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In the last couple of decades, the opening and integration of markets—what we loosely call “globalization”—has helped hundreds of millions of people in developing countries enter the middle class, bringing material security and optimism for their children’s futures. At the same time, middle classes in developed economies feel under threat and pessimistic about their families’ opportunities. CGD aims to understand this divergence in attitudes and suggest solutions.
Developing countries have made considerable progress in raising taxes in recent years. Between 2002-2014, average tax ratios rose by 2.8 percent of GDP in sub-Saharan Africa, and by 3.6 percent in the Western Hemisphere and emerging and developing Asia (see Figure 1). The IMF has long argued that there is potential for generating additional tax revenues in these regions, and since the Addis Ababa 2016 Financing for Development Conference, the World Bank, UN, OECD, and bilateral donors have joined the IMF in support of increased “DRM,” that is, domestic resource mobilization, by developing country governments.
A large proportion of revenue gains over the last two decades has come from countries’ efforts to improve the design and compliance of consumption and other indirect taxes, particularly the VAT (value-added tax); in doing so, the objective has been to minimize VAT’s regressive effects by exempting sales of small businesses below a threshold (where the poor typically tend to buy) as well as imposing zero tax on certain food and other products which take up a large proportion of consumption of poor households.
Less attention has gone to expanding the coverage of potentially more progressive taxes, such as personal income and property taxes. The challenge of these more equity-friendly taxes is that they have far more demanding requirements on government administration, data and systems than indirect taxes, and therefore are likely to yield less revenue in the short run. In advanced economies, the personal income tax generates somewhat more than the VAT on average; in developing countries the VAT generates more than twice the income tax.
We believe it is now time for countries to begin in earnest investing in the systems that support these more equity-friendly taxes.
Property taxes have been mostly neglected
Property taxes consist mostly of annual taxes on immovable property (houses, commercial buildings) and the sale of that property. The OECD countries on average generate around 2 percent of GDP in property taxes (or 5.5 percent of total taxes). The average tax-take is lower in emerging markets, at 0.6 percent of GDP (but still 3.4 percent of total taxes—reflecting their relatively lower overall tax/GDP ratios). It is even lower for low-income developing countries at 0.3 percent of GDP (or 1.8 percent of total taxes) (See Figure 2). Over 120 countries have property taxes in place with different tax bases and rates.
It’s not surprising that property taxes have been neglected. In most countries, property taxes are collected by local governments—although higher level governments may play a role in their design and operation—where administrative capacity to record ownership titles and collect revenue is not well developed. Good information on property ownership and on the base for valuing property is hard to obtain in developing countries’ thin markets for property transactions. In low-income countries, agricultural activities take up a relatively large share of land area and income derived from agriculture is relatively low. In many developing and emerging countries, urban middle-class property owners naturally resist paying property taxes; that may lie behind governments’ often providing extensive tax exemptions to different classes of property owners (for example, Kenya, South Africa, and Tanzania exempt different classes of land and give the minister and local authorities a wide latitude in granting exemptions). In Kampala, Uganda, the exercise to revise property valuations started last year and will continue until 2019—the last property valuation was carried out in 2005.
Against this background, conventional wisdom has been for developing countries to focus on revenue sources with substantially larger potential—at least until administrative capacity, particularly of local governments improved.
Six reasons to revisit property taxes
We urge a revisit of property tax potential, for at least six reasons (and for IMF endorsement, see page 12 of this book).
First and perhaps most important: Property taxes are inherently progressive—as Marx observed, it is the rich that own property, and as is the case everywhere, the rich own more and more valuable property. Where income is concentrated at the top of the distribution, property taxes will reduce post-tax income inequality. Income distribution in many developing countries has worsened since the 1980s, though less so than in the US and UK, among other advanced economies. In fact, in all countries wealth inequality is twice as high as income inequality.
