Taxation in developing countries

What is tax and tax reform

To tax is to impose a financial charge or other levy on an individual or a legal entity by a state. Taxation is the only practical means for raising the revenue to finance government spending on the goods and services that the public demands. Setting up an efficient and fair tax system is, however, far from simple.

What are the challenges

Developing countries face formidable challenges when they attempt to establish efficient tax systems. First, most workers in these countries are typically employed in agriculture or in small, informal enterprises. As they are seldom paid a regular, fixed wage, their earnings fluctuate, and many are paid in cash. The base for an income tax is therefore hard to calculate. As a result income tax and customer tax pay a diminishing role in these economies. Second, because of informal structure of the economy in many developing countries, and because of financial limitations, statistical and tax offices have difficulty in generating reliable statistics (read more about statistics here). Third, the economic and political power of rich taxpayers often allows them to prevent fiscal reforms that would increase their tax burdens.

In general, countries in sub-Saharan Africa have relatively low tax revenues, while taxes have been somewhat higher in many countries in Asia and Latin America. In many of the countries' taxation systems, there is a strong differentiation between industries and product categories, exemptions are granted for individual persons or companies and there are tax advantages for foreign investments. The sum result is a complicated tax system that offers greater scope for corruption. In addition, the often disproportionately high level of tax on publicly registered companies helps to maintain an extensive informal economy in developing countries.

With a view both to increasing tax revenues and reducing the possibilities for corruption, many partner countries have undergone major tax reforms in the last decade, with somewhat mixed results. Reforms have been particularly high on the agenda in Africa and Latin America. However, the tax administration is inefficient in several of Norway's partner countries, and there is considerable potential for increasing tax revenues even under the current tax regimes.

How should tax systems be shaped

From an economist's viewpoint, there are certain fundamental criteria that should be met in tax reforms and that produce a good system of taxation: The tax system should be clear and easy to understand, with broad tax bases and low rates and a combination of direct and indirect taxes that take account of distribution concerns. Moreover, trade-related taxes and charges should be reduced.

It takes time to establish good tax systems with political legitimacy, but the need for increased revenues creates great pressure to implement tax reforms as quickly as possible. This may in turn undermine national ownership of reform programmes and the long-term sustainability of the reforms. Raising the level of taxes without changing the design of the tax system may exacerbate existing disparities, which may in turn have adverse financial and distributive consequences. It is important to adopt a coherent approach to tax reform, and view it in conjunction with the broader discussion of governance.

Norway's involvement

The resent white paper (nr. 13, 2008-2009) on development policy underscores the importance of taxes in efforts to improve public financial management and operating parameters for business and "formalise" the informal economy.

Norway currently makes contributions in the sphere of taxation in three ways. With other bilateral donors Norway supports tax reform through different public financial management reforms. In addition, Norway makes available its experience in the field of natural resource taxation and management. We support Zambia and Tanzania with capacity development in the mining related tax administration, and serve in an advisory capacity in East Timor within the petroleum sector. Norway is also involved in taxation initiative in OECD/DAC.

Some of Norway's contributions to research are channelled to the tax research programme at the Christian Michelsen Institute and studies of taxes and charges at the Inter-American Development Bank (IDB) for several Latin American countries.