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  • Giacomo Mangoni (Italy)

How tax policy can affect growth in developing countries

In 1980, corporate tax rates around the world averaged 40.11 percent, and 46.52 percent when weighted by GDP. Since then, countries have recognized the impact that high corporate tax rates have on business investment decisions; in 2022, the average is now 23.37 percent, and 25.43 when weighted by GDP, for 180 separate tax jurisdictions. Declines have been seen in every major region of the world, including in the largest economies. In the United States, the 2017 Tax Cuts and Jobs Act brought the country’s statutory corporate income tax rate from the fourth highest in the world closer to the middle of the distribution. Asian and European countries tend to have lower corporate income tax rates than countries in other regions, and many developing countries have corporate income tax rates that are above the worldwide average. Today, most countries have corporate tax rates below 30 percent. Over the past 42 years, corporate tax rates have consistently declined on a global basis. In 1980, the unweighted average worldwide statutory tax rate was 40.11 percent. Today, the average statutory rate stands at 23.37 percent—a 42 percent reduction.

Despite a general decline in corporate tax rates around the world, OECD and non-OECD countries have also become more reliant on revenue from corporate income taxes. One cause for this change has been a shift in the jurisdictions included. Secondly, the negative revenue impact of the decline in corporate tax rates was generally offset by reducing or abolishing tax relief policies. The weighted average statutory rate has remained higher than the simple average over this period. Prior to U.S. tax reform in 2017, the United States was largely responsible for keeping the weighted average higher, given its relatively high tax rate, as well as its significant contribution to global GDP. It has shown the significant impact the change in the U.S. corporate rate had on the worldwide weighted average. The weighted average statutory corporate income tax rate has declined from 46.52 percent in 1980 to 25.43 percent in 2022, representing a 45 percent reduction over the 42 years surveyed.

Worldwide and regional average top statutory corporate tax rates have declined over the past four decades but have leveled off in recent years. Of 225 jurisdictions around the world, only six have increased their top corporate income tax rate in 2022, a trend expected to hold steady as countries have more efficient tax types to turn towards. Developing countries face formidable challenges when they attempt to establish efficient tax systems. First, most workers in these countries are typically employed in agriculture or in small, informal enterprises. As they are seldom paid a regular, fixed wage, their earnings fluctuate, and many are paid in cash, "off the books." The base for an income tax is therefore hard to calculate. Nor do workers in these countries typically spend their earnings in large stores that keep accurate records of sales and inventories. As a result, modern means of raising revenue, such as income taxes and consumption taxes, play a diminished role in these economies, and the possibility that the government will achieve high tax levels is virtually excluded.

Second, it is difficult to create an efficient tax administration without a well-educated and well-trained staff, when money is lacking to pay good wages to tax officials and to computerize the operation (or even to provide efficient telephone and mail services), and when taxpayers have limited ability to keep accounts. As a result, governments often take the path of least resistance, developing tax systems that allow them to exploit whatever options are available rather than establishing rational, modern, and efficient tax systems. Third, because of the informal structure of the economy in many developing countries and because of financial limitations, statistical and tax offices have difficulty generating reliable statistics. This lack of data prevents policymakers from assessing the potential impact of major changes to the tax system. As a result, marginal changes are often preferred over major structural changes, even when the latter is clearly preferable. This perpetuates inefficient tax structures.

Fourth, income tends to be unevenly distributed within developing countries. Although raising high tax revenues in this situation ideally calls for the rich to be taxed more heavily than the poor, the economic and political power of rich taxpayers often allows them to prevent fiscal reforms that would increase their tax burdens. This explains in part why many developing countries have not fully exploited personal income and property taxes and why their tax systems rarely achieve satisfactory progressivity (in other words, where the rich pay proportionately more taxes). In conclusion, in developing countries, tax policy is often the art of the possible rather than the pursuit of the optimal. It is therefore not surprising that economic theory and especially optimal taxation literature have had relatively little impact on the design of tax systems in these countries.

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