Tax Administration in Developing Countries: An Economic Perspective

Author(s): Charles Y. Mansfield

Source: Staff Papers (International Monetary Fund) , Mar., 1988, Vol. 35, No. 1 (Mar.,
1988), pp. 181-197
Published by: Palgrave Macmillan Journals on behalf of the International Monetary
Fund

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 Tax Administration

in Developing Countries
An Economic Perspective

CHARLES Y. MANSFIELD*

A survey of tax administration in developing countries from an economi

perspective is warranted because tax administrators in developing cou
tries in effect make tax policy by deciding how to apply tax legislation. Ta
administration links legal statutes and the "real," implemented tax system
and thus affects fiscal deficits and the tax burdens of different sectors an
income classes. A survey of analytical and empirical work concludes t
administrative constraints can severely weaken the tax revenue structure
with respect to stabilization, efficiency, and equity goals.

U NLIKE SUCH DISCIPLINES as macroeconomics or tax policy, tax ad

ministration lacks a coherent body of literature or set of principles
within which well-defined "schools" espouse particular intellectual po
tions. Instead, tax administration is a loosely defined area that embra
law, public administration, sociology, and psychology as well as eco
nomics. Nevertheless, tax administration is closely linked to fiscal policy
because its ultimate result is to increase or lower government reven
and the overall fiscal deficit; to place higher or lower tax burdens o
particular sectors of the economy; and to favor or penalize particula
income classes and different factors of production. In addition, tax a
ministration may play a powerful role in influencing the efficiency of t
economy by making intended or unintended distortions of consum
choices and producer decisions.

* Mr. Mansfield, Senior Economist in the Fiscal Affairs Department, hold

degrees from Oberlin College and Princeton University.

181

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182 CHARLES Y. MANSFIELD

I. Role of Tax Administration

A useful definition of tax administration for the purpose of economic

analysis begins with the set of statutes forming the basis of the tax
system. In general, this set of laws would include an income tax act; a
customs act covering import tariffs and surcharges; an excise tax act; a
general sales tax law; social security legislation; export, wealth, and
property taxes (if any); and other minor taxes and fees. Such a body of
legislation represents the tax system from the point of view of those who
design tax policy. In contrast to the legal statutes stands the "real" or
effective tax system, or the system as it is applied in practice (Tanzi
(1987b)). Tax administration can be seen as the link between the stat-
utory foundation and the operative tax system. If tax administration
were perfect, tax administrators would play a neutral role in determining
the overall fiscal deficit, the relative tax burden on sectors and income
classes, and the efficiency of the economy. It is well known, however,
that even the best tax administration collects some taxes more effectively
than others. A recent study of tax administration in the United States,
for example, estimates that for wages and salaries the ratio of reported
income to estimated actual income is 97-98 percent, whereas the cor-
responding ratio for income from the self-employed and for returns from
capital (dividends and interest) is far lower (Skinner and Slemrod
(1985)). Failure to administer tax law effectively or even to administer
tax law with equal ineffectiveness, then, has economic consequences as
noted above.

Although differences between law and practice exist in industrial

countries, the set of tax statutes by and large approximates the actual tax
system. For many developing countries, however, the gap between tax
law and actual taxation is so wide that one bears virtually no resemblance
to the other. A reading of statutes relating to personal and company
income tax, capital gains, customs duties, and general sales taxes in a
given developing country might lead the observer to believe that the
country's legislative tax system was close to European or North Ameri-
can models. The actual workings of the system, however, are determined
by administrators who collect a core group of easy-to-administer taxes.
In this way the line of demarcation between "tax policy" and "tax
administration" becomes blurred. Before examining actual tax struc-
tures and administration, however, it will be useful to consider tax policy
and the economic literature to see how economists have treated tax
administration.

