Fiscal Adjustment in Developing Countries through Tax Administration Reform
Vehorn, Charles L., The Journal of Developing Areas
Many developing countries undertaking a fiscal adjustment have followed the International Monetary Fund's (IMF) recommendation to create a large taxpayer unit (LTU) to ensure stable or enhanced revenue flows, but the problem is that researchers have not conducted a systematic evaluation (other than a survey) of this recommendation's revenue raising effects. It is important to understand the effects of this reform measure because limited country resources should be allocated carefully to policy reforms that have a reasonable chance of success. In order to address the issue, this paper evaluates the effectiveness of this fiscal reform using economic data. A unique panel data set has been assembled to evaluate performance of LTUs based on each country's tax share (tax revenue divided by GDP) over a seven-year period. Employing a straightforward empirical methodology of comparing changes in the average annual tax share before and after implementation, a surprising 43 percent of countries experienced a decline in the tax share after implementing an LTU. The implication for policy makers is that successful reform not only includes adopting the correct policy, but also taking adequate steps to ensure that the policy is well-implemented.
JEL Classification: H39, O23, O57
Keywords: economic development; fiscal adjustment; tax administration reform; large taxpayers' unit
Corresponding Author's Email: firstname.lastname@example.org
When a developing or emerging market country experiences a fiscal crisis, it must undergo an adjustment process that requires country officials to make difficult trade-offs. In most cases, these countries rely on the International Monetary Fund (IMF) to provide a short-term loan to assist the government in making the adjustments to its economic structure. However, the 187 member countries of the IMF do not provide a loan to a country in an economic crisis without certain conditions attached, commonly referred to as IMF conditionality.
Usually these countries are running an unsustainable fiscal deficit, so one condition of the IMF loan is to demonstrate progress in reducing the fiscal deficit. The loan is disbursed in traunches (portions), and economic data is gathered to evaluate whether the country is making progress in meeting IMF conditionality before further funds are disbursed. In order to reduce the fiscal deficit and meet the required fiscal targets, governments must decrease expenditures, increase revenue, or do some mix of both measures. Toye (2000) argues that lack of tax revenue is a binding constraint in fiscal reform. Raising revenue can be accomplished by changing tax policy (e.g. raising tax rates) or by improving tax collection. Establishing a Large Taxpayer Unit (LTU) is seen as one way to improve tax collection because a small minority of large enterprises in most countries generally account for a large share of the tax revenue.
Public officials in many countries undergoing fiscal adjustment have followed the IMF's recommendation to create an LTU. While several institutional reasons exist for adopting an LTU, (e.g., serving as a model for reform, reducing the opportunities for corruption, providing better taxpayer services through a one-stop shop for taxpayers, and improving audit effectiveness), the main rationale is to stabilize or ideally enhance current and future revenue flows. This can be accomplished by ensuring taxpayer compliance with two simple but critical procedures: filing returns and making payment of tax liabilities on time. Unfortunately, only anecdotal evidence exists (obtained through surveys of those involved in the reform) on the performance of LTUs in 33 countries that have implemented this modernizing reform (Baer, et al., 2002). The survey research approach has three main drawbacks: response bias, response accuracy, and sample bias. The tax officials surveyed may have responded to a questionnaire from the IMF by telling the IMF what they thought the IMF wanted to hear. …