Transcript Alice Sindzingre - Overseas Development Institute

Financing the Developmental
State: Tax and Revenue Issues
Alice Sindzingre
Research Fellow, National Centre for Scientific Research (CNRS,
Paris)/Research Centre EconomiX-University Paris X-Nanterre; Research
Associate, School of Oriental and African Studies (SOAS), Department of
Economics, University of London
Presentation at the Overseas Development Institute (ODI), London
Wednesday 5th April 2006
Questions
The concept of the developmental state; conditions of its
emergence and consolidation.
The modes of financing of the developmental state: taxation and
spending: major problems in LDCs.
Financing and taxation systems: institutions.
Classical ingredients of effective institutions: credibility and
trust between the state and civil society .
Constraints: domestic and international, political and
economic.
Foreign investors: LDCs as providers of natural resources; SSA
perceived as a risky region . IFIs as ‘lock-in devices’,
substitutes for domestic policies that became non credible.
Political economy, institutional processes: drying up of external
financial flows, domestic savings, investment, capital flight.
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Two main arguments
• Taxation systems - via indicators such as tax/GDP ratios,
levels and structure - insufficient to explain the
determinants of a developmental state.
Lessons of Asian developmental states: state intervention, but
under the form of policies committed towards growth, more
than under the form of ownership of important shares of
national assets, large levies, recycling of national wealth.
• For a policy or an institution to be effective, it needs to be
credible, perceived as a commitment: endogenous processes.
Effective and credible states and institutions often lacking in
LDCs, especially in SSA.
Key problem: IFI programmes and aid not well-equipped for
building domestic effective institutions, policies and
commitments towards growth, and endogenous processes (e.g.,
trust between governments and citizens).
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Outline
• 1. Main features of the concept of the developmental state.
• 2. Traits of the developmental state, taxation issues,
credibility, ‘anti-developmental’ rulers.
• 3. Main constraints regarding taxation in SSA: trade-based
taxation; public spending and growth (social policies).
• 4. Effects of IFIs programmes: reforming financial
government agencies, reducing fiscal deficits; fiscal effects of
trade liberalisation.
• 5. Current limits of aid in the building of effective and
developmental taxation systems and states: fiscal effects of
aid; aid dependence as an obstacle to the developmental
state.
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1. The concept of the developmental state
• Spectacular growth of North-East Asian late industrialisers
(Japan, Korea, Taiwan): active development strategies,
industrial policies (‘entrepreneurial’ states).
• Industrial policies: targeted taxation, protection, limitation of
foreigner shareholding, incentives for the banking sector and
firm financing, training in technology.
• Long-term relations political power-private sector.
• State intervention, political rent-seeking, but public policies
tuned to market sanctions, i.e. export performance.
• Intervention of the state under the form of credible and
growth-oriented policies, not of the ownership and direct
control by the state of large pieces of the economy.
• No reliance on high levels of tax collection, no massive
redistribution and transfers
Government spending in Asian states: an irrelevant proxy for
state intervention: low tax/GDP ratios, initially limited
redistributive capacities.
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• The ‘founding fathers’: necessity of government intervention.
• Instruments: public policies and public institutions; both must
be credible for being effective.
• At early stages of development government intervention
required for the reallocation of resources and factors, capital
and labour, which markets alone cannot achieve, only in a suboptimal way.
• State intervention necessary in order to create the conditions
for coordination between sectors and economic agents and
facilitate learning processes (Rosenstein-Rodan, Hirschman).
• ‘Getting relative prices wrong’: but conditional on
developmental objectives.
• Ingredients of growth cannot be considered in isolation: the
combination of economic, political, social factors resulted in
development outcomes: ex post.
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2. Financing the developmental state
Dimensions of taxation
• Taxation: a dimension of the developmental state: structure,
organisation of taxation: intrinsic aspects of state formation.
• Taxation: an important factor of growth
• Positive relationship between per capita income and
government spending (‘Wagner law’).
• In low-income countries/LICs, the average ratio of
government spending to GDP during the period 1999-2003:
about 29% (34% for middle-income countries, 42% in OECD
countries).
• The tax ratio (tax revenue/GDP) varies widely in LICs.
• In the past decade it rose by only 0.5 points in LICs (to around
15%). In the 1990s, 6.8% in Uganda, 8.1% in Madagascar.
• In LICs, for the IMF, a tax ratio of at least 15%: an appropriate
target.
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• Asian DS: not Western style welfare state democracies.
• Low tax to GDP ratios, lower than in SSA (in 1990 and 2003,
current revenues in the East Asia-Pacific region averaged 12
and 11% of the regions’ GDP ).
• Key issue: policies and allocation of incentives to specific
sectors that contribute to growth.