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 TAX ADMINISTRATION 183

II. Tax Administration and Economic Analysis

In general, tax administration and tax policy have been trea

separate fields of scholarship and activity. Whereas tax policy u
nomic analysis to debate the merits and economic impact of in
taxes or tax systems, tax administration focuses on the assessm
lection, and audit of a set of tax laws. Tax administration in th
"carries out the orders" of tax policy. Such a clear separation
administration and tax policy carries over to the literature in
fields. Although a comprehensive survey of tax policy literatu
yond the scope of this paper, it would be fair to say that explor
administrative constraints on tax policy, or of interconnections be
policy and administration, has been outside the mainstream of the
ture.1 As far as administration is concerned, theoretical economists
in general been satisfied with the admonition that taxes should not
costly to collect. The mainstream of the tax policy literature c
described as a normative approach, in which the ideal objective
policy are equity, efficiency, and administrative feasibility (G
(1984, p. 76)).
"Administrative feasibility" refers narrowly to the fact that the col-
lection cost of revenue should not be overly high. The requirement that
the tax system should not be excessively costly to administer has intel-
lectual origins to Adam Smith. Apart from this dictum, however, theo-
retical analysis of tax policy has in general not investigated how tax
administration might act as a constraint on tax policy. In retrospect, for
example, one can see that theoretical objectives of equity and redis-
tribution in the decades following World War II had practical expression
in high personal income tax rates, but little attention was given to
whether high tax rates might lead to avoidance and evasion, or to how
such problems might be dealt with in designing taxes. More recent
emphasis on efficiency objectives also appears to ignore administrative
concerns. As one writer has noted, optimal tax theory "is totally devoid
of administrative and political content. Administrators are expected to
possess costless and perfect information..." (Ricketts (1981, p. 42)).
He adds that "it might plausibly be argued that all theory must employ
simplification and abstraction, and that the omission of administrative

'Economists have, however, incorporated tax-administrative constraints in

the context of advice on practical situations; see, for example, Musgrave and
Gillis (1971). A recent treatment of administrative problems is contained in Bird
(1983).

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184 CHARLES Y. MANSFIELD

considerations can in principle be incorporated at a later

argument would be more persuasive if tax administration d
give rise to distributional and ethical issues..." (p. 43).2
Although the normative approach of tax policy analysis ha
ignore the practicalities of tax administration, economists have
analyzed several closely related topics. These topics includ
of tax evasion and a theoretical treatment of tax evasion as an "economic
crime" committed under circumstances of risk and uncertainty. Growing
interest in the underground economy has led naturally to its connection
with tax evasion. In addition, a topical issue that has stimulated theo-
retical discussion is the supply-side contention that tax evasion and
avoidance will decrease if personal income tax rates at the margin are
lowered.

The Risk and Uncertainty Approach to Tax Evasion

The theoretical literature on tax evasion treats the tax evader as a

rational economic agent contemplating an economic crime and making
decisions under uncertainty, given assumed probabilities of detection,
conviction, and levels of punishment. The rational economic agent is
expected to choose the level of compliance (evasion) that will yield the
greatest "expected utility," with expected utility defined as the utility of
the various possible outcomes (for example, detection or nondetection
of evasion) weighted by the probability that each possible outcome will
occur.3 Although the literature is centered on the U.S. tax system, the
methods of analysis could apply to any setting, including developing
countries.
A simple example of a probability and risk aversion approach to tax
evasion has been stated as follows: A U.S. taxpayer has an income (y)
of US$20,000 and is planning to underpay $500 in taxes (see Skinner and
Slemrod (1985)). In recent years about 2 percent of tax returns have
been audited in the United States. Allowing for the fact that the Internal
Revenue Service (IRS) has developed elaborate methods of detecting
evaders, one can say that the probability of audit (p) for the intelligent
evader does not exceed 5 percent. The maximum penalty assessed for
civil fraud and negligence is 50 percent of tax owed,4 so the penalty rate
(F) at most equals 1.5. (The probability of criminal procedure, which

2For a statement of optimal tax theory, see Atkinson and Stiglitz (1980).
3For a recent critical summary of this literature, see United States (1985).
4Note, in what follows, that after 1986 the civil fraud penalty was raised from
50 percent to 75 percent of taxes owed and modified. The change does not affect
the substance of the argument.

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 TAX ADMINISTRATION 185

requires proof of intent, is almost zero and can be eliminated b

tions available to the potential evader.) This situation can be
by

EU = (1 -p)U(y + x) + pU(y - Fx),

where

EU = expected utility of tax evasion

U = utility function
p = probability of being audited
y = taxpayer's legal after-tax income
x = undeclared taxes
F = the penalty rate on undeclared taxes plus 1.

