4 5868546332892857968

Tax Policy and Capital Formation: African Experience with the Value-Added Tax
Author(s): Malcolm Gillis

Source: Policy Sciences, Vol. 34, No. 2 (2001), pp. 195-215
Published by: Springer
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Policy Sciences 34: 195-215, 2001.
© 2001 Kluwer Academic Publishers. Printed in the Netherlands. 195
Tax policy and capital formation: African experience

the value-added tax
MALCOLM GILLIS
Rice University, Houston, TX 770051892, U.S.A.
I. Introduction
Most tropical African economies experienced severe decline in

century prior to 1995. Economic policies, including tax policie
significant role in this economic distress. In recent years, this proc
arrested in some African countries, and reversed in several othe
form has been a factor in economic recovery across sub-Sahara
reform, featuring growing reliance upon broad-based consumpti
been prominent in this turn-around. By mid 1999, twenty African
operating the most common form of value-added tax. This paper fi
the reasons for adoption of inferior tax policies in Africa in the th
before 1990. Implications of tax policy for unsatisfactory growth t
early nineties are then considered, and the principal constraints on
Africa are identified. Finally, the paper explains why the value-
figured so prominently in tax reform across Africa.
The recent policy reforms in Africa may be characterized a
forward-looking: that is they improve prospects for economic w
future generations, as well as the current one. The economic interes
generations are best served by bequeathing to them a wider and dee
capital, both physical and human, in both the private and in the pu
Forward-looking tax policies are therefore, those that encourage cap
tion and efficiency in the private and public sectors, and which gen
a predictable stable policy environment. Tax policies can play a majo
ing, but rarely the leading, role in encouraging capital formation. F
the past three decades, tax systems in the region had the opposi
policies, together with exchange rate, agricultural, monetary, an
nomic policies were prejudicial not only to capital formation a
growth, but also economic efficiency. As a result, per capita income
1992 was lower than in 1970 (Maddison, 1996). A new pattern began
after 1990 as African nations began to discard defective policie
including unsuitable tax policies.
196
II. Tax policy and economic performance in Africa:

A quarter century of decline
It is fair to say that across most of Africa of the sixties scant attention was paid
to the effects of tax policy on capital formation and growth. Africa, however,
was far from alone in this regard. For example, the U.S. fiscal system in the
mid-sixties still featured marginal rates of personal income tax as high as 91
percent. Even as late as 1980, the United States featured a top rate of income
tax of 70 percent. European patterns of taxation were not much different.
The beginning of the eighties, however, marked a major shift in the under-
pinnings of tax policy in dozens of nations outside Africa. By then, there was a
significant accumulation of empirical evidence testifying not only to the failure
of steeply progressive income tax rates to redistribute income (Engel, Galetovic
and Raddatz, 1998), but also to the corrosive effects of high marginal tax rates
on incentives to invest, save, work, and take risks. In response, governments in
Asia, North America, and Europe began a round of fundamental tax reform.
The wave of worldwide tax reform beginning in the mid-eighties featuring
decreasing reliance upon income taxes almost everywhere (Pechman, 1990)
and sharp cuts in income tax rates generally: fifty-one countries implemented
large reductions in the top rate of income tax; thirty-one of these were develop-
ing nations (Gillis et al., 1996: pp. 340-341).
Through the eighties, sub-Saharan Africa was, however, little affected by the
worldwide shift in tax policy. This was a period in which GNP per capita in the
region actually fell by 1.2 percent per year (1980-1991) (World Bank, 1993:
Table 1), while transport, education, and public health infrastructures deterio-
rated sharply.1 Only in Botswana, Guinea-Bissau, Burundi and South Africa
was per capita income growth positive over the decade, but not by much.
Moreover, the eighties, as well as the first half of the nineties was a time of
continued steady degradation in the natural resource base of sub-Saharan
Africa (Veit, Mascarenbes and Ampada-Agyei, 1995).
The period from about 1975-1985 was truly the lost decade for tropical
Africa in almost every sense. Reasons for the descent into deeper impoverish-
ment in the region differed from country to country, but there were some
commonalities across many. Some causes were largely or partially external in
origin; many African countries suffered from very serious problems in external
debt service, and/or especially weak markets for commodity exports. But other
problems were attributable to internal, not external origins: self-inflicted eco-
nomic wounds were important factors in African economic decline in the
eighties.2
Matters were made much worse for African energy exporting nations after
1983: Nigeria, Cameroon, and Gabon were already in economic decline before
the collapse of world oil prices in 1985-1986. Among oil importers, Tanzania,
Kenya, and Uganda among others, all clung to discredited economic policies
for years after their inefficacy had become evident.
While generalizations taken from the experience of nearly thirty African
197
countries are difficult to make, it is nevertheless clear that tax policy was but
one of the reasons for the African economic collapse of the eighties not only
because of the adverse economic incentives involved, but also because of the
failure of tax policy to prevent very large government budgetary deficits across
the continent.
After 1990, the economic ravages of the eighties began to recede somewhat;
yielding bit by bit to scattered economic policy reforms across sub-Saharan
Africa. By mid-decade, tax policy reform had become a fairly prominent
feature of the incipient turnaround: most nations of sub-Saharan Africa once
again began to experience positive rates of economic growth. As it happens, by
1995-1996 annual per capita income growth for the region as a whole was, at
1.9 percent, slightly above the growth rate for the world as a whole (1.7 percent)
(World Bank, 1998: Table 1.1). Moreover, the return to positive rates of growth
occurred in spite of ongoing softness in world export commodity markets,
especially for oil, timber, cocoa, nuts, and hard minerals, and in spite of the
persistence of high external debt burdens, in excess of 100 percent of GDP in
most countries in the region (World Bank, 1998: Table 4-12).
III. Constraints on tax policies in Africa
The African experience of the past quarter century shows how unsuitable
economic policies can not merely retard growth, but throw economies into
sharp decline. Good tax policy is critical to an overall policy environment for
facilitating growth, but even the best tax policy can never drive growth by itself.
Sustained growth in income requires above all else growth in productivity,
especially labor and capital. Tax policy can have particularly strong adverse
effects on capital formation. Therefore, tax policy that impinges least on pro-
ductivity will perforce favor income growth; tax policy that hampers improve-
ments in productivity retards growth.
At least five other considerations necessarily constrain the design of tax
policy in Africa. These are: revenue needs, the share of foreign trade in total
production and consumption, interactions of domestic tax systems with foreign
ones, the desire to keep the tax system off the backs of the families close to
margins of subsistence, and finally administrative capacities in tax enforcement.
These constraints limit significantly what can and cannot be done to make
tax policy serve growth objectives. Each is discussed in turn.
A. Revenue needs
It is sometimes argued that tax systems best suited for growth are those that
yield low 'tax ratios' (ratios of taxes to GDP). Such claims, of course, ignore the
uses to which tax revenues are put. Countries that offer high value for ta
money - good transportation services, strong public educational systems lea
198
ing to a well trained labor force, safer streets, and good public health standards
- have very different growth prospects from countries that offer low levels of
transportation, educational, and other public services. High levels of tax col-
lection can be supportive of growth when revenues are efficiently used to
finance improved levels of transport, education, and public health services that
contribute to growth in productivity. By the same token, low taxes associated
with low levels of such public services retard productivity, and therefore growth.
The worst of all possible worlds, from the point of view of prospects for income
growth, are high tax governments furnishing low value services.
The nations of sub-Saharan Africa generally occupy the middle ground:
moderate levels of tax burden, but low value for money. Worldwide, govern-
ment revenue averages 25.7 percent of GDP, with much higher tax burdens for
Europe and significantly lower ones for Asia. Until 1980, tax ratios for tropical
Africa averaged about 20 percent, a pattern maintained through 1997 (Table 1),
with ratios in excess of 30 percent in four nations.3 Aside from these few
exceptions, aggregate tax burdens in Africa tend to be much lower than the
32.5 percent average worldwide for developed countries of the Organization for
Economic Cooperation and Development (OECD) (Table 1). In any case, there
seems to be only limited scope for encouraging growth through a general low-
ering of tax burdens in Africa. Instead, prospects for using the government
budget as an active tool for accelerating growth appear greater, not on the tax
side, but on the expenditure side of the budget, by improving not only the
availability of transport, education, and public health but also the efficiency
with which these services are provided to the public.
B. Capital mobility
Tax policies for the first eighty years of the 20th century were in almost all
nations essentially designed to be suitable for a world in which capital was
largely immobile across national borders. Believing that capital was largely
unresponsive to differences in after-tax rates of return across nations, tax
policy-makers across the world perceived little risk in imposing high rates of
income tax upon capital income. Now, it is well understood that the inter-
national mobility of capital, never small, is significantly greater than was
believed to be the case only twenty years ago (Gillis et al., 1996, pp. 317-320).
Partly for this reason, governments around the world in recent years have
come to rely less heavily on taxes on capital income and more on taxes on
wages. From 1982 to 1996 implicit tax rates on capital in the fifteen EU
countries declined from 45 percent to 36 percent (on average) while implicit
tax rates on wages and salaries rose from 36 percent to 42 percent over the
same period (Economist, December 5, 1998: p. 95). This pattern extends well
beyond Europe, to capital importing countries around the world. One study of
fifty-eight countries shows, for U.S. manufacturing affiliates, an average effec-
tive tax rate decrease of ten percentage points from 1984-1992, (Altshuler,
199
Table I. Total tax revenue of sub-Saharan African nations.
Country Total tax revenue Country Total tax revenue

