Equitable Taxation in Africa—Could a Wealth Tax Work?

Aimée Dushime considers the issue of wealth taxation in Africa, weighing the arguments in favor and against, and argues that a wealth tax can benefit African countries by driving economic growth.

Tax equity drives the overall distribution of income and wealth, as well as facilitating economic growth and development in countries across the world.

Equitable taxation relates to fairness in the distribution of tax burdens among taxpayers. In determining what is fair, two major theories have been developed over time—the benefits theory and the ability to pay theory. The benefits theory states that taxpayers should pay taxes based on the benefits they receive from the public services provided by the government. In other words, taxpayers who benefit more from services provided through public financing should pay more taxes than those who do not.

The ability to pay theory, on the other hand, maintains that taxes should be imposed based on a taxpayer’s ability to pay. This theory is used to advocate for the taxing of high net worth individuals (HNWIs), as well as businesses and multinational corporations with higher income. The “wealth tax” or “equity tax,” as it is called, is levied on the total or market value of a taxpayer’s personal assets, including their cash, personal cars, fixed assets, real property, trusts, bank deposits, and shares.

To generate tax revenues and reduce income inequality in Africa, several commentators and policymakers have called for the imposition of wealth taxes on the net worth of wealthy taxpayers and corporations in African countries. According to the 2022 Africa Wealth Report, the total private wealth currently held in Africa is $2.1 trillion, and this figure is expected to rise by 38% in the next 10 years. The report further indicates that there are currently 136,000 HNWIs with private wealth of $1 million or more living in Africa, with South Africa, Egypt, Nigeria, Morocco, and Kenya accounting for over 50% of the continent’s total private wealth.

Despite these figures and the revenue potential of wealth taxes, African governments continue to struggle to tax HNWIs in their respective countries. Some of the challenges faced by African countries in implementing a wealth tax include valuation, political pressure, weak administrative capacity, and harmonization with existing taxes. There are also several arguments surrounding the efficiency of implementing wealth taxes in Africa.

Achieving Equitable Taxation in Africa

According to the World Bank, bringing HNWIs into the tax net may prove useful for governments to improve their overall tax collection. The offshoring of wealth by HNWIs, coupled with other forms of tax avoidance and tax evasion practices, results in a massive loss of revenues for African governments. Based on the 2020 Economic Development in Africa Report by the United Nations Conference on Trade and Development (UNCTAD), illicit capital flows by government officials and HNWIs result in revenue loss of about $88.6 billion in Africa annually, which is equivalent to 3.7% of the continent’s GDP.

As part of restoring this revenue loss and mobilizing domestic resources for African countries, several commentators in Africa have urged African governments to widen their tax base to cover HNWIs. Research however indicates that African countries face obstacles in effectively taxing the wealth of the super-rich and improving tax compliance within this class of individuals.

HNWIs create significant challenges for African tax administrations due to their political influence, which affords them the opportunity for aggressive tax planning as well as the means to manipulate tax policies in their favor. For example, in 2011, Uganda tried to introduce a system of income tax clearance for individuals purchasing land valued over $18,000: The government was later forced to scrap this tax policy as a result of political resistance.

Positives and Negatives

There is no doubt that taxing HNWIs in Africa comes with positive and negative implications for African economies. The proposed advantages of levying wealth taxes on Africa’s rich individuals include:

  • Generates tax revenue: Proponents believe that collecting wealth taxes can serve as an additional means of generating tax revenue. This makes it possible for African governments to fund public services and infrastructure, as well as drive economic growth on the continent.
  • Reduces income inequality: Through a wealth tax, its proponents argue, unequal wealth can easily be redistributed to improve public services such as housing, water, healthcare, education, public infrastructure, and other social amenities to improve economic growth in Africa. By targeting the wealth of HNWIs, African governments are able to reduce income inequality and balance the scale in favor of lower-income Africans.
  • Encourages hiring: Some scholars have argued that imposing wealth taxes on HNWIs and businesses prevents shareholders from holding on to wealth and therefore encourages hiring and creating job opportunities. This can positively affect low- and middle-income earners in African countries.

