The centre for tax analysis in developing countries

Overseas Development Institue Institue for Fiscal Studies

The coronavirus pandemic is first and foremost a public health crisis. But it also represents a large and systemic economic shock, with massive effects on both the supply and demand sides of the economy. Growing numbers of people will be unable to work, whether due to illness or social-distancing measures. And while some products – such as basic foods – are seeing a surge in demand, many others – such as travel and tourism, bars and restaurants, and discretionary retail – are seeing demand collapse, risking millions of otherwise viable businesses and jobs.

While the epicentre of the crisis was first in China and is currently in Europe and the US, such effects are now being seen in increasing numbers of low- and middle- income countries across the world, including in sub-Saharan Africa. This will likely lead to significant falls in tax revenues, which when combined with the effects of falls in international trade and commodity prices, will pose a particular problem for the many countries with limited access to borrowing.

These borrowing constraints also mean that any tax policy measures enacted to help counter the economic effects of the coronavirus need to be as targeted as possible, and explicitly temporary.

Support not stimulus

At least at this stage, the aim of such measures should be to provide support to the most affected businesses and individuals so that they can comply with social-distancing measures and survive the current crisis. A general stimulus to the economy (through, for example, broad-based tax rate cuts), may sound simple and appealing, but could risk losing valuable revenue and be less effective than usual, given that consumers will be avoiding going out and businesses are likely to be particularly risk averse; it could even be counter-productive if it reduces the effectiveness of efforts to control the spread of the coronavirus.  

The OECD has highlighted a range of tax policy and tax administration measures that countries could consider that fall within the ‘support’ category. Of course, it is important that low- and middle-income countries do not simply replicate policies designed for high-income countries.

As already mentioned, borrowing constraints are often more binding, which means the fiscal space for action may be more limited than in high income countries. On the other hand, existing high levels of poverty, combined with the fact many households have no or very limited savings, mean the provision of financial support to those who need could sometimes be literally a life or death issue. Taken together, these considerations mean it’s even more important to select those measures providing the ‘biggest bang for the buck’.

Large informal sectors mean many businesses and individuals do not pay taxes and so would not benefit directly from tax policy measures. Some measures may also be open to abuse without greater administrative capacity to regulate effectively and countries dependent on cash transactions could limited some options further.

Each country’s precise circumstances and constraints will differ, meaning there is no one-size-fits-all package of policy measures: the TaxDev team at the IFS and ODI will be supporting their partners in Ethiopia, Ghana, Rwanda and Uganda to develop, appraise and cost bespoke measures.

Poorly - and well-targeted tax policies

However, some broad principles could be helpful in guiding the selection of policies that look better suited to the issue at hand, and those that are less well suited and should generally be avoided.

1. General reductions in corporate and personal income tax rates of the kind implemented in Kenya do not seem well designed for the current crisis. This is because they provide the biggest benefit to those businesses still making significant profits and individuals with significant incomes. Only if it is felt that other more targeted approaches are infeasible, or that individuals benefiting from such tax cuts would share the gains with family and friends that are harder-hit but cannot be directly reached by the government, can such an approach be rationalised now.

2. Measures that bolster the cash-flow of businesses and individuals, especially when targeted at the groups most adversely affected (such as bars, restaurants, hotels, retailers and importers/exporters of non-essential products, and travel services, and those sectors with low profit rates, high fixed costs and high debt levels) may be more cost-effective. This could reduce the need to sell assets and the risk of business failure. Examples of such measures include temporary: 

 a) Extensions of tax deadlines and deferral of tax payments;

 b) Expediting of VAT refunds;

 c) Reductions in VAT and other withholding tax rates;

 d) Reductions in turnover-based tax rates, which are likely to represent a higher share of profits when turnover is depressed;

 e) Updating of advanced tax payment schedules to reflect likely reductions in taxpayer’s final tax liabilities.

 f) Increases in the generosity of loss carry-forward provisions, including the possibility of allowing businesses to realise losses immediately as a refund rather than deduction from future tax liability.

3. Measures that reduce the cost of labour to businesses so that they retain more staff could also be very important both to support workers’ incomes and employment now, and prevent a temporary shock becoming a longer-term shock due to the breaking of employer-employee relationships. These measures could include temporary exemptions from payroll-related taxes and employers’ social security contributions for the most adversely affected sectors. And these parts of the tax system could also be used to provide temporary wage subsidies conditional upon employers retaining their staff, providing further support to businesses and formal-sector workers’ incomes.

4. Taxes that can act as barriers to cash transfers and remittances between households, such as taxes on mobile money and money transfer services, could be temporarily waived. This will enable households in the informal sector to continue to support each other through transfers and ensure people don’t revert to sharing paper money which would increase person-to-person contact. Similarly, temporarily waiving taxes on digital communications, such as mobile phone airtime and data taxes, could reduce the costs of remote working and support social-distancing efforts.

5. Revenue-raising measures that governments had planned to implement in the next few months could be deferred, unless absolutely vital to cope with the costs of Covid-19, for example by using the revenue raised to finance spending or  temporary and targeted tax cuts. Any major reforms that could cause disruption and compliance burdens at this difficult time could also be delayed until after economies recover.

6. Support via local government and the social protection system may sometimes be more appropriate, especially for those in the informal sector. Many businesses and individuals have no interaction with the formal tax system so cannot be directly supported via tax abatements, reductions, or grants administered based on central government tax records. However, they may interact with local government and the social protection system.

 a) The provision of additional ring-fenced funding for local government may allow them to offer rebates or support to informal businesses and traders that have registered or paid licence fees or taxes at a local level. Funding could also be used to reduce or exempt particularly affected groups from local property taxes – which are generally an efficient form of tax, but may not reflect current income levels.

 b) Increases in the generosity, expansions in the coverage, and reductions in the conditionality of social protection systems are likely to be better placed to reach the most vulnerable individuals than tax policy measures. Where possible, payment by electronic means would be preferable to limit the need for physical interactions.

Concluding thoughts

Low and middle-income countries will need to think carefully about which policies to prioritise given the limited resources available to them, and the need to bolster spending on health systems and food security. Measures may need to be revised on several occasions as the health and economic situation develops. The data available to tax authorities at high frequency – e.g. daily reports from electronic billing machines which provide real-time information on economic activity, – can help with this process.

At some stage, the focus may have to shift from support to stimulus, as governments seek to re-awaken their economies. If that is the case – and it may not be – that could require a different set of measures, and a new set of challenges for Ministries of Finance and Revenue Authorities across the world.  

Published on: 27th March 2020

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