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Tax revenues and tax capacity in sub-Saharan Africa

African countries raise lower amounts of tax as a share of national income (GDP) than other countries. Researchers are interested in understanding why this is the case.

Tax performance studies —statistical analyses of factors driving the tax-to-GDP ratio— mainly focus on economic features. For example, poverty and low per capita GDP are associated with low tax revenue. Political factors, and the broader institutional framework of tax policy (loosely termed fiscal capacity), are also relevant to explain cross-country differences in tax-to-GDP ratios. Recent UNU-WIDER research contributes to this literature by identifying specific political factors that have been important in Africa.

Figure 1

Measuring tax capacity

In our forthcoming paper in the Journal of Institutional Economics, we introduce a new measure of tax capacity. The measure is applied to annual data from 39 sub-Saharan African (SSA) countries over 1985–2018 to analyse the institutional determinants of tax performance.

The first step is to estimate potential revenue for each country, a measure of how much tax (as a share of GDP) the country should be able to raise given its economic characteristics (chosen from those that explain tax performance). This is used to derive a measure of tax efficiency —the ratio of actual to potential revenue— for each country in each year.

The amount of tax raised in any given year can vary because of shocks, such as a drought or a collapse in the price of commodities a country exports (that reduces incomes), or a pandemic like COVID-19. This gives rise to annual deviations (termed cyclical variations) of actual revenue from the underlying potential.

A final step is to remove the impact of cyclical variations and derive a measure of the underlying trend. This trend component is our new measure of tax capacity. A value of 1 implies revenue is on trend with or equal to underlying potential; values above 1 imply that tax capacity is improving and revenue potential is increasing.

Figure 2 (below) shows the standard measure for how well a country is meeting its tax revenue potential as (tax effort) compared to our new measure (tax capacity), as an average across sub-Saharan African countries.

Figure 2

Evolution of tax capacity

The research shows that tax capacity in SSA has improved since 1985, consistent with increasing tax-to-GDP ratios since the late 1990s, albeit with considerable variation across countries. Low-income countries have more volatile tax capacity with values below 1 (not meeting potential) until 2000, after which capacity improves. For middle-income SSA countries, tax capacity was above 1.0, but declined in the early 2000s and did not recover until 2018. On average, low-income countries managed to improve in tax capacity more than middle-income countries. Although they have lower tax-to-GDP ratios overall, they do better at meeting potential.

Institutional determinants of tax capacity

The final stage of our analysis investigates which institutional variables, using a set taken from the Varieties of Democracy (V-Dem) Dataset, are most strongly correlated with the evolution of tax capacity in SSA countries. The indicator of equity in the provision of public services is the most important institutional variable, suggesting that capacity to tax is enhanced if the public perceive an equitable distribution of the benefits from public spending. This variable is seen as a proxy for the strength of the fiscal contract —the exchange of tax revenues for public goods and services— across countries.

The extent to which the executive, legislature, and judiciary are susceptible to bribery and embezzlement (political corruption) is negatively associated with tax capacity. This adds to evidence that corruption erodes tax morale and compliance. The research provides new insights on which political institutions —within the broader institutional framework of tax policy— support improvements in tax capacity and hence tax performance in SSA.

Abrams M.E. Tagem is a research associate with UNU-WIDER and PhD in economics.

Oliver Morrissey is a non-resident senior research fellow at UNU-WIDER, Professor in Development Economics and Director of CREDIT, School of Economics, University of Nottingham, and a Managing Co-Editor of the Journal of Development Studies.

The views expressed in this piece are those of the author(s), and do not necessarily reflect the views of the Institute or the United Nations University, nor the programme/project donors.