The fourth ITD global conference in December 2011 will address the tax issues raised by economic developments that have affected the distribution of income, wealth, and living standards within and between countries over recent years. Income inequality between countries may have diminished significantly as economic reform in many emerging economies has spurred growth. The majority of advanced countries have continued to grow, although at moderate rates, and more slowly recently given the lasting impact of the global financial crisis. However, acute differences persist in terms of wealth accumulation and human development between advanced and less developed countries.
At the same time, the nature of the economic growth that has taken place seems to have contributed to greater inequality within some countries, at least in the short term. Recent decades have seen significant changes in the distribution of both wealth and incomes within countries, although the causes are still disputed, with notable increases in the share of income enjoyed by those at the very top of the income distribution in many countries. This raises questions about the extent to which increased levels of inequality within countries may be inherent in the growth patterns observed in some cases.
The structural linkages between growth and inequality raise difficult issues about how best to raise taxes in a way which contributes to growth and equitable development. Many questions remain about how relevant wide economic, social, and institutional factors are in determing the structure and administration of tax regimes which affect growth and inequality.
Increased difficulties related to taxing capital income, whether due to tax competition, tax avoidance or evasion, are a particular concern for tax administrators and policy makers since this type of income is of much greater significance to the wealthiest taxpayers. Similarly, labor mobility has increased worldwide, especially for high income workers, raising new taxation and inequality issues. This conference will address these and other tax challenges as outlined in more detail below. These issues inter-relate with the pre-existing need to decide how best to enhance revenue in advanced countries to address fiscal consolidation, rising health costs and ageing, and for less developed countries to increase domestic resource mobilisation in an efficient and equitable manner if they are to make the public social and infrastructure investments needed to continue emerging.
The upcoming ITD conference will represent a unique opportunity for ministers and senior tax administrators to come together and discuss how best to deal with the variety of tax challenges they face in relation to inequality.
Growing Unequal: The Main Country Policy Choices
Decisions about tax and the spending of the revenues generated are at the heart of political and economic debate. The level and distribution of taxes should be determined taking into account perceptions and measurement (through fiscal incidence analysis) of how they are affecting opportunity and outcomes for the population, and who is paying what and how much of the overall tax burden different income groups are shouldering. Whilst fairness is generally seen as important, interpretations of what is fair differ significantly amongst individuals, countries, and at different stages of development. These differing views are played out in political debate at the national level, where the current fiscal choices can be seen as reflecting both the balance of political forces and external contstaints at any one time.
Work by the OECD, the IMF, and the World Bank on tax reform and economic growth stresses that whilst equity issues are important, they need to be seen against the context of the whole tax system and not assessed on a tax by tax basis. A recent IMF paper on revenue mobilistation in developing countries also stresses the point that whilst the relatively greater reliance on indirect taxes may make the system more regressive, a regressive tax may be the only way to finance strongly progressive spending. Given that the importance of publicly provided services tends to be of more importance to lower income households, the overall tax and expenditure system is likely to be progressive.
The effect of taxation on inequality cannot be isolated from the fact that tax revenues are then channeled to the population through social spending. The idea that sufficient revenue should be collected to provide at least a basic level of public services that allows most individuals and households to benefit from their talents and abilities, if they wish to, is often seen as a starting point. Principally, this has been interpreted as the state having responsibility for ensuring good quality primary and secondary schools, basic infrastructure, and good basic healthcare, whether provided directly or indirectly. Social transfers to mitigate poverty are also common in many countries as part of the contract between citizen and state. These can be motivated by ideas of pooling risks related to events such as unemployment, poor health or other life events which cause periods of deprivation, or for more altruistic reasons.
On average, cash transfers, income taxes, and social security contributions reduce inequality by one third and poverty by about 60% in OECD countries*. Publicly provided services that contribute to reduce inequality are also very important in most countries. A significant part of such transfers often relate to intergenerational aspects of inequality, with support for both the young and the old, paid for by those currently in the work force. Pensions system and publicly provided healthcare (which is used more intensively by the young and the elderly) are under pressure in many countries due to demographic changes with implications for the amount of revenue that will need to be raised in future.
Tax policies have changed significantly in the last decades, partly in response to changes in economic growth and inequality patterns worldwide. For example, large cuts in the top nominal rates of personal income taxes have been common. Some governments have also moved away from net wealth taxes, inhertitance taxes, and more generally made the tax burden on capital lighter.
