Tax Reform or Governance Revolution?

Andrew wainer

Andrew Wainer

Director of Policy Research in the Public Policy & Advocacy Department 

Washington, DC

 

“Taxes formalize our obligations to each other…They set the boundaries of what our governments can do. In the modern world, taxation is the social contract.”Aaron Schneider, State Building and Tax Regimes in Central America

Improving taxation in developing countries to enable them fund their own development is now so central to U.S. foreign assistance rhetoric that last month USAID Assistant Administrator Alex Their penned an article subtitled, “Why Taxes Are Better Than Aid.”

This follows the July announcement of the Addis Tax Initiative at the United Nations’ International Conference on Financing for Development where the United States and other donors pledged to double the amount of assistance for taxation in developing nations.

By most accounts, the potential fiscal benefit of increasing taxation – called domestic resource mobilization (DRM) in development parlance – is huge. The World Bank and International Monetary Fund find that in 2012, DRM in emerging and developing nations generated a combined $7.7 trillion.

This dwarfs average annual foreign assistance outlays, which in recent years have averaged about $135 billion.

DRM: A Cornerstone of Governance

USAID cites El Salvador as emblematic of its DRM work. Through its partnership with the Salvadoran Ministry of Finance, USAID states it was able to help El Salvador increase its tax revenue by $660 million per year. Part of this increased revenue was subsequently channeled to health, education, and social services.

Tax reform can increase the amount of money for development, which is important in its own right, but issues of fair and transparent taxation can also generate revolutionary transformations in governance. Nevertheless, the governance component of tax reform and administration is often viewed as a secondary component in discussions of DRM.

Typically, DRM analysis takes a dollars and cents perspective focused on increasing the size of the fiscal pie. As the Organization for Economic Co-Operation and Development (OECD) states, “The traditional approach to tax reform was and is technical.”

But we know from our own history about the centrality of taxation to a just social compact between citizens and the state. The American Revolution was fueled by a 1773 Boston tax protest against the British Empire. Taxation was seen as a central component of unjust governance.

And in recent months a tax corruption scandal in Guatemala led to the forced resignation and jailing of a sitting president and the “Guatemalan Spring” – a surge in citizen engagement unseen in the country’s modern history.

Even as U.S. foreign assistance agencies scale-up DRM assistance with a technical emphasis on enlarging government revenues for development, the U.S. is also increasing support for organizations that – though not their original intent – are sparking historical citizen revolutions through their revelations of governmental tax corruption.

The International Commission Against Impunity in Guatemala

The International Commission Against Impunity in Guatemala (CICIG by its Spanish-language acronym) was created jointly in 2006 by the United Nations and Guatemala to strengthen the rule of law through, “Investigation of crimes committed by members of illegal security forces and clandestine security structures.”

Since it began its work, CICIG has uncovered a series of government corruption cases that could anchor the plots of several Hollywood thrillers: government assassinations of escaped prisoners and former special forces officers running drug-trafficking rings from jail are two examples of cases that CICIG has investigated.

But it was CICIG’s 2015 revelations of a customs tax corruption network in Guatemala’s tax agency that triggered protests that eventually brought 100,000 Guatemalans into the street in a single day – an event labeled by some as the largest street protest in the country’s history. It also led to the resignation and jailing of a sitting president – also unheard of in recent Guatemalan history.

The outcry over the customs tax scandal was the tip of an iceberg – the result of centuries of economic and political injustice, widespread poverty, and deep inequality exemplified by the county’s dysfunctional tax system. Guatemala has one of the lowest tax revenue rates in the world. Much of the economy is conducted in the (often untaxed) informal sector and entrenched political interests – including parts of the private sector – have resisted tax reform.

Guatemalans don’t believe their government will use their taxes well, so they avoid paying them, resulting in inadequate resources for Guatemala’s education and justice sectors, among other pressing national development needs. The weak tax system symbolizes a dysfunctional political culture.

Tax Reform or a Governance Revolution?

CICIG is now praised by U.S. policymakers and Central American citizens. The State Department recently announced $5 million for CICIG, bringing the U.S. commitment to $36 million over the past seven years. The United States is the largest single contributor to the organization. U.S. rule of law experts also support new and expanded versions of CICIG. The Senate has allocated $2 million for such an institution in neighboring Honduras.

For their part, Hondurans are also clamoring for a CICIG-like organization, but it is being opposed by the Honduran government.

The role of CICIG, its investigations of customs fraud, and the resulting civic awakening raises important questions about how U.S. foreign assistance thinks about DRM – and categorizes – taxation and governance. As the OECD states, “The payment of tax and the structure of the tax system can deeply influence the relationship between government and its citizens.” And as the CICIG case demonstrates, this change can be revolutionary rather than gradual.

As the U.S. embraces tax for development, what approaches will be prioritized? A technical approach conducted through a development finance lens with the ultimate goal of increasing developing nations’ fiscal resources? Or supporting investigative organizations like CICIG? Certainly, the two approaches are not mutually exclusive.

But the example of Guatemala indicates that it would be a mistake for USAID and other U.S. foreign assistance agencies to engage tax reform solely through a technical, financing for development lens. Taxation and governance are intimately intertwined.

U.S. foreign assistance on DRM should leverage the governance impacts of tax reform, where appropriate.   As the case of Guatemala demonstrates, taxation is not only an exercise in increasing government revenues, but by revealing and prosecuting governmental tax corruption and other misuse of public monies, tax issues strike at the heart of ossified structures of governance and spark revolutionary changes in the relationship between citizens and governments.