In other words, the potential act of tax evasion is viewed as a gamble with
a 95 percent chance of winning $500 (the underpayment of taxes) and a
5 percent chance of losing $750 (that is, getting caught and paying the tax
owed plus a penalty). On average, over a period of years the bet will
return $437, and it is difficult to imagine a taxpayer who would not take
such a gamble.
Although this illustrative example is by no means a complete summary
of the contribution of the expected utility approach, it does show its
fundamental weaknesses in the assumptions that no allowance is made
for institutional mechanisms, such as withholding, that would interfere
with the decision of whether to evade or pay tax; and that, given such a
virtually free choice, the individual has no moral, ethical, habitual, or
peer constraints on cheating. The example also points out that the ap-
proach is static. In a dynamic context, the probability of detection may
be changing and uncertain; the potential tax evader may then become
more cautious. Indeed, the positive contribution of the risk and uncer-
tainty approach is that it leads one to wonder why people pay taxes at all.
This bare-bones approach, in which all institutional and social con-
straints on tax evasion are assumed away, shows that without these
constraints tax administrators would face a herculean task.
Theoretical analysis has also treated seemingly obvious propositions
about tax evasion, obtaining surprisingly ambiguous results (see Richu-
pan (1987)). For example, the question of whether an increase in the tax
rate would increase tax evasion would be answered in the affirmative by
tax practitioners for most situations. Yet, if a high penalty rate for
evasion is imposed on the evaded tax and the individual is risk averse,
then a higher tax rate would imply higher evaded tax and higher possible
penalties, leading such an individual to pay tax due at the higher rate.
With respect to the opposite proposition-that lower tax rates would

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186 CHARLES Y. MANSFIELD

encourage compliance-a recent article examines the popular

a lowering of the tax rate (in the U.S. context) would encou
ance, and states that "... lowering tax rates will induce gre
ance is a claim supported neither by the theory of tax complia
the empirical evidence" (Graetz and Wilde (1985, p. 359)).
"the large share of underreporting attributable to capital
[before 1986] provides a counterexample to the notion that
alone will cure noncompliance" (Graetz and Wilde (198
Thus, the seemingly obvious idea that higher tax rates stimula
and vice versa, is difficult to prove on a priori grounds.

Topical Issues of Tax Evasion

In contrast to the purely theoretical risk and uncertainty ap

tax evasion, investigation of the underground economy has led
ical efforts to measure the effect of the level of taxation on tax evasion.
Whereas the U.S. literature on the underground economy has focused
on the personal income tax, the European literature has also discussed
social security and forms of the value-added tax (VAT). In developing
countries, the underground economy surely flourishes and would affect
foreign trade taxes as well as those mentioned above. In an empirical
approach to this problem, Tanzi (1982, pp. 78-80) notes that one of the
factors influencing tax evasion is the benefit of not paying taxes. This
benefit can be measured objectively by the level of legal tax liability.
Using a regression equation in which the ratio of currency holdings to
broad money (M2) is the dependent variable (and a proxy for tax eva-
sion), Tanzi found that variables representing the level of tax rates are
highly significant in explaining changes in the ratio of currency to broad
money. Increases in several measures of the tax rate are associated with
a greater relative use of currency, presumably because of the evasion
effect.
As noted above, supply-side economics has also contributed to dis-
cussion of tax evasion. A proposition advanced by supply-side econo-
mists is that a progressive tax rate schedule stimulates tax evasion and
will yield less revenue than a proportional schedule. Using the frame-
work of the rational economic agent (divorced from institutional and
social context), this proposition is true provided that the taxpayer is risk
neutral.5 If the taxpayer is assumed to have a decreasing absolute risk
5An additional assumption is that the elasticities of the supply of labor
are such that the actions of higher-income taxpayers who will gain from the
change more than offset those of lower-income taxpayers who will lose from
the change.

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 TAX ADMINISTRATION 187

aversion, then the claim has no theoretical support, since the

would be less willing to cheat at higher tax levels. One economic
into the question of tax evasion under a progressive rate schedule i
the substitution effect and the income effect tend to work in
directions. As actual income received increases under a system
gressive taxation, the relative benefit of evasion versus tax p
rises, so that the substitution effect leads to an increase in ev
contrast, a rise in reported income that represents an increase
income means that the individual is richer, and with diminishi
ginal utility of income has less reason to evade taxes. Wherea
retical analysis does not wholly confirm the widespread view t
tax rates or a progressive tax schedule cause evasion, the effec
penalty rate on tax evasion is much clearer. According to theo
the probability of detection and the penalty rate are clearly ef
deterrents to tax evasion, and the penalty rate is relatively more e
than the probability of detection.6

