By the GEM Report
Even in low-income countries receiving a large amount in aid through grants, the main source of government revenue is taxation. Across 70 countries in 2018, taxes accounted for more than three-quarters of government revenue. If countries are to fill the finance gap for achieving their national SDG 4 education targets, which we calculated last week, tax revenue is going to have to increase.
Countries differ greatly in how they raise tax and how much they raise. Looking across 100 countries in the 2021/2 GEM Report, we found that Chad, Congo, the Democratic Republic of the Congo and Nigeria raised less than 10% of GDP in taxes. Even if they were to spend 20% of the budget on education therefore, as per the education financing upper benchmark, it would be far too little to cover their education development needs. At the opposite end, Cuba and some European countries, including Austria, Denmark and Italy, raised more than 40%, and France 46%, of GDP in tax. Overall, high-income countries depend far more upon tax than low-income countries: average tax revenue as a share of GDP was 14% in low-income, 18% in lower-middle-, 22% in upper-middle- and 33% in high-income countries.
Across those same 100 countries we looked at, the way that tax is collected also differs. For example, taxes taken from corporate income provided about half of tax revenue in Malaysia and Nigeria, but no more than 5% in France, Italy and the United States. Individual and corporate income taxes accounted for just one sixth of tax revenue in some countries, including Argentina, Brazil and Costa Rica, but more than 50% in others, including Australia, New Zealand and Papua New Guinea or Lesotho, Namibia and South Africa. More than three quarters of tax revenue in the Lao People’s Democratic Republic, Samoa and Togo came from taxes on goods and services.
But the variations end when you start comparing groups of countries. For instance, low-, middle- and high-income countries all raised one third of their tax revenue from individual and corporate income taxes, the only difference being that, within this category, the share from individual income taxes was 43% in low- and middle-income countries and 69% in high-income countries. Otherwise, the main difference in tax structures was that the richer the country, the higher the share of revenue from social security contributions and the lower the share from taxes on goods and services (e.g. consumption or trade taxes).
Improving tax systems – at home and abroad
The Addis Tax Initiative emerged in 2015 to help countries improve their domestic tax systems. With more than 60 countries participating, the initiative aims to strengthen tax systems by broadening the domestic tax base, improving domestic tax compliance and enhancing tax collection capacity through improved tools and procedures to stop cross-border tax evasion and domestic tax avoidance. The Addis Ababa conference that year also led to the Integrated National Financing Frameworks platform for sharing best practices to strengthen alignment of national development plans with financing needs.
Recent years have also seen the light shine on international tax policy. Developing countries lose much of their tax base through practices such as revenue shifting, debt shifting, transfer pricing and tax deferral. Multinational companies use various strategies to move profits to lower-tax jurisdictions rather than to pay up. Collectively, these tax avoidance activities, while not illegal, violate the good taxation principle of fairness, as tax should be paid where income is generated and where local people’s skills are used. Low- and middle-income countries need to formalize their economies to be able to collect income taxes more effectively and to build their institutions to introduce modern value-added tax systems. Countries in the Global South could also collaborate with the Global North to close loopholes in taxing corporate income.
There are serious methodological and data challenges to investigating tax avoidance losses in low- and middle-income countries. Yet recent studies have expanded understanding of the issue. Research by International Monetary Fund economists on the practice of shifting profits from high-tax to low-tax countries estimated that it reduced total corporate income tax revenue by 2.6%, or 0.07% of global GDP. However, the report recognized that the effect might be more substantial in developing countries, where avoidance practices are so complex that available data cannot demonstrate the impact. A more recent study with data from 210,000 corporations confirmed that the propensity to report zero profit was correlated with incentives to shift profit to countries with lower tax rates; this would partly explain why many developing countries reduce their corporate income tax rates despite the urgent need to improve their tax base.
A review of 79 countries using 2016 data also found that tax revenue losses from profit shifting amounted to 0.17% of GDP in lower-middle-income countries, but rose to around 1% of GDP in countries including Honduras, India and Zambia and to 3.5% of GDP in Mozambique. El Salvador and Nigeria may be losing around one quarter of their corporate income tax revenue – and the Bolivarian Republic of Venezuela as much as 100%.
Official IMF estimates put the cost of tax havens even higher, between US$500 and US$600 billion a year, taking legal tax evasion into account. The IMF estimated that low- and middle-income countries lost US$200 billion a year in tax revenue, which exceeds total official development assistance.
Prompted by research findings and civil society campaigns as well as the pressure of continuing transformation towards digital globalized economies, 130 countries signed a statement on a two-pillar solution for international tax reform in July 2021. The first pillar introduces new rights to tax multinational enterprises, whether or not they are physically present in countries, with 25% of profit over a certain margin, estimated at US$125 billion of profit, reallocated to the countries where the enterprises’ customers are located. The second pillar sets a minimum 15% tax on corporate profit to prevent harmful tax competition between countries; it is expected to generate around US$150 billion in new tax revenue globally.
It remains to be seen how these measures will benefit low- and middle-income countries. And education campaigners need to work with countries to ensure that much of the new revenue is used on education. Unfair practices are the rule. Restructuring and improving the international tax system for better disclosure, information sharing and transparency are urgently needed.