draining development.pdf - Khazar University

The Political Economy of Controlling Tax Evasion and Illicit Flows 81faced such a dramatic loss of legitimacy (for example, tax-GDP ratios inEstonia of 39 percent or in Poland of 44 percent in 1997) (Mkrtchyan2001). The World Bank, in 2009, concluded that “fundamental politicaleconomy difficulties such as . . . checks to the power of powerful businessinterests in evading customs and tax payments . . . remain to be seriouslyaddressed” (World Bank 2009c, 4). Armenia, however, highlights theneed for further research on the complex international dynamics ofillicit capital flight and flows because, despite political and economic fragility,it appears, in recent years, to have had sizable unrecorded capitalinflows that may reflect other political economy dynamics in the region(Brada, Kutan, and Vukšic 2009).Natural experiments in tax evasion and illicit flowsCross-country comparisons over time illustrate the political dynamicsbehind state legitimacy and the efficacy of tax systems. In the CentralAmerica of the 1950s, Costa Rica and Guatemala shared similar characteristicsin geographical location, size, colonial history, position in theworld economy, levels of economic development, and reliance on coffeeexports, but showed different patterns of illicit capital flows (Fatehi1994). The Costa Rican political settlement following a brief civil war in1948 successfully consolidated democracy and delivered economicgrowth. Taxpayers recognized that making the state effective required anadequate tax base to fund public services. As a result, the political settlementestablished the political will to tackle tax evasion and minimizeillicit capital outflows. The tax compliance and collection rates in CostaRica are the highest in Central America, and indicate the least evidenceof an inclination to capital flight (Torgler 2003).By contrast, Guatemala has the lowest tax take in Central America andhas a long history of widespread tax evasion and capital flight (Erbe1985). The failure of the political class in Guatemala to develop a widervision for society resulted in civil war in the 1970s and 1980s. Politicalbargaining during the drafting of the Constitution of 1985 resulted inthree articles being inserted deliberately to weaken the tax authority; as aresult, tax evasion in the early 1990s was 58 percent. 27 The peace accord of1996 has yet to generate any sense of national purpose so that, in the laterhalf of the 1990s, for every quetzal taxed, 65 centavos were evaded, leavingthe Guatemalan state without the resources to improve its legitimacy by