Business Taxation in a Low-Revenue Economy a study on Uganda in Comparison With Neighboring Countries
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B. CROSS-BORDER COMPARISON OF METR ON CAPITALIn order to focus the cross-country comparison exclusively on the impact of taxation, Uganda’s non-tax parameters and capital structure are applied to Kenya and Tanzania as well. With these assumptions, we find that Uganda has a tax disadvantage compared to Kenya in both manufacturing and tourism, mainly due to Kenya’s preferential tax treatment targeted to these two sectors (Table 14). In tourism, Uganda is also less competitive than Tanzania in terms of taxation, mainly due to its local property tax on buildings, which accounts for 71 percent of capital in the tourism sector. There are a number of factors contributing to this outcome. First, there is no property tax on structures in Kenya and Tanzania. As a result, even without taking into account the initial investment allowances available in Kenya, buildings are taxed significantly less in Kenya and Tanzania than in Uganda.30 A slightly more generous tax depreciation rate for buildings in the tourism sector (6 percent vs. 5 percent) also contributes to a lower METR on buildings in Tanzania. Second, Kenya provides an initial investment allowance of 60 percent for both buildings and machinery for manufacturing and tourism. Despite its slightly higher corporate income tax rate, buildings in Kenya are therefore taxed much more lightly than in Uganda and Tanzania. Third, a non-zero import duty on most machinery imported to Kenya and Tanzania is the main contributor to their higher METRs on machinery compared to Uganda. Fourth, the higher corporate income tax rate in Kenya results in a higher METR on inventory through inflated taxable income under FIFO. In the case of Tanzania, a higher dividend withholding tax rate induces a higher financing cost that contributes to a higher METR on inventory compared to Uganda. Finally, the different property tax rates on land play a major role on the variation in the METR on land. As a result, the highest METR on land is in Tanzania (39 percent), followed by Uganda and Kenya (33 percent and 28 percent, respectively). Table 15 provides a simulation of the base case using their country-specific interest rate and inflation rates. As shown in Table 13, both Kenya and Tanzania have had much higher inflation (9 percent and 18 percent, respectively, compared to 5 percent in Uganda) and nominal interest rate (30 percent and 25 percent, respectively, compared to 21 percent in Uganda). As a result, inventories are taxed much highly in Kenya and Tanzania. On the other hand, tax deductibility for debt financing benefits other types of assets more in Kenya and Tanzania, as their nominal debt financing costs are higher. Therefore, considering that manufacturing has a high share of inventory capital and that the share of structures is extremely high in tourism, it is not surprising that Tanzania exhibits a much higher METR in manufacturing and a much lower one in tourism when using its country-specific non-tax economic parameters. C. CROSS-BORDER COMPARISON ON COST OF PRODUCTIONAgain, in order to isolate the impact of taxation, Uganda’s non-tax parameters, including the cost structure, are applied to Kenya and Tanzania. As before, the METR on labor is the average payroll tax payable by employers, and the METR on fuel is the effective average tax rate on motor fuels. As shown in Table 16, Kenya has the lowest METR on labor, followed by Tanzania (0.1 percent and 4 percent respectively, compared to 10 percent in Uganda). Tanzania has the lowest METR on fuel, followed by Kenya (26 percent and 64 percent, respectively, compared to 174 percent in Uganda). As a result, measured on cost of production Uganda becomes the highest taxed country in both manufacturing and tourism. Tanzania’s tax competitiveness in tourism becomes more evident, while its manufacturing sector has now a lower tax burden than its counterpart in Uganda. Kenya has an even greater tax advantage over Uganda in both sectors. V. SURVEY EVIDENCE ON COMPLIANCE, TAX INCENTIVES AND ADMINISTRATION A typical METR analysis provides an assessment of the tax structure without dealing with administrative realities. Administration can, however, create major distortions no matter how well designed a tax system if it is not managed efficiently and fairly. This section examines key features of taxpayer compliance, tax incentives for investors and tax administration in Uganda, based on firm survey evidence. The purpose is to isolate factors which are likely to make the true tax burden different from that resulting from the formal system.A. SURVEY EVIDENCE ON TAX COMPLIANCETaxpayer compliance depends on economic incentives embedded in the tax structure and the effectiveness in detecting and penalizing non-compliance.31 At the margin, people engage in tax evasion when the expected benefits (lower taxes) are equal to the expected costs (bribes, punishment etc.). According to the 1998 firm survey, one third of Ugandan firms were in a tax-loss position in 1997, that is, they neither paid the CIT nor had a tax holiday (Table 17). While it may appear high, this ratio is not out of line with international experience. For example, the Canadian statistics show that, on average, over 40 percent of active non-financial firms are in the tax-loss position. Twenty-six percent of Ugandan firms did not pay the VAT in 1997 which is not unexpected either as many smaller firms may not be registered for the VAT. Commercial agriculture has the largest share of non-VAT paying firms. This is broadly consistent with the design of the VAT system (i.e., foods are zero-rated in general). Eight percent of Ugandan firms with five or more employees do not pay any taxes at all. Whether or not firms are contented with their own level of taxes, they clearly feel disadvantaged when they see their competitors escaping taxation. In the 1994 survey of Ugandan firms, respondents identified competitors’ evasion of taxes as a major constraint.32 Some 60 percent of firms reported that they faced unfair competition. Furthermore, firms estimated the informal economy (part of the economy evading taxes, duties or laws and regulations) to be substantial, with estimates centering around 43 percent. In 1998 this perception remains, with tax evasion being the leading constraint from unfair competition. However, the numerical constraint scores for competitors evading taxes, or smuggling have declined, with the most marked apparent change in the latter. Despite some improvement in perceptions, the legacy of a predatory state, coupled with little improvement in service delivery, continues to have an adverse effect on tax compliance in Uganda. In the 1998 survey, firms in manufacturing, which is the second highest taxed sector measured by the METR, estimated that one half of their competitors gain an advantage through tax evasion. In construction and agro-processing the reported share was about 40 percent. In tourism, which is the highest taxed sector as measured by the METR, firms reported that one third of their competitors engage in tax evasion, while in commercial agriculture, where the share of tax paying firms is the lowest, only 5 percent of competitors were perceived to evade taxes. |