Taxation, resource mobilisation and governance in Sub-Saharan Africa

Jonathan Di John

Taxation and tax reform is central to state-building • governments must be able 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 and help secure property rights.

• fiscal capacities are needed to build a legitimate state.

Democratic elections do not themselves ensure state legitimacy

The Political Economy of Taxation and Tax Reform

• Introduction: The Problem of State Capacity and Taxation in Less Developed Countries

• Taxation is not considered one of the five fundamentals of good governance (as spelled out in the World Bank Development Report, 1997).

• Yet, as Schumpeter notes: “the fiscal history of a people

is above all an essential part of its general history”

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 2005.

• 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).

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

Challenges Facing Low-Income Counties

• high revenues from trade taxes• 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• Non-state rivals to tax collection in some contexts

• 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.

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

Differences in Capital Flight across regions

Table 5. Capital Flight as a Share of Private Wealth in Latin America and East Asia

(percentage) 1980-9 (a) 1990-8 (a) 1980-9 (b) 1990-8 (b) Sub-Saharan Africa 27.6% 30.1 27.4 30.3 Latin America &Caribbean 8.5% 9.0 7.5 7.9 East Asia and Pacific 4.5 5.0 2.0 2.7 Note: (a) all observations; (b) full data points only Source: Collier et al. (2004, Table 1A, p.22)

Variation in Revenue Performance

• 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 low-income 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

Taxation and commodity booms• Missed opportunities?

• Example: Copper Mining Royalties in Zambia

• policy implications • urgent need for mineral abundant states to enter into a renegotiation of

mining contracts when they are unfavourable.

• need for governments to develop productive strategies that exchange mineral rights for local content conditions, whereby foreign investors are obligated to use domestic suppliers on an increasingly greater scale. Local content management has been one of the main ways in which FDI can be utilised for the benefit of national productive capacity.

• capacity-building in the geological survey capacity in sub-Saharan Africa needs to be developed in order to improve the bargaining power of states vis-à-vis multinationals. This is an area where the international financial institutions can play a leading role.

1. Taxation as Indicator of State Performance

• Main Advantage---Objective Indicator

• Components of the indicator:• Monopoly over Tax Collection• Territorial Reach of Tax Collection• Direct Income Tax Collection• Tax Effort• Compliance and coercion in tax collection

Level and Structure of Taxation in selected African Countries (annual average 1984-2004)

Country Tax share

Trade Tax

Domestic Tax

Nontax Revenue

Direct Tax

Indirect tax

Higher Tax States

Angola 32.08 4.73 12.82 10.24 71.34 18.42 Botswana 34.34 15.32 56.30 20.47 47.76 31.78 Kenya 18.75 17.10 17.96 14.69 29.38 50.68 Malawi 16.87 16.06 34.79 14.43 50.19 35.38 South Africa 23.14 3.62 34.33 7.01 54.26 38.51 Zambia 18.23 30.08 32.56 4.93 32.38 62.64 Zimbabwe 23.13 10.91 36.15 9.13 46.66 44.22 Nigeria 18.85 9.67 6.90 44.88 38.08 16.52 Lower Tax States

Cameroon 13.56 16.03 36.37 12.41 30.67 53.15 Congo. Democratic Republic

5.34 23.76 26.58 29.66 27.29 50.34

Ghana 14.15 25.90 36.33 14.13 22.09 62.83 Rwanda 9.89 31.83 39.63 56.12 24.79 72.14 Senegal 15.83 22.08 49.87 10.24 22.75 67.01 Sierra Leone 8.73 17.34 5.06 22.45 66.29 Tanzania 11.36 25.15 28.58 8.66 31.86 53.73 Uganda 8.51 49.80 28.68 7.31 14.21 78.48 Mozambique 10.52 17.30 47.77 13.52 18.38 68.11

Table 2: Share of Direct Taxes as a Percentage of Total Taxes, 2007

Country Share of Direct Taxes (%)

South Africa 55%

Zambia 45

Rwanda 37

Mozambique 33

Tanzania 32

Uganda 26

DRC 18

Source: OECD (2010a)

Tax Effort in African Case Studies, 2007

Country Fiscal Revenue per capita (US $)

Tax Effort Index (excluding resource rents)

Zambia 219.2 1.29

Uganda 66.7 1.19

Rwanda 57.1 1.17

Mozambique 66.1 1.02

Tanzania 70.6 0.96

DRC 30.7 0.88

2. Taxation and the Elite Bargain

• The creation and deployment of economic rents and privileges to relevant elites is the essence of elite bargains.

• In turn, exploring tax patterns can illuminate important insights into the shape and character of the elite bargain, which has been argued to be important in generating state resilience in general.

• At the same time, the nature of elite bargains provides a window into the political limits of expanding tax capacity.

Taxation and the Elite Bargain

• high levels of tax evasion are tolerated

• the negligible collection of urban and rural property taxes

• relatively low rates of taxation on agriculture which (while part of investment incentives) be seen to benefit elite landowners and particularly large farmers and agro-processors.

• a significant decline in the corporate tax burden on big business which has benefitted both foreign firms (particularly in mining) and political and economic elites.

Taxation and Production Strategies

• a pro-revenue approach often takes precedence over a pro-growth approach in tax policy.

