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From tax collection to redistribution policies, there are many fiscal challenges facing developing countries. Associate Professor Monica Singhal focuses much of her writing and research on these challenges. Her current research agenda focuses on state capacity in developing countries – understanding the constraints these countries face when attempting to raise revenue and what types of policies may be effective (or not) in improving state fiscal capacity.
Q: What are the themes that connect your various research interests and projects?
Singhal: A lot of my current research projects and research agenda focus on the problem of building state capacity in developing countries, and in particular thinking about the challenges that developing countries may face in trying to raise revenue to finance public goods – to finance transfer programs, social insurance programs – and so trying to understand what are some of the specific constraints that are really relevant in low-income countries and what are the potential policy responses? What can these governments do to try to improve their ability to raise fiscal capacity?
So, for example, in a lot of developed countries there’s been a big focus on one of the major ways in which governments are able to raise revenue which is through third-party reporting. So, basically, the tax authority taking advantage of the fact that it has information about a taxpayer’s true financial position from other sources. So, for example, why do I not evade on my W-2 income from the Kennedy School? Well, I know that the Kennedy School is reporting that income to the IRS, and so if I report something different, that’s going to trigger an audit, for sure.
Q: A recent of paper of yours examined tax enforcement policy in Ecuador, specifically.
Singhal: Yes, our recent project in Ecuador raised the question of whether you can you translate these concepts about third party reporting to developing countries, or are there additional constraints that we might worry about? And so we looked at a program in Ecuador where they actually tried to do this with firms, saying, okay, we have this information about revenues from these other sources and your reported revenues are lower than what we’ve calculated from third party sources, please file an amended tax return.
And what we see are two things: First, a number of firms don’t respond to these notifications, which is something that we don’t often think about in a context like the U.S. We would sort of assume, look, if you get a notice from the IRS, you’re going to respond to that because you know that they’re going to follow-up if you don’t. In a lot of low capacity countries, taxpayers may just take the risk that they know that tax authorities are under-staffed; they know that legal institutions are weak; they know that it might be difficult for the tax authority to follow-up, so they simply don’t bother to respond.
Among the taxpayers that do respond, what we see is that they shift a lot of their misreporting to margins that are harder to observe. So, we see taxpayers adjusting their reported revenues to match the tax authority estimates, but also adjusting their reported costs to almost fully offset that increase in reported revenues. And so that illustrates that some of these challenges that exist in developing countries are important to consider when we translate the types of policy instruments that we use in developed countries directly to a developing country context.
Q: A journal article that you co-wrote last year focused on the issue of “tax morale.” Tell us a little bit about that study.
Singhal: An apparent puzzle in the tax enforcement literature is the observation that tax compliance appears “too high” given that audit rates and punishments are generally quite low. The literature in response to this apparent puzzle has gone in two directions that are not mutually exclusive. One focuses on the fact that governments may have sources of information other than audits, such as the type of third party reporting discussed above. Another strand of literature has focused on the idea of voluntary compliance, which is actually something that tax authority officials tend to emphasize. Various rationales for voluntary compliance are sometimes lumped together under the umbrella term “tax morale,” which we can think of as non-financial incentives for compliance.
The paper that you alluded to was a review paper looking at what do we know about “tax morale." Does it even exist? How would we try to measure it? And if it does exist, does that mean that policymakers might have a greater range of policy tools to try to leverage tax morale to improve compliance? The first part of that question is actually harder to answer than you might think. One type of evidence tries to look at whether we see taxpayers complying more than we think they should if they were only taking financial incentives into account. However, actually trying to capture that excess compliance is really challenging. You really have to understand all the sources of information that the tax authority has available to it. It does appear that even when you look in sectors where there doesn’t seem to be a lot of third party information, that you observe higher compliance than you might expect if everything were purely driven by financial incentives. That was the first part of the project: trying to establish the existence of tax morale as a motivation for compliance.
The second part of the project looked at a variety of studies that have been conducted in collaboration with tax authorities that have tried to leverage these social factors. For example – sending notifications to taxpayers saying things like “look at the public goods that your taxes pay, this is an important civic duty.” Some notifications in different countries have given information about how much peers are complying, for example, “90 percent of your peers pay their taxes on time.” What we see is that a lot of these tend not to work. So, these appeals where we say “taxpaying is a civic duty” – even though when asked in surveys, people say, yes, this is an important civic duty – when you actually have these notifications, the evidence on their effectiveness has been somewhat mixed.
Q: Tell us about some of your ongoing and planned research projects.
Singhal: I am currently working on two projects that follow-up on both of these two arms of thinking about tax compliance in developing countries. The first is a very large scale randomized evaluation on firm tax compliance in Bangladesh where we tested many of these types of social interventions. The idea behind this project was that the tax authority may not know that much about what firms’ true revenues are. Even if it knows, it may have a hard time proving it, whereas, a firm’s neighbors may have good information about its true revenues. So, one of the interventions told firms that their compliance – whether they were registered, how much tax they paid – would be made public, in broad categories, to neighboring firms in a subsequent notification. Our preliminary evidence suggests that in high compliance areas, this did have an effect on firm behavior. Firms cared about not wanting to appear like they were tax delinquent to their neighboring firms, but we’re just getting data back from the field now to examine that in more detail and try to understand the mechanisms through which those pure effects might be affecting behavior. So, that’s very much in the “tax morale” vein – can you leverage these social forces to improve compliance?
The other project, which we’re just getting started on now, picks up on thinking more about types of constraints that might exist in low-income countries that we don’t think about as much in the context of the U.S. This project was very much motivated by conversations with tax authority officials who talked about political pressures they feel they are under. In particular, that if taxpayers are politically connected, this makes it very difficult to actually raise revenue from them even if the tax inspectors know that they’re evading.
For example, one tax authority official said, “we know that these taxpayers are evading, but there’s a pro-business party that is in power now; it’s very difficult for us to collect revenues.” And I asked the follow-up question, what would happen if you tried to do that? And he said he would be removed from his position. This is a project that’s going to actually try to examine taxpayer political connections empirically, making use of variations in elections – who’s in power, who’s not in power – and trying to link that to actual tax enforcement and compliance decisions. This sort of political economy and political dimension seems to be really important to tax officials in developing countries and a major constraint on compliance.
Q. That brings up the issue of corruption. There’s the challenge of compliance on the one side, but we often hear about the problem of corruption, too, or political influence.
Singhal: Yes, but the literature, when thinking about corruption, has generally focused on the relationship between the tax inspector and the taxpayer. For example: rather than pay my taxes, I could pay a bribe to the tax inspector and then they’ll take the bribe and they won’t enforce taxes. That’s one dimension of corruption that people have been very aware of and focused on. But this is a slightly different dimension, which is, even if you have tax inspectors that are trying to do their job, that might not even be enough if they are facing this kind of external pressure and corruption that’s happening in a different place, where taxpayers are able to leverage political connections to evade the law. That’s a different type of corruption than just the problem of the taxpayer and the tax inspector.
"What are some of the specific constraints that are really relevant in low-income countries and what are the potential policy responses? What can these governments do to try to improve their ability to raise fiscal capacity?" —Monica Singhal