Taxation, Governance and Resource Mobilisation in Sub-Saharan Africa Jonathan Di John, University of London, SOAS

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1 Taxation, Governance and Resource Mobilisation in Sub-Saharan Africa Jonathan Di John, University of London, SOAS Presentation for African Economic Outlook 2010, Expert Meeting Resource Mobilisation and Aid in Africa 14 December, 2009

2 Taxation and tax reform is central to state-building: to ensure sustainable funding for social programs, and for public investments to promote economic growth and development. taxation is the main nexus that binds state officials with interest groups and citizens. taxation, particularly in the form of land and property taxes, customs and border collection can help increase the territorial reach of the state. fiscal capacities are needed to build a legitimate state. Democratic elections do not themselves ensure state legitimacy

3 Structural Factors Limiting the tax take: 1) a large share of (subsistence) agriculture in total output and employment, 2) large informal sector and occupations; 3) many small establishments, 4) small share of wages in total national income, 5) small share of total consumer spending made in large, modern establishments

4 high revenues from trade taxes Challenges Facing Sub-Saharan Africa high levels of non-tax revenue (especially from mineral rents) narrow base of tax payers (hence the importance of large taxpayers office (LTO s) Dominance of capital/main city in generating tax revenues higher rates of tax evasion One of the greatest challenge facing low income African economies is how to replace declining trade taxes in the face of economic liberalization. Trade taxes represent over one-third of all tax revenues in Sub-Saharan African (SSA) economies.

5 Challenges Facing Sub-Saharan Africa In sub-saharan Africa, improving taxation to meet developmental needs is one of the main challenges facing the region (Gupta and Tareq, 2008). The average tax-to-gdp ratio in sub-saharan Africa has increased from less than 15 percent of GDP in 1980 to more than 18 percent in But virtually the entire increase in tax revenue in the region came from natural resource taxes, such as income from production sharing, royalties, and corporate in-come tax on oil and mining companies. Non-resource-related revenue increased by less than 1 percent of GDP over 25 years (Keen and Mansour, 2008).

6 Political Economy Factors Elite Bargains, Limited Access Orders (North et al. 2009) and the limits on tax collection Neo-patrimonial systems of government can generate corruption and weak tax collection incentives Mineral Rents and Aid: Reduced Incentives for Domestic Tax Effort? Donor Conditionality and coercive methods of tax collection

7 Political Economy Factors Despite these challenges, there is a wide variation in tax performance across countries and within countries over time. IMF (2005) study suggests that in tax revenue growth in lowincome countries has coincided with a strengthening of income tax revenues, suggesting that the burden of adjustment has not been borne solely by shifting to taxes on consumption. This result is important since it contradicts the conventional wisdom that consumption taxes are the main source offsetting trade tax revenue. Diversification of tax revenues central to recovering losses from trade taxes

8 Politics of Administrative Reforms: The Case of Autonomous Revenue Authorities International financial institutions and aid donors have developed the proposition that, in weak states, revenue collection authorities are more effective when they operate autonomously from the state (and particularly the finance ministry), as a commercial entity at arms length from the government rather than as a department within the government administration (see Taliciero, 2004). This is the reasoning behind the promotion of the so-called autonomous revenue agencies (ARAs). While there is some evidence in Africa and Latin America that autonomous revenue authorities may have been instrumental in initiating reforms, it is less clear that such arrangements are sustainable.

9 Politics of Administrative Reforms: The Case of Autonomous Revenue Authorities Such a technical approach to tax policy abstracts from politics in at least three ways. First, the reasons why such reforms were politically feasible in the first place are not addressed. Second, there is little analysis of why such autonomy is acceptable to relevant political coalitions over time. Third, there is no accepted definition of autonomy. Since tax policy, which is the domain of finance ministries, cannot practically be divorced from tax collection (which is the domain of newly created ARAs) it is not ultimately possible for the latter to function in purely autonomous ways. In effect, autonomy can never be complete where there are interdependencies among agencies and thus is always a contested notion.

10 Politics of Administrative Reforms: The Case of Autonomous Revenue Authorities Role of macroeconomic and particularly fiscal and inflationary crises has provided opportunities for leaders to gain leverage over the reform process. Centralised public authority and executive support is essential for tax reform to be undertaken and sustained (e.g. Rwanda, Ghana, South Africa, Ethiopia) the creation of a (semi-) autonomous revenue authority paradoxically can increase the political attention it receives (e.g Uganda) the pressure on governments to meet revenue targets can create tensions between the state and interest groups which can undermine the tax authority s legitimacy.

11 Administrative Reforms: The Case of Autonomous Revenue Authorities Clear and simple laws to minimize taxpayer effort and compliance costs. Adequate enforcement power of tax administration Function-based organizational structure: Tax departments organized according to key functions (registration, filing and payment, processing, enforced collection, and audit) operate more efficiently than those structured by tax-type. Automation promotes risk-based management and fast and simple file returns, declarations and payments. Treat Taxpayer as a client Develop medium- and long-run plans to gradually widen tax coverage, including small and informal sector firms. This will enhance the extent of the fiscal social contract Source: IMF: Reforming Tax Administration and Implementing GST: 2006

12 Lessons from South Africa high degree of administrative cooperation within the state, particularly between SARS, the Finance Ministry and the Central Bank. the state has historically maintained a cooperative relationship with upper-income groups, including large firms, which helped reduce the transaction costs of collecting income taxes. reforms were introduced with substantial consultation with representatives from the state, political parties, business chambers, labour unions, and national and international tax and legal experts. sustained campaign by SARS which emphasizes in its campaigns that its task effective tax collection is central for the protection of the national economy. SARS was formed in the context of a strong national political party, the African National Congress (ANC).

