76 | Chapter 11
equity, however, actually serve such ends. In many instances, the nonpoor
turn out to bene t more than the poor. In any case, policies on land tenure,
factor pricing, and rural- urban terms of trade may be more potent than s-
cal mea sures for promoting distributional goals.
IX. The chapter concludes with a discussion of how tax policy affects economic
ef ciency. Taxes carry administrative costs, which frequently are high, and
they impose an excess burden by distorting market outcomes. An ef cient tax
system would minimize the excess burden, but this standard is costly and
impractical to administer. Hence, the text favors the principle of tax neutral-
ity, whereby taxes are designed to create minimal distortions to relative prices.
This entails relying on uniform tax rates that apply over a broad tax base.
Boxed Examples
Box 11– 1: Reining in Fiscal Decentralization in Brazil and China
Box 11–2: Tax Rates and Smuggling: Colombia
Box 11–3: Tax Administration in India and Bolivia in the 1980s
Box 11–4: Indonesian Tax Reform
The rst box examines recent progress in Brazil and China in reforming scal
policy and discipline within their own countries. The second box examines how
high import duties on cigarettes by Colombia led to the emergence of widespread
smuggling and how the duties were slashed to drive the illegal market out of busi–
ness. The third box studies tax administration in India and Bolivia in the 1980s.
This mini- case study shows that relatively enormous revenue losses can come from
poor tax administration and that corresponding revenue gains can accrue when
governments take effective mea sures to simplify and improve tax administration.
The nal case study examines how the Indonesian Ministry of Finance modernized
its tax system during the 1980s, with the assistance of 25 international experts. The
reforms led to scal stability that continued when world oil prices fell in 1986.
In the New Edition
This chapter continues to focus on the key components of government expendi-
tures and revenues. The material in the chapter has been updated to examine more
current issues in scal policy faced by developing nations. A new box has been
added on the challenges of scal decentralization in Brazil and China.
Class Notes
Chapter 11 contains a formidable amount of material. Important themes pre-
sented here consider how governments can raise bud getary savings and how the
if brie y, the essential terminology to help students comprehend the wide variety
of tax policies and their implications for a developing economy. The concluding
paragraphs discuss the paradox of pursuing “proper” tax policies— only to poten-
tially face unintended consequences.
QUESTION BANK
Concept Map
Fiscal Policy
Government Expenditures
Categories of Government Expenditures
Sales and Excise Taxes
Personal and Corporate Income Taxes
Fundamental Tax Reform
Corporate Income and Property Taxes
Neutrality and Ef ciency
Multiple- Choice Questions
1. When governments raise expenditures or cut taxes on individuals and cor–
porations so that they can raise their expenditures, such actions are referred
to as:
a. scal policy.
b. monetary policy.
c. indexing.
d. regressive taxation.
2. Developing country governments are more likely to focus on mea sures to
increase investment for:
a. pro teering and graft.
b. health and education.
c. overall growth.
d. enhancing their ability to get more loans from the World Bank.
3. The term public good refers to a good or ser vice that:
a. results in income and pro t.
b. is free and portable.
c. has a value of zero.
d. exhibits nonrival consumption and nonexcludability.
4. Investments that, in general, generate a stream of income or ser vices into the
future are known as:
a. future markets.
b. public (development) expenditures.
c. recurrent expenditures.
d. private (luxury) expenditures.
5. In developing countries, borrowing domestically often means borrowing
directly from the:
a. World Bank.
b. central bank.
c. the IMF.
d. other nations in the geographic region.
6. Consumer subsidies are not unique to developing countries; although they
are in many ways costly, governments are reluctant to eliminate them because
such action typically leads to:
a. de ation.
b. neutral taxes.
c. demonstrations or even riots against the government.
d. the emergence of corporatism.
7. Although taxes on foreign trade have fallen dramatically in recent de cades, tax
revenue structures in developing countries historically have been dependent on:
a. import duties.
b. excise taxes.
c. overvaluing their currency.
d. the exploitation of one resource.
8. The primary difference between excise and sales taxes is that only excise
taxes are:
a. imposed on speci cally enumerated items.
b. paid by the consumer rather than the seller.
c. progressive.
d. revenue elastic.
9. As usually applied, the value- added tax (VAT) is a:
a. form of excise tax.
b. tax on income.
c. tax on consumption.
d. tax on domestic production.
10. Heavy taxes on alcohol and tobacco are favored because:
a. they are progressive.
b. they display a high price elasticity of demand.
c. most governments want to discourage consumption of these items.
d. all of the above.
11. High tax rates often encourage taxpayers to engage in illegal maneuvers to
avoid paying taxes. The term used for this behavior is:
a. revenue elasticity.
b. tax avoidance.
c. tax evasion.
d. excess burden.
12. One of most signi cant changes that most developing nations could take to
increase their tax revenue would be to:
a. raise taxes.
b. reform tax administration.
c. institute a strong corporate tax.
d. undertake radical land redistribution.
13. The value- added tax (VAT) form of the sales tax is preferred in many devel-
oping countries because:
a. a large share of VAT revenue is collected prior to the retail level.
b. the VAT can be levied at a higher rate.
c. rms have no way to suppress information on their purchases and sales.
d. there is no need to conduct periodic audits to ensure compliance.
14. Which of the following statements best captures the textbook’s conclusions
about using scal policy to promote equity in developing countries?
a. Equity is not a proper goal for scal policy.
b. Economic and administrative realities limit the scope for achieving
income redistribution through the tax system.
c. Highly progressive taxes can and should be used to promote equity and
ef ciency simultaneously.
d. Tax policy is far more effective than expenditure policy as an instrument
for income redistribution.
15. A neutral tax system is one that:
a. generates no excess burden.
b. affects government savings and private sector investment decisions
equally.
c. balances the government bud get.
d. relies, as far as possible, on uniform tax rates.
IDs and Paired- Concept Questions
These terms can be used individually as short- answer identi cation questions, or
they can be used in pairs. In the latter case, ask students to explain (1) the meaning
and signi cance of each of the two terms and (2) the relationship between them.
2. Development expenditures, recurrent expenditures
4. Excise tax, sales tax
6. Direct taxes, indirect taxes
8. Personal tax, corporate tax
10. Tax incentives, tax shelters
12. Effective taxes, luxury tax