draining development.pdf - Khazar University

The Political Economy of Controlling Tax Evasion and Illicit Flows 891991. Through legal exemptions alone, a taxpayer there would haverequired an income 687 times the average per capita income beforebeing liable at the highest marginal tax rate. Given the rampant evasion,the rich in Honduras were, de facto, untaxed. The state consequentlylacked broad legitimacy; development stalled; and political instabilityremained endemic. 43 These dynamics were also evident in Madagascar,for example, where the tax-GDP ratio was only 11.8 percent in the early1990s. This was the outcome of political interest in permitting the taxsystem to be too complex for the country’s administrative capabilities soas to facilitate widespread evasion for the privileged elites of the regime.This had a disastrous impact on economic growth and job creation;trade taxes discriminated across markets, while profits and wage taxesdiscouraged investment and employment (IMF 2007).Elites, in other words, often maintain their power base in highlyunequal societies by deliberately making tax systems overly complex, athuge cost to long-term development, not least because this generatesillicit capital flows. Successful development, however, such as hasoccurred in East Asia, is often accompanied by the political imperative todeliver development in the face of internal and external threats, combinedwith tight capital controls and, thereby, the absence of globalopportunities to hold illicit assets abroad. As globalization over the lastfew decades has created unparalleled opportunity to move capital easilyabroad, the political imperative for leaders and elites to deliver nationaldevelopment appears to have weakened. The democratization of the1990s does not seem to have significantly altered the incentives for corruptionand tax evasion. Indeed, the contemporaneous opportunitiesthat opened up with globalization often allowed the political class toaccept political reforms, knowing that they could protect their assets bylegally, illegally, or illicitly transferring them abroad. This has been manifestedin the use of capital flight in response to populist politics such asin Bolivia and República Bolivariana de Venezuela and of illicit flowsfrom many developing countries in the absence of a political commitmentto sustainable development.If controlling illicit flows is inherently a political problem, tax evasionis particularly important because tax structures are among the mostmeasurable manifestations of the political settlement central to stateeffectiveness. Yet, in many developing countries, particularly the low-