Doing a big Alaska: the case for a global social protection fund

Olivier de Schutter, the UN’s special rapporteur on the right to food, is consistently interesting and provocative. This call to action is currently circulating on the interwebs (although the paper it’s based on came out last October):

‘If protecting human rights could be translated into a single political action, the creation of comprehensive social protection schemes would be it.

Health care, unemployment insurance, food aid, disability benefits: these are some of the services that characterise durable human development and distinguish today’s most prosperous societies from those living one hundred, or even fifty, years ago.

Yet many of the world’s poorer states have not adopted anything like a comprehensive social safety net. Some 80% of the world’s poorest people remain without any access to basic security against poverty and the risks associated with illness, old age, or unemployment. In low-income countries a small increase in food prices can leave the poorest no longer able to put food on the table. Worse, they cannot turn to the State for help. The injustice is particularly acute if considered that, for as little as 2 per cent of global GDP, basic social protection could be provided to all of the world’s poor.

So why are we not achieving faster progress in the establishment of social protection schemes in developing countries? Some countries have failed to invest in social protection because the development models supported by major international institutions have pushed States to lower government spending and reduce the size of the State. Elsewhere it is limited infrastructure and a low ability of local populations to pay into a contributory system that holds States back.

But for others, particularly least developed countries, the main disincentive is the risk of economic or environmental shocks. In small developing countries a large portion of the population is often susceptible to the same risks of natural disasters, epidemic diseases or extreme food price increases, leading to simultaneous surges in demand for social protection and decreases in State export and taxation revenues. States have a legitimate concern that they will not be able to pay out – or will be bankrupted in the process of doing so.

But social protection is too crucial a building block of development to be allowed to fall asunder on this uncertainty, and the multiplier effects of a decent social safety net – for human development and sustained economic growth – are too great to miss out on.

Global solidarity is needed to break the deadlock.  Wealthier nations must assist States for whom the costs are too big to absorb alone. The Global Fund for Social Protection that I have proposed, alongside Magdalena Sepúlveda, UN Special Rapporteur for Extreme Poverty and Human Rights, would allow poorer States to draw on international funding to meet the basic costs of putting social protection in place, while the Fund could also be called upon to underwrite these schemes against the risks of excess demand triggered by major shocks.

States can no longer claim to believe in human rights protection while failing to invest in social protection, for the two are intimately linked. There are many ways and means of funding a decent social safety net – now we need the political will.’

De Schutter’s missive dropped into my inbox just as I was having similar conversations here in South Africa about the case for a universal Basic Income Grant. Could it be funded from mining royalties, people were wondering? I told them to look up the CGD’s ‘oil to cash’ proposal for just that. Call it ‘doing an Alaska’. The CGD/South African proposals are national, de Schutter’s global. One obvious problem with the global proposal is the lack of discussion on how it could be funded. ‘As little as 2% of global GDP’ works out at $1.4 trillion – 10 times the global aid budget. You would probably need to put together all the proposals for international taxation (on financial transactions, arms trade, airlines etc) to pull it off, and what kind of political coalition is going to do that? Which probably explains the lazy reference to ‘political will’ at the end of de Schutter’s email. Politically, doing an Alaska at national level looks a lot more realistic.

And here’s CGD’s Todd Moss trying to do a Hans Rosling in a 4m video explaining oil to cash.

Is taxation better than aid for state-building? The case of Somaliland

Domestic taxation is one of those absolutely crucial development issues that too often drop through the cracks. It’s important not just because, at a time of huge pressure on aid budgets, it is a vital source of ‘financing for development’, but also because taxation has been at the heart of politics and state-building, ever since the creation of nation states in Europe and the ‘no taxation without representation’ cry of the American Revolution.

That neglect seems to be ending– increasing numbers of development actors are picking up on taxation (see this recent report of a meeting at ODI); DFID has funded one of its big five year development research centres on Tax and Development, led by the excellent Mick Moore; NGOs are campaigning on international tax issues like multinational tax evasion, tax havens and the Robin Hood Tax, but are also starting to think through the potential of domestic tax campaigning in developing countries.

