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Public finance and development: top reads in the new year

Written by Tom Hart

See all blogs in our public finance and development series.

Welcome to 2023. The economic and fiscal forecasts are as sunny as the British weather in January. According to the World Bank’s Global Economic Prospects, last June’s ‘downside’ scenario is now January’s baseline scenario of 1.7% global growth in 2023 – the weakest in three decades outside the global financial crisis of 2009 and the Covid-19 pandemic – as the risks of faster monetary tightening in the US, the energy crisis in Europe and Covid-related disruptions in China have all come to pass. The Bank does not expect per capita income in around a third of emerging market and developing economies to surpass 2019 levels until at least 2024, with the slowest growth found in regions where poverty is highest.

Nevertheless, there is one ray of sunshine: although the IMF predicts a slowing economy this year and says risks are tilted to the downside, it has slightly upgraded its forecasts from October to 2.9% and predicts that growth in emerging market and developing economies will be marginally higher this year than in 2022.

This month, we round up the latest on public debt and look back at (or forward to?) fiscal policy under low interest rates. We take stock of some recent publications on tax, while on the expenditure side, we consider the latest research on education, health and fiscal transfers.

The latest on debt

US Treasury Secretary Janet Yellen and IMF Managing Director Kristalina Georgieva both visited the Zambian capital of Lusaka last week amid growing concerns over delays in restructuring the country’s debt. Reuters reports that the sticking point is China’s insistence that local currency debt owned by foreign investors and the debt to multilateral development banks (MDBs) are included in the restructuring – both of which the US and Zambia have rejected, the latter because MDBs have preferred creditor status.

Ghana also defaulted on its debt in December after interest payments reached over 70% of government revenues. Unlike Zambia, it is proposing to restructure its domestic debt and has agreed a debt exchange with domestic financial institutions as well as a $3 billion programme with the IMF. It will also seek external debt restructuring through the G20 Common Framework (the fourth country to do so after Chad, Ethiopia and Zambia, with only Chad so far having reached a deal). Complicating matters is the fact that one bond is partly World Bank-guaranteed, meaning its inclusion in any debt restructuring may not be possible. Pakistan is next on the watchlist, with forex reserves down to three weeks’ worth of imports as the IMF visits.

Adam Tooze characteristically takes a step back from the immediate details of the debt crisis to pose some larger questions about the future of development financing in Africa. Ken Opalo also takes the long view, looking at how we got here, why he doesn’t foresee a return to a 1980s-style ‘lost decade’, and why markets have better disciplined the PFM practices of African states.

Published in December, the World Bank’s International Debt Report provides external debt statistics for 121 low- and middle-income countries that report to the World Bank Debt Reporting System. It highlights well-known trends in the countries’ external debt stock, namely a large increase in debt owed to private creditors (61% of external debt stock) and China’s rise as the largest bilateral lender. The report finds that for IDA-eligible countries, debt service as a proportion of export revenues is above 10% – the highest since 2000, shortly after the Heavily Indebted Poor Countries (HIPC) initiative was established. It also outlines the continuing need for transparency, with previously unreported loan commitments identified during the last five years adding more than 17% to the total debt stock in 2021. For a more in-depth analysis of specific countries that considers domestic as well as external debt, look no further than this recent ODI report on the debt profiles of seven African countries (Côte d‘Ivoire, Ethiopia, Ghana, Morocco, Senegal, Togo and Tunisia) and the key risks they face.

Could a modern-day Brady bond plan help solve the debt crisis?

How do low interest rates affect fiscal policy?

The background to all borrowing is more than a decade of extremely low interest rates. According to former IMF Chief Economist Olivier Blanchard in his open-access book Fiscal Policy under Low Interest Rates, this means smaller costs and larger benefits of deficits and debt – and so a more active role for fiscal policy. Given the recent rise in interest rates to combat inflation, this may be a case of the owl of Minerva flying at dusk. But at an OECD Committee of Senior Budget Officials speaker series event last week, Blanchard advanced several reasons as to why a return to a low interest rate environment is on the horizon once inflation is under control.

