24 FINANCE & DEVELOPMENT | December 2018
ART: ISTOCK / BEASTFROMEAST; ALFEXE
Enhancing domestic tax capacity is essential for strengthening social protection
and developing human capital
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 FD).
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).