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Fact sheet "Tax and Development"

European Commission - MEMO/09/545   09/12/2009

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MEMO/09/545

Brussels, 9 December 2009

Fact sheet "Tax and Development"

(see IP/09/1895 )

Taxes are central for the functioning of a state and for the provision of public goods. Many developing countries cannot finance their policies through taxes and rely on external revenues such as development assistance. Generally, developing countries have a lower tax-to-GDP ratio than developed countries.

According to several studies examining the tax-to-GDP ratio in Sub Saharan Africa, Latin America, the Caribbean and Asia:

  • In Sub Saharan Africa, the tax-to-GDP ratio increased from less than 15% in 1980 to more than 18% in 2005. This increase is almost entirely due to natural resource taxes (income from production sharing, royalties or corporate income tax on oil and mining companies). In the same 25 years non-resource related revenue rose by less than 1 % of GDP (Keen/Mansour) 1 . There are considerable differences among African countries such as the Central African Republic and Guinea where tax revenue is under 10% of GDP, and South Africa were it reaches 25% or even Namibia where it is 30.1% (Volkerink). 2

  • In Latin America and the Caribbean the tax-to-GDP ratio has increased from 12 % in 1990 to 18.5% in 2006. The ratio is as low as 10% in Haiti and reaches more than 34% in Brazil. Mexico is the only country where the ratio decreased (from 12.6% to 11%) (Martner). 3

  • Most Asian countries have a low tax-to-GDP ratio (between 14-18% of GDP), except for South Korea and Japan. Indirect taxes prevail over direct taxes, with the exception of Japan and Malaysia. Corporate Income Taxes (CIT) generally account for a higher share of revenue than Personal Income Taxes (PIT) (Bernardi/Gandullia/Fumagalli) 4 .

Factors hampering developing countries' revenue efforts

The ability of developing countries governments to raise tax revenues is constrained by a number of internal factors. Internal factors commonly mentioned in academic studies (referred in footnotes 1-9) are:

  • weak tax authorities and administration

  • the extent of the informal economy

  • lack of transparency

  • numerous tax exceptions

  • pressure from transnational investors and global tax races to the bottom.

In parallel to internal domestic factors, there are also international factors constraining developing countries' efforts to raise revenue. The existence of non-cooperative jurisdictions, both in developed and developing countries, combined with harmful tax practices is particularly detrimental to developing countries.

A few studies have undertaken to estimate capital outflows and examine the causes. According to these studies:

  • Overall capital outflow from Africa (40 countries) amounts to 420 billion USD for the period 1970 to 2004 (Ndikumana and Boyce). 5

  • Illicit money leaving developing countries on a yearly basis amounts between 641 and 979 billion dollars, a figure that has been increasing at an average rate of 18.2% from 2002 to 2006 (Cobham). 6

  • International companies using transfer pricing practices not in accordance with international standards would account for the largest part of the money flows from developing countries (Baker) 7 . According to Cobham, developing countries are estimated to incur a yearly loss of at least EUR 40 billion in tax revenues simply because wealthy individuals place their assets in non-cooperative jurisdictions instead of in their own countries (Cobham) 8 . However, quantifying such losses is very difficult, indeed it was recently put forward that some studies overestimate the revenue losses due to profit shifting and a range of between 35 billion USD and 160 billion USD was suggested (Riedel and Fuest). 9

Role of the EU in supporting tax systems

The Doha Declaration 2008 from the UN Conference on Financing for Development lays the cornerstone for action "to increase tax income through modern tax systems, more efficient tax collection, a widening of the tax base and effectively combating tax evasion". Repeatedly the international community has engaged to fight harmful tax practices. Most recently at the G20 meeting in Pittsburgh, the world's leaders reiterated their commitment to fight tax evasion, illicit financial flows and harmful practices.

Some EU Member States have been particularly active in capacity building activities over the last twenty years. Those have included assisting developing countries in strengthening their tax administrations. These efforts have been undertaken in collaboration with the World Bank and the IMF.

The European Commission has supported tax administration reforms in a number of countries. For instance in Tanzania support to VAT and domestic revenue departments under the Tax Administration Programme (7 million euro) was provided. In a number of countries, support to tax reforms has been part of a broader package of support to economic or public sector reforms. In Ethiopia, for example, it is provided under the umbrella of the Public Sector Capacity Building Programme.

The European Commission has also been an important player when it comes to a specific aspect of revenue reforms: trade policies and customs administration. The development of Economic Partnership Agreements has increased the importance of these reforms as the mitigation of the possible negative impacts of trade liberalisation on custom revenues has increased in relevance.

The Commission is in the preliminary stages of working on an initiative on good governance in tax matters in the context of development cooperation. Its objective would be to promote tax reform in the context of a regulatory framework designed to support international tax cooperation, private sector development and economic growth.

1 :

Keen, Michael/Mansour, Mario, 2008, “Revenue Mobilization in Sub-Saharan Africa: Key Challenges from Globalization,” paper presented at the conference, “Globalization and Revenue Mobilization,” Abuja, Nigeria, February.

2 :

Volkerink, Bjorn, 2009, "Tax policy in Sub-saharan Africa" , Utrecht University.

3 :

Martner, Ricardo,2008, "Las finanzas publicas y el pacto fiscal en America Latina", Martner Documentos y ponencias presentados en el XX Seminario Internacional de Política Fiscal, Santiago de Chile, 28 al 31 de enero de 2008. [Public finance and the fiscal compact in Latin America. Papers presented at the XX International Seminar on Fiscal Policy, Santiago de Chile, 28-31 Jan 2008. Includes English papers.]

4 :

Bernardi, Luigi, Gandullia, Luca and Fumagalli, Laura ,2005, " Tax Systems and Tax Reforms in South and East Asia: Overview of Tax Systems and main policy issues". Published in: Bernardi L., Fraschini A. Shome P. (Eds) Tax Systems and Tax Reforms in South and East Asia, London, Routledge 2006.

5 :

Ndikumana, Léonce/Boyce, Ndikumana, 2008. " New Estimates of Capital Flight from Sub-Saharan African Countries: Linkages with External Borrowing and Policy Options". University of Massechusets Amherst, PERI Workinig Paper Series No. 166.

6 :

Cobham, Alex, 2005, "Taxation Policy and Development". Oxford: Oxford Council on Good Governance.

7 :

Baker, Raymond, 2006, "Capitalism's Achilles Hee: Dirty Money and How to Revive the Free-Market System". London: John Wiley and Sons.

8 :

Cobham, Alex, 2005, "Taxation Policy and Development. Oxford: Oxford Council on Good Governance".

9 :

C Fuest, N Riedel, Tax evasion, tax avoidance and tax expenditures in developing countries, Oxford University Centre for Business Taxation, June 2009


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