Ease of Doing Business Index

The World Bank’s Nonsensical Taxation Index

The “paying taxes” component of the World Bank’s Ease of Doing Business Index might seem to rest on more secure foundations than some of the other measurements, as governments have a strong incentive to acquire accurate tax data. The corresponding map, produced above, reveals some unusual patterns. Northern Europe gains a favorable ranking, as is usually the case, but it is joined in the first quintile by an odd assortment of areas, including most of the Arabian Peninsula and much of southern Africa. Unfavorable taxation policies are also found in a disparate set of locations, including much of Latin America, western Africa, central Africa, and eastern Europe.

The “paying taxes index” is based on three equal components: the number of payments required per year, the time required to file taxes, and the total tax rate. Giving equal weight to the tax schedule and the average preparation time seems odd; frequent filing need not be burdensome if procedures are simple. According to the World Bank’s own data tables, Armenian firms remit taxes five times more often than Brazilian firms, yet Brazilian firms must devote almost five times more total time to tax preparation than their Armenian counterparts.

As is true with the other sub-indices of the Doing Business poll, the three component measurements of “paying taxes” very substantially, yielding strikingly different maps. The number of annual payments varies from two in Sweden to 135 in Ukraine, whereas the total annual time burden for an average firm ranges from zero hours in Maldives to 2,600 hours in Brazil. How Maldivian firms manage to pay their taxes with no effort whatsoever is a mystery, as is the supposed fact that Brazilian companies must devote two and a half times more effort than their counterparts in the second lowest-ranking country, Bolivia. Also striking is the lack of correlation between the two indicators; many countries that require few tax filings demand major time investments, and vice versa.

The total tax rate, as a percentage of profits, might seem to be the most significant indicator of the overall tax burden on businesses. But determining the optimum level of taxation, whether for businesses or individuals, is not a simple issue. Most economists and political scientists agree that tax rates can be too low; all governments require revenue, and if they do not get it from taxation they must turn to foreign donors or the unsustainable flow of royalties from natural resources. According to the influential “resource curse” model, oil-rich countries with low tax regimes often fail to adequately develop linkages between the state and the citizenry; governments that remain financially insulated from their publics often suffer high rates of corruption and poorly developed civic institutions, sapping their potential for growth.

Boilerplate text in the World Bank’s “Doing Business” project seemingly concurs that some taxation is necessary: “taxes are essential to provide public amenities, infrastructure, and services which are crucial for a properly functioning economy.” In its tabulations, however, the Bank takes the ideal rate of taxation to be essentially zero. Its model country on this score is Timor-Leste (East Timor), lauded in every country’s “good practice economies” comparison for its minuscule total take on profits of 0.2 percent. Does the World Bank really regard aid-dependent, impoverished East Timor as having the ideal business taxation rate, with Iraq, Malawi, and the Palestinian territories not far behind? Such claims are preposterous.

The business tax data should not be taken at face value. The total tax rate category, the World Bank informs us, “measures the amount of taxes and mandatory contributions borne by the business in the second year of operation, expressed as a share of commercial profit.” Yet for seven countries, the figures exceed 100 percent; in the DR Congo, they are well beyond 300 percent. How could any firm stay afloat if it were so taxed? Perhaps actual tax rates are not really so high; perhaps rules are again being confused for realities.

All of the countries listed as having taxation rates of more than 100 percent are located in sub-Saharan Africa except Argentina, with comes in at 108.2 percent. In the Bank’s tax-rate breakdown, Argentina is shown as having a remarkably high (53 percent) “Turnover Tax* by City of Buenos Aires.” Presumably, such fees apply only to operations in Buenos Aires, but the World Bank apparently applies them to the entire country. And certainly firms in Buenos Aires have strategies for avoiding much of the official burden, as otherwise they could not remain in business. Such “unofficial” behaviors, however, do not figure into the index.

Statistics are often taken at face value, even though we have long been warned that they can be misleading. The World Bank is a generally respected and well-financed institution, and its Doing Business Index is closely followed across the world. Yet few critics take the time to delve into the data, examining what is actually being measured and how the measurements are being made. If one does so, one finds that that much of is based on obvious nonsense.

