- Laura Wallace
- Published Date:
- May 1997
Accelerating Fiscal and Financial Sector Reforms
In reaction to Peter Heller’s comment that countries should try to reduce their reliance on export taxation, Jean-Claude Brou of Côte d’Ivoire suggested that the problem was one of timing, and not whether such a step should be taken at all. If countries reduced those taxes too rapidly, trying to replace them with taxes on domestic consumption, a problem would arise because most African economies were rural and agricultural in nature, and the informal sector was still a substantial sector. Moreover, increasing taxes on domestic consumption required a strong fiscal administration—which took time to create—whereas reducing taxes on international trade could have an immediate impact on revenues. Thus, it needed to be recognized that the substitution process would take time, and if things were done too quickly, other imbalances would occur, in turn slowing down the entire readjustment process.
As for Heller’s suggestion that countries reduce and control tax exemptions, Brou pointed out that countries often ran into difficulties trying to do that because most exemptions were linked to investment codes and most developing countries offered such exemptions. Côte d’Ivoire had introduced a new investment code in 1995 after concluding that it needed to maintain a certain level of exemptions just to remain competitive.
Kwesi Botchwey of Ghana concurred with Brou’s and Heller’s assessment of the problem, noting that Ghana had once or twice committed itself to removing exemptions but then ran into legal obstacles because the exemptions were embedded in investment codes or aid agreements that stipulated that none of the aid resources could be used to pay taxes (which tax officials interpreted to mean exemptions for everyone). In addition, a study by the minerals commission showed that Ghana’s investment codes were quite competitive, and tampering with the codes would risk investor confidence. So in the end, Ghana had decided to leave the codes alone and focus on the problem of abuse. It had quickly clamped down on the extreme instances of tax exemptions for plant and equipment for mining being misused through the importation of luxury vehicles. But what could be done when the exemptions were embedded in legislation and countries had to position themselves competitively? Where was the leeway for countries concerned about effective duty rates?
Aliou Seck of Senegal concurred that governments needed to mobilize as much revenue as possible, something Senegal had been trying to do—in part by introducing a tax on the informal market and eliminating exemptions that were no longer needed. But he also stressed that external resources needed to be clearly programmed and arrive on time.
Soumaïla Cissé of Mali pointed out that his country had worked with the IMF on trying to improve the fiscal situation but had run into difficulties when donors opposed the reduction of taxes. What should countries do in such situations? As for strengthening tax administration, Cissé asked how Heller thought countries could do so while simultaneously spending more on education and health and yet limiting the number of wage earners and holding down salaries. There were only 52 cards in a deck, which the IMF wanted countries to reshuffle and deal out again. There were constraints everywhere, and countries had to rethink priorities.
The private sector perspective was introduced by Edouard Luboya of Zaïre, who observed that the seminar so far had focused strictly on the public sector, whereas it was the private sector that had made a significant contribution to Zaïre’s recent progress in lowering inflation and generating revenue. The government was now including private sector representatives in certain monthly economic discussions at the central bank, and it was important that the private sector actively participate in the design and implementation of adjustment measures. Regarding mobilization of revenues, he remarked that although procedures needed to be put in place to improve tax collections, the state should motivate taxpayers by providing better and more visible services. And tax collection efforts needed to be equitable, not singling out certain companies.
Heller responded to concerns about exemptions by noting that, first, most studies of investment incentives, particularly by the World Bank, raised questions about whether countries really gained very much by having those kinds of tax incentives. Second, to the extent countries had those incentives, there should be a “sunset rule,” perhaps ending the exemption after three or four years. Third, it was better to have those provisions in tax codes, so that policymakers could look at the tax codes in an integrated way. Fourth, competition was not a function of exemptions alone, but also of tax rates and other tax provisions—with many exemptions, tax rates would need to be higher, given the narrower tax base. In sum, the goal should be to limit these exemptions and lower the tax rate at the same time. Heller conceded that, to some extent, the room for maneuver was limited, because many donors insisted on certain types of exemptions for their projects. But the key was to at least avoid the extent to which such exemptions created the opportunities for abuse and the sort of unmandated expansion of eligibility for particular exemptions beyond what they were ever intended to be.
Turning to Brou’s concern about the timing for elimination of export taxes and the raising of domestic consumption taxes, Heller pointed out that the tax base for domestic consumption—at least domestic consumption that could be taxed—was effectively limited to imports and to what was produced by domestic manufacturing enterprises. No one expected countries to tax agricultural goods produced by subsistence farmers for consumption. So by extending the tax beyond imports to domestic producers of the same good, at least the tax base could be broadened. Heller conceded that there were some cases where export taxes might be appropriate and relevant, such as when there was very limited domestic consumption of the exportable good, but those cases were extremely limited in number.
