Taxes, Governance and the New Armenia

The aim of the above depiction is to make the source of the tension perfectly clear: that the government, in most basic terms, has a stake in value generated by others. Consequently, if the “government” in essence is a function of money and power then it becomes self-apparent that misuse of the construct might become a potential source of tension.

As a side note, the discussion in this article will take a liberal-market-economy approach whereby the role of the government is mainly to perform a facilitating function to value creation as opposed to generating value itself. That is, while one can have lengthy arguments about pros and cons of different types of economic models, the reality on the ground is that most, if not all, advanced economies have either functioned along these principles or have transitioned to such across the last decades.

Advanced Countries: Best Practice Governance Principles and Taxation

From such a vantage point, the benefits of public governance principles of advanced countries, based on democratic norms (“no taxation without representation”), fiscal transparency, rule of law and institutional (as opposed to personality based) decision-making, become evidently clear. Such an approach has been quite successful in establishing a durable social contract and guaranteeing political and institutional stability over the past many decades, if not centuries as in the case of some Anglo-Saxon nations. While there have been more frequent instances of populist movements over the last several years, I would argue that this reflects a rise in inequality and migrant flows as opposed to questioning the state construct and legitimacy per se.

It would be superfluous to delineate the benefits of a strong state, institutional stability and wide-ranging legitimacy granted by the societal stakeholders at large. Yet one could plausibly argue that the ability for the state to tax and generate fiscal revenues can be considered as a direct indicator of the strength of any given state.

Besides the issue of taxation levels though, or conversely the amount of shadow activity prevalent in an economy as a metric to gauge societal cohesion, the issue is quite an important one for the productivity of an economy overall.

One can argue that there is a certain range between the role of the Conservative and Republican “small-government” ideologies of the U.S. and UK and the Social-democratic “welfare-state” of their Scandinavian peers. Yet in all cases, provision of certain public goods such as infrastructure, healthcare, education not to mention physical and judicial security are not only performed more efficiently and effectively by the public authorities, but also do necessitate a certain amount of fiscal depth. Accordingly, an economy’s productivity is duly enhanced via certain levels of taxation and their effective allocation to the supply of public goods.

An illustrative yet not always an apparent example of such links between a strong state, taxation, productivity as well as higher levels of individualism prevalent in advanced nations, is the one connected to the provision of social welfare. While elderly care is ultimately provided by family members in most other nations, more effective and efficient centralized and publicly administered services in many advanced nations are not only more cost efficient but ultimately result in higher overall economic productivity. To be more specific, the (often) female labor is (again) not tied up in, somewhat crudely stated, unproductive and unremunerated activities. One can surely quarrel with the moral and ethical aspects of such an arrangement, but from a purely economic point of view the example is quite elucidating. Here, people’s trust towards

state-provisioned, tax-financed, high quality social services go hand-in-hand with individual self-realization and maximization of productivity. Individualism is here on a micro level, while high tax burdens reflect taxpayers’ willingness and readiness to provide collective, and productivity enhancing, welfare solutions on a society level to others, outside of one’s immediate family.

Developing Country Dynamics

On the other end, developing country governance principles, or norms to use a more relevant term, are often far removed from rich country standards. Inefficient use of funds, nepotism, graft, not to mention absence of free and fair elections, obviously work to the detriment of the government-society contract bargain. Authorities of some developing nations are more “fortunate,” as they can balance inefficient public management with income from rich endowments of mineral reserves. Consequently, they can rely less on unfavorable policy tools such as taxation and use commodity financed public spending instead. Some developing nations are less lucky and thus run the risk of more turbulent outcomes, economic or otherwise.

Such outcomes seen in modern history, where developing countries are concerned, may vary but often do share certain similarities and patterns. While advanced country governments with high levels of legitimacy and public trust, can raise and adjust tax levels (or raise the pension age for that matter) without major societal upheavals (e.g. Japan, the Netherlands and Australia in recent years), the prospects for similar policy steps in any given developing nation are not nearly as straight forward.

Instead, the traditional pattern in developing nations has been that governments not only oversee inefficient economic structures, but also implement sub-optimal economic policies. More specifically the structural reform propensity may not only be lacking but policies implemented might with time become outright regressive. This feeds a certain chain reaction. Suboptimal policies weaken the economy which together with the shadow activity decreases tax revenue intake. And ultimately, in order to close the budget gaps/deficits from insufficient tax intake, new debts are accumulated. Often in a foreign currency. Many times the local authorities are indeed aware of the structural reforms necessary to improve the economic outlook, but abstain for political reasons. There is plenty of economic advice and historic precedents to go around if one would be willing to implement reform.

Instead, it is that absence of strong public mandates and legitimacy that prevent the authorities from taking the necessary, but often unpopular, steps towards reform implementation. Because any structural reform will take time to feed through into beneficial economic outcomes (usually 3-5 years), and more importantly, will imply certain reallocation of benefits/value between different domestic stakeholders (e.g. exporters vs. importers, young vs. old, business vs. households). The phrase “don’t rock the boat” is likely to have many translations.

Even to the uninitiated, the above cycle cannot appear close to being sustainable long term. In most cases, at some juncture the country in question hits a certain debt saturation where holders of the country’s debt revolt, sending prices of both the domestic currency and debt plummeting. And here is the main difference in behavior between advanced and developing nations when it comes to structural reforms in general and taxes in particular: developing countries do indeed both raise taxes and implement reforms, yet they tend to do so only reactively. More specifically they take this path when in crisis settings; when forced to and under significant duress and social hardship (e.g. recessions, bank defaults). In many cases, if the debt piles are denominated in an external currency and they ask for hard currency (i.e. USD) loans from multilateral institutions such as the IMF or Asian Development Bank (ADB), they are explicitly “advised” to take such steps before their requests are considered.