Critique of the Theoretical Approach

to Tax Administration

This brief review of the results of theoretical models of tax evasion

shows that such work does not yet capture enough real-world conditions
to be of great use to policymakers. A key assumption underlying the
analysis is that taxpayers have a free choice to pay or to evade taxes, or
at least that all taxpayers are equally constrained in this decision. Differ-
ent taxpayers actually have different opportunities to evade, and the
level of evasion can be much more easily explained by examining what
these practical opportunities are. Clearly one important determinant of
the level of evasion is whether withholding can effectively be applied in
collecting a tax. If the withholding system is virtually foolproof, any
analysis of the individual's preferences becomes academic. Even if there
is collusion between wage earner and employer in withholding, some
amount of taxes will probably have to be paid. In addition, the model of
a rational agent deciding whether or not to pay taxes has implicitly
assumed the context of the personal income tax. In developing countries,
indirect taxes such as excises, import duties, and general sales taxes form
a much greater proportion of tax revenue. Administrative experience
has shown that under a sales tax the seller may collect the tax but only
turn over a portion to the government by underreporting sales. Formal

6 See Richupan (1987). For a full exposition of the application of supply-side

taxation ideas to developing countries, see Gandhi (1987).

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188 CHARLES Y. MANSFIELD

analysis of evasion under different types of taxes in differen

has not been undertaken, although further work in this
certainly possible. Probably the clearest conclusion of th
studies is the obvious point that, given a free choice, the leve
would be much higher than it is at present.
The lesson of the theoretical analysis, then, is that tax adm
should remove the element of free choice by such devices
holding. An effective withholding scheme, however, requires
small number of easily identifiable payers of the income.
may thus be applied to wages, dividends, and interest, but
applied effectively to rental income, income of professio
come from small businesses, of which there are as many
ceivers. Another conclusion from formal analysis of tax e
evasion can be reduced significantly by increased penalties
probability of audit. This conclusion agrees with practical obs
both developing countries and the United States. For exam
has stated that it can raise $7 in new revenue for every do
enforcing compliance, and technical assistance missions
countries would agree that increasing the likelihood of a
forcing penalties more stringently would be cost effective (s
Journal, May 8, 1986).
Equity and political considerations, however, place limits on
penalties can be. The difficulty of proving the intent to
criminal cases scarce. Equity considerations suggest that w
vidual is "caught" by random selection in an economic cri
many others are guilty, he should not be punished too s
addition, the firmly held belief that "the punishment s
crime" sets practical limits on the penalties that would tr
evaders. For example, life imprisonment for tax evasion m
economically rational individual but would be inconsiste
monly held ideas of justice. In addition, one feels that the
enforcement does indeed play a strong part in determin
penalties work. For example, legislation exists in som
whereby failure to pay property taxes results in auction of t
If such a penalty is viewed as draconian and is unlikely to be
political and social reasons, the stiff penalty loses its effe
siderations all limit penalties to a level below what would
from a tax-maximizing standard. Increasing the probabilit
appropriating funds to allow tax administrators to audit mor
also constrained by political considerations. Politicians may n
efficient a tax administration.

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 TAX ADMINISTRATION 189

Another way of reducing free choice to evade is through self-enfor

methods that will encourage taxpayers to report incomes and e
ditures. Kaldor (1956), in his well-known report on India, was pe
the first economist to suggest linking taxes to force greater complia
Kaldor suggested that five taxes-the income tax, the capital gain
the wealth tax, the personal expenditure tax, and the gift tax-be
in a single comprehensive return and assessed simultaneously. The
are self-checking-that is, concealment or understatement of item
reduce liability for a particular tax would increase liability for
taxes-and information furnished by a taxpayer to prevent
assessment of his own liabilities automatically reveals the receipt
gains made by other taxpayers. Higgins (1959, pp. 524-44) carried
dor's idea further by introducing a self-enforcing tax system for de
ing countries. Higgins' system included a personal income tax (inc
capital gains), a corporation income tax, a general sales or turnove
a wealth tax, a tax on excess inventory, and a personal expenditur
Theoretically, the Kaldor-Higgins system is self-checking becaus
sonal expenditure is defined as the excess of income over savings
savings are equal to the increase in net wealth. Thus, taxpayers
underreport their expenditure by overstating their savings increase
wealth tax liability. A seller of a property who understates his c
gains hurts the buyer, because the buyer cannot claim the full amoun
the investment, thereby forcing him to declare higher expenditures
increasing his liability under the expenditure tax. The tax on e
inventory is designed to discourage underreporting of sales, thus hel
to enforce the sales tax and income tax.

