World Bank Tax Advice

1
World Bank Tax Advice

• Does It Obstruct Equitable Development in Latin
  America?

2
The Problem

• Poverty and Inequality In Latin America
• Solution inclusive development

3
The Solution

• Progressive Taxation
• Additional tax revenue enables government to
  supply basic goods and services (BGS)
• Progressive taxation leaves disposable income for
  the poor to purchase BGS
• BGS enhance productivity and earnings

4
The Objectives

• Analyze World Bank tax advice.
• Derive tax policy.

5
Sources

• World Bank Web Page http//web.worldbank.org/WBSIT
  E/EXTERNAL/TOPICS/EXTPUBLICSECTORANDGOVERNANCE/EXT
  PUBLICFINANCE/EXTTPA/0,,contentMDK20233695menuPK
  390373pagePK148956piPK216618theSitePK390367
  ,00.html (9/6/2006)
• The World Bank, Lessons of Tax Reform (The World
  Bank) 1991.
• Wayne Thirsk, Tax Reform in Developing Countries,
  Chapter 1, Intellectual Foundations of Tax
  Reform (The World Bank, 1997)
• Norman Hicks. Sector Priorites in Meeting Basic
  Needs Some Statistical Evidence. World
  Development, Vol. 10, No. 6, pp. 489-499, 1982.

6
How to Design a Tax System

• 1. Determine Objectives
• Real World Circumstances
• E.g., fiscal deficits
• Construct a tax system that achieves the
  objectives
• E.g., Sales tax for revenue

7
World Bank Objectives

• First Objective Revenue

8
The Context

• Import Substitution Industrialization (ISI)
• Government investments
• Deficits
• Debt
• Default

9
The Context

• U.S. commercial banks in danger
• In 1982, the exposure of nine top U.S.-based
  banks to shaky foreign loans was twice the entire
  value of their own paid-in capital.
• Lindert, Peter and T.A. Pugel, International
  Economics, 570

10
The Context

• Inflation
• Average annual inflation rate in Bolivia,
  1980-1985 2,252
• Cause
• Governments printed money to pay fiscal
  deficits
• Effects
• Relatively expensive exports decline
• Lack foreign exchange to repay U.S. banks
• Growth slows
• Exports that earn foreign exchange to repay U.S.
  banks not produced
• No Growth during 1980s (Lost Decade)

11
First Tax Objective Revenue

• Increase revenue to deal with the crisis
• eliminate fiscal deficits and inflation
• To grow
• To earn foreign exchange
• To repay the debt

12
First Tax Objective Revenue

• How to contain and rationalize an over-expanded
  public sector has become one of the principal
  challenges facing many developing countries in
  recent years . . .
• (World Bank, Lessons, 2).

13
Tax Advice

• For Increasing Revenue

14
Value-Added Tax (VAT)

• Institute the VAT
• Revenue would be generated primarily by . . . a
  VAT.
• Lessons, Box 11, 57
• Relatively easy to administer
• Self-enforcing features reduce evasion
• Focus of administrative reform
• Reforma, Resumen 1

15
Income Tax

• Lower maximum marginal rates (uniform taxation)
• Reduce incentive to evade . . . for revenue
• Reduce exemptions (globalize)
• Broader base . . . for revenue
• Institute withholding . . . for revenue

16
First Objective Critique

• The recommended taxes are regressive
• The VAT is a regressive sales tax
• Lowering the maximum marginal rates of the income
  tax reduces its progressivity.

17
First Objective Critique

• A long-run policy designed to deal with a
  short-term financial crisis.
• Inappropriate for solving the long-run problem of
  poverty and inequality.
• Implied development policy
• I lead. You follow.

18
Second Objective Efficiency

• First after-thought

19
Excess Burden

• Excess Burden is the cost of taxation that arises
  from changing behavior
• Because of the tax, I buy a Chevy instead of a
  Cadillac.

20
Policy Efficient Tax System

• Defined
• The tax system that minimizes excess burden,
  i.e., changes of behavior

21
Theory of Optimal Taxation

• Aim minimize excess burden
• Conclusion
• The optimal tax system is progressive.
• Rosen, Public Finance, 343

22
Tax Advice for Excess Burden

• Nevertheless, World Bank recommends UNIFORM tax
  rates.
• Uniform
• Same rates paid by all
• Global (everybody pays)
• Thirsk

23
Tax Advice for Excess Burden

• How did the World Bank move from progressive to
  uniform taxation in the name of efficiency

24
Tax Advice for Excess Burden

• Uniform Taxation The Case
• The case rests primarily on practical rather
  than theoretical considerations
• Thirsk

25
Tax Advice for Excess Burden

• Uniform taxation The Case cont.
• All of the country studies adopt the rule of
  thumb that the cause of economic efficiency is
  best served by a less differentiated pattern of
  effective income tax rates
• Thirsk, 10

26
Tax Advice for Excess Burden

• Uniform taxation The Case cont.
• Information, administrative, and political
  requirements make it difficult to implement (a
  differentiated tax system).
• Thirsk, 10

27
Tax Advice for Excess Burden

• Uniform taxation The Case cont.
• Most of the observed non-uniformity prior to
  reform has been found to be non-optimal and
  highly distorting (inefficient).
• Thirsk 10

28
Tax Advice for Excess Burden

• Uniform taxation The Case cont.
• U.S. study concludes that the efficiency cost of
  uniform taxation of all types of capital income
  is small.
• Thirsk 9

29
Tax Advice for Excess Burden

• Uniform taxation the Case cont.
• Reduce exemptions to discourage resource shifts
  to low tax areas
• Thirsk 9

30
Tax Advice for Excess Burden

• Substitute VAT for cascade taxes
• A cascade tax is a tax on all sales (including
  intermediate goods)
• distorts relative prices.

