Revenue Policy, Revenue

Administration, and Decentralization

Public Finance and Management Course, World Bank, April 23,

2007Richard M. Bird

Overview Revenue-expenditure linkages

Macro – Fiscal space: MTFF, stabilization, elasticity

Micro – decentralization, earmarking, charges Questions considered

Who pays? How? What difference does it make?

Potential Sources of Revenue Charges and fees Earnings – SOEs, etc. Regulatory taxes Seignorage Inflation tax Borrowing General taxation

For Example - User Charges

In principle, user charges for services are excellent sources of revenue, especially local revenue

They are economically efficient They can also be fair and equitable

User ChargesBut in practice, they are not used as

extensively as they should be and are seldom well-designed.

Too often, user charges are Inefficient Inequitable Costly to administer

User ChargesThese problems arise largely because most user

charges are imposed simply for revenue purposes with no real attention to their design.

Moreover, even well-designed charges are seldom politically popular, especially if they are imposed for a service that has previously been under-priced.

User ChargesHow to Do It – in principle

1. Impose charges only where it pays to do so – especially public utilities such as water and electricity

2. Design such charges efficiently3. Ensure public acceptance of charges e.g.

through attention to distributional aspects4. Avoid “nuisance” charges

Why Introducing or Increasing User Charges is Tricky in Practice You have to

Know the product Know the data Adjust data as necessary Set the prices Justify any subsidy clearly Think through how to implement it And, importantly, sell the scheme to both clients and

suppliers

Of course can say much the same about any change in revenue policy but budgetary impacts usually larger so more likely to pay attention to (most of) these points

Turning to Taxes: 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?

Tax revenue (% of GDP)

0

5

10

15

20

25

30

35

40

45

50

0 5000 10000 15000 20000 25000 30000 35000 40000

Per capita GDP (PPP)

The Tax Burden

18.3%

22.5%

29.4%

23.2%

0%

5%

10%

15%

20%

25%

30%

35%

Low Middle High Total$0 - $4999 $5000 - $19999 $20000 +

Tax Revenue as a Percentage of GDP by GDP/Capita Category, 1999-2001

Tax Capacity (2001)

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

Tax Instruments:Regional Differences in Reliance

Latin America: Percentage of Total Tax Revenue, 1975-2002

0%

10%

20%

30%

40%

50%

60%

1975-1980 1986-1992 1996-2002

IncomeDomestic ConsumptionInternational TradeSocial Security

Tax Instruments:Regional Differences in Reliance

Africa: Percentage of Total Tax Revenue, 1975-2002

0%

5%

10%

15%

20%

25%

30%

35%

40%

1975-1980 1986-1992 1996-2002

Income Domestic ConsumptionInternational Trade Social Security

Relative Use of Different Tax Instruments... Factors influencing relative mix of different

tax instruments Revenue considerations Administrative considerations Fairness considerations Transition and political considerations

Trends in Tax Reform Increased reliance on VAT Increased pressure to reduce trade taxes Increased tax competition for foreign

investment Reduction in top tax rates under individual

income tax system Reduction in top tax rates under business

profits tax Flat taxes?

Predictions for Future Tax design will be largely dictated by domestic

considerations But no tax system can now be designed without

regard to tax systems of other countries Globalization will increase challenges in taxing

income from capital Possibly ….regional cooperation may lead to

increased harmonization of tax systems

What Can Taxes Do? Raise revenue to fund government

operations Assist in redistribution of wealth or income Encourage or discourage certain activities But always at some cost in terms of

efficiency and growth

Competing Government

Objectives What considerations exist in choosing

among the different objectives? The real and perceived role of taxes in

Encouraging economic growth Reducing disparity between the rich and the

poor Reducing poverty Sharing the cost of government fairly Favoring the ‘good’, discouraging the ‘bad’ –

one must walk very carefully in these treacherous grounds

Criteria for Evaluating Taxes

Revenue productivity Efficiency Fairness Administrative feasibility As an available policy instrument – Yes,

but…..

The cost of collecting taxes

Costs of taxation Excess burden of taxes Excess burden of tax evasion Tax administration costs Compliance - and avoidance - costs. Psychic and social costs?

Efficiency Taxes influence behavior

Work vs. leisure Save vs. spend Choice of products Choice of organizational and financial structure Choice of location for investment Operate in formal economy vs. operate in informal economy

“Deadweight” or “distortion” costs Almost all taxes distort Costs are real costs—especially for economies where resources

are scarce Focus on minimizing tax costs

Minimizing Deadweight Costs of Taxation is not a simple OT problem 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 BBLR vs. interventionist strategy?

