Rebuilding the revenue base for sustainable peace

The challenges of tax collection are formidable in low-income and post-war economies. War economies give rise to a wide range of illegal and informal economic activities beyond the control of the state. This makes tax collection in post-war states particularly difficult.

Taxation is one of the principal lenses for measuring state capacity, legitimacy and power relations in a society. Following the fiscal crises in sub-Saharan Africa and Latin America in the 1990s, designing tax systems that provide incentives for growth, meet distributional demands, and increase revenue collection is central to state effectiveness. In post-war economies, rebuilding the revenue base is essential to reconstruct a viable state and sustained peace.

In policy circles, tax reform is often discussed in technical, non-political terms. This limits understanding of the political and institutional processes underlying the power and legitimacy a state requires to extract and mobilise resources.

Direct taxation

The World Bank and the International Monetary Fund say: 'don't try difficult interventions and reforms at home'. They have promoted tax simplification and value-added taxes, which are supposedly easier to collect than income taxes and are more business-friendly. Long-term strengthening of states, however, requires moving towards more direct and progressive income and property taxation. This is particularly the case in countries with very unequal income distribution.

The most prominent features of post-war economies are that the tax base is relatively low, dependent on trade taxes, and extremely narrow. 'Large' payers contribute between 40 and 70 percent of domestic revenue collection. The need to widen the coverage of the tax base is urgent in these countries.

Trade taxes

Dependence on trade taxes presents specific policy challenges. Trade liberalisation has led to reductions in trade taxes, the main source of revenue in low income states. Evidence presented by the International Monetary Fund shows that low income countries only recover 30 cents on each dollar lost from reducing taxes on trade.

Trade liberalisation can undermine tax capacity in low income and post-war economies. Indeed, the case against rapid tariff reduction as a means of maintaining and increasing fiscal resources — a key element in state consolidation and state-building — is one of the main lessons in post-war reconstruction.

Taxation and legitimacy

Perceptions of fairness across groups and regions in taxation are central to improvements in revenue collection. If a tax is considered fair, the number of taxpayers that voluntarily pay their taxes increases. When large numbers of potential taxpayers evade or under-report their tax liabilities, the administrative costs of detecting and enforcing such cases increases the costs of collecting taxes substantially.

A main goal of tax reform, therefore, is to increase the level of voluntary compliance. Although technical aspects of tax reform are crucial, more political analysis is needed if we are to understand how and why tax reforms become legitimate.

Jonathan Di John
School of Oriental and African Studies, University of London, Russell Square, London WC1H 0XG, UK
T +44 (0)207 898 4087
jd5@soas.ac.uk

Views expressed on these pages are not necessarily those of DFID, IDS, id21 or other contributing institutions. Copyright remains with the original authors but (unless stated otherwise) any article may be copied or quoted without restriction, provided both source (id21, insights) and authors are properly acknowledged and informed. Copyright © 2006 id21. All rights reserved.