Economies of All Sizes Need Strong Tax Policies, Each Other to Grow

The global economy of the 21st century is the most interconnected in world history. Spurred by trade and technology, and sometimes by geopolitical events, new links have developed that have upended patterns of global trade and, on the whole, promoted economic growth.

China has emerged as the world’s second-largest economy, while India, Brazil, Turkey, Mexico, and Indonesia have become significant economies in their own right. Now other countries—in both the upper middle- and lower middle-income categories, best termed emerging economies—also want to compete on a broader stage. They include Nigeria, Kenya, Ethiopia, Egypt, Ghana, Bangladesh, Pakistan, Thailand, Kazakhstan, and Colombia, among others.

Growth in emerging economies generates demand for capital goods, high-value services, and other goods that are produced in the US, EU, and other more established economies. This is true whether their economic base lies in commodities which the developed world needs (where supply chains are important) or whether those economies have a broader base (and increase imports of services).

But policies—not least those related to tax—influence whether emerging economies succeed or fail. To rephrase an old saying, when established economies sneeze, emerging economies catch a cold.

Smarter growth policies keep those countries on the path to growth that has already benefited so many others—even if the developed world doesn’t make it easy by restricting access to its markets. These include policies on tax, such as streamlining value-added taxes and lower corporate income tax rates.

Airborne “illnesses” to economic development abound. Whether they’re US tariffs or EU (non-tax) regulations such as deforestation that restrict access to markets, policies of the developed economies can inhibit growth in the developing world. Even if tariffs return to their pre-2025 levels, developed countries may prefer to invest within their own borders rather than enable open markets that allow investors to find another home.

Meanwhile, emerging economies are asserting greater prominence in global affairs through regional cooperation, institutions such as the G20, and other efforts at multilateral governance. For tax, the OECD-G20 Inclusive Framework is the principal example. But regional tax cooperation efforts, such as in ASEAN and southern Africa, are also deepening.

Developed countries shouldn’t ignore the risk that emerging economies become fatigued with the rules-based economic order. The desire of developing countries to band together to resist what they see as encroachments on their economic independence is understandable.

But now that the Inclusive Framework stands on less certain ground and as the proposed UN Framework Convention for International Tax Cooperation is being negotiated, emerging economies need to take care that their response doesn’t harm foreign investment in their quest for revenue.

The UN draft simply goes too far in several respects. Consider the proposals for more restrictive definitions of a permanent establishment that permit taxation of investors. Other measures mark a significant shift toward source taxation with limited safeguards for foreign investors.

One proposal would encourage gross receipts taxes for services paid to nonresidents at a negotiated (rather than fixed) rate. This reduces the certainty and predictability of the tax regime that investors desire. It would affect the digital economy as well as more traditional foreign direct investment projects.

Developing countries should minimize or remove gross withholding taxes. They are costly, distortive, and reduce direct foreign investment because investors must pay up front rather than as projects become profitable.

Worse yet, withholding taxes risk becoming final taxes as investors develop their projects, turning them into gross receipts taxes—a type of tax that particularly discourages investment.

Investors considering a major, capital-intensive project (a factory, mine, or data center) want assurance that the host government will maintain a stable and predictable tax environment and will treat them fairly. This is especially true since these types of investments often hinge on long-term revenue forecasts.

Without that assurance, they want the right to exit and will choose to invest in countries offering more predictable tax regimes.

Emerging economies should make it easy for investors and entrepreneurs, both domestic and foreign, to start a business. The World Bank’s ease of doing business and Business Ready reports are key indicators investors consider in making investment decisions.

Countries such as India, Georgia, and Kazakhstan that have jumped in those rankings have enjoyed both increased inflows of capital and resulting growth.

Introducing the complexity of a Western system into an emerging economy will slow down growth. At worst, it can encourage or induce a vicious cycle of capital flight and the growth of the informal sector, depriving governments of the very revenues they need.

It is important for emerging economies to modernize their tax systems through simplicity and digitalization of tax administration as part of a favorable investment climate, just as developed countries should simplify their systems as well.

Greater transparency reduces the possibility of corruption, makes dispute resolution easier, and helps investors understand their true tax liability. Value-added taxes can be made to work for digitalized services, as they fill the tax gap and help achieve a modernized, digitalized system.

It takes positive actions from both sides to promote the investment that will enable emerging economies to grow.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Daniel A. Witt is president of the International Tax and Investment Center headquartered in Washington, D.C., and has worked on tax policy and administration reforms in transition and developing countries since 1993.

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