Abstract
Selected Issues
Tax Revenue Mobilization Potential in Madagascar and Lessons from Successful Episodes in SSA1
Tax revenue mobilization improved in recent years in Madagascar but remains low compared to its peers and considering its large development needs. Under the Plan Emergence Madagascar, the authorities envision a sharp increase in tax revenue over the next five years— what are the possibilities? This paper takes stock of recent developments in revenue mobilization in Madagascar, estimates the country’s tax potential based on its structural characteristics and other factors, and draws some lessons from successful revenue mobilization episodes in other sub-Saharan African (SSA) countries. The analysis shows that there is a significant tax potential including through a possible broadening of the tax base, notably for consumption taxation (VAT and excises); and underscores the importance of a comprehensive revenue strategy, including by combining reforms in tax policy and in tax and customs administrations.
A. The Need for Further Revenue Mobilization in Madagascar
1. Despite recent progress, tax revenue remains low (Figure 1). The tax-to-GDP ratio is expected to increase for the seventh year in a row in 2019. Despite this encouraging finding, Madagascar’s tax-to-GDP ratio remains one of the lowest in SSA. It is currently 10.4 percent of GDP, significantly lower than 15.5 percent of GDP in non-resource rich low-income and developing countries (LICDs) and 15 percent in all SSA countries.
2. Increasing revenue collection is essential for achieving development objectives while preserving fiscal sustainability. Substantial resources are needed in Madagascar to mitigate the country’s fragilities and make significant progress towards the Sustainable Development Goals. While part of the needed financing for such needs can come from private investment or from official development assistance (ODA), increasing domestic resources is crucial to create additional fiscal space for much needed priority spending in infrastructure, education, and health. Mobilizing domestic resources for financing is also important for preserving medium-term fiscal sustainability. While Madagascar remains at low risk of external debt distress and moderate risk of overall public debt distress, shocks could create liquidity problems as the debt-service to revenue ratio is already high.
3. Madagascar experienced several episodes of tax revenue mobilization, but they were often followed by substantial declines reversing the gains achieved (Figure 1). Tax revenues increased by 3 percentage points of GDP during 1995–2000 before returning in 2002 at a level below the initial level. Similarly, during 2002–2008, the tax-to-GDP improved by 4 percentage points of GDP in 6 years before losing half of this gain in a single year. Although these reversals are mainly due to the country’s fragilities and a series of socio-political crises, these experiences underscore the need for a continued revenue mobilization effort over an extended period.
4. The authorities envision large increases in tax revenue in the coming years. Their objective is to increase the net tax-to-GDP ratio to 15 percent of GDP by 2023, which implies increases of more than 1 percentage point of GDP per year over this period. This is extremely ambitious considering that such an increase in a single year has been observed in Madagascar only once in the last twenty years. Over the 2012–2019 period, during which revenues increased each year, the average yearly increase was about 0.4 percentage point of GDP.
B. Estimating of Madagascar’s Tax Potential
5. An empirical analysis can be used to estimate the tax revenue potential for Madagascar.2 One way to assess the amount of additional taxes that Madagascar can potentially collect is to compare its tax-to-GDP ratio with that of other countries with similar characteristics, including the level of economic and institutional development. Such an analysis can define a tax frontier (or theorical tax capacity), that is, the highest level that a country can expect to achieve given underlying macroeconomic and institutional conditions. The distance between actual tax revenues and the tax frontier in a particular year measures the theorical tax potential, which reflects the tax revenue gains that a country could achieve through tax policy changes or improvement in the efficiency of collection.
6. The tax frontier for SSA countries is estimated using a panel of 123 countries from 2000–2018 (Annex I). The model uses a set of independent variables commonly found to be associated with the level of tax revenue, including GDP per capita, trade openness, the share of agriculture in GDP, income inequality and public spending on education. Variables measuring corruption and government effectiveness are also included to assess the impact of institutions.
