INTRODUCTION 9
Th cult choices: e fall in tax revenue presented each government with diffi
either government expenditures must fall or government debt must in-
crease. Th e fall in expenditures can undercut development due to the re-
sulting poor education and inadequate infrastructure. Th e fall also risks
increasing po liti cal opposition to the reforms, since many individuals lose
more from the drop in ser vices than they gain from the new economic op-
portunities. Debt, in contrast, allows ser vices to continue but creates the
risk of a fi nancial crisis if the government does not have the revenue in the
future to repay the debt. China chose to cut ser vices and to fi nance re-
maining ser vices through user fees. India initially borrowed heavily in or-
der to maintain ser vices, but recently has shifted to cutting ser vices. To
what degree this fall in ser vices will undercut growth is yet to be seen.
A third alternative is to leave in place some provisions protecting the
formal sector. Both China and India, for example, maintained a sizeable
state- owned sector. Both countries also relied on local governments to
better monitor and tax smaller fi ectively be moni- rms that could not eff
tored by the national government. Such provisions, though contrary to
the conventional wisdom, may be important in reducing the risks faced
when undertaking economic reforms.
With the immediate loss in current tax revenue from economic re-
forms, and the combined po liti cal and fi nancial risks resulting from the
loss in tax revenue, economic reforms can seem daunting for any govern-
ment that does not have a long time horizon. Problems with tax adminis-
tration in developing countries not only create diffi culties in raising cur-
rent revenue, as documented at length in the six chapters in this volume,
but also create substantial hurdles when considering the adoption of poli-
cies that encourage a more rapid rate of economic growth.
N O T E S
1. The Rus sian study more narrowly focuses on the evolution of the value- added
tax during the past 15 years, given its complicated history.
2. In the United States, as of 2004, for example, the personal income tax together
with the payroll tax accounted for 80 percent of federal tax revenues.
3. The key assumption is that consumption patterns do not vary by ability levels,
even if they do vary by labor income.
4. Note that VAT/Consumption (VAT/Tax Revenue) * (Tax Revenue/GDP)/
(Consumption/GDP).
5. Among developed economies as a whole, corporate tax revenue on average is
under half of personal tax revenue and under a quarter of personal tax revenue in the
United States.