• The redistributive capacities of states that recycle only about
10% of the national wealth obviously limited in the context of
predatory, clientelist politics, and in the absence of
developmental objectives.
These limited capacities challenge the credibility of the state visà-vis the citizens.
• Key dimension of the Asian DS missing in SSA: the capacity
of making public-private alliances, promoting private firms,
be it for motives of collusion or personal enrichment.
• In SSA, little support to the private sector: political
economy reasons, rulers feeling threatened by its autonomy.
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Ingredients of the DS: policies, credibility, legitimacy
• DS: economic and political phenomenon: policies linked to
political objectives and interests, political support.
• Political economy theories of taxation (self-interested rulers,
rent extraction, predatory states ).
• Democracy and growth? different conclusions.
• The DS model: authoritarian regimes?
‘strong state’: capacity to credibly commit, implement policies,
change property rights, provide incentives for private and
public agents.
In SSA, mixed outcomes of democracy: e.g., social polarisation .
• Question: ingredients of trust citizens/the state?
limited by the trade off between policies oriented towards
growth (investment) and social, poverty reduction policies.
• Vicious circles in SSA: lack of credibility of the state, lack of
trust from citizens tax evasion  further scarcity of
resources incapacity of states to provide basic services 
increases the state’s lack of credibility.
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• State redistributive capacities limited by informal sectors.
However, more a continuum than a binary dichotomy:
informal firms also pay taxes.
• The issue of ‘anti-developmental’ rulers with a long term
horizon.
Growth implies a threat (uncontrolled resources, challengers).
Here taxation is irrelevant (resources based on extraction)
(Acemoglu and Robinson).
• The DS: coordination, public-private sector, coalition of
rulers, elites and interest groups, long term growth being of the
interest of all, even through collusion and corruption.
Kang on Korea: political and economic groups in a mutualhostage situation.
Typically, opposite political economy in LICs: the ‘divide and
rule’ principle.
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3. Features of taxation in low-income
countries: the case of Sub-Saharan Africa
The constraints on revenues: trade-based taxation, commodity
dependence and price volatility
• Public revenue constrained in LDCs because it relies on external trade:
• N Kaldor: “Will Underdeveloped Countries Learn to Tax?”: incentives for
collecting taxes (basic functions of the state), undermined by an over-reliance
on external resources.
• In SSA, exports of primary products: an important share of revenues;
commodity dependence; price volatility.
• Narrow industrial base, economy based on agriculture and services.
• Poverty, weak institutions, political economy, informational problems, limit
possible options: tax bases go from ‘easy to collect’ taxes (e.g., tariff) towards
‘hard to collect’ taxes (e.g., VAT, income tax).
 Taxes levied on export crops (cocoa, coffee, cotton, etc.)
E.g., Ghana, average tax rate on cocoa in the 1990s (58%): double of its level in
the 1900s (24%) (F Teal).
Stabilisation boards: redistributive functions rarely achieved.
• Theory: taxation of export commodities associated with tariffs on imports
(protecting import-substitution industries): possible immiserizing growth.
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• SSA: heavy reliance on trade taxes for government
revenue: between a quarter/a third of government revenue.
Cf high-income countries tariff revenues: less than 2% of tax
revenues.
Commodity price volatility: dramatic impact on public revenues
UNCTAD: SSA exports experienced twice the volatility in terms
of trade that East Asia’s exports in the 1970s, 1980s and
1990s, and 4 times the volatility experienced by the industrial
countries.
• A ‘natural resource curse’ ? Lack of primary commodities:
a determinant of developmental states in Asia? (R Auty);
commodity dependence preventing state-building, incentive
for corruption, associated with high inequality?
• IMF: VAT more developmental and neutral tax.
But introduction of the VAT problematic in LICs: large informal
sectors, political economy problems.
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Public spending and growth in low-income countries
and developmental states
• Developmental states: no large governments: 1980-1997
period, average level of government spending of Korea: 20%
of GDP
• Public sectors in SSA not excessive.
• Key aspect of public spending: the macroeconomic context:
stability, policies.
• SSA governments: structural fiscal deficits because of the
volatility of revenues:
Increasing share of the wage bill at the expense of investment
and maintenance spending: detrimental effects.
• IMF/WB stabilisation programmes: diminution of the wage
bill, retrenchment of civil servants: mixed outcomes.
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• PRSPs/IFIs: allocation of public expenditure to the
social sectors; importance for growth of the
composition of public spending .
• Crucial question: whether spending in social sectors is
conducive to growth.
• Positive effects of social spending on growth:
controversial: many intermediary processes, leakages.
• Not only composition, but also efficiency of social
spending more important than its levels.