So I’m sure the day will come when NGOs are lining up with their partners to campaign in favour of progressive taxation, denouncing domestic tax evaders etc etc (OK, this may not work in the US…). Weird that it isn’t already happening (do tell me if it is, and where, and whether it’s just about bashing transnationals or something more comprehensive).

If you want to understand why this matters, a good place to start is a fascinating recent paper by Nicholas Eubank, a PhD student at Stanford, about the role of taxation in an unsung development success story – Somaliland. Eubank’s thesis is controversial – that Somaliland’s ineligibility for aid forced the fledgling government to rely on local tax revenues, especially from customs and business. That in turn forced it into ‘revenue bargaining’, accepting a series of checks and balances that laid the basis for political stability and democracy.

Somaliland was formed out of northern Somalia, seceding from the Somali state that collapsed in 1991. As international bodies dislike secession (it encourages the others), that means Somaliland never got official aid (although it receives a fair bit of aid through non-government channels). After secession, several years of struggle and conflict ensued that could easily have led to a typical fragile/failed state result with a vicious circle of political instability, conflict and suffering. Instead, Somaliland’s rulers got their act together, and through a series of negotiations and national conferences, developed a stable set of institutions combining modern (presidential and parliamentary systems) and traditional (a council of clan elders as the second chamber). A new constitution was agreed in 2001 with broad public support. Since then there have been multiple peaceful turnovers of power.

The place is still poor, and health and education are patchy, but the country is progressing, opening up an ever wider gap with the dire situation across the border in Somalia. Human Rights Watch sums up its achievements as ‘both improbable and deeply impressive.’

How did this happen? According to Eubank, the absence of aid flows played a crucial role. It meant the government had to rely on local sources of finance, and to gain access to them, had to negotiate with those (other clans, businesses, an extensive diaspora that generates more dollars than all the country’s exports) who controlled the main areas of economic activity, like the ports. The result of this revenue bargaining was an inclusive political contract and enduring stability.

So is this an anti-aid argument? Eubank says not (or not totally, anyway):

‘This exploration is not meant as advocacy against foreign assistance. Recent studies have shown that foreign assistance has both costs and benefits, and if the international community wishes to best serve the countries it is aiming to help, it is imperative that it strive to understand the possible negative effects of its efforts so that it can design better policies that minimise these effects, and properly balance aid’s benefits against any unavoidable downsides.’

Aid has to be aware of its impact on the social contract between citizens and states. It can undermine that, by freeing a government from having to listen to its citizens. But it can also strengthen it, as with the current UK government’s commitment to allocate 5% of any direct funding to governments for accountability exercises by parliaments, civil society organizations etc. It’s also worth mentioning some striking counterexamples - good pro-aid stories such as its central role in the take-off of Africa’s other unsung success story, Botswana.

I’ve never been to Somaliland, and the paper appears to have been written entirely from secondary sources, so I am fully prepared to hear that things aren’t as rosy as Eubank paints them. For example, the paper only discusses intra-elite bargains and gives no impression of the extent to which poor Somalilanders (men and women) have benefited (beyond the important gain of not having to live in the middle of a civil war). Nor the costs in the shape of the foregone public services that aid might have paid for. Over to you to fill in the gaps.

Robin Hood: the long view from Ha-Joon Chang (and me)

This appeared in today’s Guardian and on its Comment is Free site yesterday. CiF is notable for the number and vehemence of comments, many of them slightly unhinged. 100 comments in the first two hours is about par for the course, evoking images of lots of angry people in bedsits and offices bashing away at their keyboards. Keeps them off the streets, I suppose.

Robin Hood: a tax whose time has come

Ha-Joon Chang and Duncan Green

The benefits of a tax on financial transactions are now so widely accepted that future generations will ask what took us so long

“In 1816, the British parliament repealed the temporary income tax that William Pitt the Younger had introduced in 1789 to finance the Napoleonic war. The MPs hated the tax so much that they even agreed that all documents connected with it should be collected, cut into pieces and pulped.

