1
Interaction of Tax and Aid
Sanjeev GuptaDeputy Director
Fiscal Affairs Department, IMF
Fourth ITD Conference, December 7-9
New Delhi
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Relevance
Trends in tax revenues and aid flows
Empirical findings
Another dimension
Policy conclusions
Outline
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Net foreign aid to developing countries has averaged between 3.7% and 6.7% of GDP during 1980-2009
Net foreign aid has averaged between 20% and 40% of tax revenues
Concern in the literature about aid dependency
Relevance
4
Impact of uncertain aid on budget planning Impact on incentives to strengthen tax systems
(by promoting rent seeking) and to build institutions
Thus aid can substitute for domestic revenues The implications of aid substitutability are:
Aid can adversely affect fiscal consolidation efforts through reduced revenues
More than estimated resources would be needed for MDGs; and
Shift the burden of taxation to donor countries
Relevance
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Tax revenue in low- and middle-income countries, 1980-2009
Trends in Tax Revenue and Net Aid
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1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
0.0
5.0
10.0
15.0
20.0
25.0
30.0
Average Total Tax Revenue % GDP
Low income
Lower middle income
Upper middle income
…Tax Revenues Have Remained Broadly Stable in Two Groups
Note: Economies are divided among income groups according to 2009 gross national income (GNI) per capita, calculated using the World Bank Atlas method. The groups are: low income, $995 or less; lower middle income, $996–3,945; upper middle income, $3,946–12,195.
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1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
10
12
14
16
18
20
22Average Total Tax Revenue % GDP
East Asia Pacific & South Asia Latin America & Caribbean
Middle East & North Africa Sub-Saharan Africa
…. Little Progress in Three Regions
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A simple plot suggests a negative association between net ODA and tax revenues
Trends in Tax Revenue and Net Aid
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Note: Tax revenue is measured on the left axis, while total ODA is measured on the right axis.
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
10.0
11.0
12.0
13.0
14.0
15.0
16.0
17.0
18.0
19.0
20.01
98
01
98
11
98
21
98
31
98
41
98
51
98
61
98
71
98
81
98
91
99
01
99
11
99
21
99
31
99
41
99
51
99
61
99
71
99
81
99
92
00
02
00
12
00
22
00
32
00
42
00
52
00
62
00
72
00
82
00
9
Tax Revenue Total ODA (net)
Percent of GDP
Average Net ODA and Tax Revenue in Low and Middle Income Countries, 1980-2009
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Studies are split between negative and positive effects of aid on domestic revenue mobilization
Some studies have also examined the relative effect of grants and loans on the domestic revenue performance
The assumption is that recipients view grants and loans differently
Empirical Findings
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The earlier results showed that a dollar increase in overall aid (net loans and grants) was associated with a decline in domestic revenues
The composition of aid also matters
ODA in the form of loans is associated with higher tax revenues; converse holds for grants
These results were challenged in more recent studies
Empirical Findings
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However, the results using updated data and that address many of the criticism support the previous conclusions
But the impact is weakening (the offset for grants was 28 percent for every dollar. It is now 8 percent)
Why? Countries are making efforts to raise more
revenue given pressing needs Figure 2 shows structural benchmarks and
indicative targets in the IMF-supported programs for low-income countries since 2002-2003
Empirical Findings
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Notes:Indicative targets (IT) refer to quantitative targets that the program is designed to achieve, but is not a prerequisite for continued disbursements. e.g., Fiscal deficit, Floor on revenues, Floor on priority spendingStructural benchmarks (SB) can be legal, institutional or policy measures that are relevant for a program's macroeconomic obj ectives. e.g., Introduction of Tax Identification Number, Increase of VAT Threshold, Establishment of a Large Taxpayer Unit, Reduction/elimi nation of tax exemption
Source: IMF
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13 10
114
30 18
259
79
44
285
84
52
0
50
100
150
200
250
300
2002-03 2007-08 2009-10 2010-11
Total SB Total IT
Fiscal SB Fiscal IT
Revenue SB Revenue IT
Structural Benchmarks and Indicative Targets
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Does the above inverse relationship hold when we disaggregate tax revenues? No study has done this until now
First, plots of different tax revenues and net ODA