The fairness objective raises issues around the moral legitimacy of the state to impose levies such as inheritance and wealth taxes – the former sometimes characterised as death taxes and imposed in addition to other taxes such as capital gains taxes and progressive income taxes – where the right to pass on ones wealth from the fruits of your own labour to ones family is often seen as a legitimate aspiration for all. On the other hand, unrestrained wealth accumulation over generations may generate very unequal societies that entrenches unfairness as part of the political equilibrium.
In practice, progress in terms of higher levels of taxation of real property might be seen as a good alternative to inheritance and wealth taxes, which are in any case difficult to administer effectively, if the goal is to end up with a more progressive tax system. Such taxes also have attractive efficiency properties compared with alternatives, and may be more promising in terms of revenue and administrative ease. However, the political economy of implementing such taxes in a way that raises significant revenue has proved challenging for most countries, irrespective of the state of development.
The variety of tax expenditures that now exist in many countries can have complex and difficult to trace distributional impacts, particularly those that relate to businesses rather than individuals and households. Transparency about the nature and costs of tax expenditures is far from ideal, with relatively few countries reporting in any detail either their existence or cost.
Concerns about inequality are also related to the treatment of gender issues in tax systems. The focus of debate has often been around the best way of defining taxable units, with some countries opting for individual taxation and others taxing the household as a unit. Both have implications for the incentives of women to participate in the labour market given that their participation tends to be significantly more sensitive to marginal tax rates than men. However, gender related tax issues extend beyond the choice of taxable unit. For example, microenterprises in some sectors in some countries can be predominantly operated by women. The way in which such enterprises are taxed may effect both investments in physical and human capital, with significant impacts overall on the imbalance of power between genders over time.
Inequality Between Countries and Global Issues
At the global level, efforts to curb offshore non-compliance by making more effective the exchange of information amongst tax authorities have been given a new impetus. Taxing high net worth individuals raises many issues, since tax competition and the elasticity of taxable incomes are greater for these groups. Tax administration focuses on acquiring the necessary information (including that from other tax administrations) to ensure compliance and dealing with the avoidance schemes and abusive tax shelters that are marketed to them by some tax intermediaries.
Surprising differences in terms of inequality are apparent between countries and regions, even amongst the less developed countries. For example, many Latin American countries have long had much higher levels of inequality than one might expect given their relative income levels. In recent years, inequality in Latin America has fallen but remain higher than in other regions given the highly unequal starting point for these countries. Even though other, non-tax related, factors have contributed to such patterns, the issue remains whether the tax structure in those countries with significant reliance on indirect taxes rather than direct income taxes despite, relatively large formal sectors in the economy, has been conducive to more inequalities.
Recent work on migration also suggests interesting and important effects for some countries on the potential tax base. Whilst many poor countries lose higher skilled workers to developed countries, the prospect of migration for the better educated raises the incentive to invest more in education and skills. Not all leave, and some of those who leave later return to set up businesses in there homeland. For tax administrations, dealing with tax affairs of migrant workers often creates extra administrative problems, some simply due to language and compliance issues, especially where migrants tend to work in the shadow economy or in sectors of the economy such as construction where tax collection has often proved difficult.
More generally, the use of tax administrations as delivery bodies for a wide variety of social goals (such as income transfer payments via earned income tax credits) creates a need to respond to and communicate with taxpayers and welfare recipients whose lifestyles and incomes sometimes sit uneasily in bureaucracies whose core mission historically was collecting money rather than paying it out, arrangements for VAT refunds notwithstanding. Many tax administrations have found that adapting to the role of welfare agency is very challenging. At the same time, the administration of many taxes is being revolutionised by a move towards e-filing and new IT systems.
Finally, the linkage between tax and inequality may be affected not only by explicit tax policy and administrative choices. In the case of low income countries, the impact and modalities of Official Development Assistance (ODA) may have significant side effects on the tax system and revenue effort. This suggests the overwhelming impact of ODA may be via its impact on tax effort and incentives in relation to tax reform which itself has a positive impact on state-building and can also be conducive to improvements in the tax administration. Recent evidence from the IMF and the World Bank about this issue will be discussed at the conference.
The ITD conference will be a valuable forum for decision makers and administators from many countries, as well as from the international and regional development banks and tax organisations to meet together, and discuss how best to deal with the variety of national and international tax challenges they face in relation to inequality, in the context of the wider tax issues they are also addresssing.
By Alan Carter
Senior Economist & Head of the International Tax Dialogue Secretariat
*http://www.oecd.org/dataoecd/8/58/47711165.pdf
| Each feature article is prepared by one of the ITD organisations. This article was written by the ITD Secretariat. |