Give it away, give it away, give it away now

Todd Moss at CGD writes about a potential solution for the natural resource curse: cash transfers.

Just as cash transfers are gaining recognition, there are also a bunch of countries facing the very real problem of what to do with newly-found oil wealth.  Ghana began pumping oil last month, Cambodia and Uganda will start this year, and the likes of Liberia, Sierra Leone, and Papua New Guinea may be next.  Given the problems so many countries have faced managing oil (Nigeria has earned some $400 billion from oil but its population has gotten poorer), so many of these new producers are fragile states, and the very limited ideas we have so far (sequester funds, promote transparency, cross your fingers) isn’t it perhaps time to try something fresh?

Why not just give the money to the people?  Why not ride the wave of cash transfers to break the resource curse?

Moss suggested something similar last year when Ghana discovered it had joined the oil club. He’s developed the idea a little further in a new working paper incorporating the growing  consensus over the efficacy of cash transfer progammes.

As I mentioned last year, the tricky bit is maintaining the social contract that exists between a government who depends on taxation and the citizens that demand services in exchange for a portion of their income. Handing point resources directly over to the population doesn’t immediately fix this problem unless the government can tax it back. Moss addresses this:

After giving cash to its citizens, the state would treat it like normal income and tax it accordingly—thus forcing the state to collect tax revenues and build tax administration, rather than simply bypassing the taxpayers by relying solely on rents. Although this initially sounds like an unnecessary step (why give something away that you are going to partly take back?), creating incentives for tax collection and administration is perhaps the most important potential benefit of this scheme (Devarajan, Le, and Raballand 2010).

Because the government must tax the oil revenue to recover some of it for public spending, the social contract is strengthened rather than broken by natural resource revenues. Governments will be forced to depend on the citizens for income, and consequently, citizens will have increased leverage and incentives to exert pressure on public policy.

There are still issues here (Ranil, in response, wrote an insightful post about tax systems). The biggest hurdle is the government’s willing to forgo all chances at rent-seeking, although this can be weighed against the obvious political benefits of handing out free cash. Countries with relative decent governance, like Ghana, may be able to clear these hurdles easily.

All of this leads to the same question I asked last year: if we think this would work with natural resources, why don’t we try this with aid?

8 thoughts on “Give it away, give it away, give it away now

  1. MJ

    January 6, 2011 at 7:32am

    Interesting ideas, and just read Ranil’s Taxing Times post for the first time. One thought that did occur to me is this: whilst there are some attractive theories behind the taxation drives accountability argument, are there any real world examples showing countries that have actually followed this kind of route to develop? I have a suspicion – which I would love if someone could prove me wrong – that the economic development has generally preceded the establishment of an effective and progressive tax regime. I.e. governments will not willingly submit themselves to this kind of accountability until a large vocal portion of their electorate (a middle class?) demands it.

  2. Ranil Dissanayake

    January 6, 2011 at 8:10am

    MI – It depends on what you mean by ‘economic development’. Taxation regimes have existed for a very long time, with most societies in history that have had any form of Government also developing a tax and tribute structure. These tax regimes have always stimulated some form of accountability. The most obvious examples of this accountability generating Governmental change would be the French and American revolutions, both of which took some form of ‘No Taxation Without Representation’ as a central element of their ethos. Both were developed relative to other states at the time, but obviously under-developed compared to most states now.

    England, too, had a working system of tribute and taxation prior to the Industrial Revolution, though the fact of economic development necessitates changes to how tax is structured and collected by changing the economy and participation therein.

  3. MJ

    January 6, 2011 at 11:55am

    Hi Ranil,

    Yes I did rather miss the obvious examples. Are they exceptions that prove the rule, or, if I knew anything more than zilch about economic history, would other cases readily trip off the tongue? Secondly, has a clear case of taxation accountability pressure ever succeeded in a relatively under-developed state without triggering a revolution?

    These may be difficult questions to answer, and it difficult to ascribe causality. But whenever an attractive economic theory is propounded I think it is always a good idea to look for solid supporting evidence.

  4. Ranil Dissanayake

    January 6, 2011 at 12:55pm

    MJ – quite right to always want evidence.

    It is very difficult to establish causality, especially when tax systems don’t result in riot / revolution. In theory they should work peacefully – you take money, we demand results, and if not, we stop paying or change regimes. If it’s expressed through voting, it’s difficult to ascribe change to taxation-induced accountability. I can’t really think how we’d go about proving this, short of looking at the historical moment at which taxation is generalised and comparing the 50 or so years before with the 50 or so after.

    Having said that, Japanese systems of taxation, even prior to the establishment of constitutional monarchy with the Meiji Restoration, were accompanied by pretty good public services, including irrigation. And after the restoration (I think) there was strong public education. I don’t know enough about the tax history of England or the rest of Asia to comment, though.

    The other issue we need to consider is that in Africa (not in Asia, generally), colonialism created new national boundaries and often replaced incipient states with much stronger bureacracies. Thus pre-colonial times had much less widespread, functioning taxation systems. But the colonies themselves didn’t spend much time thinking about taxation either – they introduced some, but most of their energy was focused on resource extraction through other means, such as mining etc.

    As a result, post-colonial African states have, by-and-large, been building taxation structures where no robust or widespread systems existed before (not all of them, though – particularly north Africa and some of the pre-colonial Kingdoms had structures and norms of tax-paying). As a result, they’ve been quite slow to develop accountability through taxation, esp. since so much of their financing comes from aid.

  5. Ranil Dissanayake

    January 6, 2011 at 1:02pm

    sorry, one other thing to add – it probably takes a long time for taxation to generate accountability, too, probably requiring other factors to stimulate greater interest in state provision. Taxation existed for a long time in France, England and the US before greater Government accountability was demanded.

  6. MJ

    January 6, 2011 at 2:04pm

    Hi Ranil,

    Thanks for the illuminating answers. It sounds like there is some kind of supporting evidence, but of uncertain weight. (And anyone who wants to try a large cross-country econometrics study on this should get bounced straight out of court.)

    Discussing the older examples reminds me of a recent thought I had. Africa’s big men look pretty lousy as democratic leaders in the republican modeal but not so bad as quasi-feudal autocrats. But even hereditary monarchs can benefit from a strong taxation system that is perceived as equitable. I vaguely recall one of England’s early mediaeval kings was credited with rescuing the country from a fiscal mess and laying a strong foundation for his heirs by his improvements to administration of taxes and justice in the country.

  7. Nick

    January 7, 2011 at 7:51am

    There are also modern illustrations, namely Somaliland, which has never been eligible for foreign assistance, and thus was forced to build a revenue base through taxation like European states. Please excuse the shameless self-promotion, but if you are interested, you can find a paper I wrote on Somaliland’s experiences here:

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1621374

    Abstract: For years, studies of state formation in medieval Europe have argued that the modern, representative state emerged as the result of negotiations between autocratic governments in need of tax revenues and citizens who were only willing to consent to taxation in exchange for greater government accountability. This paper presents evidence that similar dynamics shaped the formation of Somaliland’s democratic government. In particular, it shows that government dependency on local tax revenues — which resulted from its ineligibility for foreign assistance — provided those outside the government with the leverage needed to force the development of inclusive, representative and accountable political institutions.

    (The paper is currently under going some minor revisions for the Journal of Development Studies, but for now can only be found on SSRN).

  8. Ranil Dissanayake

    January 8, 2011 at 12:55pm

    Nick – many thanks for posting that. looks most interesting. Will definitely read it.

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