The more grandiose self-enforcing schemes suggested by economists

have in general received short shrift from tax administrators. "Most tax
administrators," Goode (1981, p. 266) writes, "regard the idea of a
self-enforcing tax system as fantastical." Despite the justified criticism of
elaborate self-enforcing schemes, tax administrators may come to see a
grain of truth in their logic, and one suspects these schemes should not
be dismissed entirely. In many developing as well as industrial countries,
import duties and taxes on domestic transactions are typically adminis-
tered by separate departments, with little or no contact or exchange of
information among them. In some countries sales and income taxes are
also administered by separate departments, and outside experts usually
recommend the exchange of information between these revenue de-
partments. Such an exchange is highly advisable because gross sales are

7See also Hart's (1967) analysis of the Latin American context.

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190 CHARLES Y. MANSFIELD

an element of income tax determination, and the exchang

tion forces consistency in tax reporting. Similarly, the id
mation furnished by one taxpayer to prevent overassessment
own liabilities will automatically reveal the receipts of ano
underlies the concept of the VAT. As computer syste
creasingly great quantities of data to be stored and used
self-enforcing taxes based on matching information fro
sources becomes more possible. Computer information s
then make more practical this "fantastical" idea of the ec
As summarized above, economic analysis related to tax ad
has centered on such topics as examining tax evasion under c
risk and uncertainty, tax evasion and the underground e
supply-side attention to tax evasion associated with high
rates. Surprisingly little attention has been given to a m
approach in which tax administration would be seen as part o
tion function in producing revenue. That is, the producti
could be seen as a function of tax bases and legal rates an
but also would depend on the input of tax administratio
(1975, p. 505) has stated, "to maximize tax revenue the ad
must so distribute the fixed amount of resources in enforcin
taxes and, for each tax, must so allocate resources among
administration that the return on the marginal dollar of adm
expense is everywhere the same."
One difficulty with this approach is how to define maximi
revenue. A short-term, cost-benefit approach would lead t
istrator to concentrate on the largest or richest taxpayers
assessment and audit efforts would yield a high return in th
Tax administrators have objected to this approach on seve
First, if substantial numbers of humbler or harder-to-ca
perceive themselves as outside the enforcement net, these ta
eventually begin to evade tax, and voluntary compliance
suffer. Second, if tax administration efforts focus too
certain economic activities, the principle of horizontal eq
equal treatment of taxpayers of equal income) will be vi
taxpayers may begin to perceive the entire system as unfair.
perception will undermine voluntary compliance. A long
proach to revenue maximization would recognize these e
Such a long-term approach would involve audit and enforcem
directed toward a broad range of the tax-paying public, with
paid to long-term effects on voluntary compliance as well as
goals of revenue maximization.

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 TAX ADMINISTRATION 191

III. Tax Handles, Tax Administration,

and Tax Structure

In contrast to the normative bent of the literature on tax policy and the
game-theoretic analysis of tax evasion stands a body of tax literature that
is based on empirical and historical thinking. This literature deals with
the questions of why a country develops a particular tax structure (a set
of taxes responsible for total tax revenue) and why this tax structure
differs among countries and changes during the process of economic
growth.8 (Note that "tax structure" refers here to the revenue im-
portance of different taxes, rather than to the legislative content of tax
laws.) This strand of tax literature not only recognizes the importance of
administrative constraints on tax policy, but in contrast to the normative
literature places administrative factors at the forefront.9 The "tax
handle" theory offers a sweeping historical explanation of tax structure
change. It argues that low-income economies are forced to collect reve-
nue from easy-to-administer taxes (or tax handles), but that this admin-
istrative constraint lessens as countries develop and become able to
choose "better" taxes as defined by the normative objectives discussed
above.10 Although economists differ on the recipe for a "better" tax
structure, there would be general agreement that broadly based income
or consumption taxes are preferable to a reliance on foreign trade taxes,
and historical evidence suggests such a shift. In any case, high-income
economies have a certain freedom to maneuver in choosing tax systems,
whereas low-income economies are in large part constrained by
administrative considerations.
The insight that administrative constraints in part determine the tax
structure of developing countries appears accurate if one examines the
actual tax structure of developing countries among themselves and in
contrast to industrial countries. For developing countries, a detailed
examination of tax structure has been undertaken by Tanzi (1987a,

