How tax leakages and unsustainable debt have eroded the social contract in Africa

Originally published by NewZWire

By Janet Zhou and Mukasiri Sibanda

Despite being replete with natural resource wealth, Africa is grappling with a malignant development financing cancer manifesting in bulging illicit financial flows and debt distress. These challenges have been made more daunting by the effects of the scaffolded crises — the COVID-19 pandemic, the climate emergency, the Russia-Ukraine war, and increasing geopolitical fragmentation.

Under such circumstances, it is not too difficult to understand why the severely weathered and eroded fiscal capabilities of many African governments are failing to deliver on expected returns by citizens.

In exchange for paying taxes, directly and indirectly, citizens expect the provision of public goods and services that are accessible to all — health, education, social security in the face of emergencies and public infrastructure. To cover up for budget deficits, and to respond to emergencies, debt is incurred normally as a supplement to tax revenue.

As it stands, the resources emanating from Africa, taxes, and international flows in the form of debt, investments and Aid have not delivered for Africans. When citizens elect their leadership in government for representative democracy, they give stewardship of their resources to their government as represented by the three arms of government (the executive, legislature, and an independent judiciary).

A huge part of that social contract is on ensuring that adequate public revenue is mobilised and managed to deliver optimal public value. That is, fighting poverty and reducing inequality through uplifting the living standards of citizens.

From a fiscal standpoint, the social contract between those that govern and the governed appears to be more illusive than before. Using African realities, this article seeks to scan the state and prospects for a more robust social contract pivoting on prevalent tax and debt injustices.

Cornered by the limited availability and accessibility of essential public services, citizens have explored atomized and alternative ways to cushion themselves. African Development Bank (AfDB) estimates show that roughly 645 million in Africa have no access to electricity, and 700 million have no access to clean cooking energy.

At a household level, boreholes are drilled for water access, while solar equipment and generators are bought and installed for reliable energy. Of course, this is how the few who have the means have reacted. The generous ones hotspot the poor with access to water, for instance.

However, some poor households dig wells in urban settlements, use rudimentary cooking energy like firewood and charcoal, signalling that urban service delivery has been restored to rural settings.

Private services are also sought in the health and education sectors. As a result, the inequalities are widened because citizens are less motivated to hold governments more accountable for the management of public finances to efficiently provide essential public services that are mostly relied upon by the poor.

When citizens feel the pinch of taxes, they are mainly pushed to scrutinise more and ask hard questions to amplify public demands for better management of public finances.

Not all taxes, however, have a similar effect in stimulating public accountability. Direct taxes on the one hand, have a clearly visible effect of reducing disposable incomes. Those employed in the formal sector can easily relate. Regrettably, informal employment is more prevalent in Africa.

The conundrum of salary negotiation for debut formal work contracts is one classic example. Regarding salary expectations, when the gross amount is shared, it may create excitement which is deflated immediately once tax obligations are factored in, Pay As You Earn (PAYE) being a case in point.

On the other hand, derived largely from consumption, indirect taxes have a blunt effect and do not hit as hard as direct taxes. Value Added Tax (VAT), deemed to be a regressive tax payable by the final consumer, is a case in point.

Consumptive taxes are deemed regressive in the sense that the poor bear a disproportionate burden relative to their income as compared to the rich. Unfortunately, most African governments rely mostly on indirect taxes to boost government revenue as evinced by African Tax Administrators Forum (ATAF)’s Africa Tax Outlook (ATO) 2021 publication.

VAT tops the contributions to total revenue with an average share of 31.33% followed by personal income tax (PIT) with 19.5%, then CIT with 17.7%.

Minerals: the double tragedy

The above situation also explains why the dominant reliance on natural resources to raise government revenue can shake the foundations of a fiscal social contract. In a scenario that depicts the tragedy of the commons, research by the UK Institute of Development Studies revealed a commensurate relationship between psychological ownership of public funds and governance expectations.

This sounds a bit scary considering the fresh potential of critical minerals — cobalt, graphite, lithium, manganese, nickel, and lithium to boost public revenue of several African countries. A possible double tragedy awaits — weakened fiscal social contract and poor economic development outcomes from lack of economic diversification from mining.

Taking a close look at the potential of improving revenue mobilization, the enormous global demand for critical or strategic depending on the respective perspective of developed or developing countries, roadblocks are found at domestic and international levels.

Two major constraints were singled out by the IMF’s Tax Avoidance in Sub-Saharan Africa’s Mining Sector Report 2021. In pursuit of foreign investments, firstly, resource-rich countries compete to lighten the tax obligations of Multi-National Enterprises (MNEs). They thereby embark on the race to the bottom which harms their collective capabilities to mobilise much-needed public revenue from finite resources. The global financial and tax framework hardly discourages international tax competition.