• Examples of developmental taxation:

• Mauritian export tax on sugar (19th and 20th centuries)

• Colombian Coffee Federation

Taxation, state territorial reach and production strategies

• History provides several examples of the importance of land and property taxes in enhancing the territorial, social and economic reach of the state (Japan, South Korea, Taiwan, US in 19th century)

• important feature of the land tax was that it was introduced as part of a production strategy to help improve agricultural production. The link between tax collection strategies and production strategies is often lost in contemporary discussion of tax collection.

• the role of agricultural marketing boards have played in some countries an important role in expanding the territorial reach of the state and in linking rural interest groups to the state

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.

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.

Taxation, state territorial reach and production strategies

• The Colombian experience with its national coffee federation also provides evidence that the state can use taxation of agriculture to solve collective action problems in production (such as the provision of funds for storage, distribution, and marketing for thousands of dispersed smallholder producers) and help forge strong state-society negotiations and mutual obligations (Thorp, 2000).

Marketing Boards

• The role of agricultural marketing boards have played in some countries an important role in expanding the territorial reach of the state and in linking rural interest groups to the state.

• Marketing boards were also an important source of state resource mobilisation through the mechanism of monopolising the purchase of cash crops at below world market prices and selling such crops abroad at world market prices.

• The surplus generated was often of similar magnitudes to formal total tax collection levels, particularly in Sub-Saharan African economies in the 1960s and 1970s. Marketing boards were effective in some countries such as in Taiwan, South Korea, Indonesia, and India because the state gave something in return to producer groups such as services, infrastructure, research, and price stability.

Marketing Boards--Kenya-Tanzania Comparison

• Bates (1995) argues that the Kenyan coffee board was, in the 1970s and 1980s more effective than the Tanzanian coffee board because the nature of the political coalition in power differed in the two countries.

• In Kenya, large and medium-sized coffee farmers were a powerful interest group; whereas in Tanzania, coffee farmers were not a powerful group in the national government’s support base. As a result, policies were in Kenya were developed in ways that extracted much fewer net resources from coffee producers than in Tanzania.

Marketing Boards and Political Stability

• Even where marketing board policies were relatively ineffective such as in Tanzania and Zambia, they have played an important role in increasing the territorial reach of the state, developing state-rural interest group links, and in providing social infrastructure and services.

• the inclusive reach of marketing boards may have contributed to the maintenance of political stability and nation-building in both these cases.

• Further comparative historical work is required to assess the differential impacts marketing boards have had in state-building and in enhancing the territorial reach, and legitimacy of the state.

Policy Implications

• Because tax is a more objective measure of governance than many prevailing governance indicators, donors and academics might more systematically incorporate it into indicators of fragility, resilience and governance more generally.

• tax reform process requires political analysis to understand what types of reforms are feasible in a given context. In particular understanding how the elite bargain is constructed and how it is related to political stability is central to proposing tax reforms that are politically sustainable.

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.

Tax Policies to Improve the Fiscal legitimacy of the State

• 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.

• Avoid the problem of the ‘dual public sector’ in aid delivery

• Need to re-think the composition of aid towards infrastructure and economic production

• Taxing the informal sector may require linking tax policy to production strategies.

Taxation, Governance and Growth • Inherent in much of the recent work on taxation is that a broader-based taxation

system will consolidate state-interest group bargaining which will, in turn, generate a greater degree of legitimacy which supposedly will generate more effective governance. Good governance, in turn, is seen as central for sustained rapid economic growth (World Bank, 1997, 2002).

• The problem with much of the new literature, however, is that it identifies the tax nexus as the main source of a state’s legitimacy. This is problematic in the context of economically underdeveloped countries.

• Because tax rates and composition are not systematically correlated with economic growth, it is not helpful to focus on taxation in isolation of other factors that affect capital accumulation, the efficiency of investment and economic growth. For instance, national savings and particularly public savings (which in part come from the efficient operation of state-owned enterprises) may be as if not more important to the growth prospects of an economy.

• Limited fiscal basis of the state makes good governance agenda unrealistic.

Aid and its Effects on Taxation and State-Building

• Positive effect of setting up Large Taxpayer Offices

• Four important elements to the Rwanda Revenue Authority strategy, which has underpinned its relative success to date

• First, the principle objective of revenue policy is to promote economic growth, rather than simply maximising revenue collection.

• Second, they have followed the general trend advocated by the IMF of moving from models of collection based on tax type to models based on types of taxpayers;

• Third, sought to widen the ownership of the tax effort beyond the revenue authority, establishing Tax Advisory Councils at the provincial and district levels involving parliamentarians and chaired by a governor, mayor or security institution. In the same vein, they organised a national Tax Appreciation Day where the RRA accounts publicly for what it has done and hears from people what they would like to see done. The “best taxpayers” are given an award by the head of state.

• Fourth, gradually phased out technical assistance from line positions within the authority and took control of technical- assistance contracting and management, moving from long-term technical assistance to short-term contracts around very specific needs.

Aid and its Effects on Taxation and State-Building

• the extent to which aid is by-passing the state in the delivery of social services (the problem of the dual public sector)

• In the DRC, OECD estimates that 146 parallel management units currently exist, which is four times the 2006 number.

• In Afghanistan, research suggests that the problem of the dual public sector in aid delivery can be overcome by through setting up “dual-control oversight mechanisms” that can reduce corruption and still ensure resources flow through the state. The Afghanistan Reconstruction Trust Fund, which was World Bank funded, seemed to play this role.

• 3) the high levels of project aid which winds up ‘off budget’, that is, is not reported to finance ministries.