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How to fix fragile states? The OECD reckons it’s all down to tax systems.

February 25, 2014
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‘Over-generous tax exemptions awarded to multinational enterprises often deprive fragile states of potential revenues that could be used to fund their most pressing needs.’ Another broadside from rent-a-mob? Nope, it’s the ultra respectable OECD in its Fragile States 2014 report.

After years of growth, aid to fragile states started to fall in 2011, so the report centres around an urgent call for OECD member states tofragile state inflows help their more fragile cousins find a post-aid arrangement that funds essential state functions and builds the ‘social contract’ with citizens.

The key is a shift from aid dependence to ‘domestic resource mobilization’ (taxes and natural resource royalties), currently averaging a feeble 14% of GDP across fragile states and far too dependent on royalties from oil, gas and mineral extraction (see chart, below). Foreign direct investment (factories, farms etc) is generally low in volume and volatile. (see graph, right – CPA means ‘aid’)

The OECD advocates a nicely balanced three-pronged approach:

  • ‘Encourage a broader tax base by focussing on approaches that give citizens a voice.’ (the ‘no taxation without representation’ path to the social contract).
  • ‘Support fragile states in designing frameworks to ensure fairer deals with multinational enterprises, in particular on proceeds from their natural resources; providers of development co-operation can lead by example by being transparent about the tax exemptions that benefit them.’ The report goes further, calling on OECD countries to ‘take steps to comply with global standards on money laundering, tax evasion and bribery.’
  • ‘Boost citizens’ tax morale by establishing clear links between tax revenue and local benefits.’

Currently a truly laughable 0.07% of aid to fragile states goes to strengthening their tax systems. So the OECD wants the diminishing pool of aid to redress ‘weak technical and institutional capacity’ in fragile states, helping them introduce and collect direct taxes.

A guiding principle in all this will be ‘leadership and political will for reform by the host country – aid alone cannot ‘buy’ effective and lasting reforms’. Ah. Houston, I think we got a problem. The defining feature of fragile states is not that they are poor, but that they are, erm, fragile. Institutions are weak and/or subject to capture. This is the Achilles’ heel for any number of well-intentioned aid efforts, which ‘assume a can opener’ in the form of an effective state, when its absence is precisely the problem it is trying to address.

fragile states natural resources v the restIt’s not insoluble – fragile states are ramshackle coalitions of ministries, interest groups, factions etc, as well as lots of non-state groups, some of which can form part of a pro-DRM coalition willing to confront the blockers who benefit from the status quo. Shocks, scandals and financial meltdowns offer windows of opportunity, in which resistance to change may melt away. But how such change might happen needs to be thought through just as much as the what of standard reform shopping lists.

I suspect the OECD knows this full well, but can’t include it in supposedly ‘neutral’ policy papers. In any case, it’s great that they are addressing these crucial topics. Bring on the DRM.

The report’s other oversight is remittances, which dwarf other sources of capital (see graph again), but are dismissed rather too easily in the report as only relevant to middle income fragile states (yes, they do exist). If Tajikistan is anything to go by, remittances matter a lot for the poor ones too, and are an obvious point of contact with OECD states and their migration policies. But maybe that was a political hot potato too……

 

6 comments

  1. Dear Duncan,
    Thanks for the review. (I was the lead author of the report).
    On a logistical note, the hyperlink provided –which did work for a while– appears to be now broken; the right link to the full report is http://www.oecd.org/dac/incaf/FSR-2014.pdf
    On the substance, the full post is kinder to the report than its title may suggest (I would argue however that it’s more about tax policies than systems), but it also makes fair points about its shortcomings — especially re the ‘political economy’ or politics of change.
    One thing though: the treatment of remittances in the report seems more comprehensive to me than you describe (which is not to say it is great/sufficient); 2 full pages of text are dedicated to remittances, in which the report reckons that “there is great potential to use remittances finance development in fragile countries, even in LDCs” and makes some suggestions as to how that may happen.
    But certainly, remittances would probably warrant a dedicated global report.
    Thank you,
    Emmanuel Letouzé

    1. Thanks emmanuel, on holiday this week and tech defeats my efforts to mend broken link. If no one at oxfam spots it, will fix at weekend. Sorry!

  2. The OECD report does do a good job of highlighting the often neglected aspect of informal and local level taxation. As it argues ‘informal payments, protection rackets, violence, and local-level coercion often rival formal tax systems and are among the key issues that distinguish fragile states from other developing countries.’ We would think it’s good because the SLRC http://www.securelivelihoods.org/ contributed this bit drawing on a lit review (http://www.securelivelihoods.org/publications_details.aspx?resourceid=226& )and ongoing surveys in Nepal and Sierra Leone being conducted in partnership with the ICTD http://www.ictd.ac/

    We argue in the report that, ‘whether these payments are legal or illegal, or corrupt or not, it is important to develop a better understanding of these local level and informal processes and their relationship to formal taxation. Without it,debates about how to mobilise greater domestic revenue miss an important part of the picture. States may already be raising much more revenue at the local level than official statistics and calculations of tax-to-GDP ratios show. Simply adding higher levels of formal taxation risks not only overburdening individual livelihoods and businesses but may also undermine prospects for growth.

    And that it’s necessary to appreciate the existing social contracts between citizens and local governance (both formal and informal) before assuming that new forms of formal taxation will necessarily build stronger social contracts between a state and its citizens

  3. This was a really good report. The point about direct taxes helping to build a social contract between the state and citizen is an important one, but it would also be good to explore further the role of direct taxation in reducing inequality – and the effect this has on fragility. Frances Stewart and the CRISE Working Group recommend direct progressive taxation as a way to reduce economic inequality between identity groups in conflict, for example.

    It would also be good to look further into what types of tax that fragile states could collect, especially given the point that fragile states are … well, fragile. Jonathan DiJohn and Frances Stewart have both discussed the role of land tax in building resilient states – it’s fairly easy to for a state to collect, difficult to evade, and is typically progressive. That’s one thought, but there’s a lot more to look at there.

  4. “Over-generous tax exemptions awarded to multinational enterprises often deprive fragile states of potential revenues that could be used to fund their most pressing needs.”

    How do we know that generous tax exemptions are not optimal (given constraints)? Yes, there’s probably a lot of corruption, but fragile states are inherently risky.

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