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Revenue Bargains Key to Financing Africa’s Development

16 Jul 2015


Revenue Bargains Key to Financing Africa’s Development
This contribution is published as part of the Think Piece Series The Road To Addis and Beyond, launched to coincide with the third and final drafting session of the outcome document of this summer's Third International Conference on Financing for Development. In this Series, global experts discuss a range of topics complementary to the UNRISD research project on the Politics of Domestic Resource Mobilization on how to fund social development and raise provocative or alternative perspectives that can generate further ideas and debates. Please share your thoughts on this article in the comments space below.

Africa has enjoyed a growth momentum since 2000 after the wasted years of the 1980s and much of the 1990s. However, eradicating poverty will require huge resources, which existing funding strategies will be unable to generate. Global commodity prices have fallen sharply; capacity to mobilize domestic revenues is waning; and aid has been insufficient in plugging funding gaps. Revenue bargains in which states extract revenues from citizens in exchange for investments that impact positively on well-being may be key to financing Africa’s development. They can substantially increase revenues, nurture effective state-citizen relations, force companies to pay correct taxes, push fragmented systems of service provision in the direction of universalism, improve policy space and make aid more effective.

Yusuf Bangura teaches international political economy at the Department of Political Science, Fourah Bay College, University of Sierra Leone. He was a research coordinator at the United Nations Research Institute for Social Development from 1990 to 2012, and was lead author of the UNRISD flagship report Combating Poverty and Inequality: Structural Change, Social Policy and Politics (2010).


Africa has enjoyed a growth momentum since 2000 after the wasted years of the 1980s and much of the 1990s. In 2014, seven of the ten fastest growing economies were in Africa, and African leaders increasingly talk about structural transformation and lifting their populations out of poverty. This optimism is underpinned by more than 10 years of high global commodity prices, improvements in domestic revenue collection, and growing demands for better services in a context of expanding rights and democratic politics. Many countries have invested heavily in infrastructure and increased social expenditures.

Africa’s turn of fortune coincided with the emergence of target-setting strategies in international development policy. These strategies include calls on poor countries to mobilize an additional 4 per cent of their GDP to fight poverty; the Social Protection Floor initiative which requires governments to commit 4.5 per cent of their GDP to basic social protection; the 20 per cent of government expenditure target for education; the MDG 1 per cent of GDP target for comprehensive access to water; and the African Union’s targets on infrastructure and agriculture.

Meeting these targets requires huge resources, which existing funding strategies will be unable to generate. Global commodity prices have fallen sharply in the last twelve months; capacity to mobilize domestic revenues is waning as governments struggle to plug loopholes in tax evasion; the jury is still out on proposals for improved funding of the newly minted Sustainable Development Goals after the less than stellar funding of the expiring MDGs; and the anticipated structural change that will diversify economies, expand employment and improve incomes is proving elusive. Revenue bargains may hold the key to breaking out of the vicious circle.

Filling financing gaps in poor countries


African countries need to address two types of bargains: domestic and global, with an emphasis on domestic bargains, which are necessary for global bargains to be effective. The Monterrey Consensus of the 2002 Conference on Financing for Development represented a revenue bargain of sorts at the global level, in which donors pledged to increase aid in return for improved tax efforts by developing countries. More than 10 years after that conference, there are no signs that aid will improve to a level where it can plug poor countries’ financing gaps. Although aid has increased by 66 per cent in real terms since 2000, reaching a record high of US$135 billion in 2014, many donors have failed to honour their pledges, citing fiscal constraints induced by the global financial crisis. Furthermore, only five countries’ aid meets the UN’s target of 0.7 per cent of gross national income, with the average stuck on 0.29 per cent of GNI.

Besides, critics of aid have become vocal, and sections of voters in donor countries are either weary of aid or insist on aid delivering results. A growing body of literature even sees aid as a curse that stifles development and democratic accountability of governments to citizens in aid-receiving countries. From the perspective of African governments, even if aid improves substantially, it often comes with conditions, including ceding considerable space in the policy process to donors.