as % of GDP, as % of GDP,
1997a 1997a
Angola 35.5 Madagascar 9.4

Benin 6.1 Malawi 14.8
Botswana 29.2b Mali 13.3
Burkina Faso 11.6 Mauritania 15.6
Burundi 12.7 Mauritius 17.4
Cameroon 9.9 Mozambique 13.3
Cape Verde 19.3 Namibia 32.1
Central African Republic 7.1 Niger 7.2
Chad 6.6 Rwanda 9.8
Comoros 14.1 Sao Tome and Principe 10.6
Congo, Dem. Rep. 9.0 Senegal 15.4
Congo, Rep. of 29.4 Seychelles 35.8
Cote d'Ivoire 18.6 Sierra Leone 5.4
Djibouti 23.5 South Africa 28.2
Equatorial Guinea 15.9 Sudan 5.1
Eritrea 20.4 Swaziland 29.2
Ethiopia 12.9 Tanzania 12.5
Gabon 11.3 Togo 13.5
Gambia, The 17.2 Uganda 9.9
Ghana 7.5 Zambia 18.6
Guinea 10.4 Zimbabwe 25.4
Guinea-Bissau 8.0
Kenya 23.1 Sub-Saharan average 19.4
Lesotho 37.9 OECDAverage 32.5c
aData is for all levels of government; b1996; C

the Organisation for Economic Co-operation a
countries from Europe, North America and
two-thirds of total world production.
Sources: The World Bank. Africa Live Database
Grubert and Newlon, 1998). The same st

taxes on the location of investment abr
after-tax returns led to a three perc
overseas manufacturing affiliates.
The lessons from the foregoing are
mobile capital, governments unable t
terms of productivity - enhancing p
capital income tax rates much above tho
find their economies shrinking beneath
Prior to and during the lost decade of
employed somewhat higher nominal rat
or North America. However, owing to w
as strong incentives to evade high marg
200
income taxes in Africa were more in line with experience in Latin America and
Asia.
Evidence presented in subsequent sections suggest that tax policy-makers in
Africa have learned fairly well one of the most important economic lessons of
the late 20th century, a lesson that can be ignored only at some peril to income
growth: capital has become increasingly mobile across national borders.
C. Interactions with foreign tax systems
Tax systems of capital-importing countries (host countries) can interact with