* A Turnover Tax is an indirect tax similar to a sales tax or a value added tax

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The Ease of Doing Business Index: Big Problems with Contracts and Credit

The World Bank’s Ease of Doing Business Index rests on a complex amalgamation of data. Each of its component measurements is based on a sub-index, each of which produces a different map. Consider Canada’s relatively low position on the ease of enforcing contracts map, posted above. Canada ranks seventh overall in the composite index, but falls to 58th place in terms of contracts. Canada drops here because it requires a few more legal procedures than comparable countries, and because its courts operate at a slightly slower pace. In terms of the costs of legal procedures, the third component of the contracts sub-index, Canada compares favorably with such high-ranking countries as the UK and New Zealand.

Of the world regions, South Asia clearly ranks last in regard to contracts. India’s exceptionally poor showing here is one of the main reasons why it scores so low in the overall business index. Such findings are not surprising, as India’s legal system in notoriously lethargic, with many cases languishing for years before a decision is rendered. As the report further indicates, legal fees in India are high, and legal procedures are intricate.

Several features of the contracts map deviate markedly from the overall business index. The high positions of the former and nominally communist countries is striking, perhaps reflecting their relatively strong state structures. Tanzania’s placement is less explicable, and that of Yemen seems bizarre. In the chaotic political environment that characterizes Yemen, formal contact enforcement through the national court system is not easily accomplished.

Yemen ranks high on the contracts sub-index, it turns out, on the basis of its official regulations, not its actual conditions. The contract enforcement measurement is determined by “data relating to the time, cost and procedural complexity of resolving a standard commercial law suit … collected through study of the codes of civil procedure and other court regulations…” Yemen’s numbers are elevated because it does not require many procedures to obtain a judgment, and because attorney, court, and enforcement costs are supposed low, amounting to only 16.5 percent of claim values. Whether such conditions obtain in practice is another matter, one that is not addressed in the report. Supposedly, “surveys completed by local litigation lawyers” factor into the analysis, but no information on such surveys is given, nor or we told how such data is weighed. We are also not informed about whether such conditions obtain outside of the capital city. As much of Yemen’s hinterlands remain largely under tribal authority, with large areas harboring insurgent groups, the “number of legal procedures required by the government for a contract to be enforced” has little if any meaning. As a result, Yemen’s ranking on the map has little if any meaning.

The second map, generated from the “getting credit” sub-index, is quite distinctive from the first. India jumps from the last to the first quintile, and Yemen does the opposite. Again, the map perplexes. Is it really easier for a businessperson to obtain credit in Kenya, Zambia, and Rwanda than in Norway, the Netherlands, or Belgium? Do Ukraine and Kyrgyzstan actually outrank France and Spain? According to the data, the United States shares sixth place with Zambia, Kenya, and Guatemala, whereas Luxembourg – ranked in first place in terms of enforcing contracts – comes in 116th. If accurate, these relative positions are extraordinary and deserve extended consideration. To assess their accuracy, let us consider Zambia in more detail.

Zambia’s surprisingly high overall ranking in the business index has attracted considerable attention. The articles that I consulted mention a number of factors, but credit does not figure prominently. One report, for example, claims that “Over the last year, Zambia made it easier to start a business and for companies to trade across borders. It also improved enforcement of contracts.” Another trumpets the fact that “Zambia eased business start-up by eliminating the minimum capital requirement and it made trade easier by implementing a one-stop border post with Zimbabwe, launching web-based submission of customs declarations, and introducing scanning machines at border posts.” If credit is really as readily available in Zambia as the World Bank indicates, it is not apparent in recent media reports.

The World Bank’s credit sub-index is based on four measurement: the strength of legal rights index, the depth of credit information index, public credit registry coverage, and private credit bureau coverage. Zambia’s elevated position stems from its extremely high ranking in the first two categories. Officially, Zambia has a credit-friendly legal regime and established credit registries. But again, no information is provided on whether such rights carry through in practice, or whether the registries are accurate and effective. More significantly, no information is supplied on actual credit availability. Zambia’s numbers may come out much better than Slovenia’s, but does that mean that a firm can obtain credit much more easily in Lusaka than in Ljubljana? And are we really expected to believe that Zambia greatly outranks Luxembourg in terms of “getting credit”? Luxembourg fails on this score because it ranks “0” (yes, zero) in both the credit information sub-sub-index and in credit registry coverage. But does that mean that firms in Luxembourg, a country with a per capita GDP $84,000, struggle to obtain credit, unlike their counterparts in Zambia?

In the end, both the credit and contracts sub-indices measure mirages as much as they do actual conditions, confusing rules with realities. Are similar problems encountered with the other component measurements of the Ease of Doing Business Index? We shall see in the next post.

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