Public Finance Goes Digital
Digitalization is starting to reshape this informational core of the
way tax and spending policies are designed and carried out.
In Kenya, people can pay their taxes on their mobile phones. In India, they
receive subsidies and welfare payments directly into their bank accounts,
which are linked to unique biometric identifiers. In several advanced and
emerging market economies, tax authorities collect information on sales and
wages in real time, which gives them immediate insight into the state of the
economy. Public finance, like so much else, is undergoing a digital
Public finance is the art of raising and spending money to deliver services
and benefits, redistributing income, and smoothing the ups and downs of the
business cycle. How effectively governments do these things depends
crucially on their ability to collect, process, and act on a vast array of
information: how much companies and workers earn, how many people are
unemployed, who qualifies for government benefits.
Digitalization is starting to reshape this informational core of the way tax
and spending policies are designed and carried out. It offers tools not only
to improve the effectiveness of existing policies but also to introduce
entirely new ones. But there’s a dark side: digitalization has intensified
concerns about privacy, confidentiality, and cybersecurity while adding to
the larger debate over inequality and redistribution.
Rich Troves of Information
Through digital systems, standardized reporting formats, and electronic
interfaces, tax authorities are better able to access the rich troves of
information collected by the private sector on such things as bank
transactions and interest income. Authorities in Australia and the United
Kingdom, for example, receive real-time data on wages paid by employers. In
Brazil and Russia, electronic invoicing systems allow immediate access to
data on firm sales.
Better data collection, combined with increased processing power, allows
governments to improve existing ways of collecting taxes. Electronic filing
makes it easier and cheaper for taxpayers to fill out tax returns and for
governments to process them. Access to third-party information is now so
complete that a small but growing number of tax authorities prepopulate tax
returns, so that taxpayers need only verify the information presented to
In Brazil, the Public System of Digital Bookkeeping allows authorities to
determine a company’s income tax obligation. China uses invoice-matching
technology to verify that merchants seeking value-added tax (VAT) refunds
were in fact charged the tax, a large step toward solving a problem that has
long stymied tax collectors around the world.
The use of biometric authentication and digital payment systems
to better target subsidies may reduce reliance on blunt
Data on individual taxpayers can now be aggregated in powerful ways. In the
United Kingdom, HM Revenue and Customs’ Connect computer system draws on a
wide range of government and corporate sources, as well as individual
digital footprints, to build a profile of taxpayers’ total income, which can
then be used to assess the accuracy of the information they report. Such
increased data processing capabilities can also be used to improve revenue
forecasts. And with increased capacity to store and analyze data,
governments can exploit the correlation of tax receipts with the business
cycle to anticipate, and perhaps forestall, an economic crisis or monitor
their 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, is also offering new
opportunities to improve tax collection. In Estonia, Uber Technologies can
report income earned by drivers directly to the country’s tax
administration. Peer-to-peer platforms can also act as custodians; an
example is Airbnb, which withholds hotel taxes on behalf of the property
owners who use the platform in 10 advanced and emerging market economies.
Digital technologies, including electronic payment systems, are not only
lowering the cost of collecting taxes but also creating the potential for
expanding tax bases (for instance, by improving the identification and
monitoring of taxpayers and making it easier for taxpayers to comply by such
means as the use of mobile technology). They are also improving the delivery
of social welfare payments. Digitalizing payments has significantly reduced
the cost of administering programs 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 technology to extend social
benefits to a larger number of people. Technology that monitors and records
biometric characteristics, such as fingerprints and iris scans, allows more
accurate and cheaper authentication of an individual’s identity, ensuring
that benefits reach only the intended recipients. McKinsey & Company has
estimated that digitalizing government payment processes (both revenue and
expenditures) could deliver savings of at least 1 percent of GDP in
developing economies. This estimate overlooks second-round beneficial
effects of improvements in public service delivery and widening the tax
base. For example, the introduction of the new tax on goods and services in
India has increased the number of registered taxpayers by 50 percent in less
than one year.
Developing economies are also starting to tap the vast potential offered by
mobile technology. In sub-Saharan Africa alone, there were 420 million
unique mobile subscribers in 2016, a number that is expected to increase to
535 million (roughly one subscriber for every two people), according to
Groupe Speciale Mobile Association, an international trade organization.
Kenya has been a pioneer in the adoption of mobile payments technology. Its
M-Pesa system, launched in 2007, can be used to pay taxes. Such solutions
may be particularly promising for fragile states, where conflict and
corruption hamper tax collection and benefit payments. Mobile technology can
also be used to deliver better public services, track medical records, and
The use of biometric authentication and digital payment systems to better
target subsidies may reduce reliance on blunt redistributive instruments.
