Chapter

IV. Revenue Policies

Author(s):
International Monetary Fund
Published Date:
September 1986
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Many Fund-supported programs contain specific statements about revenue policies and the increased ratio of revenue to gross national product (GNP). Programs in the 1970s often had plans to increase the ratio of revenue to GNP at least 1 percentage point during the program year; some aimed at even larger increases. However, as was pointed out earlier, the authorities often find it difficult to introduce new tax measures when real incomes are under pressure following other measures undertaken to reduce domestic absorption (such as devaluation of the currency, expenditure cuts, or greater price flexibility). If the tax system exhibits little elasticity with specific rate excises, with tax bases eroded by exemptions, and with imports limited by shortages of foreign exchange, as is often the case, then it will be even more difficult to introduce new tax measures.

The current tax policies of most developing countries apparently do not affect the prevailing income distribution to a significant extent.11 The reason is relatively simple: developing economies have been unable to levy successfully the direct taxes needed to introduce marked progressivity into the revenue system; such taxes are generally insignificant in the revenue structures of most developing countries. Indirect taxes, on the other hand, are significant in the revenue structures of developing countries but are known to be regressive.12 On the whole, therefore, the tax systems in developing countries have been found to reduce income inequalities only to a small extent.13 Given these circumstances and the fact that Fund-supported programs only marginally change the basic structure of the tax system, it is unrealistic to expect that tax measures in these programs will have significant effects on income distribution. Moreover, most tax measures take time to become effective (corporate taxes are typically collected with a lag of 18 months), further reducing the redistributive effect of tax changes in the short run.

Administration

A recurrent theme in a many of the earlier programs was a general statement about improvements in tax administration. In the sample of 94 Fund-supported programs during 1980–84, improvements in tax administration, including tightening of tax enforcement procedures, identifying and registering new taxpayers, intensifying tax collection efforts, strengthening tax legislation, closing loopholes, and collecting tax arrears, were mentioned in 52 programs; their revenue impact, however, was not assessed (Table 4).

Table 4.Administrative Improvements and Direct Tax Policies Employed in Fund-Supported Adjustment Programs
Number

of

Programs
Percent
Improve or reform tax administration5255
Personal income tax4346
Move from schedular to global133
Reduction of personal income tax77
Increase of surcharge in personal income tax1112
Income tax reform or extension2021
Increase in payroll tax or social security contributions910
Collection of tax arrears11
Corporate tax3234
Income tax surcharge1112
Collection of tax arrears77
Shorten lag for corporate tax payment66
Modification or reduction of income or profit tax1415
Tax on property1011
Introduce or raise land tax55
Introduce or raise urban property tax55
Other property tax66
Source: Appendix III.

In one country the reverse policy was undertaken.

Source: Appendix III.

In one country the reverse policy was undertaken.

There is no doubt, from the point of view of distribution, that improved tax administration, especially of personal and corporate income taxes, would be one of the best ways to improve equity. Regrettably, it is also one of the most difficult, involving widespread staffing reform which can take years to implement; it also requires fundamental changes in the resolve of officials to apply legislation already enacted, knowing there is a commitment on the part of the politicians and the judiciary to back them up. It must therefore be concluded that while improved tax administration is desirable, it cannot be relied on as a short-run solution to a problem of insufficient revenues. For this reason, it is unlikely to have a significant redistributional impact in Fund programs.

Direct Taxation

Changes in direct taxation have not played as important a role in Fund-supported programs as revisions of indirect taxation. Altogether, 79 of the 94 programs surveyed proposed changes in the tax system; indirect taxes were changed in 69 programs and direct taxes in only 44. Nevertheless, the use of direct taxes in 47 percent of the programs represents in itself a considerable emphasis on such tax measures.

Personal Income Tax

The direct tax policy instrument of choice is the personal income tax. Normally, it is described very broadly as a general reform of income and wealth taxation, and as such was employed in 20 of the programs. A surcharge on upper-income brackets was adopted in 11, while some programs simplified the rate structure and reduced exemptions. Other reforms, such as changes in the basis of assessment, the introduction of a minimum tax, increases in tax rates on interest and dividends or in withholding or coverage, or indexation for inflation, were used even less often. Thus, the thrust of the policy actions remains reform and simplification of the existing tax structure, rather than major revisions of the current tax system.

