The purpose of this paper is to highlight, at a high level, how tax policy may support the SDGs – either through general tax raising or supporting specific SDGs. It is not intended to be exhaustive, an in depth analysis, or to provide some kind of blue print for a perfect tax system but simply to raise points for further discussion.
The Sustainable Development Solutions Network (SDSN) has estimated that:
“Low and lower middle income countries may need to increase public and private expenditure by some $1 .4 trillion per year ($343-360 billion for LICs and $900-944 billion LMICs) in order to reach the SDGs. This corresponds to 4% of these countries estimated GDP over the period measured in purchasing power parity (PPP) and 11% of GDP in international dollars, or 0.8-1.3% of world GDP.”1
The paper estimates the growth in projected tax revenues based on assumed GDP growth and compares that with the above estimates in order to calculate any deficit in funding. It concludes:
“Subtracting the annual public financing needs identified in Table 16 ($213-224 billion in LICs, and $569-604 billion in LMICs) from average incremental central government revenues dedicated to SDGs each year ($61 billion in LICs and $984 billion in LMICs), yields a financing gap of $152-163 billion per year on average from 2015 to 2030 in LICs, while LMICs are predicted to cover investment needs with $380-415 billion to spare each year. This illustrative analysis suggests that lower-middle-income countries will be able to auto-finance public investments in the SDGs over the full period using the assumptions laid out in this paper. However, these countries may require international co-financing at the beginning of the SDG period, when investments are likely to rise faster than countries’ ability to mobilize private and domestic public resources. In contrast, low-income countries will require significant international public finance over the entire period if they are to make the investments required to achieve the SDGs.”2
According to these projections, in low income countries the short fall is in the region of $150bn per annum while lower middle income countries will still have to increase revenues substantially to meet the goals. This indicates the urgent need to improve domestic resource mobilisation.
Setting the scene - Sustainable Development Goals
This paper considers tax and the SDGs in 2 ways. In some cases targeted taxes will help specific goals - such as relating to climate change; however the most important aspect is how to increase the overall tax take in developing countries to invest in the SDGs.
Tax is, in fact, integrally linked to development in its widest, holistic, sense. Revenue is needed for the provision of public assets and services and it underpins a country’s infrastructure. The type of system chosen can encourage or dis-incentivise investment and economic growth and it can address market failure and externalities. A progressive system can help address inequality and it is a factor in promoting democracy, accountability and good governance.
The multifaceted role which tax policy plays can been seen, for example in looking at Goals, 8 and 9. Goal 8 (Promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all) and Goal 10 (Reduce inequality within and among countries) show that there are two “poles” which must be kept in balance. Taxes must be i) designed to support sustainable economic development and ii) must be progressive, reduce inequality and promote inclusive growth. These two objectives are not necessarily in conflict, but neither are they clearly totally aligned. Extremely high taxes on business and mobile, wealthy individuals, to fund SDGs may help achieve ii) – at least in the short term - but could be detrimental to i). Equally increasing VAT and reducing personal income tax and corporation tax may assist i) in the short term but not ii).
Therefore, to meet the goals, tax must be raised in a way which is fair, reduces inequality, and sustains economic growth. In the long term these goals go hand in hand as an unequal society will not sustain growth while poor economic performance reduces the tax required to sustain public assets.
Where does tax specifically impact the SDGs?
The main area will be raising the tax required for development and this is considered in more detail below. The following section looks at some of the areas where tax appears to be particularly relevant and notes what sort of tax is applicable.
Goal 8. Promote sustained, inclusive and sustainable economic growth, full and productive employment and decent work for all
8.1 Sustain per capita economic growth in accordance with national circumstances and, in particular, at least 7 percent gross domestic product growth per annum in the least developed countries.
There is a debate about who actually bears the incidence of corporation tax: is it the owners/shareholders, employees or customers? Some studies have suggested 70% falls on labour, others only 20%. However, economists generally agree that corporation tax is inefficient and acts as a break on economic development, which would indicate corporation taxes should be kept as low as possible, within the requirement to raise sufficient tax for development. A possible option is to have a lower rate of tax on new businesses so as to encourage start-ups. Some countries apply a lower rate to small businesses; however there is research showing this can create complexity around boundaries and act as a disincentive for businesses to grow. It is better to focus the reduction on the first years of a new business as this is when innovation is likely to be at its newest and also cash flow may be most important.
Other ways of stimulating economic growth would include targeted research and development allowances and refundable tax credits. Much has been written about the danger of developing countries losing tax to unnecessary incentives. Such measures should be focused, transparent and well costed and tax holidays should generally be avoided.
