One hundred dollar banknotes flying and streaming from white box, isolated on white background.

Pandora’s box is open: What should lower-income countries do to tax the wealthy now?

Authors: by Giulia Mascagni & Rhiannon McCluskey
Date:
Blog

The recent Pandora Papers leak has exposed yet again the scandal of how the world’s rich and powerful hide their wealth and avoid paying taxes. The revelations are particularly galling during a global pandemic, when tax revenue to invest in public services and social safety nets is more needed than ever. The pandemic has pushed nearly 100 million people into extreme poverty around the globe. Meanwhile, the world’s billionaires increased their fortunes by 54% during the first year of the pandemic, enjoying a $4 trillion boost to their wealth.

In this context, it is unsurprising that calls for taxing the wealthy have moved from left-leaning circles into mainstream policy debates: Last week the World Bank and IMF hosted a conference specifically about taxing the wealthy and this week the UN Tax Committee is discussing establishing a new sub-committee on wealth and solidarity taxes. Unfortunately, these debates often remain too focused on the context in higher-income countries (and the US in particular). But policies that are sensible in those contexts are not necessarily promising or even desirable in lower-income country contexts.

A wealth tax?

There are many good reasons higher-income countries should consider a wealth tax, which are clearly outlined in the UK Wealth Tax Commission’s report of 2020. Despite the challenges of implementing a wealth tax, including political resistance, valuation, and harmonisation with existing taxes, such a tax is both desirable and possible in these contexts.

On the other hand, the prospects of a wealth tax in lower-income countries (LICs) are much less encouraging. Existing taxes on the wealthy are so ineffectively administered that revenue authorities in LICs often lack even the most basic information about the tax base for a potential wealth tax. This, along with weak administrative capacity, are severe constraints in LICs, which would only exacerbate the other challenges mentioned above. In fact, trying to introduce a wealth tax now might be counterproductive for many LICs. Without being able to adequately enforce it, they may end up eroding their credibility and citizens’ trust, if the wealthy are simply able to escape the tax net yet again.

This does not mean that a wealth tax is not a good policy option in LICs – there is in fact a strong case for it. It is just that it is not a good starting point for taxing the wealthy in the short term. Before considering a new wealth tax, LICs should focus on better implementing existing taxes that target the wealthy. This will bring in more revenue in the short-term and help lay the foundation for a successful wealth tax in the future. There are three priority areas LICs should focus on now:

1. Tax income more effectively

It is well-known that the majority of the rich in LICs pay far less tax on their income than they should under the law. In fact, in proportion to their GDP, high-income countries collect about three times more revenue from personal income taxes than LICs do.

This is often due to simple tax evasion. For example, an ICTD study in Uganda found that only 20% of lawyers from top commercial firms and less than 2% of high-ranking government officials with large private business assets had paid any personal income tax (PIT) from 2012-2014. A subsequent ICTD study in Rwanda found that only 1 in 5 millionaires filed a PIT declaration in 2018.

The vast majority of PIT revenue in LICs comes from individuals whose employers (generally large companies or the government) deduct tax from their salaries through Pay As You Earn (PAYE). In Rwanda only 3% of PIT revenue was collected outside PAYE. There is therefore a large amount of revenue that LICs can collect by better enforcing income taxes.

Good ways for LICs to identify individuals with large untaxed incomes are to look at those who own large properties, buy luxury goods like cars, own big companies or extensive stock portfolios, take out large loans or make large bank deposits, or import or export expensive goods. There is also a great amount of room for better collecting existing taxes on dividends, interest, capital gains, and rental income, all types of non-wage income that predominantly accrue to the rich.

2. Tax property more effectively

The second priority for LICs should be to better tax property. Buying land and buildings is a main way the rich in LICs store their wealth. Despite this, high income countries collect over eight times more from property taxes than LICs do, in proportion to their GDP. Much of this is due to the fact that the high-value properties of the wealthy are severely undervalued, omitted from property registers, or that property tax bills simply go unpaid.

Recent experiences demonstrate that there is huge potential to collect far more revenue, in a more equitable manner, from property taxation in LICs. In Freetown, Sierra Leone, the City Council has recently added more than 50,000 properties to the register and introduced a more progressive system of valuation and tax rates. As a result, Freetown’s potential revenue from property tax has increased more than five-fold, 70% of which will come from the top quarter of most valuable properties. In just the first two months of the new system’s implementation, the city collected more than 67% of what it had collected the entire previous year.

Another thing LIC governments can do is implement transfer taxes at the point of change of property ownership. This could be part of broader efforts to tackle inter-generational inequity through inheritance taxes on transfers of accumulated wealth.

3. Make better use of exchange of information

Despite its challenges, taxing income and property held domestically may still be more feasible than trying to capture the wealth the rich have stashed in tax havens or secrecy jurisdictions offshore, as the Pandora Papers have revealed yet again. It is estimated that $8 trillion of personal financial wealth is in offshore accounts, $500 billion of which is held by Africans. Along with non-financial offshore assets like property and artwork, this translates into African governments losing up to $60 billion in tax revenue per year, which is more than the continent receives in either official development assistance or foreign direct investment annually.

To tackle this, countries need to make beneficial ownership information available (to know who the people behind trusts and companies are) and to exchange information, so that tax authorities can find out about the foreign bank accounts of their own taxpayers.

While significant progress has been made through the Global Forum, it has been far more challenging for LICs to participate in and benefit from exchange of information processes. This is largely due to the legal, administrative and technology requirements that must be met to comply with the international standards. But doing so is worthwhile: Since 2009, African countries have been able to identify over EUR 1.2 billion of additional revenue through exchange of information.

Despite this progress, it is still largely under-utilised. In 2020 only eleven African countries made exchange of information requests, and over 90% of these were made by just four countries. Thus, there is great scope for LICs to improve their exchange of information infrastructure and make better use of it to investigate and tax assets held offshore by the wealthy.

The way forward

While the challenges may seem daunting, there are enormous gains to be made by LICs in following the roadmap laid out above. By more effectively taxing the incomes and properties of the wealthy at home and unlocking the potential of exchange of information to tax their assets held abroad, LICs can start to collect substantial amounts of revenue relatively quickly.

This will help governments deal with the economic impacts of the pandemic and can also help them build credibility and trust by pairing achievable measures to tax the wealthy with visibly beneficial public spending.

This course of action will also allow LIC governments to build up the foundations for a successful wealth tax in the future. On the administrative side, following this roadmap will allow them to collect the information they need to identify the tax base for a possible wealth tax. On the political side, an agenda on taxing the wealthy centred on equity would create the momentum and political capital required to implement new taxes on wealth in the future.

Public support for increasing taxes on the rich is now high. There is no better time for leaders in LICs to take action to ensure the wealthy pay their fair share in financing the recovery and development for the future.

Image credit: © ekinyalgin
Giulia Mascagni
Giulia Mascagni is a Research Fellow at the Institute of Development Studies and Research Director of the ICTD. Her main area of work is taxation, but she also has research interest in public finance, evaluation of public policy, and aid effectiveness. She is an economist by training, holding a PhD in Economics from the University of Sussex. Her main geographical interest lies in African countries, with a particular focus on Ethiopia and Rwanda.
Rhiannon McCluskey
Rhiannon is the Research Uptake and Communications Manager for the International Centre for Tax and Development, based at the Institute of Development Studies.