Fiscal policy has never been more central to public policy debate than now, whether in relation to macroeconomic policy (Farhi and Maggiori 2017, Huidrom et al. 2016, Manasse and Katsikas 2018) or concerns about inequality (Piketty 2014, Clements et. al. 2014). Information is at the heart of this debate. The effectiveness of a government’s fiscal policy depends on its ability to collect, process, and act on a vast array of information on the economy and its actors. This includes information on the incomes and assets of taxpayers, the level of unemployment, or the identity and circumstances of beneficiaries of social programmes, actual and potential.
Digitalisation – the integration of digital technologies into everyday life – has vastly increased our ability to collect and exploit this information. It is already starting to reshape how governments formulate and implement fiscal policies. The possibilities are only now starting to be imagined, and the risks only now beginning to be recognised. These possibilities and risks are the subjects of our book Digital Revolutions in Public Finance published by the IMF (Gupta et al. 2017).
New technologies are already changing public finances
By using digital systems, standardised reporting formats, and electronic interfaces, tax authorities are increasingly gaining access to the vast amount of information held by the private sector on things such as bank transactions and interest income. Authorities in Australia and the UK, for example, receive real-time data on wages paid by employers, and hence on the state of the economy.
Better systems are emerging for implementing tax and spending policies. One of the first digital innovations for tax authorities has been the spread of electronic filing of tax returns, which has reduced the cost of compliance for taxpayers and of administration for the government. Many countries began experimenting with this a decade or more ago (OECD 2006, Deloitte 2013). Access to third-party information increasingly allows governments to pre-populate tax returns, so that taxpayers need only verify the information. And new norms in tax transparency include a global reporting standard for the automatic exchange of information between tax authorities, making it harder for people to conceal income by locating assets abroad.
Digitalisation is also allowing governments to track business activity electronically. In Brazil, the Public System of Digital Bookkeeping (SPED) allows authorities to determine the income tax obligations of companies. China uses invoice-matching technology to verify that businesses claiming VAT credits or refunds on their purchases were actually charged the tax, going a long way towards solving a longstanding problem for tax collectors around the world (Fan et al. 2017).
Increased processing capabilities have allowed tax authorities to access taxpayer risks by analysing large data sets, and by combining data sources. At HM Revenue and Customs in the UK, the Connect computer system draws on a wide range of government and corporate sources, as well as individual digital footprints, to create a profile of each taxpayer’s total income. This can be used to assess the accuracy of the information their reported earnings. High-frequency fiscal data – now available through financial management information systems – can now be used to improve budget forecasts. For example, governments can exploit the correlation between tax receipts and the business cycle to anticipate an economic crisis, or to monitor cash balances to assess liquidity and borrowing needs.
The growth of the peer-to-peer business model, which allows buyers and sellers to transact across a digital platform, offers further opportunities to improve tax collection. In Estonia, Uber drivers can opt to have their income reported directly to the country’s tax administration. The platforms can also act as custodians. In several countries, Airbnb withholds hotel taxes on behalf of its hosts.
Digital technologies, including electronic payment systems, have also improved the delivery of social welfare payments. Digitalising payments has significantly reduced costs of administering programmes such as Ti Manman Cheri in Haiti, which helps mothers support their families, and 4Ps in the Philippines, which provides cash grants to the poorest families. India has led the way in the use of biometric technologies – its Aadhaar system covers 1.1 billion people – to extend social benefits to a larger number of people. The country’s Direct Benefit Transfer programme, launched in 2013, transfers money directly into bank accounts linked to the biometric identity of the beneficiary.
Kenya has pioneered the adoption of mobile payments technology. The M-Pesa system, launched in 2007, can be used to pay taxes and for government services. This has reduced interactions between taxpayers and tax officers, and so restricts opportunities for corruption.
Much more to come
Digital technology can be harnessed to design new policies. For practical reasons, income tax systems conventionally work on an annual basis. But our well-being depends on our income over a much longer period, in principle an entire lifetime. At the same time, when we are in need we often require support immediately. Better access to, and ease of, manipulating data could allow our governments to take both a shorter- and a longer-term view of our circumstances, improving the effectiveness of the tax-transfer system.
The potential for the use of blockchain technology to improve the design and management of the public finances is only just beginning to be explored. Customs administration is one obvious area for consideration. Much more speculatively, blockchain might ultimately eliminate the need for a VAT (charged at every stage of production, with businesses allowed an offset for taxes paid on inputs). If the entire chain of transactions could be securely recorded (this is a very big ‘if’), a tax account could be continuously maintained at each stage of production. The tax could then simply be calculated and imposed at the point of final consumption.
The use of biometric authentication and digital payments systems to better target subsidies can reduce our reliance on blunt redistributive instruments. One example would be the application of reduced VAT rates for necessities, which, while aimed at the poor, benefit the wealthy even more. If we replace them with a poll subsidy targeted on the basis of biometrics, it would both help the poor and increase net revenue.
Of course, there are limits to the benefits of digital technology. It is no substitute for getting basic procedures and operations right. Pre-populating tax returns, for example, might make it easier to cheat if the information entered is inaccurate, since taxpayers have little incentive to correct errors that reduce their tax bill. Political, institutional, and human capacity constraints may slow down government innovation and the uptake of advanced solutions. Past failures in introducing integrated financial management information systems, particularly in developing countries, illustrate some of these constraints (Diamond and Khemani 2005, USAID 2008). Corrupt bureaucrats and taxpayers might bypass digital systems. And the potential for ‘leapfrogging’ by developing countries will be limited if large segments of the population lack access to the digital world.
There are also major concerns in the realms of cybersecurity, privacy, and fraud. Thefts of data from, and ransom attacks on, government agencies have highlighted their potential vulnerability. Some European countries face many fraudulent VAT refund claims that are too small individually to detect, but significant when they ae added together.
In the corporate sphere, digitalisation has amplified challenges to the current system, which focuses on a company’s bricks-and-mortar presence. Companies can have a large economic presence in a country without having much, or even any, physical presence there, and the data they collect on the users of their services have substantial commercial value (for targeting advertising, for instance).
It is an open (and contentious) question whether this requires a new approach to taxing profits. Options would include imposing liability where consumption takes place, rather than where business has a production-related presence, or perhaps – an ultimate step in the movement toward automatic information exchange that is already underway – where shareholders are located.
More widely still, advances in artificial intelligence and robotics have aroused fears of rising unemployment and widening inequality (Acemoglu and Restrepo 2016). Policymakers may face the prospect of a shrinking tax base and rising social welfare payments. Some suggest taxing new labour-replacing robot capital. Others call for distributing capital ownership more equally and taxing the profits generated through automation, to preserve productivity improvements associated with new technologies. Universal basic income, while costlier than means-tested systems, is also gaining support.
The way forward
The digital revolution is already well underway, and the challenges of responding to and absorbing this rapid, continual change are already here. Given the speed of innovation in the private sector, it is clearly urgent that governments to harness the opportunities and mitigate the risks.
Each country’s path to digitalisation depends on its circumstances. While most advanced economies are choosing incremental approaches, developing countries have the potential to leapfrog to newer and more sophisticated policy formulation, design, and implementation. All countries, however, must act if they are to exploit the benefits and avoid the pitfalls. Technology heightens the importance of strong fiscal, political, and governance institutions.
-Sanjeev Gupta, Michael Keen, Alpa Shah, Geneviève Verdier