Paying for Development: Domestic Resource Mobilization
May 5, 2014
Foreign assistance is dwarfed in terms of funding by developing countries’ own financial resources. As many traditional donors continue to deal with the after effects of the global financial crisis, it is clear that a significant increase in aid will not occur any time soon. (It should be noted that the OECD recently reported that foreign aid increased in 2013, but this was largely due to significant increases by several new and emerging donors, such as UAE.) Some believe that donors should continue to operate as if nothing has changed. Yet this ignores that fact that even without reduced aid budgets, official development assistance (ODA) is increasingly a minority shareholder in international development. In the United States, for example, ODA accounts for just 10 percent of financial flows to developing countries; foreign direct investment, remittances, and other private sources such as philanthropy accounts for the balance. These have become common facts, but what is often missed in a resource discussion is the large and growing pool of domestic revenue available in developing countries. Donors should focus their limited resources to supporting domestic resource mobilization (DRM) as part of the pathway to ending foreign assistance.
The growth and scale of domestic resources in the developing world are impressive; for example, total domestic sources of revenue grew in the 54 Sub-Saharan African countries from $100 billion in 2000 to nearly $513 billion in 2011 according to the African Economic Outlook. Contrast that with the growth of ODA during the same period, which went from $20 billion in 2000 to approximately $60 billion in 2011. Even with the rapid growth that occurred during those years and the increased donor attention on Africa, ODA only equals about 13 percent of all domestic resources in Africa. To be sure, some of this growth is attributable to high commodity prices that have enriched resource rich countries in Africa and other developing regions. It is also due to a growing middle class and an increase in businesses registered in the formal sector through reforms trigged by efforts such as the World Bank’s Doing Business Report. Yet there have also been significant improvements in DRM and more broadly public financial management on the continent through efforts such as the Collaborative African Budget Reform Initiative. This has led to a broadening of tax bases and an increase in the tax to GDP ratio in a number of countries.
For domestic resource mobilization, the April 2014 High-Level Meeting (HLM) in Mexico City could prove to be a turning point. DRM is a “pillar” of the new Global Partnership for Effective Development Cooperation, as the communique from Mexico City states, “We recognize the critical challenge of ensuring the adequate mobilization public and private domestic resources to support development…Adequate mobilization of government revenues is required for direct financing and for leveraging private funds for investments in public services and social protection, institutional and human development, basic infrastructure, and strong and inclusive economic growth.” At the HLM, developing countries clearly endorsed the need for a greater focus on DRM and called upon donors to increase the amount of aid directed toward DRM from 1 percent to 2 percent per year. This is important, because it is easy to look at a topic such as DRM and see it as a supply driven proposition driven by donors who want to reduce their foreign aid budgets. What is clear from Mexico City is how this is much more of a demand driven discussion with broad endorsement from finance ministers and other senior government officials from developing countries. They see the benefits that will accrue to their countries not only in terms of increased revenues, but also that it will strengthen their citizens’ faith in their ability to provide basic services. There are, however, clear challenges to sustaining domestic resources in developing countries, including:
- Tax bases are currently limited by the size and persistence of the informal sector with much of a country’s GDP outside. Donors should push for changes in policy to make formality easier via things such as the Doing Business Report;
- Pervasive corruption and lack of transparency in many countries inhibit citizens’ willingness to comply with tax laws and suggests that more attention needs to be paid to anti-corruption efforts;
- Accountability to taxpayers on how money is spent, which requires stronger oversight by parliaments and a strengthened civil society;
- Illicit flows, tax havens, and transfer prices circumscribe the normal taxation process; and
- Low-income countries that are not resource rich are farther behind resource rich countries and DRM may not be an immediate priority.
Donor support for DRM does produce results. The U.S. Agency for International Development (USAID), for example, has had an extensive program of DRM assistance in Georgia. In the case of Georgia, the DRM initiative targeted reform of customs and border practices, which were widely perceived to be the most corrupt. The government began by implementing a tough “zero tolerance” policy towards corruption and revising its tax and customs codes. These policies were accompanied by efforts to boost transparency, reduce administrative discretion in decision-making, provide anti-corruption incentives attached to monitoring and evaluation, and a comprehensive procedure to identify and replace corrupt officials. As a result, the percentage of Georgian business taxpayers who were “expected to give gifts in meetings with tax officials” declined from 39.3 percent in 2005 to 8.4 percent in 2008. The initiative is considered a resounding success, increasing Georgia’s tax revenue by about 12 percent of its GDP over the 9-year period. Similarly, targeting corruption was a major focus of El Salvador’s recent DRM effort. The government of El Salvador focused on creating automated, standardized systems to decrease the amount of individual discretion allowed to tax officials, as well as the formation of a Criminal Investigation Unit and an Anti-Corruption Unit.
In approaching the subject of domestic resource mobilization, donors would be wise to keep four principles in mind. First, large dollar amounts are not required in order to help reform revenue systems. Second, programs around DRM should start with the basics before tackling more difficult reforms. Third, there is an immediate need in most countries to significantly broaden the tax base. Fourth, donors should prioritize DRM in countries that demonstrate the political will to affect the change needed to increase their domestic revenue. Ultimately, DRM is a path for developing countries to fully fund their development and end foreign assistance. Beyond simply allowing a government to pay for vital social services and infrastructure though, it will also help to strengthen people’s faith in its ability to provide accountable and transparent governance.
Daniel F. Runde is director of the Project on Prosperity and Development and holds the William A. Schreyer Chair in Global Analysis at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Conor M. Savoy is a fellow with the CSIS Project on Prosperity and Development.
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