How can Africa widen the tax net?

All governments need to provide certain services to citizens. International law imposes some obligations for health and education, for example; and of course in democracies governments that fail to meet expectations are unlikely to last long. Borrowing can meet some expenses – but, especially when growth is uncertain, any government that fails to service its debts is in deep trouble. Tariffs on cross-border trade are falling away. So collecting taxes from companies and individuals is a necessity.

But many African countries receive a much lower proportion of their GDP in tax than do countries on other continents, according to a report by the Organisation for Co-operation and Economic Development (OECD). The report, which covers tax revenue data for 30 African countries between 1990 and 2018, shows that the average tax-to-GDP ratio for the 30 African countries was 16.5% in 2018. This compared with an average 34.3% in the 38 OECD member states; and 23.1% for the Latin American and Caribbean nations.

There is, however, a wide variation among African countries: some – such as the Seychelles, Tunisia, and South Africa – have tax-to-GDP ratios above 30%; others take less than 10% – examples are Nigeria, Equatorial Guinea, Chad and the Democratic Republic of the Congo.

The report attributes the low average tax-to-GDP ratio in Africa to several factors, including: weak tax policy design and implementation; low tax compliance and enforcement; and high levels of “informal” economic activity and of tax evasion. Despite these challenges, the report highlights some positive trends, such as the increase in tax-to-GDP ratio by 1.4 percentage points from 2010 to 2018, driven by higher revenues from value-added tax (VAT) and individual income taxes.

Stepping up tax collection

Keen to sustain these trends, many African countries have in recent years stepped up measures to increase tax collection. Headlines announcing increases in VAT, excise duties and individual income taxes have become ubiquitous across the continent.

The 2023-24 budget in Kenya, which was passed by Members of Parliament in June, doubled VAT on fuel from 8% to 16%. This is one of the steps that President William Ruto’s administration is taking to shore up the public coffers. Another of these steps is to raise the individual income tax rates for higher earners. Rate bands for income tax collected through the pay-as-you-earn (PAYE) system increased to 32.5% for monthly incomes between Ksh500,000 (approximately $3270) and Ksh800,000 (approximately $5240). The rate increased to 35% for incomes above Ksh800,000. Previously the rate was a uniform 30% for all high earners.

To improve revenue collection, governments in Africa have also whittled down the number of subsidies, tax exemptions, deductions, credits and preferential rates. These tend to lower the tax liability. Officials have claimed that these breaks shrink the tax base and favour the rich more than the poor. For instance, Nigeria has scrapped fuel subsidies as part of its economic reforms under President Bola Tinubu, who began his four-year term in May.

These measures have resulted in a steady rise in total tax revenues collected by African countries in recent years. For example, the South African Revenue Service (SARS) has increased its total tax revenue collection from R216.5bn ($11.6bn) in 2017/18 to R563.8bn ($30.2bn) in 2021/22, a compound annual growth rate of 6.5%.

Reform’s risks and challenges

Tax reforms can improve the fiscal situation of a country, but they also entail risks and challenges. High taxes can have negative effects on the economy if they are not applied prudently. They can lower the disposable income of consumers, which can reduce their spending and affect consumer demand, production and employment. They can also discourage businesses from investing, expanding, or hiring more workers. High taxes can also reduce the incentives to save and invest.

Analysts say that instead of targeting high taxes, policymakers should strive for a tax system that is fair and efficient. The World Bank suggests that governments should balance objectives such as raising revenue, promoting growth, and lowering administrative costs with ensuring that the tax system is fair and equitable. Fairness considerations include the relative taxation of different groups of taxpayers, such as the rich and the poor; individuals and corporations; urban and rural areas; the formal and informal sectors; labour and capital income; and older and younger generations.

The World Bank also highlights the need to simplify the tax code. “Making it easier to pay taxes improves competitiveness. Overly complicated tax systems are associated with high levels of tax evasion, large informal sectors, more corruption, and less investment. Modern tax systems should seek to optimise tax collections while minimising the burden on taxpayers to comply with tax laws,” it notes.

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Widening the net

Africa needs to enhance its domestic revenue mobilisation while maintaining economic stability and attractiveness for investors, says Daniel Ngumy, managing partner of corporate law firm ALN Kenya. “Far more needs to be done to bring in the informal sector, as this is the ideal way to expand the tax base,” he says, citing the risk this poses to the investment climate.

“The danger we see is that the same companies which pay tax are the same that are consistently being targeted for revenue generation, particularly the multinationals. They say that they have reached a place where every year they have a new tax case they are dealing with. It takes energy and time and is sometimes very draining.”