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 – perceptions

are reality in politics

Costs of Redistribution through Taxation Trade-off of equity and efficiency Costs of higher tax rates depends in part

on the elasticity of wage supply – and on that of capital

Capital flight – into gray or black economy or out of the country

Tax Policy and Tax Administration Tax policy + no administration = 0 No policy + administration = ‘policy’ Tax policy + administration = real policy

Task of Tax Administration How much administration? – setting the

budget: Lessons from history and experience?

How to administer? – organization (RA, LTO, etc.) and strategy

How far to push it? – choices at the margin

Benchmarking: The Concept

Standards or norms: Tax system performance Tax structure Tax administration structures Tax administration resources Tax administration IT systems

What is benchmarked, and how? Tax structure and performance Organization Legal framework Enforcement Collections Systems and resources

Example:Tax structure and performance No. of taxes comprising 75% of total % of taxpayers providing 75% of total Tax ratio Indirect as % total No. of tax rates VAT rates VAT collections as % total Administrative cost VAT productivity IT productivity

Example: Enforcement Taxpayer current account Unbiased audit selection Auditors as % staff Use of external data Stop-filers as % active filers Crossing information among taxes No. of officials per 1000 population Active taxpayers per official Performance indicators for auditors % taxpayers subject to audit Unified audit

Inputs

Framework

Systems

Environment

Transformation

Management

ProductivityEfficiency

The Revenue Process

Uses and Limits of Benchmarking Uses

To reduce subjectivity of comparative exercises

To help detect and understand problem areas To uncover information gaps To help determine reform strategy

Limitations Must be collaboratively derived, not imposed Need to factor in critical environmental factors Inevitable bias towards quantifiable

What Have We Learned? Know the environment – economic, legal,

‘social capital’, Keep it simple Taxpayers as “clients” – the marketing

problem of self-assessed systems

Tax Administration Reform

The will to do it – A Champion Strategy – IT is not the answer (but it is

usually part of it); nor are RAs Matching the Task to Resources Tax Architecture, Tax Engineering, and

Tax Management A Problem in Risk Management

Facilitating Compliance Identification – finding taxpayers Assessment – determining tax bases Collection – getting the revenue Service – too often forgotten but a critical

investment

What are Compliance Costs? Citizen’s costs of meeting tax obligations Excludes actual taxes paid and excess

burdens. Includes avoidance (“tax planning”) and

evasion costs. Includes costs of taxpayers, non-filers,

third parties (banks, tax withholders, helping others)

Administration costs versus CCs Substitutes…usually Other things equal, social cost

considerations should dictate the choice between compliance requirements and administration responsibilities EG: Official versus self-assessment

Other things may not be equal… Documents enclosed with tax returns Desk versus field audits, etc.

International evidence: Business income taxes

Keeping Taxpayers Honest Know the problem – know your clients;

estimate tax gaps Monitor closely – registration, filing,

payment, appeal Enforce – penalties, dispute settlement

Controlling Corruption Incentives – C=M +D – A: limit

opportunities, raise opportunity costs (positive and negative)

Training – professionalism Organization – performance evaluation,

etc. Monitoring – internal audit, etc.

Taxes and Decentralization Increasingly important to focus on

assigning taxing and spending authority to lower levels of government

Decentralization may improve government service by increasing accountability

Not a panacea, but a potentially important linkage fostering ‘trust’

Overview of Decentralization The what, why, and why not of

decentralization How to do it: a case study Financing sub-national government Some questions for discussion

To Decentralize or Not to

Decentralize?Is it really the question? Decentralization is seldom ‘chosen’Perhaps it should be…the economics…But no one gives up power easily and that’s what it’s really about: who decides what?

Choosing decentralization?

Some countries are born decentralized Some choose to become decentralized And some have decentralization thrust upon them –

for many diverse reasons But no matter why a country is (to some degree)

decentralized, it has to work out just what decentralization means and how to do it.

Modes of Decentralization Administrative decentralization – the

centre decides, the regions and localities administer

Political decentralization – sub-national governments decide

Fiscal decentralization Done right: how to make political

decentralization efficient and effective Done wrong: how to make a mess of things –

by decentralizing the wrong things or doing the right things badly

Potential Benefits Efficiency gains

The right services to the right people in the right amounts Creating incentives for growth

‘Laboratory’ for innovation More heads are better than fewer Learning from success…and failure

Revenue mobilization – broaden the base? Political aspects

Improve governance Restoring (or redressing) regional balance Helping to build (or rebuild, or hold together) a nation

Potential Costs Macroeconomic concerns

Runaway deficits Unsustainable borrowing

Equity concerns More local revenues increase regional imbalance Is local control helpful or harmful to the poor?