But do the views outlined in Blanchard’s book apply to emerging markets as well as the high-income countries he focuses on? Blanchard, together with Arvind Subramanian, former Chief Economic Advisor to the Government of India, concludes that broadly, the answer is no. Emerging market economies have had higher inflation and interest rates over the last decade and have not experienced the ‘zero lower bound’ on monetary policy, meaning there is less of a need for looser fiscal policy. The scope for it is also narrower due to more volatile growth and interest rates, and because smaller government (as a percentage of GDP) makes fiscal adjustment in the face of higher rates or lower growth more difficult. An equivalent adjustment in terms of GDP requires a much larger percentage change in taxes or spending. In short, ‘one should be careful about importing wholesale the new fiscal consensus into emerging markets.’

Making tax more equitable

If more borrowing isn’t the answer, countries will need to meet their fiscal needs by generating more revenue. Last year, the Independent Commission for the Reform of International Corporate Taxation (ICRICT) launched its ‘Emergency tax plan to confront the inflation crisis’, advocating emergency measures including taxing corporate super-profits, especially windfall profits driven by the pandemic and the war in Ukraine. It also recommends that instead of waiting for the OECD-led tax reforms, individual countries should consider their own alternative measures as a way of forcing change towards a genuinely fair international tax architecture. Relatedly, with initial steps taken towards a UN convention on tax – a longstanding demand of tax justice campaigners and African states who want responsibility for agreeing global taxation rules moved from the OECD to the UN – did last year mark the beginning of the end of the OECD’s central role in global tax reform?

Various efforts to increase tax equity were discussed at the World Bank Conference on Global Tax Equity, as outlined in this blog. Policies enjoyed varying levels of success: Uganda's attempts to tax high-net-worth individuals failed to generate additional revenue, while Argentina's 2016 tax amnesty led to the reporting of offshore wealth equivalent to 21% of GDP and financed the expansion of the pension system. The blog concludes that the momentum behind more equitable taxation justifies cautious optimism.

A recent UNU WIDER paper on informality and taxation rightly cautions against the assumption that ‘informal sectors’ will be lucrative tax bases, and makes the important point that citizens operating in the informal economy tend to be outside national safety nets.

Making tax less taxing

Can technology help to increase tax collection in African countries? A recent World Bank working paper reviews some of the opportunities and challenges in this area, including identifying the tax base, monitoring compliance, and facilitating compliance across consumption, property, trade and income taxes. Notably, the paper concludes with a view from senior tax administrators on the challenges of adopting technology, ranging from funding and poor internet connectivity to internal change management. It emphasises that tech reforms are more likely to be successful when they are part of a broader shift in structures and work cultures both within the revenue agency and across government as a whole. Last year, an ODI blog discussed some of the ways in which digitalisation is revolutionising property tax administration in developing countries (if you are interested in learning more about the role of technology in public finance, we are hosting an event on this theme on 21 March – sign up here).

Can nudges help? For property tax compliance in Dar-es-Salaam, the answer is ‘yes’. Landowners who received text message reminders ‘were 18 percent (or 2 percentage points) more likely to pay any property tax by the end of the study period… Nudges were most effective in areas with lower initial rates of tax compliance. The average estimated benefit-cost ratio across treatments is 36:1 due to the low cost of the intervention’. Interestingly, payments were higher among the sub-group that received a message emphasising the connection between taxes and public services.

The devil is in the detail, finds a new ODI paper on tax expenditure. It provides a practical guide for countries and sets out eight lessons for undertaking tax expenditure reporting to improve fiscal transparency.