those of capital exporting nations (home countries) in complex ways. Failure to
recognize these interactions can result in significant policy blunders costing
substantial tax revenue with few compensating benefits to host countries.
Much of the problem stems largely from a very common feature of income
tax systems of capital exporting nations in Europe and North America: the
foreign tax credit. When enterprises from these home countries invest abroad,
make profits, pay host country taxes, and repatriate earnings, they are ordinarily
entitled to credit income taxes paid in the host nation against income taxes due
in the home country. The difficulty arises when host countries offer investment
incentives to foreign firms. When these incentives take the form of income tax
exemptions for the foreign investor, the host country incentive can be largely
nullified by the creditability feature: taxes 'forgiven' by the host country cannot
be used as credits against home country income tax liabilities. In such circum-
stances, the host country tax incentive serves to transfer income from the host
country treasury to the home country treasury.
To be sure, a very few capital exporting nations, including Japan, but not the
U.S., offer alternatives for dealing with this problem, either through 'tax sparing'
or by special tax treaty 'sparing' provisions negotiated with host nations. Under
tax-sparing arrangements home country firms deriving income abroad are
allowed to treat repatriated income as if host country taxes had been paid.4
D. Poverty and income distribution
For much of the 20th century, governments around the world sought to utilize
the tax side of the budget to redistribute income from rich to poor. Rarely have
their efforts met with success. Important redistributive goals have, however, been
achieved through the government budget in many countries when redistribution
has been pursued through the expenditure side of the budget. Public outlays for
public health, public education, and rural works have been especially important
means of redistribution.5
There are, in any case, particularly strong reasons for concern about income
distribution and policy in Africa. Poverty is a major constraint on tax policy
throughout the region. A large proportion of the poorest nations on earth is in
201
Africa. Average per capita income in sub-Saharan Africa was but $490 in 1997,
and ranged from a low of $90 in Mozambique to a high of $4,230 in Gabon. In
fully twenty-eight of the forty-four countries listed in Table 3, annual per capita
income was less than $500 (Table 3).
In strife-torn societies such as Rwanda, Burundi, Liberia, and Sierra Leone,
close to 95 percent of the population has lived below subsistence levels in recent
years. Even in relatively more prosperous Ghana, Kenya, and Benin, as much
as three-fourths of the population cannot satisfy basic subsistence needs
throughout the year. And even in relatively high-income Gabon and Namibia,
most income goes to a relatively few persons, so that a majority of the popula-
tion may have incomes little above subsistence levels.
In such circumstances, it is unrealistic to expect significant revenues from
personal income taxation: the number of taxpayers with disposable income in
excess of any sensible exemption is generally too small to justify maintenance of
expensive personal income tax collection and enforcement machinery. Under
these conditions, tax policy must necessarily focus upon keeping the tax system
'off the backs of the poor,' while assuring that high income urban elites (including
government officials) are subject to personal income tax withholding (called
P.A.Y.E. in most of Africa).
E. Tax administration
The former colonial occupying powers left behind rather rudimentary adminis-
trative machinery for collecting taxes. Prior to independence, tax administra-
tion in the great majority of African nations was very largely in the hands of
expatriates. Except in isolated examples in Ghana and Kenya, the occupying
powers undertook little formal training of local tax officials.
Newly independent African nations in the late fifties and in the sixties were
keenly aware of the importance of improving tax administration. But becaus
of widespread economic distress in sub-Saharan Africa over the next twenty
five years, only quite limited resources were available for any purposes, including
payment of sufficient salaries to attract and keep fair-minded, capable tax
collectors. This was the case even in countries with such relatively easy-to-tax
activities as the export of tropical timber (Cote d'Ivoire, Ghana, Gabon, and
Liberia). In these countries and across Africa, taxes on timber exporters were
massively evaded throughout the seventies and eighties (Gillis, 1989).
Across the continent, the fundamental problem has been an extreme short-
age, not merely of highly skilled tax administrators, but of people trained to do
simple accounting. To take an illustration for Namibia, that could also easily
apply to Zimbabwe and Kenya, Due reports that in Namibia in 1996, 110
auditors were needed for Inland Revenue. Recruiting was disappointing: the
newest group taken in for training consisted of sixteen grade twelve graduates;
one of the sixteen had any training in accounting. Inadequate training of
personnel is the rule not the exception across the continent (Due, 1997). The
202
problem is by no means confined to tax collections, but extends to environ-

mental management (Dorm-Adzoba, 1995), public education and virtually
every other corner of government.
Some governments have sought to break the administrative constraint on
taxation by radical salary measures patterned after Indonesia's failed 1971
attempt to improve recruitment - and enforcement - in taxation by offering
tax officials basic salaries nine times that of other agencies. Tanzania was the
latest example: new personnel in tax administration in 1998 were to be paid
salaries four and five times that paid for comparable tasks in other ministries,
with the expectation that adequate salaries would reduce corruption and better
motivate employees (Due, Tanzania, 1998: p. 197). (A similar measure worked
reasonably well in Indonesia for a couple of years after it was implemented in
1971, but had no discernable positive effects thereafter.)
IV. Surmounting tax constraints on growth - forward-looking reform in

Africa
Among the major lessons learned from the African fiscal experience from
1960-1990 were: 1) that income tax structures capable of capturing any signifi-
cant revenues were likely to curtail capital formation, perhaps unduly so, and
2) income tax rates high enough to bring in significant revenues were in any
case unlikely to be administerable in the African context and therefore widely
evaded.
Consequently, no less than nine countries in the region adopted deep cuts in
marginal income tax rates by 1994.6 By 1998, virtually all nations in the region
save Cameroon, Gabon, and the Republic of Congo featured individual and
corporate income taxes with maximum rates not materially different from the
U.S. (Table 2). De-emphasis of income taxation is also reflected in the income
tax share in total current revenues across African nations. For all countries,
income taxes average about 21 percent of central government revenue; of the
thirty African countries covered in Table 2, sixteen had income taxes at less
than 20 percent of revenue. Only four of the thirty had income tax revenues
greater than 40 percent, five between 30 percent and 40 percent.
By 1995, taxes on income, profit, and capital gains worldwide averaged 30
percent of total central government revenue (Table 2). Eleven African nations
had ratios higher than 30 percent; eighteen had lower ratios. Where marginal
income tax rates are concerned, African tax systems differ little from those
elsewhere. The top marginal personal income tax rate would ordinarily apply to
households with capital income, while the highest corporate income tax rate
clearly applies only to capital income. The world average for the highest mar-
ginal tax rate on households was 38.3 percent in 1997; a rate exceeded only in
five African countries (Table 2). The worldwide average for the highest corpo-
ration income tax rate was 32 percent. African corporate tax rates tended to
be somewhat higher than worldwide practice, but not strikingly so: corporate
203
Table 2. Central government tax characteristics of sub-Saharan African nations.
Country Taxes on Taxes on income, Highest marginal Highest

income, profits, profits, and tax rate, 1997 marginal
and capital capital gains as tax rate,
gains as % % of total current Indi- On 1997
of total taxes revenue vidual income
exceed- Corpo-
1980 1996 1980 1995 ing ($) rate
Botswana 45.5 51.3 33 21 30 16,680 15