According to Ngumy, Kenya faces a serious threat from its reliance on a few large taxpayers and needs to expand its tax base by including the informal sector. “The failure to bring in the informal sector will in the long-term present challenges to the sustainability of our economy. Adding informal workers to our tax base will shield Kenya from the risk of a single big taxpayer leaving the country, which can easily happen. Whereas if you have a million informal workers added to the tax base and you’re helping them become better at generating revenue, the outcome is significantly better than relying on a single big company.”

Brian Waruru, manager of international tax and transaction services at audit firm EY, calls for top-down approaches in which larger formal firms are obliged to encourage tax compliance by smaller firms and suppliers in the informal sector. Waruru also stresses the need for governments to support the growth of the informal sector and increase its tax contribution. He suggests that governments should enhance the productivity of the informal sector by providing more access to finance and public services, and recommends that governments should make it easier and cheaper for informal businesses to register formally.

“Governments can reduce the registration fees and encourage the small firms to register. Registration places the small businesses within the radar of the formal system and will contribute to the culture of tax compliance.”

Leveraging technology and organisation

Adopting digital tools and solutions to modernise tax administration, improve data collection and analysis, and facilitate online filing and payment of taxes has helped many African governments enhance tax collection.

“The adoption of technology in the taxation system can reduce tax evasion through the exchange of information across the different tax systems within and outside the continent,” says Waruru.

“Beyond E-filing and payment systems, tax authorities should also explore other technologies such as big data, artificial intelligence, and biometrics, to improve tax administration, provide better services to taxpayers and monitor compliance.”

Use of properly-trained and specialised teams can increase the capacity to raise tax revenues. For instance, the Kenya Revenue Authority (KRA) has a Large Taxpayers Office and an International Tax Office, whose teams have been specifically trained to deal with all tax matters for large taxpayers and for multinationals.

In South Africa, the Large Business and International (LBI) office was launched in December 2018, providing an end-to-end service to its taxpayers. In each country, the respective tax authorities have set certain thresholds for entities that qualify to be part of the large taxpayer division.

“Kenya has a large taxpayers office… they have divided it into sectors. So we have people in financial services, professional services and so on. They want to have the same people looking at the same issues” observed Ngumy. “This approach has been fairly innovative and has helped KRA to become more efficient.”

Ngumy further noted that there was a need for tax authorities in Africa to collaborate more closely in order to address common issues.

He pointed to the growth and success of platforms such as the Africa Tax Administration Forum, which provides a platform for African tax authorities to share knowledge and insights on how to tackle key issues such as transfer pricing and managing multinational companies.

Confronting the risks of over-taxation

According to Ngumy, Kenya and other countries that have been raising taxes at a fast rate may have to reconsider their strategy if the evidence shows that the economy is suffering from the tax burden. He cited the case of payroll taxes in Kenya, which have underperformed in recent months after the implementation of higher PAYE rates and new mandatory deductions – for example from 1 July 2023 employers and employees have each had to pay 1.5% of gross salaries in an Affordable Housing Levy.

Disclosures from the National Treasury show that payroll taxes netted by KRA in July-September 2023 fell short of target by the biggest margin since the Covid-19 pandemic period. KRA collected Ksh123.04bn ($806m) from earnings by workers against a goal of Ksh142.93bn ($936m).

Ngumy observes that the latest economic data indicates that Kenya is experiencing the effects of the “Laffer curve”. In 1974 the “supply-side” economist Arthur Laffer proposed a theory of how tax rates influence tax revenue. He asserted that there is an optimal tax rate that maximises revenue, and that going above or below this rate will reduce revenue.

“We’re increasingly seeing the effects of the Laffer curve,” says Ngumy. “The high VAT on fuel, along with other fuel taxes and global energy prices, has reduced the demand for driving. People are opting for carpooling and public transport,” he says, adding that it is crucial to analyse the data before lowering taxes, or not. He cites Rwanda as an example, saying that it has achieved a consistent growth in tax revenues in recent years by cutting tax rates across the board.

The need for trust

Over-taxation can also lead to political instability, by fuelling protests and posing problems for incumbents seeking reelection. Waruru emphasises the importance of developing campaigns and strategies to enhance trust between taxpayers and tax administrations, as this improves compliance and creates a basis for public support for more efficient taxation. “The World Bank notes that a lack of trust in the state’s role as both tax collector and service provider remains an important deterrent for many would-be taxpayers to enter the formal economy or pay their full taxes.”

Waruru also suggests that tax authorities should adopt a more gradual approach to implementing some tax reforms, especially those likely to provoke public anger. “Instead of implementing tax reforms immediately, the governments should consider having a phased implementation to ease the immediate burden on the public, reduce public resistance and give people some time to adjust.”

He points out that for African governments to build trust with their citizens, the issue of corruption needs to be addressed decisively. “Addressing governance issues and improving transparency in the use of public resources is vital to building trust and generating increased domestic resources. Efforts should be geared toward supporting African countries to strengthen governance and tackle corruption.”