6 Active distributive policies

The Government contributes to improving national control over natural resources and increasing public revenues through programmes like Oil for Development and Tax for Development. Tax policy is an important distributive policy instrument. It should be used to even out differences between people, not increase them.

How tax revenue is spent is at least as important in the distribution context. Although Norway and other donors are still supporting the health and educational sectors in poor countries, it is an indisputable goal that all countries take over the financing of these services themselves as their tax revenues grow. Aid is not intended to relieve the authorities of responsibility for fulfilling the rights of the citizens.

The Government believes that it is important to maintain a dialogue with the authorities in recipient countries about the use of public funds. An effective distributive policy entails governments investing in public services that ensure people’s fundamental rights and provide a safety net for the most vulnerable and marginalised segments of society. Naturally, Norway cannot instruct other countries to pursue such distributive policies, but we can divert our aid to countries that choose to pursue an active distributive policy, and away from countries that use their tax revenues to further increase the differences between people.

6.1 Tax policy

Source

CIA – The World Factbook 2009.

Establishing a tax system is a key element in state-building, not just to fund public expenditure, but also to give the state legitimacy and develop democratic structures. Trust between the citizens and the authorities is a fundamental precondition for ensuring support for the tax system. This is often thought of as a social contract between the citizens and the state. The duty to pay tax comes with a right to participation and access to public services. Many countries lack the trust required for such a social contract to develop.

There is not much incentive for ordinary people to pay taxes if large international corporations and the wealthiest inhabitants are granted tax exemptions and hardly contribute at all. This is common practice in many developing countries. Starting by closing loopholes in the tax system and ensuring that those with the greatest ability pay their fair share of taxes, can both make financial sense and have a positive signal effect.

Photo: The Ministry of Foreign Affairs/Stine Horn.

It is demanding for every country, including European ones, to develop good tax systems with a broad tax base. Tax policy and tax administration are closely linked. A perfect tax system can actually have a negative effect on tax morale if the authorities do not have the capacity and resources to enforce it. It is often better to start with a few fundamental elements that can realistically be implemented and build the system step by step. It is crucial to tax morale that the system and its enforcement are perceived as fair. Willingness to pay taxes correlates strongly with trust in the state and the tax administration.

With an average Gini coefficient of more than 0.45 a year in the period from 1990 to 2005, Latin America and sub-Saharan Africa are the two regions in the world where inequality is greatest. In the Western world, the Gini coefficient for the same period was below 0.34. Differences in the redistributive effect of public revenues and expenditure are the main explanations for the difference of 0.11.

In OECD countries, it is the expenditure side that has the greatest redistributive effect. On average, the redistributive effect of cash transfers such as public pensions and child benefit is twice as great as that of the tax system. If public educational and health services are included, the redistributive effect of public expenditure is even greater. As regards revenues, personal income tax contributes most to redistribution, while indirect taxes such as customs duties and value added tax have the opposite effect. On average, low-income households pay three times as large a percentage of their income in consumption taxes as the richest tenth.

In developing countries, the level of public revenues and expenditure is considerably lower than in the OECD countries, while the redistributive effect of both the tax systems and expenditure is smaller. While the average taxation level in OECD countries is around 30% of GDP, it is around 15 to 20% in most developing countries. Developing countries rely more on indirect taxes such as value added tax, import duties and excise duties. Excise duty on fuel, alcohol and tobacco tend to have a progressive effect. Value added tax can cut both ways, and experience shows that exemptions for small enterprises, including agriculture and the informal sector, can have progressive results. Direct taxes on personal income and property are generally progressive in developing countries. However, the progressive effect is reduced by extensive exemptions and a narrow tax base.

Non-renewable natural resources are an important part of the tax base in many countries. It is a challenge that, if tax revenues from this source are very high, this can reduce the motivation to develop a system of personal taxation. In some countries where poverty is rife, the proceeds from personal taxation will hardly cover the costs of developing the system. It is nevertheless important to maintain personal taxation – partly because it will increase the government’s accountability to the people, and not just to large corporations, and partly because it can prove difficult to introduce personal taxation later on once wage levels have risen. Ideally, the tax base should comprise all citizens, but with a basic tax-free allowance to ensure that people with low incomes do not pay tax.

