Productivity is a determining factor in our standard of living. In our April 2020 edition of Fiscal Monitor, we demonstrated that countries can increase productivity by improving the design of their tax system, including both policy and administration. This would allow the hiring and investment decisions of the companies to obey commercial and non-tax reasons.
For the Companies:
Countries can significantly increase productivity by removing obstacles that limit the activity of the most productive firms. These obstacles include poorly designed economic policies, or markets that don’t work as they should. We estimate that the elimination of the obstacles would imply an average increase in the annual growth rate of real GDP of the order of one percentage point in 20 years in the countries as a whole. We also found that emerging market and low-income countries can achieve a quarter of those increases if they improve the design of tax policies and public revenue management. For taxes as an independent contractor you need to consider the same.
Do more with the same resources
Countries can increase productivity by removing obstacles that cause poor use of existing resources at the country level that is, the inefficient allocation of resources. These obstacles prevent productive companies from expanding and allow others to survive despite being unproductive.
When comparing a less efficient country with one close to the world productivity frontier, the contrast is stark. As seen in the graph below, the least efficient country actually has several highly productive firms. The main difference is that the least efficient country has many more unproductive companies.
How can better allocation of resources between companies increase productivity?
Let’s imagine two companies that produce software, with identical technologies but different tax behavior. Due to poor tax administration, a company bypasses the controls of the tax authority and skips paying taxes, resulting in a lower user cost of capital. The other company complies with its tax obligations due to a more rigorous control of the tax authority, which implies a higher cost of capital for the user. Due to the difference in the cost of the user, the evading company has resources to invest in projects of lower profitability, while the company that pays all its taxes can only invest in projects of high profitability. In this example, the aggregate product would be higher if capital shifted from the evading company to the complying company,what would allow a greater investment in projects of higher profitability.
Impact of taxes on productivity
What motivates the inefficient allocation of resources? This phenomenon occurs when public policies or poorly functioning markets favor some companies over others. As an example, they can cite tax incentives that depend on the size of the company or the type of investment, inefficient tax collection, tariffs on certain goods, product regulations that limit access to the market, preferential loans granted to certain companies, and financial markets that are not fully developed. Facing all these policies and practices is a very complex task.
