Africa is taking a growing role in the world, its population is increasing fast and so too is its need for finance to build for the future: to achieve the United Nations’ Millennium Development Goals (MDGs) and close the gap between its infrastructure and the rest of the world’s, the continent requires an annual investment of USD 93 billion over the next decade (Foster and Briceño-Garmendia, 2009). In sub-Saharan Africa alone, 3.8 million teachers would have to be recruited within five years to achieve universal primary education (UNESCO, 2009). No economy can afford to fund such development needs primarily from external sources, be they public or private.
Indeed, in 2002, the United Nations’ Monterrey Consensus on Financing for Development acknowledged that external financial resources would not be enough to meet the MDGs and that it was necessary to develop new strategies by mobilizing domestic resources. Africa is no exception. The global crisis has shown how uncertain external flows are for African governments whose revenues have been badly affected (see Part I). In the long run, the greater domestic investment can offset vulnerability as well as strengthen local ownership. Development success stories go hand in hand with better mobilization of a country’s own resources and less dependence on aid and other foreign finance.
What is Public Resource Mobilisation, and Why Does It Matter?
Domestic resource mobilization is the generation of savings domestically – as opposed to investment, loans, grants or remittances received from external sources – and their allocation to socially productive investments within the country. There are two sides to it. The private side concerns private domestic savings, which the financial sector (e.g. private banks) channels towards investment. Public resource mobilization is about public savings – the excess of public revenues on current government expenditure. This is what is available for governments to fund public investment in infrastructure, including roads, power plants, schools, health facilities, etc. It originates either from borrowing, e.g. issuing government bonds or the taxation of individuals and companies.
This part of the Outlook focuses on the latter. It examines how more “equitable and efficient tax systems and administrations” – which signatories of the Monterrey declaration have committed to secure – can be used to improve funding for Africa’s development. It focuses on the effectiveness of revenue collection rather than the quantity and quality of spending, although it highlights their importance. It also discusses how foreign aid affects the mobilization of public resources.
Why review African tax systems now?
The global economic crisis has revealed the risks for African economies of depending too much on external flows for their revenues. First, the reliance on commodities means many African countries remain vulnerable to upsets from the rest of the world, such as the swings in international prices in 2008 and 2009. Second, although major debt write-offs and the boom before the crisis helped, the risk of over-indebtedness cannot be ruled out. With the expected fall in export revenues and return to unsustainable fiscal and current account deficits, international reserves may not be able to protect economies from the shortage of external finance. Third, most African economies – particularly non-oil exporters – are prone to chronic external deficits in the current and trade accounts. Even a small reversal of capital flows can force a domestic contraction unless accompanied by very large trade improvements. Fourth, following the global crisis, the evolution of foreign direct investment (FDI) into Africa and the rest of the developing world is uncertain over the medium-term. Fifth, remittances from Africans in Europe and North America have become an important supplement to basic incomes, but they have been increasing at a slower pace in recent years, and are set to slow down further. Finally, as highlighted in Part I, Africa is set to receive only about half of the increase in official development assistance (ODA) envisaged at the Gleneagles Group of Eight summits in 2005. Although most donors plan to continue increasing aid, some have not lived up to their promises and may fall further behind on their commitments as ODA budgets stagnate or shrink. The realization of this vulnerability has given a new impetus to dialogue on domestic resource mobilization across Africa, particularly taxation.
The global economic troubles have also stimulated the international dialogue on taxation, in which Africa is increasingly claiming its stake. Confronted by budget deficits, governments are seeking to maximize fiscal revenues by strengthening campaigns against evasion and fraud. The Group of 20 nations has made it a priority to enforce internationally agreed standards against tax havens. The Organisation for Economic Co-operation and Development (OECD) countries are actively seeking to engage others in this dialogue, to build support for wider, more binding multilateral co-operation. Donor countries are stepping up financial and technical support to tax administrations in developing countries. This changing context gives African countries new opportunities to improve tax collection for development.
