Use the Scope Available! On Overlooked Levers in Tax Systems

More than a year ago US President Donald Trump effectively dissolved the national development agency USAID by executive order on his first day in office. Since then, other Western countries have also implemented significant cuts to their development budgets, albeit less drastically than the US. This includes Germany, whose budget for development cooperation (DC) has been shrinking since 2024. The budget of the Federal Ministry for Economic Cooperation and Development (BMZ) does not cover the entirety of DC, but it does reflect the general trend. It stands at just over 10 billion euros for the current year, 2026 – in 2024, it was still 11.1 billion euros.

The global cuts to DC come at a time when many countries are already under pressure. In many places, climate change, the Covid-19 pandemic and Russia’s war against Ukraine have led to a massive rise in public debt while tax revenues have often fallen. For many programmes, particularly in healthcare, food security and refugee support, the current cuts are a disaster.

Nevertheless, there certainly are voices – even outside the right-wing populist camp – that see the cuts as an opportunity. It has long been argued that development cooperation cements global dependencies and stifles self-sufficiency. The so-called ‘crowding-out’ effect – where the mobilisation of a country’s own national resources is displaced by external inflows – has been demonstrated on multiple occasions in academic publications; however, there are also research findings that point in the opposite direction or observe no significant effects. The political message that recipients of development aid should become more self-reliant is receiving considerable attention in many regions of the world. Against this backdrop, increasing domestic revenue has been a desirable goal for most countries not just since last year.

Who actually pays taxes (and who doesn’t)?

It has long been known that tax collection correlates with the general level of prosperity in countries (often measured as per capita income): on average, wealthier countries skim off a larger share of the country’s economic output and redistribute it. At first glance, this is merely a statistical correlation, which obscures significant differences between countries. One decisive factor is who or what is actually taxed. The Organisation for Economic Co-operation and Development (OECD) provides data that allows for a comparative view of the composition of tax revenues in OECD member countries and three global regions (Africa, Latin America & the Caribbean, and Asia-Pacific).

Firstly, the data confirms the statistical correlation mentioned above: OECD countries, mostly high-income nations, generate tax revenues amounting to over a third (34 per cent) of gross domestic product (GDP). In contrast, revenue in Africa, which is home to a particularly large number of low-income countries, stands at less than half this figure (16.1 per cent). Latin America & the Caribbean and Asia-Pacific, which include many middle-income countries, record rates of around 20 per cent.

OECD-Comparison of African Tax Revenue in Percentage of GDP, 2023

However, it is particularly interesting to look at the tax mix. Here there are significant differences – but also an astonishing coincidence regarding the level of corporate taxation. Measured as a share of GDP, this stands at around 3.5 per cent – slightly lower in Africa (3.3 per cent) and slightly higher in the OECD average (3.9 per cent), but essentially at the same level across the different regions and groups. From this, we can conclude that it is not primarily additional corporate tax payments that will lead countries out of their fiscal woes, even though tax avoidance and evasion are widespread and must be combated resolutely. More on this below.

A significant difference exists in the taxation of personal income. For OECD countries, this is one of the most important sources of revenue, generating income amounting to 8.2 per cent of GDP. In Asia-Pacific, by contrast, the figure is only 3.6 per cent, in Africa 2.8 per cent, and in Latin America as low as 2.0 per cent.

What does this mean in concrete terms? Direct taxes on personal income generally have a progressive distributional effect: better-off households are taxed more heavily than poorer ones. In middle- and low-income countries, however, it is often primarily employees in the public sector and in large companies who pay this tax, as it is retained by the employer as payroll tax and paid directly to the tax authorities. In contrast, the income elites contribute little to nothing towards financing public services in their countries. There is a significant equity gap here.

Another significant difference can be observed: whilst property taxation plays a major role in some OECD countries (e.g. the US, Australia, the UK), in many middle- and low-income countries hardly any revenue is generated from this tax. This is particularly relevant on the African continent, where high urbanisation rates mean that the value of property in urban areas is rising rapidly. Local authorities could partially capture this increase in value and use it, for example, to finance public infrastructure projects. However, this continues to be rarely the case.

In many countries of the so-called ‘Global South’, by contrast, the main burden of tax revenue lies with taxes on consumption. In Africa, they account for over half (52.1 per cent) of total tax revenue – compared to just 31.6 per cent in the OECD. Consumption taxes can have a regressive distributional effect, as poorer households spend a higher proportion of their income on consumption than wealthier households. Under fiscal pressure, governments sometimes raise the VAT rate to generate additional tax revenue in the short term. This places a further burden on poorer sections of the population, dampens economic growth and can fuel inflation. For this reason, this approach is rarely suitable for the long-term replacement of development aid funds.

