The OECD recently published a paper on taxation and economic development that claimed that the propensity of poor countries to tax less than rich ones is a contributor to their poverty. Thus, by raising taxes to Western levels, they could develop their economies. This view is not surprising from an organization of international bureaucrats, but it is the reverse of the truth. I thus thought it worth setting out the correct picture.
The OECD begins with the statistic that whereas the burden of tax on developed nations is about 33% of GDP, that on underdeveloped nations is only about half that level. It concludes from this that a key to poor countries developing their economies is higher tax collection, which “enables governments to invest in growth, relieve poverty and deliver public services to underpin long-term growth.”
The OECD’s analysis is grounded on an underlying fallacy: poor countries collect less of their national income in tax because a large proportion of their citizens are living at subsistence levels, and hence have no spare revenues to tax. This is why historic rates of tax collection were low; monarchs like Louis XIV and Aurangzeb had a more or less infinite desire for their people’s resources, but no possibility of getting them, even if their tax collection systems had been relatively efficient and uncorrupt.
In the Napoleonic Wars, for example, which lasted over 20 years and required maximum military effort, British public spending never exceeded 34% of GDP, and then only for one year, while tax levels barely reached 20% of GDP. Even at that level the French economist Jean-Baptiste Say was convinced that British taxes were so high that the country would be hopelessly uncompetitive once peace came. Lord Liverpool’s government were able to stabilize British finances after Waterloo by a massive effort of government economy, but life got very much easier for British statesmen by the mid-Victorian era, when public spending including debt payments had shrunk once again to around 10% of GDP.
That’s why the first welfare states, in Germany and Britain, only got going after 1880, once industrialization had raised incomes far enough that the surplus available to be taxed was considerably larger than at the beginning of the century. The large 20th Century state was initially a product of the two World Wars, but it was sustainable only because Western countries had by that stage raised the incomes of the mass of their populations far above subsistence levels. The West’s rise to riches generally happened before the expansion of the state; for example Calvin Coolidge’s United States still had public spending well under 10% of GDP.
Look at today’s emerging markets, and for countries with similar income ranges to each other, government size correlates almost completely inversely with growth rates. Latin American countries tend to have larger governments than Asian countries – and lower growth rates. Apart from Venezuela, the only Latin American country with a European size of government, 40% of GDP, is Brazil, and it has clearly suffered very badly in the last three decades from its government’s excessive size.
In East Asia, the extraordinary economic rise of Japan, South Korea and much of South East Asia has been based on government sectors that represented less than 25% of GDP. Only in recent years, as growth in those countries has slowed with their increasing wealth, has government’s share of GDP crept up towards Western levels.
In Africa, poverty is deep and governments are generally small, but the causation runs the opposite way from the OECD’s happy bureaucratic assumption: the thugs that run the dictatorships and the kleptocrats who run the democracies of Africa would all dearly love to grow government, but they are unable to extract any more tax revenues from their impoverished people, most of whom are still close to the subsistence line or indeed below it.
This explains why the tax take percentage of GDP is lower in poor countries. In general that statistic says nothing about the wishes and capabilities of poor country governments; the tax effort that they would need to extract 40% of GDP from an African country would be equivalent to that needed to extract perhaps 70-75% of GDP from a Western country. Presumably even the statist bureaucrats at the OECD must admit wistfully that any such attempt would be hugely damaging to the nation’s welfare, both economic and social.
By suggesting that poor countries should double their tax take, the OECD is implicitly assuming that poor country governments are better able to spend that money than poor country citizens. In theory and in practice, this is a travesty of sound economics. By definition, resources are deployed to the maximum of satisfaction if the people deploying the resources are the people gaining benefit from them. That principle is violated when an impersonal government inserts itself in the middle.
In practice, the idea of redeploying resources to Third World governments is much worse than the theory postulates. Most (but not all) such governments are thoroughly corrupt, if they are democratic at all. Hence increasing their tax revenue merely gives them more resources to embezzle.
The OECD cannot seriously suggest, for example, that higher taxes in the Democratic Republic of Congo would have a positive effect. That extremely poor country has for 50 years been run by two of the greediest and most corrupt kleptocrats in history. Joseph Kabila (2001-19) has been a distinct improvement over Mobuto Sese Seko (1965-97) but when you have said that, you have exhausted the case for allowing him to seize more of his people’s resources. The Democratic Republic of Congo has immense mineral wealth, so its government has more opportunities to extract taxes than other comparably poor countries. However, history has shown no benefit whatever, in terms of economic development or the DRC people’s welfare, from its doing so.
This is a core problem with international institutions: their officials interact almost solely with governments, other international bureaucrats and left-leaning academics, so their prescriptions quickly become a mish-mash of re-warmed socialism. There is no input from either the market or a political process that would tend to correct their errors. (The successes of the Brexit referendum and Donald Trump show that the political process, in countries with sensible electoral systems, is not completely ineffectual, even if it is nowhere near as good as the market in weeding out leftist error.) A world government is thus not a dream but a nightmare; there would be no effective way of removing it, no effective elections for it, and so it would quickly become a monstrous monopoly, governed entirely by political correctness and lunatic economic experimentation.
Donald Trump’s nominee for the World Bank presidency, David Malpass, may attempt to correct this in that institution; in a Financial Times op-ed this week he said: “Nations that foster innovation and freer markets, and that have lower taxes, fewer regulatory burdens, and stable currencies, tend to alleviate poverty faster than others.” Malpass seems to have got the recipe for growth more or less right; however his prescriptions will be anathema, not only to the OECD, as demonstrated by their tax paper, but also to his future colleagues at the World Bank.
The world outside the U.S. and Europe has grown restive under the cozy stitch-up deal that gives the Presidency of the IMF to a European and that of the World Bank to an American. An appointment recommended by President Trump would doubtless have been an excuse for further restiveness in any case (though bear in mind that the emerging markets do not hate Trump in the same way as the EU does). Malpass’s clear, well-thought-out views on economic development, based on a lifetime of experience in international finance in both the public and private sectors, will set the bureaucrats of the international institutions’ dials onto “Maximum Resistance” as well. It will be interesting to see whether his appointment survives this ordeal.
Should the Malpass appointment go down in flames, all men of goodwill should start a massive campaign to get rid of the international institutions, including the United Nations and its agencies. With the partial exception of the World Trade Organization, they never did serve any real purpose that could not be better be served by the private sector and national governments. As the OECD has shown with this paper, they are now thoroughly damaging and structurally incapable of reform. The world in general and developing countries in particular will be far better off without them.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)