VAT, fuel tax changes and other targeted cuts could widen tax base

The key challenge in today’s Budget is for the Minister for Finance to identify measures that widen the tax base and thereby significantly increase tax revenues. At the same time – and particularly against a background of a depressed investment climate – he needs to ensure that the budget catalyses rather than curtails economic activity, in other words it should be expansionary.I would like to suggest some possibilities for solving this conundrum.

In yesterday’s article I highlighted that the tax base remains narrow with Domestic Revenue Department of the TRA generating only 18 per cent of total collections, with the remaining 82 per cent generated in broadly equal measure by taxes on imports (Customs and Excise department) and taxes generated by large taxpayers (who number less than 500 and are managed by the Large Taxpayers department).

So the first aspect to consider is effective collection of taxes on imports. Taxes on import normally comprise customs duty (with common rates for the East African Community (EAC), including a maximum 25 per cent rate), VAT (standard rate of 18 per cent) and more recently Railway Development Levy (1.5 per cent).

On top of this there is a Customs Processing Fee 0.6 per cent. The cumulative impact of all of these imposts, and assuming customs duty at the top rate of 25 per cent, is a cost of 50 per cent. For goods also subject to excise duty the cost will be even higher.

Measures in the last year have been taken to curb evasion and ensure that taxes are properly collected on imports, with a consequent significant increase in collections. Customs duty rates are an EAC matter and it is assumed that there is therefore no scope for increase in these rates. So really any scope for an increase would only be by a VAT rate increase, which I address later.

One third of taxes on imports comprise taxes on fuel. For petrol and diesel there are three such taxes – namely fuel levy (Sh313/litre), petroleum levy (Sh100/litre) and excise duty (Sh215/litre for diesel, Sh339 / litre for petrol) – so cumulatively Sh628/ litre for diesel and Sh752 /litre for petrol. Unlike other specific tariffs (for example, on alcohol and tobacco), historically, there has been a marked reluctance to adjust tariffs on fuel for inflation.

In particular, since July 2007 adjustments have only been made in July 2011, July 2013 and July 2015. And yet the demand for fuel is relatively inelastic – people must travel, and so logically one would adjust these values at least for inflation; indeed given that the commodity is traded internationally in USD, there would be some logic to an adjustment in line with devaluation.

Fuel purchases have a big impact on the country’s balance of trade position – and changes in international fuel prices do significantly influence the exchange rate of the TZ shilling. Given this wider macro-economic impact, taxes may have a role to play in managing demand.

Against this background the case for an annual adjustment is compelling – particularly at a time when international oil prices are so low and therefore an increase can more easily be absorbed.

However, apart from being an economic instrument, the budget is also a political instrument - and the lack of automatic fuel tax increases in recent years, is a reflection that politics often wins. In particular, fuel taxes are sensitive because they automatically feed through to the pump price and with thatcreate a political reaction.

By contrast increased excise duties on excisable products and services (telecommunications, tobacco, alcohol, soft drinks) are less contentious. Partly this may be because the linkage with the consumer price may not be so visibly direct as with fuel, but more importantly it is becauseconsumption can more easily be reduced than with fuel.

Interestingly, VAT and excise duty collections on excisable products and services in the 10 months to April 2016 show no overall increase- by contrast, VAT collections on other items outside the traditional excisable goodsand services have increased significantly. The implication is clear – rather than increasing fixed excise duty tariffs to adjust for inflation, it may make more sense to adjust the VAT rate by 1 per cent or 2 per cent.

The suggestion of a VAT rate increase will probably result in howls of protest. And yet many countries across the world (including most of the major donor countries to Tanzania) have in recent years increased VAT rates whilst at the same time reducing income tax rates.

The logic for this is that lower income tax rates should encourage enterprise and income generating activity, and together with increased consumption taxes also encourage saving as opposed to consumption. Importantly, in most cases VAT is not an additional cost for business.

An added advantage from Tanzania’s perspective of such a move is that with the consumer’s spend dominated by expenditure on imports and a relatively limited number of everyday local supplies, it is easier to police and administer – by contrast, seeking to widen the tax base by increased income tax compliance is more of a challenge.

High taxes on employment (including 5 per cent skills and development levy (SDL), 1 per cent workers compensation fund (“WCF”), and 10 per cent employer social security cost) are one of the key reasons for Tanzania’s poor performance in the Paying Taxes Indicator component of the World Bank’s Doing Business Report.

Of course, on top of the costs borne by the employer, there are costs borne by the employee in the form ofincome tax collected by way of Pay As You Earn (PAYE) (up to maximum 30 per cent) and 10 per cent employee social security contribution.

None of our neighbours have such high taxes on employment – and my suggestion here would be an abolition of SDL (with shortfall in funds compensated by part of additional VAT revenues) – or if not abolition then a reduction to 2 per cent being a level where it simply funds existing commitments to theVocational Education Training Authority (“VETA”)and then transfer other commitments currently funded by SDL (namely, the Higher Education Student’s Loan Board (“HELSB”)) to be funded out of the general budget.

Additionally, the level of social security contributions are much higher than others in the region, and the suggestion here would be to reduce overall total contributions by employer and employee to 15 per cent (from the current 20 per cent).

I would also suggest income tax reforms targeted at encouraging compliance by businesses other than the largest businesses.

In particular, whilst corporate tax on the largest businesses could remain at a rate of 30%, one could consider a lower 25% rate for businesses with an annual turnover of say up to TZS 1 billion (as well considering reducing the top rate for individuals – also to 25 per cent - and an upward adjustment of individual tax thresholds).

In addition, consideration should be given to applying the simplified turnover basis of taxation to taxpayers below the VAT registration threshold (currently Sh100 million pa) instead of the current position which limits this taxation basis to a threshold of Sh20 million pa (which was the VAT registration threshold when VAT was first introduced in 1998).

Lastly notwithstanding that the VAT registration threshold increased to Sh100 million pa last year, I would suggest that it would be in the Government’s interest to increase this threshold to a much higher figure – perhaps even Sh500 million.

Why? Well for the smaller enterprises the costs of collection / administration may well outweigh the VAT generated.

Turnover of Sh100 million pa is equivalent to just over Sh8 million per month, and if one assumes a value add / margin of around 10 per cent then you come to Sh800,000 – and 18 per cent of this is only Sh144,000.

In addition, non-registration does not equate with no VAT collection – in particular, a business that is not VAT registered cannot reclaim input VAT charged on its costs, and so VAT would effectively be collected albeit indirectly.

What are my hopes for any of the above changes? Well I am not holding my breath. As mentioned earlier, Budget decisions are sometimes held hostage by political considerations rather than what objectively may be the best decision from an economic perspective.

However, with a general election still four years away I would argue that now is the time for the Minister for Finance to prioritise the economic drivers and leave the political considerations to closer to election time.

Mr Tarimo is Country Senior Partner – PwC Tanzania. The views expressed do not necessarily represent those of PwC. For updates from PwC on today’s Budget do follow @pwc_tz.