Burkina Faso 20.1 - 18 -
Burundi 20.4 25.1 19 19 - -
Cameroon 23.7 23.4 22 17 60 14,313 39

Central African
Republic 17.7 - 16
Congo, Dem. Rep. 34.5 35.8 30 33 - -
Congo, Rep. of 63.8 - 49 - - - 45
Cote d'Ivoire 14.0 - 13 16a 10 4,489 35
Ethiopia 25.4 - 21 22 - -
Gabon 60.2 - 40 28a 55 - 40
Gambia, The 18.1 - 15 14 - - -
Ghana 22.0 - 20 17 35 9,173 35
Kenya 33.3 30.7 29 28 35 374 35
Lesotho 15.6 - 13 13 - -
Madagascar 17.1 18.8 17 15 - -

Malawi 38.9 - 34 37a 38 2,763 38
Mali 20.5 - 18 - - -
Mauritius 17.3 15.7 15 13 30 2,764 35

Namibia - - - 29 35 17,152 35
Niger 28.1 - 24 - - - -
Nigeria - - - 25 754 30
Rwanda 20.7 - 18 16a - -
Senegal 21.4 - 18 - 50 24,141

Sierra Leone 25.0 16.3 22 16 - -
South Africa 64.0 54.3 56 51 45 21,440 35

Sudan 17.2 - 14 - - -
Tanzania 35.2 - 32 - 35 14,075 35

Togo 38.6 - 34 - - - -
Uganda 11.8- 11 - 30 4,800 30
Zambia 41.1 39.6 38 33 30 1,376 35
Zimbabwe 57.9 - 46 49 40 5,597 38
Sub-Saharan Average 30b 30b 22 24b 36b 35b

World Average 32b 30b 21 22 38b 32b
al992; bUnweighted average; - Data is not available for this

Sources: The World Bank. 1998 World Development Indicators
204
Table 3. GNP per capita for sub-Saharan African nations.
Country GNP per capita ($) GNP per capita average annual growth rate
1997 1976-1986 1987-1997
Angola 340 -2.7 -8.2

Benin 380 1.2 0.8
Botswana 3260 7.0 5.3
Burkina Faso 240 1.2 0.0
Burundi 180 1.1 -3.9
Cameroon 650 6.8 -5.1
Cape Verde 1090 9.4 1.2
Central African Republic 320 -1.9 -1.8
Chad 240 -2.3
Comoros 400 1.2 -2.5
Congo, Dem. Rep. of 110 - -
Congo, Republic of 660 - -
C6te d'Ivoire 690 -4.2 -1.0
Equatorial Guinea 1050 - 7.1
Ethiopia 110 -2.7 -0.5
Gabon 4230 -4.6 -0.1
Gambia, The 350 - -
Ghana 370 -2.8 1.6
Guinea 570 - 1.8
Guinea-Bissau 240 0.0 1.6
Kenya 330 0.6 -0.2
Lesotho 670 0.4 1.3
Madagascar 250 -3.4 -1.4
Malawi 220 -0.8 0.6
Mali 260 -0.9 0.3
Mauritania 450 -1.1 1.0
Mauritius 3800 0.8 4.3
Mozambique 90 -8.9 0.9
Namibia 2220 -3.8 1.3
Niger 200 -3.0 -2.0
Nigeria 260 -4.5 1.7
Rwanda 210 1.8 -5.2
Sao Tome and Principe 270 -1.1 -1.3
Senegal 550 -1.1 -0.4
Seychelles 6880 0.3 3.5
Sierra Leone 200' -0.7 -5.4
Somalia - -1.9
South Africa 3400 0.0 -0.9
Sudan 280 -3.2
Swaziland 1440 1.6 1.4
Tanzania 210 - 1.3
Togo 330 -1.5 -1.8
Uganda 330 - 3.7
Zambia 380 -3.3 -2.8
Zimbabwe 750 2.4 -0.2
a 1996; - Data is not availab

Source: The World Bank. A
205
tax rates exceeded 40 percent in only one (Republic of Congo). Otherwise, a

strong central tendency of about 35 percent is evident (Table 2), very near the
U.S. rate. Corporate tax rates prevailing today in Africa are notably below
those prevailing in the sixties and seventies.
Still, African nations are not in the process of abandoning income taxation
altogether. Virtually all have retained company income taxes, but these are
imposed primarily on foreign firms - especially natural resource enterprises -
rather than on domestic ones. There are, in many cases, good reasons to
continue to provide for corporate taxation in the tropical African setting.
Abolition of corporate income taxation in any one country would mean that
foreign firms in that country would have no host country taxes to offset (credit)
against taxes due on income repatriated to the home country. However, as
noted earlier, this is not a serious issue for taxation of Japanese firms, nor even
all American-based firms. In any case, the relatively moderate rates of corpo-
ration taxes now prevailing on firms outside the natural resource sectors7
across much of Africa do not involve very serious obstacles to capital forma-
tion and growth, certainly relative to rates in effect only two decades ago.
The shift away from income taxation in Africa coincided with steadily
growing reliance upon consumption-based taxes, with most nations opting for
one particular form of consumption tax: the value-added tax (VAT). The VAT
idea, not fifty years old, has had an astonishing record of acceptance; nothing
in the annals of fiscal economics in this century rivals the spread of the VAT
(Harberger, 1990: p. 27). Moreover, the trend toward heavier use of the VAT
has been the principal innovation in forward-looking tax policy in the entire
African region in this decade.
V. The spread of VAT in Africa: Early results
The shift to consumption taxation in Africa, as in Europe, has strongly favored

use of the VAT, in spite of possible reservations over the VAT's impact on
income distribution (See McLure, 1990, for a review). This concern may have
been one reason for the fact that in Africa the trend toward the VAT was late in
beginning. Another reason was persistence of remnants of British fiscal tradi-
tions: former British colonial nations were far less receptive to the VAT than for
former French colonies, not surprising considering that the VAT first appeared
in France in 1954.
Up until the seventies, only Cote d'Ivoire, Senegal, and Madagascar (former
French colonies all) utilized any form of VAT. The early form of VAT used in
these nations was primitive relative to the present European-style VAT. By 1999,
twenty African nations had installed one or another form of VAT (Table 4),
usually to replace other, defective forms of consumption taxes, but sometimes
to replace a part of income tax revenues. Most of the African VAT's now extend
through the retail level, as in Europe.
The reasons for the rapid spread of the VAT across Africa are fairly straight-
206
Table 4. The value-added tax in sub-Saharan Africa.
Country Year VAT adopted Basic VAT rate (standard rate)
1 Benin 1991 18 Wholesale