The most widespread transfer systems often have a smaller redistributive effect in developing countries than in developed countries. Retirement pensions and other social security benefits are usually linked to work in the formal and public sectors. At the beginning of the 21st century, only about 40% of people of retirement age in developing countries were receiving a pension, compared with 90% in European countries. In addition, many developing countries spend large amounts on regressive universal subsidies, particularly related to energy.

Global direct and indirect taxes

Taxing the richest segment of the population is a challenge in most countries. The bulk of their earnings is often capital income, and since capital is far more mobile than labour, more international cooperation will be required if taxation is to be effective. International cooperation on transparency relating to financial transactions is discussed in more detail in Chapter 8.

The challenge of ensuring that tax systems are fair is even greater at the global level. Taxpayers in Europe and the USA pay taxes that will also be spent on development in poor countries. This has been generally accepted for more than 50 years. However, the current trend, whereby some groups in poor countries with high growth rates are earning a great deal without paying taxes to their own country, could undermine the willingness to provide aid. Considerations of fairness make it paramount that very rich individuals from emerging economies also contribute to the common good. This is primarily a national responsibility, but it can also be addressed at the global level.

More and more people advocate the introduction of global taxes to target the economic financial elite in all countries, regardless of whether their home countries are rich or poor. This could be in the form of taxes on air travel, financial transactions and currency transactions, for example. The revenues raised should primarily be used to tackle global challenges that do not originate in individual countries, for example combating infectious diseases and transboundary environmental challenges.

A group of experts has calculated that a global currency transaction tax of 0.005% could raise as much as NOK 200 billion a year. However, the introduction of such a tax will require broad international support, including the support of influential countries. The Government is working in the international arena to win the support needed to introduce a currency transaction tax of this kind.

6.2 Tax exemption for aid-funded goods and services

Norwegian development cooperation emphasises strengthening resource management and tax administration, as well as combating illicit financial flows. The many exemptions that apply are a common characteristic of tax systems in many developing countries. The exemptions can apply to national sectors and individual enterprises, politicians and civil society organisations as well as foreign companies. It is also common for donors to demand tax exemptions for aid-funded goods and services. It is administratively demanding to handle all these exemptions, and they also contribute to undermining the tax system in general and make tax evasion easier for actors and products that are not formally exempt. It may seem contradictory that Norway, on the one hand, works to promote tax systems where many contribute to the common good, while, on the other hand, it is part of the exemption culture by demanding tax exemptions for aid-funded procurements. The Government will therefore, as a rule, no longer include requirements for tax exemption in bilateral agreements on government-to-government aid.

No longer demanding tax exemption has been on the international agenda for several years, and many donor countries support the principle. Several donors also abstain from demanding tax exemptions in individual cases. Some donor countries strongly oppose this change, however, and the international community has, so far, made little headway in the direction of common action. The World Bank and some other multilateral development banks have changed their policy, so that it is now common practice to pay taxes for projects that they fund. In 2012, Denmark decided to no longer demand exemption from value added tax for the country’s bilateral aid.

The best effect will be achieved if as many donors as possible stop demanding tax exemptions on the broadest possible basis, and the Government will work to this end in relevant international forums and recipient countries. Moreover, if some countries lead the way, others may follow.

Norway channels aid funds via international organisations, Norwegian NGOs, and organisations and public institutions in partner countries. It is only in agreements with the authorities in partner countries that we demand tax exemptions, and this is therefore the most natural place to start if we wish to change this practice.

Norwegian NGOs often cooperate closely with organisations from other countries, and many of them receive support from several donor countries concurrently. In this situation, it would be complicated to introduce a separate taxation practice just for Norwegian funding. Coordination at country level is in line with good aid practice, and the Government will therefore not instruct NGOs to stop demanding tax exemptions for Norwegian funds. However, the Government will encourage Norwegian NGOs to refrain from demanding tax exemptions when practicably possible, and to budget for taxes in their applications for public funding.

