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Republic of Mozambique: Selected Issues

Author(s):
International Monetary Fund. African Dept.
Published Date:
January 2016
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Fiscal Policy and Inclusive Growth in Mozambique1

A. Introduction

1. Inclusive growth is a key issue in Mozambique. Inclusive growth refers to a type of growth that is broadly shared, results in economic opportunities for the population (including through greater job opportunities) and ultimately has a noticeable impact on poverty reduction. While the poverty rate declined in Mozambique from 69 percent in 1997 to 54 percent in 2003, it seems to have remained stagnant since then (Ross et al. 2014).2 As a result, few countries offer such a stark contrast as Mozambique: one of the highest rates of economic growth in the world (average of 7.5 percent over two decades), coupled with an extremely low elasticity of poverty with respect to growth (about 0.1 percent).3 This suggests that a large share of the Mozambican population is not benefiting enough from these high levels of growth.

2. Inclusive growth issues are often complex and multidimensional. There is consensus that in low income countries inclusive growth requires (i) an emphasis on agriculture (because it is a labor intensive sector); (ii) improvements in the business environment (to attract investment and broaden economic opportunities); (iii) greater financial inclusion; and (iv) a well-designed fiscal policy. This paper focuses on this last dimension. How can fiscal policy help make growth more inclusive in Mozambique? In particular, this paper examines the role of that fiscal policy can play to reduce poverty and income inequality as a policy strategy to make growth more inclusive.

3. Fiscal policy can be one of the most effective instruments to reduce income inequality and help make growth more inclusive. The reduction in income inequality is important for three reasons. First, high levels of income inequality make it difficult to sustain growth over long periods of time (Berg and Ostry 2011). Second, it can lead to political instability (Alesina and Perotti 1996, Boix 2015) as citizens demand increasing access to economic resources – a challenge that can become even more acute in a country like Mozambique that is likely to become one of the largest liquefied natural gas (LNG) exporters in the world. And third, high levels of inequality hamper government policies to reduce poverty. In other words, the higher the level of inequality the lower the elasticity of poverty to growth is likely to be.

4. This chapter is organized as follows. Section II provides some stylized facts about inequality in Sub-Saharan Africa, and Mozambique, in comparative perspective; Section III analyzes how fiscal policy can play a greater role to reduce inequality in Mozambique, and Section IV provides some concluding reflections and highlights areas for further research.

B. Some Facts about Income Inequality

5. Income inequality has received increasing public attention since the global financial crisis and the events of the “Arab Spring”. Sub-Saharan Africa (SSA)’s income inequality remains among the highest in the world, with the second highest level after Latin America. But income inequality in SSA presents even greater policy challenges because SSA has the highest levels of poverty and gender inequality in the world, which suggests that a large share of the population is likely to be excluded from the benefits of “growth”. Another concern is the fact that income inequality in SSA is in general higher at all levels of income, compared with countries at similar income levels in other regions. International experience suggests that such persistently high income inequality can hamper macroeconomic stability and growth.

Figure 1.Selected Regions: Gini Index of Net Income Inequality 1980-2011

Source: Solt, Frederick. 2014. “The Standardized World Income Inequality Database.” Working paper. SWIID Version 5.0, October 2014.

6. In Mozambique, income inequality has increased despite high rates of economic growth. Both market-income inequality and the net Gini coefficient are worse in the 2000s than in the 1990s.4

Figure 2.Market-Income Gini Coefficient 1/

(Points)

Sources: Standarized World Income Inequality Database and author’s calculations.

1/ Unweighted average by years.

Figure 3.Net Gini Coefficient 1/

(Points)

Sources: Standarized World Income Inequality Database and author’s calculations.

1/ Unweighted average by years.