7. Results suggest that Madagascar’s tax potential is greater than 6 percent of GDP (Figure 3). The October 2017 REO chapter estimates a tax potential of about 6.5 percent of GDP for Madagascar. An updated estimation using data up to 2018 estimates a tax potential of about 7 percent of GDP, which could reflect structural improvements in recent years. The potential for Madagascar is larger than the average for SSA countries (about 4.8 to 5.5 percent of GDP) and other fragile states (about 3.9 to 5.0 percent of GDP). Since taxes on goods and services provide a substantial share of revenues in many countries, we repeat the estimation using the ratio of taxes on goods and services-to-GDP as dependent variable. Results suggest that the tax potential from taxes on goods and services in Madagascar is large, implying possible gains from value-added and excise taxes.
Tax Potential Estimate
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A001
Source: IMF staff estimate.Tax Potential Estimate
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A001
Source: IMF staff estimate.Tax Potential Estimate
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A001
Source: IMF staff estimate.8. Tax potential estimates should be used with caution and always in line with priorities. First, estimates can be sensitive to modeling assumptions and estimations techniques. Second, the tax potential does not need to be the target: it reflects preferences, including accepting higher tax burdens to finance the delivery of public services, and tax policy choices (for example, about whether tax exemptions on basic consumer staples—essential for the most vulnerable—should be removed to increase collection). Nevertheless, the tax frontier is not an absolute limit: it can be increased overtime by improving macroeconomic and institutional conditions.
C. Experience from Successful Episodes in Other SSA Countries
9. Sustained revenue mobilization can be challenging. The analysis in the October 2017 SSA Regional Economic Outlook covering the 2000–2016 period found only six episodes of sustained revenue mobilization—defined as a total increase of 2 percentage points of non-resource GDP over a three-year period with no substantial declines in the revenue ratio within or immediately following the period.
10. Successful episodes share some common characteristics. There are successful episodes in countries at various income levels, and initial levels of tax revenue. These successful experiences share some commonalities:
All cases point to the need for a broad range of tax policy and revenue administrative reforms prior to and during the mobilization episode.
Each country embarked on a comprehensive and multiyear reform strategy, with some common elements, including a focus on basic institutions, measures to broaden the tax base, and modernization of tax administrations.
A strong and sustained political commitment is needed. Progress on revenue mobilization can be slow or incremental, over a prolonged period. While a sound reform strategy that seeks to build effective and modern institutions is critical, political commitment to carry out reforms is also essential.
Need to build consensus for reform. To ensure better tax compliance, a social contract between the state and the citizen—the state exercises its legitimate right to collect taxes in exchange for effective and transparent government spending—must be established. Credible commitment to better governance and transparency is essential.
D. Lessons for Madagascar
11. The authorities’ determination to enhance revenue collection is welcome, but may be too optimistic. Based on evidence from recent achievements in Madagascar as well as successful revenue mobilization episodes in other SSA countries, ambitious but credible annual increases of about 0.5 percentage point of GDP per year over the medium-term could be considered a success.
12. The potential for taxes on goods and services could be better exploited:
The yield from VAT can be improved, notably by the rationalization of tax expenditures. The tax policy unit at the Ministry of Economy and Finance already undertaken an impact analysis of tax expenditures for 2016, 2017 and 2018 (annexed to the budget laws), and started to evaluate the many existing exemptions, their cost, and effectiveness. Some first measures on taxation of wheat and corn have been introduced in the 2020 budget law.
The yield from excise tax could also be improved. Compared to peers, excises remain a relatively untapped source of revenue in Madagascar. Country experiences show that the elasticity of demand in relation of price is generally low for some goods subjects to excise duties (tobacco, alcohol, luxury goods). Some increases have been introduced in the 2020 budget law (on tobacco and beer), but there is also considerable room for maneuver to modernize and optimize the management and control of existing excise duties on alcohol, tobacco and telecommunications. In addition, the country could also consider introducing excise taxes on new goods.
