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Proud to Pay

Posted on the 17 April 2012 by Center For International Private Enterprise @CIPEglobal
Proud to Pay

(Photo credit: Dave Dugdale)

Today, April 17, is the deadline for those of us in the U.S. to file our taxes. This morning I awoke to the following topical comment on Twitter:

@Jenbo1:  I was positive that today would be a cranky day, and then I remembered it’s tax day! We take care of each other en masse today. #proudtopay 

As former U.S. Chief Justice Oliver Wendell Holmes, Jr. put it,  taxes are what we pay for a civilized society.

Around the world, however, this economic relationship is not a given. In many developing countries, poorly designed tax policies both decrease funds available to finance development projects as well as create burdens for small and medium enterprises.

Among actors in the private sector, it is difficult to collect taxes from informal entrepreneurs and multinational companies alike. Informal entrepreneurs are, by definition, not officially registered and thus tax authorities have no record of them. It is likely true, however, that paying taxes would create such pressure on their small businesses that they might not be able to survive. Furthermore, the amount they would contribute to their national treasuries is relatively small.

On the other hand, large scale tax avoidance is a common practice among multinational companies operating around the world.  Offshore financial centers – also known as tax havens – provide destinations for multinational companies looking to minimize their tax burdens. It is estimated that developing countries lose three times more money to tax havens every year than they receive in official development assistance. In some cases tax administrations do not have the capacity to prevent this behavior, but many tax policies often allow this to occur. Indeed, tax avoidance (unlike tax evasion) is perfectly legal – it just has detrimental effects for raising revenue for public services.

While it might seem that allowing tax avoidance helps attract the foreign investment that developing countries so often seek, tax incentives are not what ultimately drive investment. According to the International Monetary Fund:

…[F]oreign investors, the primary target of most tax incentives, base their decision to enter a country on a whole host of factors (such as natural resources, political stability, transparent regulatory systems, infrastructure, a skilled workforce), of which tax incentives are frequently far from being the most important one.

The structure of tax systems is about more than business decisions or public revenue. Unproductive tax policies entail a failure in the relationship between states and stakeholders. A lack of tax revenue decreases funds for important public services such as hospitals, schools, and roads. In other words, ineffective tax systems impede the ability of people to take care of each other.

Of course, the problem is not just in tax systems – a lack of transparency in public procurement can make taxes unsavory. If governments are not efficiently providing public services, why would anyone want to pay taxes for them? Some even consider taxes a violation of private property rights. Therefore, it is clear that there has to be a balance between tax collection and the perceived benefits that taxes bring.

Each country has its own unique tax challenges, and their significance cannot be underestimated. Tax revenue has the potential to decrease developing countries’ reliance on foreign aid and thus it could lead to economically sustainable development. I would argue that this is one of the most pressing challenges facing development today.

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