In Africa, pay more attention to tax - IMF

We would like to highlight a new report in the IMF's quarterly Finance and Development magazine, which says many sensible things. For years the IMF has pursued policies often in line with the tax-cutting "Washington Consensus" which has paid little or no attention to factors such as the crime-generating features of tax havens, the democracy-building functions of taxation, and more. While we don't agree with everything in this paper, it is a breath of fresh air and appears to be part of a broader shift in thinking in the right direction.

It starts by highlighting how aid flows have risen, but have been insufficient.

"The average tax-to-GDP ratio in sub-Saharan Africa 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 income tax on oil and mining companies. Nonresource-related revenue increased by less than 1 percent of GDP over 25 years. . . . a growing share of current spending is financed by aid."

The authors then dance around the question of whether scaling up aid further would help, and make the case for focusing more on tax. Here are their main points, (edited, in our own order of preference):

1. "Tax increases incentives for public participation in the political process and creates pressure for more accountability, better governance, and improved efficiency of government spending. Domestic revenue mobilization can help strengthen fiscal institutions." This is just what we, and others, have been arguing for some time. Stable and predictable revenue, the report argues, helps medium-term fiscal planning; and the efficiency of social spending has a strong positive correlation with the quality of fiscal institutions
2. "Stronger revenue mobilization (tax) contributes to economic stability, particularly in countries dependent on external financial flows."
3. "Greater reliance on domestic revenues reduces the risk of Dutch disease," which occurs when capital inflows from aid and other inflows cause the exchange rate to appreciate, making a country’s exports less competitive. . . "This is an important, often-overlooked matter, and we will be blogging more about it in due course.
   
4. "Aid-financed projects give rise to additional spending, such as on operations and maintenance, which will need to be covered at least partly, if not wholly, from domestic resources. " The country must then raise revenue to pay for this.
   
5. "Expanding domestic revenue could also help Africa address the challenges arising from globalization. These countries are feeling the pressure to further liberalize their trading regimes, because their average tariff rate is higher than in other regions. Also, tariff rates in sub-Saharan Africa are expected to fall as a result of the formation of free trade areas and customs unions within the region as well as with other regional trading blocks, including the European Union. Currently, about a third of nonresource tax revenue in the region comes from trade taxes—about 4 percent of GDP—indicating that revenue loss from further trade liberalization would be significant. Strengthening the domestic revenue base could help recoup at least some losses from trade taxes." The report also notes that "African countries are also confronted with increasing tax competition on corporate income tax (CIT), as countries compete more aggressively to attract foreign investment."
   

In the context of the last point, the IMF also notes that African countries widely used tax incentives (spurred further by harmful Washington Consensus-style thinking), when as we have argued before, these are often highly damaging. The new IMF report has this to say:

"There are many large taxpayers who are benefiting from rising commodity prices, but they are not paying taxes commensurate with their income."

Well said, of course. It goes on:

"Tax incentives in sub-Saharan Africa are now used more widely than in the 1980s, with more than two-thirds of the countries in the region providing tax holidays to attract investment. The number of countries using free zones that offer tax holidays has also dramatically increased. Moreover, low-income countries in the region use such incentives more extensively than do middle-income countries—yet foreign direct investment in sub-Saharan Africa, other than in the resource sector, has increased very little over the past two decades. Such incentives not only shrink the tax base but also complicate tax administration and are a major source of revenue loss and leakage from the taxed economy. . . . investment decisions depend on a host of factors that often carry more weight than tax incentives."

All in all, a welcome report. Read the whole article - it's not that long, and it contains fresh data bolstering the case for more focus on tax in international development. We hope this kind of thinking - at least the bits we've highlighted here - continues to spread.