Empirical Results
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19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
Income taxes
Total ODA (net)
Percent of GDP
Average Taxes and Total Net ODA, 1980-2009
Note: Tax Revenues are measures on the left axis and Total ODA on the right axis.Source: Author’s calculations based on the IMF’s FAD Revenue Mobilization database and OECD DAC database
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80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
VAT
Total ODA (net)
Percent of GDP
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19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
1.0
2.0
3.0
4.0
5.0
6.0
7.0
Excises
Total ODA (net)
Percent of GDP
Average Taxes and Total Net ODA: 1980-2009
Note: Tax Revenues are measures on the left axis and Total ODA on the right axis.Source: Author’s calculations based on the IMF’s FAD Revenue Mobilization database and OECD DAC database
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80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
Trade tax
Total ODA (net)
Percent of GDP
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The results show that net aid has a negative relationship with VAT, excise and income taxes
Grants are negatively associated with these taxes with the offset of 12 percent for VAT—the highest among the three taxes
Significant revenue potential has been estimated from strengthening VAT productivity, adjusting excises, and eliminating tax exemptions
But ODA is positively associated with trade tax revenues
Empirical Findings
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Disaggregating the sample shows that results hold for countries in sub-Saharan Africa and for low-income countries
However, a higher level of grants ends up almost fully displacing domestic tax revenues in countries with weak institutions
These results are similar to those in the previous study
Empirical Findings
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Similar results hold for hydrocarbon producers
An additional percentage point of revenue from hydrocarbons reduces revenues from other domestic sources
Interestingly, the effect of grants on non hydrocarbon revenues is negative.
Another Dimension
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Despite some success cases (e.g. Tanzania, El Salvador, Vietnam) domestic resource mobilization continues to be below potential in many countries
Aid flows can influence the incentive structure of aid recipients and empirical studies show that is the case in SSA and low-income countries in particular
The impact is relatively large for VAT
Policy Conclusions
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The good news is that the overall impact is modest and weakening for countries with relatively strong institutions
This reflects increasing attention being paid to revenue mobilization under reform programs in many countries
However, the continuing almost full displacement of domestic tax revenues in countries with weak institutions is a source of concern
Finally, the negative relationship between hydrocarbon revenues and other domestic revenues found in natural resource producers suggests that these countries will face significant costs in moving to a higher level of domestic taxation once domestic resources are depleted
Policy Conclusions
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Thank you!
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Country Income Categories
Low incomeBangladesh, Benin, Burkina Faso, Burundi, Cambodia, Central African Rep., Chad, Comoros, Congo, Dem. Rep. of, Eritrea, Ethiopia, Gambia, The, Ghana, Guinea, Guinea-Bissau, Haiti, Kenya, Kyrgyz Republic, Lao People's Dem. Rep, Liberia, Madagascar, Malawi, Mali, Mauritania, Mozambique, Myanmar, Nepal, Niger, Rwanda, Sierra Leone, Solomon Islands, Tajikistan, Tanzania, Togo, Uganda, Zambia, Zimbabwe
Lower middle incomeAngola, Armenia, Belize, Bhutan, Bolivia, Cameroon, Cape Verde, China, P.R.: Mainland,Congo, Republic of, Côte d'Ivoire, Djibouti, Ecuador, Egypt, El Salvador, Georgia, Guatemala, Guyana, Honduras, India, Indonesia, Jordan, Kiribati, Lesotho, Maldives, Moldova, Mongolia, Morocco, Nicaragua, Nigeria, Pakistan, Papua New Guinea, Paraguay, Philippines, Samoa, Senegal, Sri Lanka, Sudan, Swaziland, Syrian Arab Republic, São Tomé & Príncipe, Thailand, Tonga, Tunisia, Ukraine, Uzbekistan, Vanuatu, Vietnam, Yemen, Republic of
Upper middle incomeAlbania, Algeria, Antigua and Barbuda, Argentina, Azerbaijan, Rep. of, Belarus, Bosnia & Herzegovina, Botswana, Brazil, Bulgaria, Chile, Colombia, Costa Rica, Dominica, Dominican Republic, Fiji, Gabon, Grenada, Iran, I.R. of, Jamaica, Kazakhstan, Lebanon, Libya, Lithuania, Macedonia, FYR, Malaysia, Mauritius, Mexico, Namibia, Panama, Peru, Russian Federation, Seychelles, South Africa, St. Kitts and Nevis, St. Lucia, St. Vincent & Grenadines., Suriname, Turkey, Uruguay, Venezuela, Rep. Bol.