• Some studies: positive relationship between public
spending and the health status of the poor.
• But other studies: weak relationship between spending
on education and health and outcomes (L Pritchett).
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• Key developmental dimension regarding trust, credibility:
effective redistribution, management of individual risks that
push into poverty = social protection.
• Asian DS: not high levels of public spending on social
protection: state, market and family structures.
• Asian DS: political use of the provision of social welfare.
Governments’ political motives: strengthening legitimacy,
building political support.
• H J Kwon (Korea): ‘productivism, selective social investment
and authoritarianism’.
Social protection incorporated in the developmental strategy:
private sources of welfare, limiting the reliance on the state.
• SSA: limited social security; provided by social networks.
But ‘informal’ social protection may be inefficient, lock
individuals (group membership), distrust vis-à-vis the state.
• Relationship between low inequality and growth?
Asian DS reduced inequality  legitimating the DS.
In contrast, many LICs characterised by high after-tax inequality.
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4. The consequences of reform on the formation of
developmental states in SSA: stabilisation, structural
adjustment programmes, PRSPs
Reforming financial government agencies, reducing
fiscal deficits
• Autonomous agencies for revenue collection: mixed effectiveness; political
economy problems.
• Recessive aspects of IMF stabilisation programmes; but the deficit-growth
nexus: nonlinear.
• Regarding revenues, IMF: the experience with tax policy during the 1990s
was mixed.
• Context of weak states, instead of enhancing coordination, IFIs over-optimism
about the minimal state (provision of public goods, macroeconomic stability).
Left aside ingredients of state-building of the DS (and the ‘Scandinavian model’),
‘more state and more market’.
• Reforms also assumed a better efficiency of private entities.
In SSA, privatisation not always efficient.
In Asian DS, transfers of state assets by bureaucracy, politicians and businessmen
linked by mutual interests (‘collusion’).
In SSA, private sector: too often, informality, antagonism vis-à-vis the state.
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The fiscal effects of trade liberalisation
• Trade liberalisation: negative impact on SSA: reliance on
trade taxes.
• Gupta (IMF): decrease in trade taxes in SSA between the early
1990s and the early 2000s: from 4.9% to 3.5% of the GDP for the
import duties, and from 1% to 0.4% of the GDP for export duties.
• Early 1990s: tax revenues in SSA, 16.3% of GDP; 15.9% in the
early 2000s.
• Criticisms: reforms should stimulate savings and investment.
• Trade liberalisation in SSA: mixed results: not a basis for long
term growth; no reduction of vulnerability to external shocks, no
diversification of exports from natural resources.
• E.g. Ghana: reforms did not address a source of failure: the heavy
taxation of agriculture (cocoa) (F Teal).
• ‘Fiscal squeeze’ : reduction of the capacity of public policies
towards export diversification (costly) and spending on
infrastructure: though crucial for the DS.
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• Lowering corporate taxes, intensified international tax
competition, rush to attract FDI
But Asian DS were cautious /openness to FDI.
• SSA: trade liberalisation: often exacerbated fiscal difficulties.
• IMF: revenue losses recouped from domestic indirect taxes?
VAT?
But revenue recovery very weak in LICs (most dependent on
trade tax revenues): IMF study: only 30% of losses .
IMF studies: uncertain revenue implications of trade
liberalisation.
Combining tariff cuts with a one-for-one increase in consumption
taxes or increases in consumption taxes?
The sequencing and implementation: very delicate .
• But: the negative relationship between trade liberalisation and
revenues not always found.
• Tension fiscal consolidation vs. trade liberalisation (which
may hinder the maintenance of industrial sectors) (IMF vs.
WB).
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5. The effects of aid in terms of taxation and
building the developmental state
• Can any developmental state be built via aid (Asian DS benefited from
aid).
• The amount of aid is not enough: at early stages of growth, what is needed is
not only external financing but long term strategies for an efficient
reallocation of factors and coordination devices.
=key role for the state, its capacity to implement credible policies and
reallocations.
• Easterly’s critique of aid surges, ‘big push’: Asian countries grew gradually,
without any ‘big push’ provided by aid .
• Shift to budget support; PRSPs: allocation of revenue to poverty reduction.
• Heated controversy about the effectiveness of aid.
Broad consensus that ‘aid works’
But many sceptical views regarding the recent commitments of donors to
increase aid (especially to SSA)
Doubts about aid effectiveness expressed at the IMF
Rajan and Subramanian: aid has a negative relationship with growth, particularly
in aid-dependent countries (overvaluation of the exchange rate, hinders
competitiveness).
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The fiscal effects of aid
• Well-known tension conditionality vs. ownership.
