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Introduction to Tax Policy Design
and Development
Richard M. Bird and Arindam Das-Gupta
March 2004
Course Objective

How can developing countries best
design and develop their tax
systems?
– Given political objectives
– Given economic and political
constraints
– Given tax administration capabilities
Key Questions




How do tax systems differ across
countries?
What can, or should, taxes do?
What criteria are useful in thinking
about the design and operation of
tax systems?
What constraints may limit the tax
policy options available in a
particular country?
Discussion in Context



This Module serves as a general introduction
to much of the material covered this week.
No magic blueprint; no system or structure
that makes sense for all countries
Taxes just one tool available to governments.
It is important to consider other government
programs, especially, government
expenditure programs, in designing and
evaluating government activity.
Comparison of Tax Systems






Types of taxes
Tax levels (overall tax burden)
Tax structure
Developed vs. developing countries
Recent trends
Predictions for future
Different Types of Taxes

Taxes on consumption
– Turnover, VAT, excise, import duties
and export taxes

Taxes on labor income
– Wage taxes and social security taxes



Taxes on business and investment
income
Wealth and inheritance taxes
Property and land taxes
Aggregate level of taxes



Differences between developed
countries (38% of GDP) and
developing countries (18% of GDP)
Relationship between tax level and
per capita income
Estimates of tax capacity
– Hypothetical tax to GDP ratio
– VAT productivity
Tax revenue (% of GDP)
50
45
40
35
30
25
20
15
10
5
0
0
5000
10000
15000
20000
25000
Per capita GDP (PPP)
30000
35000
40000
Relative Use of Different Tax
Instruments...

Factors influencing relative mix of
different tax instruments
–
–
–
–
Revenue considerations
Administrative considerations
Fairness considerations
Transition and political considerations
…and Non-Tax Instruments



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Includes royalties, user charges,
sale of goods and services, fees,
penalties
Relatively neglected (15% except
oil producers and Singapore: 40%)
Great potential
Potentially fairer than broad based
taxes
Differences Between Developed
and Developing Countries



Relative use of trade taxes
Relative use of income and
consumption taxes
Relative proportion of income taxes
between individual and corporate
income taxes
Tax-GSDP ratios and Per Capita
GSDP: c: 2001
Tax
Income Taxes Trade NonGDP Taxes on
Taxes Tax
ratio
Goods
GDPpc
+ive, +ive, +ive, -ive,
+ive,
2%
1%
1%
1%
NS
OIL
-ive,
-ive,
-ive,
-ive,
+ive,
NS
NS
3%
NS
1%
Transition +ive, -ive,
+ive, -ive,
-ive,
1%
1%
1%
1%
8%
RSq
0.315 0.288 0.209 0.211 0.365
101 countries;
Log Tax/GDP regressed on Log GSDPpc
Taxes as a % of Current Revenue
by Region
Social security
taxes
100%
80%
Taxes on goods and
services
60%
40%
20%
World
OECD
East
Asia &
South
Asia
0%
Taxes on income,
profits and capital
gains
Taxes on
international trade
Nontax revenue
Revenue Structures in SAR and
EAP Countries
Revenue (% of GDP) in SAR and EAP Countries
Other taxes
Taxes on international
trade
Taxes on income,
profits and capital gains
Taxes on goods and
services
Nepal
Bangladesh
Mongolia
Pakistan
Vietnam
Papua New
India
Indonesia
Sri Lanka
Vanuatu
China
Philippines
Thailand
Malaysia
Korea, Rep.
Singapore
Bhutan
Maldives
35
30
25
20
15
10
5
0
Social security taxes
Nontax revenue
What explains differences?


