The informal sector is difficult to tax: selling potatoes in Arusha.
The tax-to-GDP ratio does not reflect the fairness of a tax system. In most member countries of the OECD (Organisation for Economic Co-operation and Development), an umbrella organisation of rich nations, it has remained relatively constant in the past three decades. However, a big shift took place from direct to indirect taxes, which led to a redistribution of the tax burden from the better-off to the worse-off. This example shows that fairness depends on what kind of taxes are collected.
African countries could raise their tax-to-GDP ratio by collecting more money from the poor, but that would compound problems of inequality. The aim must be to establish equitable tax systems that make all citizens pay according to their ability to pay. The higher one’s income is, the higher the share of taxes one pays should be. That kind of tax system is called progressive. Moreover, African governments must do their best to curb illicit financial flows (IFF) in the global context.
African countries’ tax-to-GDP ratios are low compared with those of OECD members today. However, they resemble those of OECD nations when their economies were not yet industrialised, diversified and technology-based. Back then, for example, it was not unusual for European governments to raise only 10 % of GDP.
The structure of African countries’ economies is one reason for the low tax-to-GDP ratios. Tax collection is made difficult by the preponderance of subsistence agriculture, the lack of diversification and the huge share of the informal sector in urban areas. It would make sense to widen the tax base and raise taxes from the informal and subsistence sector. Measures to do so would not only raise revenue, but also turn the majority of the people into tax paying citizens with a voice.
International experience shows that governments are more likely to be accountable to citizens as tax payers than governments who depend less on taxes. Indeed, taxes reflect a “social contract”. The people pay taxes, and in return the government delivers social services and builds infrastructure. Typically, budgets are adopted by parliaments, and the social contract is reinforced in elections.
Unfortunately, African tax systems are not yet in a situation to strengthen the social contract. The reason is that they increasingly rely on indirect taxes – such as the value added tax. Consumers are often not conscious of paying these taxes. Moreover, these taxes disproportionately burden the poor, who must spend almost all of their income on consumption.
Thanks to loopholes and exemptions, the better-off do not pay appropriate income or other taxes. All too often, governments intentionally provide them with tax avoidance opportunities. Adopting more progressive tax systems would not only raise fiscal revenues, but also address the issue of inequality. Another important aspect would be that national revenue services would have to be made more accountable and more transparent in order to minimise corruption, enhance efficiency and boost credibility. All summed up, the governance of African countries would benefit from better and more progressive taxation.
Nominally, tax policies are a sovereign prerogative. Each country is free to determine its tax policy. In practice, however, international financial institutions (IFIs) and donor governments have a strong influence on African policies (see box). African countries have the right – and the duty – to adopt policies that serve their people rather than the interests of multinational corporations. The tax holidays that foreign investors have been granted undermine African statehood and thwart attempts to make tax systems fairer.
The influence of IFIs and donor countries in maintaining the status quo cannot be overstated. OECD countries condone tax dodging in Africa. Their stance reminds one of the attitude they used to have towards bribes. Until the beginning of the century, they not only tolerated this kind of corruption but even made bribes tax deductible. If they were to deal with multinationals’ tax avoidance and tax evasion as illegal as they at long last did with bribery, this would be consistent with their rhetoric to support African governments to mobilise more domestic resources.
Illicit financial flows (IFFs) are depleting Africa’s public revenue. Stemming them is a hot topic of development discourse. African governments’ scope for action is limited, however, as IFFs involve manipulation of international trade prices, theft of public assets and tax-haven operations. The most notorious tax havens actually belong to the OECD: 15 are British crown dependencies and overseas territories, including the Virgin and Cayman Islands.
In 2011, the African Union and the UN Economic Commission for Africa set up a high-level panel on IFF. It was chaired by Thabo Mbeki, the former president of South Africa (also see article by Mick Moore in D+C/E+Z). The panel published its report in 2015. It estimated that up to $ 60 billion a year leave the continent in the form of IFF.
Among other things, the panel recommended to eliminate secrecy jurisdictions around the world. Scandals such as Swiss Leaks, Luxleaks, Panama Papers and the recent Paradise Papers revealed the universality of tax evasion and tax avoidance. They also proved the role of secrecy jurisdictions in facilitating such practices. After a few weeks of public outrage, however, it has so far always been back to business as usual.
OECD countries are making efforts to reduce tax dodging at home and prevent profit shifting that affects their own revenues. But not much is being done in terms of profit shifting from developing countries and IFF from Africa.
If OECD governments really want to support African countries’ efforts to mobilise domestic resources, they must do more than merely offering advice on tax policies and the management of revenue services. A good place to start is to minimise revenue loss through tax dodging and IFFs. Measures of this kind would boost the legitimacy of action to improve Africa’s domestic tax systems.
Dereje Alemayehu is senior advisor to Tax Justice Network Africa.