World Bank Must Stop Encouraging Harmful Tax Competition

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Yves here. The emphasis in this article on taxation as a revenue source in developing economies may grate on MMT-savvy readers, but the “open economy” models that has been foisted on developing countries by the likes of the World Bank have the effect of reducing monetary sovereignity.

Only recently, development economists have come around to the view that protectionism and capital controls are valid, indeed preferable approaches for developing economies since potential national champions need to be shielded from global competition to have any hope of achieving the scale where they can operate successfully in international markets. Developing countries, particularly small ones, that grew up with and still rely on the old approach pushed by Washington and various NGOs, of unfettered capital flows and no defenses even for important industries, would also make the domestic currency more vulnerable to hot money. Even the then BRICs complained about how the Fed’s QE was causing them problems because “risk on” money was flooding into their economies, boosting asset prices and speculation, and they knew they would suffer a downdraft when the easy money left.

So emerging economies have to worry more about what Mr. Market thinks, particularly about what they think its foreign exchange rate ought to be. And Mr. Market is a neoliberal who thinks every small country that runs deficits on a regular basis is a banana republic in the making, even if they haven’t generated unduly high inflation.

By Jomo Kwame Sundaram,  former UN Assistant Secretary General for Economic Development and Anis Chowdhury, former Professor of Economics, University of Western Sydney, who held various senior United Nations positions in New York and Bangkok. Originally published at Inter Press Service

One of the 11 areas that the World Bank’s Doing Business (DB) report includes in ranking a country’s business environment is paying taxes. The background study for DB 2017, Paying Taxes 2016 claims that its emphasis is “on efficient tax compliance and straightforward tax regimes.”

Its ostensible aim is to aid developing countries in enhancing the administrative capacities of tax authorities as well as reducing informal economic activities and corruption, while promoting growth and investment. All well and good, until we get into the details.

Tax Less

First, the Report advocates not only administrative efficiency, but also lower tax rates. Any country that reduces tax rates, or raises the threshold for taxable income, or provides exemptions, gets approval.

Second, it exaggerates the tax burden by including, for example, employees’ health insurance and pensions and charges for public services like waste collection and infrastructure or environmental levies that the businesses must pay. The IMF’s Government Financial Statistics Manual correctly treats these separately from general tax revenues.

Third, by favourably viewing countries that lower corporate tax rates (or increase threshold and exemptions) and negatively considering those that introduce new taxes, DB is essentially encouraging tax competition among developing countries.

Thus, the Bank is ignoring research at the OECD and IMF which 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 of tax concessions and fiscal incentives on government revenues. According to the research, factors such as the availability and quality of infrastructure and human resources were more important for investment decisions than taxes.

Moreover, the World Bank’s Enterprise Surveys do not find paying taxes to be high on the list of factors that enterprise owners perceive as important barriers to investment. For example, the Enterprise Survey for the Middle East and North Africa found political instability, corruption, unreliable electricity supply, and inadequate access to finance to be important considerations; paying taxes or tax rates were not.

Yet, the World Bank has been promoting tax cuts and tax competition as magic bullets to boost investment. Not surprisingly, thanks to its still considerable influence, tax revenues in developing countries are not rising enough, or worse, continue to fall. According to some estimates, between 1990 and 2001, reduction in corporate taxes lowered countries’ tax revenue by nearly 20%.

Instead of encouraging tax competition, therefore, the World Bank should help developing countries improve tax administration to enhance collection and compliance, and to reduce evasion and avoidance. According to OECD Secretary-General Angel Gurria, “developing countries are estimated to lose to tax havens almost three times what they get from developed countries in aid.”

Global Financial Integrity has estimated that illicit financial flows of potentially taxable resources out of developing countries was US$7.85 trillion during 2004-2013 and US$1.1 trillion in 2013 alone!

Conflicts of Interest

But the Bank’s Paying Taxes and DB reports do little to strengthen developing countries’ tax revenues. This should come as no surprise as its partner for the former study is Pricewaterhouse Cooper (PwC), one of the ‘Big Four’ leading international accounting and consultancy firms. PwC competes with KPMG, Ernst & Young and Deloitte for the lucrative business of helping clients minimize their tax liabilities. PwC assisted its clients in obtaining at least 548 tax rulings in Luxembourg between 2002 and 2010, enabling them to avoid corporate income tax elsewhere.

How are developing countries expected to finance their infrastructure investment needs, increase social protection coverage, or repair their damaged environments? Instead of helping, the Bank’s most influential report urges them to cut corporate tax rates and social contributions to improve their DB ranking, contrary to what then Bank Chief Economist Kaushik Basu observed: “Raising [tax] allows developing countries to invest in education, health and infrastructure, and, hence, in promoting growth.”

How are they supposed to achieve the internationally agreed Agenda 2030 for the Sustainable Development Goals in the face of dwindling foreign aid. After all, only a few donor countries have fulfilled their aid commitment of 0.7% of GNI, agreed to almost half a century ago. Since the 2008 financial crisis, overseas development assistance has been hard hit by fiscal austerity cuts in OECD economies except in the UK under Cameron.

The Bank would probably recommend public-private partnerships (PPPs) and borrowing from it. Countries starved of their own funds would have to borrow from the Bank, but loans need to be repaid.

Governments lacking their own resources are being advised to rely on PPPs, despite predictable welfare outcomes – e.g., reduced equity and access due to higher user fees – and higher government contingent fiscal liabilities due to revenue guarantees and implicit subsidies.

Financially starved governments boost Bank lending while PPPs increase the role of its International Finance Corporation (IFC) in promoting private sector business. Realizing the Bank’s conflict of interest, many middle-income countries ignore Bank advice and seek to finance their investments and other activities by other means. Thus, there are now growing demands that the Bank stop promoting tax competition, deregulation and the rest of the Washington Consensus agenda.

