20 _Polky, Planning, and Research Working Paper Series_ To encourage investment and savings, policy-makers cannot ignore capital mobility even in situations where domestic nationals do not invest abroad and foreign investors do not invest domestically. The potential for capital to move across international boundaries creates an opportunitycostforinvestmentinaparticular country and throughout the world. In determining marginal effective tax rates it is necessary in addition to traditional considerations, such as tax rates and the distribution ofthe taxbase, toincorporate the following factors: * Source rules (the basis for taxation).

* Nexus rules (which define who must file and pay income taxes).

* Attribution rules (about accounting methods).

* The scope of bilateral accommodation between countries.

None of these factors is superior economically to the others as a basis for determiningtaxpolicy. Iftaxpolicyistoencourage international capital flows, explicit tradeoffs may have to be made between increased tax revenues and incentives to invest.

In addition, tax policy should be evaluated with respect to _net,_ not gross, capital flows. Tax policy that increases foreign investments in a capital importing country by X percent is poorly designed if it increases the flow of domestic investments abroad by a larger percentage.

Intemational capital mobility provides both costs and opportunities for developing tax policy within a country. Since investors treat taxes as a cost of doing business, each country's tax price should reflect its opportunity cost of investment (either foreign or domestic). These tax prices will differ between countries. Uniformity of taxes across countries can therefore distort rather than improve investment. As long as there is reasonable competition among the suppliers of capital, tax competition among governments may make distribution within the system more efficient. In such a context international cooperation may not be the best method for the development of tax policy for factors that are internationally mobile.

Equity across countries, however defined, should be measured by how the net benefits ofcapital investment (includingtaxrevenues)are distributed-notby how the tax base is distributed. In particular, tax treaties should not be evaluated solely on revenue potential nor should they be canceled unilaterally. Instead they shouldbe evaluated on pragmatic grounds in terms of their effects on investor confidence and their administrative costs.

This is a background paper for the 1988 World Development Report. Please contact Lupita Mattheisen, room S13067, extension 33757.

# **48. Do** Taxes **Matter?** A Review of **the Incentive and Output Effects of** Taxation

## Jonathan Skinner

## (TO COME)

# 49. Public Sector Pricing Policies: A **Review** of Bank Policy and Practice

## DeAnne Julius and Adelaida P. Alicbusan

_Six sectors - health, education, housing, fertilizer, ports, and railways - have made little attempt to incorporate efficiency pricing into public sector pricing._ And _most sectors pay far too little attention to fiscal objectives in public pricing._ Nearly a decade has passed since the Bank codified its position on cost recovery policies for public sector projects, in Operational Manual Statement (OMS) 2.25. OMS 2.25 recommended that a common analytical framework be used in all sectors to determine appropriate pricing guidelines and cost recovery targets. That framework involved two steps:

* Estimating efficiency prices - prices that would maximize the net economic benefit from the project.

* Adjusting those prices to take into account nonefficiency objectives (distributional, fiscal, or financial) and implementation constraints.

In a review of 13 sectors, the authors have found that those Bank guidelines are followed fairly closely in seven sectors: coal, irrigation, oil/gas, power, roads, telecommunications, and water/ sewerage. In these sectors, the approach has proven effective in accommodating economic, distributional, and financial - objectives primarily through carefully designed tariff structures.

In the other six sectors the focus is heavily on either distributional (health, education, housing) or financial (fertilizer, ports, railways) concerns - with little attempt to incorporate economic pricing principles.

Efficiency pricing is not irrelevant or impossible in these sectors, and -even if used only as a benchmark - could improve sector management and project selection and design.

The fiscal dimension of public sector pricing has received little attention in most sectors. In view of the serious constraints on growth that several less developed countries face because of scarce fiscal resources, this is a major shortcoming - and deserves priority attention in the formulation of future price recommendations.

This is a background paper for the 1988 World Development Report. Please contact Lupita Mattheisen, room S13067, extension 33757 (122 pages with tables).

50. Fiscal Policy and Stabilization In **Brazil**

## Celso Luiz Martone

_The 'heterodox shock"approach to stabilization is based on a flawed concept of inflation. The countries that entered this path are likely to_ remain _for a long time under a controlled economy, sacrificing theirgrowthpotential forsome stability in income distribution and less explosive_ inflation.

The theoretical basis for the 'heterodox shocks" recently implemented in Argentina and Brazil is that chronic inflation is - essentially inertial the product of staggered prices and wage adjustments. The underlying assumption is that the economic process is a cooperative game. Withoutlegal and otherforms of coercion, however, individuals tend to cheat - to fix their prices above average to start with.

The inertial hypothesis ofinflation is a good description of the dynamics of inflation but it is not a theory of the nature of inflation - so the proposed remedy (the 'heterodox shock") cannot be implemented successfully.

Moreover, applying that kind of shock destroys the spontaneous operation of the price system by suppressing the information content conveyed by prices and by distorting the allocation of resources.