Tax that supports sustainable development

For most countries, public finance, raised through tax, should be the primary source of investment in the SDGs. How can developing countries increase their tax receipts, fairly and efficiently?

FinancingSub-Saharan Africa

Sapelli wood being cut near Lieki, Democratic Republic of the Congo. Timber and other natural resources, in particular mining products, are commonly exploited as means to siphon money out of African countries. © Axel Fassio/CIFOR

The UN’s 17 interlinked Sustainable Development Goals (SDGs) have become a “blueprint to attain peace and prosperity for people and the planet, now and into the future.” Together, they underpin the global population’s survival.

The SDGs recognize, among other things, that ending poverty must go hand in hand with strategies that improve health and education, reduce inequality, and spur economic growth. These objectives all require funds from different sources – tax being one of the most sustainable. The SDGs and Africa’s development Agenda 2063 both view tax as a key enabler of their attainment. Robust tax policy and its effective administration will therefore determine the success of both agendas. This article uses the African tax landscape to illustrate this.

Comparing a country’s distribution of income before and after tax is deducted determines how much taxation redistributes resources among that nation’s citizens. Among higher-income economies, taxation is an effective mechanism for improving income equality. One OECD study of 35 of its member nations showed that taxes reduced income inequality by a third on average.

Nations with the lowest after-tax inequality are those that achieve the greatest redistribution through taxes and transfers. Fiscal policies have the power to increase resource mobilization, lessen inequality, and encourage sustainable patterns of consumption and production – both critical for sustainable development. For example, a 2022 study by the African Tax Administration Forum (ATAF) on tax and gender found that tax regimes in Africa to some extent discriminate against women, while countries with “tax policies that provide incentives for women-owned businesses enhance entrepreneurship and economic growth for women and the poor.”

The tax challenges in Africa 

Average tax collection in high-income countries is around 40% of gross domestic product (GDP). In contrast, low-income countries typically collect only between 10% and 20% of GDP. This is due to myriad challenges, such as businesses engaging in tax avoidance and planning initiatives that go undetected by revenue agencies. Further, many efficiency reforms are IT-based, requiring infrastructure support that may be outside the purview or budgetary capacity of the revenue administration. Finally, physical presence in a particular nation is no longer necessary for conducting business in today’s “global village.” This continues to pose challenges in determining tax points, and who should collect the tax. Effective tax reforms must address all of these factors to improve domestic revenue mobilization (DRM).

Despite these challenges, African countries are implementing reforms to improve tax administration and expand the tax base through robust tax policy changes, with support from organisations like ATAF. Examples include:

  • legislative reforms to address transfer pricing
  • taxation of high-net-worth individuals
  • introduction of digital services taxes
  • reviewing tax rate regimes to optimal levels
  • investment in technologies and training programs for officials

Indeed, ATAF consistently provides support in legislative changes and transfer pricing audits in different specialized sectors. This has led to revenue assessments worth USD 3.8 billion and collections worth USD 1.4 billion in the last 5 years. Importantly, toolkits are developed to become references for countries.

Equity and fairness?

The principle of equity and fairness requires that citizens contribute to government coffers according to their ability to pay. Taxes should be paid in a way that is equitable for all concerned. The impact of direct taxes on reducing inequality is usually larger than that of indirect taxes. The latter frequently lead to greater inequality, since they are paid by all without exception, including the needy. For example, in African countries VAT contributes the highest revenue according to the ATAF’s African Tax Outlook 2021. But it does not achieve vertical equity, since the same rate is applicable for both rich and poor. This lack of equity and fairness may arise from the fact that: 

  • a significant portion of economic activity in many African countries occurs in the informal economy, which is difficult to tax; thus the burden of taxation falls disproportionately on formal sector workers and businesses
  • the tax base is narrow, meaning that only a proportion of the population pays taxes, leading to higher tax rates for those who pay
  • many African countries offer tax exemptions and incentives to attract investment, but these can be regressive if they benefit only wealthy individuals and businesses – if not monitored, they may lead to a double loss as their intended purpose isn’t necessarily achieved
  • wealthy individuals and businesses may be able to avoid paying taxes by bribing tax officials, while the poor may have to pay bribes simply to access basic public services

Stemming illicit financial flows (IFFs)

Tax incentives play a major role in African tax policy. They are used often for luring investment, particularly foreign investment, into a variety of economic sectors, such as mining, tourism, manufacturing, and agriculture. Limiting tax incentives to foreign investment is ineffective and counterproductive because it disadvantages local businesses and leaves room for illicit financial flows (IFFs). As noted by Patrick Ofori, IFFs occur when local businesses restructureas foreign businesses or channel their investments through foreign companies to qualify for incentives.

IFFs seriously jeopardize efforts to mobilize domestic resources in many developing economies. In addition to the negative impact on tax collections, IFFs erode public trust in the fairness of the tax system. The United Nations Economic Commission for Africa’s 2015 High Level Panel report asserted that the estimated IFFs out of Africa of USD 50 billion surpassed the global foreign direct investment received by the continent, which at the time was USD 44 billion. The European Commission has also estimated that mining and extractive companies are responsible for 65% of revenue loss in Africa, through complex mechanisms such as tax avoidance, tax evasion, and transfer pricing. The implication, put plainly, is that the continent has revenue generation potential and can contribute to its own development without overreliance on aid. 

recent study by the Organisation for Economic Co-operation and Development and the South African Revenue Service revealed that between USD 3.5 and 5 billion in IFFs are estimated to leave South Africa annually, showing that IFFs continue to pose a serious concern for the nation. This position, which is based on estimates of between USD 40 billion and 54 billion in hidden South African assets held in international financial centers in 2018, represents roughly 10% to 15% of South Africa’s yearly GDP. 

African governments cite concerns due to the effects of IFFs on revenue, and some still lack legislation and guidelines to address these, although ATAF continues to provide support to address this. African governments also often lack adequate tax expertise and robust contract negotiation, especially in a digitalized world. Therefore, equitable taxing rights, robust policy, expertise, strong institutions, and adequately resourcing relevant institutions with necessary human and financial resources – while tackling IFFs through a whole-of-government approach – are key to effective taxation. For instance, when corporate tax avoidance is pursued in many African countries, the route is usually long and costly and often ends up in mutually agreed settlements that may not maximize benefits for African countries. This is why the African Union’s strategy on fighting tax-related IFFs highlights a range of actions as being critical to DRM, including:

  • reviewing legislation
  • building capacity in dealing with cross-border transactions
  • promoting transparency
  • addressing trade mispricing
  • supporting inter-agency co-operation
  • promoting South–South tax co-operation

The pursuit of sustainable development depends on the effective mobilization of domestic resources. This will require policies that promote inclusive and sustainable development. The financing of development is significantly influenced by tax and fiscal policy. This must be everyone’s focus, since equitable and sustainable tax will determine the attainment of these global development goals. 

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