The increase in the Gini coefficient from 0.44, on average, in the 1990s to 0.47 in the 2000s contrasts with Mozambique’s strong and sustained economic growth of above seven percent over the last two decades.5

7. Income inequality in Mozambique also has a spatial dimension. Most of the country’s wealth is located in the southern area, and especially around the capital Maputo. Similarly, higher rates of poverty appear to be highly concentrated in the central and northern regions, particularly in rural areas (Alfani et al. 2012). Fiscal transfers to rural areas could help address this spatial dimension of inequality, but experience with fiscal transfers to date so far, especially to municipalities, has shown mixed results.

Figure 4.Poverty Headcount by Posto Administrativo

(Fixed intervals)

C. Three Key Policy priorities

8. Fiscal policy can play a key role to help reduce income inequality through three mechanisms: tax policy, public investment, and social policies.

Tax Policy

9. Direct taxes, especially personal income taxes, are often preferable for redistributive purposes than consumption taxes. In Mozambique, the share of direct taxes has increased over time, and income taxes now account for about 40 percent of tax collections (excluding capital gain taxes). While property tax revenue is progressive and is considered less disruptive for economic growth,6 its current share in Mozambique is negligible. Despite the increase in the share of direct taxes over time, their relative efficiency is low. In particular, the efficiency of the corporate income tax is low due to the system of fiscal incentives (2009 Fiscal Benefits Code), which tends to favor large, capital intensive projects.7 Higher income brackets also enjoy larger tax credits. There is a special regime for small taxpayers but its equity could be improved by increasing the exemption threshold to ensure that small taxpayers are not unduly burdened.8

Figure 5.Composition of Fiscal Tax Collections

(excl. CGT)

10. Reducing consumption tax rates, with broadening of the base and improvements in efficiency to avoid a loss of revenues, can also help redistribute income. Like in other Sub-Saharan countries, the VAT has become a key source of fiscal revenues. But the Mozambican VAT is crippled with an extensive list of exempt and zero-rated items which need to be reviewed and rationalized. Exemptions have an unclear impact on the poor and shrink the tax base. VAT efficiency in Mozambique is well below the average for Southern African Development Community (SADC).9 Reviewing the current VAT structure could help prevent an erosion in the tax base and ensure that the benefits accrue to the worse off part of the society.

Figure 6.Sub-Saharan Africa: Fiscal Revenue, 1990-2011

11. Finally, fiscal incentives in Mozambique are costly and reduce fiscal space for other social spending. A variety of fiscal incentives have been offered in several sectors10 to attract investment. While tax expenditure decreased in 201411 due to a reduction in the number of investment projects, they still represented 3.3 percent of GDP, with an increasingly high concentration of VAT import exemptions for large investment projects.

Figure 7.Tax expenditure

(% total)

D. PFM and Public Investment Management

12. Public spending in Mozambique has increased rapidly over the last few years, but its efficiency and redistributive capacity is limited.12 In percent of GDP, public spending in Mozambique is higher than in most countries in the region, including South Africa (which has the highest income per capital in the SADC region). But the Mozambican economy is comparatively small (just 5 percent of South Africa) and public spending per capita is only $283 (one of the lowest in Sub-Saharan Africa). In addition, growing public spending has also been driven by the wage bill, goods and services and domestically financed capital expenditures, with insufficient controls to ensure value-for-money.

