draining development.pdf - Khazar University

The Political Economy of Controlling Tax Evasion and Illicit Flows 83that Chile, with a rate of 18 percent, collected almost 9 percent of GDPin tax revenue. By another contrast, Mexico, with a rate of 15 percent,collected less than 3 percent of GDP (Tanzi 2000). The mix of politicalwill and administrative capacity was then reflected in overall evasionrates that nearly halved in Chile during the early 1990s, from 30 to 18percent during the euphoria of the return to civilian rule; as the euphoriawore off, evasion had increased again to 25 percent by 1998, but, subsequently,because of rising political concern, matched by administrativeeffort, declined steadily to under 15 percent in 2004 (World Bank 2006).As a result, capital flight and illicit capital flows have been consistentlylower in Chile than in neighboring Argentina (Schneider, B. 2001; DiJohn 2006). Politics and institutions, not geography or economic structure,drive rates of capital flight.Political legitimacy and illicit capital flowsIllicit capital flows arising from tax evasion indicate not only the opportunityfor free-riding, but also taxpayer perceptions. If the state does notappear to be aligned with taxpayer interests, this lack of faith in a regime’scurrent legitimacy and its future legitimacy after improving governanceshapes the decision to hold assets abroad. However, if taxpaying elitesbelieve in a locally owned political vision for the future, and regimesneed their support, evasion may be tolerated by the state, yet not lead toillicit flows. As economic theory suggests, information asymmetries andhigher rates of return in capital-scarce developing countries wouldretain domestic investment rather than encourage capital flow from thedeveloping to the developed world. 31 But, if citizens see no credible longtermfuture political stability, savers and investors will seek to move theircapital abroad to contexts of more effective, more stable governance,even at lower returns on investment and higher tax rates. 32 Where thestate lacks political legitimacy, this capital flight, whether legal or not,would, as suggested above, be widely perceived as licit.Effective tax systems alone are therefore not enough. Bergman (2009,109) concludes that “moderate efficiency in law-abiding societies generatesbetter results than good administration in a world of cheaters.” Forthe state, the political imperative in curtailing free-riding on taxes is that,while core state functions such as preserving peace and upholding justiceare universal expectations, transparent and fair property rights are