Tax, Law and Development – by Miranda Stewart

Millennium Development Goals

photo credit: US Mission Geneva via Flickr cc

Tax reform is important for poverty relief, reducing inequality and economic development.  In this article, Miranda Stewart (co-editor of Tax, Law And Development) discusses the potential of tax reform and the challenges associated in realising this.

Tax reform has been an element in the package of reforms for development since postcolonial times in the second half of the twentieth century.  Since the neoliberal economic consensus of the 1980s, the main goal of tax reform for developing countries has been to reform the tax system to support market-led growth by encouraging foreign direct investment into and exports from a market economy (see CHAPTER 1 of my book and The International Monetary Fund and Tax Reform paper).

Tax reform has taken on a renewed emphasis in the last decade, as it has been seen as a way to fund poverty relief and other development goals, as well as to encourage economic growth.

In 2002, the Monterrey Conference on Financing for Development put forward proposals about how countries could finance the Millennium Development Goals. The UN Panel on Financing for Development said at that time:

Financing an adequate level of social public expenditure while limiting budget deficits calls for substantial tax revenues. Most countries of the developing world must undertake significant tax reforms if they are to raise the additional revenue that they need. These reforms should generally aim to broaden the tax base and to encourage domestic savings.

Hurdles to tax reform and the persistence of tax incentives

The ideal tax system, as proposed in economic theory, requires low taxes on capital including a broad-based but low rate company and personal income tax; the elimination of tariffs; and the increase of taxes on domestic consumption through the establishment of a broad-based value added tax. Countries that have mineral or other natural resources should also seek to tax the exploitation of those resources. For more explanation by the IMF, from 2001, see

Yet this ideal tax system seems impossible to achieve and fails to address political and inequality concerns. Most developing country tax reforms have failed to generate sufficient revenues for governments or to achieve the ideal tax system. After decades of tax reform, many low to middle income countries still have a low tax revenue to GDP ratio that is less than half that of rich countries. (In Europe, the average tax to GDP ratio is now 38.8%).

A particular concern is the persistent use of tax incentives for foreign direct investment by developing countries because of the trap of global tax competition (as explained by Brauner in CHAPTER 2). The use of tax incentives has been identified by many experts as a problem and it runs counter to the policy prescriptions of the IMF and OECD. But we are no closer, overall, to a solution. Tax incentives are a response by country governments to the current global competitive investment environment. The tax system proposed by many experts, while ideally it would achieve adequate revenues, is not much help if the reality of the international context of tax competition is ignored.

The challenge of tax and inequality

Tax and spending reforms are political at their core and must address fundamental political questions of fairness. Such reforms are ‘central to the nation itself’, as they ‘shift resources from one segment of society to another, directly or indirectly, intentionally or unintentionally’ (UN World Economic and Social Survey 1997).

Yet, in a world with global tax competition, governments find themselves with less capacity to ensure a fair tax system based on ability to pay. As Dagan suggests in CHAPTER 3, governments seeking mobile investment and labour are pushed to limit their states’ redistribution functions in a global competitive context. Governments are under pressure to abandon democratic participation traditions of voice for exit-based practices, undermining the basic principle of ability to pay and democratic principles of representation, as global mobility becomes the most important feature in taxation.

We have seen substantial reductions in basic poverty in the last decade. At the same time, we have seen substantial rises in inequality. Ensuring ability to pay and tax equity is of central importance for long term sustainability of tax reform as well as for achieving the Millennium Development Goals. This can no longer depend on increasing economic growth for the country as a whole.

Middle income countries now account for around 70% of the world’s poor, according to recent studies. There is rising economic (income) inequality in developing and developed countries around the world.

To alleviate inequality and achieve development, the main source of financing for welfare assistance, healthcare and education is taxation. As the UNDP Report states, rising inequality reflects in large part ‘a failure of national fiscal, and particularly taxation, systems’.

Searching for local solutions to achieve successful tax reform

When global tax competition is combined with domestic politics and inequities, and weak legal and tax administration institutions, it is not surprising that many tax reforms disappoint. The law and administration of tax systems must be central in tax reform. Tax reform is law reform that involves ‘transplanting’ legal notions or models across borders. The law and administrative agencies on the ground play a central role, as it is through these mechanisms that tax policy must be implemented.

Tax experts and institutions have begun to learn from the failures of tax reform in the last few decades. As acknowledged by Michael Keen of the IMF, “big ideas” in tax reform have not always been successful (see “Taxation and Development – Again”, IMF Working Paper WP/12/220 September 2012). The IMF still pursues an ideal tax system but a decade later, it acknowledges the need to take account of national politics, law and equity in tax reform (e.g. ).

How can we find effective local tax reform solutions? Bill Easterly (Reinventing Foreign Aid) has argued that poverty can only be ended by ‘searchers’, who:

‘explore solutions by trial and error, have a way to get feedback on the ones that work, and then expand the ones that work, all of this in an unplanned, spontaneous way.’

Easterly gives as examples, firms in private markets and democratically accountable politicians. In tax, ‘one size fits all’ solutions, no matter how attractive in the abstract, will have unintended consequences when the factors that affect the process of development in different countries and regions are genuinely complex and diverse.

The ‘searcher’ approach must be applied to tax reform, taking what we know about a good tax system and focusing primarily on the challenges of equity, law and administration in the particular local context.

Changing the global rules of the game: towards international tax cooperation

In a global era an improved focus on the searching for local solutions will not be enough to fix developing country tax systems for the long term. Global tax competitive pressures for mobile capital will continue to prevent many countries from achieving their national tax revenue, equity and development goals without change at the global level. This calls for both administrative and substantive tax cooperation.

Nation states need to cooperate in administering taxes to prevent avoidance and evasion across borders. The most recent UN General Assembly Resolution 69/199 (21 December 2012) calls for the international community to support country efforts to reform national tax systems, by combating tax evasion and capital flight, enhancing international cooperation and participation in taxation.

There is progress and we can be optimistic about some improvements in tax administration cooperation. As I’ve written elsewhere, there are increasingly tight networks of transnational tax administration, supported by legal frameworks such as the Multilateral Convention on Mutual Administrative Assistance in Tax Matters. We must strive to ensure that the new global tax administration processes and networks will benefit developing countries.

More fundamentally, we need to change the rules of the game for taxing mobile capital and labour in a global context, so that developing countries have genuine access to the global corporate and personal tax base. There are some ideas in the OECD Report to the G20 in April 2013.  We need a new global process of political engagement in tax reform for all countries. This would include increased transparency and participation at the global level to generate legally binding and legitimate tax base allocation. This is the next great challenge for tax, law and development.

Miranda Stewart photoMiranda Stewart is a Professor of Law and Director of Tax Studies at Melbourne Law School, University of Melbourne, Australia. Miranda has previously worked in tax policy and law in government and for the private sector. She has a long standing interest in tax, distribution and economic development in a global context and is co-editor of the recent book Tax, Law And Development with Professor Yariv Brauner, Florida University Levin College of Law, USA.

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