Taxes are part of the fiscal contract

The differences in the tax mix outlined above reflect social and political conditions that are often captured by the concept of the ‘fiscal contract’. This concept is based on the observation that citizens are more likely to comply with their tax obligations if, in return, they receive an acceptable level of public services, feel that the tax system is organised fairly on the whole, and gain the impression that the state is responsive to their demands and needs. Research shows that a tax system based solely on the risk of being caught and sanctioned for tax evasion is less efficient and stable than one with a functioning fiscal contract.

However, the concept of such an implicit contract also highlights a central issue: taxes are always political. A measure that is technically and administratively feasible is not necessarily politically achievable. Many of the actors from whom higher contributions to development financing are expected also belong to groups with the greatest political influence. It is therefore crucial to what extent governments credibly commit to actually improve, for example, public services and infrastructure. Fairness is also important, as reforms are easier to implement when the burden is structured in line with principles of horizontal and vertical equity.

Furthermore, tax systems exhibit a high degree of path dependence. Embedded within a broader context of political structures and public service delivery, radical cuts can often only be achieved at high political cost. And even then, there are many examples where ambitious reforms were first implemented, only to be gradually rolled back or watered down. This is another reason why the sudden cut in development aid poses such major problems for many countries.

Which reforms are sensible (and feasible)?

Sustainable and effective reforms are difficult, but not impossible. As outlined above, many tax systems are in urgent need of reform. This also applies to tax administrations. It is not uncommon for these to be chronically underfunded, lacking in enforcement capacity and vulnerable to corruption. International cooperation on tax matters – crucial for effectively combating tax avoidance and evasion – also suffers as a result.

In some cases, significant increases in revenue can be achieved through better administration alone. This is possible, for example, with property tax. Outdated land registers and the massive undervaluation of property are often a key cause of low revenue. In such cases, there is no need for comprehensive legislative intervention, but rather for targeted measures to modernise administration.

There are many international organisations and initiatives that support tax administrations worldwide in their modernisation efforts. The programme Tax Inspectors Without Borders is worth mentioning in this context. It has been run jointly by the OECD and the United Nations Development Programme (UNDP) since 2015 and has accompanied and supported tax audits in more than 70 countries during this time. The programme helps to ensure that tax authorities and businesses interact on a more “equal footing”. However, it has not yet been subject to a serious evaluation.

African Revenue from Income Tax Depends on Formal Employment (PAYE)

In other cases, tax policy reforms are necessary. This applies, for example, to the taxation of digital services (including financial services), the introduction of environmental taxes, or the taxation of sugar. Sometimes these taxes are less about revenue and more about their steering effect, but overall, they can help to broaden the tax base and thus make tax systems less vulnerable to external shocks.

Finally, it is also necessary to discuss tax expenditures, as these often harbour untapped potential for increasing tax revenue. The term encompasses exemptions, allowances, reduced rates, etc. through which governments support specific groups, activities or sectors of the economy. Tax expenditures are used, for example, to promote investment or combat poverty. However, data shows that they often fail to achieve their objectives. They tend to make tax systems more complicated, regressive and opaque, and can even be harmful if they generate negative external effects.

Furthermore, tax expenditures are costly. According to the Global Tax Expenditures Database (GTED), the published revenue losses resulting from tax expenditures amounted to an average of 4 per cent of GDP worldwide in 2023. As there are hardly any thorough cost-benefit analyses, most governments do not know exactly what their tax expenditures actually cost, let alone what positive or negative effects they have. Against this backdrop, many governments are currently considering reforming or completely abolishing obsolete and expensive tax expenditures. This could free up significant resources.

Thus, there certainly are ways to make tax systems more effective, sustainable and fair. These approaches are, in most cases, well known, and there is no need for external advice to bring them to the attention of finance ministries and tax authorities. What does help, for example, are regional workshops that promote peer exchange between these institutions, such as those the Addis Tax Initiative (ATI) has been organising for some time. Experiences from neighbouring countries can be incredibly useful for a country’s own reform efforts – including their political implementation.

Outlook: is there a future for international cooperation on tax matters?

Tax policy and administration are core government responsibilities, but the sovereignty of states is limited in this field. Against this backdrop, it is to be welcomed that the international community has agreed over the past 15 years to deepen cooperation on tax matters. This includes, for example, the exchange of information between tax authorities or the introduction of a global minimum tax rate of 15 per cent on the profits of large multinational corporations.

Many of these achievements are now being undermined or called into question by unilateral actions taken by major powers. In some areas, however, progress can still be observed today. The Framework Convention on International Cooperation in Tax Matters, which is currently being negotiated under the auspices of the United Nations (UN), is based on an initiative by African states. It is intended to establish rules and standards to curb tax evasion and avoidance and to adapt national tax systems to the challenges of the modern global economy. A fairer international distribution of taxing rights would be important to enable states worldwide to further enhance the effectiveness of their fiscal systems. However, just waiting for this to happen makes no sense. It is better to make use of the room to manoeuvre that is already available today.

Dr. Christian von Haldenwang ist a scientist at the German Institute of Development and Sustainability (IDOS).