Agricultural incomes key to improving tax revenue performance

The structure of the economy is an important factor in a country’s ability to collect taxes. For example countries that are heavily dependent on agriculture tend to be under-developed usually with low productivity smallholder farms that are subsistent in nature. This makes the sector potentially unprofitable and, therefore, difficult to tax in the short run.  

Recently Uganda’s gross domestic product (GDP), which is the sum of all economic activities in the country, was rebased from 2002 to 2009/10 base year. The rebasing means that we now have a more accurate estimate of the size and structure of the economy.  The rebased GDP figures suggest that the structure of the economy has changed. As such, agriculture has overtaken industry as the second most important sector of the Ugandan economy. The contribution of the agricultural sector has increased from 22.2 percent to 23.3 percent, while that of industry has decreased from 26.3 percent to 18.1 percent. These changes show that the contribution of agriculture cannot be ignored. However, even after rebasing the service sector continue to contribute the lion share of national output. The share of services to GDP has moved from 45.4 to 50.6 percent after the rebasing.

Needless to say, growth in Uganda’s agricultural sector has been low. This has been on account of institutional and policy bottlenecks as well as limited adoption of improved technology and inputs, among other constraints. Nevertheless, the sector employs two-thirds of Uganda’s entire labour force. The low productivity in Uganda’s agriculture implies, therefore, that the sector cannot effectively contribute to tax revenues in its current state.

For a long time Uganda depended on international trade taxes, ostensibly due to their ease of collection. However, recent trends indicate that the composition of Uganda’s domestic tax revenues is characterized by a gradual shift away from international trade taxes towards domestic indirect taxes.  For example the share of international trade taxes has declined to 46 percent in 2012 from 59 percent in 1999. On the other hand, the importance of domestic taxes has increased from 37 percent to 50 percent during the same time period. 

Partially, the shift of domestic revenue from international trade reflects the effects of trade liberalization characterized by a systematic decline in tariff rates, particularly for products originating from within Uganda’s regional trading blocs. Such reductions in tariff rates have been shown to negatively affect tax revenues, particularly from import duties.

The declining contribution of trade taxes suggest that domestic consumptive taxes will play an important role in Uganda’s tax revenue efforts.  However, as argued earlier, two thirds of Uganda’s population is engaged in agricultural activities. This implies that improving the incomes of this critical mass of people will largely determine Uganda’s tax effort. Clearly, growth in the agricultural sector will not only help to reduce the incidence of poverty, but will also improve the tax effort through its effect on consumption: more affluent households can consume more taxable products which will effectively improve Uganda’s tax revenue performance. Indeed on-going research at the Economic Policy Research Centre indicates that the agricultural sector holds the biggest potential for improving tax revenue performance in the long run.  Increased agricultural household incomes can spur increased consumption of taxable products.  

In addition, the development of the agricultural sector can be the springboard for development in light manufacturing as well as services sectors.  One possible explanation is that agriculture can create forward linkages in industry, for example by providing raw materials and yet ably link to the services sector, for example, through trade in agricultural products, support to banking, telecoms, and other agricultural-support services.  Moreover, agricultural development can lead to structural transformation from low productivity jobs in agriculture to higher productivity jobs in industry and manufacturing. 

This shift to higher productivity jobs widens the tax base as wages improve and taxes become easier to collect.

Therefore, policy makers should focus on transforming the agricultural sector and improving the incomes of the agricultural households to boost Uganda’s tax revenue performance.