Secondly, aggressive tax planning by MNEs leads to profiting shifting that erodes the taxable income in countries where substantial economic activities take place to tax havens where less or no tax obligations are applicable.

In a damning revelation, part of the IMF’s findings exposed the debilitating impact of tax treaty shopping.

“…For instance, nearly half of FDI inflows into SSA mining come via third country investment “hubs” (that is, countries with very high FDI to GDP ratios) which, when combined with light taxation of these conduit investment entities, are conducive to profit shifting.”

DRC is the worst affected country by this practice in the SADC region, followed by Zimbabwe, with South Africa in third place. It must be noted that the IMF report only focused on mining countries, excluding oil and gas riches.

Tax in Africa: the push for change

Although not far-reaching enough, some strides have been made under the OECD’s inclusive framework to ameliorate the harm by setting a 15% global minimum effective tax rate.

Still, this falls significantly short of the average 25% corporate income tax rate applied by African countries. This explains why African countries are pinning their hopes on the UN to lead the overhaul of the international tax rules, taking over from the OECD’s Inclusive Framework, a territory dominated by wealthy nations.

While domestic resource mobilization remains elusive, the debt conundrum does kick in. Once a government fails to adequately harness its domestic resources to finance its development, it heavily relies on external funding in the form of aid or debt.

According to Professor Yash Tandon, this sounds positive as it is covered by the media as associated with development, solidarity, and humanitarian cause. He says there is indeed little legitimate claim to what aid and debt do positively.

When a government taxes its citizens or raises resources internally without overdependence on aid or debt it is accountable to its citizens. According to Tax Justice Network, it builds healthier democratic processes, recognising that higher reliance on government spending on tax revenues is strongly linked to higher quality of governance and political representation which strengthens the social contract.

However, this has not been the case. Africa is in debt distress. Since the pandemic, there have been rising debt vulnerabilities. The Russia-Ukraine war has not made it better as tighter global financial conditions, higher inflation, lower growth, and fiscal tensions continue to present a precarious debt dynamic for poor and low-middle-income countries found in Africa. To date, four African countries (Chad, Ethiopia, Ghana, and Zambia) have applied for the G20 Common Framework to secure an IMF Bailout and Debt Restructuring.

Many on the debt map are in the risky zone of falling into debt distress. While Africa reels in debt, there is nothing to show for it in terms of the development and living standards of the people of Africa. By 2030, it is estimated that 479 million Africans will be living in extreme poverty, slightly over a quarter of the total population.

Debt service vs inequality

Inequalities in many African countries continue to widen, and this happens when the government is not able to deliver on its mandate, the poor and vulnerable are left without jobs and access to opportunities and basic human rights are not fulfilled.

According to the World Bank 2022 International Debt Report, debt service payments on public and publicly guaranteed debt by the world’s poorest were expected to surge by 35% from 2021 to over US$62 billion in 2022. Debt servicing takes away the fiscal resources from key social sectors and limits investments in the same.

This shifts the social contract from the people to fulfilling external fiscal obligations, further eroding the base of the social contract which is hinged on domestic resource mobilization.

Essentially more money flows out of Africa than goes in. According to the Jubilee Campaign, the key factors contributing to this inequality include unjust debt payments and multinational companies hiding proceeds through tax avoidance and corruption.

For example, African governments received US$32bn in loans in 2015 but paid more than half of that — US$18bn — in debt interest, with the level of debt rising rapidly. This is a clear violation of the social contract by the African governments and the international community.

Seeking a social contract

Prioritisation of debt repayments over fulfilling basic human rights is in stark contrast to International Conventions to which our governments have obligations to fulfil basic human rights such as the International Convention on Social and Economic and Cultural Rights.

Amid an almost broken relationship between the governments and citizens, citizens from across Africa continue to seek engagement with their political leadership. Questions of transparency and accountability form the cornerstone of the social contract. In trying to hold public officials to account, citizens have been organising and playing an active role to ask critical questions and be involved.

In Nigeria, Connected Development (CODE) leads an African-wide campaign called #followthemoney which tracks different government projects and seeks accountability as to the allocation of public funds. It has several chapters in different African countries that keep citizens and communities connected and with an eye on mega projects.

In Zimbabwe, Zimbabwe Coalition on Debt and Development (ZIMCODD) led an accountability campaign called #HowFar which asked critical accountability questions on use of public funds, corruption and public service delivery. The campaign got some responses from the government and kept citizens abreast with government mega projects, spotlighting the promises of the election manifesto for the sitting government as well.