2 Burkina Faso 1993 18 Retail
3 Cameroon 1995 18.7 Retail
4 Congo - Rep. of 1997 18 Retail
5 Cote d'Ivoire 1960 18 Retail
6 Gabon 1995 18 Retail
7 Guinea 1996 18 Manufacturer
8 Kenya 1990 15 Manufacturer
9 Madagascar 1969 15 Retail
10 Malawi 1989
11 Mali 1991 17 Retail
12 Mozambique 1999 17 Retail
13 Namibia 1999 (scheduled) n.a.
14 Nigeria 1961, 1990 5 Wholesale
15 Senegal 1991 20 Retail
16 South Africa 1991 14 Retail
17 Tanzania 1995 20 Retail
18 Togo 1996 18 Retail
19 Uganda 1995 17 Retail
20 Zambia 1995 17.5 Retail
21 Ghana 1994, repealed in 1995
Sources:
Cnossen, S. (1998). 'Global trends and issues in value added taxation,' International Tax and Public
Finance, p. 399-28.
Gillis, M., et al., Economics of Development, 4th Edition.
Due, J. F. (1997), 'The tax structure of Namibia,' CIBER Working Paper #97-102, University of
Illinois, College of Commerce.
Due, J. F. (1998), 'Tanzania, the enacted VAT and the use of a revenue authority,' Tax Notes
International, January 19, 1998.
Bakibinga, D. J. (1998), 'The introduction of a VAT in Uganda: Avoiding the great Ghanaian
debacle.' VATMonitor 7, March.
forward. While the VAT can take many forms, one has proven superior in
virtually all circumstances: a uniform rate VAT extending through the retail
stages, collected by the European community style tax-credit mechanism
(wherein all firm sales are taxable, but taxes paid on firm purchases are credited
against taxes due on firm sales). This form of VAT has a number of advantages
over its closest competitor, the single-stage retail sales tax (as used in forty-five
U.S. states and Zimbabwe). Taken singly, none of these advantages are over-
whelming, but all together they make for a strong case for the VAT, especially in
developing countries with inadequate tax administration and a high degree of
dependence on foreign trade. Nevertheless, there are cases wherein a non-retail
form of VAT may be usefully considered as a transition measure (Indonesia in
1983)8 toward a retail-type VAT, but these cases are now uncommon. A very
207
few countries have opted for non-retail single-stages taxes (wholesale sales
taxes, manufacturer's taxes), but never with satisfactory experience. The single-
stage retail sales tax, then, is the only plausible alternative to the VAT when
implementing consumption tax reform.9
The VAT has become the predominant form of sales tax worldwide because
of the widespread perception that a properly designed VAT can raise more
revenue with lower administrative and economic costs than other broadly-
based consumption taxes, and can do so in neutral fashion.10 Moreover, among
broad-based consumption taxes, VAT in practice involves almost no cascading
(the application of sales tax on previously paid taxes on products) and virtually
no pyramiding (product price increases in excess of the amount of tax). The
VAT is also clearly superior in its treatment of international trade: only under a
VAT is it, in practice, possible to free all exports from tax.'1
Finally, the VAT is well suited for implementing one of the basic aims for
switching to consumption taxation: the encouragement of capital formation. In
the African context, this advantage rests on two features of the VAT. First, the
marked superiority of the VAT in freeing capital (producer) goods and exports
from indirect tax burden. Second, while it seems paradoxical to some that high
revenue productivity can favor capital formation, this feature of the VAT, in a
region long plagued with high budgetary deficits, encourages capital formation
by helping to contain inflationary pressures. Both features of the tax are
discussed below.
A large share of, if not most, producer goods may be viewed as 'single-use'
goods: those used exclusively as business inputs. A consumption tax should not
apply to such goods; cascading and pyramiding would result. Other producer's
goods are 'dual use' goods, which can be used as business inputs, but they can
also be used for personal consumption. It has proven impossible to fully exempt
capital goods, especially 'dual use' goods from single stage retail taxes.12 The
inability to free producer goods from tax is by far the chief cause of cascading.
In turn, cascading of tax on producer goods discourages domestic and foreign
investment and renders impossible the full liberation of exports from tax. Alone
among broad-based indirect taxes, the VAT can be structured to fully relieve
producer goods (and exports) from tax, thereby eliminating cascading and the
ill economic effects it brings in its wake.'3
The VAT is also likely to be conducive to economic growth in deficit-ridden
countries for yet another reason: it is a revenue workhorse.14 Indeed, the VAT
has often been viewed as a'money machine'.15 While this reputation is not fully
deserved, it is nevertheless true that a simple tax-credit type of VAT can raise
more revenue with fewer economic and administrative costs than any other tax
now in use. In any case, the perception of the VAT as a 'money machine' seems
to have been a significant factor in decisions across Africa to adopt the tax.
The revenue superiority of the VAT is particularly important given the
persistence of high fiscal deficits, as in most of sub-Saharan Africa in the
eighties and early nineties (Table 5). The adverse implications of budgetary
deficits depend on many factors, not least of which is the real size of the
208
Table 5. Central government deficit and surpluses (including grants) for sub-Saharan African nations.
Country Government deficit/Surplus as a percentage of GDP
1988 1997
Angola -14.1 -17.8

Benin 15.0 -0.1
Botswana 19.0 -1.9
Burkina Faso -5.9 -2.2
Burundi -9.3 -5.3
Cameroon -5.9 -0.9
Cape Verde -1.5 -15.1
Central African Republic -4.8 -2.5
Chad -4.6 -3.8
Comoros -1.9 -2.8
Congo, Dem. Rep. of -16.0 13.2

Congo, Rep. of -18.0 -7.6
Cote d'Ivoire -14.6 -2.0
Djibouti - -8.1
Equatorial Guinea -32.4 -0.4
Eritea - -7.0
Ethiopia -4.9 -1.3
Gabon -9.4 6.0
Gambia, The 6.3 -6.5
Ghana -2.8 -8.5
Guinea -6.8 -2.8
Guinea-Bissau -15.3 -18.1
Kenya -4.2 -1.9
Lesotho -17.3 7.4
Madagascar -3.3 -2.4

