Can Uganda raise more tax revenue?

Taxes are the life blood without which governments are unable to sustain government expenditures for service delivery. The overall tax morale in a given country is driven by the citizenry’s expectations about the state of service delivery. Taxes, therefore, represent an important contract between the government and the citizens by giving citizens a stronger stake in what their government does and a stronger incentive to demand accountability.

Uganda’s tax system is comparable to global benchmarks. Income and corporate tax rates in Uganda are 30 percent; value added tax rate is 18 percent; and import duty rate is 25 percent of the import value. The major tax handles are: 1) direct domestic taxes – including pay as you earn; corporation tax, withholding tax, tax on bank interest, casino tax, and other incomes taxes 2) indirect domestic taxes including excise duty, value added tax 3) taxes on international trade 4) and Fees and licenses.

One major challenge facing policy makers in Uganda is that revenue collections are poor in spite of the relatively high tax rates and the reforms in the tax system. Tax revenue performance, as a percentage of GDP, has made only modest improvements over the last decade. Indeed Uganda’s tax revenue performance has averaged about 13 percent and is lower than in Kenya (20 percent), Zambia (17 percent), Tanzania (16 percent), and even Rwanda (14 percent).

There are various factors that could explain the low tax effort in Uganda. One of them is the low tax morale which itself can be explained, in part, by limited government investments in infrastructures that are complementary to economic performance. The other is the general public’s perception that the rampant corruption and mismanagement of public resources have hindered the delivery of value for money on public investments. These accounts points to the complex relationship between service delivery expenditures and tax effort, not least because public expenditures have to be supported by revenue.

Other factors that explain the poor tax revenue performance includes: the weak legal and regulatory frameworks that are not deterrent enough to enforce compliance; the narrow tax; large informal sector; tax exemptions, institutional weaknesses, as well as a limited institutional capacity to enforce compliance. All these factors have ensured that improvements in tax effort have only been modest over the last two decades.

The composition of the 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 while the importance of domestic taxes has increased from 37 percent to 50 percent during the same time period.

The shift to domestic revenue from international trade can be explained by several factors. First, the effects of trade liberalization due to the systematic decline in tariff rates, particularly for products originating from within Uganda’s regional trading blocs. These reductions in tariff rates appear to have negatively affected trade tax revenues, particularly from import duties. Also, the improved performance of domestic tax revenues may reflect improved efficiency in ensuring compliance and other efforts geared towards improving tax administration.

The question that needs to be answered is whether the current tax revenue level corresponds to the aspirations of Ugandan citizens in terms of what they expect from the State. Is the Government able to deliver sufficient public services and infrastructure with the current level of tax revenues? The simple answer is no. The budget deficit excluding loans was projected at 5.6 percent of GDP in 2014/15. This gap has been filled by official aid and, increasingly, by commercial borrowing. However, official aid should only be a temporary financing source to help the country in a transition towards economic emergence while commercial borrowing has to be repaid by taxpayers sooner or later.

Recent research at the Economic Policy Research Centre has examined ways in which Uganda can raise more tax revenue. In one study, we used firm level data to show that a poor business environment, characterized by inadequate Government provision of public capital; bureaucratic bribery, and an inefficient legal and institutional environment could potentially induce a firm’s behaviour towards tax evasion. In another study we used macro-data to show that that development expenditures, trade openness, and industrial sector growth are positively associated with tax revenue performance. However, dominance of the (subsistent) agricultural and informal sectors pose the largest impediments to tax revenue performance. These results suggest that:

1) Improving the productivity of agriculture by focusing on agricultural formalization and linking agricultural production to value added agro-processing in the industrial sector can unlock the structural constraints to tax revenue growth.

2) Policy makers should focus on working with the informal sector to improve tax revenue performance. Unlocking the informal sector requires carefully designed policies to widen the tax base and ensure that the informal activities are brought into the tax net.  In addition strengthening the tax body’s institutional autonomy, dealing with political interferences and strengthening institutional capacities for tax administration will improve efficiency in tax collection.

3) The positive effect of development expenditures could be strengthened through prudent use of funds. Despite the fact that development projects might take longer periods to mature and ultimately to enlist productivity gains, there are valid concerns that such expenditures are not usually implemented prudently. For example there are serious absorptive capacity constraints that usually delay project implementation. In addition, projects are usually patterned with corruption scandals leading to delays and delivery of sub-standard works which compromise quality. Corruption is likely to affect project selection, execution and quality. In such circumstances, there is scope to improve the productivity of development expenditures.

4) International trade continues to be an important source of tax revenues and continued efforts in fostering regional integration, and trade facilitation. Therefore removing trade barriers will strengthen the contribution of trade taxes.

Looking forward, fiscal revenues from the oil and gas sector should help. But this will not happen before 5-7 years.  A close look at the current reality suggests that Uganda has not yet tapped its full potential to raise taxes.