Taxation Transactions are not a One-Way Street!

According to the African Department of the IMF, the main emphasis on domestic revenue mobilisation (DRM) stands as a key priority in meeting Africa’s extensive developmental needs. Considering the recent COVID-19 pandemic, both global north and south researchers have advocated for a heightened and sustainable DRM objective in Africa to sustain development efforts, aligning with the attainment of the Sustainable Development Goals (SDGs). This underscores the significance of DRM, signifying tax revenue collection, in Africa. Consequently, the OECD, through its Africa Initiative, has advocated for Tax Transparency Standards as a means to elevate DRM across the continent. However, a notable aspect is that Africa’s tax bases are considerably restricted owing to the prevalence of high levels of ‘informality,’ worsening tax evasion and illicit financial flows (IFF). In this context, the concept of informality sparks controversy due to its limited conceptualisation as solely pertaining to the informal sector within African economies, impeding revenue mobilisation. Challenging the assumption that only informal sectors hinder effective revenue mobilisation, some researchers argue that the framing of informality concerning DRM poses an inherent problem. 

Abel Gwaindepi, a senior researcher at the Danish Institute for International Studies (DIIS) and an external lecturer at the Centre of African Studies (CAS) at the University of Copenhagen, contributes to the discourse by challenging the framing of informality concerning taxation in Africa. In his working paper for the United Nations University World Institute for Development Economics Research (UNU-WIDER), titled ‘‘Domestic revenue mobilization and informality,’’ Gwaindepi critically examines dominant conceptualisations of informality in the context of the recent COVID-19 pandemic. He aims to illustrate how the notion of ‘‘informality,’’ impacting DRM, extends beyond the visible informal sectors within African economies. He also demonstrates that informality is only one among many issues standing in the way of DRM in Africa. Gwaindepi further argues for a re-articulation of informality when it is included in DRM research. During an in-depth interview with Gwaindepi, we discussed his working paper in detail, including other aspects of taxation and revenue in Africa.

Why is taxation important for government revenue?

‘‘Government revenue has always been about taxation. Aid inflows, natural resource revenues etc. will fizzle out but taxing individuals and firms as they produce, trade, and consume goods and services is the backbone of any good tax system’’, Gwaindepi asserted. Considering his focus on the colonial and post-colonial African state and its functions, he explained that what states collect via taxation is the most reliable way for governments to raise revenue. He elaborated on his viewpoint, emphasising that some African countries, perceiving an ‘abundance’ of non-tax revenue, tend to allocate less effort to taxation. Consequently, he argued that anything pertaining to revenue fundamentally centres on taxation. Take Ethiopia, for instance, with a national air carrier like Ethiopian Airways; it serves as a revenue generator without directly taxing its citizens. Similarly, consider a resource-rich nation like Nigeria, where a substantial portion of revenue is derived from oil. In such cases, the state might not need to exert significant efforts towards taxation because of the availability of non-tax sources of revenue. Thus, within this framework, the discussion of government revenue primarily revolves around taxation, according to his argument.

The World Bank notes that Low-Income Countries (LICs), notably in Africa, which are most in need of revenue, often encounter formidable challenges in tax collection. The World Bank reiterates that taxes play a key role in sustaining growth and equity, especially within the context of the COVID-19 pandemic. Consequently, the World Bank advises that nations collecting less than 15% of GDP in taxes must significantly strengthen their revenue mobilisation to address the fundamental needs of their populace. Therefore, the question arises: How can countries effectively enhance their domestic revenue mobilisation?

Effective ways of mobilising tax revenue

‘‘Do countries have the capacity to mobilise revenue? Capacity is one side of the coin. You also have what we call the tax base, that speaks to the economy where the money is. As people and firms produce, sell, and consume goods and services, governments have an opportunity to collect tax revenue’’, Gwaindepi responded. A tax base encompasses the entirety of income, property, assets, consumption, transactions, and other economic activities subject to taxation by a governing authority or government. ‘‘You can be an effective tax collector, but if you are collecting it only from the very poor people, then your capacity does not amount to much, essentially. Many of the poor people earn below taxable income and those who can pay can only bring a drop in the ocean in terms of required revenue. So, the government has an incentive to make the economies thrive. Why? Because only then can the governments collect taxes, otherwise, if they do not promote economic development, it means the tax bases are very low. So, those to me are the two most important things – the capacity to collect taxes and a thriving economy which allows incomes to accrue to taxpayers,’’ he explained further. 

The IMF contends that the state’s capacity to collect taxes holds central importance in financing investments and crucial social services, including health, infrastructure, and various public goods. The focus is notably on ‘capacity,’ delving into the details of how, where, and when taxation occurs, representing a primary aspect of capacity. ‘‘Are there taxable economic activities or incomes in the country, and in which sectors? For many African countries the question is, is the taxable income within formal or the informal sectors? So, the capacity becomes essential. Can you reach your formal and reach your informal activities equally, and how?’’, Gwaindepi quizzed. This sparked a debate on the nexus between DRM and informality in Africa, with researchers being sceptical of what can be raised in the informal sectors. 

