Forestry Taxation in Africa
The Case of Liberia

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Countries generally tax the forestry sector to achieve the twin objectives of revenue maximization and sustainability of logging levels. In an ideal world of perfect markets and information, auctions would be the best instrument to determine the price of extraction rights. However, a number of factors-including a lack of information on the forest resources under consideration, uncertainties as to the stability of property rights over time, and a lack of access to credit-have limited the use of auctions so far, particularly in low-income countries. To establish transparency of the forestry sector's financial flows, this paper discusses a radical simplification of Liberia's current timber tax structure, including a proposal to reduce the sector's current tax system to two instruments, an area tax and an export tax.


Countries generally tax the forestry sector to achieve the twin objectives of revenue maximization and sustainability of logging levels. In an ideal world of perfect markets and information, auctions would be the best instrument to determine the price of extraction rights. However, a number of factors-including a lack of information on the forest resources under consideration, uncertainties as to the stability of property rights over time, and a lack of access to credit-have limited the use of auctions so far, particularly in low-income countries. To establish transparency of the forestry sector's financial flows, this paper discusses a radical simplification of Liberia's current timber tax structure, including a proposal to reduce the sector's current tax system to two instruments, an area tax and an export tax.

I. Introduction

Liberia is well-endowed with valuable forest resources, and the sector has made an important contribution to GDP over the past few decades. However, the diversion of revenue from the sector to fund Liberia’s civil war through 2003 led the UN Security Council to impose a ban on timber exports since mid-2003. Taking into account the sector’s revenue potential, but also concerns about sustainable logging, the Security Council has imposed a number of preconditions for the lifting of its sanctions. One important condition is the establishment of a transparent system of revenue collection.

To establish transparency of the sector’s financial flows, Liberia is taking a number of actions with external assistance. To this end, this paper discusses a radical simplification of Liberia’s current timber tax structure. The paper proceeds as follows: After a description of the evolution of Liberia’s timber sector and of its tax structure, it provides an overview of the theory of timber taxation. Based on a theoretical model, a range of taxes and fees applied to forestry activities is being evaluated in light of the objectives of maximizing revenue collections, achieving sustainable logging levels, and promoting transparency through the use of levies that are easy to administer. Based on the need to establish simple and transparent collection mechanisms, the concluding section presents a proposal to reduce the sector’s current tax system to two instruments, an area tax and an export tax. Over the medium term, and if the sector’s tax administration capacity is improved, the export tax should be replaced by a tax on production.

II. Liberia’s Timber Sector

A. Evolution of Liberia’s Timber Sector

Liberia’s forest resources are significant. About half of the country’s area is covered by high forests, compared with less than 10 percent of arable land. Liberia’s forests are equivalent to about 45 percent of the remaining Upper Guinea Forest, which spans 10 West African countries from Guinea to Cameroon. They contain a number of valuable species— such as African mahogany—that are in high demand on world markets.

Timber activity began in the late 1960s, driven by low stumpage fees and the establishment of basic road infrastructure that opened access to forest areas. Through the mid-1970s, the timber sector was the fastest-growing sector of the economy, increasing its contribution to GDP from less than 5 percent to about 20 percent. Logging activity was carried out largely by foreign concessionaries. During the second half of the 1970s, the world demand for timber products dropped in response to global recessions, and the number of concessions declined from 49 in 1974 to fewer than 30 by 1980, also owing to the depletion of easily accessible logging areas.

During the first half of the 1980s, the timber sector remained stagnant because of the weak global demand in key markets but also because of political instability in Liberia. The sector had recovered somewhat by the late 1980s, but the outbreak of civil strife interrupted the sector’s formal activities until peace was restored in 1997. Thereafter, logging activity recovered very rapidly, driven also by the demand for charcoal and firewood, reflecting the breakdown of the country’s regular electricity supply.

The surge in logging activity soon raised concerns about its sustainability. In addition, international nongovernmental organizations began to point to possible links between Liberia’s timber sector and its support for the civil war in Sierra Leone. A comparison between export data reported by the Liberian authorities and those from importing countries indicates that an important share of exports may have taken place at the margin of official channels.

Liberia: Timber Exports, 1997-2002

(In thousands of U.S. Dollars, f.o.b. basis)

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Source: United Nations COMTRADE database (commodity 4403, rough/squared wood).

U.N. Secretary General’s report to the Security Council (S/2003/793, August 5, 2003).

