An OECD report entitled “Tax and development: aid modalities for strengthening tax systems” was published on 11 March 2013. This is a result of work by the OECD’s Informal Task Force on Tax and Development, which incorporates the expertise of the OECD’s Development Assistance Committee and Committee on Fiscal Affairs. The OECD has produced the report in cooperation with the International Tax Compact (ITC) which provides an opportunity for dialogue on tax reforms in the developing world.

An important factor in the need for domestic resource mobilization is an effective system for tax administration and collection. Developing countries are well aware of the benefits of building up a tax administration that can collect tax efficiently based on a wide tax base, in support of the national development goals of each country. They are however hampered by a lack of skills and resources in the tax administration, a large informal sector that remains outside the tax system, a narrow tax base and widespread tax evasion by wealthy people. While this situation persists, tax collection remains low and the country is unable to increase the resources available to develop the tax laws and administration.

The OECD report focuses on the methods that donors of aid may employ to help developing countries build up their tax systems. The strengths and weaknesses of each modality are examined and the report identifies the context within which each modality may be most effective, either on its own or in combination with other approaches. Looking at practical examples from countries such as Ghana and Rwanda the report illustrates how tax reform may lead to better governance, pointing the way to future action in respect of other developing countries.

The strategy of general budget support is ideally accompanied by dialogue with the developing country as to strategies and objectives. Under this modality the funds become part of the developing country’s general Treasury account. Many developing countries prefer this approach as the funds are brought in transparently and the various Ministries are accountable to the developing country government for the way they use their funds. The weakness of this modality is that the donor is accountable to its taxpayers for how the aid money is used and it can be difficult to complete due diligence owing to the variety of groups and subgroups within the developing country that are accessing and using the funds, with multiple objectives and targets. Also the transaction costs are often high.

Other aid modalities considered by the report include sector budget support. This uses the same process as general budget support with funds transferring to the national treasury of the developing country, but the funds support a sector programme within the tax administration or another sector. This more specific sector support may provide a greater incentive to achieve the required objectives within the sector,  as compared to general budget support. There is a closer link between funding and performance. Host country ownership of projects is important in achieving the required reforms though this may bring with it the problem of different attitudes to the programme within the host country. The report recommends the development of an appropriate diagnostic tool for assessing the priorities for reform within a developing country.

Also considered by the report is basket financing, which can harmonize multi-donor financing for tax reforms. Basket financing involves a multi-donor partnership with a developing country. An action plan is drawn up involving an agreement on joint planning, funding, implementation and monitoring. However as funds are deposited in a separate account and earmarked for particular uses they may not be so closely aligned with the host country systems and priorities as funds provided directly to the Treasury of the host country.

The report mentions other multi-donor instruments such as trust funds or multi-donor projects. These generally provide funding outside the host country budget and are therefore potentially less well aligned with the host country budget and priorities. Such multi-donor projects may however be used in developing countries where the system of government is weak and direct support for the genera budget is therefore not advisable. One suggestion made by the report is that donors could set up recipient-managed trust funds bringing together civil society and private sector groups to finance tax-related projects where non-government groups play key roles.

The report also considers stand alone arrangements between the donor and the developing country based on a bilateral agreement. In this situation there is a danger of inconsistency owing to the possibility that a developing country is making a number of bilateral arrangements with different countries concerning the same technical area. This leads to the risk of inconsistency and high transaction costs. Such arrangements may however yield results where there is strong host country ownership and leadership of the projects. This modality may also be effective where there is mainly just one host country providing the support without the need for coordination between different donors and projects.  In any case, the responsibility is on the developing country government to avoid fragmentation and inconsistency between projects and donors. The report considers that the best approach is to avoid inconsistency by pursuing a basket financing approach or other multi-donor instrument.

Also considered in the report is the provision of support to South-South regional organizations. Such regional organizations facilitate networking between tax officials; knowledge sharing on practical solutions to mutual problems; promotion of cooperation on international tax issues; and liaison between regional tax bodies and international organizations. Organizations such as the African Tax Administration Forum (ATAF) can tap into local and regional expertise to enable tax administrators to learn from the experience of their peers in neighboring countries. Another benefit of regional organizations such as ATAF is that they can promote dialogue with local stakeholders and wider society in the developing country.  Donors may support such organizations by providing funds or by in-kind support but need to ensure that their support is harmonized with contributions by other donors.

The subject of in-kind support generally is considered by the OECD report. Some organizations provide technical cooperation in kind, examples being the IMF Fiscal Affairs Department and the US Treasury Office of Technical Assistance. This assistance may take place between governments or through regional organizations such as ATAF. In-kind support may also be given through the secondment of tax officials or twinning arrangements. One weakness identified by the report is that in-kind support programmes have often been poor at evaluating the effectiveness of the support given. However these programmes can provide expert support that would be difficult to achieve through a funding modality. The donors should consult the developing country government on priority needs and the design of the programme in addition to ensuring quality control and correct evaluation of the effectiveness of the programme in achieving its objectives.

The report concludes by making some recommendations for donors. Generally the amount of aid allocated to tax projects has been low, whereas the place of tax reform in improving governance and state building merits greater priority from donors. Donors should make greater use of graduated funding mechanisms, employing revenue-related triggers.  In assessing the effectiveness of a revenue system, donors require a standard diagnostic tool for consistent assessment, similar to those used in other policy areas.

Although it is appropriate for the developing country government to retain ownership and leadership of projects, to ensure harmonization between projects and alignment with policy needs and objectives, this should not override the need for the donor to account to its taxpayers for the results of the aid project.  Although the donor country needs to be realistic in expectations of the outcome of projects, it must be prepared to disengage from the project if the aid given to support tax reform does not produce the required results. There is also a need for transparency within the developing country to ensure that the developing country government remains accountable to stakeholders and the general population.

The report indicates that support to tax projects should incorporate projects for tax education, public information and dialogue between the public and private sectors. The programmes should bear in mind the need for sustainable development of institutions in the developing country. Otherwise there is a danger of capacity substitution rather than capacity development.

The report sets out some possible directions for future research. These include further examination of hypotheses concerning taxation and governance and research into the politics of taxation including the main drivers of tax reform and the political obstacles to reform. Further research could be performed into the design of tax systems that can deliver more inclusive growth that involves the poor members of society in the benefits of growth.  The report calls for more research into indicators of revenue performance and their use in tax programmes, and analysis of transaction costs in multi-donor programmes. More comparative research could also be performed into approaches to the taxation of micro and small enterprises.