Eight of the ten countries with the greatest inventory of natural resources are developing countries. Governments of resource-rich countries have an incentive to obtain revenues dominated by inflows from natural resources, as they are a source of economic rent that can generate earnings even in the absence of political stability or wider economic growth.
Nevertheless, this blessing may become a curse for countries if they depend too heavily on resource wealth for revenues and abandon economic and political development. The current rise of emigrants from dysfunctional developing countries with domestic conflicts, bad governance and stagnant economies is one example of said scenario.
Indeed, the situation begs for the improvement of the welfare of the migrants at home, and diversifying the revenue of developing countries is one of many steps that governments could implement. This measure could include a review of the taxation mechanism that best adapts to each country’s reality.
On average, developed countries enjoy tax revenues, measured as a tax/GDP ratio, at least twice the size of those of developing economies. The inability to raise tax revenue in developing countries relates to their economic structure as well as to political, sociological and cultural factors. The latter is further complicated by generally lower administrative and enforcement capabilities, resulting in a low tax/GDP ratio levied on a narrow tax base and a narrow set of individuals.
Regarding the taxation of individuals, most workers in developing countries are typically employed in agriculture or in small enterprises and are often paid in cash. The base for a personal income tax is therefore hard to calculate. They also spend their earnings mostly in informal sectors that do not keep accurate records of sales. Furthermore, many developing countries do not fully exploit personal income and property taxes.
As for the taxation of corporations, many developing countries are dependent on revenue from a few multinationals. However, the arm’s length principle that governs the allocation of profits between subsidiaries of multinationals does not favor developing countries, which are typically home to the subsidiaries of multinationals operating under the limited-risk profile and collect corporate income tax via transfer pricing on routine profitability.
Consequently, modern means of raising revenue such as levying income and consumer taxes pose challenges in such economies, and it is little wonder that resource-rich developing countries often choose resource wealth as their main source of revenue. Meanwhile, the citizens of these countries are often poorly served by their governments yet have less incentive to demand efficient and responsive governance in return since they are not taxed. This vicious circle is a threat to civil society and human rights and increases the risk of corruption.
Based on the above, responsible governments should rethink their taxation system, finding one that best aligns with the reality of developing countries. Corporations often decide to establish production sites in developing countries for their significant consumer base, low-cost workforce and access to natural resources for value creation, while the richest segment of the population tends to consume excessive quantities of these same natural resources. Such characteristics would suggest that the taxation of use of natural resources could be an effective alternative to income and consumer taxation, producing significant fiscal benefits, among others.
Although natural resource taxation programs have already been implemented in many developed countries (for instance, a carbon tax), this form of taxation has gone virtually unexplored in most developing countries. However, the present global economic slowdown and refugee crisis indicate that now would be a good time for developing countries to revisit this form of taxation.
The idea of natural resource taxation and shifting the tax base from value added (labor and capital) to resource throughput (depletion and pollution) is not new. However, in order for this tax system to be effective in developing countries, its mechanism must differ from traditional income taxation schemes.
The efficient taxation of natural resources should move away from mechanisms relying on income or profit calculation (for instance, the ad valorem or profit-based mining royalty) to avoid running into the same challenges as those relating to income taxation. An alternative could instead be unit-based royalties or direct taxation of negative externalities.
In terms of tax planning under the direct resource taxation mechanism, the discussion could shift from required substance to cost of negative externalities, which are easier to measure and control. A further consideration should be that collecting direct resource taxes requires a less complex system of monitoring, enforcement and compliance.
In addition, from a political perspective, taxation of common property (resources used by corporations in the production process and consumed by people) and taxation of resource owners that receive scarcity rent are more socially acceptable than is taxation of value.
Finally, taxation of resources also incentivizes investment in innovation, as innovation savings are not taxed. Since tax would be proportional to resources used, it would incentivize responsible use of resources and promote investment in innovation to generate savings on their use.
Of course, the proposed direct taxation of use of natural resources is not without various challenges. The scale of the operation (for instance, at the start-up phase) may not be sufficient to withstand the burden of a natural resource tax payment. Different natural resources may also have very different labor, cost, price, value-added, environmental and social attributes.
Moreover, higher natural resource prices can be passed on to consumers. To address those concerns, a varying natural resource tax for different groups of resources and according to size of production may be applied.
On the other hand, higher natural resource prices may put countries at a competitive disadvantage in international trade, although the proposal is to use the natural resource tax as an alternative to the traditional taxation mechanism (that is, no additional burden). There is no evidence that environmental policies lead to an exodus of corporations to locations with lax environmental policies.
In order for developing countries to move away from a heavy reliance on income from natural resources and to attempt to become fully integrated in the world economy and pursue a government role closer to that of developed countries, we need to increase opportunities for them to adopt taxation systems that are in alignment with their reality. A system of direct taxation of use of resources rather than the traditional taxation of value added to natural resources may be necessary as a means to create the proper environment for their economic and political development.
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Marta Milewska is a partner in PwC’s Global Transfer Pricing Network based in Mexico City, Mexico. Marta Milewska has over 15 years of experience in advising multinational firms on business transformation, transfer pricing, IP planning and other tax advisory issues in Mexico. In particular, she has performed projects in the mining, pharmaceuticals, consumer goods industries. Marta Milewska has written numerous articles and has made numerous presentations in Mexico regarding transfer pricing.