Local governments can collect more taxes to finance future crises themselves
HUGE NUMBERS OF PEOPLE ARE OUTSIDE THE FORMAL FINANCIAL SYSTEM, LIMITING TAX COLLECTION ▾
- The informal or ‘shadow’ economy in developing and emerging markets is big business, and a major source of lost tax revenues for governments as, by definition, people operating informally do not pay personal income or business taxes. According to International Labour Organisation (ILO), the informal economy in Sub-Saharan Africa accounts for 41% of GDP, ranging from under 30% in South Africa to 60% in Nigeria, Tanzania and Zimbabwe.
- Not surprisingly, most people in the informal economy do not use bank accounts and other formal, traceable channels, making it difficult to tax their income. Many others, who are not trying to avoid taxes, do not have access to formal financial services for a variety of reasons, including living too far away from the services, not qualifying for services due to lack of identification and not being sufficiently profitable for service providers. According to the Alliance for Financial Inclusion, an estimated 2.5 billion people worldwide are outside the formal financial system. Again, this limits governments ability to track and tax residents.
- These issues partly explain why low-income countries collect just 12% of their GDP from tax, compared to 33% in OECD countries.
FINANCIAL AID CAN BRING MORE PEOPLE INTO FORMAL SYSTEM ▾
- By delivering the money to families via banks, post offices and other formal, regulated channels, recipients become part of the formal system, enabling appropriate levels of tax to be collected. It also provides families with access formal to financial services such as credit, savings accounts and insurance, which can all help them develop socially and economically – and enables them to avoid costly informal loan sharks.
- In GiveDirectly’s study of unconditional financial aid in Kenya, people who received the money were 40% more likely to pay tax on their income than those who did not receive the financial aid.
- If people are connected digitally to the formal financial system, for example via mobile phones, there is strong evidence from several countries that tax receipts will rise, partly because digital channels are more convenient but also because they prevent ‘leakages’ from corruption and other problems. In Tanzania, it has been estimated that digitalizing tax collection could increase tax receipts by $477 million a year.
IT CAN ALSO BOOST ECONOMIC GROWTH, WIDENING THE TAX BASE ▾
- It is difficult to quantify the macro-economic impact of financial aid, beyond its local economy effects, because low-income households tend to represent only a small proportion of a country’s GDP. However, given that there are local economy impacts, there will be wider macro-economic effects, even if they are hard to discern. Indeed, the cash transfers that are common in developed economies, such as tax credits and family allowances, are known to have an impact on GDP.
- One study that used satellite data to map indicators of economic growth, such as the spread of electricity, calculated that Colombia’s conditional cash transfer scheme added 0.1% to the country’s per capita GDP via its multiplier effects.
- Another study, based on an economic simulation model, indicates that financial aid is more likely to have an impact on GDP if it is combined with supportive public investments, for example investments in rural infrastructure and irrigation.
- Nevertheless, the local economy multiplier effects, discussed early, can generate significant additional, taxable income, even though that income’s contribution to GDP might be small. Moreover, if families invest part of the financial aid in education and health, which have been shown to play a key part in economic growth, the income effects could be bigger in the long run.
- A World Bank paper adds: “Even though there is clearly a positive contribution from safety nets programs to economic growth, the return on investment in safety nets cannot justify by itself the claim for limited public funds. It is the combination of their direct effect on poverty reduction along with their contribution to growth that jointly justifies investments in safety nets.”
2bn
An estimated 2 billion people worldwide are outside the formal financial system, making it difficult to collect taxes. Financial aid can help bring them into the system.
40%
One study in Kenya found that people who received financial aid, and invested part of it in their businesses, were 40% more likely to pay taxes.
“Giving cash to poor people, no strings attached, is an amazingly powerful tool”
–Slate
“Cash is an equalizer, putting power in the hands of the people who need it most”
-Garry Conille, Under-Secretary General of the IFRC