Public finance and development: six things to read in February

25 February 2019
Loans and repayment schedules, Mumbai, India. Photo: Simone D. McCourtie/World Bank CC BY-NC-ND 2.0

Welcome to our second round-up of the year.

Growing public support for taxing the rich

Since the 1970s and 1980s, there has been a decline in marginal tax rates for the highest earners in the United States. Recent proposals in the US to raise taxes on the wealthiest show how the political winds are changing.

Alexandria Ocasio-Cortez called for a tax rate of 70% on the highest earners. This was quickly followed by Elizabeth Warren’s proposal to tax the wealth of the richest Americans. An op-ed by Gabriel Zucman and Emmanuel Saez argues more equitable tax systems aren’t just about redistributing income, but about ‘safeguarding democracy against oligarchy’.

The popular reception to these ideas seems to be indicative of growing demand to see tax systems supporting fairer societies. And where the US leads, other countries often follow.

Reforming global rules for corporate taxes

Last month also saw further momentum pick up behind radical changes to international rules for taxing corporations. This FT article provides a useful overview of the Organisation for Economic Co-operation and Development’s (OECD) latest efforts to come up with an international agreement for corporate tax reform.

Currently the corporate tax obligations of companies are primarily linked to where their offices and people are located. This has allowed multinational companies to book their profits in so called ‘tax havens’ (a useful primer here). The US government is proposing that companies should pay taxes based on where they make their sales, rather than where they are registered.

Although a specific solution remains far-off, the significance of these discussions should not be underestimated. As Alex Cobham puts it, ‘we’re closer now than ever before to the kind of open, global discussion of tax rules that could finally redress some of the glaring inequalities in the distribution of taxing rights that lower-income countries face.’

Analysing how tax and transfers affect the poorest

Good analysis can play an important role in fostering debate on the fairness of governments’ public finance policies. So it is encouraging to see the use of more sophisticated models to analyse how tax and transfer systems are affecting different actors in society. Two recent papers from UNU-WIDER compare the progressivity of tax and transfer systems in six African  and six Latin American countries.

In most of the countries reviewed, the scope for income redistribution is limited by both the overall amount of revenue collected (and consequently the resources available for spending on social protection) as well as the type of tax collected (limited revenues collected from income taxes).

In five of the six African countries (except South Africa), the current tax and transfer system reduces the amount of disposable income available to the poorest members of society, as budgets for social transfers targeted at the poorest are minimal.

How public financial management relates to governance

Understanding the relationship between public financial management and wider systems of governance is difficult. A new book (summarised here), authored by my ODI colleagues, uses information from public expenditure and financial accountability assessments to shed some light on this relationship. Although PEFA assessments have some limitations, 144 countries have now completed an assessment providing a much richer source of information about PFM than existed twenty years ago. 

They find (with a number of caveats) that the strength of PFM systems is associated with more reliable budgets for line ministries and lower levels of corruption – although the estimated size of this effect is underwhelming when compared with the magnitude of the relationship with economic growth.

There is also no evidence found that the strength of PFM systems is determined by (formal) political institutions. Although there is a general push towards voluntary compliance in administering taxes, an indicator on the use of penalties to enforce tax collection stands out as being strongly associated with higher tax-to-GDP ratios.

Addressing constraints to spending absorption

In many countries, ministries fail to spend the budgets that were authorised at the beginning of the financial year. The problem is often particularly acute in investment spending. This testimonial from an official in the Central African Republican (CAR) describes an extreme case where just 2% of budgeted investments in the health sector were spent in 2017.  A recent report in the Kenyan media also points to large under-spending in the health sector with just 63% of the overall health budget being spent.

These deviations between planned budgets and actual spending tend to be labelled as issues of ‘budget credibility’. Yet the root causes of these issues do not always relate to issues of budgeting. For instance, in the case of the CAR, spending constraints result from a combination of issues relating to feasibility studies, procurement plans and weak communication. Understanding why budgets are underspent is an area that seems ripe for further study.

We need to talk about public finances and growth

In a blog last month, Paolo de Renzio rightly points out that public budgets can often feel quite far removed from the immediate concerns of citizens. This is despite decisions on taxes and government spending having very real effects on people’s lives. So the International Budget Partnership’s (IBP) work on what might be the appropriate role of public finances is a welcome development.

The IBP argue that budgetary debate has historically focused too much on issues of deficits and growth and not enough on questions of justice, equity, service delivery and environmental sustainability. I don’t fully agree.

My experience of the international discourse on budgeting is that there are lots of materials related to these concerns: on the role of transparency and participation in the budget, gender equity, climate change and environmental sustainability and improving health services. The links above show that questions of income inequality and governance are also increasingly prominent.

But I have come across very little about the role of public finances in supporting income growth and job creation. This is despite survey findings showing that jobs and economic growth are often the number one priority for citizens. Yes, there is potentially too much emphasis on deficits and the overall fiscal position. But we could be doing much more to understand how tax and spending decisions support (or not) economic growth.

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