Jabara, Cathy L.

English

Research Papers in Economics

Agriculture  and Trade Analysis Division
Economic Research  Service
United States Department of Agriculture
Staff Report # AGES870928
1988
Trade  and  Development
Shane,  M., ed.
Proceedings of a Meeting  of the
International Agricultural  Trade  Research  Consortium
December,  1986,  CIMMYT,  Mexico City, Mexico
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searc  ConsrtkE ~CitvMexTAX  REFORM  POLICIES  IN  DEVELOPING  COUNTRIES
Cathy  L.  Jabara'
Tax  reform and tax  policies  in developing  countries  have  long  been  studied  by  economists.
However,  in  the last few  years,  tax reform  has  gained  increased  recognition  as  an  important
policy  instrument  for  stimulating  developing  country  economies.
In particular,  the adoption  of growth-oriented  macroeconomic  and  structural  policies  by  the
debtor  nations  is at  the heart  of the "Program  for  Sustained  Growth" ("Baker  Plan")  proposed
by the  United  States for  the  major  debtor nations  in Seoul,  Korea,  in  October  1985.  Under
the  program,  debtor countries  would  adopt macroeconomic  and  structural  policies  that improve
growth  and  reduce  inflation  in order  to qualify  for new  loans  from  the International  Monetary
Fund  (IMF),  the World  Bank,  and private  banks.  Growth-oriented  policy  reforms  include
reducing  subsidies  and  costly budget deficits,  as  well  as structural  reforms  involving  the
development  of  efficient domestic  capital  and  equity  markets,  increased  efficiency  in  the public
sector,  and  growth-oriented  tax reform.
Institutional Views  on  Tax  Reform
Among  international  development  institutions,  the  IMF  has  had  the  most  influence  over  tax
policies  in  developing  countries.  Tax  provisions  are  part of IMF  packages,  but  not of  explicit
conditionality.
The IMF primarily  views  the  tax system  as an instrument  of short-term  "demand management"
involving  changes  in private  consumption  and  government revenue.  Since  the  IMF  aims  at
stabilization,  its revenue  concerns  are  primarily  shortrun,  and balance  of payments  and budget
deficits  are  its top  negotiating  aims.  Budget  deficits  often require  a  revenue  increase.  IMF
tax  measures usually  favor  quick-impact  tax  changes  such  as  increases  in  sales  taxes,  import
duties,  user charges,  and public  enterprise  tariffs.  They recommend  increases  in income  and
corporate  taxes only  as  a  last resort.
However,  in the  context  of growth-oriented  tax strategies,  the  role  of taxes  in  long-term
"supply managment"  and  resources  allocation  also  becomes  important.  This  supply  management
perspective  recognizes  that the  tax structure  affects  decisions  by  economic  agents,  and  thus
resource  allocation,  and that growth  prospects  could  be  improved  with  a  tax structure  that
distorts  these  decisions  less.  This  perspective  also  suggests  close  linkages  between  tax policy
and the  structural  adjustment  work  of the  World  Bank.  Both  the  development  projects  and
structural adjustment  supported  by  the bank  take  place  within  an  environment  conditioned  in
important  ways  to tax  policy.
Characteristics  of  a  Good  Tax  System
The  criteria  most  widely  accepted  for  a  good  tax  system  include:
Economic  neutrality.  Tax  systems  should  not interfere  with  efficient  allocation  of
resources,  nor result in bias  against  capital formation.
1The author is an economist,  U.S.  Treasury Department.  The views  expressed  in this paper are the author's and
cannot be attributed to the U.S.  Treasury.
*uS.GOVERNMENT  PRINTING  OFFICE:1988-201-089,80217/ERS 172Horizontal  equity.  Structure  tax laws  so  that  those  who are  able  to  pay,  pay  more  or
less equally.
Simplicity.  Aim  for easy  compliance.
Low  rates.  Low  rates  on  a broad  base  bring  more  development  and  few  bad  economic
decisions.
Inflation-proof  the  system.  Taxes  should adjust  automatically  high  inflation.
Characteristics  of Tax Systems  in  Developing  Countries
Statistics  on  the  composition  of central  government  revenues  for  more  than  a  100  countries
reveal  that taxes on  income  and  profits  are  more  important  in  the industrial  countries  (33
percent  of revenue)  than in  the developing  countries  (17  percent  of revenue  in  the  least
developed  countries).2  The contribution  of taxes  on  international  trade  and  transactions  is
inversely  related  to  the  level  of  income  and  the degree  of industrialization  (42  percent  of
revenue  in the  least  developed  countries).  The degree  of  reliance  on  domestic  taxes  on goods
and services  is  greatest  in  the semi-industrial  countries.
In many  low-income  countries,  direct taxes  on  agricultural  producers  tend  to  be  very  light,
since  the sector,  particularly  if  comprised  of smallholders,  is difficult  to  tax.  Instead,  taxes
on  agricultural  producers  are more  commonly  levied  through  price  and  trade  taxation.  For
instance,  the  incomes  of ejido  farmers  in  Mexico  are  not  taxed  directly.  Agricultural
producers  in India also  do  not pay  income  taxes  on  agricultural  income.  A  number  of
countries  provide  income  tax incentives  to  commercial  agricultural  development.  For example,
commercial  income  from animal  husbandry  and  poultry  farming  is  tax  exempt  in India,
Pakistan,  Bangladesh,  and  Sri  Lanka.  Both  Brazil and  Mexico  apply  lower,  preferential
corporate  income  tax  rates  to  income  earned  from  commercial  agricultural  enterprises.
Tax  Reform  Issues
In  most developing  countries,  existing  tax  systems  do  not  necessarily  represent  a neutral  or
equitable  mechanism  for raising  revenue.  Tax  systems  have  often developed  in  piecemeal
fashion  with  the  purpose  of protecting  specific  sectors  or  interest  groups,  or  of  raising  more
revenue.  Thus,  the  tax structure  many  not fit  together  to  achieve  development  goals.  Tax
rates  are  often  high  and  imposed  on a  narrow  base,  which  provides  incentive  for tax  evasion.
Complex  systems  prove  too  difficult  for tax  officials  to  administer.
A  survey  of  recent  tax  reforms  undertaken  by  five  developing  countries  presents  evidence
that,  in most  cases,  the  reforms  represent  attempts  by  countries  to  reduce  the  negative
effects  of tax  systems on  economic  incentives  and  to  increase  purchasing  power.  The  reforms
also  illustrate attempts  to  raise  revenue  by  reducing  top  corporate  and  individual  income  tax
rates  and,  thereby,  broadening  the  base  to which  they apply.
2U.S.  Agency  for  International Development.  "Conference  Reviews  Country  Tax Reforms,"  Front Lines,  Sept.  1986.
173

Tax Reform Policies in Developing Countries

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