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Key Text The Poverty Impacts of Revenue Systems in Developing Countries

Author: N Gemmell and O Morrissey
Date: 2002
Size: 96 pages (401 KB)

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Summary

Few taxes are actually paid by the poor, the tax system does not provide the best instruments to target the poor. These are the two principal beliefs that this DFID report aims to assess by reviewing analytical methods for, and evidence on, the effects of tax reform on the poor. This report states that these beliefs are largely true. However, there are important exceptions. The authors start by reviewing the core features of tax systems in LDCs, then move onto the main features of tax reforms implemented in recent decades. Methods of assessing the effects of taxes on distribution and the poor are then examined and the evidence presented, concluding with a series of policy recommendations.

Typical characteristics of taxation in LDCs are: Tariffs and domestic sales taxes being the major source of tax revenue, and export, personal income, property and capital gain taxes not generating significant revenue. Collection efficiency is low, with avoidance and evasion tending to be high and the tax/GDP ratio rarely exceeds 15 per cent, except in resource-rich economies where non-tax revenues are also most significant. It is difficult to establish the distributional effects of taxes and reforms, as they tend to be country specific, however, the balance of evidence permits some general inferences, such as:

Taxes on exports, intermediates and kerosene tend to be 'bad' for the poor in the sense that they apply to commodities that the poor purchase. For similar reasons, import taxes are more likely to impact on the poor than general sales taxes
Reforms in excise on alcohol, tobacco and cars/petrol should not be justified by potential benefits for the poor
It is generally difficult to achieve significant redistribution through indirect taxes
Income tax reforms are largely irrelevant for most of the poor
Principal taxes paid by the poor are sales taxes and tariffs on the goods they consume. The tax system could be made pro-poor if such items are zero-rated or subsidised
Reforms that reduce taxes on intermediates are likely to both be pro-poor and enhance efficiency.

The final chapter provides recommendations for enhancing the potential for tax reform to be pro-poor, so that the burden on the poor is either reduced, or not increased:

Commodity taxes, both on sales and trade, should have few and relatively low rates with a low dispersion
Commodity taxes can be made pro-poor by ensuring zero rating on goods that are consumed, and activities that are engaged in, predominantly by the poor
A strong case can be made to subsidise the price of commodities that are consumed by the poor, but not by the rich (kerosene, staples). This is the only recommendation that differs from standard International Financial Insititution (IFI) fiscal policy recommendations
Reducing the dispersal and average level of tariff rates is pro-poor
A simpler tax structure (fewer and lower rates) contributes to both collection and economic efficiency with the simplification of tax structures usually increasing revenue, suggesting (in low income countries) a preference for simple sales taxes rather than more complex VAT often recommended by the IFIs
A relatively simple income tax is progressive. However, income tax is largely irrelevant for the poor, and therefore not crucial for a pro-poor tax reform strategy.

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Source: Gemmell, N. and Morrissey, O. 2002, 'The Poverty Impacts of Revenue Systems in Developing Countries. A Report to DFID,' School of Economics, University of Nottingham.
Author: Oliver Morrissey , oliver.morrissey@nottingham.ac.uk
School of Economics, Nottingham, http://www.nottingham.ac.uk/economics/
Organisation: Department for International Development (DFID), http://www.dfid.gov.uk