Trade Negotiations Insights • Volume 9 • Number 6 • July 2010

Taxation for development in Africa: A shared responsibility

by Henri-Bernard Solignac Lecomte

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Africa needs more effective, efficient and fairer taxation systems. As several African nations celebrate 50 years of independence in 2010, it is time for a continent that still relies too much on often volatile and unpredictable external flows to take a new look at taxes - a potential untapped source of billions of dollars. While the primary responsibility lies with African governments, the international community must also play its part. And this time, it’s hardly about aid.

The global economic crisis has shown, yet again, how vulnerable Africa remains to falling commodity prices and export revenues, uncertain future aid flows and declines of foreign direct investment (FDI), which resulted in a general shortfall of external finance. At the same time, the continent continues to suffer from an acute hemorrhage of capital. Indeed, Kar et Cartright-Smith (2008) estimate that Africa lost US$854 billion, at least, in illicit financial outflows from 1970 through 2008. In other words, while Africa is overly-reliant on external financing, it is a net creditor to the world. The case is clear: African economies need to mobilise their domestic resources better. This is in large part the job of governments, who mobilise public resources through taxation (and debt) to fund investment in roads, power plants, schools, health facilities, etc. Over the long term, effective taxation can not only reduce a country’s dependence upon aid and largely unpredictable external finance flows, but it will also increase its ownership of the development agenda, and lay the foundation of a social contract between state, citizens and firms.

The good news is that the 2010 African Economic Outlook finds that the average African tax revenue as a share of GDP has been increasing since the early 1990s, from US$113bn in 1996 to 479bn in 2008. The bad news is that this has been mostly induced by taxes on the extraction of natural resources: oil-related taxes alone for the top ten exporting countries totalled US$275bn in 2008. Focusing on natural resource rents distracts governments from more politically demanding forms of taxation, in particular direct forms of taxation, such as corporate income taxes on other industries, personal income taxes, as well as Value Added Taxes (VAT) and excise taxes. Indeed, income taxes (mainly personal and non-resource corporate) have stagnated over the same period, and trade liberalisation and regional integration in Africa have reduced revenue from trade taxes. Further trade liberalisation may leave a critical gap in public resources if it is not purposively sequenced with domestic tax reform.

What can African governments do?

In the short-run, strategies towards more effective, efficient, and fair taxation in Africa must complement efforts to deepen the current tax base. This does not mean trying hard to bring small, informal activities into the tax net: chasing the myriad of self-employed or micro-shops would cost more than it it would generate in tax revenues. Besides, many informal entrepreneurs already contribute, as they pay VAT on the input they purchase from retailers. Neither are small and medium enterprises (SMEs) in the formal sector the target of choice to extract more tax revenues: too visible to escape taxation and not big enough to obtain exemptions, African SMEs-the ‘missing middle’ in most economies-are not only subject to some of the highest nominal corporate tax rates in the world, they too often are the victims of abusive practices by the tax administration. By contrast, focussing on the large economic actors that pay less tax than they should could generate high revenues at a small cost. This strengthens the classic case for reviewing and removing tax preferences and exemptions, which multinational companies benefit from, and in particular for taxing extractive industries more fairly and more transparently.

In addition, governments need to crack down on fraud and corruption, and remove exemptions-sometimes as political favours-to powerful patrons with large, informal trading activities. The objective should be to levy taxes at low and relatively flat rates on bases that have been broadened through the elimination of exemptions and other loopholes. Lower, simpler taxes are not only easier to collect and administer but are a more effective policy to stimulate the development of the private sector. As for the reform of trade taxes, this should be built into the medium-term overall fiscal reform agenda, instead of coming as an afterthought once tariff cuts have been decided, as is too often the case.

In the longer-term, the capacity constraints of African tax administrations must be alleviated to open up policy space and allow for the generation of tax revenues through a more balanced tax mix. A wide tax base is more stable because it relies on a diversified set of tax revenues. It is also more efficient by helping to keep the tax burden mild on each type of taxpayer and each type of economic activity. Additionally, it engages a wide range of stakeholders in the national political process. Urban property taxes, for example, are progressive and can scale up with Africa’s explosive pace of urbanisation and the corresponding need for urban infrastructure.

