How Improved Fiscal and Financial Management Can Improve Public Trust and Reduce Corruption

Domestic resources are the single largest source of development finance. As estimated funding to tackle development challenges in Asia and the Pacific surpasses $1 trillion a year, domestic resource mobilization in developing countries has come under increased attention. 

Domestic resource mobilization is where a country raises and spends its own financial resources (e.g. taxes) for public goods and services. Improving domestic resource mobilization can help countries decrease their need to borrow and increase their finances for development. 

Efforts to increase domestic resource mobilization have focused more on one side of the equation, fiscal policies to increase tax revenues, and less on the other, financial management systems for effective expenditure management. 

The data indicate that countries where governments credibly demonstrated sound financial management of domestic resources and had robust systems to oversee its use and minimize its waste, were also able to achieve higher levels of domestic resource mobilization. 

The most common metric for measuring domestic resource mobilization is the tax to GDP ratio. It was found that tax revenues tend to increase when transparency, oversight, and corruption perceptions improve.

Transparency, oversight, and corruption are three critical links between fiscal and financial management.

Transparency in budgeting and accounting helps citizens understand how public funds are spent. Transparency demonstrates how effectively governments plan and use tax funds. Timely availability of and accessibility to information on government budgets and government expenditures are crucial for understanding what budget decisions have been made with tax funds and how they have been spent. 

Budget transparency worldwide is poor, particularly in Asia and the Pacific. The 2021 Open Budget Survey found the average global score for transparency was 45 out of 100, indicating that public availability of budget information is limited in most countries. The average score for developing countries in Asia and the Pacific region is marginally better at 48, with only six countries above the acceptable transparency score of 61. 

Efforts to increase domestic resource mobilization must balance fiscal policies to raise tax revenues with strong financial management systems for effective expenditure.

High corruption is linked to lower tax revenues and reduced public trust in government.

Corruption erodes public confidence and reduces tax morale (i.e. intrinsic motivation of citizens to pay taxes to governments).

Several studies have concluded that countries with high levels of corruption tend to have lower tax to GDP ratios, with an International Monetary Fund paper estimating this at 2.7% decline in tax to GDP ratio for every one-point deterioration in corruption index. Corruption also results in wastage and misuse of funds, and if unchecked for a prolonged period, erodes public confidence in governments to manage tax funds. 

The 2023 Transparency International report notes that Asia and the Pacific has a long stagnant average score of 45 out of 100, with developing countries in the region averaging 36 out of 100. 

Strong oversight of public funds assures citizens that tax funds are being prudently used. Assurance comes from timely external audit of government accounts and legislative scrutiny of budgets and public expenditure – crucial for holding governments accountable for use of tax revenues. 

Auditors provide independent assurance on the reliability of government accounts, and report on any misappropriation, misuse, or wastage of public funds. Legislative scrutiny, based on audit reports and other available information, is also needed to interrogate government officials on how they implemented the budget and delivered on their policies and programs. 

The average score for external audit and legislative oversight for developing countries in Asia and the Pacific region is 52 with only eight countries above the acceptable score of 61. 

Why does this matter?

This inextricable link between fiscal and financial management is indicative of a virtuous circle that influences the tax morale of citizens to pay taxes. It also alludes to a fiscal contract between taxpayers and governments - that tax funds will be managed well to deliver better public goods and services, efficiently and effectively, for the betterment of the country and well-being of its people. 

Tax policies and reforms without improvements to public financial management systems may not be as effective It is akin to asking lenders and investors to inject more funds into a corporation without disclosing the investment plans or reporting on returns. 

It is to be noted that tax to GDP ratio may vary widely across countries based on fiscal policies, economic priorities, welfare state of an economy, wealth distribution and other policies of a government. But governments’ accountability to taxpayers always remains and is crucial for implementing tax policies effectively and optimizing tax revenues for the country. 

What should governments and development partners do?

Pursue tax and public financial management reforms in tandem. Governments seeking to increase domestic resources must explicitly link tax revenues with public expenditure. And tax reforms to increase domestic resources should be combined with public financial management reforms to improve expenditure management. 

Robust institutions for external audit, legislative scrutiny, and for addressing corruption and misuse of funds will enhance the credibility of governments to manage tax funds. 

Taxpayers have expectations of their governments and working to improve both sides of the equations - how resources are collected and how they are managed – will be more beneficial to both in the long term.