Tax revenue is a strong indicator of a country’s economic growth. Tax revenue is increasingly becoming a global concern. The economic prosperity of developing countries is affected due to factors such as informal sectors and political or legislative corruption.
In developed countries, the elite evade taxes by means of offshore accounts, as the recent scandalous Panama Papers proved, digital currencies and black markets. Tax evasion through illegal practices, including drug trade, trafficking and smuggling are typical of both developed countries (DCs) and less developed countries (LDCs).
In 2015, OECD estimates showed that loss of global income tax was around $240 billion, the effect of which trickled down to the developing countries.
Developing Countries
Studies show that the poor populations of developing countries are at the losing end of tax evasion. Since people work mostly in the informal sector, it is difficult for governments to acquire tax revenue. The governments rely mostly on commercial transactions and foreign direct investment for revenues.
A report by ActionAidrevealed that more than half of the investment in developing countries was generated from tax havens. Tax evaders get away due to gaps in information exchange between countries.
Tax Havens
The tax havens of the most prosperous nations entrap citizens of developing countries in a vicious cycle of poverty and hunger, even though LDCs have the capacity to counter poverty via public funds. By routing tax, both DCs and LDCs lose billions in tax revenue.
A case study showed that India forewent $2.2 billion in tax revenue, which was sufficient to subsidize snack for public school students per year, due to an offshore transaction.
A report by UN Economic Commissionshowed that African governments lose nearly $60 billion to tax evasion via illegal capital flows. Loss of tax revenue affects economic prosperity and sovereignty of poor nations.
Countries then rely on foreign aid and may be exploited for resources at the cost of citizens’ welfare and environment.
Low Level Voluntary Tax Compliance
Developing countries lack tax morale or willingness to paytaxes due to several factors. Citizens expect good-quality services and benefits for paying taxes. However, most of the revenue is lost due to administrative corruption and is invested abroad to transferred to personal accounts.
Citizens are unwilling to pay taxes when the government fails to provide them with public goods and serves adequately.
Secondly, high tax rates may induce tax avoidance or evasion. When tax burden increases, an individual’s disposable income falls. Taxpayers may perceive it as unfair and take advantage of loopholes to evade payment.
Thirdly, lack of accountability in tax institutions instills public distrust towards the government, which increases willingness to evade taxes.
Due to corrupt practices at institutional levels, citizens cannot determine whether their expenditures are being spent on public welfare or private monetary gains.
Informal sector
The informal sector in LDCs can be used synonymously to represent black markets, shadow or hidden underworld economies. The hidden economies comprise of all income-earning activities that are not legally regulated.
Since incomes from informal sector are not legally contracted, workers avoid paying taxes. Due to the size and scale of the informal sector in LDCs, there is no scope for growth and development from shadow economies.
The informal sector distorts a country’s unemployment, inflation and GDP growth rate. The state incurs budget deficits due to loss in revenue, causing further increase in tax rates.
The informal sector widen technological gap between the affected country and other countries. There is low productivity in informal sector and people earn low incomes. Workers of the informal sector are worse off than workers of the formal sector due to lack of public security, benefits and working conditions.
Citizens are provided with false information with respect to growth statistics. Informal sector workers have unfair advantage of exclusion from tax payments and social security contributions.
Statistics would provide misleading information about the state and public policies. This increases incentive for corruption in government offices.
Developed countries
Panama Papers and Paradise Papers
The papers revealed high-profile individuals across the world who transferred their incomes to offshore accounts or invested in property abroad. The law-firm Mossack Fonesca assisted the wealthy elite around the world to launder money and evade taxes.
The leaked documents showed evidence of notable political leaders and celebrities. Iceland’s Prime Minister Sigmund David resigned after his name showed up in the papers.
Paradise papers exposed more tax evasion schemes of high-ranking individuals and corporations. Names of over 100 prominent politicians from 50 countries appeared in the documents.
The documents expose how the wealthy elite used tax havens to hide their money from tax authorities.
Tax haven Giants
A new report by Tax Justice Network ranked Switzerland and United States as tax haven giants. The wealthy elite used US as loot wealth and avoid taxes. The US is currently home to 22 percent of the global offshore market.
The US financial giants hold secret information, which poor countries do not have access to. Due to loopholes in the financial operations, the elite of foreign nations easily take advantage to gain wealth. The secret information is manipulated to extract resources and withdraw wealth from developing nations.
There is a huge global industry of tax evasion that assists the elite in hoarding wealth illegally.
Cryptocurrencies
The recent scandals show that high-ranking individuals used e-commerce currencies to generate wealth and avoid taxes. Online transactions are handled anonymously and without legislative regulations. Digital currencies operate without centralized authorities.
The nature of online transactions remains anonymous, which gives leverage to individuals for unlawful ways to increase wealth and evade taxes. Investments in cryptocurrency have increased doe to convenience of storing, transferring and handling transactions.
Buyers and seller don’t need to disclose personal information. There are no tangible resources required for operation or distributions because they could all be done online.
The IRS uncovered US wealth that had been hoarded in Swiss banks. The investigation shows that tax evaders used cryptocurrencies to hide wealth. Moreover, digital currencies are being used to cheat tax authorities and draw in money-launderers and other criminals.
Cryptocurrencies can be used in the same manner as foreign bank accounts to avoid taxes.
Since tax evasion is a development problem, countries need to collaborate on exchange of information and build capacity. Developing nations need resources to facilitate diplomatic dialogues with multinational corporations and foreign nations.
Governments should improve partnerships between regional tax organizations. Developing countries need to be helped to recognize their national capacity and improve resource mobilization.
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