Taxation in developing countries: some recent support and challenges to the conventional view.

In addition, it is possible that the underlying explanation for a whole set of policies exercised by developing countries is their desire to cultivate a certain type of tax abiding firm. This hypothesis, suggested by Gordon and Li, calls for a close examination of questions such as who is taxed in developing countries and what information flows from banks to tax authorities in developing countries. (137) Lastly, it is still an open question whether offering tax incentives to attract foreign investments is warranted or not.

Reuven Avi-Yonah* and Yoram Margalioth**

* University of Michigan Law School.

** Tel Aviv University Faculty of Law. This paper was presented at the first OECD International Network for Tax Research (INTR) Conference, which took place in November 2006 at the University of Michigan Law School. We would like to thank the participants for their valuable comments. Yoram Margalioth would like to thank the Cegla Center for Interdisciplinary Research of Law for financial support.

(1) Robin Burgess & Nicholas Stern, Taxation and Development, 31 J. ECON. LIT. 762 (1993).

(2) Id. at 821.

(3) Id.

(4) See id. at 819-20.

(5) See id. at 799.

(6) Id.

(7) Id. at 773 tbl.5, 777.

(8) Id. at 777.

(9) See M. Shahe Emran & Joseph E. Stiglitz, On Selective Indirect Tax Reform in Developing Countries, 89 J. PUB. ECON. 599, 599-600 (2005). Emran and Stiglitz state:

A reduction in the trade tax with a compensating or revenue-enhancing

increase in value-added tax (henceforth VAT) has been the center-piece

of such a reform, and it has been implemented in a large number of

developing countries under the structural adjustment and stabilization

policy conditionalities of the IMF and the World Bank. Id.

(10) See, e.g., Alex Easson, Tax Incentives for Foreign Direct Investment Part 1: Recent Trends and Countertrends, 55 BULL. FOR INT'L FISCAL DOCUMENTATION 266, 266 (2001).

(11) See Emran & Stiglitz, supra note 9, at 599; see also Roger Gordon & Wei Li, Tax Structure in Developing Countries: Many Puzzles and a Possible Explanation (Nat'l Bureau of Econ. Research, Working Paper No. 11267, 2005).

(12) Yoram Margalioth, Tax Competition, Foreign Direct Investments, and Growth: Using the Tax System to Promote Developing Countries, 23 VA. TAX REV. 161, 188 (2003).

(13) Government expenditure of the gross domestic product (GDP) is 31.5% in developed countries, as opposed to 25.4% in developing countries. Burgess & Stern, supra note 1, at 765.

(14) Non-tax revenue in developing countries comprised about 21% of GDP compared to 10% in developed countries. These are aggregate figures and substantial variation exists across countries. Id. at 782.

(15) Id. at 770.

(16) Id. at 772 tbl.4, 773 tbl.5, 775.

(17) Id.

(18) Id.

(19) Id.

(20) Id. "[T]here appears to be a pattern of evolution of tax structure [in developing countries]." Norman Gemmell & Oliver Morrissey, Tax Structure and the Incidence on the Poor in Developing Countries 5 (Centre for Res. in Econ. Dev. and Int'l Trade, Univ. of Nottingham, No. 03/18, 2003), available at http://ssrn.com/abstract=503101. "At low levels of income, trade taxes are relatively important and income taxes relatively less important." Id. (citation omitted). A shift occurs, from trade to domestic sales taxes, as income increases. "As incomes rise again, trade taxes become unimportant and various income taxes become most important. These averages, however, conceal wide disparities between countries." Id.

(21) See Emran & Stiglitz, supra note 9.

(22) See, e.g., The WTO in Brief, http://www.wto.org/english/thewto_e/whatis_e/inbrief_e/inbr00_e.htm.

(23) See Richard M. Bird, Value-Added Taxes in Developing and Transitional Countries: Lessons and Questions (Joseph L. Rotman Sch. of Mgmt., Univ. of Toronto, ITP Paper 0505, 2005), available at http://www.rotman.utoronto.ca/iib/ITP0505.pdf.

(24) See Emran & Stiglitz, supra note 9, at 600.

(25) See id. at 600.

(26) The theory of comparative advantage was first introduced by David Ricardo. See DAVID RICARDO, ON THE PRINCIPLES OF POLITICAL ECONOMY AND TAXATION (3d ed. 1821), available at http://www.econlib.org/library/Ricardo/ricP.html.

(27) Gemmell & Morrissey, supra note 20.

(28) Id.

(29) Id. at 22.

(30) Id.

(31) Id. at abstract.

(32) Id. at 29.

(33) Id. at abstract.

(34) Id. at 29.

(35) Id.

(36) Id. at 22.

(37) Id. at 27-28.

(38) Id. at 29.

(39) Id. at 28.

(40) Id. at 29.