The second type of revenue bargain involves mutual accountability of states and citizens in the mobilization and use of revenues. This type of bargain may substantially increase revenues as well as help to overcome the problems of accountability and mutual mistrust that have plagued the aid relationship. The sources of revenue for constructing such bargains are taxes, savings, social insurance schemes and mineral rents. With growing economies, the tax-to-GDP ratio of African countries has increased in the last 15 years, even though non-resource related taxes have stagnated. Indeed, the boom in global commodity prices and widening of the tax net through value added taxes contributed to a modest decline in aid dependency.

The savings rates of African countries have also risen even though in many countries they are yet to return to pre-structural adjustment levels. Governments have also launched social security schemes to provide old age, invalidity and survivors’ benefits to formal sector workers. Because of the youthful age structure of the African workforce and the period it will take for benefits to mature, these schemes have generated huge savings that can finance development.

Revenue bargains are at the heart of development


Revenue bargains may be crucial in maximizing yields from these various revenue sources. They were at the heart of state formation, extension of the franchise, and improvements in welfare in Europe. In democratic contexts, they imply negotiation and less coercion in extracting resources from citizens. In bargains over taxation and political representation, for instance, European governments wanted resources to finance wars and citizens wanted representative governments that could deliver public goods.

Similarly, East Asia’s extraordinarily high savings rates that financed its development were based on a bargain: state pursuit of growth with jobs, security of tenure and social protection for the employed, universal provision of housing especially in Singapore, and affordable quality education for all.

In Western Nigeria, in the 1950s and 1960s, the Action Group party’s development programme was based on a policy of extracting surpluses from cocoa farmers in exchange for universal primary education, and extension and social services that benefited farmers and their children, giving that region the highest literacy rate in the country. The close party-state-citizen relationship that was a hallmark of that bargain ensured the party’s dominance in regional elections.

Following Eritrea’s independence and resolve to finance its development without dependence on donors, a bargain was struck with its Diaspora citizens to pay two per cent of their income as a tax in exchange for state services. Although a laudable bargain at the time, the persistence of authoritarian rule and lack of accountability to citizens on how the money is spent has undermined the maximization of revenue from the Diaspora tax. Many Eritreans now question its legitimacy and have stopped paying the tax.

Concerns for environmental standards and pressure by mining communities for a fairer share of mineral rents have also produced a variety of bargains in mineral-rich countries. In Sierra Leone, Community Development Agreements allocate about 3 per cent of diamond export tax revenues to local mining communities for services and other benefits. However, most of the bargains are lopsided, and local elites, especially traditional rulers, are the main beneficiaries.

Five potential benefits of revenue bargains


Revenue bargains that are transparent, and in which citizens exercise influence, provide five potential benefits. First, they offer opportunities to build purposeful, mutually supportive and durable state-citizen relations that have been lacking since the structural adjustment period of the 1980s that eschewed planning and dialogue. Despite the spread of democracy, governments are hardly present in most people’s lives in terms of jobs, social services and social security. People invariably fend for themselves and very often do not trust the word of government. The Ebola crisis in West Africa demonstrated this problem in bold relief as weak citizen-state ties and lack of trust in government made it difficult to curb the high rates of infection.

Revenue bargains work best when they are crafted around benefits that impact directly on well-being, such as social services and social protection. Unfortunately, trends in aid allocation that have prioritized social sectors because of the MDGs, and Africa’s growing dependence on aid to finance its social services, may act as a constraint in building effective revenue bargains. Aid should focus on infrastructure and the productive sectors and African governments should construct viable bargains with their citizens that will fund social programmes as is the case in all countries that have grown out of poverty. In East Asia’s industrialization, aid supported agricultural technology, basic industry and economic infrastructure, not social programmes. Social programmes were the exclusive responsibilities of states and citizens and were central to the construction of effective state capacity in advancing the project of economic transformation.

Second, revenue bargains can deepen accountability by improving citizens’ capacity to organize and make claims on public policy. Such activism may be driven by expansion of the tax net to most citizens in productive work, including those in the informal sector. Tax yields are low in Africa partly because tax advocacy groups, such as the Tax Justice Network, are few, lack strong ties with tax payers, and mostly address the extractive sector. When more citizens pay taxes and are brought into bargains with defined benefits, they are likely to develop an interest in how revenues are spent, making it easier for more groups to be formed and for strong links to develop between advocacy groups and tax payers. Activism may also serve as pressure to upgrade the quality of institutions in social provision, which tend to be neglected in economic policies that emphasize tight spending. Since the 1980s, financial institutions, such as central banks and finance ministries, have been better capacitated than social sector institutions in advancing public policies. This needs to change if development is to impact positively on the poor.

