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Should we aid low-tax nations?

October 8th, 2010

The “low-tax nations” in this headline isn’t generally referring to tax havens, (or secrecy jurisdictions, as we like to call them.) It is aiming at a different kind of low-tax nation, and it poses a question raised by U.S. Secretary of State Hillary Clinton, who said last month:

This is one of my pet peeves: Countries that will not tax their elites but expect us to come in and help them serve their people are just not going to get the kind of help from us that they have been getting . . . Pakistan cannot have a tax rate of 9 percent of GDP when land owners and all of the other elites do not pay anything or pay so little it’s laughable, and then when there’s a problem everybody expects the United States and others to come in and help,” Clinton said to a round of applause.”

It is a good question. Tax evasion and illicit flows — which are major reasons for Pakistan’s low-tax status — are serious security issues, not least in unstable nuclear-armed states. Taxation, and cracking down on tax evasion, are key elements in building strong states, as plenty of new research is beginning to discover. The attached graph, while not actually proving anything in itself, offers one pointer to a possible link between development and taxation. Click to enlarge it (and “the authors” in the graph refers to the authors of the paper below).

On the question of aid conditionality, a new paper by the German Development Institute Deutsches Institut für Entwicklungspolitik (D.E.I) asks the question in its headline: Should we Engage in Development Cooperation with Countries that Have a Notoriously Low Tax Ratio?

And its conclusion fleshed out some interesting points, worth pondering:

“Is it appropriate to stop development cooperation with these countries altogether? Not necessarily, but the nature of cooperation should at least be adjusted in such cases. States that are highly fragile, are engaged in a military conflict or post-conflict situation or have difficulty in collecting taxes for structural reasons should not be uncoupled from development cooperation, but greater emphasis in that cooperation should be placed on strengthening their tax systems. Governments should be supported in their efforts to increase tax revenue (through the linking of financial allocations to improvements in the tax system, for instance). However, in the absence of success and when the partner countries’ decision-makers obviously lack the will, donors must ask themselves how cooperation with such governments can be justified in development policy terms and continue to be legitimised at home.”

The overall question puts an interesting twist on the issue of conditional aid. Conditionality has had quite a bad press, not least because it smacks of colonialism and external pressure and imperialism and all that. But what this particular conditionality would do is to seek to make countries less dependent on donors, by encouraging them to develop their autonomous tax-raising systems.

It’s worth repeating: this is not just a development issue, but a security issue too.

Written by Nicholas Shaxson

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