Nigeria is facing a fiscal crisis. A perfect storm of the pandemic, remittances falling by 28%, and an oil price crash meant that in the first quarter of 2020, 99% of revenues (yes 99%) were spent on debt service.
This year, despite being in the middle of a global pandemic, the federal government cut funding to health by 4%. It may come as a shock, then, to learn that, in 2019 (the only year for which we have data) just one tax incentive cost the federal government US$3.2 billion in revenue, nearly identical to what it spent on healthcare that year, and double what it spent on education.
Nigeria isn’t an isolated case: forgone revenues through tax expenditures (a broader term that includes tax incentives) in low- and lower-middle-income countries averaged just under 2.7% of GDP in 2019. In some countries, the figure is much higher: 8% of GDP in Mauritania and more than 6% in Cabo Verde and Senegal. Extrapolating from the spotty tax expenditure data currently available, we estimate that sub-Saharan African countries collectively experienced forgone revenues of roughly US$46 billion in 2019. That’s more than they received in foreign assistance in 2019 (US$41 billion) and owe in debt service payments next year (US$35 billion).
Tax incentives come in many forms (from tax holidays to credits and exemptions), with the aim of attracting greater investment, spurring growth, and creating jobs.
With COVID-19 devastating African countries’ economies, and governments struggling to provide the support their citizens need to survive the pandemic, now is a good time to assess whether tax incentives provide the economic benefits their proponents have long claimed.
We looked at the evidence on tax incentives to see whether they help or hinder the equitable development of low-income countries. Here’s what we learned:
1. Investors say they would have invested anyway
Tax incentives are often redundant, meaning they are frequently implemented even when an investment would have been made without them. A World Bank survey of investors across seven African countries showed that, in four countries, 90% would have invested even without the tax incentive.
Why? Because, it turns out that tax incentives are one of the least important factors in influencing investment decisions. Other factors, such as economic and political stability, matter far more, and depend on public investment. It’s noteworthy that only one of the 60 indicators used in the Global Foreign Direct Investment Country Attractiveness Index focuses on corporate tax rates. A United Nations survey of foreign investors in Africa concluded that tax incentives were among their least important considerations.
2. Size doesn’t matter
Investment decisions are often not affected by the amount of tax incentive offered. An analysis of 12 West African countries, for instance, found that providing more generous tax incentives had no impact on foreign direct investment.
3. Tax incentives are often a black box
While the forthcoming Global Tax Expenditure Database has tax expenditure data for 97 countries, too few low- and lower-middle-income countries publish such data, making it challenging to assess impact. Nearly 60% of low- and lower-middle-income countries provide no information on the types of tax incentives offered and their revenue implications, and eight countries provide only aggregated data.
Only half (28 of 54) African countries publicly reported their tax expenditures at least once between 2000 and 2019, and the data quality has often been poor.
With poor, or little, data to guide their decision-making, policymakers are flying blind, placing big bets that tax incentives will leave a country better off. Citizens, journalists, and NGOs can’t scrutinise whether these huge investments are good value for money or whether those gambles paid off. In the absence of data, the conventional wisdom prevails — which suits those who are benefiting just fine.
4. We need better data and analyses
The available evidence suggests that tax incentives typically don’t pay off for low-income countries. But without detailed data and scrutiny of their value for money we just don’t know.
We also need more analyses of the impact of tax incentives and the circumstances under which they do and don’t work. Estimates of forgone revenue resulting from tax incentives should form a core component of comprehensive assessments.
Understanding the scope and impact of tax incentives is a necessary condition for the reform of tax incentive systems in Africa, enabling citizens to assess whether policymakers are making informed decisions to increase revenue at a time when Africa’s financing gap is widening.
To learn more, read our full review of recent studies on tax incentives.