Creating fiscal space

• Author: David Coady
• Position: Division chief of the Expenditure Policy Division in the IMF's Fiscal Affairs Department
• Pages: 24-27

24 FINANCE & DEVELOPMENT | December 2018

ART: ISTOCK / BEASTFROMEAST; ALFEXE

Enhancing domestic tax capacity is essential for strengthening social protection

and developing human capital

David Coady

A

key challenge for developing economies

wishing to streng then their social pro-

tection systems and expand access to

education and health is how to raise

the necessar y revenue in the context of a large

informa l sector.

e informal sector is t ypically cha racterized

by high levels of self-employment, low skill levels,

and often multiple and volatile sources of income.

is limits the potential to r aise revenue by taxing

income— especially f rom lower-income groups—

which requires the ability to verify total indiv id-

ual income. In the context of socia l insurance, it

also means greater reliance on financing t hrough

general government revenue sources than on t he

contributory models emphasized in adva nced econ-

omies (see “Shifting Tides” and “Reima gining

Social Protection,” in this issue of FD).

Recent research also finds that countries move to a

higher growth path once tax revenue reaches about 15

percent of GDP (Gaspar, Jaramillo, and Wingender

2016), in part reflecting higher social spending.

However, about half of low-income countries—and

a third of emerging market economies—have tax ratios

below this 15 percent threshold. Low tax ratios in turn

result in low levels of social spending (see Chart 1).

CREATING

FISCAL SPACE