BUSINESS WORLD Taxation And Development in Sierra Leone Posted by on Jun 18, 2009, 13:07

From time past, government leaders around the world have always attempted to collect taxes from their citizens in the form of income taxes or other taxes as part of a broader effort to finance rapidly growing expenditures. Income taxation proved to be an incredibly lucrative source of revenue for many governments, while having the desirable property of being “equitable,” as it could be collected with progressive rate structures.

In their attempts to collect this tax, however, governments discovered that they are faced with high monitoring costs and required relatively high levels of cooperation and “quasi-voluntary” from the citizenry. Unlike other forms of tax revenue, such as consumption tax and social contributions, which tend to be paid more indirectly and/or with some promise of specific benefit, income tax payments tend to be highly visible and unrequited. Because the very demand for taxation provides incentives for citizens to free ride on the tax payments on others.

Initially, citizens have tended to resist the enactment of such policies. And while states have generally threatened coercion against those refusing to pay, coercion can be both expensive and ineffective in the wake of extensive avoidance and evasion schemes. Thus, state leaders attempting to collect income taxes have been highly dependent on the willingness of employees and other income-earners to pay such taxes. Since the years, following independence for most African countries, levels of cooperation with state demands for income tax payment have varied widely.

In some countries, citizens have essentially ignored the state’s income tax policies, and virtually no tax has been collected at all. In others, some income tax revenue has been collected, but with significant challenge from those liable during the policy-making and/or compliance stages. And in other countries, the tax has been collected effectively and efficiently, with few significant challenges from within society.

In turn, such variation has influenced the size of the state treasury, the functioning of markets, and the after-tax distribution of income within society. Such patterns of income tax policy and administration also reflect more generally on the relationship between the state and upper class groups within society and the degree to which such relations can be described as either adversarial or cooperative.

The Role of Taxation

Over the years, taxation has been an underrated tool in the effort to build more capable and responsive states in Sierra Leone. We have depended largely on donor funds and foreign aids for our development agenda. However, with the formation of local councils, coupled with the negative impact of the current financial crisis, the focus is now being directed to domestic sources of revenue-tax being an important part of the base.

Although, we are quite aware that no underdeveloped country has the resources or the money to fund all its development programmes from domestic revenue, yet it is now being realized that domestic sources should contribute the lion share of the development budget of our country.

It is now sufficiently recognized that the revenue service is the 'point of entry'; if we concentrate on this, we would secure the means for the rest of our development needs. The role of taxation as a central force in the development of democracy resonates strongly our history. The duty of paying for government legitimizes demands for services and accountability.

Democracies are built not only on periodic elections but also on a social contract, based on bargaining over the collection and spending of public revenue. Without the ability to raise revenue effectively, governments are limited in the extent to which they can provide security, meet basic needs, and foster economic development. Yet the political importance of taxation extends beyond the raising of revenue.

Taxation can stimulate calls for more representative governments, while the need to increase revenues can stimulate institutional capacity building. Both have the potential to bolster the legitimacy of the government and enhance democracy. Foreign aid can be a substitute for absent revenue, allowing critical development functions to be performed. But funding state expenditures primarily through resources that are raised without much effort (foreign aid or revenues derived from oil and other natural resources) does little to stimulate the development of state capacity.

In developed countries, taxes not only helped create the state, they also help make it democratic. The origins of representative governments are intimately bound up with the evolution of taxation. The bargain between taxpayers and governments encouraged a rule of law that protects private property rights. Backed by taxation, rulers are able to sell bonds in private capital markets.

Economic Influences

Analysts from a range of theoretical perspectives have argued that the processes of industrialization and economic development have strongly influenced the development of taxation systems around the world. Empirically, it is easy to verify that wealthier and more developed economies tend to generate not just more tax revenue in an absolute sense, but even relative to the size of their economies.

The central state’s collection of direct taxes on income and property also tend to increase with levels of economic development. From a more dynamic, historical perspective, the development of the income tax (and other domestic taxes) in developing countries was associated with the process of economic development, but again, most evidence suggests that patterns of economic development across the developing countries were very similar.

Most scholars date the onset of industrialization around 1870 for some countries along with financial windfalls from primary commodities sold on international markets, such as coffee, cocoa, gold, diamonds, etc. Secondary “infant” industries were established with the protection of high tariffs, particularly beginning in the 1950s and 1960s. These patterns of development in many developing countries help to explain rapidly increasing needs for public goods. They also gave rise to potentially large and increasingly concentrated income tax bases, lowering the transaction costs of collection for revenue authorities.

State Corruption

Another alternative account of variations in revenue collections and structures and of citizen compliance more generally, focuses on the trustworthiness and credibility of the state executive and the revenue collection agency such as the National Revenue Authority in Sierra Leone. Specifically, one could hypothesize that the problems of corruption and the failure to gain the trust of upper- and lower-income citizens have been more acute in developing countries than developed ones, and that this variation explains important differences in the amount of direct income tax revenues collected.

Although perceptions of corruption, credibility, and trustworthiness influence taxation outcomes, we gain more analytic leverage if we consider these factors as part of the puzzle that need to be explained, rather than as exogenous determinants of tax compliance and levels of collection.

First, corruption on the part of tax collectors in particular, the deliberate under-valuation of the tax liabilities of a firm or individual of imported goods in return for a bribe is simply one aspect of the outcome that should be investigated. One would assume that most tax collectors are vulnerable to graft, but it is only when citizens actively attempt to evade their tax liabilities that tax collectors engage in such behavior as a regular practice.

Secondly, tax fraud, whether carried out in partnership with the state’s agents or without it, is a phenomenon that is conceptually so proximate to the outcome of measured levels of collection that is hardly useful to say that the former “explains” the latter. Rather, we can restate the more general puzzle, which is, why is there more tax corruption and less income tax collection in this country? Why is it that NRA is persistently failing to meet its revenue targets set for the quarter and hence for the year?

If what we read in the newspapers concerning NRA activities is anything to go by, then one would say that tax fraud is a very serious issue undermining the existence of the country. At a deeper level, to assess the arguments that “credible commitments” made by government leaders, we need to explore the hypothesis that citizens are less likely to meet their tax obligations quasi-voluntarily if they believe that the national treasury is being pilfered for private or narrow gains.

In many societies, the citizens who challenge the state’s demands for tax payment in the policy arena or through aggressive avoidance and evasion strategies typically justify their resistance to taxation with the claim that they are not getting a “fair deal,” and that the money is being wasted, either on bad policies, poor implementation, or through outright stealing by individuals in government. At the extreme, when state executives and their agents demonstrate a wanton disregard for public interests, and when virtually no government services are provided, it would be reasonable to predict that citizens will resist tax payments.

Ironically, transparent democratic institutions, such as a free press, may lead the average citizen to resist higher levels of corruption simply because such information is made available to the public. Certainly, in the case of Sierra Leone in the 1960s and 70s, the government has demonstrated through substantial expenditure projects that the treasury has not been used exclusively for the personal gains of government leaders, although much more could have been done with the tax revenue raise in those years.