Why Teachers Need Tax

Thursday, November 10, 2016 - 10:59

The Sustainable Development Goal on education establishes ambitious targets and to finance the achievement of these, we need a radical shift, a rebuilding of confidence in the capacity of the governments to fully finance public education that is of good quality – and that can only come from a substantial scaling up of investment. Fundamentally education is a long term investment that requires predictable financing. It is not a short term, one-off, quick win. The major returns to investment in education accrue over 10 or more years (when children complete their education and contribute to their society). The biggest single costs are recurrent costs – especially for teacher salaries. Aid is seen as both too short term and too unpredictable to cover such costs. We need systemic solutions and sustainable financing – features that are most closely identified with tax.

Tax is presently the major source of financing government’s education plans– even in highly aid-dependent low income countries. Many countries are coming close to achieving the two common benchmarks of 6% of GDP and 20% of public expenditure being spent on education, but still lack sufficient revenue and this means we need to pay more attention to the size of government budgets overall. Tax-to-GDP ratios are a widely used measure of tax collection and in order to provide universal education, a state is likely to require (according to Piketty) at least a ratio of 20% - which many low income countries fall short of.

Focusing on tax as source of revenue has other benefits – as well as raising predictable revenue, it is a key means to redistribute resources and reduce inequality. There are also major benefits in terms of building accountability – strengthening relations between citizens and state and encouraging better governance.

Some forms of tax are “progressive” (put simply, where those with more, pay more as a proportion of their income) and some “regressive” (where those with more pay less as a proportion of their income). Whilst a case can be made for expanding revenue for education by any means, there is a particular virtue to use a progressive tax base for progressive spending on education as this doubles the dose of inequality-reduction at a time when everyone from the Pope to the IMF are concerned to achieve this.

One important place to start in promoting tax reform is around corporate taxation, partly because this has become the focus of a lot of international attention in recent years as illustrated by the OECD’s Base Erosion and Profit Shifting (BEPS) process and the G20 political impetus behind it, the African Union’s High Level Panel on Illicit Financial Flows and the growing popular movement calling for companies to pay a fair share of tax. This is also an area of taxation where there is a huge impact from tax avoidance strategies in developing countries - and which therefore represents a potentially significant means for scaling up financing of education. The $39 billion resource gap for education could be more than filled by coordinated action in this one area!

A major focus needs to be on multinational corporations because domestic businesses are not usually offered the same tax incentives or holidays (which are mostly used to attract foreign investment); because MNCs have particular opportunities to avoid tax due to their international nature, and because a tremendous amount of money is at stake. A progressive intervention in the area of tax justice should rightly start where the inequality is greatest – and this is particularly so when supporting education which has such a powerful equalising potential.

In focusing on corporate tax and multinational companies we need to recognise that there are many ways in which the scope for domestic action depends, in part, on better coordinated international action. At present global tax rules are set by the club of rich nations – the OECD – and it is clearly time for an inclusive and well-resourced UN body to be established to both set fairer rules and enforce them. The failure to agree such a recommendation was a major disappointment from the Financing for Development conference in Addis in 2015 which sought to come up with ways to finance the SDGs.

There is a particularly strong case for teachers and education activists to push for tax reforms in four areas:

  1. Ending harmful tax incentives ($139 billion in revenue is foregone by governments under the illusion that they need to give tax breaks in order to attract investment),
  2. Challenging aggressive tax avoidance (between $100 and $200 million is lost to education and other public services by increasingly common but unethical practices),
  3. Renegotiating dodgy tax treaties (many treaties are profoundly imbalanced, depriving developing countries of desperately needed resources), and
  4. Raising earmarked taxes (specifically for education).

Each of these is spelt out a little further in the annex below. It can get a bit technical – but we all need to overcome our fear of tax! An excellent new toolkit “Financing Matters” jointly published by the Global Campaign for Education, Education International and ActionAid will help in this task - offering some practical, easy-to-use resources for teacher unions, coalitions and activists around increasing domestic financing of education.

The bottom line is that we need to raise both significant and sustainable new financing to help countries achieve full implementation of all the targets in the education SDG. Short-term, one-off solutions will not represent a breakthrough. An extra billion or two will not make a lasting difference. Placing a strong focus on how to expand the tax base for financing of education offers the best prospect for delivering what is urgently needed – tens of billions of dollars in sustainable funding, year on year to pay for the millions of new professional teachers that are urgently needed around the world. Crucially, this also offers a way to provide sustainable financing that deepens rather than undermines the accountability of national governments to deliver on the right to education.