Africa’s taxing question: fiscal legitimacy and the state
Tax is not an end in itself. Development economists have long recognized its importance in the consolidation of a well-functioning state (Kaldor, 1980 and Toye, 1978). A healthy public finance system is needed for rapid, equitable, and sustainable growth: government revenue should adequately finance basic security, education, health services, and public investment while avoiding inflationary financing. Taxation is one of the few objective measures of the power and legitimacy of the state (Di John, 2009). In post-war economies, for instance, reconstruction of the revenue base is essential to restore a viable state. Tax revenues are also necessary to fund the military, which ensures that a state can secure its borders. Not only do states rely on tax revenue to function, but taxes are also the primary platform for political negotiations amongst a country’s stakeholders. They are part of the social contract between a state and its citizens: taxpayers want to know that everyone is paying their fair share and that the money they hand over is put to good use and not preyed upon by corrupt officials. They are more likely to comply with paying taxes and to accept new forms of taxation if they consider the taxes to be legitimate. This is what is known as “fiscal legitimacy”.
In many developing countries though, poor revenue performance often prevents governments from supplying adequate public services. This creates a vicious circle of dissatisfaction of citizens and firms with those services and a greater willingness to avoid paying taxes. This is largely the result of weak tax administrations, as well as corruption and resistance from ruling elites, who bargain tailored tax cuts and exemptions for themselves and in some cases multinational enterprises. Tax administrations may thus be kept weak because maintaining good relations with donors and large firms exploiting natural resources is easier than being accountable to taxpayers. By contrast, more vigorous taxation and greater fiscal legitimacy imply entering into more constructive dialogue and negotiation with citizens and firms over the spending of taxes collected, with legislators and civil society overseeing tax legislation and government spending. It also requires enlarging the tax base by encouraging the accumulation of capital and the growth of business outside the immediate sphere of influence of the state. Public resource mobilization, therefore, goes straight to the heart of Africa’s development challenge. But if the aim is legitimacy and greater ownership by a nation of its own development path, does it mean getting rid of foreign aid?
Public resource mobilization is no alternative to aid in the short run
Africa depends on external resources because domestic savings fall short of current investment needs. Given that this gap will not be closed quickly, most African countries will continue to rely on external resources in the near future. And yet greater independence from ODA is part and parcel of the development process. Better public resource mobilization is thus not an alternative to aid; they must go together. The challenge is for African countries and their partners to end the vicious circle of aid dependency that shifts government accountability away from citizens towards donors. Instead, they need to start a virtuous circle of aid working to make itself redundant, by supporting public resource mobilization.
Indeed, aid remains of vital importance for many countries: its share in government revenues is such that if it were to disappear, several states would simply collapse. Figure 1 measures aid dependence as the percentage ratio of aid flows over gross national income (GNI) in countries for which data is available. The most dependent countries are found in sub-Saharan Africa along an arch that crosses the continent from North-West to South-East.
Stimulating public resource mobilization, the equivalent of increasing the public savings rate, is a necessarily lengthy process. Meanwhile, countries will continue to rely on foreign aid. Yet, the end game should be one in which African countries graduate from, or at least cease to depend upon, aid as a primary source of financing. Mobilizing domestic resources better is one way to reduce aid dependency over time. Every effort should thus be made to ensure that aid does not “crowd out”, or discourage, domestic resource mobilization, in general, and public resource mobilization, in particular. Yet, with so much of Africa’s private savings channeled away from productive private investment, or fleeing the continent, the risk of crowding out private savings is relatively limited. Public resource mobilization actually allows a greater share of savings to remain on the continent and be spent on economic development. One of the dividends of effective tax systems is thus greater ownership of the development process, whereby the government shapes an environment that is more conducive to foreign and domestic private investment, sustainable use of debt and effective use of ODA.
Tax revenues should therefore not be seen as an alternative to foreign aid, but as a component of government revenues that grows as the country develops. Comparing ODA levels with tax revenues in African economies actually reveals that the former is overall much smaller than the latter in many countries. Is that proof that “independence from aid” is within reach in Africa? A closer look at the evidence shows a more complex picture.
