One of the 11 areas that the World Bank’s Doing Business Report include in ranking a country’s business environment is paying taxes. The background study for the Doing Business Report 2017 (DBR 2017), “Paying Taxes 2016” claims in the foreword that its emphasis is “on efficient tax compliance and straightforward tax regimes.” The aim is to aid developing countries enhance the administrative capacities of their tax authorities, reduce informal economy and corruption, while promoting growth and investment.
The very noble intention and much needed support for developing countries from the World Bank, at least on paper, deserves accolades. But, in practice, it is not what it proclaims to be.
First, the issues that the World Bank solicits are not just administrative efficiency, but also tax rates. Any country that reduces tax rates, or raises the threshold for taxable income, or provides exemptions gets a positive nod. For example, Dominica, Dominican Republic, Guatemala and Peru were evaluated positively for reducing the corporate income tax rate. Algeria was seen favourably for decreasing the tax rate on professional activities while Cameron was given a negative tick for increasing the minimum tax rate for companies. Poor Puerto Rico was evaluated positively for abolishing gross receipts tax, but received a negative mark for raising capital gains tax rate.
Second, the DBR methodology inflates the tax burden by including, for example, employees’ health insurance and pensions and charges public services like waste collection and infrastructure or environmental levies that businesses must pay. But these requirements, legitimate ways for States to guarantee enjoyment of certain rights by their citizens, are not taxes, but “social contributions.” Even the IMF’s Government Financial Statistics Manual treats them separately from the general tax revenues. Thus, some countries’ rank were lowered because they increased the road user levy rates, while others got a positive nod for reducing rate of accident compensation levy paid by employers. For example, Indonesia was seen unfavourably for levying a new pension contribution at a rate of 2 per cent paid by employers. Moldova received a negative evaluation for raising rates for road tax, environmental levy and health insurance contributions paid by employers. Montenegro, too, lost for increasing the health contribution rate paid by employers. South Africa was mentioned negatively for increasing the rates of vehicle tax and property tax, but received positive tick for reducing the rate of social security contributions. Tanzania was evaluated negatively for improving the compliance with a skills development levy and introducing a workers’ compensation tariff paid by employers.
Third, the DBR, in seeing favourably the countries that lower corporate tax rate (or increase thresholds and exemptions) and negatively those that introduce new taxes, is encouraging tax competition among developing countries. However, research at the OECD and IMF has not found any convincing evidence that lower corporate tax rates or other fiscal concessions have any positive impact on foreign direct investment. Instead, they found net adverse impacts on government revenues of tax concessions and fiscal incentives. According to the OECD and IMF research, such factors as the quality and availability of infrastructure and human capital play a more important role in investment decisions than taxes.
The World Bank’s own Enterprise Surveys also do not find tax high on the list of factors that the enterprise owners perceive as important barriers to investment. For example, the four areas of concern that stand out in the Enterprise Survey for the Middle East and North Africa region are: political instability, corruption, unreliable electricity supply, and inadequate access to finance. Paying taxes or tax rates are not among them.
Yet, the World Bank has been promoting tax cuts and tax competitions as a magic bullet to boost investment. Thus, tax revenues in developing countries continue to fall: according to some estimates, between 1990 and 2001 the reduction in corporate taxes accounted for a drop of nearly 20 per cent in these countries’ tax revenue. According to an IMF study, the forgone tax revenues in Caribbean countries ranged between 9½ and 16 per cent of Gross Domestic Product (GDP) per year, whereas total foreign direct investment did not appear to depend on tax concessions).
The World Bank’s encouragement of tax competition is contrary to what its former Chief Economist, Kaushik Basu, said: “Raising it [tax] allows developing countries to invest in education, health and infrastructure, and, hence, in promoting growth.”
Instead of encouraging tax competition, therefore, the World Bank should have truly focused on helping developing countries improve tax administration to enhance collection and compliance, and to reduce evasion and avoidance. According the OECD’s Secretary-General, Angel Gurria, “developing countries are estimated to lose to tax havens almost three times what they get from developed countries in aid”.
The Global Financial Integrity think tank estimates that illicit financial flows of potentially taxable resources out of developing countries during 2004-2013 was USD 7.85 trillion, with illicit outflows increasing at an average rate of 6.5 per cent per year—nearly twice as fast as global GDP. In 2013 alone at USD 1.1 trillion!
The Bank’s own estimates show revenue loss to corruption and tax evasion in Malawi and Namibia accounts for between 5 per cent and 10 per cent of the GDP.
But, the Bank’s Paying Taxes and Doing Business Report do the opposite. For example, the DBR 2017 viewed Antigua and Barbuda positively for eliminating the tax compliance certificate required for import customs clearance. While DBR 2017 praises a country for streamlining its tax administration, it laments the country for introducing an innovative new tax or environmental levies (e.g. Turkey, Uganda and Vietnam) or measures to reduce tax evasion.
In fact one should not be surprised at the clever encouragement of the DBR and the Paying Taxes Report for corporate tax cuts and penalizing countries for regulations aimed at tackling tax evasion or enhancing social contributions by treating them as a burdening barrier to business. Its partner in the paying tax study is PwC, one of the four (other three are KPMG, Ernst & Young and Deloitte) leading International Accounting and Consultancy firms which assist offshore tax planning. PwC assisted its multinational clients in obtaining at least 548 tax rulings in Luxembourg, enabling them to avoid corporate income tax globally between 2002 and 2010.
The question is: where will developing countries find money to finance their infrastructure investment needs, or increase their social protection coverage, or repair their environment damaged by industrial/mining activities when the Bank’s flagship reports encourage them to cut corporate tax rates and social contributions, and they compete to improve their Doing Business ranking? How are they going to achieve the internationally agreed Agenda 2030 for sustainable development and its accompanying Sustainable Development Goals in the face of dwindling foreign aid when only a few donor countries fulfilled aid commitment of 0.7 per cent of their Gross National Income, agreed more than four decades ago?
No doubt, the Bank would say, borrow from us and engage in public-private partnerships (PPPs). Countries starved of its own funds will have to borrow from the Bank. Governments lacking their own resources are also advised to rely on PPPs, despite disappointing welfare outcomes – i.e., reduced equity and access due to higher user fees – and higher contingent fiscal liabilities of governments due to revenue guarantees and implicit subsidies.
But clearly this exposes the Bank’s conflict of interest. Financially starved governments boost the Bank’s lending activities and PPPs lift the activities of its International Finance Corporation (IFC) that promotes private sector business.
Moreover, the Bank’s product enters into conflict with essential human rights principles. As put by the Special Rapporteur on Human Rights and Extreme Poverty, in a landmark report, “In some States, despite significant efforts to increase revenue through taxation, the amount actually collected is demonstrably inadequate to realize human rights.” She went on to find that “low levels of revenue collection have a disproportionate impact on the poorest segments of the population and constitute a major obstacle to the capacity of the State to finance public services and social programmes.
Thus, civil society organizations and development practitioners are demanding for the Bank to stop promoting tax competition and deregulation.
There is of course no guarantee that the Bank will listen. It ignored the recommendation of an independent panel to stop misleading country ranking using some dubious argument. It gives the impression that it listened to the demand of the International Labour Organization (ILO) and others to stop ranking countries on the basis of labour market flexibility, but then continues to include labour market narratives that promote deregulation.
So, the best option for developing countries is to ignore the Bank and its Doing Business Report or Paying Taxes Report.
Anis Chowdhury is a former professor of economics at the University of Western Sydney and held senior United Nations positions during 2008–2015 in New York and Bangkok.