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Benedek, Dora, Sanjeev Gupta, and Priscilla Muthoora, 2011,“Foreign Aid and Revenue: Still a Crowding Out Effect?” Forthcoming IMF Working Paper.
Bornhorst, Fabian, Sanjeev Gupta, and John Thornton, 2009, “Natural Resource Endowments and the Domestic Revenue Effort,” European Journal of Political Economy,” Vol. 25, pp. 439–46.
Brautigam, Deborah, and Stephen Knack, 2004, “Foreign Aid, Institutions, and Governance in Sub-Saharan Africa, “Economic Development and Cultural Change, Vol. 52 (January) pp. 255–85.
Clist, P. and O. Morrissey, 2011, “ Aid and Tax Revenue: Signs of a Positive Effect since the !980s,” Journal of International Development, 23, 165-180
Gupta, Sanjeev and Shamsuddin Tareq, 2008, “Mobilizing Resources,” Finance and Development, September 2008.
Gupta, Sanjeev, Benedict Clements, Alexander Pivovarsky, and Erwin R. Tiongson “Foreign Aid and Revenue Response: Does the Composition of Aid Matter?” Chapter 14 in “Helping Countries Develop: The Role of Fiscal Policy,” edited by Sanjeev Gupta, Benedict Clements, and Gabriela Inchauste (Washington: International Monetary Fund), 2004.
Gupta, Sanjeev, Benedict Clements, Emanuele Baldacci, and Carlos Mulas-Granados, 2004, “The Persistence of Fiscal Adjustments in Developing Countries,” Applied Economics Letters, Vol. 11 (March). pp. 209–12.
References
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Heller, Peter S., 1975, “A Model of Public Fiscal Behavior in Developing Countries: Aid, Investment, and Taxation,” American Economic Review, Vol. 65 (June), pp. 429–45.
IMF, 2011, “Revenue Mobilization in Developing Countries”, available at www.imf.org/external/np/pp/eng/2011/0308011.pdf
Khan, Haider, and Eiichi Hoshino, 1992, “Impact of Foreign Aid on the Fiscal Behavior of LDC Governments,” World Development, Vol. 20 (October), pp. 1481–88.
McGillivray, Mark, and Akhter Ahmed, 1999, “Aid, Adjustment and Public Sector Fiscal Behavior in the Philippines,” Journal of the Asia-Pacific Economy, Vol. 4, No. 2, pp. 381–91.
Moss, T., G. Pettersson, and N. van de Walle, 2008, An Aid-institutions Paradox? A Review Essay on Aid Dependency and State Building in Sub-Saharan Africa. In W. Easterly (Ed), Reinventing Foreign Aid, Cambridge, MA: The MIT Press.
Odedokun, Matthew, 2003, “Economics and Politics of Official Loans versus Grants,” WIDER Discussion paper No. 2003/04 (Helsinki: United Nations University, World Institute for Development Economics Research).
Remmer, K, 2004, “Does Foreign Aid Promote the Expansion of Government?” American Journal of Political Science, 48, 77-92.
References
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