The personal income tax is generally considered to be the main progressive element in any country’s tax structure. Several arguments, however, suggest this role is exaggerated. First, the existence of substantial tax evasion in both developed and developing countries reduces its effective progressivity.14 Second, the distributional impact of the personal income tax may be somewhat exaggerated by virtue of its being an intensely discussed topic by the urban middle and upper classes who bear most of the burden of the tax and who are convinced that the tax tends to distribute income away from them. Third, the usual presumption that the ultimate incidence of the tax is on the immediate taxpayer does not distinguish between short-term and long-term effects. While in the short run tax shifting may be unlikely, in the longer run an elastic labor supply may affect the total labor pool as well as the composition across vocations, particularly if marginal tax rates are high. In developed economies wage negotiations increasingly emphasize take home pay, which enables the increasing burden of an unindexed personal income tax (in an inflationary situation) to be shifted to the cost of production.15 In developing economies the most talented and most responsive individuals to after-tax differentials are often the most internationally mobile.16

Other features of the personal income tax structure also have redistributional effects. Exemptions may have a progressive impact, even though inflation erodes the effect. The effective tax base after deductions, income splitting, maximum taxes, capital gains tax preferences, and so on, also affects the effective progressivity of the system. Schedular income taxation, which taxes income from different sources separately and often differently, has worse distributional implications compared with a global income tax system in which pooled income is taxed. Last, but not least, the effectiveness of tax administration, or the lack of it, also plays an important, probably the most important, role in determining the ultimate burden of the personal income tax, as mentioned earlier. The effective application of the personal income tax is usually restricted to a PAYE (pay-as-you-earn) system levied on employees in the public sector and in a few large firms, as professionals and small traders are often difficult to tax.

Despite those problems, developing country studies reveal that the effective personal income tax structure is usually progressive in the modern sector, although frequently less so than the apparent or legal income tax structure. A comparison of 28 developing countries indicates that while the marginal personal income tax rates reach on average 55 to 60 percent at incomes equal to an average of 40 times per capita income, the effective marginal rates, after accounting for the different forms of exemptions and deductions cited above, are about 40 percent at incomes equivalent on average to 30 times the per capita income.17

Country-specific studies have also tended to show a progressivity in the personal income tax structure, or a U-shaped incidence curve with the highest income groups facing the highest effective tax rates.18 The personal income tax measures in Fund-supported programs typically do not increase the regressivity of the income tax, since they are usually geared toward administrative improvements to reduce evasion, reduce exemptions, increase tax rates on interest and dividends, surcharges on upper income brackets, and to globalize income for tax purposes, which are all directed toward the upper income groups. If anything, they, along with surcharges on income taxes, should add to the progressivity of the effective tax structure.

Corporation Income Tax

The main use of the corporation income tax to raise revenue in Fund-supported programs has been on a once-and-for-all basis, moving assessments and collections into a current year basis (in 6 programs). Most of the explicit discussions of the corporate income tax measures focused on simplifying the rate structure; 14 of the 94 programs surveyed specified a reduction in the tax rate. Other reforms, such as the elimination of tax preferences and increases in coverage, were mentioned even less frequently.

Given the controversies surrounding the short-run incidence of the corporate income tax, no definitive statement can be made regarding the distributive impact of such corporate tax reforms.19 To the extent that corporate taxes are an instrument of adjustment in Fund-supported programs, it may be asserted that the tax falls on capital owners once factor movements stop and intersectoral rates of return of the factors equalize. In this sense the corporate tax incidence would not be regressive but, in practice, the corporate profits tax in many countries is often levied efficiently only on a few large firms (often foreign-owned) and is subject to erosion through generous provisions to encourage investment and exports.