Efficiency and effectiveness – can LG really do the job? Capacity – can LG really do the job? Critical infrastructure from a national perspective Corruption – more …or less? Political concerns – exit and loyalty

Striking the Balance Much discussion but little solid evidence Complex, multi-faceted issue Some general ‘lessons’

Make rules clear to all Finance follows function Need for financial control system

Hard budget constraint - accountability Some local revenue flexibility Get intergovernmental transfers right Borrowing – keep an eye open for problems

Asymmetry – the big, the small and those in-between Universal problems, local solutions Strategy, process (‘buy-in’), time…..

How to Decentralize Make local government responsible for

some appropriate services and some appropriate revenues – get the balance right

Make LG accountable to local people - and also to central government through good financial management system

Let LG decide priorities

How to Do It Successfully Seize on local willingness to act Build trust within LG and between LG and

CG At the same time build legitimacy and

sustainability for system Communicate, communicate,

communicate

Fiscal Decentralization: The basic questions Who should do what? How should it be accounted for? Who should pay? Determining local revenue sources Closing the ‘fiscal gap’ and designing

intergovernmental transfers What is role of borrowing?

What taxes for SNG? Common criteria

Revenue adequacy, buoyancy Correspondence principle, local accountability Administrative and compliance cost Latitude for corruption Political acceptability Distortionary impact Effects on regional disparities Equity

Usual results User fees, property taxes (esp. residential) Business taxes? Sales and income taxes – not in most cases

Conclusion – usually unimportant or transfer dependent

What powers should LG have?

To decide what taxes and charges to levy? To decide what rates to impose? To identify and assess taxes? To bill and collect taxes? To spend the proceeds freely?

Local Tax Administration Is it necessary?

Not for any economic purpose. What sub-national governments need are taxes for which they are economically and politically accountable – but this does not require that they necessarily administer such taxes.

Is it desirable?There may be some informational and accountability advantages.If others administer local taxes, will the money come to local government?

Is it feasible?But there may also be serious resource and political constraints on local capacity to

administer many taxes well.Consider splitting the task? (e.g. assessment)

Improving local government accountability Financial accounting –the essential base

Framework laws Training, pilot projects Budgeting, reporting, auditing

Monitoring – Error correction Policy, analysis, audit, feedback Dealing with hard cases

Transparency and democracy

Fiscal transfers Close the ‘fiscal gap’ Equalize fiscal capacity and need Adjust for spillovers Increase leverage of central expenditures Serve political ends Key point is that transfers are instruments:

it’s outcomes that matter

Closing the Gap Change revenue and/or expenditure

assignments Control/restrain local spending Enhance local fiscal effort Any form of fiscal transfer?

Equalization A matter of taste Equalize governments, not people. If

concern is poverty alleviation, transfers are not the way to go

Unconditional – let them spend as they wish?

Avoid ‘fiscal dentistry’ – capacity measure is the (seldom used) key

Some Key Design Issues The ‘distributable pool’ Formulas incorporating elements related

to objectives Objectives drive design Nothing stays the same Should everyone be treated the same?

Borrowing Borrowing for local capital investment

sometimes makes sense…when it is possible (capital markets exist) and when bailouts are ruled out (so that HBC is in place).

Usually, however, neither of these provisos holds, so any borrowing needs to be carefully watched

Back to the National Level. A Last Look at Tax Reform: The Key Questions What is to be done? How is it to be done? Who is to do it? When is it to be done? What will happen as a result?

Lessons from Developed Countries Need for a Champion Both Wrapping and Contents of Package

Matter Visible benefits essential Adequate discussion – virtues and

limitations (from tax reform perspective) of democracy

Lessons from Developing Countries Timing, timing, timing Simplify – don’t “complify” Sequencing and Scope Clarity (versus the political advantages of keeping

tax matters in ‘decent obscurity’) Details matter Incrementalism Politics…always and everywhere There is No Such Thing as a ‘Politician-Proof

Policy’: but should there be?

An Example: 30 Years of Reform in Colombia Gradualism Duration Education Did it Matter? The Question of ‘Fiscal

Equilibrium’

Conclusion The Optimist - ‘Taxes are the price we pay

for civilized society’ The Pessimist - ‘To tax and be loved is not

possible’ The Realist? -‘Above all, do no harm – or at

least as little as possible’ The Realistic Optimist – Focus on

improving the knowledge base and capacity for countries to solve their own problems – NOSFA rules!