Tax policy is one of the key ways governments generate revenue for national budgets, yet changes to tax structures can be difficult to implement when countries lack the capacity to collect them. Zainab S. Ahmed, Nigeria’s minister of finance warned that developing countries are being penalised through unilateral declarations and blacklisted by forums they do not belong to.
Tax incentives
Tax incentives are popular tools used to encourage economic development. Easy to implement and cost-effective, tax incentives can provide significant economic stimulus without straining finances or innovation. Unfortunately, tax incentives may also be misused and lead to perverse outcomes; misused to fund political finances or inhibit innovation for instance. Furthermore, special interests lobby for them and they’re subject to corruption; therefore despite their attractiveness these should be carefully considered before being put in place and limited in scope.
Literature on optimal taxation suggests that developing countries should use their taxes to promote market activity rather than inhibit it, thus it is crucial to learn how to design tax incentives to achieve this objective.
Many developing nations have switched from excise taxes to value-added taxes (VAT), which offer one rate and few exemptions, replacing excise taxes with this approach. Unfortunately, it can reduce informal activities, thus hindering overall growth, as well as being susceptible to tax evasion. Therefore it’s vital that effective measures are identified that can minimize this evasion and improve compliance.
Tax holidays
Tax holidays are government-sanctioned exemptions of sales or income taxes for limited timeframes, intended to increase economic activity and foster investment. Recently, governments have implemented numerous tax holidays as a way of encouraging business investment – these may include temporary reductions or exemptions of sales/property taxes and customs duties duties.
Though tax holidays seem promising, their true impact remains unclear. Studies indicate that they do not significantly increase consumer spending; rather they shift purchase timing instead. Furthermore, sales taxes’ regressive nature outweighs any advantages low-income households might gain during tax holidays.
Tax incentives in developing countries often violate the principles of symmetry and inclusiveness, with deductions narrowing tax bases and negating effective progressivity; furthermore, top marginal personal income tax rates tend to be excessively high allowing taxpayers to use expense deductions to escape paying their due share of taxes.
Tax competition
Ms. NORONHA advocated for a binding multilateral convention on tax competition, noting that the UN possesses legitimacy, convening power and normative impact necessary for leading such an inclusive process. Furthermore, she highlighted illicit financial flows as threats to development and advocated stronger provisions against profit diversion in international investment agreements.
She noted that incentives may be legitimate if targeted toward high-tech sectors that promise significant externalities that extend beyond individual beneficiaries, yet currently in use, most incentives are ineffective and may even erode domestic revenue bases.
She underscored the necessity for developing countries to lessen their reliance on foreign trade taxes and strengthen their capacity to generate domestic revenue, particularly through personal income tax. Unfortunately, many developing nations’ personal income tax systems contain exemptions and deductions that erode effective progressivity and symmetry – violating basic principles of tax policy that hinder economic development while increasing fiscal instability risks.
Tax-to-GDP ratio
Tax-to-GDP ratio is an indicator of a country’s ability to fund government expenses. Policymakers use it as a gauge of economic development as higher ratios indicate wealthier nations that are further along in their development journeys.
Development countries often find it challenging to increase their tax-to-GDP ratios. Workers in these nations often receive their pay in cash, making it challenging to establish an effective income tax basis and consumption taxes. Furthermore, many goods imported and exported between countries makes tax collection an ongoing task.
Tax-to-GDP ratios that are too high can discourage investment. This has an adverse impact on the economy and requires striking an effective balance between investment and tax revenue collection. Furthermore, higher ratios may cause unfair income distribution; by decreasing them we may increase equity. But there are also numerous other factors which influence this ratio.