By Sebastian Nieto Parra, Head of Latin America and the Caribbean Unit, OECD Development Centre, Mario Pezzini, Director of the OECD Development Centre and special Advisor to the OECD Secretary General on Development, and Joseph Stead, Senior Policy Analyst, OECD Centre for Tax Policy and Administration
The “Decade of Delivery” for the 2030 Sustainable Development Goals (SDGs) calls for finding sustainable ways to finance development. Closing the financing gap by 2030 will require between USD5 and USD7 trillion annually, and between USD2.5 and USD3 trillion of that amount for developing countries alone. There are several approaches to financing the SDGs in low-income countries. External private financing and official development assistance both have a role to play but these are not the only options. We must take an in depth-look at all options, including taxes, local financing through domestic private banks or national development banks, and local public-private partnerships. Due to the colossal amount needed to finance the SDGs, they must all be taken into consideration. But some can be particularly costly. Experiences of public-private partnerships in developing and emerging economies for example, have often resulted in high fiscal costs and a high rate of renegotiations after only a few years of operation.
Domestic resource mobilisation is a priority as a means to increase national capacity to finance the SDGs. Taxes are already the largest single source of financing, and have the potential for growth. As while the average level of taxes in developing countries remains low, countries have shown capacity to expand their revenues. In 2017, total tax revenue was 14.8% of GDP in low-income countries, compared to 18.5% in lower-middle income, 20.9% in upper-middle income and 33.5% in high-income economies. However, tax revenues in low-income countries have increased by 5.8 percentage points in the last 25 years, compared to a 3.9 increase in upper-middle income and 0.8 in high-income economies (based on the OECD Global Revenue Statistics Database and the World Bank income classification).
Countries need to take on a more proactive approach to increasing sustainable public revenues if their potential is to be realised. Some avenues include (i) adjusting revenue structures, (ii) policies to avoid tax evasion and avoidance as well as illicit financial flows, (iii) improving tax morale and (iv) facilitating international co-operation. While these four dimensions are interconnected, some specificities can be highlighted.
The significant differences in revenue generation through social security contributions and personal income tax account for most of the gap between tax revenues as a percentage of GDP in OECD and developing regions. Tax revenues in low-income countries are mainly from indirect taxes (i.e, taxes on goods and services) and direct taxes on corporations. Following experience in countries with higher levels of income, further efforts should be made to increase revenues in low-income countries from, for instance, direct public revenues from individuals and property taxes (Figure 1).
Figure 1. Average tax structure by income levels (% of total revenue, 2017)
Source: Own calculations based on OECD Global Revenue Statistics Database and the World Bank income classification
The structure of the taxation system also helps to explain why fiscal systems in OECD countries tend to be far more redistributive than in Latin America or Africa. Overall, OECD countries are able to finance their welfare states (and other public programmes) through taxes, that themselves reinforce redistribution. Therefore, strengthening direct personal income taxation can both mobilise resources and help improve the redistributive capacity of tax systems. Improving revenues through efficient and progressive taxes, for instance by streamlining inefficient and cost-intensive tax expenditures or increasing marginal tax rates, is crucial for sustainable economic development.
Second, developing countries can also boost sustainable public revenues by tackling tax evasion and avoidance, and illicit financial flows. Practiced by multinational enterprises and high-net-worth individuals, shifting profits and assets to avoid or evade taxes can decrease state capacity and middle-class citizens’ willingness to pay taxes. While such practices are a global problem, there is evidence that they are more pervasive in less developed countries. Developing countries have some of the highest shares of financial wealth held offshore (22% in Latin America and 30% in Africa, compared with 10% in Europe), indicative of the high risk of tax evasion, especially by high net worth individuals. While for multinational enterprise activities the implied long-run revenue losses in developing countries are close to 1.3% of GDP. Similarly, illicit financial flows – including money laundering, tax evasion and bribery – tend to originate in developing countries, while ending up in OECD countries and associated jurisdictions. While estimates are often debated, it is widely thought that illicit financial flows are likely to exceed aid flows and investment in volume. Weaker institutional capacity leaves developing countries more exposed to tax evasion, cross-border profit shifting, and illicit financial flows and less prepared to adopt the best response to these increasingly common practices.
Third, countries need to boost tax morale, including through strengthening their institutions to improve legitimacy of tax administrations vis-à-vis citizens and firms. Tax morale is vital for tax systems as they rely on voluntary compliance of taxpayers for the bulk of their revenues. Improving how citizens perceive the legitimacy of tax authorities has the biggest impact in boosting tax morale. Additionally, building the social contract (i.e. demonstrating the impact of taxes in improved public services such as health and education), can improve willingness to increase tax payments. More broadly, structural changes are necessary and comprehensive national development strategies should contribute to improve public spending and in turn, job opportunities. These strategies must give voice to citizens and allow the “negotiation” of a nationally agreed vision of the taxation system. Finally, perceived administrative difficulty to pay taxes has a negative effect on tax morale. Taxpayer education programmes and increasing the use of technology in tax collection are therefore important tools to raise tax morale.
Finally, international co-operation has an important role to play in this context by promoting development on an equal footing among all countries. Renewed international co-operation involving information exchange among all actors – public and private and in all countries – would enable developing countries to improve resource mobilisation and respond to their citizens’ needs. Policy dialogues and knowledge sharing to increase local tax administration capacity are necessary; the joint OECD/UNDP Tax Inspectors Without Borders initiative is one example of how to share technical tax expertise internationally. International co-operation to avoid tax evasion and avoidance, which are taking a heavy toll on developing countries, must be strengthened through global initiatives. The Global Forum on Transparency and Exchange of Information for Tax Purposes and the OECD/G20 Inclusive Framework on Base erosion and profit shifting (BEPS), are crucial to support countries’ domestic efforts in tackling illicit financial flows and building international transparency.