Widening the tax base and catalysing economic growth

How can we strike a balance?

Widening the tax base and thereby increasing government revenue is expected to be a theme of the Budget speech to be read today. Government needs to increase revenues so as to cover for increased expenditures such as the recommended increments in salaries to public servants. At the same instant, the budget needs to catalyse rather than curtail economic activities and continue to improve the investment climate. The question is how to balance these competing objectives.  Amongst the suggestions that we would propose are measures (i) to support Small and Medium Enterprises (SMEs), (ii) to rebalance the fiscal structure for particular sectors to be more growth oriented, and (iii) to explore the scope for environmental taxes.

The SME sector plays a crucial role in the economy of developing countries like Tanzania, but our fiscal regime does pose a number of challenges that affect their growth and profitability. Part of the challenge is the myriad of taxes that result not only in undue tax cost but also a knowledge gap related to compliance requirements. To address this we propose measures to: (1) ensure administratively it becomes easier for SMEs to comply and in the same instance get prompt and convenient assistance from the revenue authorities; (2) reduce the overall tax burden by revisiting the number of taxes and the applicable rates.

A tax that is particularly complex to administer is VAT and yet quite small businesses are required to be in the VAT net given the current VAT threshold of annual turnover of TZS 100m.  If you assume 300 business days in a year, this would imply a daily turnover of only TZS 333,333 - a threshold that probably a number of “mama ntilie’s” (informal food sellers) would exceed.  We would propose this be increased to TZS 500m (or if not then somewhere in between) so as to exclude very small SMEs from the related administration cost of VAT compliance. This would also help the Tanzania Revenue Authority (“TRA”) as the costs of collection / administration for the very small SMEs are likely to outweigh the additional net VAT generated.  Such a change would also not result in significant loss in revenue as most VAT revenue is generated from the largest suppliers; indeed, a narrow band of goods and services which include telecommunication services, beer, spirits, soft drinks, cigarettes, soft drinks, electricity, cement and sugar account for approximately half of total VAT and excise duty on local supplies.

Whilst being outside the VAT system does reduce a business’s administrative cost, it does also result in the inability to claim VAT input tax.  As such the suggested increase in the VAT registration threshold could in fact result in a tax collection increase rather than decrease.

As for reduction in tax rates, we would assume that the simplified turnover basis of income tax (currently applicable to businesses with turnover not exceeding TZS100m, and with a top rate of 3.5% of turnover) would be extended to the new turnover threshold.   Consideration could also be given to a reduced income tax rate (say 15% instead of 30%) for SMEs with annual turnover above the turnover basis threshold (currently linked to VAT registration threshold) but below a separate annual threshold applied for this purpose - for example, TZS 1bn. 

A familiar cry from a number of sectors is that the level of taxation constrains the level of activity within those sectors - sectors that come to mind include telecommunications and tourism.  Taking telecommunications as an example, notwithstanding that indirect taxes on electronic communication services (excise duty, VAT) are amongst the major contributors to tax collections in Tanzania, the concern remains as to the adverse impact of a very high excise duty rate of 17%.  Importantly, excise duty is just one component of the turnover taxes on electronic communication services; if aggregated together these taxes (excise, VAT, service levy, TCRA, UCAF) come to a staggering 40.2% of pre-tax turnover.

In its March 2021 report (Tanzania: Driving social and economic value through mobile-sector tax reform) the GSMA commented that “the tax contribution of the mobile sector in Tanzania is considerably higher than the average for Sub-Saharan Africa and also above other regional averages; this could limit the country’s transition to a digital economy”, noting that the 17% excise duty rate on mobile services is the second highest in Sub-Saharan Africa. 

In order to catalyse the growth of this sector, we would propose an immediate reduction in the excise duty rate to 14.5% - being the rate applicable prior to the change in July 2014. At the time the increase to 17% was stated to be a temporary measure (to compensate the Government for the loss of revenue resulting from removal of sim card tax of TZS 1,000 in the FY 2013/14), with the intention that the rate revert to 14.5% in subsequent years. However, no amendment has been made since then and so 7 years later the 17% rate remains! This proposed change will improve the digital inclusion that will subsequently increase the base of the government collecting additional revenues not only on the electronic communication services but other related services such as digital financial services.

A similar concern applies to tourism which is burdened by multiple taxes and regulatory costs that combine to make Tanzania quite a high cost destination.  As with telecommunications, the opportunity is to rationalise these costs so as to catalyse growth and ultimately generate more taxes as well as more economic activity generally.

Finally, environmental taxes should be explored in more depth. On the agenda of many developing countries, for both revenue purposes and for meeting countries’ commitments on climate change and sustainable development, these taxes target behaviour harmful to the planet's health. Based on a simple principle that those who pollute should pay, examples include taxes on energy use, emission of harmful gases, motor vehicle taxes, other taxes on transport, and taxes on waste and plastic. 

Even in the absence of global cooperation, developing countries should still seriously consider carbon taxation.  Yet, in sub-Saharan Africa, carbon tax is implemented in only one country (South Africa) and under consideration in two others (Côte d'Ivoire and Senegal).  Adopting environmental taxes in Tanzania would be a further step to show our commitment as a country on climate change, particularly given the commitments made at the 26th United Nations (UN) Climate Change Conference of the Parties (COP26) Summit.

To summarise, our expectation is that best-practice principles of taxation will be adopted to ensure that the government efficiently widens the tax bases while at the same time catalysing an effective economic growth. A good starting point would be to rationalise taxes on SMES, ensure fiscal policy is growth focussed, and take further steps on the environmental taxation journey.

By Godluck Mushi and Julieth Modu - Manager and Senior Associate, respectively, specialising in Indirect Tax Services at PwC Tanzania.