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CAGE Chatham House Series

Registering for Growth: Tax and the Informal Sector in Developing Countries

Christopher Woodruff, The CAGE-Chatham House Series, No. 7, July 2013

Low- and lower-middle-income countries typically have a large informal sector, very high self-employment rates and low levels of tax collection. A recent project in Sri Lanka to induce small firms in the informal sector to register did little to change the trajectory of most, but registration did help some firms generate rapid growth – an outcome with important policy implications. For governments in developing countries, getting firms to register should not be simply a cost-benefit calculation involving a trade-off between enforcement costs and tax collection. Registration can also improve the attitude of small business owners towards the state and, more importantly, help stimulate economic growth. The tendency of small firms to remain in the informal sector may have an even more pervasive detrimental impact on growth than one might expect. Their informal status usually allows them to avoid taxes by keeping costs and revenues off the books. However, the lack of information arising from production costs, and the basic accounting systems on which they rely, mean many costly errors in pricing can be made, resulting in considerable lost business. Focusing on avoiding taxes in the informal sector can often distract firms’ attention away from important growth opportunities. Although taxes may discourage some economic activity, the problem in low-income countries is typically lack of capacity and under-enforcement, rather than over-taxation.

Africa's Growth Prospects in a European Mirror: A Historical Perspective

Stephen Broadberry and Leigh Gardner, The CAGE-Chatham House Series, No. 5, February 2013

The relatively rapid growth rates achieved by many African countries in the last decade have raised hopes that the continent is finally on a path to economic convergence with Asia and Latin America, but history suggests that such optimism could be misplaced. Previous periods of rapid growth across Africa have often been followed by phases of economic decline which have erased many of the gains countries have achieved in per capita income. The continent's transition to modern economic growth will thus require a break in the boom-and-bust pattern which has characterized its economic performance during much of the 20th century. European experience since the Middle Ages suggests that the pattern of growth based on increasing demand for export staples, followed by economic reversals, has often resulted in limited overall gains in per capita income. This pattern was only broken following the introduction of significant institutional change. Placing Africa's recent economic performance in a wider historical perspective highlights the fact that the continent's level of per capita income is comparable to pre-industrial Europe and that the institutional changes needed to ensure sustained economic growth have yet to take place. Growth reversals remain a serious threat to Africa's future prosperity, and therefore it is incumbent on policy-makers to focus a great deal more on the introduction of measures that can encourage the development of a robust civil society.

Tax Competition and the Myth of the 'Race-to-the-Bottom': Why Governments Still Tax Capital

Vera Troeger, The CAGE-Chatham House Series, No. 4, February 2013

The majority of OECD countries have only experienced minor effects of capital market integration and capital tax competition since the mid-1980s. There have undoubtedly been some winners, mainly capital owners in larger liberal market economies, and some losers, especially large continental European welfare states. Not only have the dire predictions of the early doom theories not materialized; they have failed. Therefore, there is much to be gained in making the key assumptions underlying traditional tax competition models much more realistic, particularly in terms of predicting the impact of globalization on Western democracies. Tax competition affects countries differently and does not lead to a ‘race to the bottom’ since capital remains incompletely mobile. The competitiveness of a country determines fiscal adjustment strategies by others. Cutting capital taxes, therefore, will not necessarily generate more capital inflows. Tax competition and taxation have broader implications for the fiscal responses of countries to globalization and their redistribution efforts. Given that tax competition affects countries differently, governments will choose diverse strategies to cope with these international pressures. Competition will more negatively affect income inequality in countries that predominantly redistribute via the tax system than in those that historically set up a welfare state by redistributing via social transfers.