Tax in Developing Countries: Increasing Resources for Development

Written evidence submitted by Michael Hubbard, Reader in Development Economics,

International Development Department (IDD)

Public revenue from large companies in developing countries--- research findings in IDD regarding two initiatives with which DFID is involved

The International Development Department (IDD) at University of Birmingham has long involvement with research on the management of public revenue and expenditure, particularly at local level, in which tax negotiation, selection and collection plays a key role, alongside the good management of transferred resources.

We wish to bring to your attention the findings of two current doctoral research projects in IDD which are relevant to the following concerns of your inquiry:

· how DFID can better support developing countries to improve revenue collection

· tax evasion and avoidance in developing countries by private individuals and companies

Both focus on important current initiatives in public revenue collection and management, namely large taxpayer units (taking the case of Bangladesh) and the Extractive Industries Transparency Initiative (EITI) taking the case of Nigeria. There is a common message from both: that each of these initiatives has greater potential than is currently realised, but realising that potential depends on reforms in the environment in which it is located. We set out below their findings and practical implications.

Is Nigeria’s involvement in EITI sustainable?

Michael Uzoigwe has explored the implementation of NEITI as a multi-stakeholder process [1] .

The Extractive Industries Transparency Initiative (EITI) is a global initiative which was begun in 2003 with strong support by the UK Government under Prime Minister Tony Blair. Of the fifty countries classified by the IMF as resource rich, thirty three have signed up to the EITI, as have numerous international mining companies. They undertake to publish all payments made by mineral extraction companies to governments and all revenues received by governments from the companies; to have this information reconciled and validated by regular independent audit; and to actively engage civil society organisations in this process.

Nigeria signed up to the EITI in 2004 and has been at the forefront of implementation. Nigeria’s implementation model (NEITI) is considered the most elaborate and comprehensive and Nigeria has achieved the coveted ‘compliant’ status from the global EITI. But despite the international approval of the NEITI and its success in conducting and publishing audit reports, the information is little used by the public and institutional weaknesses highlighted by the audits remain.

The research investigates the interaction of NEITI with stakeholders and its governance environment through the process of its implementation, chiefly by means of interviews with a wide range of stakeholders. By so doing it seeks to explain the paradox of Nigeria's good standing in EITI compared to its much weaker weak performance on the Revenue Watch Institute’s ‘Revenue Transparency Index’ which assesses transparency of mineral revenues more broadly. It finds that because NEITI is run virtually as part of government it has similar failings in limited disclosure and poor responsiveness as the rest of government. Furthermore the connections with civil society as stakeholders are limited to major NGOs whose own constituencies are found to get limited feedback from them. The legacy of military rule in which the executive and business worked closely together with little involvement of parliament, the judiciary and the wider population, is found to be an important factor.

Recommendations from the findings include greater disclosure of arrangements between government and oil companies (especially contracts), more active and independent regulation of oil companies, a freedom of information act to enable private challenges via the judiciary, a more authoritative role for parliament, less reliance of NEITI on external donor agencies which distorts its accountability, a more thorough validation process, and greater outreach using the rapidly growing internet penetration of the Nigerian population. These are argued to be necessary to counter the main risk to NEITI which is non-sustainability. NEITI is the creation of President Obasanjo and since he left power government commitment has been less lively, as in the delayed implementation of the ‘remediations’ demanded by a recent audit of NEITI which resulted in Nigeria being threatened with suspension from global EITI.

What determines large taxpayer unit (LTU) performance ? A case study from Bangladesh

Although large corporate taxpayers are easy to identify for the legal requirement of registration with tax offices, taxing large corporations faces several challenges. They have bargaining power with government through the possibility of relocating the business, they have professional expertise, and much experience in using sophisticated accounting and pricing techniques (e.g. transfer pricing, thin capitalization, inventory valuation) to under- report their taxable income.

Large taxpayer units (LTUs) are a major initiative of recent decades to simplify collection of large corporate taxes. They are built on the idea of concentrating government expertise to provide an efficient and easy means for large firms to deal with government on tax matters.

As in many other countries adopting LTUs, Bangladesh LTU (started in 2004) has enjoyed initial success in increasing tax revenues from large firms. But is it collecting all the tax revenue it should? And what approach works best in an LTU--- making it easier for large corporations to deal with government over tax (persuasion), or firmer enforcement (coercion)? Answering these questions is the focus of Zakir Akhand’s research on large corporate tax collection in Bangladesh [2] . Using tax return data he measured tax compliance by large corporate taxpayers in the LTUs; and then on the basis of a survey and in-depth interviews among tax officials and firms explored whether coercive instruments (penalties, audit, imprisonment) or persuasive instruments (taxpayer services eg. helpdesk, taxpayer education) are more effective in raising compliance.

The research found that the 154 large corporations sampled are generally good in filing returns (84% filed on time), quite good in paying their assessed taxes (75% paid on time), but poor in reporting their taxable income accurately (only 54%). And few firms achieve all three ie. full compliance---only 37% of those sampled.

The research finds this pattern of compliance is not straightforwardly explained by the use of coercive or persuasive tax collection instruments. Rather it is caused by a complex interaction of incentives: chiefly the competing strategies of large taxpayers and LTU officials (eg. taxpayers deliberately under-report because officials want to contest the first submission in order to impress their superiors, and because reporting high profits tends to attract tax audit); widespread corruption in tax audits, which results in its overuse; limited skills and finance in the LTU to pursue prosecutions, and to provide services of value to large taxpayers, or to regulate eg. assess whether transfer pricing takes place; and tax penalties which are lower than borrowing costs, making delayed payment a rational decision for firms that need to borrow. Underlying much of this strategic behaviour is an over-complex tax law, including multiple business tax rates.

The conclusion is that Bangladesh’s LTU remains far from the ideal of mutual understanding in which a competent tax authority enforces a straightforward tax law which limits strategic behaviour and reduces compliance costs. The international literature on LTUs suggests Bangladesh’s experience is not unique. Rather it emphasises that greater effectiveness of LTUs depends as much on their environment---including a simplified tax law, and regulation of transfer pricing and tax audits---as it does on their resources and management.

February 2012