When the income tax was reintroduced in Britain in 1842 by Robert Peel, everyone considered it a temporary measure to replenish the depleted exchequer. But despite generations of politicians after Peel promising to abolish it, the tax never went away.

It proved impossible to abandon a tax whose time had come.

By the time Benjamin Disraeli and William Gladstone kept breaking their promises to abolish the income tax (one of the few things they agreed on), the homespun capitalism of the 18th century had already given way to a more organised form of capitalism.

With economic development, the social division of labour was becoming more and more sophisticated, increasing the importance of collective inputs such as infrastructure and education. A more effective provision of collective goods required a well-financed state, for which an income tax was seen as a new vital ingredient.

As they too developed, countries such as the US and Sweden followed suit. Today, the income tax is the biggest source of government revenue in most rich countries.

The same destiny may now await the Financial Transactions Tax (FTT) – or Robin Hood tax, as it is widely known. Although the French government, which chaired meetings of the G20 finance ministers and the IMF/World Bank member states last weekend, supports a global FTT, American opposition means that initial progress is more likely within a smaller “coalition of the willing”, including France, Germany, and South Africa. French and German support may ensure that the eurozone is the first international forum that agrees an FTT.

Even a decade ago, when it was doing the rounds under the alias of “Tobin tax” (named after James Tobin, the Nobel laureate economist who first raised the idea), the levy was an absolute taboo in polite society. But after the great financial crash of 2008, the case for it is looking “obvious” to many, as indeed the income tax did in the late 19th century. Its time, too, has come.

This levy on financial transactions, even at the very low level that is currently proposed (0.05%), is expected to slow down the most speculative elements of international capital flows and raise the significant sums needed to provide the newly required global collective goods – especially green technologies and development aid.

Of course, the FTT alone will not achieve much in terms of stabilising our financial system. It needs to be implemented as a part of a comprehensive package.

First, countries that cannot issue “hard currencies” should be allowed to use capital controls. The significant change of position by the IMF in this regard following the 2008 crisis is encouraging, but capital controls should be seen as normal policy tools – rather than a measure of last resort, as the IMF still suggests.

Second, we have to reform the rating agencies. Despite their incompetence and even cynicism, revealed both in the 1997 Asian crisis and in the 2008 crisis, these agencies are still deciding what is a good financial asset and dictating how governments should conduct their policies – not just fiscal policies but also monetary and social welfare policies. They need to be regulated more heavily, and a non-profit public agency should be set up to provide a credible alternative to their ratings.

Third, if we are serious about the revenue implications of our financial policy, tax havens need to be reined in, if not totally abolished. That single act would generate sums on a par with a global FTT.

Last but not least, overly complex financial instruments should simply be banned, unless they can be shown by their inventors to bring significant net benefits in the long run, in a manner similar to the drugs approval procedure. Otherwise our ability to manage the system will be outstripped and we will repeat the crisis of 2008.

What finally emerges from this new round of post-crisis tax invention may differ somewhat from the FTT, but the general principle – taxing international financial flows for the public good – looks here to stay.

Thirty, 50 years on, our children and grandchildren may be wondering how we ever thought to run the world without such tax – just as few of us can imagine how our grandparents and great-grandparents used to manage without the income tax.”

Here’s my review of Ha-Joon’s latest book, 23 Things They Don’t Tell You About Capitalism. Plus Robin Hood supporter Bill Nighy looks at how to spend the money on UK poverty in this video, and more support for Robin Hood in this Observer editorial on Sunday.

