When Do Elites pay Taxes?Tax Morale and State-Building

in Developing Countries

Max Everest-Phillips

Presented by

John Piper

WIDER elites conference 12 June 2009

The argument

1. Tax systems not just reflect but also shape political dynamics and economic growth: Tax as State-building

2. Tax therefore matters for Development outcomes3. Elite attitudes to Tax therefore crucial –

• ‘Tax Morale’ shapes Tax Compliance

4. Elite Tax Morale reflects the consensus (‘political settlement’) for development

5. Operational Implications• Elite tax morale as key to tax reform in DCs• Elites and tax complexity/tax simplification reforms• Elite Tax Morale as Indicator for Aid Effectiveness

1. Why tax systems build effective States in poor countries

HOW taxes are raised – not just amount/ not just public expenditure – has profound state-building importance

Why Tax is State-Building1.Raising taxes efficiently requires political

effort to secure taxpayer consent.

2.Raising taxes effectively requires the development of a competent bureaucracy; and

3.Raising taxes equitably requires concern for the fair and equal treatment of citizens by the state.

State-Building Goals

State-Building View of Tax

Tax as SYSTEM:1.Political culture:

Social Contract 2.Legitimacy and

indicator of ‘Rule of Law’

3.‘National Purpose’ – ie. Equity and Economic growth

Traditional Revenue Goal

Raise revenue for government expenditure

2. Tax and Development

BUT development agencies focus mainly

• On public expenditure not revenue-raising

• On tax as technical not political challenge

AND unresolved challenge of whether aid undermines tax effort/ the political will of leaders and elites to raise taxes

3. Elites, Tax and State-Building

If elites are not prepared to fund the development of their own country where they hold the biggest stake in future prosperity, the political incentives for, and credibility of the commitment to state-building and long-term sustainable development are lacking

Tax system at the heart of the ‘political settlement’

Elites are the taxpayers in LICs and highly unequal societies in MICs

4. Tax Morale and Tax Compliance

Tax morale = the intrinsic willingness to pay taxes: reflects citizen-taxpayer attitudes to the legitimacy of the state, the extent of corruption, voice and accountability / trust in the state on which political stability + economic growth (ie. State-building and development) depend.

ie. legitimate and effective exercise of state power

Taxpayer compliance: combination of • intrinsic merit of state and its tax system (tax morale) AND• instrumental ‘value for money’ of taxation

– providing public goods that benefit the citizen efficiently (at reasonable cost: acceptance of level of tax burden);

– reflecting legitimacy in the tax authority’s powers of enforcement (not unaccountable coercion) and capacity to make all taxpayers shoulder their fair burden (ie. prevent free-riding); and

– the effectiveness of that enforcement.

virtuous circle of mutually reinforcing trends towards improving consent and higher effectiveness, or a vicious circle of increasing coercion, higher collection costs, and declining effectiveness of the tax system.

virtuous circle of mutually reinforcing taxation and governance emerges, enabling tax authorities to focus attention efficiently on high-risk categories of taxpayer

5. Elites Tax Morale

• Arises from the political settlement – do elites really buy in to, and therefore prepared to pay for implementing the political vision for the political and economic development of the state, based on trust in its institutions and its legitimacy?

• Do elites then build ‘quasi voluntary compliance’ – work with political leadership and revenue authority to tackle free-riding (eg tax holidays and exemptions; tax complexity; tax evasion) or exploit it?

6. Operational Implications

i) Elite tax morale key to tax reforms in Developing Countries: is there ‘political commitment to shared prosperity’?

E.g. Rwanda: élite tax morale reflects post-genocide political settlement of political and business élite around delivering the economic development and sufficient political stability.

• political vision to make the tax system's effectiveness in achieving élite quasi-voluntary compliance for national transformation, preventing repetition of ethnic violence. 

• long-term strategy of becoming a middle income country by 2020 with its ‘Economic Development and Poverty Reduction Strategy’

• The success of the Rwandan Revenue Authority (RRA) state-building vision under its slogan of ‘Taxes for Growth and Development’.

• personal commitment of the Rwandan political leadership to the effectiveness of the RRA

ii) Elites and tax complexity/ tax simplification reforms:

with universal suffrage but extremes of inequality, tax system complexity that facilitates tax evasion and avoidance has replaced repression as the cost-effective way élites contain populist challenge to their power base.

Tax complexity deliberately constructed by élites to ensure tax systems both regressive and ineffectual

Tax simplification as tehcnical reform therefore always prove ineffectual unless underpinned by real political will – ie. Combination of leadership, vision and elite support

iii) Elite Tax Morale as Indicator for Aid Effectiveness: aid effectiveness requires

• elites bargaining formally and informally on tax; • elites vision of state-building, of legitimacy through state-

elite social contract around paying tax in return for accountability about its use.

• Aid as matching fund for tax effort: donor commitment to building elite tax morale

• Taxpayer perception surveys – monitor shift in both tax morale as well as compliance – as indicator of credible commitment of elites to long-term sustainable development