Reflecting these developments, the UN Security Council began to pay increasing attention to the possible link between Liberia’s timber activities and the civil war in Sierra Leone and the reemergence of internal hostilities in Liberia. Following the imposition of sanctions on Liberia related to its diamond trade and the civil war in Sierra Leone in 2001, the Security Council’s panel of experts highlighted the existence of extrabudgetary transactions associated with timber activities and the involvement of timber companies in violating UN sanctions.2

To address these issues, the UN Security Council requested in 2002 that the government take steps, including the establishment of a transparent audit regime, to ensure that revenue from timber and other activities would be used for legitimate social, humanitarian, and development purposes. Independent audits sponsored by the European Union (EU) were expected to provide the necessary assurances, but the external auditor hired by the EU withdrew from the audit in late 2002, and the government of Liberia hired a local auditor. However, the UN Security Council determined in May 2003 that the local auditor did not provide the required assurances and, in light of the intensifying internal conflict, decided to impose a ban on exports of all timber products, which went into effect in July 2003.

Although the National Transitional Government of Liberia (NTGL) took office in October 2003, the Security Council decided against lifting the sanctions, citing the NTGL’s lack of control over the logging areas, the continued lack of transparency of the revenue flow, and the need to establish effective oversight of the sector’s activities.3 Sanctions were again extended for 12 months at end-2004.

B. Liberia’s Timber Revenue System

Over time, the number of taxes, charges, and fees on forestry activity has proliferated, driven particularly by the introduction of new taxes for specific purposes during the 1980s (see Appendix I for all current taxes, fees, and changes in timber activity). Four different charges are levied on the volume of trees (not specified by species) at the felling stage: two schedules of export taxes, differentiated by 28 species and also, for processed wood, by three stages of processing. In addition, eight administrative fees are levied on forestry activity and six on port services. Finally, there is an area tax. In sum, a tree can easily be subject to about 20 taxes, fees, and charges, based, to varying degrees, on volume, species, degree of processing, and administrative actions required.

Timber companies are also financially committed under concessions to the construction of schools, clinics, or roads. Furthermore, it became common practice for timber companies to undertake certain tasks that were originally the responsibility of the government, such as road construction, and were granted tax credits for those activities.

It is doubtful that the existing revenue system has any clear objective. Also, the presumed earmarking of certain revenue for specific purposes has been ineffective, given a revenue-sharing agreement between the Forestry Development Authority (FDA) and the Ministry of Finance, which does not recognize such earmarking and the absence of a sign that the FDA has directed collected revenue to the intended purposes. However, the existence of multiple processes to assess these different charges has created a lack of transparency and significant opportunities for misappropriations of revenue.

These concerns are compounded by the FDA’s weakening over time. Founded in 1976 to oversee the timber sector and collect revenue, the FDA’s functions were severely curtailed when a law was passed in 2000 to transfer the administration of contracts of so-called strategic commodities (including timber) to Liberia’s president and when the FDA’s Board of Directors was suspended for administrative reasons. Furthermore, with the hostilities in 2003 completely destroying its facilities, car park, and files, the FDA will require substantial technical and financial support to rebuild its structure before it can resume any role in the oversight of the forestry sector. A decision on the institutional arrangements for collecting revenue and granting concessions will also need to be made—the FDA’s role in supervising the sector conflicts with its function as tax collector and administrator of concessions.

III. Why Are Forestry Taxes Different from other Taxes?

The taxation of the forestry sector is different from that of other sectors. First, the government, the sovereign tax authority and, in many cases, the natural resource owner, play a dual fiscal role. As the sovereign tax power, the government is responsible for ensuring that the natural resource sector makes its due contribution to public revenues. As the resource owner, the government must determine when to exploit its natural resources as well as ensure that it obtains an appropriate price for its resources, with related considerations of distributing the benefits of resource exploitation so as to promote sustainable economic growth and intergenerational equity. At one level, there is a fundamental conflict between resource companies and the government over the division of the risk and reward of resource development. Both parties want to maximize rewards and shift as much risk as possible to the other party. At another level, resource agreements and the associated fiscal rules create mutually shared interest between the resource company and the government. The magnitude of revenues to be divided is maximized through fiscal arrangements that encourage a stable fiscal environment and efficient resource development.

