Insights From Mckinsey: Revamping Africa’s Tax Systems To Sustain Economic Growth

By Gatuyu T.J

Sleepy lions?

McKinsey & Company, in their recent (2016) report, “Lions on the move: The progress and potential of African economies” aptly interrogates Africa’s immediate economic challenges and prospects.

lion-sleepingIt observes, even though Africa economies are growing, they are performing below potential, and huge business building opportunities for companies remains unexploited. To accelerate growth and human development to renewed dynamism in Africa, governments are encouraged to effectively play their role.

One of the key priority governments must deliver is mobilizing more domestic resources. This will enable funding development and business growth, help to accelerate economic diversification, ramp up infrastructure investment, scale up the development of skills and supporting healthy urbanization.

Pooling domestic resources is only viable way of resource mobilisation given weakening currencies in emerging markets, rising interest rate spreads on sovereign debts, low commodity prices and higher volatility in capital inflows.

Further, data shows Africa’s financial depth, being total financial assets as a percentage of GDP, has declined from 108% in 2009 to 97% in 2015. The savings rates have dropped from 27% of GDP in 2005 to 16% in 2015.

Revamping revenue collection

To unlock funding for economic growth momentum, governments must adopt efficient and fairer tax collection methods by modernizing national tax systems, and this will lead to doubling of Africa’s tax revenue which today totals between $295 billion and $320 billion.

In Kenya, tax collection levels stands at a paltry 19% of the GDP.

Many factors lead to low tax collection. One, revenue authorities have limited data on the number of potential taxpayers. In Kenya, a citizen not registered for PIN will easily avoid paying direct taxes. Second, tax collection processes are often complex and burdensome.

Modernising tax system will significantly eliminate non-compliance resulting from fraud, neglect, error, and non-payment, and revenue collection will increase. Revenue authorities must therefore overcame structural challenges, the key one being high levels of informality in doing business.

The second challenge is revamping the tax system. Time taken to prepare and pay taxes and other tax related payments needs to be addressed. The third challenge is tax administration. This relates to the level of e-filing for corporations and qualitative assessment of tax administration modernization.

If revenue authorities were able to tackle the informality in doing business, revamp the tax system and make tax administration efficient, there would be an increase in the collection of both direct taxes, Indirect taxes, trade taxes, and lastly the resource taxes such as extraction royalties.

“Kick-starters and modernisers”

To measure tax modernisation efforts, McKinsey & Company formulates a modernisation Index classifying countries into three tiers: “kick-starters,” “transitioners,” and “modernizers”. Each tier measures efforts taken by countries to strengthen tax administration, build capabilities, and boost revenue.

‘Kick-starters’, being smaller countries, have a lax tax system collecting a relatively small proportion of GDP in tax revenue. These have a long way to go in modernisation efforts. They need to standardize and simplifying internal processes, closing tax loopholes, and improve collection procedures.

The second tier is the ‘Transitioners’. Kenya falls here. These are countries with more established tax systems and on path to modernization. They have potential to advance to higher-quality systems through tax reform. They need to diversify the tax system, upgrading IT infrastructure, increase the use of pre-filing and e-filing, and introduce sophisticated compliance programs.

The third tier is the ‘Modernizers’. Only Morocco and South Africa meet this cut. These are countries with well-functioning tax systems. These have an opportunity to build state-of-the-art tax administrations, rolling out targeted modernization initiatives to improve customer experience, and to use advanced risk analytical engines to improve compliance.

Transitioning Kenya

Kenya needs to move from a ‘transitioner’ to a ‘moderniser’. To achieve this, the country must improve the tax system. This could be done by expanding the tax base, balancing tax incentives and exemptions to attract Foreign Direct Investment without overly eroding tax revenue.

The administration of tax systems could be made more efficient by improving on data collection, using data to drive risk-based compliance, and ensuring better enforcement.

The informality in doing businesses in the country should be imperatively addressed. When businesses do not pay tax, they create unfair competition for the formal sector. Informality could be curtailed by digitisation of the economy efforts.

Lastly, tax regulations needs to be revamped. This will strengthen financial integration and encourage deeper regional market integration, resulting to increased cross-border capital flows and investment. Robust law reform effort in tax statutes and entering into tax treaties to deter double taxations should be prioritised

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