Tax Fairness and the Developing World

Spurred on by the G20, governments and financial centers around the world have come forward with pledges to open up bank records to foreign tax investigators.

The message could not be clearer: Aiding tax evasion is no longer acceptable. For scores of tax havens, it’s time to reform.

At this year’s recently held spring meetings of the World Bank Group and the International Monetary Fund, or at other future occasions, growing intolerance of tax evasion is good news for developing countries desperate to raise tax revenues to pay for schools, roads and hospitals.

Poor people in these countries mostly don’t pay much in taxes. But they are most in need of the improvements in infrastructure and services that can be financed by the tax dollars of the rich.

With aid budgets under pressure and trade volumes weakening amid the global economic crisis, governments are looking to tax systems as a new frontier for development policies. In the long run, they have concluded that more can be done to boost development by helping developing countries collect taxes than can be achieved through foreign aid.

There are two dimensions to this question: efficiency and fairness. The best tax systems bring in money efficiently, fairly and from a wide range of sources. Systems that focus on just a few sources, such as minerals production, luxury goods sales or corporate profits, are likely to be vulnerable to changes in the economic landscape

But tax systems also need to be fairly administered. Governments need to be able to prevent money due to them from being siphoned offshore.

Every year, billions of dollars are transferred from developing countries to foreign tax havens. If more of that money stayed at home, it could finance bigger development budgets.

That’s one reason why success in the OECD’s decade-long drive against tax havens and cross-border tax evasion is so important. Thanks to G20 backing — most recently at the April 2 G20 summit in London — more and more jurisdictions are signing up to international standards on transparency and exchange of information.

For individuals, banks and companies, these standards (agreed by OECD and non-OECD countries and approved by the United Nations) mean an obligation to keep reliable books and records and provide access to information about beneficial ownership and banking transactions.

Once implemented, they will enable foreign tax authorities to track down tax evaders by gaining access to financial information that until now was safely hidden.

For developing countries, the crackdown marks a step forward in a process likely to lead to better governance and improved compliance.

The next step for aid donors should be to help developing countries develop their tax collection capabilities. Poor countries with large informal sectors often lack the resources and capacity to build effective tax collection systems. But the benefits from well administered tax systems can be considerable.

Taxpayers, however small their contributions, become part of the formal economy, acquiring rights and entitlements to pensions and social security.

Taxpaying can also provide a foothold into the credit system. In Malawi, for example, banks use a certification scheme for proof of tax paid as a rating of credit worthiness.

In 2007, less than $100 million dollars out of more than $100 billion in total official development assistance (ODA) from OECD countries was dedicated to tax-related tasks. There is plenty of scope for raising this proportion, and there are plenty of projects that merit support.

The gearshift that we are witnessing in the fight against cross-border tax evasion shows that change is possible. If developing countries can take advantage of this changed environment to improve their tax policy and revenue administration, they will establish more stable long-term revenue streams alongside ODA. In today’s uncertain environment, that can only be a plus.

Internationally, the challenge will be to ensure that the countries and jurisdictions that have promised increased transparency live up to their commitments.

The OECD, tasked with a mandate to monitor their performance, will be watching like a hawk.