Some criticisms of taxing HNWIs include:

  • Results in double taxation: Opponents argue that taxing HNWIs creates unfairness and duplication of taxation, especially since most wealthy taxpayers are already subject to other forms of tax such as personal income tax, estate tax, and corporate income tax. They contend that levying a wealth tax on the net worth of rich taxpayers means they would have to pay not only for earning their income, but also for retaining that same income, and advocate that wealthy taxpayers should be able to retain their wealth free from government interference.
  • Discourages savings and investment: Since capital accumulation and investment are crucial to driving economic growth in Africa, critics contend that implementing wealth taxes on the continent would only discourage HNWIs from investing in their home countries.
  • Encourages wealth relocation: Another criticism is that a wealth tax encourages the rich to move their assets out of their home countries. In most cases, African super-rich individuals can easily renounce their citizenship so as avoid any wealth tax which may be imposed on them by their home countries.
  • Creates opportunity for tax avoidance and evasion: Africa currently records high rates of tax avoidance and tax evasion by HNWIs. Imposing a wealth tax will only increase the rates of tax avoidance in African countries, especially in light of the fact that many super-rich individuals may try to avoid paying such taxes by sheltering their assets in tax havens and offshore accounts.
  • Increases compliance and administration burdens: African tax authorities may find it difficult to ensure tax and administrative compliance by HNWIs, particularly due to the high costs involved and the political influence of some of these individuals. Moreover, tax administrations in Africa may face challenges when determining the fair market value of several forms of wealth and personal assets that lack publicly available prices, such as works of art. This can result in valuation disputes between taxpayers and tax authorities. In addition, critics have argued that rather than generating revenue, wealth taxes may place an additional financial burden on African governments when driving tax compliance, since tax administrations will have to employ government lawyers to drive compliance against wealthy taxpayers who have access to skilled tax attorneys.

Practice of Taxation of HNWIs in African Countries

There is no doubt that wealth tax contributes a significant share of the total tax revenues collected in developed countries. Yet this is not the case in developing economies, which includes many African countries. It has been observed that this is so because most personal income taxes in African countries are collected from taxpayers in formal employment, especially in the public sector. While some countries in Africa are considering bringing HNWIs into their tax net, only a few African countries have effectively implemented wealth taxes against HNWIs.

In September 2015, the Uganda Revenue Authority (URA) successfully implemented an HNWI unit which aims to mobilize tax revenues from HNWIs in the country through research, audit, and intelligence gathering. The HNWI unit was able to increase tax revenue collection by 19 billion Uganda shilling ($5 million) within the first year of setting up the operation. Moreover, URA reports revealed that there was an improvement in voluntary tax compliance among HNWIs, as the number of wealthy taxpayers who filed income tax returns increased from 13% to 78%.

In achieving this success, the unit had to adopt several approaches during the two different phases of its operations.

During the first phase, the unit identified and categorized HNWIs, paying special attention to taxpayers who had land transactions for large amounts; high valued rental income; income from imports and exports; expensive cars; large loans and bank transactions; were CEOs and business owners. In addition, the unit took steps to assess URA’s legal and administrative strengths and weaknesses. During the second phase, the unit approached the identified HNWIs and educated them on their rights and tax obligations under the law.

There is no doubt that URA’s effective management and high level of commitment, as well as their active engagement to tax politically influential HNWIs, contributed greatly to the success of this tax policy.

Aside from Uganda, other African countries such as Mauritius, South Africa, Kenya, and Swaziland have established specialized HNWI units. In particular, the South African Revenue Service (SARS) has categorized HNWIs in the country into less affluent individuals who earn less than 3 million South African rand a year ($170,000); affluent individuals who earn between 5 million and 7 million rand a year or who have assets worth more than 16 million rand; and HNWIs with income of more than 7 million rand a year or who have net assets of more than 40 million rand. SARS has its own trust system and therefore uses a risk profiling matrix to identify HNWIs and their associated trusts for tax audit and compliance checks.

In driving the taxing of wealthy taxpayers in South Africa, the HNWI unit adopts different strategies, such as gathering information from publicly available sources such as the media, as well as creating channels for accessing local and offshore third-party information. In addition, the unit conducts active engagement with HNWIs in the country to educate them on their rights and obligations, as well as to understand their needs, to drive voluntary tax compliance.

Conclusion—and Way Forward

Notwithstanding the numerous challenges African countries may face in implementing wealth taxes, the potential of taxing HNWIs can contribute to total tax revenues on the continent. Revenues derived from wealth taxes are particularly useful in providing public services and driving economic growth in African countries. Indeed, URA’s experience in Uganda shows that with proper implementation, taxation of HNWIs can actually benefit African countries. With Uganda’s experience, African tax administrations can learn from the different strategies employed in taxing HNWIs.

For many African tax authorities implementing wealth taxes in their countries, it is essential to remain committed to the taxing of HNWIs, as well as to receive the support of the senior management of their revenue authority, as in the case of Uganda.

In addition, there is a need to communicate and proactively engage with HNWIs before carrying out enforcement actions. This engagement will involve educating wealthy taxpayers about their rights and obligations, as well as about the tax policy in place. In most African countries where HNWIs engage in tax avoidance and tax evasion, there is need for officials in the HNWI units to be properly equipped with the appropriate technical expertise, which enables them to communicate tax matters in a simplified manner.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners. The views expressed herein are personal.

Original Source: Bloomberg Tax