Tax and fragile states: Challenges for Norwegian development assistance

Fragile states are characterized by weak institutions, widespread corruption and are unable to collect taxes to fund basic services. Norway has doubled its allocation for development assistance to strengthen developing countries’ tax system, and is in the process of rolling out a new major commitment plan for the Norwegian Agency for Development Cooperation's (Norad) aid program "Tax for Development". Can Tax for Development make a difference in some of the most demanding countries in the world to work in? How can this possibly be done? During Arendalsuka (Norwegian political gathering), researchers, civil society and leading actors from the aid field and tax administrations met to discuss tax and state building in fragile states - and what Norway can do in these countries.

What role does tax play for fragile states?

– A fragile state is lacking mostly everything. They often have a malfunctioning tax administration. They are poor, struggling with the consequences of climate disasters and many are also affected by war and conflict, says Sigrid Klæboe Jacobsen, director of Tax Justice Network Norway.

– We must do more than prevent collapse in these states. The challenge is to create states that can act as an autonomous entity that can provide health care, protect the population, and preserve its own borders. To do this, they need their own income. Taxation of own population and business is crucial; there is no other solution to the problem of state-building – we are talking taxes! says Morten Bøås, research professor at NUPI.

–  State legitimacy is achieved by the state producing services that the population wants and needs, such as safety, health and education, roads, etc. We know that if taxation is implemented in a way that promotes greater accountability, together with improvements in the state's institutional capacity, then the development of the tax system can become a catalyst for further institutional building, explains Odd-Helge Fjeldstad, research professor at CMI.

But what about the dependence on revenue from natural resources?

–  Misrule is often correlated with the fact that the state does not depend on income from its own population and the business community. We also know that developing countries that receive most of their revenue from other sources such as natural resources are generally characterized by mismanagement and poor public institutions, says Fjeldstad.

Venezuela's mismanagement is perhaps rarely associated with taxation issues, but was nevertheless used as an example of how the lack of taxation of the population plays a role in transforming a relatively well-functioning state into a fragile one. Benedicte Bull, professor at University of Oslo, says that the public income system was changed from being tax-based, to becoming a system based on oil revenues that funded social programs. How do you get from there to where we are today?

Firstly, more and more is about retaining power for those who control oil revenues. This means that there are less and less incentives for democratic institutions to be held accountable by their own citizens. There is a clear link between low tax revenues, large natural resources and a lack of democracy.

–  Second, when oil revenues plummeted, there was no longer a tax system to lean on. The solution then was to raise money and raise loans internationally. This contributed to the collapse of the state as we see it today, continues Bull.

How does Norad work with tax aid?

Through the aid program "Tax for Development", Norad and the Norwegian Tax Administration work with partner countries to strengthen their tax systems. The role of Norwegian tax experts in these countries is dependent on the demand, competence and scope they find themselves in. Jon Lomøy, director of Norad, explains how Norway works with tax in a developing country context.

- We say that we stand on four legs. One leg is the Norwegian Tax Administration (NTA). We must take into account that there are not so many Norwegian tax experts who want to settle in Yemen, Mali or other fragile states over a longer period of time. The other leg is multilateral cooperation. Norway is the only donor to have cooperated with all the four major, i.e. the IMF, the World Bank, the UN and the OECD. We are working to bring the voice of developing countries to the table when international tax rules are to be established. The third leg is knowledge. Considerable resources have been invested in producing more knowledge about what works or not. The fourth foot is civil society. They have a primary role in the global debate on norms for international taxation, but also to bridge the gap between the production of social services and the role of the government here.

• World Bank news: Norway Provides $10 Million to Support World Bank on Reforming Tax Systems in Fragile States

–  We are anxious bureaucrats who thrive in safe Norway.

Norway is often highlighted as a country where the social contract - the relationship between the population's tax payment and the state's service provision - stands strong. But is the Norwegian tax model applicable in countries that are very different from Norway?

–  We have tremendous access to information about the citizens in Norway - this is not the case in the countries we are talking about now, and the low level of trust between the state and citizens does not allow for such exchange of information. In addition, we are in a foreign world when we in the  NTA comes to these countries. We do not have the same access to data or technology - in some ways it is like sending a car mechanic from our time back to 1912. But we are not dismissive of working in countries where working conditions are difficult. In the new phase of Tax for Development, we have chosen two states that are "almost" fragile, Rwanda and Nepal, says Program Director of the International Unity in the NTA, Fredrik Aksnes.

 However, when it comes to the most fragile states with war and conflict, it becomes much more complicated.

–  We are unable to build a tax administration from nothing. For that we have neither the experience nor competence. That we find multilateral institutions such as IMF and World Bank, which are, after all, rigged for this type of measure.

– We also cannot work in countries where the security situation involves a risk to our employees' lives and health. We are anxious bureaucrats who thrive in safe Norway, says Aksnes with a twinkle in his eye. But, as I said, we're open to working in some fragile states, he emphasizes.

The role of taxes in state building

Is the tax solution, do you automatically get good, functioning states from taxing more?

– State building without own income makes no sense. But it is naive to believe that increased tax revenues will automatically make everything better. Increased taxation without improving the way income is used on the expenditure side does not contribute to increased welfare for the population. The challenge in fragile states is therefore not only to tax more, but to tax better, i.e. more efficient, fair and predictable. It is risky to get involved in countries characterized by weak institutions, epidemic corruption and a lack of trust between the state and society. The probability of failure is high. But doing nothing is even worse. As  NUPI's Morten Bøås argues, artificial life support system through massive international assistance is not sustainable in a state-building perspective. Domestic resource mobilization through the construction of the tax system is a necessary prerequisite, emphasizes Odd-Helge Fjeldstad.