How Real Aid Can Boost Tax Revenues

September 15th, 2011

Real Aid 3 Report

ActionAid UK

Whether it’s tackling corporate tax dodging, changing international rules on tax havens, or improving tax systems, everyone involved in the international tax justice movement is aiming to increase the tax take in developing countries.

This is both to increase the money available to pay for nurses, teachers and roads, desperately needed when you’re trying to run, say, a health service on a few dollars per person per year – as is the case in many of the poorest countries. It is also to encourage and develop the social contract between state and citizen, improving accountability. And it is to afford poor countries autonomy over their own development.

Ensuring greater autonomy over development policies is less discussed than many of these reasons, but no less important. Broadly speaking, the alternative to domestic revenue as a source of public finance is aid. Aid is a good thing – a useful and necessary form of finance, not to mention, at its best, a display of international solidarity. But dependency on aid is a bad thing. Not, as is sometimes argued, because it dampens growth or inhibits tax effort – the evidence for these assertions is thin at best.

Rather, dependency on aid undercuts developing countries’ ability to take charge of their own development, which is what is needed if development is really to take root. This means countries can lose space to design their own development policies and implement their own priorities. It makes governments tend to be accountable to donors thousands of miles away, rather than their own people. And it undermines predictability of government spending – aid flows are often very volatile.

But there is good news. As ActionAid’s new report, Real Aid 3 – Ending Aid Dependency, shows, aid dependency gone down overall by a third over the last decade. For example, in Ghana aid has fallen from around half to a quarter of government spending over the last decade, and in Nepal from half to a third. The difference has, in part, been made up by increased tax revenues.

Given the vital role that increased tax revenues play in helping counties escape from aid dependency, it seems odd that more aid isn’t used to help improve domestic tax systems and therefore in the long run raise more tax revenue. Some countries have used this strategy with stunning success. For example in 1998 Rwanda invested £20 million of UK aid into its tax system. It now raises that much revenue every four weeks (and Rwanda’s aid dependency has fallen from 85% to 45% of government spending within a decade).

Now that is one effective use of aid – and the potential is huge.  ActionAid estimates that if all developing counties achieved a tax to GDP ratio of just 15%, it would generate an additional $198 billion a year.  That’s enough not just to achieve the MDGs, but to put poor countries firmly on the road to sustainable self-reliance.

Written by Anna Thomas

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