This is an issue whose time has come. The furore around the world following the Panama Papers showed the widespread public and political support for reform. It is time for the negative cycle of lost revenue and low investment in education to be replaced by a positive cycle of expanding domestic tax revenue to invest sustainably in the core recurrent costs of education that will yield the long term economic growth - that in turn will expand revenues further.

This article is based on a report “Domestic Tax and Education” written by ActionAid for the Education Finance Commission. Also recommended is a new toolkit “Financing Matters” that offers practical guidance on domestic financing of education for teacher unionists and education activists.

For further details contact david.archer@actionaid.org / Twitter @DavidArcherAA


ANNEX: Four areas where action on tax can make a difference for education

There are four key areas where action on tax could make a massive difference to the financing of education in the coming years.

  1. Strategically targeted tax incentives can play a crucial role in supporting national development but many tax incentives cause far more harm than good in developing countries. They can massively reduce government revenues by removing the requirement for companies to pay fair levels of tax and they can encourage corruption and secrecy when negotiated in highly discretionary ‘special deals’ with individual companies. Indeed they mainly attract ‘footloose’ firms which move their investments from one country to another, and therefore do not encourage stable long term investments. Where they favour foreign investors tax incentives they can disadvantage domestic investors and deter them from entering markets or expanding. Finally, they often require large resources to administer and are rarely transparently implemented. The ostensible reason for governments providing tax incentives to business is to attract foreign direct investment (FDI), yet the evidence, including the academic literature, suggests that tax incentives are not needed to attract FDI. There are four types of incentives that are particularly problematic: discretionary incentives, tax holidays, tax incentives in free trade zones and stability agreements. ActionAid estimates that developing countries lose US$138 billion a year just from one form of tax incentive – corporate income tax exemptions, or nearly US$3 billion each week. In just over two months, if channelled to where it is most needed, this could fill the annual global finance gap for basic education.
  2. Action is needed on an ethical approach to tax compliance – to challenge both tax evasion (which is illegal) and tax avoidance (which whilst legal often breaks the spirit or intent of the law). There are various ways used to avoid tax compliance, including transfer pricing manipulation (where goods or services traded among different companies within the same group can be manipulated in order to shift money from one jurisdiction to another with lower tax rates), transfer mispricing (where deliberate and illegal steps are taken to artificially shift income and/or profits), excessive interest deductions and thin capitalisation (where guarantees are used to create excessive debt or where excessive interest rates are charged on intra company loans), trade misinvoicing (which involves deliberately misreporting the value of a commercial transaction on an invoice submitted to customs), artificially channelling funds through tax havens (attracted by low rates and high secrecy) and hybrid mismatches (which depend on differences in the tax treatment of an entity or instrument in two or more jurisdictions that, working together, result in double non-taxation). The very lowest estimated figure for tax losses is US$ 100bn annually and if 20% of this was spent on education, it would be enough to cover half of the global resource gap to get all children into primary and lower secondary school, estimated at US$ 39 billion. To achieve progress there is an urgent need to: strengthen tax rules and systems in developing countries; change rules in developed countries where they affect developing countries; increase transparency and information exchange; and revamp corporate taxation at an international level.
  3. There is an urgent need to review bilateral tax treaties. Some treaties are very old, which means they were not designed to deal with the increasingly globalised and digital economy and, in some cases, reflect a different balance of power (e.g. from colonial times) at the time of negotiation. There are challenges that arise owing to the allocation of taxing rights (especially where “resident based taxation” – taxing a company where it is based - is preferred over “source based taxation” – tax paid where the economic activity occurs), owing to reductions of withholding taxes and owing to the differences between treaties that can be exploited for tax avoidance purposes. The aggregated impact on developing countries could amount to billions of dollars a year.
  4. There is a strong case for exploring earmarked taxes for education. There are many examples of these, such as the Ghana Education Trust Fund (funded by 2.5% of VAT collections), the Nigeria Tertiary Education Trust Fund (to which national companies pay 2% of assessable profits), the Brazilian Fund for Maintenance and Development of Basic Education (partly financed by earmarking 15% of VAT revenues), China’s Educational Surcharge levied on VAT taxpayers at 3% of Consumption and Business Taxes; and India’s flagship education programme that is funded partly by an ‘education cess’ (a ‘tax-on-tax’ introduced on all Union taxes at the rate of 2 per cent). In any scenario where earmarked taxes are used for education there is a particular need to ensure that they are only one source of funding and that they are supplementary to existing allocations - generating genuinely additional revenue that would not otherwise be raised. A key step here is setting a benchmark on existing tax allocations or spending on education, before introducing a new earmarked tax - so that it can be clearly seen (and tracked) that the earmarked tax is providing additional revenues.

(All data comes from “Domestic Tax and Education”, research produced for the Education Finance Commission by ActionAid 2016)