Malawi -2.7 -1.7
Mali -4.7 -2.1
Mauritania -3.6 5.0
Mauritius -2.2 -5.1
Mozambique -8.8 -4.1

Namibia -7.7 -4.3
Niger -5.1 -1.5
Nigeria -13.1 1.4
Rwanda -6.7 2.9
Sao Tom& and Principe -22.1 -26.7

Senegal -1.1 -0.2
Sierra Leone -5.3 -3.9a
South Africa -5.6 -5.2
Sudan -12.1 -0.8
Swaziland - -2.5
Tanzania -3.4 2.1
Togo -3.3 -1.5

Uganda -3.9 -1.8
Zambia -9.3 -2.3
Zimbabwe -7.6 -7.3
Sub-Saharan Average -7.9 -3.3
World Average -3.6 -3.3b
a1996; b1995; - Data is not available for this ye

Source: World Bank. African Development Indic
1990.
209
financial system: the ratio of net financial assets to GNP. Where this ratio is 100
percent or even 200 percent of GNP, as in the U.S. and Canada, budget deficits
of 3 percent to 4 percent of GNP pose little threat to price stability, since
deficits of this size are a small fraction of the real size of the financial system
and therefore involve - by themselves - only modest increases in a nation's
nominal monetary base (Gillis et al., 1996: p. 359-380).
As it happens, budget deficits worldwide averaged about 3.3 percent of GNP
in 1995, a period of low world inflation. Deficits of this magnitude do not
involve serious threat of inflation in nations with well-developed financial
systems. But in countries where the real size of the financial system is quite
small, deficits of 3 percent to 4 percent of GNP are matters of serious concern
indeed. For example, in the early nineties, the real size of the financial system
(the financial ratio) was less than 40 percent of GNP in Tanzania and Kenya,
while in inflation-wracked Ghana and Nigeria it was less than 20 percent. With
financial ratios as low as 40 percent, a 4 percent budget deficit is by itself
tantamount to a 10 percent increase in the nation's nominal money supply.
With a 20 percent financial ratio, the same deficit is equivalent to a 25 percent
increase in the nominal supply of money. Financial ratios across Africa through
the late nineties ranged between 10 percent and 50 percent, with a central
tendency at about 33 percent. In such circumstances, budgetary deficits in
excess of 4 percent of GNP involved very severe inflationary risks.
The revenue productivity of the VAT has been favorable for capital forma-
tion largely because the VAT has helped to shrink budget deficits in many
nations across the region. This is important, because of the effects of inflation
itself in retarding capital formation and misallocating scarce capital, both of
which are clearly inimical to economic growth. Not only does inflation curtail
private sector investment by constricting the flow of funds through the organized
financial system; inflation increases the riskiness of all financial decisions. More-
over, the higher the level of inflation, the more serious is the effect on capital
formation.16
The consequences of VAT adoption across Africa have been broadly consis-
tent with the expectations for the tax, except in Ghana where the VAT was
adopted in 1994 and repealed in 1995.17
In a majority of African nations that have adopted the VAT, revenue per-
formance of the tax has been reasonably strong, an important consideration
in a region where high budgetary deficits and low financial ratios prevailed
throughout the early nineties.
Even as late as 1997, nineteen of the forty-five sub-Saharan African nations
in Table 5 had budgetary deficits in excess of 4 percent of GNP. Of this deficit-
ridden group, however, only three (Republic of Congo, Gabon, and South
Africa) were VAT countries (Tables 3 and 4). Much more telling, however, has
been the evolution of budgetary deficits in the VAT countries themselves. The
average budget deficit was 6.6 percent of GDP in African VAT countries in
1988. By 1997, the average budgetary deficit for these nations was but 1.8% of
GDP. Moreover, all African nations adopting the VAT were able to reduce the
210
share of the deficit in GDP by more than 50 percent, except Madagascar,

