Taxes and Transparency: The Way Forward for Africa

June 28th, 2010

While Asia and Latin America have seen dramatic reductions in poverty over the last several decades, Africa remains as poor, by some accounts even poorer, than fifty years ago.  Indeed, of the 26 countries classified with “low human development” by the UN Development Program, all but two are in Sub-Saharan Africa.  For decades, billions of dollars in foreign aid have been channeled to the continent, but have had little effect on alleviating poverty.  Building strong institutions, solid infrastructure and a vibrant private sector requires things far more intangible than simply dollars.  But let us not kid ourselves: dollars will be needed – and a whole lot of them, to get Africa on the track to prosperity.

The recently published 2010 African Economic Outlook by of the OECD and African Development Bank, focuses on an important facet of finance for development: taxation.  According to the report, tax revenue accounts for about 22% of Africa’s GDP, compared to 35% for OECD countries.  Further, in Africa’s lower-income countries, taxation accounts for only 15% of GDP.  This means that without enough tax revenue these African governments are not able to provide or maintain even the most basic of public
goods and services needed to develop.

The Outlook report specifically identifies abusive transfer mispricing as a significant problem in Africa’s taxation system.  Multinational firms engage in abusive transfer pricing when they under-value goods shifted to parent entities out of the continent to avoid taxes.  Trade mispricing, which broadens the definition to include non-affiliated partners, is even larger.  A GFI report estimates that tax revenue due to trade mispricing averaged up to USD 4 billion annually between 2002-2006.   Ethiopia, for instance, Africa’s second most populous nation, by a GFI estimate lost 16.2% in tax revenue from trade mispricing.  In the interim perhaps this is a good thing, given the fact that Ethiopia spends three times more on defense than on health and education.

Looking forward, however, the ability of a government to finance its’ own development is extremely important.  Botswana, one of the few middle income countries in Africa, was able to quickly develop by harnessing its immense mineral wealth and investing prudently in education, health and infrastructure.  Unfortunately, Botswana is a rare exception to the rule of bad governance and squandered natural resource wealth prevalent in Africa.

Not only are the African countries losing big in tax revenue, they are losing ever bigger in money simply flying out of the country by illegal methods. Looking at total illicit outflows from the continent between 1970 and 2008, GFI estimates that Africa hemorrhaged close to a trillion dollars during this period.  This is most likely an underestimate.  The true number could be double that.  What’s certain is that Africa remains a capital-poor continent and huge investments to build and strengthen infrastructure and institutions is vital for its economic growth.   Improving Africa’s ability to tax through transparency and better governance – both multinational corporations and its own citizens – is a vital step forward for sustained development.

Written by Ilmari Soininen

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