Business Taxation in a Low-Revenue Economy a study on Uganda in Comparison With Neighboring Countries

Business Taxation in a Low-Revenue Economy

A Study on Uganda in Comparison With Neighboring Countries

Table 2 Non-Tax Parameters for Uganda 36

Table 3 Marginal Effective Tax Rate on Capital for Ugandan Firms 37

Table 4 Marginal Effective Tax Rate on Capital for Small Ugandan Firms 38

Table 5 Marginal Effective Tax Rate on Capital for Ugandan Firms

Simulation for LIFO Accounting Method 39

Table 6 Marginal Effective Tax Rate on Capital for Ugandan Firms

Simulation for Initial Allowance for Investment in Buildings 40

Table 7 Marginal Effective Tax Rate on Capital for Small Ugandan Firms

Simulation without Property Tax 41

Table 8 Marginal Effective Tax Rate on Capital for Ugandan Firms

Simulation Assuming Zero Inflation Rate 42

Table 9 Marginal Effective Tax Rate on Capital for Ugandan Firms

Simulation for Debt-to-Assets Ratio 43

Table 10 Marginal Effective Tax Rate on Capital for Ugandan Firms

Simulation Using a Higher and Lower Economic Depreciation Rate 44

Table 11 Marginal Effective Tax Rate on Cost of Production for Ugandan Firms 45

Table 12 Business Tax Provisions Applicable to Manufacturing and Tourism in Uganda, Kenya, and Tanzania (1998) 46

Table 13 Non-Tax Parameters for Cross-Country Comparison (1998) 47

Table 14 Marginal Effective Tax Rate on Capital for Foreign Firms (Applying Uganda's Non-Tax Parameters to Kenya and Tanzania) 48

Table 15 Marginal Effective Tax Rate Cost of Production for Foreign Firms (Applying Uganda's Non-Tax Parameters to Kenya and Tanzania) 49

Table 16 Marginal Effective Tax Rate on Capital for Foreign Firms with Country-Specific Interest Rate and Inflation Rate 50

Table 17 Summary of Firm Survey-Tax Administration 51

Table 18 Exemption Regression 52

Table 19 Private Sector Enterprises Based on the 1996 Updated Industrial Census 53

Table 20 Distribution of Establishments and Employment Within the Five Selected Industrial Sectors 54

Table 21 Characteristics of the Firms in the Sample 55

I. INTRODUCTION

Post-conflict countries often begin economic recovery at a low level of domestic revenue. At the same time the incidence of poverty is high and the need for public spending on social services and infrastructure is massive. These circumstances could lead one to conclude that a rapid increase in domestic revenue and a corresponding increase in public services should be a policy priority. Such a conclusion may not, however, stand a closer scrutiny. First, increased taxation may have adverse supply side effects by constraining already low private investment, thus undermining growth and the prospects for increasing public revenue in a sustainable manner. Second, the private sector may receive little value for their additional taxes because of weak delivery systems, which in themselves prevent the creation of a positive tax culture.¹ At the margin, the cost of raising additional taxes in terms of foregone private investment could be much higher than the benefit from increased spending on service delivery.

In many low-income economies access to and the cost of credit are important constraints upon enterprise growth, particularly upon smaller firms; hence investment is largely financed by internal funds.² For example, in Uganda 70 percent of private investment is financed by profits and personal savings. As a result, taxation is linked to private investment in two ways. First, it reduces the expected after-tax revenue from a given investment project. Second, it reduces the availability of investment finance. Even if an adequate number of profitable investment projects was available, high business taxation is likely to have a negative impact on the level of private investment by constraining investment finance.³

The rebuilding of government’s revenue base from an almost complete collapse has been one of the key features of Uganda’s economic recovery. Institution building for tax administration was given priority, and a semi-autonomous Uganda Revenue Authority (URA) was established in 1991, inspired by Ghana’s example.⁴ As URA is not part of the civil service, it is able to offer higher pay and hence to attract more qualified staff. As a result, domestic revenue has increased to 11.4 percent of GDP by 1998, from mere 4.8 percent of GDP in 1986.⁵ This together with prudent expenditure management and sustained donor inflows has contributed to a stable macro economy since 1992.⁶

Until recently, the main tax policy objective in Uganda was to raise public revenue rapidly. The target was to increase tax revenue by one percentage point of GDP per year. This policy was not, however, backed by a concrete medium-term strategy on policy and administrative measures which could be expected to deliver such growth. Over time ad hoc increases in tax rates, particularly taxes on fuel, were increasingly relied upon to achieve the revenue target, with little information on the supply side effects. In a firm survey carried out in 1994, respondents found high tax rates to be their leading constraint to future operation and growth.⁷ This ranking applied for all size categories of firms and most sectors. It was noted at the time that as total tax collection had been relatively low in the past, but had risen rapidly, it could be expected that firms would complain about their tax burden. In a similar survey in 1998 taxes continued to rank high on the list of constraints, this time as the second leading constraint to private investment after cost of utility services.⁸ In both surveys, tax administration was the firms’ leading regulatory constraint, while regulations in general were found to impose little constraint on most Ugandan firms.

Given that firms throughout the world dislike taxes —even in relatively low-tax OECD countries, such as the United States, taxes are perceived as the leading constraint to business — perceptions alone are not an adequate measure for assessing the impact of increased revenue effort on firms. There is a need for a more quantitative analysis of the tax burden. As a range of tax instruments are also used for investment promotion by the Government, the final tax burden on firms is an outcome of multiple factors, some of which may operate in opposing directions. Where institutions are weak, tax administration has a major impact on the tax burden. Hence there is also a need to bring administrative practices to bear in the assessment.