Business tax as state-building in developing countries: Applying governance principles in private sector development

Abstract

The new concern for the ‘state-building’ approach to taxation requires an understanding of how to construct effective and fair taxation systems that constitute an important component of good regulatory and governance regimes. A systemic approach requires the construction of a tax policy and its administration, which can deliver state-building by strengthening the legitimacy of the state in the eyes of its citizens through five core characteristics—political inclusion; accountability and transparency; perceived fairness; effectiveness; and political commitment to shared prosperity. This paper provides evidence of these operational principles for state-building tax reform. The state's ‘fiscal social contract’ with its private sector is a critical intermediary step on the political development path towards full citizen-taxpayer liberal democracy. Formalizing the often largely informal private sector in developing countries and creating ‘quasi-voluntary compliance’ of MSEs (micro- and small-sized enterprises) are essential for the state-building objectives of broadening the tax base, increasing the reach of the state and providing incentive for institutionalized engagement with the political process. The importance of medium-sized business, particularly MSE taxation regimes, has been neglected for too long because revenue-raising administrative concerns have predominated long-term state-building concerns. Based on the ongoing work in Yemen, Sierra Leone, and Vietnam, this paper offers recommendations on potential reforms to implement the principles of ‘tax as state-building’.