Tax and poverty work

A plenary session and several workshops were held to highlight the importance of tax analysis for anti-poverty work.  Speakers from Croatia, India, Mexico and the USA shared case studies of their work at national and sub-national level, and learning on fundamental tax policy concepts and issues.  Budget groups in the USA have a longer experience of this work, but discussions focused around opportunities and constraints for tax analysis in developing and transition countries, such as the availability of reliable information. 

Tax issues and concepts      Potential for analysis      
Tax analysis problems in developing countries
Tax policy work at national level     Tax policy work at sub-national level

When pro-poor groups begin to use budget analysis to analyze or track government policies and activities from a poverty perspective, the focus tends to be on expenditure.  Through analyzing expenditure we can see how much is being dedicated to services and activities which benefit the poor and make conclusions about the intentions and priorities of the government.  

However, this analysis can not tell us where the money came from, who pays for the services, and decisions about the amount of expenditure funds available.  For this we need to analyze the revenue side of the budget, and in particular the tax system.  Overall, tax policy reveals much about a government's priorities.

Taxes are often seen as the domain of the rich and commerce – the more conspicuous taxpayers.  However, taxes do affect the poor and actually the poor usually pay a larger proportion of their income into state coffers:

• …as payers of sales taxes, VAT, and user-charges;

• …as users of public services which require funding from tax revenue;

• …as a group largely excluded from tax breaks and preferences which hide government expenditure through private/ corporate books.

Tax policy issues and concepts:
Chuck Sheketoff from the Oregon Center for Public Policy, and Joel Friedman from the Center on Budget and Policy Priorities spoke briefly about the fundamental concepts and issues underlying tax analysis, based on their experience in South Africa and in the USA respectively.

… tax burden:  “As Monty Python said: the best tax is that levied on a foreign national living outside the country.”

The tax burden is the term for the distribution of taxes among the population.  As the quote above suggests, there is no such thing as an intrinsically fair tax system – what is fair to the beneficiary is usually not fair to the payer.  However, there are measures of equity in tax systems, from progressive taxes which grow relative to income to regressive taxes such as poll tax and VAT which are charged at a flat rate and make up a higher proportion of the income of the poor. Activities which are heavily taxed such as alcohol consumption and tobacco, are prevalent in poor communities, meaning states rely heavily on poor people’s money.

Tax is an ideological issue, and can be levied according to services received, such as user charges in hospitals, or can be designed according to the ability-to-pay principle.  In countries with a high inequality of income the tax structure should be more progressive, but there are limits to the level of tax inequality or progressiveness that can be applied before evasion and capital flight become endemic.  

Caution is needed in identifying who bears the tax burden as taxes are often passed on. For example business taxes can be avoided, or passed on to the consumers or workers as higher prices or lower wages. This is even more complicated in countries with a large informal sector, corruption, and non-compliance with the tax system.  Furthermore, tax breaks designed to attract investment, or encourage or discourage certain social or economic behaviors in most cases benefit the wealthy and business, who often end up paying low, or even negative, taxes. 

… revenue adequacy:  “A government’s ability to raise revenue is a reflection of its capacity to provide for its citizens.”

Revenue adequacy relates to whether enough revenue is generated to fund necessary or planned expenditure.  Revenue adequacy depends on stability of revenue to facilitate planning, and economic growth to keep pace with expenditure demands and enable sustainable development.  

Many factors affecting revenue growth are external, such as commodity prices and trade-related taxes which are being phased out due to economic globalization and liberalization policies.  Revenue adequacy is also affected by internal factors such as commodity depletion and political pressures to raise and (more commonly) lower taxes.  

Expenditure takes place through tax preferences and this requires close scrutiny just like any other government expenditure program.  As analysts we need to advocate for more transparency in this spending to ensure cost-benefit scrutiny and require that targeting and performance standards are attached.

