An efficient and fair tax system is an important component of a progrowth strategy.19 While foreign aid can make an important contribution, the main source of finance for a country’s public expenditure must be its own tax revenue. This requires an effective tax administration and a tax policy that minimizes distortions to ensure that the best use is made of resources across the economy. To minimize distortions, tax systems should avoid excessive complexity, focusing on taxing a broad range of goods and services at relatively uniform rates. Income taxation also has a role to play, although weak administrative capacity limits revenue from this source in many developing countries. Tax systems should also be sensitive to the possibility of market failure, not least in relation to the use of the environment and natural resources, and be administered in a manner that is transparent, impartial, and rules-based.
The tax system also needs to be accepted by domestic constituencies as equitable, although experience has shown that taxation is generally less effective than well-targeted spending programs in pursuing pro-poor policies.
The wealthy have proved adept in avoiding high tax rates on their income by, for instance, locating assets abroad or taking advantage of relatively favorable treatment of capital gains. Taxes on consumption and trade, which are particularly important in many developing countries, are also blunt instruments for pursuing equity objectives. For example, exempting some basic foodstuffs from the value-added tax (VAT) certainly conveys some benefit to the poor, since they are likely to spend a larger fraction of their income on food. However, the rich may well spend a larger absolute amount on the exempted good, so they derive the largest benefit. Removing the exemption would yield revenue that could be spent in a more propoor way,21 along the lines discussed in the section on “Fiscal Policy, Human Development, and the MDGs.”
Improving the efficiency and equity of tax systems is a critical component of IMF-supported programs. Almost three-fourths of PRGF-supported programs in low-income countries incorporate measures to broaden the tax base and improve horizontal equity (treating taxpayers with similar incomes equally) by, for example, removing exemptions and abolishing special tax breaks for foreign investors. Many programs also seek to improve tax efficiency by lowering or reducing the number of import tariff rates, simplifying the structure of the personal income tax, or improving tax administration.
Similarly, some programs seek to improve equity by, for example, increasing the progressivity of the personal income tax.22 The IMF also continues to play a key role in the adoption and improvement of the VAT, which has proved to be a key tax innovation for many developing countries. By introducing modern methods of self-assessment, the VAT is also seen as an important first step toward modernizing tax administration.
Fiscal Dimensions of Sustainable Development Prepared for World Summit on Sustainable Development Johannesburg, August 26–September 4, 2002
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The IMF is an international organization
of 185 member countries. It was
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monetary cooperation, exchange stability,
and orderly exchange arrangements; to
foster economic growth and high levels of
employment; and to provide temporary
financial assistance to countries to help
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Since the IMF was established its purposes
have remained unchanged but its
operations—which involve surveillance,
financial assistance, and technical
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changing needs of its member countries in
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