Tax and the IMF's policy advice

* Update June 27th: IMF praises Liechtenstein *

IMF advice to developing countries on aspects of tax policies appears to have contributed strongly to inequality, according to a new briefing paper prepared for the Bretton Woods Project by three researchers at the London School of Economics. They say:

"Over the past three decades, the IMF has been heavily involved in tax reforms in developing countries, in the form of both advice and conditions linked to the Fund's loans. The tax package put forward by the IMF places great emphasis on the value added tax (VAT), a consumption tax levied at each stage of production and sale, and pushes countries to have few rates and few exemptions."

VAT is typically a regressive tax, which means that the poor shoulder a greater burden than wealthier people. They studied 54 IMF reports on lower-income and middle-income countries and found that

"the IMF recommended or endorsed VAT in 90 per cent of the sample, and told countries to broaden their tax base 80 per cent of the time. Eighty percent of the Article IVs recommended a decrease in tax exemptions, but in only 25 per cent of the total sample were the distributional consequences of abolishing tax exemptions addressed."

and they added that:

"Does the IMF look at the distributional consequences of its advice? The answer seems to be 'not a lot'. The IMF mentions distributional consequences of their taxation advice in 25 per cent of the total sample. However, only one of these instances occurred in a low-income country, whilst the IMF acknowledges or addresses distributional consequences in 40 per cent of the lower-middle-income countries."

Amid a world of high inequality in poor countries, exacerbated recently by high oil prices and rising food prices (which, like regressive taxes, hit the poor hardest), this issue is increasingly important. The report takes a more in-depth look at the cases of Mexico, Bolivia and Mozamique. But we would also like to point out a paper prepared for TJN by Arun Kumar looking at the effect of such taxes in India. It said similar things, such as:

"Indirect taxes taken as a whole are regressive while if direct taxes are properly designed and collected, they are progressive. This is important in a poor country like India. Thus, government should collect more from direct taxes and as little as possible from indirect taxes."

and yet, he noted, just one percent of the Indian population pay direct taxes while one hundred percent pay indirect taxes; "thus, those who are considered to be too poor to pay direct taxes because their incomes are low are also forced to pay taxes." India has one of the world's lowest ratios of direct taxes to GDP, he said, and added that:

"The growing black economy led to more and more tax evasion by the well off. Hence in spite of their obviously rising incomes, the direct tax to GDP ratio stagnated at a low value. Government’s attempts to raise the rates of direct taxes did not make a dent. Nor did the lowering of the rates of direct taxes."

Kumar's paper makes many other points, such as drawing attention to research on the (theoretically stagflationary) macroeconomic effect of indirect taxes on demand whereas progressive direct taxation impacts most upon high income earners and wealth holders, with a greater propensity to consume imported luxury goods.

All of this adds to something of an indictment of IMF policy advice on VAT. The Bretton Woods Project report concludes:

"It appears that the IMF had and continues to have little thought about the distributional consequences of rushed VAT implementation, and that consulting with actors outside the government has been neglected."

This is an important matter, and deserves further research. The authors did not tackle another crucial matter, which we have blogged about before and devoted a section of the TJN web site to: how different kinds of tax have different effects on state-building and developing links of political accountability. The last chapter in the book Taxation and State-building in Developing Countries , as well as Alex Cobham's article in Tax Justice Focus looks in more detail at the problems with the standard tax advice given by the IMF and others to developing countries. This is an area where much more research is needed.