Taxes, debt and development: A one-percent rule to raise revenues in Africa
Since building the capacity to collect more from personal income taxes takes time, in the next few years VAT and excise taxes are likely to offer the biggest potential for additional revenue.
Tax revenues play a critical role for countries to create room in their budgets to increase spending on social services like health and education, and public investment. At a time when public debt levels in sub-Saharan Africa have increased sharply, raising tax revenues is the most growth-friendly way to stabilize debt. More broadly, building a country's tax capacity is at the centre of any viable development strategy to meet the ongoing needs for expanding education and health care, and filling significant infrastructure gaps.
While our advice will always be country and context specific, we see potential in many countries of sub-Saharan Africa to raise tax revenues by about one percent of GDP per year over the next five or so years. While this is ambitious, experience in the region and elsewhere shows this is achievable in a sustainable and businessfriendly way. Improving domestic capacity for tax and other revenue collection is a target that countries have agreed under the United Nation's Sustainable Development Goals (Goal 17).
Tax structures in sub-Saharan Africa
On average non-resource related tax revenues in the region have increased over the last few years, but they remain low by international standards and relative to the region's significant developmental spending needs. The tax structure also matters. Currently, unlike advanced economies, the share of personal income taxes in the region is relatively low, while the share of consumption taxes is higher. Over time, with the growth of incomes, and as more economic activity moves into the formal sector, a country can expect the role of income taxes in revenue collection to increase.
This has been the long-term trend in advanced economies, where the share of modern taxes, which include income taxes and VAT, increased, while the share of traditional taxes (including inheritance taxes, excise and sales taxes, customs duties) declined.
We see similar trends in sub-Saharan Africa. For example, in Ghana the relative importance of revenues from traditional taxes declined over the last 25 years from about 75 to less than 40 percent of total tax revenue. The key distinction between these two types of taxes is that modern taxes rely on information from third-parties, such as employers, banks, investment and pension funds while traditional taxes, which are based on self-reporting, require less information and are easier to administer.
The future is now
Since building the capacity to collect more from personal income taxes takes time, in the next few years VAT and excise taxes are likely to offer the biggest potential for additional revenue. For example, recent studies by the IMF indicate a revenue potential of about 3 percent of GDP from VAT in Cape Verde, Senegal, and Uganda, and ½ percent of GDP from excises for all countries in sub-Saharan Africa. Reforms of the design of fiscal regimes for extractive industries such as oil and gas could help countries secure a fairer share of revenue for the government without compromising investment.
The impact of fiscal policy on income distribution comes from both expenditures and tax. In countries where fiscal policy has a significant impact in reducing inequality most of the effect comes from spending. This is particularly important when assessing the VAT. While VAT can be regressive, the overall impact on inequality is likely favourable if the revenues are used to finance social expenditures and programmes targeted to people with lower incomes.
It is also important to consider newer sources of revenue, such as property taxes. At present the contribution from property taxes is very low – at most half a percent of GDP. In addition to its considerable revenue potential, countries can use property taxes as an instrument of redistribution. Property taxes are equitable and efficient, but their effective design and implementation depends on administrative capacity. Where a typical property tax is not viable, there may be simplified schemes, such as area-based systems that governments can use instead. Also, the use of new technologies for mapping and collecting taxes provides ample opportunities for leap-frogging to better tax systems.
Beyond the need to recalibrate current taxes and consider new ones, there are several additional factors holding back countries in sub-Saharan Africa from achieving their tax potential:
· There are visible weaknesses in the areas of policy design, legal and regulatory frameworks and administration. Examples include the excessive use of tax exemptions and incentives, as well as base erosion and profit shifting away from the region.
· Poor legal drafting results in arbitrary interpretation of prevailing rules and increases the cost of compliance.
· The lack of risk-based audits, weak coordination between tax and customs administrations, low levels of tax return filing, limited use of modern technologies, and ineffective taxpayer services point to significant weaknesses in tax administration.
To help address these shortcomings, the IMF, including through its regional technical assistance centres, is working with countries to develop Medium-Term Revenue Strategies. The concept was developed and proposed by the Platform for Collaboration on Tax, and is a high-level roadmap countries can use for tax system reform with a four-to-six-year time horizon.
The approach treats taxation as a system covering tax policy, law, and administration. Medium-term revenue strategies rely on a broad social and political commitment to tax system reform. These strategies, which are designed in close partnership with countries, set clear quantitative mediumterm tax revenue objectives. A few countries, including Uganda and Indonesia, have already begun developing their strategies.
Raising revenues is often a politically difficult task. But the current economic junction in sub-Saharan Africa together with sustained development needs creates an imperative for action now.