How can developing countries learn to tax?

By Antonio Savoia, Global Development Institute, University of Manchester; Roberto Ricciuti, University of Verona and CESifo; and Kunal Sen, UNU-WIDER and Global Development Institute, University of Manchester

Development-Finance-shutterstock_524218915The capability to raise revenues from taxes – often called fiscal capacity – is a crucial aspect for the functioning of every state, particularly in developing countries. Two reasons account for this. First, greater fiscal capacity is fundamentally important for state formation, as it is usually associated with the creation of a civilian bureaucracy that can itself provide an enabling environment for the consolidation of statehood. Second, greater fiscal capacity implies greater access to resources needed to provide public goods. Developing countries are only able to raise a small share of taxes over GDP compared to advanced economies. They need higher revenues to invest in a number of economic and social areas that are crucial for their growth, such as healthcare, education and infrastructure. This is also relevant to pursue the Sustainable Development Goals (SDGs) by 2030, an ambitious enterprise requiring far greater resources. Indeed, SDG 17 explicitly refers to the mobilisation of government revenues (Target 17.1).

Our recent research1 finds that learning to tax depends on what kind of political institutions are in place. Political systems that place stronger constraints on the executive power are more likely to lead to taxation systems that have a higher degree of transparency towards their citizens. This is because in such systems non-state actors can control and limit the elites’ access to resources. Thus, they are able to demand greater accountability on the part of the state with respect to the taxes they pay. In turn, processes of tax payment and collection characterised by greater transparency and accountability of tax authorities make taxation more consensual between states and citizens. This builds tax morale and has a significant effect on the amount of revenues raised.

Based on a sample of 47 developing economies, our analysis looks at whether greater constraints on the executive have a positive effect on the transparency of the taxation system. We use a popular measure of the effectiveness of checks and balances on the executive power by Polity IV as well as a set of indicators created by the Public Expenditure and Financial Accountability project to capture the degree of transparency and accountability of tax authorities. For example, we selected a variable evaluating taxpayers’ access to information on tax liabilities and administrative procedures (Figure 1) and one assessing the quality and functioning of tax appeals mechanisms (Figure 2). Using various estimation methods to check the robustness of our results, we first conclude that the existence of effective constraints on the executive makes tax systems more accountable and transparent.

Figure 1Transparency of taxpayer obligations and liabilities
and constraints on the executive

Source: Ricciuti R., Savoia A. and Sen K. (2019), “How do political institutions affect fiscal capacity? Explaining taxation in developing economies”, Journal of Institutional Economics, forthcoming.

Figure 2
Quality of tax appeals mechanisms
and constraints on the executive.


Source: Ricciuti R., Savoia A. and Sen K. (2019), “How do political institutions affect fiscal capacity? Explaining taxation in developing economies”, Journal of Institutional Economics, forthcoming.

Does this have an effect on tax revenues? Our second key finding is that a typical increase in the constraints on the executive index results in an average growth in total tax revenues or income tax revenues (measured as a share of GDP) of 2.4 percentage points over just under a decade. Bearing in mind that developing economies typically raise 10-20% of their GDP in taxation, this is a significant impact.

So, an important way for developing countries to learn how to tax is to strengthen the political institutions providing effective checks and balances on the executive’s discretionary power. Designing and implementing reforms in this direction presents challenges, such as opposition from elites who stand to lose from political change. Benefits may only materialise in the medium- or long-term. But it is still worth trying. After all, mobilising revenues is itself a development target in the SDGs. It is also crucial for providing the much-needed resources to make progress on all the other targets, thereby generating synergies across different development goals.

1. See Effective States and Inclusive Development Centre, now published in the Journal of Institutional Economics.