Emerging markets and developing economies face the daunting challenge of securing $3 trillion annually through 2030 to meet their development goals and address the climate transition. This amounts to roughly 7% of their combined 2022 gross domestic product (GDP), creating a significant hurdle, especially for low-income countries, according to IMF.
The IMF’s new research identifies that many of these nations can boost their tax-to-GDP ratios by up to 9 percentage points through improved tax design and stronger public institutions. Realizing this potential not only enables the provision of essential government services but also fosters financial development and private sector entrepreneurship. By facilitating easier financing and efficient, well-targeted spending, including strengthening social safety nets, these measures can significantly contribute to sustainable development.
CLIMATE TRANSITION; PROGRESS SLOW
However, progress has been slow in raising tax-to-GDP ratios in emerging market and developing economies, with an average increase of 3.5 to 5 percentage points since the early 1990s. This growth was primarily driven by consumption-based taxes, such as value-added and excise taxes.
Some countries have been successful in raising revenue, including Albania, Argentina, Armenia, Brazil, Colombia, and Georgia, each mobilizing over 5 percentage points of GDP. Nevertheless, these gains occurred largely before the 2008 global financial crisis, highlighting the fragility of progress in the face of recent shocks.
CLIMATE TRANSITION; MORE ROOM
The research underscores the significant room for improvement. Low-income countries could potentially increase their tax-to-GDP ratio by an average of 6.7 percentage points. Further enhancements in public institutions, including reducing corruption, could yield an additional 2.3-point increase. This 9-point total revenue-raising potential, equivalent to a two-thirds increase relative to their 2020 tax-to-GDP ratio, would enable governments to fulfil their vital role in development.
Similarly, emerging market economies can raise their tax-to-GDP ratio by an average of 5 percentage points. Improving institutions to match the average of advanced economies could add an extra 2 to 3 points.
While some anticipate additional revenue from international efforts to tax large multinational corporations, the direct impact is expected to be limited. Therefore, comprehensive domestic reforms are essential.
CLIMATE TRANSITION; APPROACH
To build tax capacity, governments should adopt a holistic, institution-based approach, focusing on core domestic tax policies. Recommendations include:
Enhancing the design and administration of core domestic taxes, such as value-added taxes, excises, personal income taxes, and corporate income taxes. For instance, doubling VAT revenue in low-income countries could be achieved by limiting preferential treatments and improving compliance without increasing standard tax rates.
Implementing bold reform plans that prioritize tax base broadening through the rationalization of tax expenditures, neutral taxation of capital income, and efficient use of property taxes. Headline tax rates are not the main concern; instead, focus on achieving equity and efficiency.
Improving institutions governing the tax system and managing tax reform. This includes staffing for economic impact analysis, professionalizing public officials working on tax matters, leveraging digital technologies for compliance, and ensuring transparency and certainty in translating policy and administration into legislation.
Prioritizing and coordinating reforms across government agencies, recognizing the importance of the broader institutional context. Strengthening institutions leads to improved state capacity, enhancing the quality of tax design and its acceptance by citizens.