In many successful high-growth countries, the state has played an important role in attracting investment; improving productivity, technology, and competitiveness; and protecting property rights, contract enforcement, and economic and political stability. For a government to be effective, the main elements to get right include: economic management, regulation, and taxation; efficient financial and labor markets; public safety and security, and the building and maintenance of infrastructure.
Accountable and capable states with strong institutions are recognized to be fundamental to economic and social development, but it is still difficult to quantify what is meant by good governance or to measure the quality of institutions.
International Development Association Resource Allocation Index
The World Bank measures the public policies and institutions through the IDA Resource Allocation Index (IRAI), which is based on the results of the annual Country Policy and Institutional Assessment (CPIA) exercise, which covers the IDA-eligible countries.
Country assessments have been carried out annually since the mid-1970s by World Bank staff. Over time the criteria have been revised from a largely macroeconomic focus to include governance aspects and a broader coverage of social and structural dimensions. Country performance is assessed against a set of 16 criteria grouped into four clusters: economic management, structural policies, policies for social inclusion and equity, and public sector management and institutions. IDA resources are allocated to a country on per capita terms based on its IDA country performance rating and, to a limited extent, based on its per capita gross national income. This ensures that good performers receive a higher IDA allocation in per capita terms. The IRAI is a key element in the country performance rating.
The CPIA exercise is intended to capture the quality of a country’s policies and institutional arrangements, focusing on key elements that are within the country’s control, rather than on outcomes (such as economic growth rates) that are influenced by events beyond the country’s control. More specifically, the CPIA measures the extent to which a country’s policy and institutional framework supports sustainable growth and poverty reduction and, consequently, the effective use of development assistance.
All criteria within each cluster receive equal weight, and each cluster has a 25 percent weight in the overall score, which is obtained by averaging the average scores of the four clusters. For each of the 16 criteria countries are rated on a scale of 1 (low) to 6 (high). The scores depend on the level of performance in a given year assessed against the criteria, rather than on changes in performance compared with the previous year. All 16 CPIA criteria contain a detailed description of each rating level.
In assessing country performance, World Bank staff evaluate the country’s performance on each of the criteria and assign a rating. The ratings reflect a variety of indicators, observations, and judgments based on country knowledge and on relevant publicly available indicators. In interpreting the assessment scores, it should be noted that the criteria are designed in a developmentally neutral manner. Accordingly, higher scores can be attained by a country that, given its stage of development, has a policy and institutional framework that more strongly fosters growth and poverty reduction.
The country teams that prepare the ratings are very familiar with the country, and their assessments are based on country diagnostic studies prepared by the World Bank or other development organizations and on their own professional judgment. An early consultation is conducted with country authorities to make sure that the assessments are informed by up-to-date information. To ensure that scores are consistent across countries, the process involves two key phases. In the benchmarking phase a small representative sample of countries drawn from all regions is rated. Country teams prepare proposals that are reviewed first at the regional level and then in a Bank-wide review process. A similar process is followed to assess the performance of the remaining countries, using the benchmark countries’ scores as guideposts. The final ratings are determined following a Bank-wide review. The overall numerical IRAI score and the separate criteria scores were first publicly disclosed in June 2006.
Taxes are the main source of revenue for most governments. The sources of tax revenue and their relative contributions are determined by government policy choices about where and how to impose taxes and by changes in the structure of the economy. Tax policy may reflect concerns about distributional effects, economic efficiency (including corrections for externalities), and the practical problems of administering a tax system. There is no ideal level of taxation. But taxes influence incentives and thus the behavior of economic actors and the economy’s competitiveness.
- Tax revenue as a percent of GDP The level of taxation is typically measured by tax revenue as a share of gross domestic product (GDP). Comparing levels of taxation across countries provides a quick overview of the fiscal obligations and incentives facing the private sector. The table shows only central government data, which may significantly understate the total tax burden, particularly in countries where provincial and municipal governments are large or have considerable tax authority.
Low ratios of tax revenue to GDP may reflect weak administration and large-scale tax avoidance or evasion. Low ratios may also reflect a sizable parallel economy with unrecorded and undisclosed incomes. Tax revenue ratios tend to rise with income, with higher income countries relying on taxes to finance a much broader range of social services and social security than lower income countries are able to.
