The missing 27 billion
Governments need funds for stimulus packages and aid to address COVID-19. But corporate tax avoidance and tax breaks for aid in African countries is undermining emergency responses.
Africa loses about $27 billion per year – an amount equivalent to about 50% of the continent’s public health budget – due to profit-shifting to tax havens.
The COVID-19 pandemic has presented the world with an unprecedented health and economic crisis. The pandemic occurred in the context of already weakened economies in Africa, with high levels of debt and increasing fiscal deficits. Given the present precarious conditions of many developing countries, more and better effective use of Official Development Assistance (ODA) could play a crucial role in addressing the immediate impact of the pandemic. In the medium to long term, however, further increases in the mobilization of domestic revenue are critical for improving health systems and achieving the Sustainable Development Goals (SDGs).
Over the last two decades, African countries have implemented various tax policy reforms aimed at improving domestic resource mobilization. As a result, tax revenues have increased in absolute terms since 2000 with an average tax-to-GDP ratio of about 17 % between 2000 and 2018. However, the amount is lower than the 20% minimum tax-to-GDP ratio needed to finance the SDGs in developing countries. The financial gap for African countries has been further exacerbated during the current pandemic and is likely to persist. Under different scenarios, the financial gap in Africa is expected to be between $130 billion and $410 billion from 2020–2023, with the debt-to-revenue ratio expected to reach 27 %.
Despite progress, the collection of tax revenue in Africa still faces a number of structural challenges. Large numbers of small-scale informal services and agriculture dominate the majority of African economies, resulting in low effective tax bases and limited tax compliance. The incorporation of small informal sectors into the tax system can be very costly while generating small net revenues. On the other hand, improvements in the efficiency of tax collection can be made in the management of corporate income taxes, and in curbing illicit financial flows and unnecessary tax exemptions. For instance, Africa could bridge half of its SDGs funding gaps by curbing the total annual capital flight of US$88.6 billion per year, which is more than the amount the continent receives in ODA of US$48 billion or foreign direct investment (FDI) of US$54 billion.
In addition to limited local institutional capacity, efforts by African countries to curb illicit financial flows and increase revenue from corporate income taxes has been constantly undermined by weaknesses in international tax rules and profit-shifting strategies by multinational corporations and wealthy individuals. Africa loses about $27 billion per year, an amount equivalent to about 50% of the continent’s public health budget due to profit-shifting to tax havens. Moreover, rich nations often aggressively negotiate with developing countries to ensure reduced withholding tax rates. This essentially means that African governments are providing some of the largest withholding tax cuts for richer nations. Such approaches significantly restrict African countries taxation rights and may further lead to a downward trend in tax rates due to competition between African countries.
Eliminating unnecessary tax exemptions can also significantly increase tax revenues in Africa. In order to attract foreign direct investment, African countries are losing large amounts of tax revenue due to special tax arrangements, such as tax exemptions, reduced rates, tax holidays, and royalty concessions. Tax exemptions for various government-to-government aid-related projects are also very common in Africa. According to a report by the African Tax Administration Forum, more than 95 % of the countries in their sample (including 15 African countries) reported that they had granted various tax exemptions for the foreign aid they received. The estimated tax revenue foregone as a result of aid-related exemptions in most African countries ranges from 1% to 2% of GDP, with the figure being 3% of GDP for Rwanda, Mozambique, and Malawi. For Liberia, one of the most aid-dependent countries on the continent, tax revenue foregone due to aid-related exemptions was as high as 7.5% of the country’s GDP in 2016. The main rationale for aid-related tax exemptions is that taxing aid will reduce the value of aid. However, tax collected on aid-related projects contributes to the national budgets of recipient countries. Therefore, tax exemptions of this nature may contribute to a weakening of the state’s tax collection capacity.
Project aid represents about 70% of all ODAs in most developing countries, and recipient countries need to negotiate tax exemptions for each project. As a result, over and above the state’s revenue losses, tax exemptions significantly increase the workload of the tax and customs administrations in the recipient countries. Furthermore, aid-related tax exemptions can also undermine the perception of fairness in the tax system in recipient countries, while at the same time reducing the tax bases and creating economic distortions. Local suppliers in aid-recipient countries often have to compete with tax-exempted products and services financed by aid projects. This is more problematic when aid is tied—where funds are used for the procurement of goods and services from donor counties, limiting the development of local firms in recipient countries. Although progress has been made in untying more aid in recent years, about 15% of donors’ total bilateral commitments in 2019 were reported as tied aid, with some countries reporting 40% to 70% of their aid as tied.
The current pandemic demonstrates the critical need to strengthen public systems in order to meet basic needs, such as health and food security in developing countries. However, instead of significantly tackling tax issues that limit domestic resource mobilization efforts in developing countries and strengthen their public systems, there is growing pressure to use ODA funds to subsidize private sector involvement through blended financing to finance SDGs. Without improving the capacity of African countries to effectively tax private companies, the use of ODA to subsidize private sectors may lead to additional tax avoidance and evasion by shifting profits to tax havens while increasing debt burdens.