The sense of fairness matters—including for ensuring tax compliance. There is global consensus that developing countries must raise more revenues domestically to finance priority spending on Sustainable Development Goals, as set forth in the Addis Financing for Development agenda. But tax compliance is a challenge everywhere; the middle classes will accept a rising tax burden, including on their own modest properties, only if they see that the visibly wealthy are contributing a fair share.
Second, property taxes can reduce corruption when adequately enforced—adding to the sense of fairness in many developing countries in which the majority of citizens believe their government is corrupt. With rapid urbanization in Asia and Africa in the next several decades, governments will be investing in more roads, mass transit, power and sanitation projects, and public housing. That will raise land values. In the past it is wealthy land developers and political insiders that have too often reaped the resulting enormous rents; a system that imposes property taxes will discourage rent seeking and related inefficient land use as well.
Third, property taxes are less distortive; they do not have the bad incentive effects of taxes on labor, and they do not reduce investment. The supply of urban land is fixed and its taxation does not negatively affect urban investment. Rather it creates incentives for land owners to use their land more productively.
Fourth, more urbanized cities attract more educated and productive middle-class workers who capture a share of unpriced benefits of urban life, including the rising value of their urban property. From the perspective of fairness, these workers (or their landlords) should pay property taxes (and be subject to progressive income taxation as well).
Fifth, property taxes have the advantage of creating accountability to the local citizenry—a political benefit in terms of good governance.
And finally, the advent of new technologies means that it is possible to do things now that we could not do as well before. Technological innovation can help overcome the capacity constraints that developing countries currently face in levying property taxes. Property registers can now be digitized, and use of satellite data and computer-aided mass valuation systems can make valuation of property and updates of values cheaper and quicker. Many Indian municipalities are complementing property surveys with satellite imaging to value property with significant increases in revenues. The computer systems are now being used to appraise property values in Slovenia and Tanzania.
A bottom line
Of course, we have to be realistic. More equity-friendly taxes face even greater political and technical obstacles to effective implementation as the more tried-and-true VAT (and excise taxes and the corporate income tax). The process of implementing property taxation will have to be gradual, the rates will have to be reasonable—not 10 to 30 percent as in Egypt and Kenya which has resulted in poor compliance—and exemptions from the tax will have to be minimal.
But the time for action is now. The IMF, World Bank, and bilateral donors have committed to scaling up their support for building tax capacity of developing countries as part of the Addis agenda. We urge them to ramp up support for strengthening the systems and infrastructure critical to collecting equity-friendly property (and potentially progressive personal income) taxes. Though in some countries it will take many years, the returns (in revenue, a sense of fairness, reduced corruption, greater compliance, and better local governance) can be substantial—contributing directly and indirectly to measurable progress on the SDGs by 2030.
Mohamed Bouazizi is the man whose protest sparked the Arab Spring in December 2010. Bouazizi, shown in the second slide here, was a typical “struggler,” as in the title of my keynote speech at the Australasian Aid conference several weeks ago: “Strugglers: This Century’s New Development Challenge.” Below is a rough summary of my talk. (I have modified the slide titles slightly to better convey the gist of my remarks.)
Bouazizi was a street vendor in his early 30s in a small town in Tunisia who triggered uprisings in the Arab world by immolating himself. He was not poor—in fact, he gave to the poor in his town. He supported a younger sister, hoping she would finish secondary school and attend university. But the police regularly harassed him, whether for a bribe or for the permit he allegedly needed to sell produce from his vegetable cart in the open market. The day he took his own life, the police had destroyed his cart and seized his electronic scale and the produce he had bought the day before on credit, depriving him of the assets on which his livelihood and that of his family depended. His protest was apparently a reaction to an acute sense of injustice in a system in which the institutions of the state brought predation rather than protection for people struggling day to day to earn a living.
Who are strugglers exactly? In crude income terms, a struggler is a member of a group (see this 2013 paper) wedged between the world’s poor (living on $1.90 a day or less, the World Bank international poverty line) and the secure middle class (at least $10 a day in household income per capita, PPP). The probability that a struggler will fall back into poverty is high (slide 4).