In practice, taxes paid can be regarded as non-earmarked support for the authorities similar to budget support. Assessments relating to governance are part of the basis for deciding whether to enter into an aid agreement with the authorities of a country. At the same time, a certain amount of flexibility will be necessary in implementing the new practice, for example in connection with co-funding with other donors and if the tax demanded is obviously unreasonable or does not comply with internationally accepted taxation norms. In humanitarian crises, tax exemptions will still be necessary in order to ensure that aid is provided in accordance with international humanitarian principles.

Experience of the change in practice will be evaluated within three years.

6.3 Health and education

The key element in a good distributive policy is guaranteeing all citizens the right to fundamental health services and education. Norwegian and international aid and development policy has long emphasised this element and provided extensive support for health and education programmes.

Photo: UN Photo/John Isaac.

In the long term, it is nevertheless important that countries that are able to do so, take over responsibility for financing these services themselves. According to the Global Monitoring Report 2012, the percentage of their national budgets that low-income countries spend on education has increased by an average of 7.2% a year over the past decade. The Global Partnership for Education (GPE), to which Norway is an important contributor, emphasises that the recipient countries should increase the percentage of the national budget spent on this sector.

Education is a precondition if young people are to find work in growth sectors, and a good public education system is important in order to promote social equality. Education equips people to stand up for and fight for their rights. Education promotes political participation and democracy. Education is a key to paid employment and higher income levels, and thereby facilitates increased social mobility. A more educated workforce provides a better basis for economic growth, which, in turn, gives the authorities greater freedom of manoeuvre to improve distribution.

The right to education is incontrovertibly laid down in several of the UN’s key human rights documents. The Convention on the Rights of the Child states that primary education shall be free, and Norway supports this important principle. Research nevertheless shows that, even if free education is provided, other expenses, such as the cost of uniforms or textbooks or the cost to the household of losing a child’s labour, can be an obstacle to children actually enjoying this right. Poverty forces families to make difficult choices. It is the state’s responsibility to ensure that the right to education can be fulfilled in practice.

Recent UN decisions concerning children and armed conflict underline the importance of children and young people in conflict areas getting the education they are entitled to. It is in such countries and regions that the goal of universal education is furthest from being achieved. Vulnerable and marginalised groups, such as ethnic minorities, people with disabilities, refugees and internally displaced persons, single providers and orphans, are most at risk. Girls and women are also often more vulnerable in such situations. Norway has taken particular responsibility for ensuring that children in conflict areas receive an education and for girls’ right to an education.

The difference between the number of boys and girls who attend school has narrowed. Globally, there are now 97 girls in primary school for every 100 boys. The differences between boys’ and girls’ participation in education are great between countries and within countries, however. At the lower secondary school level, there is a bigger difference between boys’ and girls’ participation.

Norway’s most important partners in education-related aid are the World Bank, GPE, the United Nations Children’s Fund (Unicef) and NGOs.

A population in good health is a social asset that forms the basis for productivity and economic growth, while poor health results in higher costs as well as lower productivity. There are clear connections between the distribution of income and health status, between the distribution of health services and income, and, even more self-evidently, between access to health services and health status.

Health is very unevenly distributed globally, regionally and nationally. One example of inequality in health status is life expectancy at birth, which is 32 years in Swaziland and around 80 years in Norway. The health-related MDGs (4, 5 and 6) have contributed to substantial reductions in child mortality, the prevalence of malaria and AIDS-related deaths, but maternal mortality is lagging behind in many areas.

There are also big differences in health status between income groups within developing countries. Families with low incomes have poorer health and less access to health services. They are also more vulnerable when disease strikes. The consequences are greater for people who become ill, but also for their families, who are often in danger of ending up in a poverty trap. This is particularly true if the costs of treatment or medicines are high, but also in connection with loss of income as a result of a provider falling ill or if sick children require care that makes it impossible for the provider to continue to work.

