AfricaFocus (Washington, DC)

Africa: Taxation Key to Fighting Inequality

analysis

Editor's Note

'In many countries, it is the poor who end up paying more tax as a proportion of their income and this is just not right. When the rich are able to avoid paying their fair share of taxes, a government must rely on the rest of its citizens to fill its coffers.

While tax dodging goes unchecked, governments are severely hampered from putting in place progressive tax systems - so fairer domestic tax systems depend on global transparency measures' - Alvin Mosioma, Director, Tax Justice Network - Africa

There are many different analyses of the reasons for inequality, and the many proposed solutions are most often rendered ineffective by lack of political will.

But the debate on inequality is definitely rising on the agenda world-wide, as illustrated by the runaway popularity of the new book by economist Thomas Piketty on Capital in the Twenty-First Century (http://www.africafocus.org/books/isbn.php?B00I2WNYJW).

Without countervailing government intervention, both Piketty's book and recent experience agree, inequality between rich and poor will continue to grow.

The most prosaic remedy, taxation, is inevitably a component of any effective strategy to reverse the trend. This new report from Tax Justice Network-Africa and Christian Aid provides considerable documentation on the inadequacies of both international and country-level taxation systems, including systematic tax evasion and tax systems that have regressive rather than progressive effects.

This AfricaFocus Bulletin includes the executive summary and brief additional selections from the study, which focuses on experience in Ghana, Kenya, Malawi, Nigeria, Sierra Leone, South Africa, Zambia and Zimbabwe. The full 78-page report, with much country-level detail, is available at http://www.christianaid.org.uk/resources/policy/tax.aspx

For previous AfricaFocus Bulletins on related issues, visit http://www.africafocus.org/debtexp.php

Africa rising?

Inequalities and the essential role of fair taxation

February 2014

Tax Justice Network - Africa and Christian Aid

http://www.christianaid.org.uk/resources/policy/tax.aspx

Executive Summary

After a decade of high growth, a new narrative of optimism has taken hold about Africa and its economic prospects. Alongside buoyant growth rates, there has been some poverty reduction and some positive progress in sectors such as health and education.

However, despite this, there is a broad consensus that progress in human development has been limited given the volume of wealth created. There is growing concern that the high levels of income inequality in sub-Saharan Africa are holding back progress.

This report investigates the issue of income inequality in eight subSaharan African countries (Ghana, Kenya, Malawi, Nigeria, Sierra Leone, South Africa, Zambia and Zimbabwe).

While there is growing public recognition that inequality is the issue for our time - both globally and in sub-Saharan Africa - there is little definitive analysis of income inequality trends on the continent.

This report seeks to contribute in this area, looking at whether income inequality is, in fact, rising and in what context this is occurring.

In particular, this report seeks to locate an analysis of tax systems in sub-Saharan Africa in the context of these economic inequalities, given the primary importance of national tax systems in redistributing wealth.

The report looks at national taxation systems and international taxation issues - and, critically, the relationship between them.

In this way it reveals how the enabling environment for tax dodging impacts on national tax systems in sub-Saharan Africa. It also dissects the trends in revenue generation, tax equity and tax reforms across the eight countries.

It has a special focus on the experiences of two countries - Kenya and South Africa - which have two of the stronger tax systems in sub-Saharan Africa but which also have extensive shortcomings in the area of tax equity.

The evidence gathered in this report shows that increasing income inequality should be of huge concern to governments in at least six out of the eight countries - Ghana, Nigeria, South Africa, Zambia, Kenya and Malawi.

In Ghana and Nigeria, income inequality is rising strongly. In Nigeria, between 1986 and 2010, there has been a 75% increase in the concentration of income in the country. In Ghana there has been a 50% increase in the concentration of income over an 18-year period.

In Zambia income inequality is now at its highest levels since data was collected. South Africa has one of the highest levels of inequality in the world and one which keeps increasing. The sharp rise in the incomes of the richest 5% is driving the increase at the top end. Yet there is no evidence of progress in tackling this inequality, or even much preoccupation with it, in South Africa's new National Development Plan.

It is also clear that this trend is not just a result of the rich getting richer. There is clear evidence that this is at the expense of the poor who are also getting poorer, and are therefore actively impoverished in this process.

To make matters worse, we know that we are vastly underestimating the problem. As Tax Justice Network research has shown, both wealth and inequality are being dramatically underestimated to a very significant degree, in every study and in every country.

In this context of rising inequality, the role of taxation in redistributing income is particularly critical, with progressive tax systems being one of the most important tool available to governments. However, the report shows the extent to which illicit financial flows undermine this prospect.

A central contention of this report is that rising income inequality is going hand in hand with - and is ultimately caused by - the current growth model and the illicit financial flows which have increased significantly throughout Africa's high growth period.