What is happening on global bank taxes? Robin Hood reports from the frontline

Earlier this year, I posted a fair amount on the new Robin Hood Tax campaign for a financial transactions tax to fund aid and the fight against climate change (start here and follow the links). In a guest blog, Oxfam’s top RHT obsessive, Max Lawson, updates us on the subsequent behind-the-scenes progress

“In today’s aid-speak, Robin Hood was a pretty outcome-focussed kind of guy. He didn’t much care how he got the cash from the rich, as long as there was plenty to hand over to the poor. So it is with the fate of the tax that bears his name – a bunch of proposals are now in play, all of which could become ‘Robin Hood Taxes’ – compared to where we were even a year ago, the progress is astonishing. The key issues will be how big the eventual tax or taxes will be, and whether any of the revenues will be used to fight poverty and climate change. 

So what’s the state of play? First the G20: in the face of another set of bumper bank profit announcements  (see graph), in Canada the G20 failed to take action or agree a co-ordinated tax or taxes on the financial sector.  The Canadian government actively opposed any tax on banks, and as chair of the summit ensured it was barely discussed.

But don’t despair – agreement on a tax or set of taxes on the financial sector in the coming months still looks likely, partly because the G20 kicked the can down the road by agreeing a set of principles that will enable those countries that wish to do so to press ahead with a tax.  The leaders of four of the major G7 economies, the US, UK, France and Germany, have publicly backed a tax or taxes on the financial sector in the last two months. This is critical since the vast majority of financial transactions take place in London, New York and Frankfurt.

The IMF has quietly released its final report on taxing the financial sector, which puts numbers on its proposed (and wonderfully named) financial activities tax, or FAT. Set at 5%, it could raise $93 billion dollars annually.  It also reiterates two powerful points from its draft report – that the financial sector is arguably ‘under taxed’ and ‘too big’. The IMF also confirms that government debt in advanced OECD nations will be 40% higher largely as a result of the financial crisis and new Oxfam research shows the poorest nations face a $65 billion dollar shortfall in their budgets due to the crisis.

Three types of tax are proposed and supported by different countries.  The US, UK, France and Germany (along with most of the EU) want a levy on bank liabilities.  The UK is pressing ahead with a small levy of £2.5 billion a year, and also has said publicly it is in favour of a further tax on profits and bonuses (i.e. a FAT).  The German government has said it favours a further tax, and this could either be a FAT tax or a tax on financial transactions (FTT).  The French support an FTT, which the Robin Hood Tax campaign still sees as the simplest, easiest and fairest way to raise sufficient cash.

A lot depends on whether or not the Obama administration succeeds in implementing its proposed bank levy before the new congress takes office in January.  This will be tough as they are short on both time and political capital.  Separate bills proposed by different congressmen for transaction taxes will help increase the pressure though. Whilst not huge ($10 billion a year), or linked to good causes, if implemented the US levy would still free up space for additional taxation in Europe without fear of undue US competitive advantage and an exodus of banks to New York.

Looking to the next few months, the G20 in Korea in November will definitely see further discussion and potential agreement between a ‘coalition of the willing’.  The French have also indicated that this will be a central part of their G20 presidency in 2011. Parallel discussions at the EU level will also be important, pushed by the Belgians who hold the EU presidency and have called an emergency finance ministers meeting on September 7th to discuss financial sector taxes. 

A potential compromise could be a tax on currency transactions only (rather than all transactions), which is hard to avoid, easy to collect and would not affect competitiveness.  A tax on just the euro and pound of just 0.005% (half a basis point) could raise $17 billion annually.  If the dollar and yen are included this rises to $40 billion. As the IMF would say, this kind of amount is ‘nontrivial’. This is the preferred option recommended by the Leading Group of experts, representing 12 governments including the UK, France and Japan.

Trapped between big promises and big deficits, the EU nations are also the most likely to push for using this revenue being used in part to pay for aid and climate change, and many have already made this link publicly (though notably not the new UK government as yet).  A tax on the financial sector is being investigated by a UN-convened Advisory Group on Climate Finance including George Soros, charged with looking at ways to finance climate change adaptation and mitigation.

What is certain is the political climate will remain propitious, with profits, bonuses and champagne continuing to flow in the unrepentant financial sector (see video) whilst hundreds of thousands of people face cuts, tax rises and job losses to pay the bill for the bankers’ folly.

