Tax in Developing Countries: Increasing Resources for Development

Written evidence submitted by Christian Aid

1 Introduction

1.1 Christian Aid is a Christian organisation that insists the world can and must be swiftly changed to one where everyone can live a full life, free from poverty. We work globally in 45 countries for profound change that eradicates the causes of poverty, striving to achieve equality, dignity and freedom for all, regardless of faith or nationality. We are part of a wider movement for social justice. We provide urgent, practical and effective assistance where need is great, tackling the effects of poverty as well as its root causes.

1.2 Christian Aid has been working on tax and development issue for a number of years, and became the first leading NGO to make it a major campaign priority in 2008. Since then the importance of the issue has been recognised by the G20, the UN, the OECD, the IMF and by many large businesses. Christian Aid was in 2010 identified as one of the 21 most influential organisations in the world of tax by International Tax Review. [1] Christian Aid is a member of the OECD Informal Taskforce on Tax and Development, the Taskforce on Financial Integrity and Economic Development, the Tax Justice Network and the International Tax and Development Centre.

1.3 We welcome the opportunity to provide written evidence to the International Development Committee on taxation and development. We are happy to provide further written/oral evidence on any of the subjects covered in this submission via Sol Oyuela, Senior UK Political Adviser

1.4 We would like to draw attention to the submission presented by CTPD [2] , a Christian Aid partner in Zambia. Given their extensive work in the country on tax and development issues, we consider they are better placed than Christian Aid to comment in depth on the situation in Zambia, therefore we will not extensively address Zambia’s situation in this submission. We are also signatories to a joint submission by Christian Aid, ActionAid and the Confederation of Business and Industry (CBI) highlighting our common concern for the need to support developing countries in mobilising revenue through capacity building and technical assistance.

2 Why tax matters for development

2.1 Effective tax systems are essential if developing countries are to end their reliance on aid. Developing sustainable and effective tax regimes providing revenues for essential public services is key to ensuring that in the long-term developing countries are free from reliance on Official Development Assistance (ODA) for development needs. [3] The OECD recently highlighted the crucial role of domestic resource mobilisation in financing the MDGs. [4]

2.2 Yet the ability of developing countries to collect revenue is undermined by tax abuse, facilitated by financial and corporate secrecy. Christian Aid estimates abusive tax practices relating to international trade cost developing countries $160bn each year. [5] Other organisations, such as the UNDP [6] , have provided a range of estimates. While estimates vary, it is recognised by all organisations undertaking such studies, including the OECD, that the revenue lost to tax dodging is vast, significantly more than the levels of ODA currently (or ever likely to be) available to developing countries. [7]

2.3 There are three inter-related issues hindering the development of effective tax regimes in developing countries: (a) lack of capacity to collect revenue; (b) limited policy space to devise and implement appropriate tax policy; and (c) a global financial system governed by rules and norms detrimental to developing countries which they had (and continue to have) a limited voice in determining.

2.4 These issues combine, resulting in a situation whereby developing countries have narrow tax bases and high levels of abuse, evasion and avoidance of tax. This triple challenge of expanding the tax base, countering abuse, and building trust in the tax system is faced by many of the countries in which Christian Aid works.

2.5 Our submission will focus on the three issues outlined above, highlighting the connections between them. DFID’s focus on building the capacity of governments to increase tax revenue collection is welcomed (though can be improved) and an important aspect of the solution to this problem. However this is not enough to enhance the effectiveness of tax regimes for better development outcomes; such efforts must be coupled with work at the international level to ensure that policies and practices of actors at the global sphere do not undermine the capacity and space for developing countries’ governments to enhance the effectiveness of tax regimes. To genuinely address tax and development, DFID must work across Government to promote a coherent approach to addressing this challenge, to ensure that DFID’s aid efforts deliver value for money in a bigger context.

