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Money Talks - Do you listen? / Jason Mrachina via Flickr.

Tax-free poverty reduction?

Niels Keijzer, Timo Mahn | 18 April 2014

Global efforts to counter tax avoidance by multinational companies call for a rethink of policies on the taxation of aid workers and development projects.

The ongoing struggle of European governments to reign in public deficits, as well as the growing evidence base on multinational tax avoidance were key among the reasons why international  legislation on taxation was high on the agenda in 2013, and led G20 leaders to declare that:  “Profits should be taxed where economic activities deriving the profits are performed and where value is created”. Since then, the principle of local taxation has become the new mantra in global discussions on taxation, with substantial efforts by development cooperation actors such as Christian Aid and the Evaluation Unit of the Netherlands Ministry of Foreign Affairs.

While international taxation policy and practice are becoming an increasingly important subject for development research and advocacy, development cooperation itself has to date not been the object of such analysis. Existing taxation practices in development cooperation in fact go against most of the recommendations for reforming international tax legislation and practices, and need to be reconsidered as part of ongoing efforts to improve aid and development effectiveness.

The present situation is mostly a product of history, and a strongly outdated one. Over the decades, development cooperation has evolved from the temporary post-colonial phenomenon it once was into a permanent component of international cooperation. Crucially, its rationale has changed, too: instead of representing a gift from industrialized countries to the third world, today it is more and more motivated as an investment to promote common values and mutual benefit. Today’s global development discourse also gives greater priority to ‘domestic resource mobilization’ and recognizes that developing countries’ own resources are by far the most important source of development finance. The United Nations Secretary General’s High Level Panel report on a Post-2015 framework on global development even considers it a condition sine qua non for development: “Only through sufficient domestic resource mobilization can countries ensure fiscal reliance and promote sustainable growth.”

The OECD estimates that for many of the poorest countries in the ‘Least Developed Countries’ category, over 70% of their external finance comes in the form of Official Development Assistance (ODA). Over half of global ODA is considered ‘country-programmable’ in the sense that developing countries ‘could have a significant say’ over its use. If such a high amount of the 127 billion USD that was provided in 2012 is country-programmable, it seems inconsistent that these are not ‘country-taxable’ as their tax returns could greatly contribute to developing countries’ resource base.[1]

While the international discussion calls for local taxation of multinational companies, why should we not have the same discussion on Western technical experts posted to a developing country and paying taxes at ‘home’? The same goes for the goods and materials that are procured through development interventions, as well as other transfers made in this context. Instead of this, providers of development cooperation actively seek to ensure that their development assistance is not subject to taxation, and push recipients of that assistance to exempt them from VAT, registration fees, import duties, etc.[2] Development agencies also argue their hands are tied because of existing international treaties against double taxation, or lack of support from their ministries of finance. Finally, because tax returns levied on development cooperation may represent a source of discretionary funding or ‘indirect budget support’ to developing countries, donors may be highly reluctant to allow this due to fiduciary or political reasons.

On the receiving side things are not straightforward either. Intertwined legal, political and technical factors together explain why so little has changed over time. For one, least-developed countries frequently lack systems for effective tax collection and administration, and fiscally unsustainable policies are all too often supported by donors.[3] Middle-income countries principally in turn may choose to ‘voluntarily’ opt not to tax development cooperation so as to maximize access to ODA.  

Despite the obsolete current state of affairs, it would thus be naïve and unrealistic to expect a wholesale move to local taxation of development cooperation. The international community could instead take a step-by-step approach and introduce local taxation in a select number of developing countries with continued aid dependence but reliable and strong public finance management systems. If donors prove unable to take such collective action, then one slightly less ambitious solution would be to require OECD members to deduct income tax incurred over ‘their’ projects and advisors from their ODA reporting. It is interesting that this idea does not get much attention at all in the ongoing discussions on modernizing the international system for reporting on development finance.[4]

[1] For more info, see the website of the OECD: http://www.oecd.org/dac/stats/final2012oda.htm.

[2] Ismaïla Diallo, 'Tax exemptions for aid-funded projects: reasons for change', International Centre for Tax and Development, 14 March 2013 (http://www.ictd.ac/en/tax-exemptions-aid-funded-projects-reasons-change).

[3] David Booth, 'Development as a collective action problem. Addressing the real challenges of African governance' (2012) (http://www.institutions-africa.org/filestream/20121024-appp-synthesis-report-development-as-a-collective-action-problem).

[4] Erik Solheim, 'The future of aid', The Guardian, 14 January 2014 (http://www.theguardian.com/global-development-professionals-network/2014/jan/14/official-development-assistance-reform-aid).

Photo credit main picture: Money Talks - Do you listen? / Jason Mrachina via Flickr.

About the author

Niels Keijzer

Niels Keijzer is a researcher at the German Development Institute / Deutsches Institut für Entwic...

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Timo Mahn

Timo Mahn is a researcher at the German Development Institute / Deutsches Institut für Entwicklun...

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