Malawi, Namibia, and South Africa. Finally, in four VAT nations, the deficit
ratio fell by 90 percent or more. The tax has been especially successful in South
Africa, bringing in 25 percent of total tax revenue. The VAT was not the only
factor leading to improved budgetary outcomes, but it was the most impor-
tant: income tax revenue in Africa did not expand significantly, and the period
1988-1997 was one of largely stagnant export prices, for most African com-
modities, so that taxes on foreign trade expanded little.
Enforcement considerations have also often tipped the scales toward the
VAT; especially where tax administration and compliance is relatively weak
as in Africa. As Due has noted for nearly fifty years, more effective enforce-
ment is possible under a VAT for several reasons.18 First, much of the tax - as
much as two-thirds in many nations - is necessarily collected at pre-retail
levels. Thus, significant revenues will be collected even if retail level enforce-
ment is inadequate. Second, the operation of the tax-credit mechanism leaves a
fairly clear audit trail: taxes paid on sales by one firm become taxes paid on
purchases by the buying firm. Understatement of VAT paid by the former
results in fewer taxes that can be credited by the latter. These considerations
have led some to believe that the VAT can 'administer itself.' While this is not
so, the VAT possesses evident enforcement advantages.
Other than Ghana, other aspects of the African VATs have typically met or
exceeded expectations, except for certain aspects of indirect tax administration.
Across Africa, desired improvements in tax administration have not fully
materialized. This has been the case especially for Tanzania (Due 1998; Due
1999) and Egypt (Bird 1991). Uganda, implementing the tax in 1996 (Due,
1999) draws heavily on the negative lessons from Ghana in 1994-1995, was
especially attentive to the need for preparing and training officials to administer
the tax. Because the tax was scheduled to be enacted only in 1999 in Zimbabwe
and Mozambique, there are few details for these nations on administration,
successful or otherwise.
For the future, successful operation of the VAT in Africa will require that
heavy emphasis be placed upon much expanded training in tax enforcement,
along with stress upon the use of simple straightforward tax provisions that can
be enforced with a relatively small number of adequately trained officials.
Fortunately, a number of African governments have begun to heed this advice.
With few exceptions, African governments adopting the tax have taken care to
avoid features that could unduly complicate operation of the tax, such as multi-
ple tax rates, or very high VAT rates generally. In eleven countries,19 reliance
has been placed upon uniform rates of tax instead of administratively complex
multiple rates. Exceptions, however, have been Cameroon, Gabon, and Kenya.
Relatively high rates of VAT, whether uniform or otherwise, tend to increase
taxpayer incentives for evasion and avoidance. Rates of VAT throughout Africa
are higher than is typical than in Latin America, but not materially different
from those employed across Europe: the median and the average standard rate
among African nations in 1998 was 18 percent.
211
The impact of the VAT on income distribution has been mixed. Complaints
over the possible regressivity of the VAT were particularly common in South
Africa, where the tax was introduced in 1991. However, subsequent studies
showing that the overall tax system was roughly proportioned in distributional
impact helped allay these concerns, to the extent that a commission of inquiry
in 1995 recommended against increasing tax rates on less essential goods (Due
1999: p. 123). However, one of the primary factors leading to the repeal of the
tax in Ghana in 1995 was widespread public concern over alleged regressivity
of that VAT. On the other hand, the fact that eleven African nations utilize a
uniform rate of tax with no higher rates for 'non-essential' goods suggests
strongly that concerns over possible VAT regressivity were not significant in
those locations.
Finally, virtually all African nations using the VAT have either exempted
exports from VAT or adopted the more efficacious methods of zero-rating
exports (universal in Europe). Exemption frees only the export sales itself from
VAT; zero rating makes exports nominally subject to tax but at a zero rate. As
a result, VAT collected prior to export, at earlier stages of production and
distribution can be fully refunded, freeing exports from all VAT burdens.
VI. Concluding comments
The nations of sub-Saharan Africa began the twentieth century tightly linked to
the interests, if not the yoke, of several colonial European powers. Living
standards improved slightly, if at all, for most Africans from 1900 until the
winds of change began to blow in the fifties, resulting in independence in
virtually every corner of the continent. After independence, economic well
being began to rise perceptibly in many countries' Hopes for major improve-
ments in living standards were, however, soon dashed, owing both to external
and to internal reasons. In the quarter century after 1965, country after country
in the region slipped back into stagnant, if not declining, economic conditions.
With few exceptions, economic distress was exacerbated by unsuitable economic
policies with highly corrosive effects. Tax policies played a notable, but never
the principal role in almost all cases of chronic economic decline in Africa.
Signs of a reversal in policy orientation began to appear as early as 1986 in a
very few countries, most notably Ghana. By the early 1990's, the beginnings of
policy turnaround were evident in countries such as Ghana, Tanzania, Malawi,
Uganda, South Africa, and Namibia.
Some of the earmarks of forward-looking tax policy began to emerge in
widely diverse nations across the continent. The process began with a fairly
widespread, if tentative, movement toward income tax reform, especially in the
form of deep cuts made in top rates of income tax. The most significant
manifestation of an incipient African policy turnaround has, however, been
the region-wide shift to the form of sales tax most conducive to growth and
stability in a developing country setting: the value-added tax. In 1990, only
212
three African nations operated a value-added tax in any form; by 1999, this tax
was used in nineteen countries, with another (Namibia) expected to join the
fold by mid-year.
The shift to the VAT has also been favorable to growth to the extent that the
VAT's reputation as a 'revenue-workhorse' is deserved. By curbing - however
moderately in some countries - budgetary deficits, the VAT has helped to
contain inflationary pressures across Africa, furnishing a more stable policy
environment supportive of capital formation and economic growth, and has
done so without any appreciable worsening of income distribution.
Tax reform has played a notable role in helping many African nations regain
their economic footing since 1990. More ambitious efforts to utilize tax policy
to promote investment and growth not to mention income redistribution will
need to await the rebuilding of tax enforcement mechanisms across the region.
Acknowledgement
The author is grateful to Craig Johnson for research assistance.
Notes
1. Economic growth has lagged behind the rest of the world most of the past two centuries.
By 1992, real per capita income in Africa was essentially identical to Angus Maddison's
authoritative estimate of the level of real per capita income in Western Europe in 1820 (Gallup,
Sachs and Mellinger, 1998).
2. The Ghanaian experience was not untypical. Ghana was among the richest of tropical African
nations at independence in 1957. But over the next quarter century per capita income fell
steadily by an average annual rate of 0.7 percent. The prime cause of sustained negative growth
there stemmed from the economic policies followed by successive governments from 1960-
1980 (Roemer, 1984: p. 201; Gillis, 1988: pp. 304-305). These include policy commitments to
greatly overvalued exchange rates, devastating price controls on agriculture, heavy subsidiza-
tion of high-cost production as well as consumption through both interest rate and tax policy,
and high degrees of protection for domestic industries.
3. These were Angola, Lesotho, Namibia, and Seychelles (Table 1).
4. Finally, it should be noted that generalizations about interactions between income tax systems
are difficult to make for non-Japanese firms. Many United States firms are, at least in some
years, in major excess tax credit positions (e.g. they have significant unused foreign tax credits).
Forgiving taxes on such firms does not have the effect of transferring tax income from the host
country to the U.S. Treasury. Also, some capital exporting countries tax according to the
'territorial' system, and thus have no crediting system.
5. The latest in studies showing the greater efficacy of redistribution through the expenditure side
of the budget is Engel, Galetovic, and Raddatz, 1997).
6. These were Tanzania (75% to 30%), Malawi (50% to 35%), Uganda (70% to 30%), Kenya (65%
to 45%), Nigeria (70% to 35%), Senegal (65% to 50%), Ghana (65% to 35%), and Zimbabwe
(61% to 50%) (Gillis et al., 1996: p. 341).
7. As the author and others have shown in several publications over the past quarter-century,
taxation of natural resource projects of large international firms is, especially in Africa, often
better handled by special contracts rather than general law. See for example: 1) Gillis, Malcolm
213
and Ralph E. Beals. Tax and Investment Policies for Hard Minerals: Public and Multinational
Enterprises in Indonesia. Cambridge, MA: Ballinger Publishing Company, 1980. 2) With
Ralph Beals. 'The Evolution of Hard Mineral Agreements in Indonesia.' Natural Resources
Forum 4 (1980). 3) 'Evolution of Natural Resource Taxation in Developing Countries.' Natural
Resource Journal (Spring 1982). 4) 'Energi dalam Perekonomian Indonesia' (Energy in the
Indonesian Economy) in Analisis Dan Metodoloaic Ekonomi Indonesia, edited by Sjahrir.
Jakarta: P.T. Gramedia Pustaka Utama, 1991, (with David Dapice).
8. See Gillis, 1989; 1990.
9. For a detailed discussion of the merits and limitations of the VAT relative to single stage taxes
(retail and otherwise) (Gillis, 1986). The most authoritative critique of alternatives for sales tax
reform which has now been in print for nearly a half century: remains John Due, Sales
Taxation, (Urbana, University of Illinois). Another comprehensive recent examination of
alternatives for consumption tax reform may be found in Gillis, Mieszkowski, and Zodrow,
1998.
10. Cnossen, 1998: p. 399