The Robin Hood Tax campaign in the UK has plenty of oomph with over 200,000 supporters on Facebook and dozens of high profile actions planned for the autumn, together with campaigns in Germany, France, the US and increasing numbers of other countries.  The Sheriff of Nottingham should continue to watch his back.”

A global taxation system, as proposed by the IMF

IMF suggests
Global taxes on all banks
History is made

What have they put in the water supply at the IMF? First they see the light on capital controls, and now they’re putting out ground-breaking ideas on the international taxation of banks. I’ve been reading the supposedly confidential (but available on the BBC website – if you have problems with this URL, just search on BBC + title of report) interim report to last week’s IMF Spring Meeting with a growing sense of astonishment and delight. There are some potentially historic shifts in thinking going on. Apologies in advance for a long post, but I think it’s worth it for this issue. To keep some kind of ceiling on size, I’ll post tomorrow on what the report says about the Robin Hood Tax.

The report, titled ‘A Fair and Substantial Contribution by the Financial Sector’, was commissioned by the G20 ministers, who at their summit in Pittsburgh last year, asked it to ‘“…prepare a report for our next meeting [June 2010] with regard to the range of options countries have adopted or are considering as to how the financial sector could make a fair and substantial contribution toward paying for any burden associated with government interventions to repair the banking system.”

The mandate is important – the IMF effectively stretched it to include the indirect costs of the crisis in the rich countries – fiscal stimuli, quantitative easing and all the rest, as well as the direct costs of bank bailouts, but unfortunately, stopped short of extending it a bit further to include the indirect costs of the crisis on poor countries, in the shape of a large fiscal hole that will need to be filled. And it was never going to extend it all the way to the wider need for innovative financing to meet aid targets and the big money needed to deal with climate change.

As widely reported in the press last week, the paper proposes two kinds of tax: a ‘financial stability contribution’ (FSC) and a ‘financial activities tax’ (FAT – the IMF has even acquired a sense of humour). The FSC seems to be based on the US ‘Financial Crisis Responsibility’ fee, and the FAT on the British and French Governments’ bonus taxes.

In an excellent blog on the IMF site, the paper’s lead author Carlo Cottarelli explains the reasoning:

On the FSC: “One reason the crisis was such a painful mess was that many governments did not have the tools to wind down failing institutions in a quick and orderly manner. All too often their only options, both hugely unpleasant, were to either (1) let a systemic institution fail and bear the chaotic fallout or (2) pump in enough public support to keep it alive, so confirming the prior suspicion that these institutions were indeed too big to fail. Governments lacked a way to ‘resolve’—a new word even for many economists—large failing institutions.

Resolution means equity holders would be wiped out, management replaced, and unsecured creditors take a loss—a ‘haircut’—on their claims. All this should be nasty enough for owners and managers to reduce any problems of ‘moral hazard’ (taking too much risk in the expectation that someone else will bear the costs if things turn out badly). But most countries still don’t have such a mechanism. Financial stability requires creating them.

So where does the idea of a contribution come in? Resolution requires upfront cash, to reduce uncertainty for creditors (and the creditors’ creditors…) by quickly giving some value to their claims. And the industry should pay for this: it is, or should be, a cost of doing business just like paying for deposit insurance, or maintaining their information systems. This is what we call a Financial Stability Contribution (FSC).”

On the FAT: “FAT is just a tax on the sum of the profits and remuneration paid by financial institutions. Profits plus all remuneration is value added. So a tax of this kind would be a kind of Value-Added Tax or VAT. And that could make sense because current VATs don’t work well for financial services, which are largely VAT-exempt.

This means that a FAT of this kind could make the tax treatment of the financial sector more like that other sectors and so help offset a tendency for the financial sector, purely for tax reasons, to be too large—or too fat.

Now suppose that the base included only remuneration above some high level, and only profits above a ‘normal’ rate of return. Then the base of the FAT may not be a bad proxy for taxes on ‘rents’—return in excess of competitive levels—earned in the sector. Some might find taxing that excess fair.