The G20 has noted that growth in Africa will come from intra-African trade. While there are a number of customs unions within Africa, many countries do not have significant number of tax treaties with other African countries. Introducing such treaties should help trade growth by providing greater certainty for business, reducing double taxation and providing mechanism to fight tax avoidance.
Goal 8 suggested that, in order to encourage employment for all, taxes on labour should be kept as low as possible.
Goal 10. Reduce inequality within and among countries
10.1 By 2030, progressively achieve and sustain income growth of the bottom 40 percent of the population at a rate higher than the national average.
10.4 Adopt policies, especially fiscal, wage and social protection policies, and progressively achieve greater equality.
Goal 10 indicates the need for a progressive personal income tax system and for a social security system for all funded by the better off rather than through private insurance that the poorer members of society cannot afford. Working tax credits may be a way of encouraging people into work and boosting the income of the low paid; however this would have to be balanced against the danger of requiring society to underwrite poor employment practices or unproductive work. Direct subsidies to certain industries may be more efficient than tax credits to top up low wages.
Goal 11. Make cities and human settlements inclusive, safe, resilient and sustainable
This goal might indicate the need for specific local taxes raised by cities to invest in regional development. Possibilities would include local property taxes, a local trade tax on businesses (for example as in Germany) – subject to issues around complexity and cost of compliance - or local sales taxes such as in the US although the latter could have a regressive effect.
Goal 12. Ensure sustainable consumption and production patterns
12 c Rationalize inefficient fossil fuel subsidies that encourage wasteful consumption by removing market distortions, in accordance with national circumstances, including by restructuring taxation and phasing out those harmful subsidies, where they exist, to reflect their environmental impacts, taking fully into account the specific needs and conditions of developing countries and minimizing the possible adverse impacts on their development in a manner that protects the poor and the affected communities.
Goal 13. Take urgent action to combat climate change and its impacts
Goal 12 c and 13 raise the whole issue of the taxation of natural resources which is a technical area in its own right.
There are arguments that developing countries have not raised sufficient tax from allowing the exploitation of their resources – whether in terms of royalties, duties, or corporation tax. Increasing taxes on natural resources would raise more, much needed revenue. Nevertheless, overreliance on taxing natural resources can be detrimental as it means that governments can rely on a captive source of income. On the one hand they do not need to widen the tax base on a sustainable basis and on the other the lack of need to raise tax can potentially undermine the democratic process. UNESCO states3: “It has been estimated that a 1% increase in the share of natural resource rents in government revenue lowers the fiscal capacity of the country by 1.4% because there are fewer incentives to collect taxes from other sources”.
It also has to be recognised that many natural resource projects provide employment and the multinational owners often also invest in infrastructure such as schools, roads and housing for remote communities. They require substantial upfront foreign investment and result in losses for a number of years before profits are made. The tax regime needs to give appropriate relief for capital expenditure and losses and over taxing the sector may prove counterproductive in terms of development by reducing investment.
Natural resources are therefore not necessarily untapped, tax cash cows.
Taxes can also be targeted at activities which drive climate change or degradation of the environment - on the principle that the “polluter pays”. This would include carbon taxes, green taxes on waste disposal or specific levies on industries that create pollution, or just increasing the tax on the hydrocarbon sector and reforming existing fossil fuel subsidies. In designing such taxes it is necessary to decide whether the aim is primarily to raise funds or to prevent certain behaviour. By their nature, if such taxes are successful in changing behaviour they reduce the tax take and vice versa.
These goals also suggest tax breaks could be given for green energy - for example enhanced or accelerated depreciation for investments in solar and wind power. It would be necessary to balance carefully the cost of such incentives against the benefit of encouraging the relevant activity.
Goal 16. Promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build effective, accountable and inclusive institutions at all levels.
16.4 By 2030, significantly reduce illicit financial and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organized crime.
16.6 Develop effective, accountable and transparent institutions at all levels.
This goal involves strengthening anti-money-laundering rules and ensuring that developing countries can participate in the Common Reporting Standard in order to fight tax evasion. Registers of beneficial ownership of companies and trusts are also required. There is some dispute about whether or not it is necessary for the information to be public or only available to authorities and those with a legitimate interest. Registers where the entries are authenticated by regulated service providers are more trustworthy than those that rely on pure self-declaration. Further work is probably required on means for repatriating the proceeds of crime and evasion and ensuring they are put to the common good – rather than being recycled into corrupt activity, for example through the World Bank and United Nations Stolen Asset Recovery Initiative (StAR).