Second, taxation of forestry sector represents the price for the right to extract a scarce resource, whereas traditional taxes are concerned with raising a given amount of revenue while minimizing efficiency, equity, and administration costs. Third, forests provide multiple services to society, not merely the market value of the wood harvested. These services include watershed protection, rangeland, recreation opportunities, and aesthetic values. Since many of these services are nonmarketable, private owners will make harvest decisions that may not coincide with maximizing the social benefits from woodland exploitation. However, the form in which these taxes are imposed influences the owner’s decision on when to cut and hence the size of the social benefits obtainable from forestry. Forestry taxes can thus help reduce negative externalities and create positive externalities. Also, property rights, which define the rights to natural resources and the associated fiscal arrangements, are often not stable. The design of natural resource tax arrangements plays a role in determining the stability of natural resource property rights and thus influences the efficiency with which natural resources are exploited and their potential fiscal return.

In pursuing its objectives, the government needs to assess how efficient the various types of tax instruments would be in achieving them, their effect on the incentives and behavior of taxed companies, and their simplicity in terms of administrative costs. Based on a theoretical model presented in Appendix II, the following section compares alternative tax instruments being used in the forestry sector, with regard to their impact on efficiency, incentives, and administrative simplicity.

IV. Assessment of Fiscal Instruments Used in Forestry Sector4

The potential use of auctions as a policy tool for allocating public resources is increasingly being recognized in the economic literature.5 Not only can well-designed auctions raise revenue for the government, but they also promote efficient allocation of resources. The government can also design the rules of the auction to address various policy goals, such as avoiding a monopoly or directing licenses to local firms. However, in many countries, auctions do not work because of poor design, political preference, market failures, and the absence of natural resource property rights. In the forestry sector, the costs to potential bidders in obtaining information on the forest, the timber, the contract requirements, and the costs of fulfilling the requirements can be a significant problem in auctioning forest contracts. In the presence of imperfect credit markets, the costs, along with the risk and uncertainty of inadequate information, can discourage bidders and result in lower bids on forest use contracts (Gillis, 1992).

In light of these difficulties, a variety of second-best fiscal instruments are used in the forestry sector. (See Figure 1 for an overview of the taxes and fees that apply to the forestry sector.) The most common fees that apply to forest sector activities are stumpage fees, or royalties, based on the amount of timber harvested. This type of fee can be based on the volume of timber harvested (per cubic meter), the number of trees harvested, or the value of the trees harvested, with each type having its own advantages. However, fees based solely on the quantity of timber extracted may lead to “high grading”—the practice of selectively extracting only the most valuable tree species, leaving harvestable timber in the forest. This practice is economically inefficient in the long run because it creates disincentives for forestry practices that would maximize the net present value of log production under sustained production—that is, the entire value of areas set aside for logging is not captured. It can also increase waste because trees are often damaged or destroyed in the process of getting to the high-value trees scattered in large forest segments.

Figure 1.
Figure 1.

Flow of Timber Through the Forest Sector and Application of Taxes

Citation: IMF Working Papers 2005, 156; 10.5089/9781451861754.001.A001

In general, stumpage fees and royalties, if they are differentiated enough across species and updated frequently to reflect market conditions, have the potential to yield a high proportion of revenues. Their key disadvantage is that they can be quite complex to determine and can thus burden understaffed and poorly funded forestry agencies that are in charge of measuring and classifying timber harvest. Fees can also be applied to timber after it has been extracted and processed into other wood products, such as sawn wood, veneer, and plywood. Fees on processed products are classified as postharvest fees, as opposed to the harvest-based fees discussed above. One of the main advantages of postharvest fees is that they can be applied to logs that are illegally harvested. In countries where a large proportion of timber is processed for export, and illegally harvested timber makes up a large portion of processed wood products, postharvest fees can raise significant revenues. They are also easier to apply because it is relatively simple to measure the quantity of products manufactured or exported. Postharvest fees are quite common, with many governments applying them (or even imposing outright export restrictions) on unprocessed logs to encourage domestic processing of timber. However, because post-harvest fees are often estimated based on the amount of timber that would be required to produce a given amount of processed wood, these fees can penalize more efficient processing firms.

The profit tax and the area tax are in a different category. The profit tax is levied on a company’s total returns (after other taxes); the area tax is as a productivity tax, charged on an equal and annual basis on each hectare under concession. These taxes represent a powerful instrument with which to collect revenues. Unfortunately, they are, to differing degrees, difficult to monitor or are arbitrarily applied, particularly in countries with weak tax administrations. For the profit tax, in particular, transfer pricing practices and the global characteristics of most timber-producing companies pose significant administrative challenges. In fact, many tropical forests are exploited by firms that have a short-term exploitation mentality and “hop” from one forest to the next—a behavior that can be changed only after property rights, including mechanisms to distinguish between investors, are well established and have been in place for a long time.

