Hole in the pocket: why unpaid taxes are the missing link in development finance

Hole in the pocket: why unpaid taxes are the missing link in development finance

Published Nov 2008

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Taxation is a crucial source of sustainable, predictable, and long-term development finance

The predicted fall in growth for developing countries is equivalent to a loss of $414 billion. Rich countries have introduced all kinds of fiscal measures to spend their way out of the recession and are exploring ways to retain much needed capital within their own borders. Poor countries simply do not have the funds to follow suit; indeed, the likelihood is that the downturn may force them to make further cuts in vital spending on education, health and rural development.

Taxation, along with aid and other forms of financing underpins the future development prospects of all countries including low income countries. Contrary to popular belief, huge amounts of capital flow out of poor countries. As much flows out through illicit capital flight much comes in through aid and foreign direct investment. If this money were retained, much of it could be taxed and the revenue could support development.

Illicit flows comprise of three main types of transactions: flows arising from criminal activities such as the drug trade, capital flight due to corruption, and commercial illicit flows through abusive transfer pricing and other tax evasion and aggressive tax avoidance practices. The latter is highlighted as the biggest issue for developing countries.

Taxation is a politically sensitive issue with a chequered past. Many politicians have made and broken promises on tax, and taxes were, and sometimes still are, used by elites to capture wealth and exert power. However, this past failure should not detract from the fact that breaking the cycle of aid dependence and weak tax administration are essential first steps towards better governance.

There are a number of actions needed to make the world fairer in terms of how tax is collected, avoided and evaded:

  • the international community must start to record, monitor and measure what’s going on
  • governments and international institutions, led by the UN, should strive to better regulate the global tax system and set up structures that have the power and authority to effectively deal with global issues such as tax competition, tax evasion and aggressive tax avoidance
  • Southern countries have a responsibility to develop and design tax systems that will allow for the achievement of the Millennium Development Goals they have committed themselves to

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