Certainly the growth model has led to a concentration of wealth, but income inequality is also being considerably exacerbated by the inability of governments to tax the proceeds of growth, because a large part of sub-Saharan Africa's income and wealth has escaped offshore.

Much of this is also driven by the reliance on the natural resource sector, which is known to be rife with tax-dodging techniques. In fact sub-Saharan Africa is suffering excessively because of a variety of factors which combine to create the 'perfect storm'.

The dependence on natural resource extraction, and the region's relatively undiversified economies, means a much higher percentage of African countries' wealth is likely to be diverted by the elites that control that wealth via opaque tax haven structures; at the same time weak tax authorities have a much lower capacity to confront this problem. This exacerbates the concentration of wealth greatly.

The UK is a recognised beneficiary. A recent report from Jersey Finance shows the extent of African assets held on the island: 9.4bn UK pounds in customer deposits in banks (as compared to £3bn from China) and 31bn UK pounds in Jersey trusts (as compared to 1bn UK pounds from China).

While the UK - and a small number of Africa's super rich - are gaining via the structure of offshore finance in Jersey, African citizens are losing significantly.

The report also finds that, to a large degree, governments are hamstrung in their efforts to tackle income inequality. To make progress, sub-Saharan Africa must be able to tax its vast income and assets held offshore. This means tackling illicit financial flows and tax dodging in all its forms.

However, as this report spells out, there are severe limits to national level action. Systemic, global reforms are a vital part of the answer. Progress at this level had been haltingly slow, though recent developments have shown promise.

Yet, while discussions advance in the G8, G20 and OECD, it is still far from certain whether African countries will be correctly included in, and benefit from, the projects and reforms, as these are designed to benefit G20 and OECD countries first and foremost, over the subSaharan African countries that are most in need.

While illicit financial flows undermine the scope for African governments to put in place progressive tax systems, tax systems have also been heavily influenced by the tax consensus, led by the International Monetary Fund (IMF) and supported by other multilateral institutions, bilateral donors and tax professionals.

The tax consensus has focused on reducing corporate and, to a lesser extent, personal income tax rates while expanding the base for consumption taxes and value added tax (VAT) in particular. Its impacts have been well documented and have contributed to a heavy reliance on indirect taxation at the expense of more progressive income and wealth taxes. ...

This report also finds many shortcomings in direct taxation in the countries studied. The personal income tax (PIT) systems lack equity as the bulk of the burden is on employees. The self-employed rarely pay tax. The visible lack of equity erodes citizens' trust in the system.

Often income tax thresholds are too low and do not protect the poor. This is highlighted by the cases of Zimbabwe and Malawi, where the poor are now eligible to pay income taxes before they earn enough to even comply with minimum food basket requirements.

At the same time, threshold adjustments at the upper end to tax the rich more heavily are not in evidence. In South Africa the government has been actively reforming the PIT system so that the tax burden on higher earners has been reduced year on year.

The same yearly income in real terms was being taxed at 33.8% in 1994/95 but only 18.2% in 2010/11. In South Africa, the Alternative Information and Development Centre (AIDC) has estimated the annual cost of this regressive policy at US$17bn.

Enforcement is also a significant issue. The scale of the tax evasion problem is very evident from recent revelations regarding high net worth individuals (HNWI) in Kenya and South Africa.

In Kenya only 100 HNWI are registered with the tax authority even though the country has 142 Kenyan shilling billionaires, whose net worth exceeds US$30m each. Apart from the non-declaring billionaires, there are likely to be a further 40,000 HNWI in the country who are evading tax.

In South Africa it is estimated there are somewhere between 28,000 and 114,000 HNWI who are not registered with the tax authority. AIDC estimates that US$10.9bn in tax revenue goes uncollected in South Africa because of HNWI tax evasion.

...

This report also finds that countries struggle to introduce new taxes on income, wealth and property. Kenya's recent efforts to reintroduce a capital gains tax on the sale of property and shares is an emblematic example, with the government backtracking at speed after private sector resistance.

Equally notable is that Ghana and Zambia have so far failed to introduce their desired windfall taxes on mineral production. Nowhere is the failure to progress more visible than with tax incentives.

Few would now argue in favour of tax incentives unless these are very carefully targeted in pursuit of clear industrial policy or social and environmental goals.

The removal of those tax incentives that bring no clear benefits would be administratively simple and would immediately have a positive and significant impact on revenue. However, they continue to dominate tax systems in sub-Saharan Africa, leading to huge revenue losses.

Given the many difficulties with direct taxation, reliance on indirect taxation is still high. This continues to have negative impacts, as demonstrated by the recent VAT reforms in Malawi and Kenya, which will increase the tax burden on the poor. ... It is notable that while the tax burden on the poor is rising in Kenya, the country's elite successfully continue to resist paying taxes on the profits made from their real estate and stock market investments.