Work on illicit financial flows should be distinguished from measures to prevent tax avoidance as this is a different phenomenon from criminal activity and requires different measures.
16.6 also points to the need for greater transparency from governments about how much tax is collected and how it is spent. Furthermore, the issue of corruption needs to be faced. For example, The African Tax Outlook, 2017 produced by the African Tax Administration Forum (ATAF) notes that tax authorities are considered the third most corrupt institution in Africa and that 2% of GDP is lost through corruption. Addressing such issues is essential both to create a climate of trust in which tax morale and voluntary compliance improves, and to enable a real debate about tax policy.
Goal 17. Strengthen the mean of implementation and revitalize the Global Partnership for Sustainable Development
17.1 Strengthen domestic resource mobilization, including through international support to developing countries, to improve domestic capacity for tax and other revenue collection.
17.5 Adopt and implement investment promotion regimes for least developed countries.
17.9 Enhance international support for implementing effective and targeted capacity building in developing countries to support national plans to implement all the Sustainable Development Goals, including through North South, South South and triangular cooperation.
Goal 17 involves creating broad based tax regimes which are supported through international cooperation, transparency, collection mechanisms, and capacity building. It also involves changing the tax morale in countries so that voluntary compliance is increased. There are already a number of initiatives aimed at capacity building both through international organisation and collaboration between developing countries. These include work in the UN on the Transfer Pricing Manual and the Extractive Industries Manual; the Platform for Collaboration on Tax between the UN, World Bank, IMF and OECD; programmes through which businesses undertake to help tax authorities understand their business models organised by the OECD; and the work of ATAF which, inter alia, produces a very good summary of best practice in the African Tax Outlook.
Enhancing support for developing countries may also include upgrading the UN tax committee to an intergovernmental body in order to ensure that all countries are fully represented in the international tax debate.
As well as being relevant to particular SDGs, tax is obviously essential to raise revenue to pay for all development. Increasing the overall tax take will require a number of levers to be used: developing countries need better capacity to enforce their laws; better anti-avoidance rules are required to stop avoidance and evasion; and the tax base itself needs to be widened.
At the same time it needs to be recognised that many businesses operating in developing countries, and many taxpayers, consider they are over taxed already, while widening or deepening the tax base may be very difficult due to entrenched interests. Part of this stems from taxpayers not seeing where the tax revenues go. Increasing transparency on behalf of governments is therefore an essential part of trying to increase the tax take. Equally it is important to focus on reducing corruption, making tax laws clearer and easier to understand, ensuring fair and transparent processes, providing taxpayers with more certainty and improving tax morale. Such measure can encourage investment and trade which can benefit tax revenues.4
Ultimately, strengthening domestic resource mobilisation is not just a technical issue concerning types of tax but is more fundamentally a societal issue. According to Besley and Perrson:
“For modern low-income countries, the problem of raising more tax revenues is ultimately a wider issue than having the right kind of technical expertise. Government institutions and tax systems evolve together, and taxation may feed back to the development of political systems (as argued for example, by Levi 1988). Weak and unaccountable states are unlikely to have strong motives to build fiscal capacity, and their citizens are unlikely to evolve strong norms of compliance. This is a classic problem of positive feedback, which can yield good and bad equilibrium paths.”5
Nevertheless, there needs to be specific taxes which can be addressed and the sections below now look at some particular areas of policy.
Corporation tax - International elements
The African Tax Outlook 2017 notes that corporate tax rates in ATO countries are as high as in OECD countries. It also notes that some countries are very reliant on a few MNE and corporation tax is vulnerable to global economic shocks. It suggests countries should not over-rely on corporation tax. Consequently, it seems simply increasing the tax rate is not advisable.
There is a debate about the size of tax avoidance by MNEs in developing countries. Various figures have been produced in recent years but the consensus has been it is somewhere between $100-200bn per year. However this is all developing countries and therefore includes such countries as China, Brazil, India and Saudi Arabia. A paper produced by Alex Cobham and Petr Jansky for UNU-Wide in March 2017 re-evaluated earlier work and looked at particular income categories. The paper finds that low income countries are losing about $5bn per year. This underlines the fact that stopping MNE avoidance is not a panacea for delivering the SDGs. Nevertheless it is still a significant sum which needs addressing.
