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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 Per capita GDP (PPP) 30000 35000 40000 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 NonGDP 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 taxes 100% 80% Taxes on goods and services 60% 40% 20% World OECD East Asia & South Asia 0% Taxes on income, profits and capital gains Taxes on international trade Nontax revenue Revenue Structures in SAR and EAP Countries Revenue (% of GDP) in SAR and EAP Countries Other taxes Taxes on international trade Taxes on income, profits and capital gains Taxes on goods and services Nepal Bangladesh Mongolia Pakistan Vietnam Papua New India Indonesia Sri Lanka Vanuatu China Philippines Thailand Malaysia Korea, Rep. Singapore Bhutan Maldives 35 30 25 20 15 10 5 0 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 Capital Receipts 44% Tax Revenue 37% Non-tax Revenue 19% Centre 1990-91 Capital Receipts 42% Capital Receipts 32% Tax Revenue 62% Non-tax Revenue 6% States 1990-91 Tax Revenue 45% Non-tax Revenue 13% States 2001-02 Non-tax Revenue 11% Capital Receipts 13% Tax Revenue 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 valueadded – 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’