Like Bouazizi, strugglers have fallen between the cracks in development—they are a forgotten majority, the new poor of the twenty-first century. They comprise about 60 percent of people living in developing countries today and are likely to still comprise about 60 percent in 2030. They are heavily concentrated in middle-income countries, including upper- and lower-middle-income countries, using World Bank country classifications (slide 8).
Most strugglers have primary education or more, and most are probably informal workers in peri-urban and urban areas, working without the regular paystubs that provide a sense of security to workers in the formal sector. Except in Latin America, they benefit little from public pension and health insurance programs; in many developing countries, they are net payers to tax systems, unlike the traditional poor, who are more likely to receive cash transfers.
As a group, strugglers have benefited more from growth since 1990 than any other income group (the elephant graph, slide 16). Perhaps as a result, they probably have high expectations for a better future for themselves and their children. Like Bouazizi, who hoped to see his sister enter university, many have middle-class aspirations—if not for themselves, for their children. They are strivers as well as strugglers. But they live anxious, stressful lives, in which a health crisis for a family member, or a sudden increase in bus fares, or the loss of their minimal “capital” to thievery or a local weather disaster, can mean a choice between the monthly rent or adequate protein in their children’s diet.
What are the implications for students of development? One has to do with good governance and accountable states. Strugglers, unlike members of the secure middle class, have little capacity to pay taxes and hold accountable their own governments. But the middle class is still small in most countries of the developing world—between 5 and less than 50 percent almost everywhere. Most developing countries are “struggler” states.
Another implication relates to jobs, productivity, and adequate livelihoods. What can governments do to support increased productivity (and thus earnings) of the billions of struggling people, including children, who are informal workers—short of providing them with credit, training, and police protection in their homes and on the street? Would increased provision of tax-funded social insurance help? For development advocates and thinkers, this challenge is immediate and pressing—compared to the slower-evolving prospect of job-stealing robots and artificial intelligence in the rich world.
For other policies to ponder through a struggler lens, including the role of outsiders, see slides 28 and 29. And please weigh in with comments, concerns, and ideas.
Sources are shown on slides. Many thanks to Kyle Navis for help with the presentation.
Recently, the World Bank published its latest Global Economic Prospects report (GEP), which highlights a welcomed cyclical recovery for all major regions of the world following recent slow growth. I was pleased to participate in a panel discussion at CGD analyzing the report’s findings, and to share my perspectives both on its implications and on future global outlooks—especially for emerging market and developing economies (EMDEs).
Although short-term growth prospects have improved for EMDEs, with an expected average of 4.5 percent for 2018 and 4.7 percent for 2019 and 2020, the report stresses that this is no time for complacency. Despite improving economic activity, potential long-term growth is predicted to extend its decade-long falling trend in these economies. Undoubtedly, this impedes the likelihood of any foreseeable convergence of per capita income with those of advanced economies. So then, what should policymakers in EMDEs do? The answer is straightforward: they should implement proper reforms to improve potential growth. As the GEP report emphasizes, the right policies should aim to boost human and physical capital and improve productivity through reforms in infrastructure, education, health systems, labor markets, governance, and business climate.
The question then becomes, how likely is it that these necessary reforms—to improve productivity and convergence prospects—will materialize? The answer depends on two factors: the capacity and the willingness of policymakers to pursue proper reforms.
Many reforms inevitably require large financing capacities. This is often the case, for instance, with infrastructure investments. Yet, one does not need to look further than the IMF’s latest World Economic Outlook to recognize the vastly limited fiscal space amongst EMDEs, especially commodity exporters. Consequently, policymakers from many EMDEs are taking advantage of the currently favorable conditions in international capital markets, which continue to offer attractively low interest rates. This outcome is supported by little risk differentiation among EMDEs’ debt by investors, as reflected by very low spreads (the difference in yield between EMDE bonds and US Treasury bonds of a similar maturity). This points to an underpricing of risks.