13 Urban property taxes The role of land and property taxes is especially important as local governments seek to raise revenues in the context of decentralization reforms. The same is true for local governments in urban areas. Why focus on this tax? one of the most underutilized forms of taxation in LDCs and can potentially provide the financing of urban infrastructure investment which is central to improving the production and export capacity of light manufacturing plants, many of which are located in urban centres. provides one of the few potential sources of taxation for municipal governments. can provide the impetus for the creation of urban property databases which could help improve the synergy between municipal taxation and urban planning. provides one of the few mechanisms through which progressive taxation can be developed in LDCs. contributes to making property rights more secure.

14 Aid and Domestic Tax Effort Potential Problems the incentive for the government to raise revenue may be diminished. Second, the capacity of the government to identify and assess macro-level expenditure revenue trade-offs are reduced as ministers are not forced to prioritise spending based on what revenues they can collect; instead they simply present a wish list. Third, there is considerable uncertainty and volatility in the actual aid flows that are dispersed creating problems for macroeconomic management and planning.

15 Matching Aid Funds and Domestic Tax Effort The matching funds approach can address these concerns if donors could agree to match a percentage of the funds collected by the government up to a fixed limit. The matching percentage could be reduced over time, reflecting the increased capacity of the government to raise revenue. The main advantage of this approach is that it increases the incentives for revenue collection since state officials will know that raising extra revenue will result in additional inflows of donor resources.

16 OTHER ISSUES TO CONSIDER there is a need to improve the capacity and legitimacy of Large Tax Payer Offices (LTOs) Harsh tax enforcement in situations with poor service delivery may contribute to undermining the legitimacy of local government and increase tax resistance. Trying to meet very ambitious tax targets can be counterproductive Tax exemptions of donor employees creates a bad demonstration effect for low-income states trying to build domestic tax bases. Taxing the informal sector may require linking tax policy to production strategies.

17 Notes for Further Discussion

18 Table 1: Tax Collection and Composition in selected Sub-Saharan African countries Years Tax Revenue Trade Taxes GDP/cap lower tax countries (as % of GDP) (as % of total taxes) (market prices*) Congo (DR) % 32.0% $600 Central African Rep ,055 Chad Niger Rwanda Tanzania Uganda ,167 Mozambique Ethiopia Mali Malawi average higher tax countries Botswana % 18.0% $8,347 South Africa ,764 Zimbabwe ,498 Kenya ,033 Zambia Cote d'ivoire ,582 Senegal ,427 Nigeria average ,420 average (excl. Botswana, S. Africa) 1,363 Note: * at $US 2000, market prices Source: IMF, Government Finance Statistics; Fox and Gurley (2005)

19 Taxation, state territorial reach and production strategies In the case of Mauritius, export taxes on sugar, the main export commodity in the 19th and most of the 20th century had several positive effects on state-society relations and in increasing the productive capacity of the sugar sector (Bräutigam, 2008). First, the tax was an effective substitute for income taxes, and was generally progressive as it shifted the burden of taxation and redistributive spending on the wealthy and middle classes. Second, the tax was used by the state to finance research and development, infrastructure, and marketing which enhanced production and productivity growth in the sugar sector.

20 Export taxes in Mauritius (cont.) Third, the export tax helped the private sector organize, and it built their capacity to interact with the government over time. As well, it helped both the state and society to solve collective action problems they faced in building skills and in supporting research on sugar. Finally, the export tax helped develop the territorial reach of the state since the tax affected the main employer in the countryside and promoted mutually beneficial rights and obligations between the state and farmers, both large and small.

21 Recommended Readings Baunsgaard, T. and Keen, M. (2005) Tax Revenue and (or?) Trade Liberalization, IMF Working Paper 05/112. Burgess, R. and Stern, N. (1993) Taxation and Development. Journal of Economic Literature, 31, no.2, pp Brautigam, D., Fjeldstad, O-H & Moore, M. (2008) Capacity and Consent: taxation and state-building in developing countries. Cambridge, Cambridge University Press. Di John, J. (2006) The Political Economy of Taxation and Tax Reform in Developing Countries, World Institute of Development Economics Research (WIDER) Research Paper No. 2006/74, Helsinki: United Nations University-WIDER. Herbst, J. (2000) States and Power in Africa: Comparative Lessons in Authority and Control. Princeton, Princeton University Press.

22 Recommended Readings Tilly, C. (1990) Coercion, Capital and European States: AD Oxford, Blackwell. Gupta, S. and Tareq, S. (2008) Mobilizing Revenue. Finance and Development, vol. 45, no. 3, pp Toye, J. (2000) Fiscal crisis and reform in developing countries. Cambridge Journal of Economics, vol. 24, no.1, pp Lieberman, E. (2003) Race and Regionalism in the Politics of Taxation in Brazil and South Africa. Cambridge, Cambridge University Press.