In any event, the policies included in Fund-supported adjustment programs have been in the nature of adjustments in tax rates or the simplification of the rate structure which, by themselves, would not add to whatever regressivities might be present in the existing structure. Such recommendations might, in the long run, favor a more efficient allocation of capital.

Property Tax

Property taxes have played only a marginal role in Fund-supported programs. Of the 94 programs surveyed, only 10 proposed introducing or raising land or urban property taxes or improvements in the valuation of property, while 6 changed other property taxes, such as some modification in real estate taxes or taxes on transfer of property.

There is active debate on the distributional implications of property taxes, but it is clear that given the rather marginal role they play in Fund-supported programs they rarely raise important distributional issues, for several reasons. First, property taxes frequently form a very small percentage of total tax revenue of developing countries.20 Second, reform of the property tax is usually considered a structural issue and the country’s authorities are often unwilling or unable to do much to overhaul property taxes in the short run. Third, even in the context of an extended arrangement, time may be much too short to conduct the cadastral survey, valuations, and overhaul of collection procedures needed to improve property and property taxes. Thus, while property taxes may or may not be significantly progressive, Fund-supported programs tend to ignore them for reasons of administrative and political feasibility, urgency, and their meager revenue potential.

Indirect Taxation

Domestic Taxes

Fund-supported programs have depended heavily on indirect taxes for generating revenues; 69 out of 94 programs in 1980–84 involved changes in domestic taxes on goods and services and 54, changes in import duties (Table 5). Taxes on petroleum products and sumptuary taxes on goods have been raised frequently, as have the rates of broad-based consumption taxes, such as the sales tax, value-added tax, and turnover tax. Taxes on selected services have also been raised in a few cases. As the incidence of indirect taxes is generally assumed to be on the consumer, the burden of all these tax increases can be presumed to have fallen on various segments of the population in proportion to their consumption of the taxed goods and services.

Table 5.Indirect Tax Policies Employed in Supported Adjustment Programs
Number

of

Programs
Percent
Domestic tax on goods and services6973
Raise excise tax rates (alcohol, cigarettes, etc.)4851
Increase tax on petroleum3436
Raise or modify sales tax2324
Temporary selected tax reduction33
Raise taxes on other domestic goods and services1314
Import duties5457
General or selected increases in customs duties2931
Increase of petroleum import duties1011
Reduction or elimination of selected import duties44
Tariff reform (exemptions)3436
Import duty surcharge66
Export duties2324
Increase in rates177
Extension of coverage66
Export compensation schemes77
Others (reform/reduction)77
Other tax and nontax4851
Tariffs, fees, and charges4649
Other77
Source: Appendix III.

In one country the reverse policy was undertaken.

Source: Appendix III.

In one country the reverse policy was undertaken.

Selective Taxes on Goods

The distributional impact of taxes on petroleum products is tied principally to the ownership of a private automobile by higher-income families and the use of public transportation by lower-income urban families. Other aspects of petroleum usage, however, are also politically important. Often the price of kerosene, which is extensively used by the poor for lighting and cooking, is the most politically sensitive of all price issues. Moreover, in many countries the authorities attempt to minimize the cost of foodstuffs in urban markets through special tax rates on diesel fuel (which is used in agricultural production and transport). Electricity tariffs are related to the cost of hydrocarbon-fired generating stations and power consumption rises with household income. On the whole, with these differential rates a tax on petroleum products tends to be progressive in incidence, so that the increases in the tax rate frequently enacted under Fund-supported programs (34 of the 94 programs) can be expected to enhance the progressivity of the tax system. The outcome is particularly likely given the emphasis in these programs on the full pass-through of all increases in petroleum costs (including those from devaluation).