Different demands and tastes for
government services
Different capacities to tax
– Level of economic development
– Size of informal economy

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Different abilities to impose and
collect taxes
Other revenue sources
Trends in Tax Reform

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Increased reliance on VAT
Increased pressure to reduce trade
taxes
Increased tax competition for
foreign direct and portfolio
investment
Reduction in top tax rates under
individual income tax system
Reduction in top tax rates under
business profits tax
What Can Taxes Do?
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Raise revenue to fund government
operations
Assist in redistribution of wealth or
income
Encourage or discourage certain
activities
At a cost in terms of efficiency and
growth
Competing Government Objectives

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What considerations exist in
choosing among the different
objectives?
The role of taxes in
– Encouraging economic growth
– Reducing disparity between the rich
and the poor
– Reducing poverty
Criteria for Evaluating Taxes

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Revenue productivity
Efficiency
Fairness
Administrative feasibility
Raise Revenue
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Match budgeted expenditures with
estimates of likely revenue receipts
Income tax elasticity
– Growth of tax revenues relative to growth in
the economy

Effect on tax revenue from economic
recessions and expansions
– Total tax revenues
– Revenues from specific tax instruments
Efficiency

Taxes influence behavior
–
–
–
–
Work vs. leisure
Save vs. spend
Choice of products
Operate in formal economy vs. operate in informal
economy
– Choice of location for investment

Reduce “deadweight” or “distortion” costs
– Almost all taxes distort
– Costs are real costs—especially for economies
where resources are scarce
– Focus on minimizing tax costs
Minimize Deadweight Costs of
Taxation

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Tax bases should be as broad as
possible
Tax rates should be as low as
possible
Careful attention must be paid to
taxes on production
Fairness

Different ways to think about
fairness
– Horizontal and vertical equity
– Focus on single tax provision, single
tax, or tax system as a whole
– Focus on government activity as a
whole

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Tax incidence
Actual vs. perceived fairness
Tax Incidence

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Distinguish between who has liability to
pay tax and who suffers the economic
burden of taxation
People pay taxes—in role of consumer,
producer or factor supplier
Tax incidence depends on market
conditions (ability to shift taxes to others)
Economic conditions vary among
countries—hard to predict tax incidence,
especially in developing countries
Administrative Feasibility

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Cost of collection
Cost of compliance
– To taxpayers
– To third-parties

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Cost of enforcement
Designing rules and regulations
Challenges to tax administration
How To Choose Among Competing
Criteria?

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What factors to consider in
choosing among the different
criteria?
Why do countries make different
choices among each other and
over time?
Taxation and Growth

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Does economic growth mean
greater inequality?
Is there a relationship between
level of tax rates and rates of
economic growth?
Bad tax systems can stifle
economic growth; unclear whether
good tax systems can substantially
increase economic growth
Taxes and Decentralization

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Increasingly important to focus on
assigning taxing and spending
authority to lower levels of
government
Notion that decentralization may
improve government service by
increasing accountability
India: Centre vs state revenues
2001-2 vs 1990-1
Centre 2001-02
Capital
Receipts
44%
Tax
Revenue
37%
Non-tax
Revenue
19%
Centre 1990-91
Capital
Receipts
42%
Capital
Receipts
32%
Tax
Revenue
62%
Non-tax
Revenue
6%
States 1990-91
Tax
Revenue
45%
Non-tax
Revenue
13%
States 2001-02
Non-tax
Revenue
11%
Capital
Receipts
13%
Tax
Revenue
76%
Tax Decentralization
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Ownership of tax revenues
Choice of tax base
Choice of tax rate
Responsibility and coordination of
tax administration
Taxes and Globalization

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Increased pressure to reduce trade taxes
Increased pressure on corporate tax
revenue
– Tax competition
– Intra-company trade increases opportunity for
tax evasion

Increased pressure on individual tax
revenues
– Easier to work or invest outside of country of
residence

Increased pressure on VAT revenue
– Services and intangibles larger part of valueadded
– Digitized products
Predictions for Future

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Tax design will still be largely dictated by
domestic considerations
However, increased cross-border activity
means tax system can no longer be
designed without regard to tax systems of
other countries
Globalization will increase challenges in
taxing income from capital
Regional cooperation may lead to
increased harmonization of tax systems
Conclusion
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‘To tax and be loved is not possible’
‘‘Taxes are the price we pay for
civilized society’
Above all, do no harm – or at least
as little as possible’