Impotent Taxation and African Development: Causes and Concerns
By Tonna Emenuga
Among the nations poised to exhibit exceptional economic growth in the twenty-first century comfortably sit many African nations, particularly those in the Sub-Saharan portion of the continent. Catalyzed by increasingly fervent efforts to implement economic strategies targeted at strong, continual development, countries such as Ethiopia and Cote d’Ivoire have begun to chart a path towards robust economic growth. As a result of innovative investments and more efficient utilization of natural resource endowments, many across the continent have experienced ameliorations in living standards. However, there exists a key impediment towards the long-run economic and fiscal visions of these countries: lackluster tax policy.
As it stands, African countries presently grapple with chronic undertaxation, characterized by excessive tax breaks given by governments. These often manifest themselves in the form of exemptions which range from the establishment of special economic zones similar to those of China or business dispensations that are instituted on an ad hoc basis. The issue with these tax breaks, however, is that they are often taken to their insidious conceptual extremes. These economic zones regularly give foreign firms complete tax exemptions lasting up to 10 years, and business dispensations are routinely granted at the whim of government officials, often for the sole purpose of avoiding tedious tax-related paperwork and administration.
The effects of these policies are staggering. For example, according to the World Bank, tax administrators in Kenya and Uganda annually forgo up five percent of gross domestic product due to unjustified exemptions. And, in total, African counties lose upwards of 50 billion dollars annually due to this sort of inefficiency. Additionally, in the majority of African countries, wealthy rentiers are able to avoid taxation through creative manipulation of tax regulations without any recourse from state officials.
This poses a grave problem for fiscal policy and economic development in the continent. Many development initiatives, including well-known programs such as those involving small business subsidies or micro-credit distribution, are contingent upon a steady stream of state revenue. Moreover, vital economic research is often heavily dependent on state grants. Consider the advent of randomized controlled trials, a research method notably pioneered by MIT economist Esther Duflo. Over the past two decades, economic research has shifted towards this methodological framework, in which theory and abstractions are substituted in favor of evidence-illuminating experiments. These experiments, for example those which seek to discern the effect of additional schooling on economic outcomes, are often labor and capital intensive and thus require financing from both private and public organizations. In the absence of well-defined, codified and enforced tax laws, the requisite capital for these programs is bound to greatly exceed that which is readily available.
Moreover, compounding the issue of under-taxation is the inevitability that levies on common items will have to be increased in order to maintain state funding levels. This means that in order to compensate for tax-related revenue losses, national governments may be forced to heighten excises on common household goods and widely used services, which has already begun to take place.
Thirdly, consider the economic fallout from a consumer/agent behavioral standpoint. The macroeconomic theory of Ricardian equivalence posits that fiscal policy, such as tax cuts (which would, in turn, raise public debt), can be rendered ineffective if consumers are forward thinking and thus internalize future economic ramifications. That is to say, if individuals are aware that current economic decisions may increase their tax burden in the future, they may cut back on spending due to risk aversion. One can analogize between this theory and the present African situation because lackluster tax policy can effectively be a tax cut; in both cases, economic agents are aware that they are paying less in excises, a reality often sanctioned by government officials. Thus, it is possible that aggregate demand may drop precipitously because consumers are aware of the perilous economic situation and will thus lose confidence in the economy’s strength. And, as previously mentioned, a lack of significant tax revenue will inevitably lead to untenable levels of public debt, as governments will have to finance expenditure with debt instruments due to a dearth of available funds.
If public debt rises, interest rates will surely follow suit. Although this may have the effect of spurring foreign direct investment, especially if market inefficiencies and information asymmetries lead to very high risk-adjusted rates of return, domestic consumers will likely suffer. This is because interest-sensitive consumption, such as housing and car purchases, may become less feasible for the average person due to higher rates.
It is clear that the fiscal and developmental externalities of languid tax policy pose serious issues for the long-run economic situation of much of Sub-Saharan Africa. But what, then, is the root cause of these difficulties? Two potential roots appear the most plausible: corruption and colonialism.
Firstly, many African countries are plagued with exorbitant levels of rent-seeking, i.e. behavior on the part of powerful economic agents that is aimed at manipulating the existent socio-political environment for the purpose of gaining wealth at the expense of others. In layman’s terms, rent-seeking encompasses efforts to increase one’s share of the economic pie, if you will, without growing the overall size of the pie and without attention to its equitable distribution. The high degree of corruption in Africa is captured by the Corruptions Perceptions Index, which in 2017 rated 22 African countries among its 34 most corrupt, and only featured 3 in its top 50 least corrupt nations. Because of high levels of corruption in Africa, government officials are often at fault for agreeing to surreptitious deals with business executives which place personal gain ahead of state welfare. Such deals extend to tax breaks, which are routinely granted even when there exists no widespread economic benefit to doing so. Per The Economist, “When surveyed, most businesses in African countries say they would have invested even without tax breaks. They tend to rank other factors, such as stability and the cost of raw materials, more highly.” Clearly, tax breaks should not be the objective of African nations; rather, curbing corruption is of higher importance. If business owners and investors are more concerned with stability than they are with tax rates, it makes little sense to focus efforts upon tax rates while allowing corruption, and, by extension, stability, plummet. Thus, in the process of prioritizing economic development and ameliorating a weak tax situation, African policymakers must limit the power and influence held by rent-seeking, corrupt activity in the continent.
The second potential cause of Africa’s tax conundrum – colonialism – is more nuanced, albeit rich in significance. In the aftermath of the 1884 Berlin Conference through the mid-20th century, European nations engaged in an imperialist scramble for land and as a result drew haphazard political boundaries to stake territorial claims. These boundaries, which are still present today in the form of modern African states, are patently at fault for having taken no heed of ethnic divisions, and thus the newly post-colonial sovereign states became rife with civil strife and socio-political tension. In many cases, this hostility has given rise to the national question, that is, the question of whether a national ought to be separated rather than kept as one state, as was famously demonstrated in the 2011 example of South Sudan. This degree of animosity has economic ramifications: in 2017, Harvard economist Nathan Nunn found that citizens in countries with lower levels of generalized trust are more likely to disapprove of economic decisions by leaders and exhibit a higher level of skepticism with respect to political governance in general. Thus, it is clear that a lack of trust in government can effect tax policy, not only because citizens are likely to be skeptical of state revenue policies but also because they may be reluctant to part with their income for the purpose of benefitting people of groups with whom they may be at odds. That is to say, if one harbors resentment towards members of certain ethnic groups, it would not be in their personal interest to pay taxes which may fund initiatives such as transfer payments and welfare which may benefit said group. This sort of perverse incentive structure has been thoroughly documented and has been shown to hurt efforts towards democratization in the continent. As a result, potential taxpayers in African may be dissuaded from paying duties, and instead be more so prone to cheating tax regulators due to a lack of faith in government. In addition, government officials themselves may refrain from properly enforcing regulations due to the same qualms on an individual level, yet another representation of the salient socioeconomic impact of imperialist colonization.
Admittedly, issues related to ethnic fractionalization are less actionable than are those related to rent-seeking and corruption due to their complexity and the degree to which they are imbedded in cultural norms and values. However, both potential causes effectively shed light on the salience of undertaxation in Africa. The continent, which exhibits tremendous economic potential, yet remains hamstringed by lackluster government revenue assurance, must tackle the its revenue difficulties if it is to chart a prosperous path in the twenty-first century. Not only are fiscal and monetary stability at stake, but moreover the futures and outcomes of millions across the continent.