3 The national context: the importance and limitations of capacity building.

3.1 Governments need to be able to formulate and implement tax policy responsive to their national contexts, as well as be held accountable by citizens for the funds raised and spending made [8] . Christian Aid is working in developing countries supporting local partners to ensure that governments are responsive and accountable to citizens, both in identifying needs and how governments raise and spend revenue (for example, monitoring budget spending and campaigning to improve its allocation). With DFID’s support, Christian Aid’s Governance and Transparency Fund supports in Dominican Republic Centro Montalvo which has formed the ‘Educacion Digna’ coalition, calling for the government to meet the law requiring 4% of GDP to be spent on education [9] . It is vital to combine efforts to increase revenues with efforts to ensure these revenues are spent effectively, with a clear development outcome. Moreover, an increasingly tax aware civil society is likely to play an effective part in expanding the tax base to the large informal sector, not least from tax payer education and building trust in the tax system. Christian Aid would welcome additional support to civil society for such initiatives.

3.2 There is currently a substantial demand from developing countries, in particular in Africa, for support from the UK and other developed countries to help them increase tax revenue. Such is the consensus on this area that Christian Aid, ActionAid and the Confederation of Business and Industry (CBI) have submitted separate evidence urging DFID to proactively coordinate the capacity building work that is undertaking through its country offices, HMRC and via multilateral organisations.

3.3 DFID provides technical support directly to revenue services in developing countries, which we encourage. For example, in Zambia DFID is one of only two governments providing support to the revenue authority [10] . However, we understand DFID is now looking to move away from this to focus on governance [11] which could leave Zambia’s revenue authority short of the support it needs. Also in Zambia, DFID’s efforts to strengthen the policy unit in the Ministry of Finance, has been described as delivering ‘mixed results’ [12] . Overall there is limited reporting on the strategic direction of DFID’s work in relation to tax, the initiatives that are being supported and how aid spending is being allocated. This makes it difficult to assess DFID’s work in the area, and therefore there is a need for more transparency with regard to DFID’s work in the area, including improved reporting.

3.4 While strengthening tax revenues authorities and expanding the tax base is crucial, such efforts must be coupled with work to improve taxation policy making at the national level. For example, the OECD shows that policies of tax exemptions and holidays offered by many developing countries have delivered limited results in terms of increased revenues or investment [13] . In Ghana, the ability of the Revenue Authority to devise effective transfer pricing legislation is hindered by its inability to estimate the cost of transfer pricing abuse. While a strong evidence base is vital for effective policy formulation, capacity constraints mean robust research is rare.

3.5 Policy and technical assistance provided by DFID should be coordinated with other donors and demand driven in line with the Paris Principles on Aid Effectiveness. In Zambia for example, while the revenue authority is receiving donor’s support, a lack of coordination with other ministries means that the Ministry of Finance, which usually undertakes policy development, is being usurped of its policy making responsibilities to the extent that a ‘serious imbalance of power’ is noted. [14]

3.6 This shows the importance of donors and others working on tax to consider the wider policy context in which capacity-building interventions happen. Christian Aid strongly welcomes DFID’s support to the International Tax and Development Centre, and encourages DFID to ensure that policy support on tax is impartial and needs based.

3.7 However domestic capacity building is limited by global constraints; it is to these factors that we now turn.

4 The global context: the need for UK Government policy coherence

4.1 Globalisation has made tax an international issue; capital can cross borders instantly, the growth of international trade and multinational companies creates challenges for taxation policy. The constrained power of developing countries at the global level makes it difficult for them to assert their right to independent tax policy, and to influence global norms which have been developed to serve the purposes of developed countries. This severely hinders their ability to effectively tax their economies and become independent from aid.

4.2 Capital flight and tax evasion and avoidance, as referred to in the ToR of this enquiry are areas of significant concern for developing countries. Capital flight from developing countries is vast, $8.44 trillion 2000-9 [15] ; in Africa it is of such a level that despite being the poorest continent in the world it is a net creditor to the rest of the world, a situation that guarantees that it will remain the poorest continent [16] . However, actions at developing country level are not sufficient to tackle the problem.

