Optimisation of government revenue in a framework of fiscal space, tax potential and tax effort

Jean-François Brun Gérard Chambas CERDI

Module 2

Objective: optimum level of government revenue

• Multi-criteria analysis required to assess an optimum level of government revenue

• Level of government revenue contingent upon political choices

1EU Workshop Brussels 2014

Outline

• I - Limits of traditional analyses of Government Financial Operations Tables (GFOT)

• II - Optimal management of public finances, the notion of fiscal space

• III - Tax potential and tax effort

2EU Workshop Brussels 2014

I Limits of conventional analyses of Government Financial Operations Tables (GFOT)

Analysis in a restricted time frame

Lack of international references

Lack of standards that take into account the specific characteristics of the countries analysed (for example, tax potential)

Analysis per item without considering the whole (inability to identify an optimum or take into account interrelationships)

3EU Workshop Brussels 2014

II the fiscal space (1)

• fiscal space : the diamond shape•

4EU Workshop Brussels 2014

II the fiscal space (2)

ODA• Mobilisation of ODA: a political and technical choice

Refusal of aid that is too costly (inappropriate conditions, implicit clauses relating to land, mining or natural resources, etc.)

• Integration of aid in the common law budgetary circuit (avoid annexed budgets)

Impact of ODA on:

• The DRM: an overestimated problem (Clist, Morrissey, 2010) in countries with good governance (Brun Chambas, Guerineau, 2008) but real in the weakest countries

• The quality of governance and public spending

5EU Workshop Brussels 2014

II the fiscal space (3)

• Deficit financing by external borrowing

• Besides the financial cost (interest rate, deadline) and risks inherent in external borrowing (exchange, rates), the associated conditions should be taken into account

• Cost of payments due in foreign currencies may change (the case of mining countries in a downward cycle or the opposite at the start of the cycle)

7EU Workshop Brussels 2014

II the fiscal space (4)

Internal borrowing from the banking system • Less risk than in the case of external borrowing

• Probable foreclosure effect due to the behavior of banks and the legal framework of loan transactions

• Actual burden on the state reduced by inflation but disincentive for savers (without indexation)

• Education to savings (Treasury bonds).

• Mobilization of hoarded money

8EU Workshop Brussels 2014

II The fiscal space (5)

Mobilisation of internal resources

• Need to reduce dependence on development aid

• Potential factor of the improvement of governance

• Poorest countries with poor ability to pay, difficulty in generating sufficient resources

8EU Workshop Brussels 2014

II the fiscal space (6)

• Seigniorage

• Minimum cost if not inflationary (virtuous)

• Virtuous seigniorage must be put at the service of the states (Morocco, Israel) and not retained by central banks.

• Major inflation risk (DRC with dollarisation)

• High economic and social cost of inflation (Latin America in the 80s)

• Inflation affects other GFOT items with knock-on effects (negative effects on revenue)

9EU Workshop Brussels 2014

II The notion of fiscal space (7)

• Public expenditure, crucial aggregate due to the volume of the resources concerned (20 to 30% of GDP)

• States are the main contractors

• Prevent ruptures in the expenditure cycle

• Need to consider the action of the state in an overall framework

• Optimise state action

10EU Workshop Brussels 2014

II the fiscal space (8)

• Improvement of the effectiveness of public spending

• Major guidelines to be given priority

• Margins of progress are considerable

• Progress underway but remains far from the one observed in terms of the mobilisation of internal resources.

• Positive effect on public resources in the form of: Tax compliance

Reduction in poverty and greater economic growth

11EU Workshop Brussels 2014

• Effectiveness of public spending: mechanisms available

• Strict application of usual budgetary procedures (network of public accounting, PEFA audit, etc.)

• Establishment of an instrument to ensure coherence of expenditure programmes (MTEF)

• output indicators

• Efficiency indicators with international benchmarking

II the fiscal space (9)

12EU Workshop Brussels 2014

Schém a 1: R eprésentation schém atique de l’espace budgéta ire

R éduction de lapauvreté

Seigneuriage

R essourcesexternes

R essourcesin ternes

D onsArrié rés in ternes,

externesEm prunts in ternes

Pré lèvem entspublics : im pôts,

tarifs...

E ffortfisca l

C ivism efisca l

Ba lancedes

paiem ents

Em pruntsexternes

C ro issance

O ffres de b iens e t deservices pub lics

1 12 111

3

4

56

7

8 8

9

1011

12

Augm entation del’e fficacité des

dépenses pub liques

13

III Tax potential and tax effort (1)

Structural factors (inelastic in the short term) determine the tax potential: “Natural” ability to pay

Economic policy determines the “tax effort “

Positive (negative) tax effort means higher (lower) tax performance than tax potential

14EU Workshop Brussels 2014

III tax potential and tax effort (2)

• Structural factors determining the tax potential:

• Opening up trade (+)

• Income per capita (+)

• Mining and oil exports (+) and (-) (depends on dependent variable)

• Part of the “hard to tax” : agricultural added value (-)

15EU Workshop Brussels 2014

III tax potential and tax effort

Economic policy determines the tax effort

• Tax policy stricto sensu (legislation, administration)

• Monetary and exchange policy (inflation)

• Budgetary policy (effectiveness of public spending)

• Institutional policy (decentralization)

• Legal framework (governance, transparency, contract security, etc.)

• Institutional stability (democracy)

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III tax potential and tax effort

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III tax potential and tax effort - Chad

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•Thank you for your attention

EU Workshop Brussels 2014