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Public Finance

“Taxes don’t bother investors much”

by Omari Issa

In depth

“There must be incentives for small and medium enterprises to formalise operations.” Shop in Arusha, Tanzania

“There must be incentives for small and medium enterprises to formalise operations.” Shop in Arusha, Tanzania

A healthy business environment hinges on the quality of governance in many ways. Omari Issa of the Investment Climate Facility for Africa shared his views in an interview with D+C/E+Z’s Hans Dembowski. Interview with Omari Issa

In Germany, many people worry that there is an international race to the bottom, with countries lowering tax rates to attract investors. Does that apply to Africa?
No, I don’t think so, though some African countries do try to attract investors with low tax rates. But for an investor, taxes are only one of many things that matter. Investors consider the whole picture. Is electric power available? Is its supply reliable and affordable? And what about water? Are the roads in a decent shape? Labour issues matter too, of course, but not just in terms of costs. The real question is: how do wages and salaries relate to skills? Investors, whether they are foreign or not, have to consider all of these factors. They will most likely prefer paying – let’s say – 20 % taxes on their sales or profits to having to cope without infrastructure and without a skilled work force.

So a well-performing public sector that ensures the quality of physical and social infrastructures, for instance, is more important than low taxes?
Governance is crucial in many ways. The rules and regulations that apply to businesses need to be coherent, consistent and predictable. A scenario where a regulator can wake up in the morning and decide on the spur of the moment to hike the power rates is a nightmare for any investor. Investors must do their calculations diligently, and ad-hoc changes will fast thwart their efforts. Contract enforcement matters too. Investors appreciate settings where they can take a business partner to court if that business partner is not living up to the commitments made. Therefore, an efficient, transparent and fair judiciary is an important component of a healthy business enviroment. Even public health services or the quality of housing can make a difference to investors, because they are more likely to find skilled staff in places where these matters are taken care of. The tax rates in themselves are not what attracts investors.

Nonetheless, business lobbies, in Germany for instance, keep on complaining about taxes.
Well, I don’t think anybody enjoys paying taxes, but most business leaders certainly accept the need to pay taxes in principle. What investors resent is unpredictability, they don’t want to spend money on starting a venture and, half way through, learn that the tax system has changed and they must pay more than they initially expected simply because a new finance minister has taken office. To attract investors, a tax system therefore has to be consistent and somewhat stable. Investors, moreover, do not like tax systems that are onerous. An occasional audit is fine, but they don’t want to have revenue service officers sitting in their offices for weeks, or even months, endlessly checking files in what feels like a permanent audit and that really is only an expression of permanent suspicion. Finally, the system has to be simple. There should not be lots of forms and complicated procedures. The system should be straightforward and not involve too much time and bureaucracy.

Please give an example.
In many African countries, businesses have to prepay the value-added tax, or VAT for short. If it takes a long time and a lot of effort to collect the VAT refunds, that hurts the companies concerned. If they have to wait for months or longer before they get their money back, that will undermine the viability of their operations. After all, they need money to buy raw materials and pay their
staff.

What kind of tax reforms contribute to improving a country’s investment climate?
One thing we promote is customer care. A country’s revenue service should cooperate with the taxpayers. It should not just enforce the law, but make it easier to pay taxes. We tell the tax authorities we work with: If someone else besides you were collecting taxes on behalf of the government, and doing so in a friendlier manner, that is where your taxpayers would be turning to. Tax authorities can help to improve the investment climate by becoming more citizen-oriented. For instance, they can allow people to file taxes online. If the procedures are not too onerous, more businesses will volunteer to pay their taxes.

So you are thinking of formalising the informal sector.
Yes, but not primarily for the sake of collecting more taxes. There must be incentives for small and medium enterprises, most of which are informal in most African countries, to formalise their operations. And there are such incentives. If they register, they are more likely to be eligible for credit from the financial sector, and those loans will be cheaper than loans they get from traditional moneylenders. Formalisation can also give companies better chances of enforcing contracts through the courts. Similarly, they will have better opportunities to hire skilled staff, since they’ll be able to do so on the base of skills and performance rather than merely family ties. Once more, I am discussing governance issues in a comprehensive way – and that is the way they matter to investors. Where governance is good and business friendly, taxes don’t bother investors much.

The informal sector is typically controlled by Mafia-type organisations. They collect protection money and promise to ensure that businesses can operate.
Yes, that is true. And in a way, protection money is like a tax, only that it is informal and, of course, illegal. Consider the minibuses in many African cities. Their owners are paying money to some illegal organisation to make sure they get customers and that competition on their routes does not get too tough. To an extent, we are looking at a self-regulating system, and it is not just an African phenomenon. Pizza parlours in New York City are said to pay protection money too.

And that is said of restaurants in Frankfurt too. But if you want to change that, you’ll run into the opposition of the protection rackets.
I’m not so sure. To return to African minibuses, they could actually benefit from formalisation. For instance, their legal situation would improve, and in many cases, the police could sort out problems, which would probably be cheaper. Generally speaking, formalisation can make the difference between a one million dollar business and a ten million dollar business – and when that kind of growth becomes possible, no investor worries about paying 20 % taxes.