Systemic problems encountered in many developing country tax administrations have hindered efforts to increase public saving and have proven to be the weak link in a number of economic stabilization programs. For these reasons, consideration of radical reforms of tax administrations is warranted.
This paper analyzes the merits of the arguments put forward in favor of an alternative tax collection mechanism—tax farming—that was commonly employed in the past by governments facing problems similar to those facing contemporary developing countries. Tax farming is a system wherein the right to collect certain taxes owed the state is auctioned off to the highest bidder. The farmer then keeps whatever revenue is collected. A winning bidder wishing to maximize profit will operate at the point where private marginal revenue equals private marginal cost. Tax farming represents a private sector solution to the tax collection problem.
Although some contemporary observers, such as Azabou and Nugent (1988), argue that tax farming should have a bright future, this paper concludes that tax farming was popular primarily because of its ability to generate the maximum gross revenue in a way that obfuscated the government’s role in setting policy. This objective is unlikely to be congruent with that of an enlightened modern tax administration. Although it is certainly true that direct government administrative costs are lower under tax farming, these costs will be borne by the private sector and will be deducted from net government revenue. Moreover, if the government seeks to ensure a fair and proper administration of tax law, considerable effort would be necessary to monitor the process of tax collection by tax farmers. Consequently, tax farming seems to have significantly less to offer developing countries today than its proponents claim.
Azabou, Mongi, and Jeffrey B. Nugent, “Contractual Choice in Tax Collection Activities: Some Implications of the Experience with Tax Farming,” Journal of Institutional and Theoretical Economics, Vol. 144 (September 1988), pp. 684–705.
Chand, Sheetal K., and Henri R. Lorie, “Fiscal Policy,” in Fiscal Policies in Transition, ed. by Vito Tanzi (Washington: International Monetary Fund, 1992).
De Vries, Jan, The Economy of Europe in an Age of Crisis, 1600–1750 (Cambridge, England: Cambridge University Press, 1976).
Stella, Peter, “How Lucrative Should Tax Enforcement Be?” paper presented at the Western Economic Association meeting in San Diego, California (July 1990).
Tanzi, Vito, “Fiscal Policy and Economic Reconstruction in Latin America,” IMF Working Paper 89/94 (Washington: International Monetary Fund, November 1989).
Webber, Carolyn, and Aaron Wildavsky, A History of Taxation and Expenditure in the Western World (New York: Simon and Schuster, 1986).