Third, revenue bargains that are crafted around citizens’ taxes may help governments to increase yields from other revenue sources, such as those in the extractive sector and value added taxes paid by trading enterprises. African countries have been unable to capture a large share of resource rents because of generous concessions in the form of royalties, corporate taxes, value added taxes and import duties, given to mining companies, as well as widespread corruption by regulatory institutions and state officials dealing with such companies. It has been estimated that Sierra Leone lost US$224 million in 2012 largely because of generous tax concessions given to the five largest mining companies. In Guinea, an Israeli company, which bought iron ore mining rights for US$160 million, sold those rights to a Brazilian company for US$2.5 billion. In Zambia, an Indian businessman was caught on video boasting that although he paid only US$25 million for a copper mine, he makes US$500 million every year on the mine. Mining companies get away with these kinds of deals because of lack of transparency in negotiating contracts, the limited number of groups that monitor the extractive sector, and lack of sufficient citizen engagement with revenue issues.

Similarly, many trading companies do not fully pay value added taxes because of collusion between tax collectors and trading companies and consumers’ indifference to the culture of demanding receipts. In Sierra Leone, for instance, many trading companies circumvent or exploit value added taxes by issuing illegal receipts to buyers, or none at all. As buyers do not often ask for receipts, let alone insist on the official ones, the companies appropriate the taxes that they should pay to the state. Increasing the stake of citizens in revenue bargains may encourage them to police the behaviour of companies in the payment of taxes. It may also help to strengthen regulatory institutions and curb the rampant illicit financial flows (IFFs) from Africa, which the Thabo Mbeki-led African Union-Economic Commission for Africa panel report on IFFs estimates at US$50 billion a year—more than what Africa receives yearly in foreign aid.

Fourth, revenue bargains may help to reverse the perniciously inegalitarian and fragmented system of social provision that has emerged in much of Africa since the 1980s. In the field of education, even though enrolment rates have risen, the quality of education remains poor, and the public schools that offered opportunities for upward mobility to children from poor backgrounds have been seriously degraded. Now rich and middle class parents send their children to well-resourced private schools, and children from poor backgrounds are condemned to very poor public schools or none at all. Many in the middle class that have opted for private provision may be tempted to return to public provision, if more people with incomes are brought into revenue bargains and insist on quality services for their taxes. This would further enhance demands for improved services based on the standards of the middle class.

Fifth, revenue bargains may improve state capacity to exercise relative autonomy vis-à-vis donors in policy making, avoid capture by powerful interest groups, and help policy elites to provide leadership in the development process. They may encourage citizens to play active roles in the monitoring of aid and ensuring that such aid reaches the right targets. This may raise the credibility of African governments in the aid relationship. It has been estimated that aid that is linked to domestic revenue mobilization can lead to a 10-fold increase in revenue yields in Africa. In other words, if aid and domestic revenue mobilization work in tandem, African governments will be responsive to both citizens and donors, and over time may be weaned of aid dependency.

Successfully constructing resource bargains


Constructing revenue bargains is challenging but doable. Success requires a focus on four issues. First, revenue bargains are always imperfect. Some citizens may want to evade taxes while still enjoying services that others have paid for; and governments may under-supply services if bargains are not institutionalised. Second, citizens may support revenue bargains when they are perceived as fair in terms of the level and progressivity of taxes, and when all tax payers honour their commitments. Third, the credibility of governments to deliver their own part of the bargain is important, especially in countries where the track record of governments in supplying services has been poor. How governments signal credibility is crucial in understanding the politics of revenue bargains and their chances of success. Fourth, lessons from participatory budgeting in Brazil, which focuses on the expenditure side of bargains, suggest the following: revenue bargains may be effective in situations where governing elites are committed to changing power structures in favour of low-income groups and where there is a dense network of groups that can engage the state in bargaining.

 

 

This article reflects the views of the author(s) and does not necessarily represent those of the United Nations Research Institute for Social Development.