Bank Must Support SDGs

However, nothing guarantees that the Bank will act accordingly. It has already ignored the recommendation of its independent panel to stop its misleading DB country rankings. While giving lip service to the International Labour Organization (ILO) and others who have asked it to stop ranking countries by labour market flexibility, the Bank continues to promote labour market deregulation by other means.

If the Bank is serious about being a partner in achieving Agenda 2030, it should align its work accordingly, and support UN leadership on international tax cooperation besides enhancing governments’ ability to tax adequately, efficiently and equitably. In the meantime, the best option for developing countries is to ignore the Bank’s DB and Paying Taxes reports.

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  1. Jim Haygood

    Second, it exaggerates the tax burden by including, for example, employees’ health insurance and pensions.

    As we are now learning to our sorrow, systematic understatement of government pension and benefit liabilities is far worse than had been admitted, as new accounting standards go into effect.

    For instance, new GASB standards requiring states to include OPEB (Other Post Employment Benefits) on their financial statements are in effect this fiscal year, for reporting next year. It’s not going to be pretty.

    Flippant rhetorical claims to the contrary, it’s actually impossible to exaggerate how badly the tax burden has been understated by improper and deceptive cash basis accounting. There’s a reason that Kentucky teachers are bailing out — even as we speak — like rats off a sinking ship.

    Get it while you can.‘ — Janis Joplin

  2. Equity

    Third world and other governments may get waylaid by the economic hitmen who encourage debt peonage. That encouragement, sanctioned officially or not, results in more pliable countries. When their focus is concentrated on meeting debt service obligations, they become less likely to pursue their own social policies or to exercise much of what used to be a respectable sovereignty of self-government. That debt always comes with strings attached, many of which are not apparent at first blush, or are hidden before signing on the dotted line.

    It would be instructive to look at how such policies from the World Bank and its fellow traveler the IMF have impacted developing countries, and which countries have resisted or tried different methods to ensure the health and dignity of their citizens.

    1. Hiho

      “which countries have resisted or tried different methods to ensure the health and dignity of their citizens.”

      Syria, libya, iran…

      When finance is not enough as warfare so as to “open” a country real war follows.

      Take the case of libya for example. One of its sins was to demonstrate that financial independence was possible. It financed one of the greatest infrastructure project ever created, the great man made river, virtually without foreign debt via its own central bank. 33 billion $ totally interest-free. No wonder this was the very first objetive that was targeted by the nato.

      Now for example regime change is beginning to brew in hungary as orban further rejects IMF dictates. He has even asked imf officials to leave the country.

      The point being. There is a bunch of institutions: imf, world bank, nato, UE… That have been created under the washington consensus and will never ever allow any country to achieve fiscal and financial independence. Their mission is to remove any obstacle to international predatory capital by any means necessary: junk economics, debt peonage, colour revolutions, open warfare…

      And their enemy: any country that dares to priorize the interest of their citizents over that of international capital.

  3. Thuto

    In many developing countries where multi-party democracy is somewhat entrenched, ruling parties have very little policy making wiggle room. If they happen to ascend to power on a ticket of “being a party for the people” and inherit intractable issues like high unemployment, opposition party demagogues pull out the neoliberal hymn book and sing (very loudly) from the pulpits the need to “lower taxes and institute a flexible labour laws regime to attract FDI, promote growth and create jobs”. This neoliberal rhetoric-on-steroids is amplified by their allies in the mainstream media who act as echo chambers for the views of these elites, and guess what “research” they reference to buttress their claims: exactly this type of gibberish that comes from the likes of the world bank. I should know, in South Africa that’s exactly what happens, deficits are frowned upon, PPPs are promoted as a panacea, trade liberalization is revered with religious fervour and anybody who dares to question the prevailing narrative is roundly dismissed as a lunatic. Sooner or later, one sees this fear of upsetting the orthodoxy apple cart sipping into policy making that leaves the status quo intact, even by ruling parties who ostensibly represent the interests of the people.

  4. ChrisAtRU

    This is more about liberalization of financial flows than macro-prudence. In the neoliberal paradigm, the captains of industry are first in line for state welfare, and relief from taxes is a favoured transmission mechanism. This also allows for maximum ex-filtration of profits out of these countries – ” … US$1.1 trillion in 2013 alone!”.

    When you combine this with #OriginalSin, it’s no wonder developing countries end up with horrible domestic economic conditions (bogus fiscal constraints) as well as excruciating external debt (often causing massive devaluation of their currency).

  5. Steve Ruis

    Re “Only recently, development economists have come around to the view that protectionism and capital controls are valid, indeed preferable approaches for developing economies since potential national champions need to be shielded from global competition to have any hope of achieving the scale where they can operate successfully in international markets.” Only recently? Amazing. I am unaware of any major economy that got where it was any other way. All of them were protectionist from the get-go. The only source of advice to the contrary would be economists that had hidden agendas (exploitative agendas).

    1. Thuto

      +1, here in South Africa we have an entire poultry industry being decimated (farms going under and massive job losses under way) by US imports of chicken so that some niche growers of citrus fruits could have access to the US market to sell their harvests. No less than Obama himself, no doubt under intense from US poultry industry lobbyists, issued a threat/ultimatum that if US chicken was not on SA supermarket shelves by March 15th 2016, there’d be hell to pay. And of course the neoliberal opposition party demagogues mentioned in my post above were, for all intents and purposes, the local arm of US poultry bigwigs, bringing to bear massive pressure on government to relent and allow the chicken in while spewing the “this is what’s needed for growth” propaganda.

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