes. This is true of policy makers (in developing countries and, especially, in donor countries) and among civil society and academics (with, it has to be said, a historically low level among the last of these). Now we are entering an “up” phase of interest, not least from the donor community. At their November 2010 summit, for instance, the G-20 leaders emphasized the importance of strengthening revenue mobilization in developing countries and asked involved organizations to report on how best they could help.1 The explanation is perhaps not hard to find. Many developing countries need substantial additional revenue to finance poverty reduction—an additional 4 percent of GDP2 or so is needed in many low-income countries if they are to have a good chance of meeting the UN’s Millennium Development Goals—as well as pressing needs for infrastructure and adaptation to climate change.3 At the same time, the dire post-crisis fiscal position of many advanced economies is naturally focusing attention on the extent and effectiveness of the aid they provide to developing countries, and on ensuring that it supports rather than discourages the latter ’s own revenue-raising efforts. Hence the renewed focus on, in the jargon, “domestic resource mobilization.” This welcome resurgence of interest makes it timely to take stock of experience and lessons in the area, and to assess newer challenges to resource mobilization in developing countries, such as those from globalization. But that is not the purpose here; this chapter does not aim to provide a sweeping review of technical issues, largely because there is no shortage of surveys and there are quite a few books on resource mobilization and development.4 Nor is the aim to identify important areas for research or methodological improvement, though there will be some of that. (This volume itself is evidence of the importance and
value of strengthening empirical work in the area.) Instead the purpose of this essay is to reflect, no doubt idiosyncratically, on some wider issues in the practical advice that developing countries are commonly given on tax matters. The theme, perhaps, is to caution against the over-simplification (at best) to which this area has been, and remains, prone. Four topics are selected for discussion (perhaps more accurately, a bit of a rant), each with a view to informing the renewed focus on resource mobilization issues—or at least avoiding past mistakes. 1
Developing Countries Differ—Yes, and . . . ?
The literature in this area is rich in papers and policy documents with variants of “Taxation and Development” in their titles. There is no harm in that, of course, and many of the more recent contributions—not least, those in this volume—go beyond generic information and advice to provide detailed case studies of the effects of taxation in various developing countries. But the recurrence of “Taxation and Development” in the titles does reflect a search for generalization that, after decades of work in the area, one might have hoped to have moved beyond. By comparison, specialists in public finance rarely set out to provide similarly generic treatments of taxation in advanced economies. The point is not simply that developing countries differ greatly from one another. No one would say otherwise. Even if one separates out the newer group of emerging market countries (itself ill-defined, and overlapping with the category of those still regarded as “developing”) and the transition economies (yes, there still are some), considerable differences in physical characteristics, political structure, and institutional history remain. Development economists have become increasingly sensitive to these differences, with a lively and sometimes heated debate on the importance and relative roles of institutions—shaped in large part by colonial histories and legal traditions—and geography, especially climatic conditions.5 The question for present purposes is whether such differences really matter for thinking about taxation. Some aspects of geography clearly matter a good deal. Probably the single most important tax-relevant difference across developing countries—indeed, perhaps across all countries—is in natural resource wealth.6 This is far from entirely exogenous, of course, in that the level of exploration for resources is an outcome of economic decision making,7 but also far less than fully controllable. Between the early
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1980s and 2005, resource-rich countries in sub-Saharan Africa increased their tax-to-GDP ratios by about 7 percentage points; non-resourcerelated tax revenue in the region, on the other hand, was essentially stagnant.8 For such countries, the central question for tax design is how to secure an acceptable share of the resource rents in a way that ensures proper exploitation of those resources.9 In the extreme cases—the Timor Lestes of the world—the question is, in effect, whether to have a domestic tax system at all. Even in more moderate circumstances, the role of the non-resource tax system can be quite different from what it is in resource-poor countries: largely a means of diversifying the revenue base and, perhaps, of increasing government accountability, rather than primarily a matter of raising revenue. Tax design for such countries becomes, in large part, an aspect of the wider issue of resource management. Transparency, macroeconomic management, and savings decisions have wider implications for the political and economic future of the country. Resource taxation in low-income countries (including the treatment of such exhaustible resources as fisheries and forests) has been left to sectoral specialists much too long. Other aspects of geography also matter for tax design. Smaller countries—especially rugged, distant islands—can impose taxes at their borders much more easily than can large landlocked countries, so it is not surprising that smaller countries tend to have more efficient value-added taxes10 and indeed seem less inclined to adopt a VAT, given the relative ease of raising substantial amounts by customs duties.11 Even a country’s shape may matter. Gambia’s long, thin structure has contributed to extensive re-export activities and hence—with tax not being remitted on exports, some of which are presumably controlled at the border—to unusually strong revenue from a single-point sales tax. Nor is there any doubt that politics, in the broad sense, are important. This is not simply a matter, as we tend to think of it in advanced economies, of building some minimal consensus for tax changes. Political instability, for instance, lowers incentives for the incumbent government to invest in developing administrative capacity; Acemoglu (2005) and Besley and Persson (2009) explore these incentives more generally (as discussed further below), and, in a fascinating example, Aizenman and Jinjarak (2008) show that political instability is associated with reduced effectiveness of the VAT.12 Still more obviously, some national governments simply do not have full control over all their territory. When that is the case, the standard prescription for the
revenue-desperate of relying on customs revenue and aiming to move to a VAT (most of the revenue from which is collected at borders) is of limited use. More generally, tax policy is in such cases likely to be constrained by the need to avoid worsening internal conflict; levels of mistrust and frank dislike, for instance, can make reallocating tax powers across levels of government effectively impossible even when it is demonstrable (insofar as these things ever can be demonstrated) that all could gain by doing so. In this and many other ways, tax reform can get very personal. Not least, its momentum and effectiveness can depend on the presence of one or two “champions,” the risk then being of backsliding once they have departed the scene. Less immediately evident, and under-studied, is the question of whether colonial histories continue to make a difference to the nature of, and possibilities for, domestic revenue mobilization. Certainly there are particular instances in which this seems to be the case. In both India and Pakistan, for instance, a major obstacle to arriving at coherent VATs has been a constitutional restriction originating in the 1935 Government of India Act, which allocates the powers to tax goods and services uniquely to distinct levels of government13—a distinction running counter to the appeal and logic of the VAT, which must apply on an integrated basis to both goods and services. There are also clear differences in tax design between Francophone and Anglophone countries in sub-Saharan Africa. The former, for instance, have traditionally used a “complementary” income tax (a progressive tax levied on the sum of net incomes after application of a series of schedular taxes), seem to make more use of VAT withholding and advanced collection schemes,14 and have been inclined to use a territorial approach to the taxation of foreign income. These features (with the possible, and possibly telling, exception of withholding, discussed later in this chapter) are all echoes of tax practice in France—or, rather, of the France of many years ago. Similarly, Lusophone African countries have tended to follow peculiarities of tax rules inherited from Portugal. The distinction between the experiences of Francophone and Anglophone countries in sub-Saharan Africa is potentially a particularly interesting one. In the wider development debate, it has been argued that the Anglophone countries (or, somewhat different, those with the British common law tradition) have fared significantly better in the post-colonial period. A natural question is whether that is true in the area of taxation. Table 2.1 suggests that it might be. The first column reports the results of a standard, very parsimonious “tax effort” panel