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Taxpayer’s dilemma: how can ‘fiscal contracts’ work in developing countries?

Author

Listed:
  • Pamela Lenton

    (Department of Economics, University of Sheffield)

  • Mike Masiye

    (Department of Economics, University of Sheffield)

  • Paul Mosley

    (Department of Economics, University of Sheffield)

Abstract
The theoretical literature around effective tax systems, which are a preconditionof an effective state and therefore of development, has coalesced around the idea of a‘fiscal social contract’, in which beneficial expenditures are delivered to taxpayers in returnfor their tax payments, rather than a coercive relationship existing between them and thegovernment. However, these ideas about governance have with few exceptions not beenincorporated into empirical analyses of tax yield and how to increase it. In this paper, weattempt to fill this gap. Our starting-point is the model of the (fundamentally) democratic social contract proposedby Rousseau 250 years ago, which suggests that increased democracy will be good for manystate-building functions including fiscal mobilisation. We develop this idea by means of aprisoner’s dilemma model, which shows that a ‘fiscal contract’ between taxpayers and thegovernment (in the sense of a top left-hand corner, ‘win-win’ solution of the prisoner’sdilemma) will be most likely to emerge not only as a result of greater democraticaccountability, but also if taxpayers feel that they are getting good value from, and are wellinformed about, government expenditures in exchange for their tax payments. This modelis then estimated empirically against a sample of 62 developing countries between 1980-2008 (with the share of human capital expenditures in public expenditure used as anindicator of the value which taxpayers derive from that expenditure), backed by two casestudies of Ghana and Zambia. Our results, both from econometric analysis and the casestudies, suggest that increasing levels of democratic accountability and the quality of publicexpenditure are correlated, and causally connected, with increasing tax/GDP ratios, and thatin countries where competitiveness is blunted by high levels of rent-seeking, the tax ratiowill be less buoyant. Also, the process by which fiscal contracts are constructed isimportant. The government needs to send the taxpayer an effective signal, or bona-fide,illustrating the benefits to be derived from paying their tax bills. Illustrations of effectivebona-fides are provided.

Suggested Citation

  • Pamela Lenton & Mike Masiye & Paul Mosley, 2017. "Taxpayer’s dilemma: how can ‘fiscal contracts’ work in developing countries?," Working Papers 2017004, The University of Sheffield, Department of Economics.
    • Handle: RePEc:shf:wpaper:2017004
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    File URL: http://www.sheffield.ac.uk/economics/research/serps/articles/2017_004
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    References listed on IDEAS

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    Cited by:

    1. Tony Addison & Miguel Niño†Zarazúa & Jukka Pirttilä, 2018. "Fiscal Policy, State Building and Economic Development," Journal of International Development, John Wiley & Sons, Ltd., vol. 30(2), pages 161-172, March.
    2. Paul Mosley & Abdul‐Gafaru Abdulai, 2020. "The political economy of progressive fiscal contracts in Africa and Latin America," Development Policy Review, Overseas Development Institute, vol. 38(4), pages 411-427, July.
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    4. Oluwafadekemi S. Areo & Obindah Gershon & Evans Osabuohien, 2020. "Improved Public Services and Tax Compliance of Small and Medium Scale Enterprises in Nigeria: A Generalised Ordered Logistic Regression," Asian Economic and Financial Review, Asian Economic and Social Society, vol. 10(7), pages 833-860, July.
    5. Tony Addison & Miguel Niño†Zarazúa & Jukka Pirttilä, 2018. "Fiscal Policy, State Building and Economic Development," Journal of International Development, John Wiley & Sons, Ltd., vol. 30(2), pages 161-172, March.

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    More about this item

    Keywords

    fiscal policy; tax ratios; fiscal contracts; bona-fides; democracy;
    All these keywords.

    JEL classification:

    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior
    • D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development

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