… compliance  “If a corporation is paying taxes it is because they need a new accountant” Chuck Sheketoff

Revenue adequacy depends not only on the tax structure but also on tax administration and the systems to ensure compliance.  Non-compliance with tax payments undermines the integrity of the tax system and provides opportunities for broader issues such as corruption and favoritism. Without a system to show what has been collected it is difficult to hold tax collectors accountable.  As analysts we need to ask whether the government is fair in dealing with non-compliance.

Compliance can be increased through better systems and data, greater transparency and attitude change, creating a stronger link between tax collection and positive social spending. 

Potential for tax analysis:
What are the political, economic and management principles of taxation from a pro-poor perspective?  We need to develop a framework for tax analysis, based on these principles and focusing on transparency and equity. 

The speakers suggested some types of projects and programs which could make use of tax analysis for anti-poverty work in different contexts, including:

• Assessment of the tax burden, with trends over time. Income tax payers are often seen to have moral edge over the poor in access to quality services, but the truth is that the poor pay taxes. Poor and marginalized groups need to prove how they pay taxes indirectly, through indirect taxes or corruption, and that they are not getting free services;

• Development of a handbook or manual on the tax structure and implications;

• Analysis and awareness raising on the cost of tax cuts and preferences;

• Analysis of tax proposals for equity and adequacy;

• Translation of government or academic reports on tax into plain language;

• Identification of issues that can’t be analyzed due to lack of information, such as costs and beneficiaries of tax breaks, to add to the debate and highlight information inadequacies;

• Development of alternative tax reform or tax relief packages to benefit the poor.  Fully-fledged tax reform is a huge project but pieces of the tax structure are changed each year and there are many places where we can enter into the debate about parts of the system. 

• Development of tax administration and compliance principles;

•  Identification of regional tax burden differences;

• Analysis of external and international influences on the tax structure, such as the IMF and World Bank proposals for tax reform on the table for most developing countries;

• Research into transparency in tax management and corruption.  Tax management is the root of corruption in India, with large corporations funding political parties in exchange for tax cuts on investments. 

There is an assumption that a dichotomy of interests exists between corporations and the poor in relation to tax, but evidence from USA and Europe shows that corporations often favor areas with high tax because the labor force and services are of better quality.   

Tax analysis problems in developing countries: 

 
Gemma makes a comment about tax policy in Tanzania

Much of the experience in tax work comes from the North, and doesn’t necessarily apply to developing and transitional countries.  For one matter, tax reform in most developing countries is heavily influenced by multilaterals, the World Bank and IMF.  These institutions are promoting simplification of tax structures and broadening of tax bases, which could be in our interests as long as they are applied well.  However, the multilaterals emphasize adequacy but not distributional issues, which is an area to monitor.

Following the plenary, two workshops were held on tax analysis at national and sub-national levels.

Tax policy work at national level:

Joel Friedman shared some of the lessons learned from the experience of the Center on Budget and Policy Priorities in USA on using analysis of tax policy for anti-poverty work.  Katarina Ott, from the Institute of Public Finance in Croatia talked about research into tax and the informal sector, and Fausto Trillo, from CIDE, presented some research on the tax burden in Mexico.

 … analyzing tax cut proposals in the USA:  In the USA, in the context of a large economy with budget surpluses, a major issue has been the allocation of tax cuts and rebates.  Many of these proposals are apparently targeted to social problems or particular sectors of society, such as small businesses or workers.  However, analyses frequently show that the proposals are an ineffective and expensive way to address such problems or needs, and benefits tend to flow to those with higher incomes.

The analyses used data from government sources (Treasury, Congressional Budget Office, General Accounting Office) and other NGOs to explore whether the issues addressed by proposed tax cuts were high-priority, whether the proposals were cost-effective and how the benefits were distributed. The analyses are produced as reports and used to add quality technical analysis to the policy debate.  They are timed for distribution to Members of Congress and the media at the appropriate policy moment.  

click here to see a recent example of a CBPP tax analysis report

Each report includes relevant background to frame the issue, including explanations of basic terms and concepts used.  The reports are short, with text boxes and summaries to ensure that the key messages are noticed.  They are kept on the internet and frequently updated to reflect new data and legislation.

