Developing Country Tax Policy

 

 

Why are there taxes? The basic explanation is that, until someone comes up with a better idea, taxing is the only feasible way of obtaining revenue to pay government expenditure on the products and services that the majority of us require. Setting up an effective and equitable tax system, on the other hand, is far from simple, particularly for emerging countries seeking to integrate into the global economy. The ideal tax system in these countries would raise necessary revenue while avoiding excessive government borrowing, without discouraging economic activity or differing too much from tax systems in other countries.

When developing countries strive to construct efficient tax systems, they face enormous hurdles. To begin, the majority of workers in these countries are often employed in agriculture or tiny, informal businesses. Their incomes fluctuate since they are rarely paid a regular, fixed wage, and many are compensated in cash, "off the books." As a result, calculating the income tax base is difficult. Workers in these countries also do not generally spend their money in major stores that keep precise sales and inventory records. As a result, current revenue-raising methods, such as income and consumption taxes, play a limited role in these economies, and the likelihood of the government achieving high tax levels is almost ruled out.

 

 

 

Second, it is challenging to develop an effective tax administration without an educated and trained workforce, when funds are lacking to pay tax officials well and computerise the process (or even to provide effective telephone and mail services), and when taxpayers have limited ability to maintain accounts. As a result, instead of creating logical, contemporary, and effective tax systems, governments frequently choose the route of least resistance, creating tax systems that enable them to take advantage of whatever alternatives are available.

Third, statistical and tax departments struggle to produce accurate figures due to the informal nature of the economy in many developing nations and to a lack of funding. Policymakers are unable to evaluate the possible effects of significant changes to the tax system because of the absence of data. As a result, even when significant structural changes are plainly preferable, marginal alterations are frequently chosen over them. This keeps outdated tax systems in place.

Fourth, income distribution is uneven within developing countries. Although raising large tax revenues in this situation would ideally require affluent taxpayers to be taxed more heavily than poor taxpayers, rich taxpayers' economic and political power often permits them to block fiscal measures that would increase their tax burdens. This helps to explain why many developing countries have not fully utilised personal income and property taxes, and why their tax systems rarely achieve sufficient progressivity (i.e., the wealthiest pay proportionately more taxes).

 

 

 

Revenue from Taxes

At a given amount of national revenue, what level of public spending is ideal for a developing country? Is it appropriate for the government to spend one-tenth of national income? What about a third? Half? Only once this question is resolved can the next question of where to set the ideal level of tax income be addressed; identifying the best tax level is conceptually comparable to determining the optimal level of government spending. Unfortunately, there is little practical guidance in the vast literature on optimum tax theory on how to integrate the optimal level of tax revenue with the optimal level of government expenditure.

Nonetheless, an alternative, statistically based approach to determining whether a developing country's overall tax burden is appropriate consists of comparing a specific country's tax burden to the average tax burden of a representative group of both developing and industrial countries, taking into account some of these countries' similarities and differences. This comparison simply shows if the country's tax level is above or below the average when compared to other countries and taking into consideration various factors. This statistical approach has no theoretical foundation and cannot determine the "optimal" tax level for every country.