The Latin American Committee on Macroeconomic and Financial Issues (CLAAF), over which I preside, explored this underpriced risk phenomenon in our most recent statement. We noted the resounding success that EMDE nations—even those with low credit ratings—have had in issuing international bonds. This was the case both with Côte d’Ivoire, which successfully sold bonds internationally during a military riot, and with Iraq, which issued a bond with demand that far exceeded what was offered, to name a few. This growing debt accumulation is alarming as there are many external risk factors (as noted in the GEP report) that can increase both the costs of servicing this debt and the likelihood of defaults. Therefore, for the rise in debt levels to be justified, they must be accompanied by a willingness on the part of EMDEs’ policymakers to pursue reforms that will lead to future growth—a necessity to amortize these liabilities and avoid potential crises.
Although there are numerous reforms where funding is not the binding constraint—labor market reform being a point in case—all reforms are bound by policymakers’ willingness to pursue them. This is the part of the story that meets the reality of the current political economy in many EMDEs.
In many EMDEs, there is growing resentment towards democracy. Recent data from Afrobarometer depicts a slowdown in the demand for democracy in Africa since 2008, with 24 of the 36 countries surveyed experiencing negative or neutral changes. Similarly, surveys by the Latin American Public Opinion Project at Vanderbilt University show that support for democracy in Latin America has dwindled from 66.4 percent in 2014 to 57.8 percent in 2016/17. This trend is supported by a frustrated new middle class in EMDEs, who experienced a significant increase in their standards of living until recent years. According to a poll by Latinobarómetro, 37 percent of people in Latin America self-identified as belonging to the middle class in 2011, and this value rose to 42 percent in 2017. Surely this middle class feels more entitled as they have seen solid gains in their consumption and societal status, which they wish to continue experiencing and will not be willing to give up. A similar picture can be painted for the middle class in many other EMDEs.
As noted by Daniel Zovatto, in Latin America, this middle class discontent is materializing as we approach a marathon of important presidential elections. This heavy election cycle appears to be a common occurrence amongst EMDEs. For example, there are 12 Latin American presidential elections in the next two years and 14 African elections (general or parliamentary) in 2018 alone. This creates a good moment to propel populist political candidates to power who promise to secure the improved lifestyles of the middle class, which they strongly fear losing. If this were to materialize, the easily accessible external funding available to policymakers would likely be used to meet the demands of this vulnerable middle class through short-term benefits—not long-term productivity investments.
A great risk facing EMDEs is that although external funding conditions are favorable, the current domestic political economy suppresses the incentives for proper reform. The outcome then could be a major debt problem. Let’s hope that citizens of EMDEs choose the right leadership to put in place the proper reforms to increase the much-needed potential growth.
Globalization is under attack in the West. The debate among pundits is no longer about whether globalization is to blame or not. It is about why globalization is now the bugaboo it has become. A common thread are changes, for the worse, in the economic and social standing of the Western middle class.
The two economic developments that have garnered the most attention in recent years are the concentration of massive wealth in the richest one percent of the world’s population and the tremendous, growth-driven decline in extreme poverty in the developing world, especially in China. But just as important has been the emergence of large middle classes in developing countries around the planet. This phenomenon—the result of more than two decades of nearly continuous fast-paced global economic growth—has been good not only for economies but also for governance. After all, history suggests that a large and secure middle class is a solid foundation on which to build and sustain an effective, democratic state. Middle classes not only have the wherewithal to finance vital services such as roads and public education through taxes; they also demand regulations, the fair enforcement of contracts, and the rule of law more generally—public goods that create a level social and economic playing field on which all can prosper.
