An IMF blog post of 24 March 2022 considers the potential for developing countries to raise more revenue from the personal income tax. This issue has gained importance as low-income countries look for a sustainable recovery after the pandemic and need to raise more revenue to achieve stability in their finances and promote economic growth.

The authors (Dora Benedek, Juan Carlos Benitez and Charles Vellutini) argue that there is scope for more revenue to be collected from personal income tax in developing countries. They refer to the research included in their IMF working paper entitled Progress of the Personal Income Tax in Emerging and Developing Countries published in January 2022.

In advanced economies the personal income tax raises on average around 9% of GDP; and reduces inequality as it is charged at progressive rates. By contrast, in emerging market and low-income economies the average amount of tax collected from personal income tax is only 2.5% of GDP. This is partly due to the narrow tax base for the tax. As a result, the personal income tax is not contributing to reduction of inequality in those countries.

There have, however, been gradual increases in tax collection. In the past two decades the amount collected from the personal income tax has grown in low income and emerging market economies, both in real terms and as a share of the total tax intake, which is now around 8% of total tax revenue in low-income countries and 11% in emerging markets.

The authors look at the drivers of personal income tax growth; the effect of increases in personal income tax on the total revenue collection; and the effect on the redistribution of income.

The authors note that policy changes in recent years have aimed at changing the highest and lowest rates of personal income tax, and the level of exempt income, but these changes have not made much contribution to the increase in tax revenue. In emerging market countries, the policy changes have sometimes reduced the tax collected, partly because flat rate tax systems have been used in some countries, and countries with progressive rates have reduced their rates over recent decades.

Economic conditions have been a more important factor in increased tax collection. Variables such as increases in per capital incomes; the size of the public sector wage bill; reduction of the informal sector; and the share of agriculture in the economy have driven the increase in revenue from the personal income tax. This suggests that as economies develop further the importance of the personal income tax will continue to increase. This will be helped by improvements in tax administration and the shift to digitalisation that has accelerated during the pandemic, leading to more efficient design and enforcement of taxes.

The redistributive impact of the personal income tax is restricted in low-income countries owing to the small coverage of the tax. In emerging market economies, the personal income tax is often a flat tax rather than being progressive in nature, so there is scope for emerging market countries to increase the progressivity of the tax and increase its contribution to reducing inequality.

The authors consider that in the medium term, increases in tax collection by low-income countries will come mainly from the taxes that are currently important sources of revenue, such as the value added tax and other indirect taxes. However, if income taxes are appropriately designed, the research indicates that the personal income tax will become more important as economies develop.