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Data privacy and security are strong, but governments’ ability to use that information to boost revenue proves to be a sensitive area.
There’s been an extraordinary political progress in sub-Saharan Africa in the past 30 years along with steady economic growth. Yet there still remains a need to improve tax collections.
Even though governments have allocated more resources to the process, revenue from taxation is shrinking instead of growing, both in real and absolute terms. There are 49 countries worldwide that collect less than 13% of their GDP, and 20 of them are to be found in sub-Saharan Africa.1
“The International Monetary Fund suggests that’s the right number countries need to collect to fund basic state functions as well as additional investment in physical infrastructure, education, health and other development initiatives,” says Jeff Saviano, EY Global Tax Innovation Leader and founder of EY Advanced Technology Tax Lab. This unit spearheads the EY organization’s role as a founding member of the Prosperity Collaborative, a new multi-stakeholder initiative focused on helping emerging markets and developing economies create better tax systems through innovative technology. Other members of the Collaborative include the World Bank, the Massachusetts Institute of Technology, the Michael Dukakis Institute for Leadership and New America.
The opportunity is huge: improved governance and efficiency could deliver as much as US$110b in new tax revenue over 2020-25, according to a study by the United Nations Economic Commission for Africa (UNECA). That’s more than double the US$51.8b it received in official development assistance as of 2018, according to the Organization for Economic Co-operation and Development (OECD).2
The coronavirus pandemic in early 2020 illustrates the consequences, says Larry Eyinla, EY Africa Regional Tax Leader. South Africa, which stands out in the region for its taxation abilities, was also the only country able to introduce a stimulus package in the early stages of lockdown. “Collecting enough revenue opens up policy options and the capacity to execute them faster and better,” he says.
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Chapter 1
Bridging the gap
Most tax authorities now have good systems and additional steps towards digitalization should lead to an enhanced broadening of the tax base.
Tax authorities have responded with various strategies to reverse the trend, including deepening their use of digitalization, making it easier to pay tax and further penetrating their sizable informal economies to find eligible taxpayers.
They also cooperate with each other, in regional information exchanges, and with peers worldwide — 22 have signed up to implement the OECD Base Erosion and Profit Shifting Action Plan initiative, the biggest global rewrite of taxation laws and regulations in history.3 “The policy direction is clear both globally and in Africa,” says Ekow Eghan, Country Tax Leader, EY South Africa. “Tax authorities are looking to tax where the value is created.” Still, revenue has been declining for about 15 years for the region. In 2018, weighted tax revenues stood at 14.6% of GDP, down from a peak of 19.9% in 2005.4
That peak came as governments began reforming their tax functions. Separate tax authorities became a trend in the early 2000s, part of the governance reform process that in many sub-Saharan countries began after the Cold War ended.
It started with the transition to democratic politics, and then led to reforms of public financial management. These reforms included the shifting of tax and customs authorities from finance ministries to newly formed, quasi-independent and self-financing agencies. This change was particularly prominent in sub-Saharan Africa’s English- and Portuguese-speaking countries, says Joe Cosma, EY Africa Government and Infrastructure, Advisory Sector Leader.
“Digitizing old analog processes was the next step,” Cosma says. “Most tax authorities now have good systems, and they know how to use them.”
These systems also allow tax authorities to keep data private and secure, and that makes them one of the most trusted branches of government in many countries. Progress is being made in bringing additional taxpayers onto the tax base.
Digital systems for identification would speed up the pace, Cosma says, but are progressing slowly because of sensitivities. They could help to broaden tax bases by identifying more potential taxpayers, because 86% of Africans work in jobs in the informal economy, according to the International Labor Organization.5 This segment of the economy includes millions of traders and small businesses keen to avoid taxes. Though the tax authority views them as candidates to join the tax base, politicians also see them as voters.
One solution is to further enhance digital security, says Sandile Hlophe, EY Africa Industry Leader for Government and the Public Sector. “Many of the tools authorities could use to boost revenue are hosted in the cloud,” says Hlophe. “Few tax authorities would store data outside the country, so they should be leaders in investing in domestic data centers.”
