Joe Penney / Reuters Customs tax receipts are piled up at the National Treasury in Bangui, Central African Republic, November 29, 2013.

Cheers to the Taxman

Why Taxes Are Better Than Aid

As Benjamin Franklin once said, “In this world nothing can be said to be certain, except death and taxes.” For a long time, though, in many developing countries, death was all too certain and taxes were not. These countries had few domestic resources to invest in the health, education, infrastructure, and agricultural projects needed to raise life expectancy, grow their economies, and end extreme poverty. Today, however, things are starting to change. By focusing on growing domestic revenues and achieving fiscal self-reliance, some of the same countries are reaching their development goals and improving their citizens’ quality of life.

El Salvador is a case in point. In 2004, the U.S. Agency for International Development (USAID) launched a project to broaden the tax base and increase tax collection, in part by modernizing El Salvador’s revenue service. Within five years, El Salvador’s Ministry of Finance had increased its tax revenue by 2.7 percent of GDP without increasing tax rates, earning an extra $660 million per year. And these funds are going to the right things. Since the late 1990s, El Salvador has doubled its per capita spending on health, education, and social services, with a $160 million increase in annual social spending alone. In that same period, the percent of the population living in extreme poverty dropped by nearly 25 percent.

USAID has helped the Republic of Georgia make similar inroads. In 2005, USAID invested $12 million in technical assistance to modernize and transform Georgia’s Customs and Tax Departments. Between 2005 and 2008, Georgia increased the number of registered taxpayers by 134 percent. That, in turn, boosted tax revenue by $4 billion, enabling Georgia to invest in the country’s health infrastructure and to double the government’s monthly cash transfers to the country’s poorest households.

A man walks past a wall graffiti in Nairobi, Kenya, March 24, 2012. The mural depicts a black-suited Kenyan legislator with a vulture's head, a caricature that represents the kind of greedy and corrupt lawmaker who taints Kenya's political class.

These USAID programs not only enabled El Salvador and Georgia to grow a consistent source of domestic funds, but also nurtured the virtuous cycle of accountability: the willingness of citizens to pay taxes depends on the quality of government service and responsiveness. Indeed, tax reform became a critical part of Georgia’s efforts to stamp out public sector corruption and build trust in the government after the 2003 Rose Revolution, which led to the resignation of President Eduard Shevardnadze and ended Soviet-era leadership. One remarkable result was a steep drop in bribes. The number of businesses reporting demands for bribes from tax collectors dropped precipitously, from 39 percent in 2005 to a mere 0.2 percent in 2013.

Even more important than simply raising the revenues is using the resources equitably to benefit the many, rather than just a few. Too often the easy money that comes from exploiting natural resources leads to pervasive corruption and to a deficit in other economic investment. There is also a chicken and egg problem with industry and development—there is not enough industry and economic activity to tax in order to sustain the sort of investments, such as infrastructure and education, which are essential to building industry. The international private sector also contributes to the problem by seeking “tax holidays,” or tax abatements, and engaging in transfer pricing or profit shifting: essentially, whatever strategies they can muster to avoid paying taxes or pay as little as possible. These roadblocks, in turn, create a rift in the citizen–state relationship. Citizens do not pay into the state because they are afraid their money will not be used responsibly.

The key to real reform is the political will to both raise the revenues and to use the resources on social spending and investment that improves citizens’ lives. For Georgia, this meant introducing a zero-tolerance policy toward corrupt customs officials who were identified through undercover Ministry of Finance police investigations. Similarly, El Salvador’s Ministry of Finance formed the Transparency and Anti-Corruption Unit in 2014 to support government efforts to enhance the integrity of civil servants. The increases in social spending, made possible through USAID’s support for reform, ultimately led to tangible results for taxpayers and enhanced government legitimacy.

At its core, the Addis Tax Initiative represents the best of what foreign aid can achieve: catalyzing stronger commitments and greater pools of resources to reach development objectives. And perhaps that begins with venerating rather than vilifying the tax collector.
Reuters Customers queue outside the closed doors of a local commercial bank August 4, 1998. The strike by some 12,000 bank staff nationwide entered its second day as the government continued to reject demands to scrap a controversial tax on staff loans.

A NEW AGENDA

With the United Nations set to define a new set of global development goals for the next 15 years at the end of September, the world is finally turning its attention to the importance of helping countries make the most of their domestic resources. In July, 174 nations gathered in Addis Ababa, Ethiopia to reevaluate approaches to financing development. The biggest breakthrough in this year’s historic Addis accord on development finance was the prioritization of domestic resource mobilization and commitment to helping countries achieve economic self-sufficiency.

In Addis, the United States, in partnership with Ethiopia, the Netherlands, and dozens of other countries and institutions launched the Addis Tax Initiative. It cultivates strong partnerships between developing countries committed to undertaking serious reforms and donors, states, as well as institutions (such as the Bill and Melinda Gates Foundation and international organizations like the World Bank, International Monetary Fund, and the OECD) that are committed to domestic resource mobilization.

The Addis Tax Initiative addresses the factors that typically undermine tax collection, namely tax evasion and avoidance, but most critically, lack of administrative capacity to collect taxes consistently, effectively, and transparently. The organizing principle behind this effort is that every country holds primary responsibility for its own economic and social development. Although the initiative commits donors to double the provision of technical resources, the real work will be in fueling the virtuous cycle of institution building—collecting taxes, delivering on public services, cutting corruption and improving governance, and improving the lives of the neediest. The good news for donors is that studies of past programs show that for every dollar invested in growing domestic resources, ten are on average returned within just a few years. But this progress relies on a country taking a certain level of initiative and understanding—that the path to prosperity and fiscal self-reliance is through increasing its own resources.

A trader weighs gold nuggets at an illegal mine-pit in Walungu territory of South-Kivu province near Bukavu, April 5, 2014. Democratic Republic of Congo aims to double tax revenues from minerals but investors warned that an overhaul of the mining code could remove incentives to invest there.

Countries that have sought to wean themselves from development aid have seen substantial results. Since 2000, total collected tax revenue in Africa, particularly in South Africa, Nigeria, and Angola nearly quadrupled to $527 billion in 2012. But building a larger domestic resource base requires complex policy changes, years of administrative capacity building, and consistent political will (that means not only seeing changes through, but also effectively communicating to citizens how tax revenues will serve them).

The international community, through initiatives such as the Addis Tax Initiative, can help developing countries navigate the challenges ahead. They can assist in ensuring that more revenues stay within developing countries rather than flow to international investment, multi-national enterprises, or private coffers. With the technical assistance and the concerted commitment that the Addis Tax Initiative provides, the program can meet the growing demand within developing countries for domestic resource mobilization.

As we look ahead to implementing a new set of global development goals for 2030, strengthening developing countries’ ability to tap their domestic and international resources must be a priority. At its core, the Addis Tax Initiative represents the best of what foreign aid can achieve: catalyzing stronger commitments and greater pools of resources to reach development objectives. And perhaps that begins with venerating rather than vilifying the tax collector.

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