Introduction to Tax Policy Design and Development

1. Introduction to Tax Policy Design and Development Richard M. Bird and Arindam Das-Gupta March 2004

2. 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

3. 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?

4. 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.

5. Comparison of Tax Systems • Types of taxes • Tax levels (overall tax burden) • Tax structure • Developed vs. developing countries • Recent trends • Predictions for future

6. 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

7. 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

9. Relative Use of Different Tax Instruments... • Factors influencing relative mix of different tax instruments • Revenue considerations • Administrative considerations • Fairness considerations • Transition and political considerations

10. …and Non-Tax Instruments • 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

11. 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

12. Tax-GSDP ratios and Per Capita GSDP: c: 2001

13. Taxes as a % of Current Revenue by Region

14. Revenue Structures in SAR and EAP Countries

15. What explains differences? • Different demands and tastes for government services • Different capacities to tax • Level of economic development • Size of informal economy • Different abilities to impose and collect taxes • Other revenue sources

16. Trends in Tax Reform • 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

17. What Can Taxes Do? • 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

18. Competing Government Objectives • 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

19. Criteria for Evaluating Taxes • Revenue productivity • Efficiency • Fairness • Administrative feasibility

20. Raise Revenue • 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

21. 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

22. Minimize Deadweight Costs of Taxation • 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

23. 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 • Tax incidence • Actual vs. perceived fairness

24. Tax Incidence • 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

25. Administrative Feasibility • Cost of collection • Cost of compliance • To taxpayers • To third-parties • Cost of enforcement • Designing rules and regulations • Challenges to tax administration

26. How To Choose Among Competing Criteria? • What factors to consider in choosing among the different criteria? • Why do countries make different choices among each other and over time?

27. Taxation and Growth • 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

28. Taxes and Decentralization • 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

29. India: Centre vs state revenues 2001-2 vs 1990-1

30. Tax Decentralization • Ownership of tax revenues • Choice of tax base • Choice of tax rate • Responsibility and coordination of tax administration

31. Taxes and Globalization • 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 value-added • Digitized products

32. Predictions for Future • 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

33. Conclusion • ‘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’