The OECD BEPS programme should assist in stopping avoidance by aligning tax with value creation through, for example, changes to transfer pricing rules. A challenge for developing countries is how to apply these rules and how to find comparable and this is been partly addressed through the UN’s Practice Manual on Transfer Pricing. Changes to tax treaties to stop treating abuse (the principal purpose test) and to stop conduit financing will also assist. Ensuring that developing countries have access to the OECD Country by Country Report can also help in risk assessments.
One possibility for stopping avoidance by MNEs which is sometimes promoted is formulary apportionment. However there are a number of significant issues with this. First it would require global, or nearly global agreement to work properly and avoid double taxation, which is unlikely to occur - the EU has been talking about a common consolidated corporate tax base (CCCTB) for a long time but is unlikely to introduce such a regime in the near future as countries that might lose out are resisting it. Secondly, there are significant complexities about how the formula would be drafted. It is unlikely that one formula would fit all types of industry and there are boundary issues where a multinational is involved in multiple industries. Thirdly, it is not appropriate for extractive industries which make up a large part of the tax base of some developing countries. Finally, and perhaps most importantly, it is by no means clear that formulary apportionment would increase the tax take in low income developing countries – it may shift it to large industrialised nations such as the US and possibly China and India.
One area which needs further examining is the balance between residence and source taxation. One possibility to increase the developing world tax take would be to allow higher withholding taxes on cross-border flows (for example as a recent amendment to the UN Model Treaty does as regards technical fees). This however may create double taxation and reduce investment where investors are unable to obtain a full credit for tax withheld on gross income flows. There is also a wider debate about the extent to which residence and source is still relevant in a globalised economy where value often comes from intangible assets which are co-created in multiple locations. Nevertheless, until this larger issue is solved, reconsidering tax rights and withholding tax may be a way forward.
Another issue which has been raised by the IMF and a number of NGOs is the extent to which developing countries unnecessarily give away tax through incentives. Tax holidays appear to be particularly costly and inefficient. Clearly, developing countries need to consider the cost and benefit of any incentives. On the one hand, targeted measures may encourage inward investment. On the other hand, governments need to be careful not to give away inefficient tax breaks or engage in a race to the bottom with other countries.
Corporation tax - domestic companies
The OECD notes that “Where administrative capacity and incentives to comply are weak, hard to tax sectors, including small businesses, small farms, and professionals, become particularly difficult. Structural constraints, including low levels of economic development, large agricultural and informal sectors are common challenges.”6
According to UNESCO: “On some estimates, the informal sector accounts for 55% of GDP in sub- Saharan Africa, and revenue foregone by not taxing it can be equivalent to at least 35% of total tax revenue. As the majority of the poorest work in the informal sector, governments need to ensure the taxation of the sector is not regressive. However, the sector also includes prosperous small to medium-sized businesses that often pay little or no tax.”7
The African Tax Outlook 2017 notes that in ATO countries the informal sector accounts for “50% to 80% of GDP, 60% to 80% of employment and as much as 90% of new jobs.” Proposals for dealing with the informal sector include reducing compliance costs, simplifying record keeping, providing pre-filled tax declarations for filing returns, strengthening legal and regulatory systems and building a better culture of compliance through education and outreach. An example is given of Kenya where small businesses are subject to a flat rate tax of 3% of annual turnover.
It therefore appears that potentially quite substantial amounts of tax could be raised by focused taxation of domestic businesses.
The ATO notes ATO average PIT: GDP ratio is 4% which is about half OECD countries. This is largely due to low bottom marginal rates. Personal income tax can be the most progressive, redistributive, form of tax but is also recognised as being detrimental to growth. ATAF therefore recommends further research on personal tax policy. Certainly increasing bottom rates is unlikely to assist in meeting the SDGs but there could be room for removing exemptions in the higher brackets or increasing the top rate in some countries.
Enforcement is another key issue. According to UNESCO: “For many of the world’s poorest countries tax evasion results in resources being used to build personal fortunes for the minority elite”8. It is noted that the Pakistan Federal Board of Revenue estimated that only 0.5% of Pakistanis (768,000 individuals) paid income tax in 2012. An Education Commission paper9 refers to various estimates of assets held offshore and tax evaded. It quotes an estimate by James Henry for the Tax Justice Network in 2012 which suggested a range of $21-32 trillion. Using the lower figure and a 3% return, Henry estimates a figure of $189 billion is being evaded. Care is required with these figures as, even if the $21 trillion figure is correct, there is nothing to say that it is all illegal and that tax on the income thereon is being evaded. Nevertheless the evidence shows that a significant amount of personal taxes are being evaded in developing countries.