PovcalNet, the World Bank’s global poverty database, provides all kinds of country statistics, including mean income, the share (and number) of the population living in absolute poverty ($1.90), the poverty gap and several measures of income inequality, such as the Gini coefficient. But one thing it doesn’t provide is median income or consumption. The median is a better measure of “typical” well-being than the mean, which is always skewed to the right.
We’ve been waiting for the World Bank to add these medians to its PovcalNet database, but we got impatient and did it ourselves. By manually running a few hundred queries in PovcalNet, we now have (and can share with you) the latest median income/consumption data for 144 countries (using 2011 PPPs — more on our methods below).
By making this data public, we hope to encourage more development professionals to use the median in evaluating individuals’ material well-being in developing (and developed) countries and progress toward broad-based economic growth and shared prosperity. We also hope that wider use of the median will provide an incentive for the World Bank to publish the data in an easily accessible format along with the full distribution, in line with its open data policy.
Why the median?
Average or mean-based measures of income, such as GDP per capita, will always be higher than the median — the value at the midpoint — of that distribution, which is inevitably skewed to the right. So medians convey far better the material well-being of the typical individual in a country and have other advantages including simplicity and durability. The simplicity helps explain why the stagnation of the median wage is so often cited in the US press in the context of middle-class decline as the benefits of growth go to the top. Real median household income has been about $53,000 a year or $48 a day per person for a family of three. That puts median income per person in the US at only just about one-third of average income measured as GNI per capita.
A better example for the development community: the median reflects how much the person at the 50th percentile of the income distribution earns (or spends), giving us a better picture of the well-being of a “typical” individual in a given country. Take Nigeria and Tanzania: in 2010, Nigeria’s GDP per capita (at PPP) was $5,123; Tanzania’s stood at only $2,111. This suggests that Nigerians were more than twice as well off as Tanzanians. Yet, if we compare consumption medians, a different picture emerges: a Nigerian at the middle of the income distribution lived on $1.80 a day, while his or her Tanzanian counterpart had 20 cents more to spend, at $2 a day.
That difference is illustrated in the graph below, with countries plotted left to right according to their GDP and vertically according to their median income or consumption. The highlighted pairs, such as Nigeria and Tanzania, have very different GDPs per capita while sharing similar levels of typical well-being as measured by median income or consumption.
Using PovcalNet to extract the medians: data and very brief methodology
Despite the illustrative power of the median, the development literature still relies largely on GDP (per capita) or sometimes on the marginally more representative GNI (per capita). For the last five years, the data needed to calculate country medians has been available via the World Bank’s PovcalNet database. PovcalNet provides information about poverty and inequality across the globe based on over 800 representative household surveys and 1.2 million households in over 140 economies. It is a treasure trove for scholars, students, and development professionals, but it fails to live up to its full potential in its current format. In one query, one can view average monthly income, the share of the population below a user-determined poverty line, the poverty gap, the Gini index, and other, more obscure measures of poverty and inequality (see the screenshot on Brazil’s data below). But there is no easy way for users to check the median income or consumption for a country or to access a country’s full income distribution. There is also no way to download query results in an easily editable format like a csv or xls file.
A year and a half ago, our colleagues Justin Sandefur and Sarah Dykstra ran 23 million queries through PovcalNet over the course of nine weeks and made the resulting global poverty and income distribution data (using 2005 PPPs) available to the public. We didn’t attempt to repeat their herculean efforts, but we did create a dataset of median income/consumption for all countries available using the recently updated 2011 PPPs. Our median data was obtained in its entirety from the World Bank’s PovcalNet database. We use the latest survey year available and list whether the median is based on consumption or income data. We also note — as PovcalNet does — whether the data is grouped (C or I) or whether it represents unit-record data (c or i). For China, India, and Indonesia values for rural and urban areas are listed separately. The data were collected by manually entering a guesstimate for the given country’s median as the “poverty line,” and revising the guesstimate until the associated headcount was 50 percent. Deviations of up to 1.5 percent in the headcount associated with the median are possible.