The role of tax in Africa

Tax matters a lot, but no more so than in Africa, where regimes are failing their people and local businesses, according to an influential report out this week.

The last decade has seen high levels of economic growth across the continent, but governments are failing to adequately tax the proceeds of this rapid expansion, says the report from Christian Aid and Tax Justice Network-Africa.

A substantial amount of sub-Saharan Africa’s income and wealth has “escaped offshore”, says the study, which is widening the gap between rich and poor. Moreover, even as countries have focused on reducing corporate and personal income tax rates while expanding the base for consumption taxes and value added tax (VAT), revenues “have barely risen over several decades”; confirming, say the authors, that “progress in recent years is not significantly affecting this picture”.

Enforcement seems to be failing in many countries. For example, Kenya has just 100 high net worth individuals registered with the tax authority, despite the country having 142 Kenyan shilling billionaires. In South Africa there are thought to be somewhere between 28,000 and 114,00 such individuals who are not registered with the tax authority.

Race to the bottom

One of the main problems for the countries in the report is an unhealthy amount of competition. As each nation vies for inward investment and jobs, tax rates are slashed. The authors say the focus on tax incentives leads to damaging competition between states and a “race to the bottom”.

“Tax competition occurs when firms are able to locate where tax rates are lowest. This encourages countries to lower their tax rates in order to retain and attract investors and, in practice, leads to ever-declining rates and revenues,” says the report.

In some countries the tax exemption deals are done behind closed doors, which does not create an image tax and regulatory stability required by businesses. In Sierra Leone, for example, there is a discretionary system for granting exemptions, rather than one based on clear rules, which leaves it “wide open for abuse”. The authors of the report add: “It is widely suspected that the system is beset by corruption and that exemptions are granted to the well connected.”

Some progress

But some progress has been noted. In Zambia the government has taken steps to ensure any incentive is beneficial for job creation and industrial development. Its 2013 budget means tax breaks can only be given when the investor meets their obligations around employment creation for Zambians. In addition, if an exemption from customs duty is offered as an incentive, it will only apply to goods that are not locally produced.

However, the improvements across Africa are haltingly slow, something that is just as damaging for investors as for the local poor.

The case for reform

Shortcomings of tax regimes are not just bad for communities, but businesses, too. “Research repeatedly finds that the evidence that tax exemptions and incentives are an effective tool to attract foreign investment is weak,” say the report’s authors.

In fact, investors value a much broader range of  issues, such as  infrastructure, political stability, skilled labour, contract enforcement and governance concerns. Generous tax incentives have “little impact” on foreign investment.

Odd-Helge Fjeldstad, research director of the International Centre for Tax and Development, said reforms of exemptions would improve collection, but would also benefit businesses.

He explained: “Tax authorities could handle this more easily than reform in the area of property taxation or attempts to tax the informal sector, for example.

“Exemptions and incentives are currently complex and burdensome from an administrative perspective. Reform in this area would certainly be one of the easier to focus on.”

G20 role

The report comes as Australia makes international tax reform a key priority for its presidency of the G20 group of nations. Leading nations are upping efforts to collect more tax, but as can be seen from the Christian Aid study, under-developed countries have a lot more to gain.

Oxfam spokesperson Dr Helen Szoke, the chief executive of Oxfam Australia, stresses that global taxation is a major issue for the developing world. She explained that the kind of issues outlined by Christian Aid in its report sees “huge amounts of capital” flow out from the world’s poorest countries. “Between 2008 and 2010, sub-Saharan Africa lost on average $63.4 billion dollars this way each year, or more than twice what it received in aid,” she said.

Tax is a complex issue in Africa. Reforms are clearly needed to help local businesses grow and thrive. Failure to create stable and well enforced tax systems creates uncertainty and unease among investors, even when large exemptions are available. Ultimately, ill-considered tax legislation and badly-governed regimes are bad for everyone.