With dwindling oil prices, Nigeria has to take a serious look at taxes as a critical source of government revenue.
This article was first published in Public Finance International.
Africa: pumping up the tax volume
By: Mark Smulian
African countries urgently need to expand the revenue they raise from taxes. How can this be done in a sustainable way, without reliance on depleting natural resources?
Tax revenues pay for everything governments do, or hope to do. But no politician ever got popular by creating new taxpayers. Unsurprisingly, expanding the national tax base is treated with some caution.
In African countries, this is a particular problem. Alongside the many development challenges they face, few governments want to run the risk of increasing the tax they collect from individuals and businesses – many of whom pay little or nothing.
Yet it is essential, even for governments that are confident they can get by through taxing finite natural resources. Otherwise, they will simply not have the funds they need.
According to Wilson Prichard, co-director of the International Centre for Tax and Development, Africa still has a long way to go. Outside South Africa, only Kenya has an effective tax collection system, he says, although Tanzania has made significant recent progress and Zambia stands out for its effective taxation of mining.
“It’s really difficult to answer which African countries have done well, as data may be poor, or the underlying GDP data might be. So claims about increasing tax as a proportion of GDP need to be treated with caution,” he tells Public Finance International. “I would say the main issue is difficulty in national tax collection, since local taxes are only a small proportion of what is collected – about 5% of the total.”
Countries that have done the most to increase their tax base have some factors in common, says Caleb Fundanga, executive director of the Macroeconomic and Financial Management Institute of Eastern and Southern Africa. These include establishing efficient tax administrations, creating incentives to bring the informal sector into the official tax system, and industrial expansion, which creates companies that may be taxed.
Fundanga thinks most African countries are not well equipped to take some parts of their economies into the tax system, such as the informal sector and the other components of the ‘unobserved’ economy. Plus, taxation of individuals is almost entirely through pay-as-you-earn systems.
There is a persistent inability to tax self-employed individuals, such as doctors and lawyers, who can avoid it, says Prichard.
Then there is the question of politics. People with money tend also to have influence, he says: “Widening your tax base is a political issue, as it may mean widening the number of people who will oppose you or that you are taxing influential people who will object.”
Many governments have given tax breaks to various business sectors in an attempt to attract international investment. “There is little evidence to suggest the investment is really additional,” Prichard says. “Governments may struggle to identify taxpayers and corruption undermines collection, so there are many opportunities for companies to evade tax and using these tax breaks has been rather ineffective.”
Fundanga also doubts that international investors need or expect specific tax breaks. He says: “A transparent tax system would be enough. Serious international investors do not need tax breaks to attract them to invest. The ability to pay tax is part of their capacity as investors.”
Tax Justice Network–Africa and ActionAid denounced the practice of granting corporate tax incentives, in a joint report issued last August. Looking at the experience of the Economic Community of West African States, they urge countries to review all corporate tax incentives and assess tax that would be foregone against any investment attracted.
While a lack of reliable data hampers calculations, the report estimates that Ghana, Nigeria and Senegal are together losing up to $5.8bn a year through tax incentives. Corporate tax incentives are often managed by multiple, uncoordinated entities in each country and granted arbitrarily rather than according to cost-benefit analysis.
The report also found foreign direct investment to West Africa has increased, but not in the sectors that create the most jobs, such as manufacturing. “The use of corporate tax incentives is causing a competitive race to the bottom among countries in West Africa, which is detrimental to national revenue bases and regional integration,” it concludes.
Another option for raising revenues is taxing natural resources.This is tempting, since it allows large sums of money to be raised from a few companies. However, relying on this can mean countries forgoing additional revenue they could raise from other sources, and having little tax revenue to fall back on once natural resources are exhausted. “Many countries are not very effective at taxing extractive industries; they may have very large industries but receive relatively little revenue,” notes Prichard.
Fundanga also warns against over-reliance on natural resources for tax revenues.
“This income source is only available as long as the natural resources exist – once depleted, it ceases to exist. What countries should do while this income source is still available is convert the natural resources into financial resources by establishing sovereign wealth funds and other such facilities,” he says.
“It is not safe to depend entirely on natural resources revenue because they get depleted at some point – but tax revenue from natural resources can be used to develop other sectors of the economy, which will expand the tax base.”
The news about Africa’s tax base is far from uniform. Martin Brownbridge, an adviser on African banking, writing in African Economic Outlook, argues that many countries have successfully enlarged their bases, citing Tunisia’s yearly average increase of 3.5%, while Egypt’s revenues have more than doubled in the past five years and Côte d’Ivoire has rebuilt its tax base after a civil war.
A recent International Monetary Fund working paper, examining tax administration reform in Francophone sub-Saharan Africa, concludes these states have taken many steps associated with good administration – but lag behind many other African countries when it comes to the ability to raise revenue.
Political and social contexts play a role, and are common to countries that successfully reform their tax operations, argue the authors, economists Patrick Fossat and Michel Bua. “This was true, for example, in Rwanda following the genocide and in Uganda where the political situation remains difficult,” they note.
“Despite these difficulties, an effective use of the technical and financial support provided by the World Bank and [UK] Department for International Development have enabled these countries to structure their tax administrations as revenue agencies in which major organisational and procedural reforms were implemented. Less than ten years after the launch of these reforms, the Rwandan and Ugandan tax administrations are now recognised as models for others in Africa.”
So could African countries do more to collect local taxes? “The big under-exploited area of tax is property and that is true across Africa, although action to do that may be stopped by the people who own property,” explains Prichard.
The Commonwealth Local Government Forum’s 2015 conference in Gaborone, Botswana, heard from Morris Chikosa, revenue mobilisation officer of Mzuzu City Council in Malawi, about how this can be done. The council has significantly increased its revenue through improved, comprehensive and accurate property information, a mass valuation assessment – and better enforcement backed by the political will for change.
This, it seems, is the critical issue. The ways in which African countries could expand their tax bases are now well known. Whether there is the political will to act on this knowledge is another question.
3.5% a year
Tunisia’s average rise in tax income
Annual loss through tax incentives in Ghana, Nigeria and Senegal