Or one might include only profits above some level well above normal. Taxing away some of these high returns in good times may help correct for any tendency to excessive risk-taking implied by financial institutions not attaching enough weight to outcomes in bad times (whether because of limited liability, or because they think themselves too big to fail).”

Might have to adjust that message

Why does this matter?

1. The most orthodox of international financial institutions has just set out the basis for an international taxation regime

2. That sets precedents for how public goods other than financial stability could be funded – like climate change and development

3. The FAT explicitly aims both to shrink the financial sector, which has grown so large that minor fluctuations imperil the much smaller real economy, and to change behaviour to reduce excessive risk-taking.

4. The FAT’s idea of a windfall tax on rents could easily be extended to other sectors – like the suddenly super-profitable oil and gas industry (see BP’s latest jump in profits)

5. All this is a wonderful counterweight to widespread pessimism on financing for development following the crisis. If the IMF thinks we can rustle up 2-4% of global GDP as a resolution fund, suddenly 0.7% for international development doesn’t look such a big deal.

One big question that the IMF paper ducks (but will hopefully answer in its final version in June) is what level of rate (and thus revenue) a FAT could raise. For the FSC, 2-4% of GDP corresponds to $1.2-2.4 trillion, so to fill up the resolution fund over a five year period, it would have to raise about $400bn. Coincidentally, that’s how much the Robin Hood Tax campaign reckons is needed for climate change and development. So when the resolution fund hits its target, there’s a ready-made use for further revenue…..

The danger is that in the negotiations that follow, the FAT will be sacrificed to get the FSC. That would be a shame, as it’s the more interesting of the two proposals. The final version of the IMF’s paper will go to the G20 summit in Canada in June. In the UK, income tax was introduced in response to a crisis - William Pitt the Younger put it in his budget of December 1798 to pay for weapons and equipment in preparation for the Napoleonic wars. Could international taxation be the biggest legacy of the 2008-10 global crisis?

How can tax reform build effective states?

Taxation is one of those issues that usually causes the eyes of development types to glaze over. At best it’s relegated to the ‘important but braindeath’ category. When we do talk about tax, it’s often just as a way to raise money for schools and hospitals (if aid isn’t enough to do the job, that is).

This is a serious mistake. Sure, tax funds essential services, but its importance goes far beyond that, as a new paper by DFID tax wonk Max Everest-Phillips in the Development Policy Review journal argues (sorry, doesn’t seem to be any online version available – don’t you just hate that?). He starts off by quoting then South African Finance Minister Trevor Manuel:

‘Effective revenue administration contributes to a country more than simply filling its national coffers; it is an essential component of good governance. When states are obliged to bargain with their citizens over taxation, or cannot rely on coercion or external resources, then they must become more responsive to their citizens.’

States build taxation systems, but taxation also builds states (indeed modern states were largely born out of the need to create efficient tax-raising bureaucracies). So if the key to development is the combination of an effective state and active citizens, taxation is likely to play a key role, both in building the state, and in its relationship with its people.

Using DFID’s experience in promoting tax reform in Yemen, Sierra Leone and Vietnam, the paper argues that seeing taxation explicitly as an exercise in state building, rather than simply revenue raising, changes the way you do it. How taxes are raised becomes as important as how much cash the state can find.

Max E-P starts off by discussing a country’s ‘tax culture’, which in turn relies on what he calls

Low tax morale

‘tax morale’. Between one country and another, citizens and businesses vary hugely in their attitudes to tax (just compare US and European elections….): in some they are grudgingly accepting, in others actively hostile (with the possible exception of weird bits of Scandinavia, there probably aren’t many where places where people leap out of bed in the morning actively excited at the prospect of paying their taxes).