Morocco is a good example of a comprehensive fiscal reform, successful in improving the balance in its tax mix and broadening the tax base, lowering the average tax share gradually over several years. As a result, new sectors were incorporated into the fiscal net, such as construction, banking and telecom services. The government modernised tax administration, enabling it to implement the planned reform. This resulted in a 10% increase in the share of direct taxation, while VAT realised its full potential after a wide range of exemptions were eliminated.
What can the international community do?

The international community can do more to support sustainable forms of development financing through enhanced mobilisation of domestic resources in African countries. Aid used to stimulate public resource mobilisation can have a ten-fold multiplier effect on a country’s resources. Yet, donors have in some cases neglected the support to tax policy and administration: a mere 2 % of DAC-funded technical cooperation is spent on public sector financial management, of which taxation systems are only a subset.

Tax revenues should not be seen as an alternative to foreign aid, but as a component of government revenues that grows as the country develops. Greater ownership of the development process, one of the development dividends of effective tax systems, helps governments shape an environment that is more conducive to foreign and domestic private investment, sustainable use of debt and effective foreign aid. The challenge is therefore for African countries and their partners to reverse the vicious circle of aid dependence, which shifts government accountability away from citizens towards donors, and trigger a virtuous circle of aid becoming redundant by supporting public resource mobilisation.

One Africa-led initiative that receives strong donor support is the African Tax Administration Forum (ATAF), a platform for articulating African tax priorities and building the institutional capacity of the continent’s fiscal administrations through peer learning. The importance of such dialogue cannot be understated on a continent where countries often compete for tax revenues and investment from multinationals.

Yet the responsibility of Africa’s partners extends far beyond aid. More efficient and fairer mobilisation of domestic resources by African countries critically depends on enhanced international cooperation in tax matters. The fight against tax evasion and avoidance through tax havens, or against the abuse of transfer pricing (whereby multinational firms declare profits in low-tax jurdisdictions, and losses in countries where operations actually take place[1]), the rationalisation of fiscal incentives and tax exemptions that are eroding African tax bases can only be tackled internationally. The interests of Africa and of richer developed or emerging economies can therefore converge on the international tax agenda, a priority of the G20. While significant progress has been made in combating bank secrecy, tax evasion and tax havens in recent years, the challenges ahead remain considerable. The European Commission’s Communication on Tax and Development issued last April therefore provides welcome political impetus to the debate, in particular by supporting “the adoption and implementation of the OECD transfer pricing guidelines in developing countries”, as well as “ongoing research on a country-by-country reporting requirement as part of a reporting standard for multinational corporations, notably in the extractive industry”.

Author: Henri-Bernard Solignac Lecomte is Head of Unit, Africa, Europe & Middle East, OECD Development Centre. Henri-Bernard.Solignac-Lecomte@oecd.org

Related reading

African Economic Outlook 2010, by the African Development Bank, the OECD Development Centre and the United Nations Economic Commission for Africa.

http://www.africaneconomicoutlook.org/en/in-depth/

European Commission (2010) Tax and Development - Cooperating with Developing Countries on Promoting Good Governance in Tax Matters, Communication from the Commission to the European Parliament, the Council and the European Economic and Social Committee, COM(2010)163 final, Brussels, 21.4.

http://ec.europa.eu/development/icenter/repository/COMM_COM_2010_0163_TAX_DEVELOPMENT_EN.PDF

Kar et Cartright-Smith, (2008) “Illicit Financial Flows from Developing Countries, 2002-2006″, Center for International Policy, Washington DC.

http://www.gfip.org/index.php?option=com_content&task=view&id=300&Itemid=75

Hollingshead, A. (2010), The implied Tax Revenue Loss from Trade Mispricing, Center for International Policy, Washington DC.

http://www.gfip.org/storage/gfip/documents/reports/implied%20tax%20revenue%20loss%20report_final.pdf

[1] Although models for assessing the loss of tax revenues to improper transfer pricing are still being developed, Hollingshead (2010) estimates a yearly average of USD 3.8 billion would have been lost in Africa between 2002 and 2006.