Overcoming Tax Administration Challenges in Developing Countries

Tax administration in developing countries faces significant challenges in collecting revenue efficiently and equitably. Low tax-to-GDP ratios, high rates of informality, limited taxpayer compliance, and outdated technology all hinder the ability of tax authorities to mobilize domestic resources. However, with the right reforms and investments, these obstacles can be overcome to strengthen fiscal capacity and support economic development.

The Promise and Limitations of Technology

Technology has immense potential to transform tax administration in developing countries by improving taxpayer identification, enhancing compliance monitoring, and facilitating voluntary compliance¹. Digital tools like electronic fiscal devices, e-filing, and e-payments can help tax authorities create comprehensive taxpayer databases, automatically cross-check reported liabilities against third-party data, and provide convenient services to taxpayers.

However, realizing the full benefits of technology requires overcoming significant barriers. Inadequate infrastructure like electricity and internet access can lead to system failures and user frustration, especially for small businesses and rural taxpayers. Resistance from taxpayers and tax officials, lack of institutional strategy, and outdated regulatory frameworks also limit the impact of new technologies.

To address these challenges, tax authorities should adopt a multi-pronged approach. Investing in basic infrastructure and offering alternative solutions like offline filing for underserved groups can mitigate access issues. Robust change management, targeted training, and assistance can help overcome human resistance. Sequencing reforms, cleaning up data, and retraining staff should precede technology rollouts. Policymakers should also update regulations for data sharing and cybersecurity.

Improving Compliance through Behavioral Insights

Compliance is a major challenge in developing countries, with high rates of tax evasion and avoidance. Households and firms often underreport income, especially for activities that are harder for authorities to observe. Complexity and lack of awareness also lead to unintentional noncompliance².

Behavioral insights offer promising solutions. Simplifying tax processes, providing clear information, and sending reminders can significantly boost compliance. For example, SMS reminders increased tax payments by 6% in Uganda, while simplified information decreased late payments by 23% in Belgium².

Adjusting tax policies can also encourage compliance. Bachas and Soto² found that increasing corporate taxes on profits in Costa Rica led firms to evade by inflating reported costs, suggesting revenue taxes as an alternative. Londono-Velez and Avila-Mehecha² showed that improved information on offshore accounts and amnesty programs had large impacts on wealth tax compliance in Colombia.

However, not all noncompliance is strategic. Brockmeyer et al.² found that failure to pay property taxes in Mexico was often due to limited liquidity rather than evasion. Policymakers should consider taxpayers’ circumstances and use a mix of incentives, simplification, and enforcement to promote compliance.

Strengthening Tax Administration Capacity

Developing countries face extensive political, economic and administrative challenges in closing tax gaps³. Weak institutional capacity, lack of skilled staff, and corruption undermine the effectiveness of tax administrations⁴. Reforms are often difficult due to vested interests and resistance to change.

Building sustainable capacity requires a long-term, holistic approach. Investing in human capital through training and performance management is crucial. Organizational restructuring, risk-based audits, and large taxpayer units can improve efficiency. Enhancing taxpayer services and communication can increase voluntary compliance.

Political leadership and a whole-of-government approach are essential for successful reforms. Policymakers should champion modernization, align tax policies with development goals, and coordinate with other agencies. Engaging stakeholders, managing change, and monitoring progress are also key.

Leveraging International Cooperation

In an increasingly globalized world, international cooperation is vital for tackling cross-border tax challenges. Aggressive tax planning and transfer mispricing by multinational corporations lead to huge revenue losses for developing countries, far exceeding foreign aid. Tax incentives, though ineffective at attracting investment, still result in significant forgone revenue³.

The international community has taken steps to address these issues, such as the OECD’s Base Erosion and Profit Shifting (BEPS) project and the Addis Tax Initiative. However, more action is needed to ensure that developing countries can fully participate in and benefit from global tax reforms.

Developed countries and international organizations should provide technical assistance, capacity building, and financial support to help developing countries strengthen their tax systems. Sharing best practices, facilitating knowledge exchange, and supporting regional cooperation can also accelerate progress.

Ultimately, domestic revenue mobilization is a shared responsibility. By working together to overcome challenges and build effective, equitable tax systems, developed and developing countries can unlock the resources needed to achieve sustainable development.

Written with the support of perplexity.ai and chat.bing.com.