Already some 260 years ago, the great philosopher and economist Adam Smith noted:
“Little else is required to carry a state to the highest degree of opulence…but peace, easy taxes, and a tolerable administration of justice.”
It is striking that he singled out taxation alongside peace and justice as the key to a successful society. This insight is now more important than ever.
Today, I would like to take Adam Smith into our modern time and talk about two ingredients of taxation for successful 21st-century economies.
The first one is the ability of countries to generate robust government revenue. This is, of course, the lifeblood of modern states. This is what allows governments to provide public goods that support strong and durable growth.
The policeman on the beat, the nurse who is attending to a patient, the teacher who is inspiring young minds, the scientist who is conducting cutting-edge basic research: these are only some of the people who could not do their work without reliable government income.
Now, we all know that, right now, there is in many countries a pressing need to generate higher and more reliable revenue, although not necessarily for the same reason.
For example, oil exporting-countries are adapting to a new reality of low commodity prices. Developing economies need more domestically generated revenue to achieve the new Sustainable Development Goals. And some advanced economies, especially in Europe, need higher fiscal revenue to bolster their economic recovery and financial stability.
The second ingredient of successful 21st-century economies is international taxation. This is an essential means by which governments mobilize their revenues in a globalized economy.
Recent headlines about Google, Starbucks, or Ikea have underlined that an international tax system needs to work for everybody. We need a system that discourages the artificial shifting of profits and assets to low-tax locations. And we need a system that discourages overly aggressive tax competition among countries.
In other words, we need a tax system in which ordinary citizens are convinced that multinational companies and wealthy individuals are contributing a fair share to the public purse, to the common good.
While talking about these two angles of taxation, I would also like to highlight the role of the IMF in helping counties achieve the best possible form of government financing—one that is reliable, fair, and efficient.
1. Revenue Mobilization
So let us start with the first ingredient of successful 21st-century economies—revenue mobilization—which is on the minds of so many policymakers, especially in the Middle East and North Africa.
Higher government revenues would create much-needed fiscal room for maneuver and allow for more spending on all the things that drive potential growth over the medium term, including infrastructure, healthcare, and education. In addition, more reliable sources of revenue would help avoid volatility in public expenditure and pro-cyclical fiscal policy.
This is particularly important for oil-exporting countries that have been heavily affected by the recent plunge in oil prices.
Last year, for example, oil exporters in the MENA region lost more than US$340 billion in oil revenue from their budgets, amounting to 20 percent of their combined GDP.1
Not only have oil prices fallen by around two-thirds from their most recent peak, but supply and demand-side factors suggest that they are likely to stay low for an extended period. The size and likely persistence of this external shock means that all oil exporters will have to adjust by reducing spending and increasing revenue.
Of course, the fiscal adjustment needs vary from country to country. For instance, thanks to their prudent polices, most members of the Gulf Cooperation Council (GCC) are now in a position where they can pace their adjustment over several years and thus limit the impact on growth.
It is also worth remembering that GCC economies have made large fiscal adjustments in the past—and I am confident that they can do it again.
At the same time, these economies need to strengthen their fiscal frameworks and reengineer their tax systems—by reducing their heavy reliance on oil revenues and by boosting non-hydrocarbon sources of revenues.
This would help bolster growth and job creation and, at the same time, help to maintain debt sustainability and strengthen resilience. It also provides a unique opportunity to design tax systems that emphasize fairness, simplicity, and efficiency.
How can GCC countries achieve this?
• Start by putting in place a simple system that initially focuses on VAT—ideally, a harmonized regional VAT. Even at a low single-digit rate, such a tax could raise up to 2 percent of GDP.
• Add to this a greater emphasis on corporate income taxes, as well as property and excise taxes.
• And continue to invest in building tax administration capacity that could eventually allow for the introduction of personal income taxes.
Progress is already visible in many countries. In Kuwait, for example the IMF has assisted in the study and design of broad-based taxes, such as VAT and business profit tax.
This work has contributed to a national dialogue on why and how Kuwait should diversify its revenue sources. Proponents of reform argue—rightly—that this would allow the country to better manage the fiscal risks associated with volatile oil prices.
Middle-income oil importers & low-income countries
Likewise, many middle-income oil importers are also facing significant challenges in revenue mobilization and designing more equitable tax systems.
What about low-income countries?
In these economies, additional fiscal space is critically needed to provide the opportunity for greater investment in human capital and infrastructure.
New IMF research suggests that once the tax-to-GDP ratio reaches 12½ percent, real GDP per capita increases sharply.4 Countries should, therefore, aim to remain comfortably above this threshold—say, above 15 percent. In about half of all developing countries, tax ratios are below 15 percent of GDP—compared with 18 percent in emerging economies and 26 percent in advanced economies.5
This is why domestic revenue mobilization is an imperative for those countries that are seeking to achieve the new Sustainable Development Goals. It means implementing tax systems that are simple, broad-based, and fair.
Of course, it also means that—once revenues are raised—they must be spent efficiently and effectively in support of inclusive growth. Strong fiscal institutions and public financial management are essential.
These are areas in which the IMF is providing extensive technical assistance and capacity building every day.
2. International Taxation
Let me now turn to international taxation—another key ingredient of successful 21st-century economies.
As I noted previously, taxation is the tool that allows governments to mobilize their revenues. But these vital efforts can be undermined by overly aggressive tax competition among countries. This beggar-thy-neighbor strategy hurts everybody.
As you know, tax evasion and avoidance is not only hitting the headlines recently, but is also at the top of the global policy agenda. This reflects frustration in many countries at a time of rising fiscal pressures and modest global growth. It also reflects anger among many ordinary citizens around the world over rising inequality of income and wealth.