Many middle-income countries with a high degree of inequality, for example India and Indonesia, have universal health coverage as a goal. Surveys carried out in India show that health-related expenses is the single factor that contributes most to keeping people in deep poverty. Inequality can be reduced by making a defined minimum of health services available to the whole population and organising ways of financing them, for example general health insurance. This work has also been placed on the agenda through the joint Foreign Policy and Global Health Initiative in which Norway participates.

In its global health efforts, the Government prioritises MDGs 4 and 5 – reduction of child and maternal mortality. The most important partners in this work are the WHO, the GAVI Alliance and the Global Fund to Fight AIDS, Tuberculosis and Malaria. The WHO, the UN’s specialised health agency, works to promote the MDGs. The WHO’s mandate is to contribute to better health for all and to be the leading coordinating body for international health cooperation. The WHO plays an important role in setting global norms and standards. In addition, the WHO provides professional support to developing countries in connection with the implementation of recommendations and standards, the strengthening of health systems and the development and implementation of national health plans.

6.4 Direct cash transfers

Photo: Reuters/Erik De Castro.

The combination of increasing inequality, high growth rates and less reduction of extreme poverty than expected has increased the need to consider direct redistribution to the poor. Direct cash transfers to select groups have proven to be a cost-efficient measure. Such cash transfers have become much more widespread, and evaluations and other research indicate that they often work well and are a well-targeted distribution instrument.

It is seldom possible to come up with a simple answer to the question of what prevents inclusive growth. Many countries use methods to identify and, in some cases, rank obstacles, and there are usually many factors that must be addressed concurrently. Country-specific analyses show that there are differences in what constitute the most important obstacles to growth. There are certain common factors, however, such as energy supply, business climate, skill level and macroeconomic and political stability.

Measures aimed at creating jobs and removing poverty traps are often interdependent. Direct support for poor households and small-scale production will work better if job creation is emphasised at the same time. Correspondingly, there are examples of investments in energy supply and infrastructure that have failed to produce the expected results due to a lack of expertise or other preconditions for development. There is no general answer to which combination of measures will produce the best result; it depends on the local context.

Direct financial support can increase the effect of other measures, such as increasing the range of services provided and investments in infrastructure. Cash transfers make it possible for families to improve their health and nutritional status. This is crucial if improved educational opportunities for the poor are to result in better learning outcomes. Increased human capital will also improve poor people’s opportunities to engage in economic activity when investments in infrastructure increase.

The extensive transfer schemes in modern welfare states have other primary economic functions than redistribution. They can be public social insurance schemes (unemployment benefit, sickness benefit) or they can replace private savings (retirement pensions). Social safety nets are increasingly seen as a way of improving the overall functioning of the economy.

In developing countries as well, the issue is how to protect individuals in a manner that strengthens the economy as a whole. A broad approach to social safety nets, rooted in the right to social protection under international law, is gaining support internationally. The World Bank launched its new Social Protection and Labor Strategy in 2012. Its main message is that various forms of safety nets should be included in national development strategies in all developing countries.

The way in which transfer schemes are designed and organised will vary depending on the situation in each individual country. Low-income countries face greater challenges and have less economic freedom of manoeuvre than middle-income countries. It is quite common for transfer schemes in middle-income countries to be permanent, rights-based and organised and financed as part of a state system. In low-income countries, such schemes are usually short-term arrangements aimed at addressing temporary problems. They are often organised outside the state system and partly or fully financed by aid funds. Norway has supported a World Bank programme to increase developing countries’ own capacity in this area. It is called Rapid Social Response.

Poverty means having little or no income, and it often entails uncertainty and variation in income over time. Even a modest, but regular sum will enable households to maintain a certain minimum consumption during hard times and maybe invest a little when times are good, thus improving their long-term income potential. The transfers can represent a safety net that improves resilience in relation to crises. The support empowers recipients and gives them an opportunity to prioritise their own spending. This requires functioning local markets, or at least that the fundamental preconditions for markets to begin functioning are present. One drawback associated with handouts of food and other goods in crisis situations, is that they can undermine national production and local markets. Direct cash transfers strengthen purchasing power and demand, thus stimulating local markets and leading to positive ripple effects in the local economy.