In contrast, the consumption of goods on which sumptuary taxes are levied (beer, liquor, and cigarettes) increases more slowly than income.21 House-hold budget surveys of selected developing countries reveal that alcohol and tobacco together generally count for about 5 to 6 percent of taxable expenditures of the lower-income classes and only 2 to 3 percent of the upper-income classes, so that the demand for these goods is generally income inelastic.22 The incidence of excise duties on these goods (especially when they are undifferentiated with respect to quality and price) tends to be regressive. An increase in the tax rates on these items can be seen as increasing the regressivity of the tax system.23 However, the regressive distributional effects of sumptuary taxes are often accepted by policymakers as necessary to restrict the consumption of alcohol and tobacco on social grounds or to generate substantial budgetary revenues—the consumption of these goods is generally price inelastic—to meet fiscal deficits. Moreover, the redistributive impact of such taxes can be viewed as affecting not so much the transfer of resources between rich and poor but more within income groups according to consumption patterns, for example, from those who drink and smoke to those who do not.

Taxes on alcohol and tobacco were increased in 48 programs. They were used in most cases because excises are easy and cheap to administer, the revenue is reliable, and the accrual is immediate; the same reasons lead developed countries to rely heavily on these taxes despite their likely regressive impact on low-income households. Another reason for frequent discretionary increases in these taxes is that they are usually specific and not ad valorem and must be updated during inflationary periods to ensure that the real tax yield does not decline.

General Taxes on Goods

Broad-based consumption taxes in developing countries take a variety of forms—sales tax, value-added tax, turnover tax—but the consensus is that their burden is regressive,24 primarily because consumption forms a larger proportion of the incomes of lower-income groups. As a result, a uniform rate tax on all consumption becomes a larger burden on the lower-income than on the upper-income households. Even a consumption tax which exempts unprocessed and essential food and levies a relatively higher tax rate for luxury goods is rarely progressive with respect to income in developing countries.25 A uniform increase in the rate or rates of taxes on consumption—an element in 23 of the programs surveyed—intensifies rather than counteracts the inherent regressivity of the tax. It is only when the consumption tax rate differential is widened or luxuries are taxed at higher rates than before that the regressivity of consumption taxation can be expected to decline.

Selected Taxes on Services

Finally, some Fund-supported programs widen the tax net to include additional services or increase the rates of tax on services that are already taxed. The impact of these indirect tax measures on distribution is favorable, for the income elasticity of taxable consumer services in developing countries is substantially greater than unity. Taxation of such services therefore improves the progressivity of tax burdens, and additional taxation of services supports further efforts to redistribute incomes.26

Fund-supported programs have sometimes also included measures for widening the indirect tax base to cover commodities or taxpayers that were formally exempt from excise duties or other forms of consumption taxes. Depending upon the income elasticity of the taxed commodities—namely, whether they are basic necessities or conspicuous luxuries—the distributive impact can be negative or positive. Frequently, the documentation for Fund-supported programs does not spell out the new items brought into the tax net, so that little can be said with confidence about the distributive effect of such tax measures. Such changes, however, often involve the taxation of electricity and telecommunications, which generally constitute a larger share of household expenditure as income increases; in these circumstances the progressivity of the tax system is probably increased.

Taxes on International Trade

Import Duties

Import duties are relatively direct instruments of income redistribution: they clearly serve to increase the prices of consumer-imported finished goods, and thus in practice they generally redistribute income from consumers to traders of imported items or to the capital and labor used to produce import substitutes. They also affect the prices of many goods which are domestically manufactured when the imports of intermediate goods used in production are subject to import duties. Given the frequency of increases in these taxes in Fund-supported programs (in 54 of the 94 programs), it is important to determine their contribution to overall tax progressivity.

Given the obvious significance of these taxes, the authorities of developing countries frequently impose differentiated import duties to improve the impact of these taxes on social equity. Commonly, the rates of duties increase as goods are perceived to represent luxury consumption, in the belief that the consumption patterns of richer individuals are more import intensive than those of less well-off individuals.

In respect of equity, import duties tend to be much like excise duties or sales taxes and often do not have a significant positive redistributive impact. While it is difficult, however, to assess the distributional impact of changes in import taxes, sometimes the comparison is between a system of import duties and quantitative restrictions on imports, and here the conclusion is less ambiguous. The general approach in Fund-supported programs is that quantitative restrictions on imports should be replaced by tariffs so that the economic rent from the limited volume legally imported is transferred from private sector importers to the government. As such favored importers tend to belong to the higher-income groups, such a policy clearly supports a more equal income distribution.