Another enhancement to digital security that helps tax authorities is a mobile-phone registration process. In some countries, including South Africa, Nigeria and Kenya, consumers cannot buy a mobile-phone SIM card without showing identification. With that know-your-customer check already performed, tax authorities can then send taxpayers facilitated compliance nudges to their phones. Taxpayers, meanwhile, can download prepopulated returns and other forms to their phones, making it faster to pay and reducing the need for auditing.
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Chapter 2
Policies that work
Efforts to boost tax revenues should focus on value-added taxes, as well as creating appealing systems that employers want to opt in to.
Policy changes shouldn’t be abrupt or inconsistent, says Cosma. That principle applies to indirect taxes as well as direct ones. In Nigeria in 2015, the Government aimed to use tax policy as a tool to boost domestic automotive production by hiking tariffs on imported used vehicles, but the result was a surge in used vehicles smuggled into the country.6 Hiking tariffs on rice had the same effect.7
Those policies are tied to goals other than boosting tax revenue, including import replacement and job creation. But if the goal is simply to collect more revenue, the focus should be on value-added taxes (VAT), says Eyinla. “Africa has the room to raise rates, and you can keep doing it without angering people,” he says. Nigeria boosted its rate from 5% to 7.5% in February 2020. The change happened without protest and still leaves Nigeria well below the 20% threshold at which fraud tends to rise.8
VAT gaps are significant: a 2018 study by UNECA analyzed VAT data from 24 African sovereigns and found a gap of 50% or more in 12 instances. Gaps were caused by compliance issues and a lack of enforcement ability, and from policy challenges such as large volumes of exemptions. The report found that if Nigeria were to address compliance issues, and had it raised its rate to 10% instead of 7.5%, it would have doubled VAT revenues from 0.8% of GDP to 1.6%.9 “Tax authorities have greater capacity now, and part of that comes from technology addressing VAT challenges,” says Eghan.
The e@asyFile system from the South African Revenue Service (SARS) is a model for the continent, says Hlophe. The system features real-time submissions from a company’s enterprise resource planning software to the SARS system, with monthly reconciliations to process refunds within 48 hours of the month’s close. Participation is voluntary but popular, with about 90% of eligible businesses opting in. “Speed is the incentive, especially for small businesses,” says Hlophe. “The alternative is a painful process that takes longer to produce your refund.”
The VAT gap of 13.3% was the lowest in Africa, according to the UN study. The next lowest rate was that of Cape Verde, the island state in the Atlantic Ocean, at 15.3%. All others had gaps of 27.5% or more.10
The Rwanda Revenue Authority is another digital leader on the continent, having introduced a digital VAT-collection system in 2013. A study found that the average firm increased its VAT payments by about 8%, but also found compliance issues that shrank the total.11 United Nations data shows that the country’s tax-to-GDP ratio broke above the 15% threshold in 2015 and 2016, but slipped back below that level in 2017.12
For the Kenya Revenue Authority (KRA), an emerging focus is on speeding up dispute resolution. Rather than rely solely on its Tax Appeals Tribunal and courts, it offers taxpayers mediation as an option after the 60 to 90 days it takes the KRA to evaluate an assessment the taxpayer wants to contest. Mediation offers an outcome within a further 90 days, as well as the option to revert to the conventional methods at any point.
Two companies tried it in its first fiscal year of availability, in 2015-16. In the following two periods the figure rose to 139 and 155, and in 2018-19 it jumped to 502. Though the system resolved almost as many cases as the tribunal and courts, the revenue total was about a third less.13
As tax authorities explore their options with the current tools, the Prosperity Collaborative aims to give them new ones. It is pursuing applications of blockchain, machine learning and other technologies to increase transparency, reduce friction and boost social trust in the taxing system – often referred to as “tax morale”. There’s an emphasis on creating open-source technology solutions.
“The existing procurement model features the transfer of IP rights to bespoke software, but we think tax authorities can scale up faster and more effectively through reliance on digital public goods. That lowers the cost of implementation and enhances interoperability,” says Saviano.
As tax authorities evolve, long-term investors have as well. “The old model is gone. We’re seeing investors who are interested in a fair policy narrative,” says Eghan. “They want to pay the right amount of tax and to be able to say it.”
Summary
Tax authorities have responded with various strategies to reverse the trend of stretched tax collection, including deepening their digitalization narratives, making it easier to pay tax, and further penetrating their sizable informal economies to find eligible taxpayers.
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