The roots of citizens’ tax morale are pretty straightforward – is the tax system honest, fair and efficient? Does the government do good things with the money? But business tax morale is more complex, the paper argues. Often, a small formal sector bears a heavy tax burden. This creates a strong disincentive to investment and participation in the formal economy. Big companies use their political clout to carve out tax exemptions, while small ones flee the formal sector for the tax haven that is the informal economy. The result is a ‘missing middle’ – developing companies tend to have much fewer small and medium enterprises than they should. (An Oxfam paper I reviewed at the end of last year showed how this ‘missing middle’ is also starved of credit  – small business life is tough!)

This matters economically because small businesses in the formal sector tend to grow faster and employ more people than if they remain informal. And politically because it is the small business sector whose political voice is often central in moving a political system from oligarchy to something resembling democracy, but being outside the tax system means that voice is muted. In Bangladesh, less than 1% of the population pay taxes – that’s not good news for the social contract.

Early tax activist

Another mess that needs sorting out is local taxation. Many developing countries have a chaotic system of local levies and taxes, many of which are coercive and hated by the population (remember Robin Hood’s fight against the anti-poor taxes of the Sheriff of Nottingham?). Replacing detested local taxes with marginally more respected national ones can rebuild tax morale.

Overall, the key question becomes ‘how a weak state dominated by vested interests with limited tax morale and funded by a narrow tax base evolves into a liberal democracy of citizen-taxpayers with a high tax morale.’

Max E-P argues that this can be done, but only if those in charge

a) see state building as an essential part of tax reform, and so are prepared to do things that may not maximize revenue in the short term (like taxing small firms rather than keep stinging the big guys)

b) think about carrots as well as sticks. In Mauritius, the government has been successful in bringing small businesses into the tax net by offering targeted access to finance; in China, larger firms may be willing to pay higher rates of local taxation in return for more secure property rights, which allow the business to develop securely; in Liberia, over 60% of respondents who had begun to formalise were driven by the desire to avoid rampant corruption and the high unofficial ‘payments’ needed to maintain their informal status, (which also undermine the effectiveness and legitimacy of the state).

Finally, my favourite corruption stat: In Yemen a ‘taxpayer survey suggests that, while the bribe ranges between 25% and 40% of the total assessed tax amount, paying a bribe can lower the assessment by 50%.’ So at an individual level, firms keep on paying bribes even though it diverts money from government, and is disastrous for both tax morale and state building.

Do poorer countries have less capacity for redistribution? A new paper

When can a country end poverty by redistributing wealth from its rich people, and when must it instead rely on aid or growth? That’s a question Martin Ravallion, head of the World Bank’s research department seeks to answer in a new paper. Essentially he is trying to put precise numbers on the relatively obvious point that the richer a country becomes, the more potential it has to redistribute wealth.

Ravallion is trying to measure the capacity (rather than political will) for redistribution. He does so as follows:

He specifies that redistribution will only take place from those who would not be considered poor in the US (> $13 a day income; all $ figures are 2005 PPP)

He then calculates how much cash would need to be transferred to end absolute poverty ($1.25 a day) or to fund various basic income schemes of social protection, where the whole population receives a transfer of $1.25 a day (i.e. uniform, rather than targeted)

He then converts this into a marginal tax rate on the rich – the extra tax they would have to pay on all earnings above $13 a day. An MTR above 60% (the highest rate in rich countries) is seen as an impossibly high level.

His findings?

‘Developing countries fall into two distinct groups. The first appears to have little or no scope for making a serious impact on the problem of extreme poverty through internal redistribution from those who are not poor by Western standards. The second group appears to have far more scope for such redistribution. Most of the poorest countries in terms of mean consumption fall into the first group.

The marginal tax rates needed to fill the poverty gap for the international poverty line of $1.25 a day are clearly prohibitive (marginal tax rates of 100% or more) for the majority of countries with consumption per capita under $2,000 per year. Even covering half the poverty gap would require prohibitive MTRs in the majority of poor countries.

Yet amongst better-off developing countries–over $4,000 per year (say)–the marginal tax rates needed for substantial pro-poor redistribution are very small–less than 1% on average, and under 6% in all cases.