In fact, there is a widely shared recognition that too many multinational companies and wealthy individuals are “gaming” a creaking system of international taxation that is no longer fit for the modern global economy.
Let me be clear: significant progress has been made in recent years. A good example is the automatic exchange of taxpayer information among governments. This new global standard will make it harder for wealthy individuals to avoid income and wealth taxes by moving assets to offshore locations.
These low-tax locations have become part of the increasingly vigorous debate on excessive income and wealth inequality. According to one estimate, about 30 percent of Africa’s financial wealth is held offshore—and the percentages are thought to be even higher in some major oil-producing countries.
The BEPS project
On the corporate side, we have also seen significant progress. Let me highlight the recent agreement by the G20 on measures to prevent “base erosion and profit shifting”. This so-called BEPS project led by the OECD is an important step in the right direction, because it seeks to prevent multinational companies from artificially shifting profits to low-tax locations.
The OECD estimates that government revenue losses from this kind of tax avoidance have grown to as much as $240 billion a year, or 10 percent of global corporate income-tax receipts.
In other words, the BEPS project is good news for countries that are seeking to protect their national tax bases and bad news for corporate tax avoidance strategies.
Nevertheless, much more work needs to be done both in terms of substance and scope.
On substance, it is clear that the BEPS rules are designed to work within the traditional architecture for international taxation. This system was developed nearly a century ago for a world in which cross-border trade was far less important and took place almost entirely in physical goods. Today’s big challenges include the taxation of traded services and the shifting of intellectual property across borders.
This shift in the global economy is set to continue, and more value-added will likely come from services and intellectual property rather than fields and factories. This is why we need an international taxation system that is truly fit for the 21st century.
We also need a system that works for all economies. For example, a major effort has been made to include developing economies in the discussions that led to the BEPS rules. But these measures do not fully address some of the specific needs of these countries.
Their gains from curbing tax avoidance could be significant: estimates by IMF staff suggest that lost tax revenues in developing economies are equivalent to 1.3 percent of their GDP, compared with one percent in advanced economies.7
Of particular concern to developing economies is the indirect, offshore transfer of interests in certain assets—telecoms or mineral licenses spring to mind. In some cases, this practice has caused hundreds of millions of dollars in lost government revenue. This can be a huge blow to low-income countries that may already have fragile public finances.
The IMF has a special responsibility here because of our global membership and because of our ability to provide world-class technical assistance and training on a global scale.
Our key objective is to help develop approaches to all of these taxation issues that are relevant and appropriate for our low-income members. And we are not doing this alone, but very much in cooperation with our international partners: the World Bank, regional development banks, and the United Nations.
3. The Role of the IMF
Let me expand a little on the Fund’s role in achieving fair and reliable government financing—it is the unsung story of many small successes, one step at a time.
It is based on our unique experience of working with our member countries over more than 70 years. This gives us the ability to cover the full spectrum of fiscal issues—through our research, policy advice, and direct technical assistance and training. This is how we can address the specific needs of our 188 member countries.
The lion’s share of our technical assistance is provided to our low- and middle-income members. For example:
• We work with Ministries of Finance on their expenditure policy and public financial management so that high-quality public services are delivered in a transparent and cost-effective manner.
• We assist our members in establishing fiscal rules, strengthening public debt management, and managing natural resource wealth.
• And every year, we help more than 100 countries improve their domestic revenue mobilization—through analysis and hands-on assistance on tax policy and administration.
Over the past five years, our worldwide technical assistance on revenue mobilization has more than doubled—and we plan to further expand this work as we respond to strong demand from our members.
In this particular area of technical assistance, success often depends on a combination of political resolve and long-term commitment.
This why the Fund has developed deep, long-standing relationships with many of our low- and middle-income members—and I am pleased to say that these efforts have helped produce tangible results. Just to give you a few examples:
• In Kosovo, the Fund helped align the country’s tax administration with internationally recognized standards, including the introduction of electronic filing of tax returns. These measures allowed Kosovo to boost its tax revenue by 8 percent in 2013.
• In Peru, the IMF has over several years supported the government in adopting a more modern tax administration and improving revenue performance, especially on VAT. These reforms contributed to an increase in the tax-to-GDP ratio from 15 ½ percent in 2010 to 16 ½ in 2014.
• In Senegal, IMF technical assistance helped trigger a jump in the number of tax payers subject to VAT and led to a sharp increase in revenue collection from medium-sized enterprises. Senegal has used these fresh resources to drive growth and poverty reduction.
These are only some examples of where our technical assistance has helped to move the needle.
To be clear: while our members are learning from us, we constantly learn from them, too. We enrich our policy advice by making use of the wealth of data from our technical assistance work and our close links with our members on fiscal issues.
Both domestic revenue mobilization and international taxation will feature prominently in our Article IV reports over the next few years. It means that our insights from technical assistance will feed even more into our country surveillance work—which, in turn, will improve the effectiveness of our technical assistance.
This mutual learning process is taking place right now—right here at the Arab Fiscal Forum. For all of us, this is a unique opportunity to listen, learn, and engage in a regional dialogue on pressing revenue and tax policy issues.
Before we engage in these discussions, let me conclude by returning to Adam Smith, who wrote in the Wealth of Nations:
“Political economy…proposes two distinct objects: first, to provide a plentiful revenue or subsistence for the people…and secondly, to supply the state or commonwealth with a revenue sufficient for the public services.”
My main message today is this: creating successful 21st-century economies requires robust government revenues and an international tax system that works for everybody. These ingredients are essential for growth, fairness, and development.
They provide the fertile ground for the prosperity of nations. And we at the IMF are ready to play our part for the benefit of our membership.
SOurce: International Monetary Firm (IMF) Communications Department