Striving for fairness

Source: IMF (2006), p. 94, OECD (2006)

Despite higher revenue shares, African governments still realise only part of their full tax potential. International studies show that just 60 % of possible tax income is actually collected (von Soest 2006, p. 4). Moreover, state revenues on the whole still do not meet the costs of all the tasks government bodies should handle. Compounding the problem in many countries, the composition of total government revenue is often not geared towards promoting development. A typical and decisive shortcoming is the large share generated through taxes on foreign trade and customs duties. In Africa, they account for an average 25.1 % of all revenues. For OECD countries, the comparative figure is a mere 0.8 % (Walsh 2006, p. 48).

Africa’s comparatively high tax rates on cross-border trade mean that growth stimuli are probably inhibited, and that further integration into the global economy is hindered. Certainly, given today’s production structures, one might argue that Africa’s integration into the world market is just a pipe dream anyway. In theory, selective customs duties could therefore protect domestic production, and thus boost the economy. Empirically, however, it does not make sense to argue that way. After all, the vast majority of African countries impose high duties on a broad front permanently. These trade barriers probably have negative consequences for most countries concerned.

Where the share of revenue from customs duties is high, one is right to suspect misguided fiscal policy to be the reason. Duties are easier to impose than taxes, which are levied on all regular business activity. There is only a limited number of border crossing-points, and policing them is fairly simple. If governments apply customs duties, they normally abstain from establishing adequate tax authorities and procedures, instead generating revenue regardless of economic consequences. In the short term, doing so stifles growth. In the long run, governments’ chances of implementing a more rational fiscal policy wane because their capacities remain weak. Recent years have therefore seen increased attempts to cut customs duties and introduce value-added taxes instead.

Moreover, a government’s strong dependence on customs duties indicates poor state-citizen interaction. Customs duties do not directly tax the people of the country, who would then be inclined to hold the government accountable (see Mick Moore’s essay, p. 56). Furthermore, customs procedures are particularly corruption-prone as they are based on individual inspections, with officials enjoying a great deal of discretion.

Yet another weakness is typical of developing countries’ tax systems. What they would really need are progressive tax rates, which place a greater burden on the wealthy than on the deprived. Tax-free allowances and transfer payments could then be used to support disadvantaged sections of the population in order to reduce poverty. In many developing countries today, the opposite is happening. Their tax systems tend to be regressive, burdening people with lower incomes more than they do the better-off, exacerbating inequitable distributions of income (Martens, 2006).

There are two reasons for such regression. First, a large proportion of tax revenue is generated from payroll taxes, while profits and assets are barely taxed at all. Typically, the number of people in formal employment – those who bear the tax burden – tends to be rather small because of the substantial percentage of people working in the informal sector. The taxpayers are thus normally not the poorest people in the country, but they do not belong to the top quintiles either.
A second regressive impact often stems from the value-added tax (VAT), which has now been introduced in many countries. VAT systems tax anyone who spends on consumption in the formal sector. Of course, those with the highest incomes are affected, too, but they only spend a relatively small share of their money on consumer items (see David Nguyen-Thanh’s article on p. 58). These regressive effects tend to impact negatively on the acceptance of fiscal policy – and even on state activity as a whole.

It takes an efficient administration to collect taxes in a fair and transparent manner. In recent years, considerable efforts were made in Africa to set up the necessary capacities. With the help of donors and international institutions, tax administrations in many countries have been split away from finance ministries. They are now run as subordinate, but nonetheless autonomous revenue authorities. Such reforms make sense, resulting in fairer, more transparent and effective government bodies and less corruption, which is all too often rampant among top-tier politicians and civil servants.


Table 2: Semi-autonomous tax authorities established since 1985:

Country Year in which established
Ghana – 1985
Kenya – 1995
Lesotho – 2003
Malawi – 2000
Mauritius – 1999
Rwanda – 1998
Zambia – 1993
South Africa – 1997
Tanzania – 1996
Uganda – 1991
Zimbabwe – 1999
Sources: Manasan (2003) and IMF (2006a)

Initial empirical studies paint a positive picture of such (semi-)autonomous tax administrations (von Soest 2006; Fjeldstad 2002). On their own, however, such reforms are not enough – as the example of Tanzania illustrates. Seven years after the creation of the Tanzania Revenue Authority, revenue targets were still not being met, and corruption had evidently only been reduced temporarily (Fjeldstad 2002). IMF studies similarly indicate that this authority has failed to create a comprehensive register of people liable to taxes, and that it does not keep track of all tax-relevant flows of money.


Options

From experience in rich countries, we know that tax reforms are difficult to design and may have far-reaching implications. In development cooperation, tax reform is not a simple issue either. Understanding all underlying political and administrative conditions is essential for proposing adequate measures. Raising the revenue collected is only one of several issues at stake. Others include the appropriateness of any action taken, the determination of the political leadership and the quality of implementation.