The incentive mechanisms provided by conditionality (ex ante and based on
action) and ownership (ex post and based on outcomes) not easily
distinguishable (Dixit).
• Moss and Subramanian (2005): if states rely on donors for finance, ‘why
bother to tax your own citizens’?
Aid provides incentives for reducing the tax effort, lowers the incentives to
broaden the tax bases and reduce aid dependency.
• Gupta (IMF): key issue: composition of aid.
Repaying loans leads to increased domestic revenues: concessional loans
associated with higher domestic revenue. Grants: opposite effect.
• More general issue: the fungibility of aid; e.g., using aid for recurrent
expenditures.
Aid dependence, aid fungibility, aid volatility: detrimental effects on revenues
and on the consolidation of state capacity.
• Ongoing debate: whether loans or grants would be optimal means.
Key issue: whether projects have the level of returns that would not aggravate
fiscal deficits.
But aid finances through grants projects that have high social value but
uncertain returns, e.g. education and health.
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• McGillivray and Morrissey on fiscal response models: aid may
discourage tax efforts or encourage increased borrowing;
but aid may increase tax efforts, encourage increased spending
on investment, and support improved fiscal management so
reducing borrowing.
=mixed results.
• IMF: cautious towards aid and the aid increases promised for
SSA.
Gupta et al: mixed empirical evidence on how aid flows affect
domestic revenue collection, but often negative.
IMF: the scaling up of aid: important impact on revenue
mobilisation:
Governments may view aid as substitutes for domestic
revenues.
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Aid dependence as an obstacle to the developmental
state
• In LICs, aid: major source of external finance since the 1970s.
Between 1970-75 and 1991–95, aid as a share of GDP in LICs
increased from 6% to 15%; private capital inflows (including FDI)
fell from 2 to 1 % of GDP (Morrissey).
• Aid dependence: negative effects: volatility, unpredictability of
aid flows, problems of capacity of absorption.
• Bulir and Hamann: volatility of aid much higher than that of
revenue and increased in the late 1990s.
The average volatility of aid is 40 and 20 times higher,
respectively, than that of revenue when expressed in percent of
GDP and constant U.S. dollars per capita.
Relative volatility of aid is the highest in the least and most aiddependent countries, defined as having aid-to-revenue ratios of
less than 25% and more than 50% respectively.
• Aid also unpredictable: Bulir and Hamann: aid delivery falls
short of pledges by more than 40% (esp. for poorest countries).
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• IMF: aid dependency accentuated by the programmes of
poverty reduction, higher spending in social sectors.
The goals of poverty reduction, surge in aid: risks for the
prospects of building developmental states in SSA.
• IMF: moderating aid inflows, limiting primary deficits,
increasing taxation, curbing aid dependency
Vs. WB: may support aid inflows.
• Problems inherent with aid: it is external, with a multiplicity
of players  non cooperative games.
E.g., MTEFs resulted from assessments of the deterioration of
budget institutions in SSA, and the responsibility of aid as a
major part of budget financing in the fragmentation of the
budget and the distortion of budget priorities.
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• Aid dependence: weakening of institutions.
It weakens the credibility of governments and their policies,
therefore weakens political institutions and their legitimacy.
• Moss et al. (CGD): increases in aid to SSA: negative effects on
state revenue and on political institutions.
Aid dependence transforms the state-citizens relationship: if
governments raise their revenues from aid, they become
more accountable to donors than to their citizens.
No need to build legitimacy nor devise credible policies, effective
institutions.
Erodes the developmental state?
• Questions:
- How to identify the ingredients of credibility and commitment of
a government, and of a right composition of policies, which are
credible, politically feasible, effective in terms of growth.
- Can external assistance have a role, if these processes are
endogenous?
- Conditions for building a ‘fiscal contract’ ? (FIAS-DFID study)
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Conclusion/summary
• Constraints on taxation in SSA: dependence on external trade.
Trade liberalisation: mixed outcomes, mixed contribution to
conditions for DS.
• Aid: incentives that may undermine tax structures and state
institutions (policy credibility, legitimacy).
• Two arguments.
- Asian DS: capacity for a state to credibly commit and intervene,
under the form of policies that are directed towards growth,
not policies that recycle the national wealth through taxation.
=capacity to address coordination failures and to reallocate
factors of production, coalitions between the state, private
firms and the civil society.
Political dimensions: growth instrumental in the building of
political support
- For a policy or an institution to be effective, it needs to be
credible and perceived as a commitment: endogenous processes.
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Questions
- can external players (IFIs, donors) contribute
to the building of effective institutions and
policies, as well as to developmental taxation?
- Can donors only create the conditions for these
developmental processes to emerge?
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