As for concerns about equity, Heller said the IMF was simply suggesting that countries focus their tax efforts on the larger enterprises above a certain scale—those that provide the government with 80–90 percent of the revenues—because that was much more efficient in an administrative sense. Otherwise, tremendous and limited administrative resources were wasted. Of course, it was important to have some way of covering the smaller enterprises, but they were already in the tax net to the extent that they had to pay taxes on imported inputs.
Heller sympathized with Cissé about the feeling that “there are only 52 cards in a deck,” agreeing that it was hard to do everything at the same time. But he argued that a strong, well-run tax administration, run by well-paid tax administrators, paid for itself. It was a net gainer for the economy. That was one of the reasons why Uganda and several other countries had sought to move the tax administration out of the civil service and put it on a better paid autonomous basis.
Finally, Heller responded to Shahid Yusuf’s observation that East Asia only began introducing significant fiscal reforms in the early to mid-1980s, and Africa was following with a decade’s lag. Heller said he knew where Asia had been 20 years ago and where Africa was today, but sometimes he wished that Africa today were where it had been 20 years ago—in that case, most countries would be much better off. So the question was: How was Africa going to get from where it was now to where it wanted to be—rather than to continue to follow the path of the past 10 or 15 years, which had been one of major setbacks?
On the topic of financial reform, Botchwey agreed with David Cole that individual country circumstances might dictate the need to proceed cautiously, but for Ghana, at least, a quick move to a market-oriented exchange rate and interest rate system helped depersonalize and de-politicize decision making. Initially, Ghana had tried the gradual approach to exchange rate reform until policymakers decided it was impossible to proceed that way. Whenever the exchange rate needed to be adjusted, even the slightest bit, according to the agreed formula, it took long meetings in the middle of the night, with daggers drawn. Eventually, policymakers realized that the only way to end the paralysis was to adopt a market-based system overnight, and, interestingly, those who were the most vociferous in opposing even the smallest changes very quickly got used to what the market said and did. A similar dynamic occurred in the case of interest rates, with overnight reform alleviating the pressure on the central bank and commercial banks to influence the Minister of Finance.
George Anthony Chigora of Zimbabwe, however, emphasized the need for a more gradual, market-building approach, noting that the abrupt measures have tended to be abandoned by some countries. He went on to say that developing countries were being asked to change in a very short time what had taken other countries a very long time.
Cissé raised the issue of stability in policymaking, suggesting that countries such as Indonesia had found it easier to succeed with reforms because the Minister of Finance there, for example, had held his position for 20 years. If a country had the same ministers and advisors for a long period of time, there was a certain continuity. But for Africa the opposite had occurred, resulting in a lot of go, no-go, starts, and stops. As for the speed of reform, Cissé acknowledged that there was a need for patience. But he worried that given the changed economic environment—replete with Internet and cable television—Africa had to accelerate or risk being swept out of the way.
David Cole responded that he, too, desired rapid development of the financial system. But his main point was that if countries tried to go too fast and leap over some of the necessary developmental steps, the result would be a slowing down of the entire liberalization process. That did not necessarily mean, however, that countries had to follow the same sequences as others before them. A great deal could be learned from the use of modern communication systems.
How about Basant Kapur’s concern—a concern also raised by Patrick Downes—that there was no reference to a nominal anchor in the Cole and Slade proposals, meaning that unanticipated shocks to money demand or supply, for example, could lead to short-run variations in the domestic inflation rate, which would then be “validated” by automatic adjustments of the rate of crawl of the exchange rate? Cole countered that a nominal anchor was not the real issue, but rather that there were other ways of trying to control reserve money besides treasury bill open-market operations. Reserve money growth could be a target or nominal anchor, as could the inflation rate of nominal GDP. It was important, however, that this not be implemented in a rigid way. Flexibility of both interest and exchange rates might be needed to accommodate temporary shocks that could be both favorable and unfavorable. Also, adjustments of reserve money growth targets were often needed to accommodate significant changes in the structure of the financial system.
As for Kapur’s suggestion that countries focus monetary policy management on a target rate of disinflation or the maintenance of a low, steady-state inflation rate, Cole said he had no problem with that. Moreover, he also agreed that fiscal policy was an essential requirement in most countries for making significant changes in the financial system. But he cautioned that if countries tried to introduce a treasury bill market before they had achieved any control over fiscal policy, they would destroy the bill market even more rapidly than they would destroy the banking system through fiscal laxity.
Finally, Cole noted, there were many different types of rural financial models besides the community-based lending ones. The Bank Rakyat Indonesian Unit Desas was not an example of a community-based lending system, but a government-owned bank that made loans to individuals, with strong incentives to repay on time. Furthermore, there were a lot of informal institutions in Africa that could be easily linked to the organized financial system in constructive and creative ways.