Taxation in Fragile States: The Missing Piece of the State-Building Puzzle?

Fragile, conflict and violence (FCV)-affected countries struggle to collect revenue, with a reduced tax to Gross Domestic Product (GDP) ratio of an average of 4 percentage points. The needs are so acute in FCV countries, but reforms are difficult to sustain due to multiple issues including poor governance, high level of corruption, weak institutional capacity, political and social instability, and dire economic and developmental challenges. 

Discussions around state building and spending do not focus on taxation so we would like to share some ideas  that emerged from a recent seminar in Dakar, Senegal, that convened researchers, civil society representatives, and policymakers working on West Africa:
 
-    Taxation and state-building in fragile States - tax bargaining, tax fairness and implications for state-society relations. Paying tax is the glue in the social contract (Cobham 2022). When people pay taxes, they are empowered to hold their governments to account for how their money is spent. But a minimum level of trust is required to enable tax bargaining between citizens and the state (IDS, 2010). In the fragile states of West Africa and the Sahel, the tax bargaining process is limited and tends to concern the state and the most powerful actors in society.  According to Mick Moore et al.  “how you tax is as much as important as how much you tax”. Finding the balance between tax effectiveness and fairness is a key challenge . For most of the population in West Africa, pressure on taxpayers is usually inversely proportional to their power and unconnected taxpayers are the ones who face the strongest scrutiny and enforcement.

-    Natural resource taxation and incentives for state-building. In West Africa, revenue from natural resources accounts for a larger share than in other countries with more potential for an increased taxation of the revenue derived from natural resource extraction.  This is a crucial issue as gold mining (especially artisanal gold mining) is increasingly important, particularly in Sahel countries such as Burkina Faso, Mali, and Niger. While research finds that these revenue sources do less to build a fiscal contract than direct taxes (Braütigam et al. 2008),  questions should be raised on how tax regimes for taxing natural resource exploitation can be improved to increase revenue while contributing to greater public accountability and transparency in West Africa. A solution could, for instance, be a partial transfer to the population to be partially taxed to (re)create an accountability link between the state and citizens.

-    The role of customs for revenue generation and territorial security. Customs revenue collection is still an important source of domestic revenues (between 30 and 50 of total revenues) and has remained central to taxation in West Africa . However, customs’ reforms are usually neglected assuming a fiscal transition towards direct taxes, which has not happened especially in FCV countries. The main function of Customs in FCV countries is to collect revenues whereas their security role and control of the territory is critical. Moreover, revenues collected by customs usually remain concentrated and a better understanding of the political economy of customs reform is necessary to improve taxation performance in FCV countries.

-    Taxing the informal economy – a pot of gold or simply misunderstood.  The informal sector accounts for at least one-third on average for Sub-Saharan Africa and some countries in the region impose various taxes. Attempts to tax informal sectors have produced fewer benefits than expected (Lediga et al., 2020) even though it is sometimes presented as a solution to boost state budgets (and defining the informal sector is not straightforward). This is due to the challenges in designing and administering effective informal sector tax regimes, coupled with the small average size of informal enterprises which makes registration of informal sector taxpayers and their activities costly. Moreover, informal enterprises often pay fees and levies which makes them de facto taxed. Taxing the informal sector does not lead to a fiscal contract because it is hard for taxpayers to see an improvement in access to quality public services. Finally, the potential tax revenue, scale, and ability to pay taxes vary greatly, thus presenting the possibility of formalization processes and broadening the tax base.

Applied research has enabled policy makers in Africa to improve knowledge and lead to increased revenues.  The discussions we had in Dakar are a good example that should be replicated. Taxation is not only a technical issue and should be accompanied with a comprehensive and multidisciplinary approach to generate impact at scale.

* Editor’s note: The seminar mentioned in the blog took place in Dakar, Senegal, and was organized by the TaxCapDev network – co-chaired by Odd-Helge Fjeldstad (CMI) and Morten Bøås (NUPI) – in collaboration with the World Bank Group (WBG) and the Global Tax Program (GTP).