Tax Heaven

A major theme in this year’s African Economic Outlook, an annual OECD review,  is domestic resource mobilization (read: taxation), a topic that clearly deserves more attention in the region.  In a position paper released in May, the OECD points out that African tax revenue has been on the rise in recent years, but that the bulk of this increase is the result of the “scramble for Africa,” the spike in foreign-led investment in extracting Africa’s natural resources.  To be sure, African governments should reap the benefits of the natural resource bonanza, but, as the report argues, there is still a need to broaden and deepen the tax structure of African states.

One must start any discussion of African taxation by acknowledging that the meager non-resource related tax yields in most African countries are largely the result of deep structural constraints on African state capacity.     The OECD admits as much.  The report also suggests that many Africans are unwilling to pay taxes as long as they do not perceive these funds as leading to the delivery of public goods.  There is something of a catch-22 here, since governments are constrained from making major welfare improving investments by a lack of funds, and their inability to make these investments deepens skepticism among potential taxpayers about the utility of paying taxes, preventing governments from increasing their resource bases. (This is not to excuse mismanagement of existing funds, which is also a well documented problem in many African states.)

But while it is true that what Jeff Herbst has called the limited “broadcast power” of African states is a serious impediment to improved taxation, this kind of argument tends to paint with too broad of a brush.  African governments face serious obstacles in increasing their tax yields, but this should not lead to overly pessimistic assessments of what can be accomplished.

A key area where something probably can be done is to increase the transparency of the exemptions granted to various actors from existing tax structures.  Exemptions from existing tax rules for specific groups or individuals are known as tax expenditures.  The creation of tax expenditures can be in the public interest, or it can be the result of lobbying by well-connected but already profitable industries.  Tax expenditures that may be in the public interest subsidize activity which might otherwise not occur and that is desirable from the standpoint of employment generation, social protection, economic growth or economic diversification.  Tax expenditures that are not in the public interest rob the treasury of important resources in order to provide subsidies that serve no special social function, or support businesses that are already profitable without the incentive.

Governments that are capable of providing tax expenditures are probably also capable of reporting on them, but very few do so.  According to the 2008 Open Budget Survey, 57 of 85 countries surveyed provided no information at all about tax expenditures.  In Africa, only Kenya, Ghana and South Africa made substantial information about tax expenditures public.

As noted, tax expenditures are not inherently bad.  Public subsidies may be part of a well thought-out, welfare-enhancing set of industrial policies.  But because subsidies may also be a sign of favoritism and inefficiency, it is crucial that governments make information about these subsidies public.  When they do, debate can ensue about whether the subsidies are well-targeted or not.

The OECD position paper describes a process of this type which occurred in Morocco, and holds it up as a model for the role that information about tax expenditures can play in enhancing the political prospects for tax reform:

“Tackling the challenges encountered during fiscal reforms is a sensitive political undertaking and must be embarked upon only after having built a strong constituency that supports change.  The Moroccan experience has shown that this process is helped by conducting a fiscal expenditure survey that identifies the cost of exemptions granted to corporations and individuals and by bringing this survey to the attention of members of Parliament and other stakeholders.”

Indeed, it appears that the Moroccan government’s report on tax expenditures, partially discussed in these slides, brought public attention to the high cost of tax expenditures, and VAT exemptions in particular.  This may have played a role in generating public pressure for tax reform and the elimination of various VAT exemptions.

The path from producing information to generating greater tax revenue is surely winding, but unlike creating a buff new administrative behemoth overnight to increase tax yields, better reporting on tax expenditures is something governments can feasibly do in the short term.   If they need support,  donors might also step in.  As the position paper notes, while Public Financial Management support can be critical for improving financial systems in many developing countries, donor support for PFM constitutes less than 2 percent of all technical support provided by OECD countries.

Once the information is produced, parliament, civil society or other actors can use it to ignite debate over the use of current revenues, and, if need be, push for tax reform.  The more information that is available and the easier it is to use, the more likely that it will eventually find its way into a debate over how to raise more tax revenue.  Even in countries that are ready to tackle the deeper structural constraints on tax collection capacity, knowing how much you are already collecting, or how much you are letting slip through your fingers, is the cornerstone of a rational tax regime.   The ball rests squarely in the camp of the nay-sayers: why NOT make information on tax expenditures publicly available?

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