31
Tax Advice for Excess Burden

• Income Tax
• More uniform rates
• Fewer tax incentives

32
Critique Concept of Efficiency

• The WB first designs a tax system for quick and
  easy revenue.
• Second it reinterprets efficiency to produce
  policy that conforms to its initial
  recommendations

33
Critique Concept of Efficiency

• . . . tax reform, in tandem with cuts in public
  expenditure, may be needed to generate public
  revenue in a reasonably non-distorting,
  equitable, and sustainable manner.

34
Critique Concept of Efficiency

• Empirical evidence on the cost of excess burden
  is weak.
• Reliable estimates of the efficiency costs of
  taxation in developing countries are rare.
• One study of the U.S. in the early 1980s
  concluded that they are high
• Lessons, 3

35
Critique Definition of Efficiency

• Excess burden is an inadequate definition of
  efficiency
• It ignores the inefficiency of under-utilizing
  human resources by not satisfying basic needs.
• Or its interpretation ignores the changes in
  behavior generated by not satisfying BN.

36
Critique Uniform Taxation

• The correct policy
• eliminate inefficient tax differentiation . . .
• for political reasons
• . . . and institute efficient tax
  differentiation.
• For satisfying basic needs

37
Third Objective Administration

• Second After-thought

38
Importance

• Tax administration is (de facto) tax policy

39
The case

• Grave lack of capacity
• Thirsk, 10
• Unnecessary complexity of tax systems
• Small taxes in which cost revenue

40
Advice

• Simplify the tax system
• Tax uniformity (Reduce progressivity of
  progressive taxes)
• VAT (Regressive)

41
Advice

• Improve administration
• Computerized information systems
• Training
• Salaries
• Use of banking system for collection
• Withholding

42
Critique Undue Pessimism?

• Regressive taxation is defended because tax
  administration is hopelessly inadequate.
• But administrative improvements are advised,
  cited and commended.

43
Fourth Objective Equity

• Third After-thought

44
Tax Advice

• Uniform taxation
• Exempt items consumed by the poor from the VAT.
• E.g., non-processed food
• High VAT rate on luxury items.
• Income tax exemptions for the poor.

45
Tax Advice The Rationale

• Uniform taxation enhances horizontal equity.
• Thirsk 10, 15
• Horizontal equity everyone with the same
  income pays the same tax.

46
Tax Advice The Rationale

• If developing countries are unable to make
  personal income taxes work effectively (because
  of tax evasion, accounting difficulties, long
  collection lags, and other enforcement problems),
  it may be the better part of wisdom to aim
  instead for the achievement of an efficient
  indirect tax system and use its revenues to
  finance targeted subsidies for the poor.
  Ultimately it is fiscal rather than tax incidence
  that affects peoples welfare.
• Thirsk, 15

47
Tax Advice The Rationale

• Progressive taxation has not worked.
• Therefore, it cannot be done.
• Therefore, focus on expenditures.

48
Tax Advice The Rationale

• In none of the countries studied has a
  pre-reform schedule of progressive tax rates
  successfully generated a progressive distribution
  of tax burdens.
• Thirsk, 15

49
1st Critique Undue Pessimism

• Undue pessimism about the ability to establish
  progressive taxation.
• What if Dr. Martin Luther King had said We have
  been the object of racism for 200 years. Nothing
  can be done?

50
1st Critique Undue Pessimism

• It is technically possible to establish
  progressive taxation through
• Presumptive taxation.
• Administrative reform.
• Outside pressure from WB and others.

51
2nd Critique Concept of Equity

• Redefine equity to conform to tax advice
• Virtually abandons vertical equity
• (fair distribution of tax burden between persons
  with different incomes).

52
2nd Critique Concept of Equity

• For WB, equity fair distribution of tax
  burden.
• Better distribution of tax burden that
  generates equitable (inclusive) development.

53
3rd Critique Politics

• The regressive tax advice misjudges political
  reaction by oligarchies to the advice.
• Misrule for 500 years
• Culture of domination
• Seize the opportunity for retrenchment
• Use new power to cut, not expand, expenditures
  for the poor.
• Deepen exclusive, not inclusive, development.

54
3rd Critique Politics

• World Bank
• Dominated by industrialized countries whose
  immediate concern was to save the banking system?
• Why has the international institution whose
  mission is development not adopted the tax
  objective of inclusive development?
• Instrument of control.

55
4th Critique VAT Exemptions

• None of the reforms examined appear to have
  achieved notable success in reducing indirect tax
  burdens on the poor, although . . . most
  countries (examined) try to remove some of the
  VAT burden on the poor by either exempting . . .
  Unprocessed food products.
• Thirsk 24

56
EMPIRICAL RESEARCH
57
Research Hypotheses

• Progressive Taxation enhances the satisfaction of
  basic needs.
• Raises the revenue necessary to pay for basic
  goods and services. . .
• While leaving the poor with more money to
  purchase BN
• Tax and BGS Data

58
Research Hypotheses

• Uniform taxation does not reduce evasion
• Evasion of the income tax is a function of
  administration and political domination, not
  taxation.

59
Research Hypotheses

• The tax advice has been exploited to retrench the
  oligarchies.
• The VAT has been emphasized relative to the
  income tax.
• Few exemptions
• Revenues have not been used to satisfy BN
• Evasion not reduced

60
Research Hypotheses

• Presumptive taxation can enhance progressivity.