Informality and shadow economies in Africa

‘‘Informality refers to any activity which is not registered. So, this is doing an economic activity, which the state does not know about and thus cannot assess incomes for tax purposes. In the world of measuring progress, not knowing more about the majority of citizens´ economic activities possess many taxation challenges,’’ Gwaindepi clarified. However, this concept of informality has faced opposition in Gwaindepi’s working paper and that of other researchers . He posited that in developing regions such as Africa, informality does not solely pertain to unregistered businesses or individuals. Gwaindepi highlighted that informality extends its influence even within the formal realm. He elaborated that formal businesses might opt not to register certain transactions to exploit perceived advantages, thereby concealing paper trails and evading tax payments. This practice fosters an environment conducive to tax evasion and corruption, ultimately nurturing what is commonly referred to as a ‘‘shadow economy.’’

The shadow economy, known by various names like the gray economy, hidden economy, black economy, or cash economy, is outlined by Leandro Medina and Friedrich Schneider in their IMF working paper as comprising all economic activities hidden from authorities due to monetary and institutional motives. Notably, Africa trails behind other global economies in revenue mobilisation due to housing the largest share of shadow economies worldwide, encompassing not only informal sectors but a broader spectrum of economic activities. Supporting this standpoint, Gwaindepi asserts that shadow economies potentially hold greater significance than the informal sector. He likens shadow economies to a larger umbrella, encompassing and sheltering informal sectors within its broader scope. ‘‘I think the shadow economy is more important than the informal sector when it comes to taxation in Africa. For the informal sector, the visible street vendors are usually targeted but a lot more happens informally, and pockets of high incomes are not within sight. It is much harder to discover where real pockets of wealth are within the informal economic activities. While vendors are harassed for not paying taxes, for instance, there are home based and online based car sales with taxable incomes. But when you say shadow economy, you are saying, wait a minute, there could be even big companies who go under the radar, so to speak. So, the shadow economy is much broader and useful when thinking about taxation. It is like the bigger umbrella here, where the subsistence informal workers also find themselves’’, Gwaindepi argued.

Focusing only on the informal sectors addresses a fraction of the broader issue. Therefore, it is important to delve deeper into the scope of informal economic activities, spanning from small, unregistered enterprises to larger, formal ones. This comprehensive understanding of informality within an economy shapes the most viable strategies for revenue mobilisation. Hence, the effectiveness of taxation hinges upon the specific type of informality present. In developing regions like Africa, the base tier of informality comprises individuals with limited education, often unemployed, who rely on subsistence activities, particularly in agriculture, to sustain their livelihoods. 

Understanding these diverse aspects of informality is crucial for designing targeted and effective revenue mobilisation approaches. Addressing the largest category of informality in Africa, despite its size, remains a challenge in achieving substantial revenue projections. The conventional approach would typically involve digitising systems and aiming to register everyone, with the expectation that this process would result in increased revenues. ‘‘I think that is one of the huge assumptions I and other researchers are trying to unpack. We have low tax revenues because we have huge portions of citizens generating livelihood in the big informal sectors. If only we could register them, the assumption goes, and make sure everyone is paying taxes, then, we reach our goal. This is an error, because not all informal businesses are equal. They are segmented as I show in the working paper. Subsistence informality cannot produce the desired taxes even with state-of-the-art registration programmes and systems!’’ Gwaindepi exclaimed. 

Gwaindepi further proposed that understanding the root causes prompting people to engage in informal sectors stands as the primary concern and a key step in improving low tax revenues. Merely imposing new taxes through digitisation does not naturally translate into increased revenues. For instance, cases in both Kenya and Ghana illustrate that government-imposed taxes or levies on electronic transactions via digital platforms, such as M-PESA and MOMO (akin to MobilePay in Denmark), resulted in panic withdrawals and a decline in electronic transactions rather than the anticipated revenue surge.  

The role of the informal sector in revenue mobilisation

‘‘The question is what has the state done and what is it doing for the informal sector for reciprocal voluntary tax compliance to exist?’’, Gwaindepi quizzed. 

Gwaindepi advocates for incentivising tax payment among citizens by offering improved services. This a marathon rather than a sprint because it takes time, but it is necessary. He proposes that interventions, such as empowering the informal sector, could effectively achieve this goal. By demonstrating tangible government support to the informal sector, individuals within it would likely feel encouraged and equipped to contribute taxes. ‘‘I think that is where the issue is. Taxation transactions are not a one-way street. Tax morale remains low because taxpayers do not get public services. Many informal sectors are underserved by governments, and this is the big problem we have in Africa. We think that it is only about capacity to raise taxes, but governments need to invest more. It is a two-way street, and it is about service provision’’, Gwaindepi asserted. 

Moreover, the World Bank asserts that governments should prioritise fairness and equity within their tax systems. This necessitates aligning objectives, such as enhancing revenue mobilisation, fostering sustainable growth, and minimising compliance burdens. Fairness plays a pivotal role in augmenting tax collections. It is crucial for governments to ensure that fairness considerations encompass the equitable taxation of both the affluent and the impoverished, as well as encompassing both formal and informal sectors. The international tax systems also matter. Large firms/corporations have been able to take advantage of globalisation and lapses in international tax systems. Base erosion and profit shifting remain a menace that affects LICs, especially in Africa. A recent Global tax evasion report shows that global billionaires pay only 0-0.5% of taxes due to the use of shell companies. This adds to the existing illicit capital flows from Africa.

Joel Agbesinyale holds a Master Degree in Development Studies, Lund University, Sweden

Abel Gwaindepi, Senior Researcher, Danish Institute of International Studies and External Lecturer, Center for African Studies, University of Copenhagen