8This literature includes Hinrichs (1966); Lotz and Morss (1967); Chelliah
(1971); Bahl (1971); Chelliah, Baas, and Kelly (1975); Tait, Gratz, and Eichen-
green (1979); and Tanzi (1981).
9A complete explanation of differences in effective tax structures would cer-
tainly acknowledge that differences in the structure of production and income
distribution play a role in determining tax structure. For example, that large
numbers of the population in many developing countries live in poverty explains
why a mass income tax would not be feasible.
10 The tax handle theory has also been used to explain different tax levels as
well as tax structures among different countries (see the references cited in
footnote 8).

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192 CHARLES Y. MANSFIELD

1987b), who used a pool of 82 countries divided by strata of

income. The group of countries with the lowest per capita incom
sents countries in which the tax structure is most determin
ministrative considerations-that is, the availability of acces
handles. For these countries, import duties-based on a very c
tax handle-account for 32 percent of total tax revenue. The
income tax-a much more difficult tax to collect-accounts fo
percent of tax revenue. In contrast, for the most wealthy de
countries (those with per capita income above US$1,550) the
import duties drops to only 18 percent of tax revenue, eve
the share of imports in gross domestic product (GDP) has not
For the same group of higher-income countries the share of
sonal income tax rises to 13 percent, indicating a greater us
difficult-to-collect tax.
When Tanzi compared developing countries as a whole with selected
industrial countries, the importance of administrative constraints in de-
termining the tax structure was again demonstrated. Foreign trade taxes
are the most important source of revenue in low-income developing
countries and remain important for middle- and upper-income develop-
ing countries. In contrast, such taxes are scarcely used for revenue pur-
poses in the major industrial countries. Another important difference in
tax structure between developing and industrial countries is that the
latter rely to a much greater extent on a single, broadly based income or
consumption tax. Revenue from taxes on general consumption, such as
the VAT, amounted in 1984 to 9 percent of GDP in France, 5.6 percent
in the United Kingdom, and 6.3 percent in the Federal Republic of
Germany, compared with an average of 1.6 percent in developing coun-
tries. For the same year, personal income tax amounted to over 10
percent of GDP in the United States, the United Kingdom, and
Germany-compared with 1.9 percent of GDP in the average develop-
ing country.
In accordance with the tax handle theory, then, the effective tax
structure of developing countries (as opposed to the legislative tax sys-
tem) is characterized by reliance on a half dozen narrow tax bases,
reflecting administrative convenience. "Administrative convenience"
takes on a number of meanings in this context. For import duties, the
centralization of taxable goods in a port leads to ease of administration.
Export duties also apply to goods concentrated in a port and may be
applied to a central marketing board or to a few large exporters in lieu
of collecting personal income tax from a multitude of small farmers. For
excises, production of goods is concentrated in a few factories. The
problem of valuation is simplified by this concentration or can be circum-

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 TAX ADMINISTRATION 193

vented entirely by using specific duties or administered reference

For the personal income tax, withholding of taxes on wages paid by
enterprises and government is the meaning of administrative
ience. Other taxes, such as the corporate income tax, may be in
more difficult to administer because the base of net profits requir
sophisticated accounting measures such as depreciation. In the
administrative convenience may take the form of simply accepting
only perfunctory audit that presents no serious challenge, a
able" amount of taxation as defined by the firm. If firms are u
to contribute a reasonable sum, governments may then adopt
rules of thumb, such as using a percentage of gross sales to rep
concept of net profit.

