Written by Iris Bootsma
Taxation is the way for governments to raise revenues to finance government expenditures. However, setting up such a system is not as easy as it may look like. An ideal system raises revenues without excessive government borrowing, and should not discourage economic activities or deviate largely from other countries.
From OECD numbers it appears that tax revenues for developing countries are less than a fifth of their GDP, in comparison with OECD countries this is over a third of GDP. But an efficient tax system is necessary to pay for public goods and services and stimulating economic and social development.
Developing countries face a few problems regarding an efficient tax system. Probably the largest problem is the fact that most of the workforce is paid ‘off the books’. This means that they are paid in cash, which makes it hard to calculate a base income tax. Besides when they would earn their money on the books, still they don’t buy stuff in regular large stores which makes it hard to track the money, and therefore consumer taxes are hard collect. Secondly, it is necessary for a good functioning tax authority to have skilled employees and therefore they need money to pay those well educated people. The money issue is one of the reasons why there is no rational and efficient tax system. Thirdly the informal economic structure and its financial limitations makes it hard to collect reliable information and statistics. This lack of data makes it hard to evaluate and reform existing policies, which may result in keeping an inefficient policy intact. Lastly, the combination of income inequality, its unevenly distribution of income and the power of the rich results in an obstruction of a tax policy reform.
Although that a good tax system may be created with the help of developed countries, corruption and power of the wealthy individuals may remain as a problem. An example of such behaviour is shown by Obiang Junior, the son of the president of Equatorial Guinea. He is accused of corruption, money laundering and stealing of government money by the Swiss government. Not only Switzerland is investigating Obiang Junior, the United States has investigated him for a corruption case of $70 million. France followed with a similar corruption case of $110 million, which will be resumed at the 19th of June. This is not the first accusation the country faces, a few years ago the country settled for $240 million with the Dutch and US government for bribery.
So how would one set up a tax system in such an African country? One could first ask himself if a flat or progressive tax rate would better suit. The main difference is the final income distribution. In the case of a flat system, the contribution of the lower incomes is larger than the contribution of the higher incomes, with respect to the percentage of their total income. Therefore, the income inequality with such a system will increase. Consequently, it is desirable to include a progressive tax system, with some exemptions. Examples of these exemptions may be tax relief for the poorest and tax relief for investment opportunities. Next to individual and corporate taxes, also VAT plays an important role in the tax policy. VAT is already included in many African countries but it suffers from incompleteness and on the other hand many important sectors are left out of the VAT net. A good excise system is invariably one that generates revenue from a narrow base and with relatively low costs. Import tariffs also play a major role in the tax policy of developing countries and are reducing due to trade liberalization. Especially import tariffs have a large influence on the economic position of African countries with respect to OECD countries. A reduction of tariffs leads often to a short term revenue loss and is mainly advantageous for foreign investors.
Concluding, African countries face a few obstacles when it wants to change it’s tax policy. Not only they should rely less on foreign trade taxes they need to increase their tax levels without creating economic disadvantages, and reform their domestic policy with regard to corruption, income inequality and the power of the wealthy individuals. Off course, a good efficient working tax system alone wouldn’t do the trick and solve all the problems for the undeveloped countries. Therefore they also need to work on their capacity, infrastructure, and on the transparency of their financial systems. Unfortunately therefore they need money and an efficient tax system with a suitable tax rate will contribute to that.