(41) Richard M. Bird, Taxation in Latin America: Reflections on Sustainability and the Balance between Equity and Efficiency 7 (Joseph L. Rotman Sch. of Mgmt., Univ. of Toronto, ITP Paper 0306, 2003), available at http://ideas.repec.org/p/ttp/itpwps/0306.html.

(42) Id. at 44.

(43) See, e.g., id.

(44) Id. at 41; see also Richard M. Bird, Jorge Martinez-Vazquez & Benno Torgler, Societal Institutions and Tax Effort in Developing Countries 13-14 (Joseph L. Rotman Sch. of Mgmt., Univ. of Toronto, ITP Paper 04011, 2004), available at http://ssrn.com/abstract=662081 (describing Latin America as a region in which the combination of the dominant policy ideas and the dominant economic and social interests combine with the key political and economic institutions (democracy, decentralization, and budgetary; and free trade, protectionism, macroeconomic policy, and market structure) to produce a generally low tax level and an uneven tax structure).

(45) See Bird, supra note 41, at 40.

(46) Id.

(47) Id. at 43.

(48) Id. at 43 n.58.

(49) Id. at 43.

(50) Id.

(51) Id.

(52) Id. at 47.

(53) Id.

(54) Id.

(55) Richard M. Bird & Eric M. Zolt, Rethinking Redistribution: Tax Policy in an Era of Rising Inequality: Redistribution via Taxation: The Limited Role of the Personal Income Tax in Developing Countries, 52 UCLA L. REV. 1627 (2005).

(56) Id. at 1630.

(57) Id. at 1688-90.

(58) Id. at 1683.

(59) Id. at 1684.

(60) Id.

(61) Id. at 1685.

(62) Id.

(63) Id. at 1686.

(64) Id. at 1690.

(65) Id. at 1695.

(66) Emran & Stiglitz, supra note 9, at 618.

(67) Id. at 602.

(68) Id.

(69) Id. at abstract.

(70) Id. at 600 (describing M.S. Emran & J.E. Stiglitz, VAT Versus Trade Taxes: The (In)efficiency of Indirect Tax Reform in Developing Countries (mimeo, Stanford Univ. & Brookings Inst., Washington, D.C., 2000)).

(71) Id.

(72) See id. at 600 & n.4.

(73) Id. at 602 (citing M. Michael et al., Integrated Reforms of Tariffs and Consumption Taxes, 52 J. PUB. ECON. 417 (1993)).

(74) Id.

(75) Id.

(76) Id.

(77) Id.

(78) Id.

(79) Id.

(80) Id.

(81) Id. at 602 (footnote omitted).

(82) Id. at 620 (citation omitted).

(83) Id.

(84) Id. at 621.

(85) Thomas Baunsgaard & Michael Keen, Tax Revenue and (or?) Trade Liberalization (Int'l Monetary Fund, Working Paper No. 50/112, 2005).

(86) Id.

(87) Id. at 14.

(88) Id.

(89) Id. at 3.

(90) Emran & Stiglitz, supra note 9, at 600.

(91) Gordon & Li, supra note 11.

(92) Id. at abstract.

(93) Id. at 2.

(94) Id.

(95) Id. at 3.

(96) Id.

(97) Id. at 3-4.

(98) Id.

(99) Id.

(100) Id.

(101) Id. Gordon and Li state:

The optimal inflation tax is limited, though, by the possibility that

dollars or some other foreign currency replace the local currency, in

order to avoid the inflation tax. Since this currency substitution

provides no further shift in resources towards the taxed sector but

leads to a discrete fall in seignorage revenue, the optimal inflation

rate is capped due to this treat of currency substitution.

Id. at 21.

(102) Id. at 4.

(103) Id. at 26.

(104) Id.

(105) Id. at 26.

(106) Id. at 27.

(107) Compare id. (suggesting the imposition of tariffs, printing money, state-ownership of banks, discouraging entrance of foreign banks thereby limiting the competition in the banking sector, and introducing red tape in certain sectors of the economy), with Burgess & Stern, supra note 1 (suggesting a switch from relying on tariffs to general consumption taxes, preferably VAT, avoiding money printing, eliminating red tape, and increasing competition).

(108) Gordon & Li, supra note 11.

(109) Id. at 30.

(110) Margalioth, supra note 12, at 169; see also Burgess & Stern, supra note 1, at 821 (predicting that developing countries would not change their reliance on corporate taxation).

(111) Margalioth, supra note 12, at 168-69.

(112) Id. at 167, 177.

(113) Id. at 183.

(114) Id. at 184-85.

(115) Id. at 187.

(116) Id. Margalioth states:

We generally assume that plant and equipment investments in medium and

high tech industries promote growth. Various tax code provisions, such

as faster-than-economic cost recovery, investment allowances and tax

credits attract these desirable investments. Tax incentives for

increasing investment in human capital range from allowing taxpayers

to deduct or expense education and training costs to providing

employers with tax credits for the same. Id. (footnote omitted).

(117) Id. at 188.

(118) Id.

(119) Id.