IV. A Critical View of Tax Structure

in Developing Countries

Although the tax statutes in developing countries resemble those of

industrial countries, a handful of easy-to-administer taxes account for
virtually all revenue. If one compares the actual tax structure of develop-
ing countries with ideal norms of a desirable tax structure, it would be
difficult to find greater contrast. The prototypical tax structure of de-
veloping countries can be criticized on stabilization, efficiency, and
equity grounds.
For stabilization, a tax system should comprise one or at most several
predominant taxes with a rate schedule that can be adjusted quickly and
with a high degree of certainty to alter the purchasing power available to
the private sector. These predominant taxes can then be used to increase
or cut back private spending to achieve stabilization goals related to
growth, prices, or the balance of payments. Because the tax systems of
developing countries are cluttered and tax bases are narrow, adjustment
of revenue for stabilization purposes must come about by piecemeal
measures-in general the raising of rates on indirect taxes such as import
surcharges, excises, or sales tax because these taxes are considered to
increase revenue with greater certainty and speed. From a dynamic point
of view, the continued reliance on these tax bases for revenue needs
tends to be self-defeating: higher rates on the narrow bases further
distort the allocation of resources and lead to evasion or to consumer
resistance. In sum, the lack of a predominant, broadly based tax and the
clutter of rates and exemptions on existing taxes make it difficult to use
the tax system for stabilization purposes.

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194 CHARLES Y. MANSFIELD

For efficiency, a good tax system is considered to be one that

the least amount of distortion of relative prices, both in the pri
the consumer and in those facing the producer. Although on
sum poll tax would satisfy the criterion of noninterference in a
prices, broadly based income or sales taxes with one or a few
considered desirable in that they lead to less distortion in con
producer prices. Against this view some theorists would argu
ation of products with low elasticity of demand would bring
interference with consumer choices. In any case, in developing c
many different import and excise tax rates on narrow bases are
with a variety of exemptions to produce almost random effec
sumer choice and producer incentives. Efficiency goals are als
mised by selective administration of the personal and corpor
taxes. Because the personal income tax is in practice mainly
wages, companies using more labor-intensive productive meth
a disadvantage. Large companies are forced to pay tax, whe
companies and retailers can avoid taxes.
The heavy reliance on foreign trade taxes can be singled o
most undesirable aspect of tax systems in developing countries f
point of view of both stabilization and resource allocation (G
(1981)). From the standpoint of stabilization, foreign trade taxes
tie government revenue to unpredictable fluctuations o
commodity prices, and so to aggravate fiscal stabilization pr
vicious circle can also begin if a reduction in imports impose
mand management purposes leads to a fall in import duties
enlarging the fiscal deficit. From the standpoint of resource
(efficiency), trade taxes have no place in a "first-best" tax struct
discriminatory nature of trade taxes ensures that their use impo
a production distortion cost and a consumption distortion cos
duties, often relied upon for revenue, may lead to excessive
protection and may encourage inefficient domestic industry.
Equity goals are also heavily compromised by the tax stru
developing countries. To an outsider this tax structure may appe
highly progressive because the rate structure of the personal inc
is often highly progressive. On closer examination, however, the
equity of the system is compromised by the fact that the person
tax collects a relatively small share of total revenue and appli
to wage earners, whose incomes may be lower than those of
employed. High nominal rates on luxury consumer imports su
tor vehicles may equally be offset by exemptions and evasion. Ex
such staples as cigarettes and beer are clearly regressive when
the context of the monetized sector. Thus an apparent vertical eq

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 TAX ADMINISTRATION 195

rate structure of personal income tax and import duties is negat

combination of selective administration and legal exemptions. W
gard to horizontal equity-the principle that those with equal
pay equal taxes-the tax structure of the typical developing cou
perhaps more clearly inequitable. For the income tax, selective a
tration on wages favors the self-employed, partnerships, and
from capital. Taxes on consumption also violate horizontal equ
cause of their uneven and almost random application.
On a broader basis, one can say that selective administration
statutory tax system in developing countries systematically discrim
against the modern sector of the economy. The modern sector
fall into the income tax net because it keeps better accounts,
centralized, and thus is more revenue-productive in the eyes of
collector. Although a heavier burden of taxation on the modern
may be appealing on equity grounds, one should bear in mind
the present tax system tends to impede the growth of the dynami
that may be the key to more rapid long-term growth in deve
economies.
In view of the above criticisms, the tax administrator is left with a
dilemma. Strict adherence to a cost-benefit, revenue-maximizing strat-
egy would worsen efficiency distortions in the present tax structure and
would eventually undermine voluntary compliance. But political pres-
sure for immediate revenue to reduce large fiscal deficits may be strong.
In such circumstances, the tax administrator should strive to balance
immediate revenue objectives with the need to support changes designed
to produce a "better" tax structure in terms of the efficiency, equity, and
stabilization goals mentioned above. These latter efforts would seek to
reduce dependence on convenient tax handles and to tackle the more
difficult problem of implementing more broadly based income and con-
sumption taxes.

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