How should aid be taxed? This remains an important issue for many countries with high levels of aid as a proportion of GDP. The experience of Benin, Cameroon and Kenya suggests that trade-offs are difficult. While Kenya’s regime of systematic exemption of indirect taxes and tariffs on all goods and services related to project aid is a simple approach, it exposes the country to greater risks of fraud. In the case of Benin and Cameroon, their more complex approaches may reduce tax loss, but their administrative burden is large.

Challenges in education spending…

According to the 2022 Education Finance Watch, 41% of low- and lower-middle-income countries slashed education spending during the Covid-19 pandemic, with expenditure declining by an average of 13.5%. In low-income countries, spending levels in 2022 remained lower than they were before the pandemic. Will Ghana’s free school meals fall victim to the country’s debt crisis?

ODI’s report on escaping the low-financing trap addresses static levels of public investment in education over the last two decades, calling for investment in enhanced efficiency and effectiveness and new goals tailored to local capabilities and resources.

Using data from 2010 to 2022, a new UNICEF brief analyses the equity of education financing in 102 countries and territories. It finds that on average, learners from the poorest 20% of households benefit from only 16% of public education spending, while the wealthiest 20% benefit from around 28% of education spending – a disparity that is even more pronounced in low-income countries (11% to the poorest quintile compared with 42% to the wealthiest quintile). These patterns are attributed to poorer children having less access to schools, dropping out sooner and being less likely to attend higher levels of education (which tend to receive more spending per capita). It suggests that government can increase the provision of resources for school development in disadvantaged areas and target scholarships to disadvantaged students. Beyond education policy, the report argues that social protection schemes such as cash transfers have an important role to play. It also recommends ensuring the equity of the decentralised allocation of resources.

A recent book published by the World Bank highlights the importance of subnational governments and fiscal transfers in addressing the adequacy and effectiveness of education financing. Given that 84% of children reside in countries where schools are run by subnational governments – which rely on central government for most of their revenue – understanding and tackling challenges in intergovernmental fiscal transfers is key to improving education financing. This book does just that, and evaluates how fiscal transfers affect education funding and outcomes.

Continuing with the theme of fiscal transfers, a World Bank review of its experience with performance-based fiscal transfers for urban local governments concludes that they have improved the institutional performance (e.g. revenue collection, PFM, HR transparency, and public investment management processes) and delivery of urban infrastructure. The review provides useful advice on the design of such grants, the implementation of annual performance assessment processes, and the provision of capacity-building support. Looking ahead, it considers how urban performance grants can be sustainably embedded in intergovernmental fiscal transfer systems and be used to promote local action on climate change mitigation and adaptation.

More broadly, the third edition of the World Observatory on Subnational Government Finance and Investment was released late last year, which presents data on subnational government responsibilities, expenditure, investment, revenue and debt across 135 countries. The 2020 data shines a light on the fiscal impacts of the Covid-19 pandemic on subnational governments.

… and health spending

The WHO’s annual Global spending on health report confirms that health spending rose in countries at all income levels in 2020. The question now is whether this is being sustained under tighter fiscal conditions. A CGD note looks towards the future of global health spending amidst multiple crises. The health budgets of lower-income countries will experience a significant fiscal crunch at precisely the time when more – and better – spending is needed. The note lays out seven policy options for governments and their partners to consider as they seek to protect essential health spending.

The Head of the Health Division at the OECD, Francesca Colombo, says that to secure further investment in health systems in the context of elevated national debt, the health sector ‘will need to get better at getting buy-in from finance ministries, by showing how the returns from such targeted investments extend well beyond health benefits, and by continued efforts to tackle waste – from spending to correct preventable medical errors to poor flow of data to decision makers – that does not deliver improvement in health outcomes'.

On the theme of tackling wasteful spending, a World Bank report outlines how stronger data analytics in procurement could help save some of the $1 trillion lost in public procurement each year. This includes in-depth analysis of procurement data, impact evaluations of reforms (such as e-procurement), interactive data monitoring tools and open procurement data.