The possibilities of increasing tax rates with the aim of sustainable development
Vitor Gaspar, Mario Mansour, Charles Velutini
Emerging markets and developing economies need 3 trillion. dollars annually until 2030 in order to finance their development goals and the climate transition. This amount corresponds to approximately 7% of the cumulative gross domestic product of these countries in 2022 and represents a very serious challenge, especially for low-income countries. Our new research finds that many countries have the potential to increase their tax rates to GDP by up to 9 percentage points through better planning and strengthening institutions, which will enable them to provide the public with key public services . In addition, harnessing this potential will contribute to economic growth and private sector entrepreneurship. Easier financing, in turn, combined with efficient and well-targeted spending, including strengthening social safety nets, would go a long way toward achieving sustainable development. The average tax-to-GDP ratio in emerging market and developing economies has risen by about 3.5 percentage points to 5 percentage points since the early 1990s, mostly due to taxes on consumption, such as value-added taxes and excise duties.
Some countries had notable success in increasing their government revenues, such as Albania, Argentina, Armenia, Brazil, Colombia and Georgia, which activated more than 5 percentage points of GDP. Much of this growth, however, materialized before the global financial crisis of 2008, suggesting that progress has been difficult and fragile due to recent shocks. Moreover, progress in income growth since the early 1990s has varied widely across countries. Half of emerging economies and two-thirds of low-income countries had a tax-to-GDP ratio in 2020 below 15%, a threshold beyond which growth was found to be accelerating. And wealthy countries typically have less tax revenue because some governments have reduced taxes as a result of higher revenues from the exploitation of natural resources. States, in particular, have large margins for collecting higher revenues based on their tax potential, that is, they can reach the maximum they can collect, given their economic structure and institutions. We find that low-income countries could increase their tax-to-GDP ratio by up to 6.7 percentage points on average.
And upgrading institutions, including reducing corruption, to the levels of counterparts in emerging market economies, would result in an additional increase of 2.3 percentage points. The overall revenue growth potential of 9 percentage points of GDP, a staggering two-thirds increase in the tax-to-GDP ratio in 2020, would go a long way in enabling the state to play its critical role in development. Similarly, finally, emerging economies can increase their tax-to-GDP ratio by 5 percentage points on average, while improving their institutions to the levels of the advanced economy average could increase it by an additional 2 to 3 percentage points.
* Messrs. Vitor Gaspar, Mario Mansour and Charles Velutini are senior tax policy and fiscal affairs officials at the IMF. The article is published on the IMF blog.