While the report notes some signs of progress, such as some mineral taxation reforms, there is also a clear gap between rhetoric and reality.

There is national and international consensus that it is urgent to address issues such as tax incentives, extractives taxation, the taxation of HNWI, tax evasion and illicit financial flows.

However, countries are struggling to introduce new direct taxes and to enforce tax compliance against companies and elites. Support to make such transformational changes is inadequate.

The responsibility of the international community is clear. This is not only because of the misplaced emphasis of the tax consensus applied by international financial institutions over the last few decades.

It is also due to the rich world's foot-dragging on global reforms with regard to financial secrecy and tax havens. While the global reform agenda has picked up pace recently, there remains a serious risk that African countries will be excluded from the processes, with benefits mainly accruing to G20 and OECD countries.

Yet, the more ambitious reforms that Tax Justice Network Africa and Christian Aid are calling for could transform the panorama for direct taxation in Africa.

If countries in Africa cannot tax income and wealth correctly, they will shift the tax burden onto the poor - as this report demonstrates. While individual governments must be held accountable for their policy choices, the international community must shoulder a lot of the responsibility for increasing economic inequalities and for the shortcomings of tax systems and public finances in subSaharan Africa.

Introduction

...

A new narrative has taken hold about Africa. From the Afro-pessimism regularly expressed during the 1980s and 90s, the continent has become the subject of increasing optimism in some quarters, based on a decade of high growth rates.

This is commonly noted by mainstream economic commentators, who see that many of the world's fastest growing economies are in sub-Saharan Africa.

Reports indicate that there have also been gains in terms of poverty reduction and human development. World Bank poverty data shows that in 2008 - for the first time - the average poverty rate in subSaharan Africa fell below 50%.The most positive changes have been in relation to education and health.

Most countries have achieved universal primary school enrolment, with rates above 90%, and nearly half of the countries in Africa have also achieved gender parity in primary school.

The under-five mortality rate has reduced significantly between 1990 and 2011, as has the maternal mortality rate. ... However, despite this picture, there is a broad consensus that progress on poverty reduction has been too limited and highly uneven. Most countries will fail to meet most MDG targets.

Many are therefore asking how the proceeds of growth are being shared. Is growth accompanied by decreasing inequality, with a greater share of income going to the poor?

Or is income inequality increasing across sub-Saharan Africa? Could the type of growth that Africa is experiencing itself be driving inequalities? There is very little information and analysis available to answer these questions.

Inequality is, today more than ever before, a pressing issue globally. Research in developed countries by the OECD finds that in the three decades prior to the global financial crisis, wage gaps widened and household income inequality increased in a large majority of OECD countries.10

This occurred even when countries were going through a period of sustained economic and employment growth. Public opinion in OECD countries is certainly coalescing around an understanding that the global system is rigged to suit the interests of the (ultra rich) minority at the expense of the rest. The emergence of the 99% and Occupy movements is a testament to the strength of public feeling about inequality.

Of course, in Africa - as elsewhere - inequality is far from a new phenomenon. Following independence, and in the decades since, wealth has, to too great an extent, remained concentrated in the hands of elites who replaced the colonial powers and failed to reform existing structures and redistribute assets.

Political economists such as Yash Tandon and Samir Amin have analysed the shortcomings of global capitalism and economic development paradigms imposed on Africa for many years and there is a body of literature on these debates.

Civil society organisations and social movements in Africa have also long challenged the traditional growth model, the narrow focus on foreign investment, natural resource extraction and export-led growth, the neglect of the agricultural sector and strategies to create good quality jobs, grow domestic demand and develop the domestic private sector.

Inequality is now becoming more prominent in documents and statements emanating from pan-African bodies. In March 2012 the African Development Bank (ADB) published a report on income inequality in Africa finding that: 'In the 2000's six of the world's ten fastest growing economies were in Africa, but this has not significantly helped to equal incomes or to redistribute wealth.'

The Africa Progress Panel (APP) report published in 2012 is strongly critical of the patterns of buoyant growth alongside increasingly visible wealth disparities and cites equity alongside justice and jobs as a central feature of their report.

This focus continues in their 2013 report where they look more closely at equity and the extractives sector, including the role of illicit financial flows in worsening inequality and poverty in Africa.

The UN Economic Commission for Africa, (UNECA), in its 2012 report, also states that: 'Despite the acceleration of economic growth in Africa over the past decade, however, Africans' welfare has generally failed to improve.

Social indicators have picked up only modestly, but with unemployment, particularly among youth, remaining stubbornly high, while income inequalities have widened'.

The African Economic Outlook's (AEO) 2013 report highlights how growth has been accompanied by insufficient poverty reduction, persisting unemployment and increased income inequalities.

