Governments worldwide are obligated to provide essential services to their citizens, as outlined by international law. In democracies, failure to meet these expectations can lead to political instability. While borrowing can cover some expenses, governments facing uncertain growth must ensure debt servicing to avoid financial crises. With tariffs on cross-border trade diminishing, tax collection from both companies and individuals becomes crucial.
A recent report from the Organisation for Co-operation and Economic Development (OECD) reveals that many African countries collect a smaller proportion of their GDP in taxes compared to counterparts on other continents. The average tax-to-GDP ratio for 30 African countries in 2018 was 16.5%, considerably lower than the 34.3% average for 38 OECD member states and the 23.1% average for Latin American and Caribbean nations.
Significant variation exists among African countries, with some like Seychelles, Tunisia, and South Africa boasting tax-to-GDP ratios above 30%, while others such as Nigeria, Equatorial Guinea, Chad, and the Democratic Republic of the Congo fall below 10%. The report attributes Africa’s low average tax-to-GDP ratio to factors such as weak tax policy design and implementation, low compliance and enforcement, and high levels of informal economic activity and tax evasion.
Despite these challenges, positive trends emerge, including a 1.4 percentage point increase in the tax-to-GDP ratio from 2010 to 2018, driven by higher revenues from value-added tax (VAT) and individual income taxes.
In recent years, many African countries have intensified efforts to boost tax collection. Measures include increasing VAT, excise duties, and individual income taxes. For instance, Kenya’s 2023-24 budget doubled VAT on fuel and raised income tax rates for higher earners.
Governments are also reducing subsidies, tax exemptions, deductions, credits, and preferential rates to enhance revenue collection. The rationale is that such breaks tend to lower the tax liability but disproportionately favor the wealthy over the less affluent. Nigeria, for example, has eliminated fuel subsidies as part of its economic reforms.
These initiatives have led to a consistent rise in total tax revenues collected by African countries. For instance, the South African Revenue Service (SARS) has seen its total tax revenue collection grow from R216.5bn ($11.6bn) in 2017/18 to R563.8bn ($30.2bn) in 2021/22, with a compound annual growth rate of 6.5%.
However, tax reforms, while improving a country’s fiscal situation, come with risks and challenges. High taxes, if not applied prudently, can negatively impact the economy by reducing consumer spending, discouraging business investments, and lowering incentives to save and invest. Instead of focusing solely on high taxes, policymakers are advised to aim for a fair and efficient tax system that considers various factors.
The World Bank suggests balancing objectives such as raising revenue, promoting growth, and minimizing administrative costs while ensuring fairness. Fairness considerations include relative taxation for different groups of taxpayers, such as the rich and the poor, individuals and corporations, urban and rural areas, the formal and informal sectors, and various income sources.
Simplifying the tax code is crucial, as overly complicated systems are associated with high levels of tax evasion, large informal sectors, corruption, and reduced investment. Modern tax systems should optimize collections while minimizing the burden on taxpayers to comply with tax laws.
To widen the tax base, African countries must focus on bringing in the informal sector, a significant source of untapped revenue. Daniel Ngumy, managing partner of ALN Kenya, emphasizes the need to expand the tax base by including informal workers. Relying on a few large taxpayers poses risks, and incorporating the informal sector can mitigate the impact if a major taxpayer leaves the country.
A representative from EY advocates for top-down approaches where larger formal firms encourage tax compliance by smaller firms and suppliers in the informal sector. Governments should support informal sector growth and increase its tax contribution by providing better access to finance and public services. Simplifying the registration process for informal businesses can contribute to a culture of tax compliance.
Leveraging technology is key to modernizing tax administration. Digital tools can enhance data collection, analysis, and facilitate online filing and payment of taxes. The adoption of technology can reduce tax evasion through information exchange across different tax systems within and outside the continent.
Specialized teams within tax authorities can also increase capacity for tax revenue collection. Large Taxpayers Offices and International Tax Offices, such as those in Kenya and South Africa, have teams specifically trained to handle tax matters for large taxpayers and multinationals.
Collaboration among African tax authorities is essential to address common issues. Platforms like the Africa Tax Administration Forum provide opportunities for sharing knowledge and insights on tackling key issues like transfer pricing and managing multinational companies.
However, caution is required in tax reforms. Evidence should guide countries like Kenya, which has experienced underperformance in payroll taxes after implementing higher PAYE rates and new mandatory deductions. The effects of the “Laffer curve,” proposed by economist Arthur Laffer, where there is an optimal tax rate for maximizing revenue, must be carefully considered.
Over-taxation can lead to political instability, protests, and challenges for incumbents seeking reelection. Building trust between taxpayers and tax administrations is crucial for compliance. Developing campaigns and strategies to enhance trust is vital, as noted by the World Bank, which emphasizes that a lack of trust in the state’s role as both tax collector and service provider deters taxpayers from entering the formal economy or paying their full taxes.
A gradual approach to implementing tax reforms can ease the immediate burden on the public, reduce resistance, and provide time for adjustment. Addressing governance issues and improving transparency in the use of public resources are crucial steps toward building trust and generating increased domestic resources. African countries should focus on strengthening governance and tackling corruption to foster trust and promote efficient taxation.