11. Under the tax-credit type of VAT so strongly favored in Africa and elsewhere, export trans-
actions are free of tax, while all taxes paid on a productprior to the export stage are refunded
(rebated).
12. See Gillis, Zodrow and Mieszkowski: p. 756-757.
13. This feature of the VAT has often proved to be decisive when tax reform has been under
consideration. As early as 1969, Sweden switched from a single stage retail tax to a VAT
precisely to encourage capital formations and exports (Gillis, 1981), because of the greater
ease with which producer goods can be treated correctly under the VAT.
14. See Cnossen, 1998: p. 413.
15. The fear that the VAT will in fact result in large revenue increases accounts for the reluctance
of many otherwise market-oriented politicians and even economists to endorse the tax for
developed economies (Gillis, 1986). Liberals, on the other hand, fear the VAT will be regressive
(McLure, 1990). A recent article by Gary Becker and Casey Mulligan (1998) agrees that a flat-
rate VAT is in fact the most efficient way to raise revenue. The authors go on to argue that this
is not an unalloyed advantage of VAT. Becker and Mulligan's analysis indicates that countries
utilizing 'more efficient' broad-based taxes such as a flat-rate VAT tend to have a larger role
for government in the economy. Indeed, the authors argue that less efficient tax systems can
improve taxpayer welfare because the system creates additional political pressure for suppress-
ing the growth of government.
16. To see how inflation increases the riskiness of all investment decisions, consider the following
example taken from Gillis, et al., 1996: p. 370. Suppose that businesses can anticipate inflation
with a margin of error of plus or minus 20 percent of the actual rate. (If the margin of error is
wider, the effects about to be described will be more pronounced.) If inflation has been running
at 5 percent per year, there may be a general expectation that it will settle within the range of
4 to 6 percent in the near future. But if inflation has been running at substantially higher rates,
say, 30 percent, then expectations of future inflation may rationally be in the much broader
range of 24 to 36 percent. The entrepreneur therefore faces far higher levels of uncertainty in
planning investments and production. The more uncertain the future and future returns are,
the more likely is the entrepreneur to reduce her risks. Investments with long lives (long
gestation periods) tend to be more risky than those with short lives. Thus inflation tends to
have especially serious effects on private-sector investments in projects with a long-term
horizon; the inhibiting effects rise with the rate of inflation. Unfortunately these are often
precisely the types of investments most likely to involve high payoffs in terms of income growth
for society as a whole. Note also, however, the contention by Becker and Mulligan (1998) that
use of inflation (to be called inflation taxes) that are highly inefficient (in a Ramsey gauge)
could be advisable as a means of suppressing the growth of government.
17. Bakibingi (1996) attributes the stillbirth of Ghana's VAT to bad policy timing, lack of govern-
mental preparation for a major policy change, and political instability.
214
18. See John Due, Namibia, 1997; Due, Tanzania, 1998. See also Cnossen, 1998; Gillis, 1986;
Gillis, Mieszkowski and Zodrow, 1998.
19. This group includes Benin, Bukavo, Faso, Republic of Congo, Guinea, Madagascar, Niger,
Nigeria, South Africa, Uganda, and Zambia.
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Tax Policy and Capital Formation: African Experience with the Value-Added Tax

Author(s): Malcolm Gillis

Tax policy and capital formation: African experience

Most tropical African economies experienced severe decline in

II. Tax policy and economic performance in Africa:

III. Constraints on tax policies in Africa

Table I. Total tax revenue of sub-Saharan African nations.

Country Total tax revenue Country Total tax revenue

Angola 35.5 Madagascar 9.4

aData is for all levels of government; b1996; C

Grubert and Newlon, 1998). The same st

C. Interactions with foreign tax systems

Tax systems of capital-importing countries (host countries) can interact with

D. Poverty and income distribution

problem is by no means confined to tax collections, but extends to environ-

IV. Surmounting tax constraints on growth - forward-looking reform in

Table 2. Central government tax characteristics of sub-Saharan African nations.

Country Taxes on Taxes on income, Highest marginal Highest

Botswana 45.5 51.3 33 21 30 16,680 15

Cameroon 23.7 23.4 22 17 60 14,313 39

Madagascar 17.1 18.8 17 15 - -

Mauritius 17.3 15.7 15 13 30 2,764 35

Senegal 21.4 - 18 - 50 24,141

South Africa 64.0 54.3 56 51 45 21,440 35

Tanzania 35.2 - 32 - 35 14,075 35

Sub-Saharan Average 30b 30b 22 24b 36b 35b

al992; bUnweighted average; - Data is not available for this

Table 3. GNP per capita for sub-Saharan African nations.

1997 1976-1986 1987-1997

Angola 340 -2.7 -8.2

a 1996; - Data is not availab

tax rates exceeded 40 percent in only one (Republic of Congo). Otherwise, a

V. The spread of VAT in Africa: Early results

The shift to consumption taxation in Africa, as in Europe, has strongly favored

Table 4. The value-added tax in sub-Saharan Africa.

Country Year VAT adopted Basic VAT rate (standard rate)

1 Benin 1991 18 Wholesale

21 Ghana 1994, repealed in 1995

Country Government deficit/Surplus as a percentage of GDP

Angola -14.1 -17.8

Congo, Dem. Rep. of -16.0 13.2

Madagascar -3.3 -2.4

Mozambique -8.8 -4.1

Sao Tom& and Principe -22.1 -26.7

Togo -3.3 -1.5

a1996; b1995; - Data is not available for this ye

share of the deficit in GDP by more than 50 percent, except Madagascar,

VI. Concluding comments

The author is grateful to Craig Johnson for research assistance.

10. Cnossen, 1998: p. 399

Maddison, A. (1996). Monitoring the world economy, 1820-1992. Paris: OECD.

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