4.3 The main causes of capital flight in Africa have been assessed by the US based think- tank Global Financial Integrity to be: corruption (3%), criminal proceeds (30-35%) and the processed of commercial tax evasion, primarily transfer pricing abuse (60-65%). [17] Domestic capacity building alone cannot address these problems. The Zambia revenue authority has 0.099 tax officials per 1000 people, nearly three times higher than the sub-Saharan African average of 0.037, but more than eight times lower than the world average of 0.82. [18] Given developed countries themselves struggle to run effective tax regimes with significantly more capacity [19] it’s implausible that developing countries will be able, in the medium term, to effectively bridge the capacity gap to make the gains required to meet the Millennium Development Goals. To address this problem effectively one must focus on the global mechanisms enabling capital flight. The international policy responses that can be implemented to solve this problem must be led by both developed and developing countries, as today, developing countries lack the agency to do so.

4.4 Global financial secrecy undermines the effectiveness of developing countries tax regimes. Tax evasion and avoidance is facilitated by tax havens (or secrecy jurisdictions) which provide financial and banking secrecy making it very difficult for developing countries to trace funds that flow to such jurisdictions, and to obtain information from such jurisdictions to conduct investigations. [20] Developing countries need ways to access information without high administrative burdens. The current ‘on request’ information exchange agreements have shown limited effectiveness. [21] Automatic Exchange of Information (currently applied within the European Union through the Savings Directive) would provide developing countries revenue authorities with the information necessary to more effectively trace and tax funds. Yet, while much progress has been made through the G20 and Global Forum [22] , many more agreements which enshrine Automatic Information Exchange are required. Today, developing countries lack the influence to effect change in relation to tax havens, yet are bearing a high cost. Christian Aid is part of a global campaign which in the context of the G20 in November 2011 delivered a petition to President Sarkozy, signed by 40,000 people around the world, calling for an End to Tax Haven Secrecy. Christian Aid believes that the UK Government is in an unique position of influence over the matter given the significant power that it holds over the global financial sector (and in light of the UK Crown Dependencies and Overseas Territories), and should therefore lead and support action to end tax haven secrecy, including at the G20.

4.5 Developing countries need to counter transfer pricing abuse, but their scope to act is limited. One of the primary methods by which tax is avoided is through abusive transfer pricing. [23] Effective regulation of transfer pricing under the current global norm of the arms length principle is difficult [24] and was recently confirmed by the system’s arch proponent – Jeffrey Owens, Former Director of the Centre for Tax Policy and Administration at the OECD. [25] This applies especially to developing countries facing capacity constraints. However given the OECD’s composition, developing countries have lacked, and will continue to lack, any meaningful say in the development of these guidelines. This is significant as there are substantial questions on both the practicality and applicability of these guidelines for developing countries [26] , yet without the ability to influence their development it is impossible for developing countries to address this problem.

4.6 International policy space must be created for developing countries needs to be considered. This is an area with scope for DFID, and other parts of the UK government to improve efforts to support developing countries. The United Nations is a more legitimate and representative organisation to lead on international taxation issues. The UN has a Committee of Experts on International Cooperation in Tax Matters, [27] which is chronically under-funded and under-resourced, but still valued by many for what work it does despite limited resources. For example, the UN model tax treaty (for which the tax committee is responsible) is relied on by many developing countries for double taxation treaties [28] as it ‘preserves a greater share of tax revenue to the country where investment or other activity takes place, while the OECD Model preserves a greater share to the country of the investor, trader, etc.’ [29] This consideration is vitally important in the development of transfer pricing legislation, and a key reason why the UN needs resources to enable its transfer pricing work to fully address the needs and requirements of all the countries of the UN, especially developing countries. Such are the limits to the Tax Committee’s resources that Christian Aid co-sponsored a conference to advance the work of the Committee on transfer pricing [30] . While we were pleased to help advance the work of the UN in such a vital area, this is not a long-term sustainable model. In a report by the Secretary General to the ECOSOC General Assembly [31] the challenges faced by the tax committee were made clear, and all options suggested recognised the need to enable the committee to undertake more work. Christian Aid, along with many other CSOs [32] , supports the recommendation of creating an intergovernmental Commission for tax, and retaining the current Committee of Experts as a subsidiary body of the Commission. We strongly urge DFID, and the UK government as a whole, to support this.