Figure 8.Sub-Saharan Africa: Public Expenditure

13. Certain reforms could increase the efficiency of public spending and its redistributive potential:

  • Public spending should be better aligned with a robust medium-term fiscal framework that ensures fiscal sustainability. No redistributive policy can succeed over the long term if it does not ensure fiscal sustainability. The pace of debt accumulation and the increase in public spending in recent years are not sustainable, also resulting from the poor quality of debt contracted and a lack of rigor in project selection criteria. This can lead to a negative stop-and-go spending pattern. An abrupt need for fiscal consolidation often hits the poor and the most vulnerable segments of the population as governments often resort to across-the-board cuts. The adoption of a fiscal rule, embedded in fiscal responsibility legislation, could help achieve this objective and ensure that the revenue boost provided by natural resource revenues is used effectively, including by focusing on equality-enhancing expansions in health and education.
  • The public investment management system should ensure that the best and most efficient programs are chosen as part of the multi-year planning and annual budget cycle process. Choosing projects without proper due diligence or highly concentrating projects in one part of the country mean that some regions benefit more than others, or that some sectors get a disproportionate amount of public resources. This is not conducive to effective redistribution and inclusive growth. Although borrowing was concentrated on projects in the South of the country until 2012, new loan contraction has become increasingly more geographically balanced. Current reforms are likely to contribute to further improvements, including efforts to (i) approve a new legal and institutional framework for public investment management, (ii) introduce mandatory evaluations by a centralized evaluation committee using feasibility studies and a set of well-defined rules, and (iii) develop a comprehensive project database.
  • Expensive fuel subsidies could also be eliminated taking advantage of lower oil prices. These subsidies are costly and highly regressive. In 2014 they were equivalent to 1.4 percent of GDP and less than 2 percent of the subsidy accrued to the bottom quintile of the population.

E. Priority Spending

14. The current definition of priority spending is too broad and makes it difficult to identify the most critical social programs. Under the current budget classification, over 70 percent of the government budget is classified as priority spending. The use of an administrative classification means that the budget of entire ministries is classified as “priority” irrespective of the actual programs/projects that are being financed by a particular ministry. For example, the purchase of new cars for the Ministry of Health would be classified as priority to the same degree as the procurement of vaccines. There is therefore a need to identify specific programs as priority, rather than classifying the whole budget of a particular ministry.

Conclusion

15. Mozambique has benefited from strong and sustained economic growth over the last two decades. However, this economic growth has not been sufficiently inclusive. Mozambique’s income inequality has increased over the last decade despite high rates of economic growth. This suggests that the benefits of growth have not been broadly shared, and the elasticity of poverty to growth has been relatively low. Geographical inequality (with much higher income levels in the Southern provinces) could also become a source of political tension given that most of the natural resource wealth is located in the Northern provinces.

16. Within this context, fiscal policy can play a useful role to help reduce income inequality. Key reforms would include (i) expansion of the tax base, reduction of exemptions (which have accrued to large corporations) and increasing reliance on direct taxes; (ii) greater focus on the efficiency and the appropriate sectoral and geographical distribution of public investment; and (iii) a reduction in the scope of priority spending to focus on the most critical social sectors and programs.

Reference

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1

This chapter was prepared by Leandro Medina and Alex Segura-Ubiergo.

2

Mozambique is undertaking a household survey which is expected to update the poverty rate in the coming months.

3

This means that a one percent increase in per capita income only results in a reduction of 0.1 percent in the poverty rate.

4

The Market-income Gini coefficient is a standardized measure of income inequality before taxes and transfers, while the Net Gini coefficient measures inequality after taxes and transfers.

5

The Gini coefficient is a standardized measure of statistical dispersion intended to represent the income distribution of a nation’s residents, and is the most commonly used measure of inequality. The highest the Gini index, the more unequal the income distribution in a given country.

6

Tax and Economic Growth, Economics Department Working Paper No. 620. OECD, 2008.

7

A recent independent study argues that large mining projects by foreign companies in Mozambique account for up to 12 percent of GDP but contribute less than 3 percent of tax revenues and represent 3 percent of employment. Fjeldstad and Heggstad, 2011.

8

Varsano, IMF, 2012.

9

Public Expenditure Review. World Bank, 2014.

10

This includes tax holidays, tax rate deductions, investment tax credits, accelerated depreciation, and exemptions and deductions for inflated expenses.

11

Tax expenditure is reported in fiscal reports and decreased from 4 percent of GDP in 2013 to 3.3 percent in 2014.

12

Total expenditures and net lending reached over 42 percent of GDP in 2014.

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