Figure 2 plots total ODA per capita and total tax revenues per capita in 2008. On average, Africa collects USD 441 of taxes per person per year while it receives USD 41 of aid per person per year. In other words, aid represents less than 10% of collected taxes on the continent as a whole. Of course, the average does not apply to all countries. Of the 48 African countries for which data is available, aid exceeds tax revenues in twelve countries, is larger or equal to half the tax revenues in 24 countries, and exceeds 10% of tax revenues in 34 countries. And yet, in nearly one third of African countries (14 out of 48), aid already represents less than 10% of taxes. Many of those are relatively resource-abundant and/or small in terms of their population (Algeria, Angola, Congo, Equatorial Guinea, Gabon, Libya, Namibia and Swaziland). Figure 2 therefore indicates that, with the exceptions of Egypt, Morocco, South Africa, Seychelles and Tunisia, those countries who made most progress towards “graduating from aid”, the “good performers” in terms of tax collection over the last decade, tend to be those who benefitted disproportionately from rising energy and commodity prices. These have generated higher associated tax revenues, as we see in the next chapter.
Based on the 50-country African Economic Outlook 2010 survey, Chapter 2 analyses recent trends in tax collection and compares the performance of African tax administrations.
- The trend of tax revenues on the African continent is positive. The average African tax revenue as a share of GDP has been increasing since the early 1990s. African countries generally collect tax revenues similar to those of countries at similar stages of development on other continents.
- However, this positive trend has been mostly driven by resource-related tax revenues, that typically distract governments from generating revenue from more politically demanding forms of taxation such as corporate income taxes on other industries, personal income taxes, Value Added Taxes (VAT) and excise taxes.
- By contrast, countries without large natural resource endowments have made relatively more significant efforts in improving the quality and balance of their tax mix.
- In fact, non-resource related tax revenues have stagnated at best, while trade taxes have declined as a result of trade liberalisation. Corporate income taxes are reported to have been resilient, despite decreases in rates at which profits are taxed across Africa, and increases in the number and type of exemption granted by African countries to investors.
Chapter 3 analyses three types of challenges which African economies are facing with respect to further mobilisation of public resources.
- First, the cross-cutting structural bottlenecks: high levels of informality, a lack of fiscal legitimacy and huge administrative capacity constraints, against which donor support has hardly been enrolled.
- Second, the already shallow tax-base is eroded further by excessive granting of tax preferences, inefficient taxation of extractive activities and inability to fight abuses of transfer pricing by multinational enterprises.
- Third, the tax mix of many African countries is unbalanced: they rely excessively on a narrow set of taxes to generate revenues. Some stake-holders are disproportionally represented in the tax base. Declining trade taxes leave a critical gap in public resources.
Finally, Chapter 4 provides policy options for African decision makers and donor countries to tackle those challenges, reviewing some of the good practices in taxation policies, administration and multilateral co-operation.
- Tax reform will bring long-term results only if it is visibly linked to a growth strategy.
- Improving tax collection must be accompanied by a general discussion about governance, transparency and the eventual use of increased public resources by the government.
- Proper sequencing of policy reforms is essential. Administrative bottlenecks are such that in the short run, deepening the current tax base is the only effective policy option. In particular, countries should consider retrenching tax preferences and negotiating fairer and more transparent concessions with multinational enterprises.
- However, developing administrative capacity today is a prerequisite to opening policy options for more progressive tax policies in the medium run.
- In the long run, African countries need to improve the balance between different taxes. Urban property taxes could yield a much higher return if decentralised, as local governments usually have a more direct access to the relevant information.
- Trade liberalisation needs to be purposively sequenced with domestic tax reform. The policy response to declining trade-related tax revenues has to be designed in the context of a broader reform agenda.
- Donors can do more to build capacity in support of public resource mobilisation in Africa. They also need to deliver on their pledges of policy coherence by putting pressure on their own conglomerates to strike decent deals with African nations.
In addition to this report, new data on the tax capacity of African states and the key features of tax systems used across the continent can be downloaded at www.AfricanEconomicOutlook.org. In each country note in the Outlook, readers will find a section highlighting key developments in tax collection in the national context.