Debates about taxation and its role in reducing income inequality are beginning to gain traction. African civil society is calling for fair taxation of companies, a lower tax burden for the poor, for African assets abroad to be traced and for the African elite to be effectively taxed. There is also a renewed interest in tax reform from donors as aid budgets fall in these times of austerity.

But efforts to address inequality and to put in place fair tax systems need to be significantly increased, and supported by international processes.

International taxation issues are already clearly on the agenda of the G8, G20 and OECD and in recent months processes towards greater financial transparency and fairer taxation of transnational corporations have appeared to advance. However, it remains unclear whether the rhetoric will translate into real benefits for African and other developing countries.

...

The countries that are the central focus of this report are: Ghana, Kenya, Malawi, Nigeria, Sierra Leone, South Africa, Zambia and Zimbabwe.

These countries were chosen as they are countries in which TJN-A and Christian Aid's partners and members are actively collaborating to advocate for progressive taxation reforms.

While some of these countries can provide us with some examples of good practice, generally there is great concern over the need to ensure a progressive taxation system is in place and the lack of progress being made to reduce inequality.

...

South Africa - The Inequality Elephant in the Room

South Africa is a special case that deserves attention. It has extremely high income inequality, topping the rankings for Africa and the world in this respect. Amongst its peers - the emerging economies of Argentina, Brazil, China, India, Indonesia and the Russian Federation - it has by far the highest inequality levels, far surpassing Brazil.54 Inequality in South Africa has its roots in the country's colonial history and the practice of apartheid and as a result, income inequality has a strong racial dimension.

There have been some attempts at redress since the end of apartheid, with various economic development strategies including black economic empowerment initiatives and land reform. These are seen as piecemeal and relatively ineffective.

In fact a huge indictment of the attempted reforms is that since the end of apartheid in 1994 income inequality has risen significantly. Figures from the World Bank show a peak in 2006.

However, analysis of national statistics allows a more precise estimate of inequality as income data can be used. (This is more accurate than the figures reported by the World Bank, which are based on expenditure data, used as a proxy for income to enable cross-country comparisons.)

A comprehensive report by the OECD, which looked at income distribution trends and household surveys from 1993, 2000 and 2008,55 finds that the Gini coefficient increased from 66% in 1993 to 70% in 2008, a remarkably high figure by international standards and much higher than the figure used in cross-country comparisons.

South Africa's income and expenditure survey from 2005/06 shows the wealthiest 10% of the population had 51% of income, while the bottom 10% had only 0.2% and the poorest 40% accounted for less than 7% of total household income. This corresponds to an extremely high Palma ratio of 7.3.

Looking at trends over time, the OECD reports the share of the richest 10% in the period 1993-2008 as jumping from 53% to 58%.

Interestingly, it also looks at the share of the richest 5% and finds that it is a sharp rise in the share of this group that is driving the increase at the top end.

The super-rich really are getting richer. The report also finds that these increased shares at the top end of the distribution came at the expense of all the other income deciles.

The report further suggests that the tax-funded social assistance programme that provides means- tested cash transfers to poor children, old age pensioners and people with disabilities is failing to significantly affect income inequalities as the value of the transfers is too low.

The poorest and those dominating the lower income deciles are predominantly black South Africans. At any poverty line, black South Africans are poorer.

This is of course a direct legacy of apartheid, given the active discrimination in state policy, the labour market and in relation to the provision of education, health and other social services under the apartheid regime. Rising wage inequality is a major factor.

Most workers have experienced virtually no improvement in their wages, with the median real wage for a formal sector worker in 2011 being the same as it was in 1997.57 Low-skilled workers' wages furthermore have a historic legacy of dampened wages for black workers (who occupied these positions under job reservation legislation) under apartheid.

On the other hand, the 22.7% increase in the average formal sector wage has been entirely due to increases for top earners. This dramatic increase in wage inequality has been paralleled with widespread social protests, strikes and conflict amongst poor communities.

Of utmost concern is the approach of the South African government to this issue. The new National Development Plan (NDP), launched in 2012, lays out the vision for the nation up to 2030. Instead of ensuring a vision of redistribution at its heart, the NDP rests on the acceptance of high levels of inequality.

According to a discussion paper published by the Congress of South African Trade Unions (COSATU), the Plan only proposes a decrease 'from its current world-beating level of 69% to an excessively high 60%.... This target is an embarrassment for a country claiming to be serious about combating inequality.'

In fact the NDP proposes that after 18 years of implementation, the share of income going to the bottom 40% of income earners would have increased from the current 6% to a mere 10%.

It is little wonder that some have concluded: '... the NDP attempts to paper over the deep cracks in the structure of South African society - to ignore the inequality elephant in the room'.

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