The political economy of progressive fiscal contracts in Africa and Latin America

Motivation: How can poorer developing countries escape the vicious circle in which, because the state is fragile, they cannot raise sufficient public revenue to be able to finance development, leading to the persistence of poverty and state fragility? We explore a new approach to this problem, which we call progressive fiscal contracts, in which government earmarks the proceeds of particular taxes to be spent on forms of expenditure which will have widespread benefits for lower income groups, such as health, education and social protection. Taxpayers are thus offered a contractual relationship with government (better-targeted delivery of public services in return for tax payments) in place of a coercive one (simply being ordered to pay taxes, with nothing being offered in exchange). We seek to examine whether this kind of contractual approach offers a way forward for developing countries. Purpose: Across five countries (Bolivia, Ecuador, Venezuela, Ghana and Zambia) between 2000 and 2015, we seek to find out whether tax yields have improved following the introduction of progressive fiscal contracts, whether conflict and poverty have declined, and whether there have been countervailing costs in terms of reduced efficiency. We also examine the experience of two countries (Brazil and Chile) where there is no formal earmarking but government has encouraged the public to think of particular taxes as being associated with particular forms of expenditure. Approach and methods: We assess the impact of changes in tax yields, welfare indicators and conflict indicators by means of panel-data regressions, tabular comparisons and, in Bolivia, qualitative interviews. Changes in efficiency are assessed through examination of changes in tax structure. Findings: Across all of the countries surveyed, the introduction of progressive fiscal contracts has been associated with a reduction in headcount poverty between 2000 and 2015, and in Bolivia our qualitative evidence suggests that the relationship can be seen as a causal one. In three cases out of five (Ghana, Bolivia and Ecuador) tax yields have increased, and in two (Bolivia and Ecuador) there was a significant reduction in political violence. In the Latin American cases examined, but not the African ones, there was a shift from royalty-based taxation to income-based taxation of natural resources, suggesting the likelihood of an improvement in efficiency over the period in those countries only. In these cases, the stereotypical view that progressive fiscal contracts improve equity at the expense of efficiency is contradicted. Policy implications (or conclusions): Progressive fiscal contracts, which originated as a device for making tax payments more palatable by offering social benefits in return, show promise as an innovative strategy for boosting tax ratios, reducing political violence and reducing poverty, which deserves further exploration.