- Taxes payable by businesses The total tax rate payable by businesses provides a comprehensive measure of the cost of all the taxes a business bears. It differs from the statutory tax rate, which is the factor applied to the tax base. In computing business tax rates, actual tax payable is divided by commercial profit. The indicators covering taxes payable by businesses measure all taxes and contributions that are government mandated (at any level—federal, state, or local), apply to standardized businesses, and have an impact in their income statements. The taxes covered go beyond the definition of a tax for government national accounts (compulsory, unrequited payments to general government) and also measure any imposts that affect business accounts. The main differences are in labor contributions and value-added taxes. The indicators account for government-mandated contributions paid by the employer to a requited private pension fund or workers insurance fund but exclude value-added taxes because they do not affect the accounting profits of the business—that is, they are not reflected in the income statement.
To make the data comparable across countries, several assumptions are made about businesses. The main assumptions are that they are limited liability companies, they operate in the country’s most populous city, they are domestically owned, they perform general industrial or commercial activities, and they have certain levels of start-up capital, employees, and turnover.
The Doing Business methodology on business taxes is consistent with the Total Tax Contribution framework developed by PricewaterhouseCoopers, which measures the taxes that are borne by companies and affect their income statements. However, PricewaterhouseCoopers bases its calculation on data from the largest companies in the economy, while Doing Business focuses on a standardized medium-sized company.
Although national defense is an important function of government and security from external threats that contributes to economic development, high levels of military expenditures for defense or civil conflicts burden the economy and may impede growth. Data on military expenditures as a share of gross domestic product (GDP) are a rough indicator of the portion of national resources used for military activities and of the burden on the national economy. As an “input” measure military expenditures are not directly related to the “output” of military activities, capabilities, or security. Comparisons of military spending between countries should take into account the many factors that influence perceptions of vulnerability and risk, including historical and cultural traditions, the length of borders that need defending, the quality of relations with neighbors, and the role of the armed forces in the body politic.
Data on military spending reported by governments are not compiled using standard definitions. They are often incomplete and unreliable. Even in countries where the parliament vigilantly reviews budgets and spending, military expenditures and arms transfers rarely receive close scrutiny or full, public disclosure (see Ball 1984 and Happe and Wakeman-Linn 1994). Therefore, the Stockholm International Peace Research Institute (SIPRI) has adopted a definition of military expenditure derived from the North Atlantic Treaty Organization (NATO) definition . The data on military expenditures as a share of GDP and as a share of central government expenditure are estimated by SIPRI. Central government expenditures are from the International Monetary Fund (IMF). Therefore the data may differ from comparable data published by national governments.
SIPRI’s primary source of military expenditure data is official data provided by national governments. These data are derived from national budget documents, defense white papers, and other public documents from official government agencies, including governments’ responses to questionnaires sent by SIPRI, the United Nations, or the Organization for Security and Co-operation in Europe. Secondary sources include international statistics, such as those of NATO and the IMF’s Government Finance Statistics Yearbook. Other secondary sources include country reports of the Economist Intelligence Unit, country reports by IMF staff, and specialist journals and newspapers.
In the many cases where SIPRI cannot make independent estimates, it uses the national data provided. Because of the differences in definitions and the difficulty in verifying the accuracy and completeness of data, data on military expenditures are not always strictly comparable across countries. However, SIPRI puts a high priority on ensuring that the data series for each country is comparable over time.
Data on armed forces refer to military personnel on active duty, including paramilitary forces. Because data exclude personnel not on active duty, they underestimate the share of the labor force working for the defense establishment. Governments rarely report the size of their armed forces, so such data typically come from intelligence sources.
Data on public policies and institutions are from the World Bank Group’s CPIA database. Data on central government tax revenue are from print and electronic editions of the IMF’s Government Finance Statistics Yearbook. Data on taxes payable by businesses are from Doing Business. Data on military expenditures are from the most recent edition of SIPRI’s Yearbook: Armaments, Disarmament, and International Security.