Many Fund-supported programs contain measures such as an across-the-board increase in the rates of import duties, sometimes in the form of an import surcharge, to contain imports and improve balance of payments. As stated above, such measures do not necessarily serve to improve the income distribution, unless they can be linked to items commonly purchased by higher-income groups. Examples of such policies are (a) increases in the rates of import duties on luxury items, (b) differential increases in the rates of import duties, (c) an across-the-board reduction of all duty rates following devaluation, and (d) the removal of exemptions that favor particular groups (a policy in 34 programs). Similarly, any measure widening the tax base of import duties to cover hitherto exempt items of a semiluxury or luxury nature whose demand is income elastic also tends to favor redistribution, if it can be successfully implemented.

Export Duties

Fund-supported programs do not usually rely on export duties for quick revenue even though several authors have defended them as a good tax revenue source.27 Some programs have called for increases in taxes on traditional exports; a few others have included income tax relief to exporters. Altogether 23 programs included policies on export duties: 7 included increases in export duty rates, 6 an extension of the coverage, and 7 reform and reduction of export taxes.

Countries whose exports have high elasticities of demand and low elasticities of supply, such as many developing countries, typically find a higher percentage of the overall incidence of export duties tends to be borne by the domestic producer in the short run. As time passes, the incidence depends on the relative abilities of the domestic exporters and foreign importers to adjust to the tax, that is, to the relative differences between the short-run and long-run elasticities of supply and demand. To the extent that demand for a country’s export is inelastic, in the short run the country may be successful in shifting the burden of the export duty to the consumers of its exports. More commonly, however, the country is a price taker in international markets and its producers must bear any such tax.28

The share of the overall burden on the producer may, however, be further divided among different economic agents of the domestic economy, as the incidence of export taxes also depends on how exporters of different goods are treated by the tax regimes of developing countries. Usually, while exporters of traditional exports with low supply elasticities face high export duties, those of nontraditional exports—light manufacturing, textiles, and so on—may actually receive subsidies and tax holidays. Indeed, this distinction is present in most countries with Fund-supported adjustment programs that proposed changes in export duties.

Another aspect of export tax incidence is that agricultural small-holders frequently pay higher tax by way of export duties than their counterparts in urban areas pay by way of income tax, especially where traditional exports in the agricultural sector are heavily taxed.29 Export duties, thus, affect the pattern of intersectoral distribution. Export duties also affect the intrasectoral distribution between domestic consumers and producers of the exportable commodity. For example, in the case of staples, such as rice, or mass-consumed items, such as tea and coffee, export duties may be sufficiently high to discourage growers from exporting their crops. To the extent this policy lowers domestic prices for these items and consumers are from lower income groups than the producers, these export duties have a redistributional impact in favor of the lowest decile of both rural as well as urban consumers.

The effect is by no means always favorable to redistributional efforts, however. In many countries producers of exportable commodities (particularly agricultural commodities) have lower incomes than the average consumer, and the export tax favors the higher-income consumers at the expense of the lower-income producers. Moreover, if domestic consumption of the taxed goods is small, the effect may be to discourage any domestic production.

Finally, export tax incidence depends on the administration of export taxes. Marketing boards and stabilization funds often levy and administer these duties in lieu of the central government in addition to functioning as the marketing agency. To the extent that the revenues of these boards and funds are often higher than their expenditures and that they transfer their surpluses to the general budget, the exporters, often comprising small producers, subsidize the rest of the economy.30

On the whole, then, little can be said with any certainty about the incidence of export duties in general and the effect of an increase or decrease in their rates on income distribution. Nevertheless, Fund-supported programs have tried to anticipate potential windfall gains to exporters arising from devaluation and have made recommendations to channel a part of extraordinary gains to the budget through progressive temporary export duties. In one case, the need for budgetary revenue was so acute and the increase in profitability related to the devaluation so great that the marginal tax rate on coffee exports was 100 percent.

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