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 30000 35000 40000

Per capita GDP (PPP)

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

 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 Non-
GDP 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
100%
taxes
80%
Taxes on goods and
60% services
40% Taxes on income,
20% profits and capital
gains
0% Taxes on
OECD

World
Asia &
South

international trade
Asia
East

Nontax revenue
 Revenue Structures in SAR and
EAP Countries
Revenue (% of GDP) in SAR and EAP Countries
35 Other taxes
30
25 Taxes on international
20 trade

15 Taxes on income,
10 profits and capital gains

5 Taxes on goods and

0 services
Malaysia
Pakistan

Sri Lanka
Bangladesh

Maldives
Philippines
Mongolia

Thailand

Singapore
Indonesia
Nepal

India

China
Vanuatu
Papua New

Korea, Rep.
Vietnam

Bhutan
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
 Different abilities to impose and
collect taxes
 Other revenue sources
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
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
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
Criteria for Evaluating Taxes

 Revenue productivity
 Efficiency
 Fairness
 Administrative feasibility
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
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

 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
 Tax incidence
 Actual vs. perceived fairness
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
Administrative Feasibility

 Cost of collection
 Cost of compliance
– To taxpayers
– To third-parties
 Cost of enforcement
 Designing rules and regulations
 Challenges to tax administration
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?
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
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
 India: Centre vs state revenues
2001-2 vs 1990-1
Centre 2001-02 Tax States 2001-02
Capital
Capital Revenue
Receipts
Receipts 37%
32%
44%
Non-tax Non-tax Tax
Revenue Revenue Revenue
19% 6% 62%

Centre 1990-91 States 1990-91

Capital Capital
Tax
Receipts Receipts
Revenue
42% Non-tax 13%
45%
Revenue
Non-tax
11% Tax
Revenue
Revenue
13%
76%
Tax Decentralization

 Ownership of tax revenues

 Choice of tax base
 Choice of tax rate
 Responsibility and coordination of
tax administration
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
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
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’