Nobody likes paying them, but taxes are an integral component of institution-building, growth, and democracy. Effective taxation is a balance between collecting the necessary revenue to support state budgets, while not imposing too high of a burden on individual incomes or on the ability of businesses to operate. In some sub-Saharan African countries, achieving the balance is often like scaling a high wall. A combination of ineffective institutions and extensive poverty results in narrow tax bases, which create a vicious cycle where governments are constrained in their ability to raise revenue to support institution-building and enhance development.
Governments, which are ironically the largest stakeholders in raising revenue, may be their own worst enemy when it comes to effective taxation. Princeton University professor and international relations analyst, Atul Kohli, refers to a culture of neo-patrimonialism in sub-Saharan Africa, describing it as, “The façade of a modern state, [where] public officeholders tend to treat public resources as their personal patrimony.” This undermines the legitimacy of the state, with taxation being perceived as a way of lining bureaucrats’ pockets rather than supporting government services. Drawing from the history of state-building in Europe, and more recent studies in the region, United States-based International Development expert, Professor Deborah Bräutigam, discusses the importance of building the capacity of tax collecting institutions, as part of a larger social contract between government and citizens. She concludes that, “Well-designed tax systems can consolidate stable institutions in developing countries, increase revenues, refocus government spending on public priorities, and improve democratic accountability.” Taxation can enhance good, accountable governance.
It is somewhat ironic that the development of effective taxation tends to be hindered by three factors that should complement it; namely aid, comparative advantages in the primary commodity trade, and foreign direct investment.
Africa has some of the world’s most aid-dependent countries. Over time, extensive studies on the effectiveness of aid have shown that poorly directed or managed aid resources can serve as an antithesis of development. Aid may also stand in the way of the formulation of any social contract among stakeholders, by removing the need to enter into it in the first place. Bräutigam argues that aid foregoes an essential actor-agent relationship in fiscal policy. Governments that are fairly dependent on aid as a source of revenue are more likely to be accountable to donors rather than to their electorates. Apart from anything else, this is detrimental to state legitimacy. The inevitable lack of accountability to the citizenry wastes [already] scarce resources. [And] Most worrying is the high opportunity cost of not permitting the state to develop reciprocal relationships and mutual obligations with interest groups,” says well-known tax expert Dr Jonathan Di John from School of Oriental and African Studies (SOAS) at London University.
The continued high dependence on primary commodity trade by many African countries produces two problems. First, prices of these goods tend to be highly variable, making economies particularly vulnerable to shocks in the market. Second, countries with low tax bases are more likely to try to increase the collection of tax revenue through trade taxes. This puts them at odds with international financial institutions, which largely encourage trade liberalisation (lowering trade taxes) to fund development programmes. It also conflicts with the profit maximisation inclinations of multinational enterprises (MNEs) keen to exploit natural resources. As a result, countries that depend on taxing commodity exports often have to contend with abusive transfer-pricing practices by MNEs. This leads to decreases in the main revenue streams for some countries. An International Monetary Fund (IMF) study in 2005 found that low-income countries only recover about 30 cents for every dollar lost to trade.
Foreign capital as direct investment is sought in order to speed up economic growth and improve human capital and technology for the receiving country. In order to attract this investment, countries without abundant natural resources or diversified economies tend to create tax havens for foreign non-resident companies. While it can create employment opportunities and give the impression of a diversified economy, a tax haven regime is ultimately detrimental to tax revenue. Special dispensations through preferential tax rates, and undertakings of confidentiality to protect their business dealings, bring governments in tax havens into a relationship in which they are more accountable to foreign private actors than to the electorate. It is not a sustainable model for governments, because foreign direct investment is by its nature fickle. It is apt to leave countries if political instability risks returns on investments.
Governments should recognise that the development of sound tax institutions takes time. It is a continuing process that evolves overtime with the development of the relationship between government and citizens. One possible model to look at is the history of state capacity to tax in South Africa. Di John explains the relative success of South Africa to tax through; cooperation between different government agencies tasked with administering the economy, (including the Ministry of Finance and the South African Revenue Service), proper maintenance of relationships with key stakeholders in the civil service, trade unions, big business, and effective public campaigns characterising taxes as essential for a strong country.
Botswana is another good model for countries to look towards. Analysts attribute part of the success of Botswana to effective institutions, including taxation. From the onset of independence, government made it a priority to cooperate between the politically influential cattle-herding population, and foreign actors in the diamond business. The state was effective in redirecting revenue to human development to reinforce growth and legitimise state actors. However, for both South Africa and Botswana-challenges remain. Di John warns that for institutions to remain viable, the foundation that sustains them must grow and develop. Economic diversification away from commodities and natural resources remains critical. Participation in the economy by previously excluded sections of the population is an important part of this.
- Patrick McLennan, Consultant, Transnational Threats and International Crime, ISS Cape Town. This article was published in the ISS Today. It is republished here with the permission of ISS.