Excise Taxes
(Percent of GDP)
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A001
Source: IMF staff.Excise Taxes
(Percent of GDP)
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A001
Source: IMF staff.Excise Taxes
(Percent of GDP)
Citation: IMF Staff Country Reports 2020, 061; 10.5089/9781513534213.002.A001
Source: IMF staff.13. Reforms initiated in 2015 at the Tax General Department must be continued and strengthened. Significant progress has been made in terms of organization, simplification of procedures, management (including with the establishment of performance contracts), and dialogue with the taxpayers (including the organization of tax controls). A recent FAD TA mission3 stressed the following priorities:
Revive tax control operations that have slowed down during the installation of the new government and new administrative teams. This enhancement of control activity should come with external and internal communication efforts, and tax audit performance should be measured based on the proportion of active taxpayers (notably the big enterprises) controlled.
Optimize the management of human and budgetary resources, proceeding without delay to the assignments of new agents, starting with those intended for tax control. Beyond the performance contracts by directions, establish systems for evaluating individual performance, and apply planned disciplinary measures when necessary.
Improve the collection of outstanding tax payments (“Restes à Recouvrer”), with the stock estimated at about 1 percent of GDP.
Strengthen the reliability of taxpayer identification already initiated. Efforts to better exploit the anomalies detected in the use of the Tax Identification Number (NIF) must be pursued.
Define an appropriate threshold for the application of VAT. The current threshold is low (MGA 200 million, about US$ 50,000), and its application requires important resources for very limited results. A threshold of MGA 500 million could result in the elimination of less than 100 companies from the portfolio of the Large Enterprise Directorate, representing barely 0.01% of total VAT revenues, and would allow this Directorate to focus on more important cases.
14. The modernization of customs administration should continue. A customs administration reform plan for the 2020–2023 period is under finalization, and FAD TA recommendations include:
Target the organized fraud and reduce the irregularities in customs clearance. Up to 70 percent of the import declarations remain non-compliant, but only 3 percent are notified by the customs offices.
Intensify the control of the companies benefitting from free zone- or other exemption-agreements. While they account for 40 percent of total imports, no customs infringement has been officially recorded in 2018 and 2019 regarding exemptions and free enterprises.
Strengthen the fight against corruption, including by improving internal ethics and implementing disciplinary measures.
15. Communication between the two tax administrations could be improved. The tax administrations should notify each other if a case of fraud. Also, the domestic tax administration should have access to customs import/export data: many importers are active and make customs declarations without being identified by the domestic tax administration.
16. Getting the buy-in of all stakeholders remains a challenge. Given the weaknesses in the provision of public services, social dialogue and consultation are important to explain the rationality of the tax system and the use of the tax revenue by the State. It is also important that an improvement in tax collection is accompanied by a facilitation of the administrative procedures for the taxpayers. In this regard, the development of on-line declaration and payment procedures, already successfully used by a growing number of large companies, is welcome.
Annex I. Estimating Tax Frontier and Tax Potential
Step 1: Estimate the tax frontier from a cross-country panel data set
where
yit is the log of the rax revenue-to-GDP ratio for country i at period year t
Xit is a vector of independent variables that affect yit
μit is the inefficiency, which is correlated with Xit, but independent from ϑit, and if is the residual, and normal distribution with N(0,1)
Step 2: Determine the tax effort
Step 3: Determine the tax frontier and tax potential
Data and Variables
Log of tax to GDP: World Economic Outlook (WEO)
Log of tax on goods and services to GDP: WEO
Lag of log of real GDP per capita: WEO
Lag of log of real GDP per capita squared: WTLO
Trade openness—sum of imports and exports in percent of GDP: WEO
Agriculture: Value added of agriculture in percent of GDP: World Bank, World Development Indicators (WDI)
Gini coefficient: WDI
Oil: dummy for oil exporters
General Government: dummy for General Government tax revenues.
Corruption and Government Effectiveness: Worldwide Governance Indicators (WGI).
Prepared by Gabriel Léost.
We follow the estimation approach in the October 2017 SSA regional Economic Outlook “The Impact of Fiscal Consolidation on Growth in Sub-Saharan Africa” and the April 2018 SSA Regional Economic Outlook “Domestic Revenue Mobilization in SSA: What Are the Possibilities?”
See the November 2019 mission on Progress in tax and customs administrations reforms (Clark, Montagnat-Rentier, de Santis, Wood and Lesprit).
