AfCTA post implementation impact on tax revenue mobilisation

This article analyses the potential impact of the African Continental Free Trade Area (AfCTA) on tax revenue mobilisation when fully operational, and measures that can be taken by member-countries to mitigate the impact of shortfall of tax revenue in the short to medium term.

AfCFTA is an initiative by African states focused on helping to develop Africa. AfCTA is possibly the largest trade block by member-states. It is a single market (Duty-free, Quota-free) covering the entire African continent with a total population of 1.3 billion and a combined gross domestic product (GDP) of almost US$3trillion[1]. The World Bank estimates that AfCFTA would significantly boost African trade, particularly intra-regional trade in manufacturing. By 2035, the volume of total exports would increase by almost 29 percent relative to business as usual. Intra-continental exports would increase by more than 81 percent, while exports to non-African countries would rise by 19 percent. This would create new opportunities for African manufacturers and workers.[2]

Signing & ratification of the AfCFTA

African member-states showed huge political will on the record, 54 out of 55 member-states have so far signed the AfCFTA which was adopted at the AU Extra-Ordinary Summit in Kigali, Rwanda on 21^st March, 2018. Eritrea is the only African country yet to sign the agreement.

43 member-states have ratified and deposited their Instruments of Ratification with the AU Commission.[3]

AfCFTA is currently in its implementation stage, for which negotiations on some key aspects such as intellectual property rights, investment, competition policy are currently ongoing, and negotiation on e-commence yet to begin.

 Strategic objectives & benefits of the AfCFTA 

Some of the key strategic objectives and benefits to be derived from the AfCFTA include the following:

(a) Create a single market for goods and services, facilitated by movement of persons in order to deepen the economic integration of the African continent, and in accordance with the Pan African Vision of “an integrated, prosperous and peaceful Africa” enshrined in Agenda 2063;

(b) Create a liberalised market for goods and services through successive rounds of negotiations;

 (c) Lay the foundation for the establishment of a Continental Customs Union at a later stage;

(d) Promote and attain sustainable and inclusive socio-economic development, gender equality and structural transformation of the State Parties;

 (e) Enhance the competitiveness of the economies of State Parties within the continent and the global market; and

(f) Promote industrial development through diversification and regional value chain development, agricultural development and food security[4]

Possible tax & other implications when AfCTA becomes operational

When AfCTA takes effect, it will negatively impact Customs Revenue in the short term, and the impact will be marginal resulting from reduction in custom tariffs on imports among African states. This is because the share of intra-African exports as a percentage of total African exports was estimated around 17 percent in 2017, but it remains low compared to levels in Europe (69 percent), Asia (59 percent), and North America (31 percent).[5]

In the medium term to long term, AfCFTA is expected to improve trade, and therefore impact positively on Gross Domestic Product. Real income gains from full implementation of the agreement could increase by 7 percent or by nearly US$450billion, according to the World Bank.[6] Hence, positively affecting domestic tax by increase in income levels for individuals and entities. In addition, increase in productivity and consumption resulting to increase in domestic taxes both direct and indirect taxes.

According to the World Bank, AfCFTA’s short-term impact on tax revenues is small for most countries. Tariff revenues would decline by less than 1.5 percent for 49 out of 54 countries. Total tax revenues would decline by less than 0.3 percent in 50 out of 54 countries. Two factors help explain these small revenue impacts. First, only a small share of tariff revenues come from imports from African countries (less than 10 percent on average). Second, exclusion lists can shield most tariff revenues from liberalisation because these revenues are highly concentrated in a few tariff lines (1 percent of tariff lines account for more than three-quarters of tariff revenues in almost all African countries). In the medium to long run, tariff revenues would grow by 3 percent by 2035 relative to the baseline as imports rise, and as tariff liberalisation is accompanied by a reduction in non-tariff barriers and implementation of trade facilitation measures.[7]

AfCFTA can lift an additional 30 million people from extreme poverty (1.5 percent of the continent’s population) and 68 million people from moderate poverty. By country, the poverty rate is 77.7 percent in the Central African Republic, but just 0.4 percent in Algeria and Egypt. In West Africa, the poverty headcount would decline by 12 million people, while the decline for Central and East Africa would be 9.3 million and 4.8 million, respectively. AfCFTA has the potential to lift 67.9 million people, or 3.6 percent of the continent’s population, out of poverty by 2035 which will result to an increase in personal income tax, other direct taxes and consumption taxes as well.[8]

Medium and long term tax revenue implications of AfCFTA

The reduction in trade barriers stemming from the AfCFTA would affect tax revenues of member-countries through four channels:

First, following the phasedown of imports tariffs, a direct reduction in tax revenue is anticipated due to reduced import tariffs.

Secondly, on account of the lower tariffs, trade diversions would also reduce revenues.

Thirdly, due to potential increase in production efficiency, a higher GDP would lead to increase income levels for individuals and entities resulting in more domestic tax revenue

Fourth, after increasing imports and income, higher consumption would also raise tax revenues.

Recommendations to mitigate the possible tax revenue shortfall in the short to medium term

To compensate for the short-term custom revenue losses, African countries could resort to other revenue boosting measures that target domestic taxes.

This include expanding the tax base by focusing on new streams of domestic tax-related revenues, examples are Digital Service Tax (DST), Environmental taxes, VAT on cross-border supplies, High Network Individuals (HNWI).

Review tax incentive policies by eradicating non-beneficial incentives. Ghana, in recent times, through its parliament, passed the Tax Exemptions Bills 2022, which is a step in that direction. The new rules, under pillar 2 solution, will see Multinational Enterprises (MNEs) operating in Africa paying their corporate income tax up to 15 percent to their home countries where tax incentive is in place in African country. This will result in a ‘double loss’ for Africa and a gain for the country where that company is headquartered.

In addition, renegotiating some of the existing tax treaties with treaty shopping provisions that result in full exemption provisions for certain incomes and persons or that provide for lower withholding tax rates.

Identify the use of technology and big data analytics. In the case of Ghana, the digitisation agenda by the current government is a step in the right direction which will provide uniform and harmonised data for analysis by the revenue authority to help to bring in more persons under the informal sector under the tax net.

Combating illicit financial flows by adopting blockchain to help track some of the illegal financial flows. African countries cannot ignore the ongoing effect of aggressive tax planning, tax evasion and illegal cross-border activities which have resulted in the continent losing close to US$90billion in the form of illicit financial flows, according to the Economic Development in Africa Report 2020 by the UN Conference on Trade and Development (UNCTAD).[9]

Customs officials should be capacitated with requisite skills, such as proper interpretation and implementation of rules of origin and preference to reduce the risk of dumping, smuggling and trans-shipment (trading in goods made outside Africa, but fraudulently declared as made in Africa.

Conclusion

Most sub-Saharan African countries have always recorded low tax-to-GDP ratio, Ghana recorded a tax-GDP ratio of 11.34 percent in 2020 and 13.5 percent in 2019, and Nigeria recorded 6 percent in 2019. Both countries achieved below the 2019 Africa Tax-to-GDP average of 16.6 percent[10]. Moreover, to mitigate the possibility of revenue shortfall when AfCTA fully becomes operational, it is imperative for member-states to be forward-thinking in adopting measures to boost domestic tax revenue mobilisation.

The writer is a member of the Chartered Institute of Taxation (Ghana) and a tax consultant.