… researching tax and the unofficial economy in Croatia:  Croatia is a small country in transition to democracy with high unemployment and a low overall growth rate in the economy.  Over 8% of the population are living below the poverty line, and in this group fall a disproportionate number of elderly and poorly educated people.  The opportunities for this group are limited, with few formal employment opportunities.  

click here to read the IJF paper on the unofficial economy in Croatia

The unofficial economy is very evident in Croatia, with markets full of smuggled goods and unregistered and unregulated workers. While an unofficial economy may provide opportunities in countries with strong democratic and regulatory frameworks, in countries like Croatia, where the unofficial economy is large and institutions weak, it is a problem.  

The unofficial economy could become prevalent in the country, with consequences such as corruption, rent seeking, Mafia, lawlessness, insecurity, budget deficits and poor public services.  Underground rooted practices could become the driving forces for the measures taken in the formal economy, legal and political system further weakening democratic institutions and attitudes.

The Institute of Public Finance undertook research on the role of the unofficial economy, its relationship with economic policy, its role in the process of privatization and its influence on growth and development. The study found that in Croatia the sector was mainly generated by the state.  The informal economy grows where private and public ownership meet, fuelled by the transformation of ownership rights where opportunities for rent seeking, bribery and corruption are rife.  The government needs to improve state institutions, with more transparent laws and regulations, stronger independence of the courts and more accessible and comprehensive statistics and stronger mechanisms of democratic control.

The findings of the research were published and sent to the media and the legislature.  The Institute's website has a series of occasional papers detailing this research. The study has also thrown up themes for further research, concentrating on tax issues, including:

• Tax structure and burden

• Tax compliance and evasion

• Administrative and compliance costs of taxation

• Social security contributions and reform

• The size of the state and budgetary expenditures.

click here to read the IJF paper on tax reform in transition economies

Research into compliance and administrative costs of the tax system found that 2% of budgetary revenues are spent on the activities.  These costs are regressive, and are an indicator of the complexity of the tax system.  However, there is little interest, research efforts are solicited in this area this area, by the WB or IMF, and there are few tax experts in civil society willing to take on the work.

… the tax burden in Mexico  
The revenue system is very weak in Mexico.  Taxes collected make up only 9.8% of GDP although the rates are not low, leading us to conclude that the collection mechanisms must be weak.  CIDE began to look at the tax system as part of their budget analysis work aimed at measuring the impact of social expenditure on the poor. In order to reach the poor the tax system must be strong and social expenditure high, but public services are negatively affected by tax evasion and elusion.  CIDE therefore decided to look at the impact of the tax structure on the distribution of income and public expenditure. 

The systems for generating public information are weak, and this, coupled with a lack of transparency and official incompetence caused great difficulties in accessing data for research on the tax structure and system.  CIDE therefore generated their own data using available demographic data such as the national survey of household income and expenditure.  

The study showed that rules on VAT exemption were being manipulated by businesses and producers to avoid payment, making the system more regressive than expected. Calculations showed that although the rich are subject to more tax, exemptions and subsidies benefit them up to five times more than the poor.

Tax work at sub-national level
Liz McNichol gave a case-study of the use of tax analysis with state level groups of Center on Budget and Policy Priorities in the USA, while Chuck Sheketoff shared experiences of advocacy around the incidence of tax cuts in Oregon, and Vivek Pandit shared lessons from the journey into tax analysis of Vidhayak Sansad, Maharashtra.  