There is therefore room both to enforce personal tax laws and potentially to increase the overall take by ensuring progressive tax bands and removing personal exemptions that tend to reduce the effective rate of tax for higher earners.
The IMF Fiscal Monitor, October 2013 notes:
“There is a strong case in most countries, advanced or developed, for raising substantially more from property taxes;” and
“In principal, taxes on wealth also offer significant revenue potentials at relatively low efficiency costs.”
An issue with these taxes is wealth does not necessarily indicate an ability to pay where you have people who are “asset rich” but “cash poor”. In low income countries there would be a limited population who could afford to pay such taxes. It is noticeable that they are not mentioned in the ATO. Nevertheless, both should be considered in attempts to widen the tax base.
VAT, Customs Duties and Excise
VAT is generally considered to be the least distortive of taxes but, equally, is regressive. The Education Commission paper is critical of the “long-standing ‘tax consensus’ promoted by the IMF and others” which was the removal of trade taxes and their replacement with VAT or similar sales taxes. There are, perhaps, arguments to reverse some of these changes - although the impact on international trade would need to be considered. Also, within Africa there are a number of regional customs unions which will restrict countries’ ability to increase duties.
Nevertheless, according to the OECD , the VAT gap in some developing countries is 50-60% in comparison with 7-13% in developed countries. There is therefore also room to increase the VAT take through better enforcement without having to increase the rate or broaden the base. Part of broadening the VAT base will be to bring businesses in the informal sector into the formal one through, for example, simplification of compliance.
The ATO recommends that VAT rates should not be set too low. It states “ATO countries need to strike a balance between considerations of fairness and the need for revenue. At the same time, though, they should bear in mind the distributive aspects of public expenditure and that, were it to benefit society, they might be able to expand regressive taxation and make it more acceptable.” The IMF Monitor notes “Broadening the base of the value added tax ranks high in terms of the economic efficiency (new findings tend to confirm) and can in most cases easily be combined with adequate protection for the poor.” Nevertheless, any increase in tax on poorer members of society would need to be carefully modelled. Research suggests that even a tax system which is overall a progressive one can have the effect of pushing people into poverty or making certain classes of the poor even poorer.
Another area to consider is excise duties charged on items such as fuel, tobacco and alcohol. The ATO describes such taxes as creating a double dividend in that they raise money and control undesirable consumption. It points out however that by increasing the cost too much a country may lose both dividends as it may encourage smuggling. While there is unlikely to be much room to raise such taxes more could be done to stop evasion.
Given the need to promote employment, payroll taxes would not appear to be a good option.
The Education Commission paper moots a global wealth tax proposed by Thomas Picketty. It is suggested that this would require a global registry of financial wealth. In 2015, private global financial wealth was estimated to stand at $156 trillion. A global wealth tax of 0.01% annually would raise around $15.6 billion. The proposal is that the tax would be shared between countries according to the wealth held by their residents. However, if this is to be a global tax linked to the SDGs, in principle there seems no reason why the entire amount could not be shared out between developing countries. Clearly this would require global agreement. The Education Commission paper also notes, when referring to a global financial transaction tax (FTT), that if a tax is distributed as aid it does not have the political benefit of requiring governments to account their citizens for how their tax money is spent.
An alternative global tax put forward by the Education Commission paper is a global FTT. A downside with such a tax is that, on the basis that each country would keep its own tax base, it would raise very little for low income countries which do not have an established stock exchange.
There is no one perfect blueprint which fits all countries nor is there a silver bullet. But clearly how tax regimes are crafted and applied will have a huge impact on the delivery of specific SDGS and on how funds are raised to meet the overall goals and development in the widest sense.
The common themes are likely to be around raising voluntary compliance through education and increasing accountability and tax certainty; stopping evasion and avoidance by building capacity and embedding international best practice and cooperation; broadening and deepening the tax base by, for example, removing inefficient tax breaks and exemptions, adjusting personal tax brackets, and formalising the informal sector; and using targeted measures either to drive specific SDGs or raises new revenue through things measure like property taxes.
Each country will need to find the right balance of taxes given its characteristics such as the presence of natural resources, GDP, distribution of wealth, industry base and geographical location.
Chris became Head of Tax Policy for KPMG UK in 2011. In this role he was a regular commentator in the press, as well as on radio and TV, led discussions on various representations with HMRC/HMT. In 2014 Chris spearheaded KPMG UK’s Responsible Tax for the Common Good initiative. In September 2016 Chris took on the role of Head of...