Governments have increasingly adopted preharvest fees such as concession fees and area fees. From a revenue perspective, preharvest fees have certain advantages. They are independent of the amount of timber harvested and encourage intensive use of the forest, with high recovery rates of timber from all valuable tree species, therefore effectively precluding “idle” concession areas.6 They also tend to be simpler to collect because they are defined in the concession agreement and do not require measuring and classifying the harvested timber. However, such fees could result in inefficient harvesting of low-value timber and the unnecessary destruction of forest biodiversity. Determining the appropriate fees may require a considerable amount of information on the quantity and quality of timber at specific sites unless the government auctions concessions.

Auctioning concessions may require less information, since governments can establish a minimum price for the concessions and the burden of evaluating the full value of such a concession falls on bidding companies. Under competitive conditions, auctions can be a mechanism to extract a high proportion of the rents available. However, the auctioning process is not free from political maneuvering problems.

In addition to fees specific to the forestry sector discussed above, other types of government taxes and charges may apply to activities in this sector. Just like other types of economic activities, the forestry sector may be subject to sales, export, and corporate profit taxes. While the primary motive for such taxes is to raise revenues, they do capture some amount of rent if forest-specific fees are below efficient levels. These taxes can sometimes be easier to collect, since they rely on institutions and procedures that are a part of the normal tax raising functions of a government. But because such taxes are not specifically designed to capture resource rents, they are usually inefficient mechanisms for this purpose, and have little or no incentive impact on the logging and wood processing industry. A summary of the advantages and disadvantages of forest taxes is given in Table 1.

Table 1.

Advantages and Disadvantages of Forest Taxes and Fees

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V. An Interim Proposal for Timber Taxation

A country’s forestry sector offers significant opportunities for its resource-constrained government to raise domestic revenues. Currently, the private sector captures a large proportion of forestry rents. Rent collection would result in social redistribution of rent between the state and the private sector, thereby freeing up resources for social and environmental investments. Economic theory suggests that the links between rent capture in the forestry sector could lead to a more efficient use of forest resources, which may, indirectly, reduce deforestation. However, the theoretical results on the links between rent capture in the forestry sector and resource efficiency are not definitive. Definitions of rent vary, and different taxes and competitive mechanisms penalize certain conservation practices and encourage others. Further, the economic and institutional context of individual countries determines whether and to what extent resource taxation enhances resource use and harvesting efficiency. Low rent capture in developing countries is closely tied to illegal harvesting and to implicit and explicit contractual agreements that benefit a few interest groups.

The inability of Liberia’s revenue collection agencies and the FDA to oversee timber activities requires that the tax and fee system be radically simplified. The collection activities should concentrate on stages of the process that do not require a high level of expertise and that are easy to monitor. While simplicity and transparency of the collection process need to take priority under these circumstances, sustainability should also be considered so as to avoid a return to unsustainable logging levels when UN sanctions are removed. As mentioned before, some tax instruments do a better job of gearing activity toward sustainability, which is imperative given that effective oversight of forestry activity does not exist.

One solution would be to reduce the current tax system to two instruments: taxes on timber exports that should be differentiated by species and an increased area tax. While an export tax should be strictly temporary, its ease of collection and the presence of an external collecting agency (Bureau Veritas) with a mandate to assess the value of exports, including timber, are important arguments for such a shift. Differentiation of the export tax by species will address the sustainability of forests because it will deter people from logging the higher-value species of trees. At the same time, the tax should be based on the number of logs filled to encourage the logging of larger trees, thus protecting the younger ones.

The higher area tax is proposed in light of the on-going review of concessions. As noted above, an area tax will not alter production decisions when the area has already been determined (like a change in the property tax for property already purchased); however, if concessionaires are permitted to determine the size of their concessions, the area tax is expected to influence those decisions. An early announcement of a change of area taxes could therefore induce concessionaries to request smaller areas, thus reducing logging and also helping to address the issue of overlapping concessions. On the collection side, area taxes are easy to administer once the area has been determined.

Forestry Taxation in Africa: The Case of Liberia
Author: Mr. Saji Thomas and Mr. Arnim Schwidrowski