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Chapter eleven: Summary and concluding remarks
A major objective of structural adjustment programs in late developing countries is to reduce the level of effective taxation of agriculture and mobilize resources for growth. The effective taxation of agriculture can be reduced by devaluating the exchange rate, and by policies aimed at decreasing the subsidies, or increasing the taxes on the non-agricultural sectors. At the same time all structural adjustment programs try to diminish the size of the public sector by reducing current government spending.
The first conclusion of this paper is that the total surplus of the economy, defined as the sum of private saving and tax revenues, is conceptually separate from the issue of the division of the surplus between the public and the private sector. It was seen in the body of the paper that to increase the size of the surplus in an agrarian developing economy, agricultural explicit and implicit taxation must be increased. The size of the surplus can be increased by suppressing both domestic real wages as well as by increasing domestic profits, explicit tax receipts and rents.
It was seen that at low initial levels of effective agricultural taxation it almost always pays to depress the terms of trade of agriculture. Under a policy regime whereby external donors accommodate any ensuing external deficits, such a policy will improve worker welfare. This perhaps comes close to illustrating the situation in many late developing countries in the nineteen fifties and sixties.
Under constraints in external finance it was seen that the impact of increased agricultural taxation leads to declines in worker welfare, the volume of exports, and substantial increases in the surplus. However, the magnitude of the relevant multipliers depends on the particular policy regime. Under flexible exchange rates the multipliers of the surplus with respect to agricultural taxation are smaller compared to a situation of fixed exchange rates and import rationing. Similarly the response of the surplus to external shocks is better under import rationing, albeit at the cost of worsened worker welfare. This perhaps illustrates the reasons for which so many governments in developing countries adopted import rationing regimes in the face of external shocks.
From a growth perspective, however, the issue is not one of the size of the surplus, but the division of this between current public consumption and total investment [public and private). If the size of current government spending expands faster than the increase in the total surplus of the economy, then aggregate investment will be crowded out and subsequent growth will be smaller.
Consider now the question of the type of government spending. Conceptually total current public spending can be divided between two parts. The first part can be viewed as that needed in order to maintain an internal agricultural terms of trade at some level below the international level. In other words one needs some bureaucracy to maintain border and other taxes and collect revenues from the export marketing boards. The second part of public current spending is that going for all other purposes. The split can be thought of as between the budget for the taxing authorities and all the rest.
It will usually be the case that increased amounts of taxation will necessitate increased public expenditure on running the taxing bureaucracy. The marginal net revenue from increased rates of taxation, namely the difference between the extra revenue obtained and the extra cost needed to collect the revenue should be positive before higher levels of taxation are contemplated. However, what has happened in many developing countries is that this net marginal revenue has become negative. For instance, some export marketing boards in some countries have run up operational expenses that are above their trading profits arising from paying farmers a price lower than world price. In such a case of course the cost of running the bureaucracy is above the tax revenue that is obtained. Clearly such cases should be targets of reform.
Reform, however, can take several forms. On the one hand the whole process can be privatized and the bureaucracy abolished. This will decrease the rate of taxation on the private sector and will also decrease public spending. However, since tax revenues must be obtained somehow in a modernizing state, it might be more appropriate to restructure the taxing bureaucracies without abolishing them, so as to make them more efficient, and at the same time reduce the level of taxation. It must be realized that high rates of taxation can created strong incentives to bribe and hence corrupt taxing authorities. One way to diminish this is, of course, to lower the overall rate of taxation. However, unless this decrease in taxation is combined with a reduction in inefficiency or size of the bureaucracy the reduction in the rate of taxation might increase the public deficit from this source. In some countries innovative ways have been suggested to improve enforcement. For instance tax personnel in one country were given a share of the tax proceeds with very positive response in terms of total public revenue collected.
Assuming that public spending is viewed conceptually in this mode, one of the objects of reforms is thus seen to be to improve on the "benefit-cost" ratio of taxation. The rate of taxation must also be viewed in this sense in addition to its impact on private savings. However, it is usually the other "part" of public spending which might need real reduction. This other part includes expenditures for basic services such as defense, police, running public infrastructure, etc., as well as other social and economic programs. Cutting of these latter programs is what often gives rise to acrimonious arguments between governments and donors. From the above arguments, however, it can be seen that concentrating on the restructuring and the efficiency of the taxing authorities might be a way to increase public revenues without necessitating cuts in other services considered basic.
Turning now to the issue of the rate of taxation of agriculture it has been taken for granted in almost all structural adjustment programs that it should decline. The issue that was raised in this paper, however, is that the level of effective agricultural taxation should not be viewed independently of the enforcement institutions, as well as leakages through parallel markets. The functioning and welfare implications of such markets has not been adequately studied, but they are crucial in the context of developing economies. For instance it is interesting to ask what is the overall rate of agricultural taxation beyond which the creation of parallel markets and tax evasion makes increased taxation counterproductive. Simply said what is the "hump" of the Laffer curve for agricultural taxation? It was suggested here that the level of taxation at which this hump occurs is smaller in the presence of parallel markets.
Structural adjustment programs by depreciating the exchange rate tend to increase private savings at the expense of public savings. An interesting issue is the response of private savings to the reforms. It is almost an axiom of the reform programs that private savings and hence investment will be more efficient from a growth perspective. However, much private saving in developing countries goes for consumption smoothing and not for productive investment. If this is the case then shifting the overall structure of saving from public to private, through reduction in the agricultural terms of trade, might reduce the overall rate of capital accumulation. This, however, depends on the relative efficiency of public versus private investment. Given risks, economies of scale etc., it is not at all clear that in a developing country context private investment will be more efficient than public one. However, the question is not so much that, but rather the structure of public investment between investment in productive activities and investment in public infrastructure. It is the heavy involvement of governments in the former to the detriment of the latter that has created the serious problems facing countries currently under adjustment programs.
The overall conclusion of this paper is thus that agricultural taxation in developing countries in its various forms, must be looked at from a wider perspective than has been the case thus far. The importance of agriculture as a source of investible surplus should not be neglected, and should be kept separate from the institutional mechanism of surplus extraction. In fact it appears that it is the latter who are mostly under attack and reform. Care, however, should be taken not to use reduction in agricultural taxation as a substitute for direct institutional reform.