In middle-income countries such as Brazil and Mexico, direct cash transfers come with conditions attached. This can be necessary in order to ensure the support of the electorate and taxpayers. Transfers can, for example, be conditional on children attending school or undergoing health check-ups. Experience from Latin America shows that, for the most part, direct cash transfers improve the living conditions of the families that receive them and have a positive effect on school attendance and the use of health services.

Unconditional transfer schemes are more common in African countries. However, experience indicates that these schemes also have positive effects on school attendance and the use of health services. Poor families give high priority to their children when their economic freedom increases. This is important in countries with low administrative capacity, because conditional payments require more administration. Moreover, health services in African countries are in many places not sufficiently developed for their use to be made a condition.

In Norway and other welfare states, the extent to which various transfer schemes can weaken the motivation to work is an issue. There is very little evidence to indicate that this is a problem in developing countries. On the contrary, it has been found in some cases that transfer schemes strengthen the recipients’ capacity to seek work and participate in the labour market. Another explanation for the difference in behaviour between rich and poor countries is that, for the poorest people, leisure time is less valuable than income from employment.

An overall assessment of the available experience of direct cash transfers and the major poverty challenges we are facing indicates that transfer schemes should be given higher priority in developing countries. A lot is known about the effect of direct cash transfer schemes when they are organised in a sensible manner, and also about the potential pitfalls, including the risk of corruption that lies in inadequate adaptation to the recipient country context. On this basis, the Government will increase its support for the development of direct cash transfer schemes as part of a comprehensive and poverty-oriented development policy. Funding for the actual transfers will only be provided for limited periods and only to low-income and lower middle-income countries.

6.5 Financial management systems and national budgets

Good public financial management is important to a country’s macroeconomic stability, transparency and accountability relating to political priorities, administration and democratic control over public funds. Norway plays an active part in the efforts to increase financial transparency and accountability relating to the use of public resources, both at the international level and in individual countries. This is regarded as important, both in the fight against corruption and to ensure the efficient use of resources.

If donors channel aid through countries’ own public administration systems instead of establishing parallel donor systems, this will help to develop the national systems. Supporting the development of certain aspects of public financial administration can also reduce the risk of misappropriation of funds and increase transparency about public expenditure. Norway supports broad financial management reforms in several countries, not least in relation to supreme audit institutions, tax administration and petroleum management.

Strengthening supreme audit institutions contributes to democratic control and transparency as regards the use of public funds. This work has begun to produce results in that reports from supreme audit institutions are increasingly being debated in the parliaments of partner countries. Cooperation between supreme audit institutions in the South and institutions in the North, including the Office of the Auditor General of Norway, has also increased. The Government supports such professional cooperation.

Analyses indicate that there have been improvements in recent years and that there is now greater transparency in public financial administration in Norway’s partner countries. At the same time, improving whole systems requires a long-term perspective.

The Government will:

• maintain a dialogue with the authorities in developing countries on the use of public funds, particularly in those countries where we are helping to increase tax revenues

• give priority to cooperation with countries that want to pursue an active distributive policy

• continue its level of support for health and education services

• continue its global health efforts in line with the white paper Global health in foreign and development policy

• work in the international arena to win the support needed to introduce a currency transaction tax

• make it clear that the aim is for partner countries to be able to finance health and education services themselves, and emphasise the importance of ensuring real access for all. Particular focus will be placed on equal participation by girls and boys in education beyond primary school

• emphasise that developing countries are eventually to take over the full financing of their health and education services

• support the development of schemes for facilitating direct cash transfers to vulnerable groups, and provide funding for such transfers for limited periods in low-income and lower middle-income countries

• as a general rule, no longer include requirements for tax exemption in bilateral agreements on government-to-government aid.