Basic-income schemes financed by progressive income taxes also require prohibitive marginal tax rates in the poorest half of developing countries. Indeed, if the tax burden is confined to those who are not poor by developed-country standards, then providing a basic income of $1.25 a day would call for marginal tax rates of 100% or more for three-quarters of countries. Even for middle-income developing countries, this type of redistribution only starts to look feasible if one allows for a basic income appreciably less than $1.25 a day and/or significant tax burdens on the middle class [i.e. those earning less than $13 a day].’

He illustrates this in Brazil, China and India:

‘For Brazil in 2005, covering the poverty gap for $1.25 a day would only require a MTR of 1% on those who are not poor by US standards. Even for the $2 a day line, the necessary marginal rate would only be 4%. Recall that these are international lines, and they are lower than the poverty line commonly used in discussing poverty in Brazil, which is about $3 a day; filling the poverty gap for this line would call for a MTR of about 12% on those living over $13 a day.

The marginal tax on Chinese living above the US poverty line that would be needed to cover the poverty gap for $1.25 a day is 37% in 2005. China’s national poverty line is closer to $1 a day, which would only requite a MTR of 30%. However, the tax rate needed to cover the $2 a day poverty gap would require a prohibitive rate of 100%.

The capacity for redistribution in India is far more limited than in China or (especially) Brazil. Indeed, it would be impossible to raise enough revenue from a tax on Indian incomes above the US poverty line to fill India’s poverty gap relative to the $1.25 a day line; the required MTR would exceed 100%. Even at a 100% MTR, the revenue generated could fill only 20% of India’s aggregate poverty gap.’

These findings are important for a number of reasons:

They make the case for a much greater focus on redistribution and taxation in middle income countries, where tax systems are generally much less progressive than in many developed nations.

They raise serious questions about the affordability of tax-funded universal social protection

They suggest that poverty reduction in very large poor countries like India is primarily going to be achieved through economic growth, rather than aid or redistribution.

In small poor countries, the best combination is growth + aid – large scale redistribution has to wait until there is something to redistribute! However, I would add that even in poor countries, there are other reasons for strengthening a government’s tax base, such as building the social contract between citizens and state.

The rise of the informal sector and why it should be taxed

I’ve been reading a couple of interesting things on the informal economy recently. The OECD has a new book out with the engaging title ‘Is Informal Normal?’ which gives a pretty decent overview.

Informal employment refers to jobs or activities that are not registered or protected by the state. Informal workers are excluded from social security benefits and the protection afforded by formal labour contracts. The majority of them cannot opt for scarce better jobs in the formal sector. Others voluntarily opt out of the formal system. For them, the savings from being completely or partly informal – no social security contributions, no tax payments, no binding labour regulations, and more freedom for business activities – outweigh the benefits accrued through registration and compliance. The prevalence of informal employment in the developing world is striking. Even before the current crisis, over half of non-agricultural jobs there could be considered informal. Read More …

Taxation and development: a great new book

Finally finished an illuminating book on the link between taxation and development: (Taxation and state-building in Developing Countries), edited by Deborah Brautigam, Odd-Helge Fjeldstad and Mick Moore). Here are a few highlights – a bit long, but I’m trying to summarize a densely argued 260 page book, so bear with me.

Taxation is the new frontier for those concerned with state building in developing countries. The origins of representative government in Europe are intimately bound up with the evolution of taxation. The oft-told narrative begins with war: the costs of warfare led European monarchs to increase direct taxation, which they were only able to do through bargaining with their societies’ elites. This had two political outcomes: it prompted the rise of parliaments, and it led to larger, more capable, and more professional state bureaucracies. Read More …

So what do other people think of the book?

I’m nearing the end of the initial series of launches + discussions with NGOs in the UK (CAFOD, Christian Aid, World Vision, WaterAid, ActionAid) and at DFID (the UK’s development ministry). What’s emerging (apart from powerpoint poisoning)? Read More …