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September 21, 2018

Generating public revenue to build resilient economy

Kenya Power technicians repair street lights along Homo Kenyatta avenue to help boost economy in Mombasa county./ANDREW KASUKU
Kenya Power technicians repair street lights along Homo Kenyatta avenue to help boost economy in Mombasa county./ANDREW KASUKU

After many years of feeble growth, the International Monetary Fund is expecting global economic activity to pick up this year and next, and across both the advanced and emerging economies. However, this does not mean we are out of the woods – conflicts and lower oil prices will continue to affect growth and, by extension, government revenue. While oil prices have increased recently, we do not expect them to return to levels we have seen before 2014. And there are, of course, questions about geopolitical developments in many regions of the world.

In the face of such uncertainty, countries need to build resilience. Robust public finances are one way to create such resilience. Indeed, governments in this region and elsewhere need to increase their efforts to create a stronger and more reliable stream of revenue. With this in mind, let us pick up on the conversation we began last year about building 21st-century economies and generating higher government revenue in a rapidly changing environment. As the Arabic proverb puts it: “A tree begins with a seed.” So how can countries build tax capacity to sow the seeds of a healthy and inclusive economy, for the benefit of all citizens?

The momentum toward revenue mobilisation, and the associated work going on at the international level, present the region with a major opportunity. By creating state-of-the-art tax systems, countries can generate resources needed to tackle future challenges — and do so in an efficient and equitable manner. This, of course, requires a clear and comprehensive strategy that interlinks tax policy reform with revenue administration reform. In other words, what and whom to tax should go hand in hand with how you go about collecting these taxes.

Let us begin by looking at the steps needed to design a comprehensive tax policy. We at the IMF think that a good first step is establishing a five-to-ten-year revenue target. After that, a comprehensive reform plan is necessary, aiming at long-term institution building rather than short-term fixes. Finally, collecting and disseminating good data is vital for making good decisions.

We need revenue targets because these are essential goal posts that can help you align your revenues with your spending — both in the short term and the medium term.

If tax reforms are to be successful and achieve their targets, policymakers will need to focus their tax policy on key priorities. In the oil-exporting countries, this means diversifying the sources of revenue away from oil and gas. As a first step, countries are introducing a VAT and other consumption taxes — for example on tobacco and sugar-sweetened beverages. Over time, governments may also consider deriving additional revenue from income and property taxation. Countries in the Gulf, for example, are working to introduce a harmonised VAT in 2018. These efforts — which the IMF has supported through is technical assistance — could raise anywhere from one to two per cent of gross domestic product, assuming a VAT rate of five per cent.

Our experiences underscore the positive impact of diversification. Mexico, for example, was able to boost its non-oil tax revenue by more than three per cent of GDP — by broadening the VAT base and raising energy taxes and personal income tax rates. In the oil-importing countries, the key priority is to generate higher revenue by broadening the base of existing taxes. Such reforms would make tax systems simpler, more efficient, and more equitable. This requires, for example, rationalising multiple VAT rates and other tax preferences. Some of the key measures here include simplifying the rate structure and getting rid of exemptions, tax holidays and other carve-outs that benefit only a few and create opportunities for arbitrage. In some countries, tax reform also means making tax systems more progressive — by lifting the top marginal tax rate on personal income. And of course, current tax rules should be applied in a consistent and coherent way.

Christine Lagarde is the IMF managing director

 

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