Taxes are always levied in a specific environment, which is defined by history, tradition, religion, population structure and many other factors. Sometimes, a central tax authority may compete for citizens’ dues with other institutions, for instance, municipal authorities. Traditional authorities (like chieftains in Ghana) or religious institutions (such as Islamic foundations) may also collect money. Once again, Tanzania provides a good example. The central government’s Tanzania Revenue Authority taxes farmers’ profits, and local bodies impose marketing levies on agricultural products. This kind of double taxation pits authorities against one another and can stand in the way of their popular acceptance.

Reform success always depends on political leaders’ determination to implement as well as on strategies to deal with evasion attempts. Insufficient preparation for – and poor political management of – reforms can undermine the legitimacy of a government, as became evident in the introduction of Ghana’s VAT.

During the first wave of tax reforms in Africa in the early 1990s, the government in Accra wanted to replace the existing sales tax with a VAT. The step made sense in terms of avoiding double taxation and other destructive disincentives. In Ghana, however, the reform ran into bitter protest and was ultimately rolled back. The reasons lay in a number of technical mistakes (Edling and Nguyen-Thanh, 2006):
– The VAT was set at a higher rate than the sales tax it was to replace. Therefore, the reform was perceived as a massive tax hike.
– The timing was unfavourable. Farmers had been hit by poor harvests, so people were already suffering from an inflation of food prices.
– Parliament passed the law just three months before it came into effect – leaving too little time to inform consumers and businesses about the point and purpose of the reform.
– The customs authority, which had been in charge of collecting the sales tax, and the new VAT Service engaged in disputes over matters of jurisdiction.
– Moreover, resistance was probably fuelled by the widespread perception that the reform was only being implemented because of international donor pressure. Both government and donors failed to involve local actors – such as trade unions and employers’ associations – in decision-making.

Lessons were learned from those mistakes. In 1998, the government made a second attempt to launch the VAT; and successfully so. The Value-Added Tax Act was approved by Parliament ten months before it came into force. There was thus ample time for training staff and raising public awareness. The VAT rate was set fairly low at 10 %, and certain products were declared exempt. Ghana’s experience shows that underlying conditions need to be understood and reforms need to be planned in the light of the local context. Donors can support governments in these matters if they offer appropriate assistance. However, there is no blueprint for successful reform.

On the other hand, it is still a moot question whether donors can only support a target country’s home-grown policies or whether donor engagement can also strengthen a partner’s political will. It has been warned that, despite conditions attached, budget support can weaken a government’s determination to levy taxes, thus cementing the country’s dependence on ODA (Gupta et al., 2003).


Recommendations

Several conclusions are to be drawn from what we have argued:
– Taxes are the most important source of state revenue – even for developing countries. If development cooperation is supposed to sustainably strengthen governance, donors must pay attention to the quality of tax systems and the way they work. Effective tax-system reform is crucial for state services to be funded from a country’s own resources and for avoiding long-term dependence on donor transfers.
– Higher state revenues are not the only issue at stake. The relationship between citizens and state is equally important, and it does not only hinge on tax authorities’ fairness, transparency and credibility. By its very nature, fiscal policy affects interests. Some groups are advantaged, others disadvantaged. At very least, some groups feel that way. There is thus a need for intricate political bargaining, involving all relevant actors in legislatures, governments and civil society.
– A key to success is the government’s will to reform. If the government does not implement policy systematically, even well-conceived plans cannot succeed.
– There are no blueprints. To support tax reforms adequately, one requires a good understanding of the prevalent political landscape. Relevant factors include the form of government, its procedures for making decisions and the citizens’ idea of the state. Models cannot be simply transposed from one country to the next.
– Even if the action taken stays limited, close attention must be paid to the scheduling and sequence of reform stages. Effective tax reform takes time and solid planning. Accordingly, those who want to support such reforms need to be patient. As time pressure tends to be counterproductive, donors should prepare for staying engaged in the long run.

References:

Edling, H. and D. Nguyen-Thanh, 2006:
Steuern und Kultur – Nachhaltige Entwicklung durch kultursensitive Steuerreformen? GTZ, Fiscal Studies No. 5, Eschborn.
Fjeldstad, O.-H., 2002:
Fighting fiscal corruption: The case of Tanzania Revenue Authority,
CMI Working Paper 3/2002.
Gupta, S. and B. Clemens, A. Pivovarsky and E. Tiongson, 2003:
Foreign aid and revenue response: does the composition of aid matter?, IMF Working Paper 03/176.
IMF, 2006:
Regional economic outlook – Sub-Saharan Africa, May 2006.
IMF, 2006a:
Kingdom of Lesotho: Poverty Reduction Strategy Paper, prioritisation and cost matrix, IMF Country Report No. 06/143.
Manasan, R. G., 2003:
Doing it right for tax administration reform: (semi)autonomous revenue authority anyone? PIDS Policy Notes, No. 2003-12.
Martens, J., 2006:
Die öffentliche Armut der Entwicklungsländer, DGB-Bildungswerk, Global Policy Forum and terre des hommes.
OECD, 2006: Revenue Statistics 1965-2005.
von Soest, C., 2006:
How does neopatrimonialism affect the African state? The case of tax collection in Zambia, GIGA Working Papers No. 32.
Walsh, J. T., 2006:
New customs. Finance and Development, Volume 43 (March), No. 1, pp. 48-51.