… state level tax analysis in the USA:  The state level fiscal analysis projects of the CBPP originally focused on expenditure in the budget, but came to realize that a lot of the decisions being made in the budget were actually in the tax system, decisions which determine who benefits and who loses out.  

click here to read the 'Texas Taxes' executive summary

The tax analysis work varies depending on the particular design of the system in each state.  In Texas, for example, the Center for Public Policy Priorities worked on a basic guide to the tax structure for use by other NGOs, activists and researchers.  The guide did not include any new data or information, but pooled all existing information, including comparisons with other states, on who pays different taxes and where the money goes.  Dissemination of the guide was backed up with trainings for target audiences. 

In Colorado work revolved around analyzing the incidence of tax cuts.  Colorado has a provision in state law that spending can only grow by a certain percentage each year, and any excess revenue must be returned to the electorate through tax cuts and rebates.  The state legislature has the power to determine how this money is to be returned, a decision which can favor different sectors of the society.  When the decision was made to return the money as a credit on income tax the Colorado fiscal analysis group made a case that this would not benefit those who contributed to state coffers through sales tax, but did not earn enough income to pay income tax – i.e. the poorest citizens.  They formulated an alternative proposal, calculated on a combination of both taxes and targeting tax credits to low income families.

The emergence of tax analysis in India:  Vidhayak Sansad has been using the budget as a tool to strengthen arguments and advocacy for marginalized people.  They are not economists or accountants, but are looking at the budget from the perspective of grassroots activists.  As Vivek said, “this can be a limitation, but in action it becomes our strength.”  

After three years of studying expenditure as laid out in the budget, the group realized that decisions and policies on the revenue side of the budget are also important to the provision of rights and services to the marginalized. 

In Maharashtra there is a professional tax collected from salaried persons and earmarked to provide employment for all unemployed within the state. Nearly 80 billion rupees are collected through this tax in the state, but since 1984 government has not spent even half of that on employment generation.  When the Centre looked into the reasons for this lack of spending, it found that a strong lobby in the government represented the interests of rich farmers, who require plentiful, cheap employment during the agricultural season.  The existence of a well-funded employment generation scheme gives laborers more bargaining power at this crucial time.  Analysis of the budget showed that the funds raised through these supposedly earmarked taxes were used to build roads and bridges, providing employment to contractors rather than laborers. 

Analysis also showed widespread corruption in collection of taxes, with government officials waiving their own tax arrears.  Meanwhile the government is not collecting the taxes necessary for planned expenditure.  Without systematic collection mechanisms it is not possible to see who pays for government expenditure. Loopholes should be plugged.

… analyzing tax cut proposals in Oregon:  In 1999 a proposal was tabled in Oregon to flatten the rate for capital gains tax, which had previously varied from 5-9%, to a universal 4%.  Although this means a reduction for all payers of the tax, it clearly represents a more significant reduction for some than others.  The tax is levied on profits from sales of stocks, bonds, real estate and other property.  Capital gains, which are profits from the sale of stocks, bonds, real estate and other property are currently taxed at different rates by individuals and corporations. The Oregon Center for Public Policy prepared an analysis of the incidence of this tax and the justification for the loss of income to the state.  

The first step in the analysis was to look at who pays capital gains, and would benefit from the tax cut.  This analysis showed that while the 20% with the lowest income gained nothing from capital in 1999, the top 20% earned 36% of their income from capital gains, with 83.3% of total capital gains from the state.  This meant that the tax cut would add $10 to the income of the poorest 40% of Oregonians, it would add $7,770 to the average income of the richest 1% of the population.   Analysis also showed how much would be lost to the state through such a cut, and this amount of money can be translated into spending items or services to clarify the issues to the audience.

To publicize the inequity of the tax cut the Center published the findings in a report which was issued with a press release on the day the bill was heard in the House, with copies for colleagues at the Capitol.  On the same day the researcher testified against the bill, and illustrated in simple terms how unfair the tax cut would be.  Members were asked to imagine going to a meeting of 100 constituents and justifying that they had passed a tax cut which for 80 of them would earn 16 dollars, while for one of them would earn $7770. The bill was not passed.

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