One example is the application of reduced VAT rates for necessities, which,
while aimed at the poor, benefit the wealthy even more. Better-targeted
payments that can reliably provide relief to the poorest would be more
efficient and effective. More controversially, technology has the potential
to create new sources of tax revenue. Many companies, such as Facebook and
Alphabet’s Google, now collect hugely valuable information on their
customers when they interact with them online. If it’s true, as some say,
that “data is the new oil,” do we need a special regime to tax it, as we
would a natural resource?
Secure storage of sensitive data is another crucial area for fiscal
authorities in developing and advanced economies alike. This is where
blockchain, or distributed ledger technology, holds considerable promise.
Blockchain increases trust in transaction systems by putting data into
shared, distributed ledgers in a way that creates permanent records of
transactions that cannot be lost, altered, or stolen. In the United Kingdom,
the Department of Work and Pensions is experimenting with the use of
blockchain to record benefit payments and reduce overpayment of claims.
While digital technology can be harnessed to improve existing tax systems,
it also offers tools for devising new ones. One example: current income tax
systems arbitrarily use a one-year period as the basis for assessment. But
this is too short a time horizon, because people’s well-being depends on
their income over a much longer period—in principle their entire lifetime.
It is also too short a horizon for tailoring benefits to immediate needs.
Technology could enable collection of taxes and delivery of benefits over
more appropriate time spans.
Big data too could be used to assess risks of noncompliance and predict the
behavioral impact of new tax and spending policies. Widespread use of
blockchain technology could in principle obviate the need for a VAT, which
is charged at every stage of production, with businesses allowed an offset
for taxes paid on inputs. An entire chain of transactions, securely recorded
(a very big “if”), could allow a tax account to be maintained continuously
at each stage of production. The tax could then simply be calculated and
imposed at the point of final consumption.
Limits and Pitfalls
Of course, there are limits to the benefits of digital technology. It is no
substitute for the basics of getting procedures and operations right.
Prepopulating tax returns with erroneous information, for example, could
encourage cheating because taxpayers have little incentive to correct
mistakes that reduce their tax bill. Political, institutional, and human
capacity constraints may hinder government innovation and uptake of advanced
solutions. Corrupt bureaucrats and taxpayers might bypass digital systems,
and cryptocurrencies might be used to evade taxes. And for all the talk of
low-income countries harnessing new technologies to overtake more advanced
economies, the potential for leapfrogging will be limited if large segments
of the population lack access to the digital world. The past, it is worth
remembering, is littered with unsuccessful and costly IT projects.
What’s more, digital technology raises new concerns in the realms of
cybersecurity, privacy, and fraud. The theft of data from US agencies such
as the Internal Revenue Service and State Department have highlighted the
vulnerability of government systems. Some European countries have faced
multiple fraudulent VAT refund claims that are too small individually to
draw attention but significant in the aggregate. We should expect the
digitalization of public finance to involve an arms race in which victory
may not always go to benevolent governments.
In the corporate sphere, digitalization has amplified challenges to the
current system, which focuses on a company’s brick-and-mortar presence.
Companies such as Alphabet, Amazon, Apple, and Facebook can have substantial
economic presence in countries without having much, or any, physical
presence. Still more fundamental is a point touched on earlier. Many
believe—and these are very contentious issues—that business models in which
commercial value (not least for advertisers) is provided not just by the
business itself but by the users of an online service fit poorly into
current approaches. In response, some European countries have proposed
taxing some element of turnover, rather than profits, when such
user-generated value is significant. Singling out digital companies for
special tax treatment is inherently problematic, however, as these
technologies become critical to the operations of effectively all companies.
Moreover, advances in artificial intelligence and robotics have aroused
fears of rising unemployment and widening inequality. If these fears prove
true, policymakers may face the prospect of a shrinking tax base and rising
social welfare payments. Some observers suggest taxing new labor-replacing
robot capital. Others see that as in effect taxing progress and call instead
for fairer distribution of capital ownership and taxing the profits
generated through automation, which they say would preserve productivity
improvements associated with new technologies. The idea of a universal basic
income, while costlier than means-tested systems, is also gaining support.
But these are issues that go far beyond public finance. The digital
revolution presents markets, society, and governments with the challenge of
adapting to continual change. For governments, both the positive and
negative effects are likely to be profound. Given the speed of innovation by
the private sector, the urgency of action to harness the opportunities and
mitigate the risks is clear. Experience so far suggests that many benefits
are within reach. To reap the full dividends of the digital revolution,
countries must focus on solutions that address their most pressing
priorities. Developing economies struggling to identify and help vulnerable
populations may for instance benefit most from biometrics and information
systems (social registries) used to implement social programs. Others may
turn to electronic payment systems and mobile technology to reduce leakages.
But all will need to take steps to avoid the pitfalls—digital exclusion,
cyberattacks, fraud, privacy infringement. That will require strong fiscal,
political, and governance institutions.