Strengthening domestic revenue bases is key to creating fiscal space for Africa's developmental needs
Financial flows to sub-Saharan africa have increased sharply since 1980. Between 1980 and 2006, net aid (including debt relief) increased fivefold, remittances ninefold, and foreign direct investment fiftyfold. Increased resource flows into the region and the associated high growth rates have enabled these countries to scale up public spending, including on social sectors. as a result, education and health spending increased in the region's oil-importing countries, in relation to both GDP and total spending (see Chart 1).
While these increases in spending are welcome, they are insufficient to meet the vast needs of the region's population in a sustainable manner. It is therefore essential that donors live up to their commitments of increasing aid to these countries.
But aid-receiving countries in the region could also do more to generate resources internally-and to ensure that both new and existing resources are used efficiently.
In this article, we propose expanding the tax base in these countries by capturing activities not adequately taxed because of policy or administrative weaknesses. Such a step-together with strengthened fiscal institutions-would hasten the progress of african countries toward achieving the Millennium Development Goals (MDGs) and produce an array of other benefits. This does not mean that tax rates should be increased. In fact, high tax rates in some countries in the region, particularly on mobile production factors (such as skilled labor and capital), may be hindering economic growth. an effective broadening of the revenue base may enable these countries to lower the tax rates while raising more revenue to finance pressing developmental needs.
The average tax-to-GDP ratio in sub-Saharan africa increased from less than 15 percent of GDP in 1980 to more than 18 percent in 2005. But virtually the entire increase in tax revenue in the region came from natural resource taxes, such as income from production sharing, royalties, and corporate income tax on oil and mining companies. Nonresource-related revenue increased by less than 1 percent of GDP over 25 years.
Even in resource-rich countries, nonresource-related revenue has essentially been stagnant (Keen and Mansour, 2008).
Also, in many of africa's low-income oil importers, domestic revenue mobilization has not kept pace with rising public spending. as a result, a growing share of current spending is financed by aid. For example, from 1997-99 to 2004-06, the share of current spending financed by aid increased from 16 percent to 36 percent in Ghana, from 22 percent to 40 percent in Tanzania, and from 60 percent to 70 percent in Uganda (see Chart 2).
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It is not inappropriate for low-income countries to finance a rising share of their recurrent outlays from aid, one might argue. after all, these countries have pressing needs at this stage of their development, and increasing expenditures for infrastructure and human development would only promote growth over time. although this argument has some merit, policymakers in these countries still need to take into account a number of other considerations.
First, aid-financed projects give rise to additional spending, such as on operations and maintenance, which will need to be covered at least partly, if not wholly, from domestic resources.
The country must generate sufficient revenue to finance these expenditures, or the productivity of aid-financed projects and assets will suffer.
Second, strengthened revenue mobilization contributes to economic stability, particularly in countries dependent on external financial flows. rising domestic revenue not only creates additional fiscal space for supporting high-priority spending, it also allows a country to maintain spending con-Page 45sistent with its policy...