Making fiscal policy more pro-poor in Africa

In many parts of the world, fiscal policy is a powerful tool used by governments to reduce inequality and alleviate poverty. However, in Africa, the reality is starkly different. Efforts to tax the rich and redistribute resources are not enough, as most African households pay far more in taxes than they receive in transfers and subsidies. This imbalance not only perpetuates poverty but also exacerbates inequality. What can countries do about this in an increasingly constrained fiscal environment? In this blog, we explore three transformative policy shifts that could level the playing field and accelerate poverty reduction across Africa, as outlined in a new regional flagship report.
 

The distributional impact of fiscal policy

Fiscal Policy and Inequality: On average, inequality after taxes and transfers in Africa is higher than inequality before taxes and transfers in other regions. While richer households pay more in taxes than poorer households, thus reducing inequality, the taxes that poorer households pay are high relative to their incomes. African countries rely on consumption taxes, and while the poor largely purchase goods in informal markets, wholesalers pass on at least a portion of taxes and customs duties paid to the final consumer in the form of higher prices. Indeed, for lower income households this tax burden is higher than the benefits they receive through transfers and subsidies, leading to higher poverty in the short run. 

Constrained Fiscal Environment: Given the constrained fiscal environment of most post-COVID pandemic African economies, there is a need for greater equity and efficiency in tax and spending policies. Policies aimed at domestic resource mobilization must avoid placing an undue burden on the poor. 

Three policy shifts could make a real difference and help level the playing field.

1. Shift toward more progressive taxation. This includes placing greater focus on collecting property taxes and reducing corporate tax incentives. It also includes eliminating value-added tax (VAT) exemptions, which largely benefit rich individuals, while the poor largely purchase goods in informal markets. For instance, Senegal eliminated VAT exemptions on selected goods mainly consumed by the wealthiest part of the population, such as non-medical services delivered in private healthcare institutions. At the same time, careful design of simplified tax regimes can make a big difference for small businesses.
   
   
2. Spending choices need to make sure every cent counts. This includes shifting spending away from untargeted subsidies toward strengthened safety nets. High energy and utility subsidies mostly benefit high-income households, increasing inequality with limited impact on the poor. In contrast, adaptive social safety nets, which can flexibly adjust their coverage and benefit amounts, along with school feeding programs, are particularly effective and efficient in reducing poverty and inequality. Ethiopia has moved in this direction in the past year with a four-fold increase in domestic financing of targeted safety nets, while reducing energy subsidies.
   
   
3. Shift toward improved state effectiveness on taxes and spending while considering political economy factors and varying levels of government capacity. This includes incentivizing tax compliance among high-income taxpayers, using technology and simplifying the taxpayer interface especially for firms and households at the lower end of the distribution South Africa is a good example. The revenue authority uses big data to generate a draft tax assessment for five million low-middle income households, who can use their phones to pay or adjust these statements. Moreover, while tax refunds used to take six months, a fully digitized process means that 70% of them are now done within 72 hours. On the spending side, better debt management, planning for disaster risk spending and improved procurement practices can provide the fiscal space for more pro-poor spending. While these are well-known, the task is to shift political incentives to achieve these goals.
    

Conclusion

Clearly Africa faces a constrained fiscal environment in a context where the needs are great. Yet the fact that the poor pay more in taxes than they receive in transfers has to be reversed.  Efforts towards domestic resource mobilization must ensure they don’t inadvertently worsen poverty and equity. Increasing tax-GDP ratios need to place equal emphasis on changing the structure of taxation so that the burden falls on the better off. Governments can do more to level the playing field through fair fiscal policies in Africa both on the tax and expenditure side, and the examples we present show that it can be done