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Another love affair with the IMF comes to an end

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On her visit in December to Ghana’s capital, Accra, the Managing Director of the International Monetary Fund (IMF), Christine Lagarde, extolled the government’s economic management in the last two years, which has produced rising economic growth, declining inflation and interest rates, and improving public finances.

The economic gains reflect the government’s stronger implementation of the IMF-supported financial and economic program which it inherited in 2017 from the previous administration. The program, which began in 2015, is due to be completed in April, and despite its accomplishments, the government has ruled out a follow-up arrangement.

Ms. Lagarde’s visit therefore had the semblance of a mission to say adieu. However, whether this marks a certain end to Ghana’s habitual romance with the Fund is an open question, which rests on whether the country applies the experience of the past to illuminate the path of its future.  

Four years ago, the economy was in dire straits, with GDP growth that was slackening amid high inflation, outsize budget deficits, and ballooning public debt. The former administration, under President John Mahama, at first demurred when suggestions to turn to the IMF for a rescue program were made.

As confidence in the economy plummeted, however, it called in the Washington-based lender for discussions that led to a program supported with a US$918 million loan from the Fund’s extended credit facility. The program was built on fiscal consolidation (that is, expenditure containment plus tax increases to induce reductions in government borrowing) to restore macroeconomic stability, high economic growth, and debt sustainability.

In 2015, the first year of the program, the fiscal deficit was reduced from 7.4% to 4.9% of GDP, partly helped by donors unfreezing previously-withheld budget support. Although the macroeconomic environment remained volatile initially, noticeable improvements emerged in the second half of 2016, when the exchange rate stabilized and inflation began finally to retreat.

The fiscal deficit was projected to fall again in 2016, to less than 4% of GDP, but this turned out to be grossly overoptimistic. Ignoring underperforming budget revenues, the administration spent lavishly, but ultimately fruitlessly, in a bid to retain power in an election year. The actual budget gap that resulted was 6.5% of GDP, with a substantial backlog of unpaid bills.

As Mr. Akufo-Addo swore the presidential oath of office under a hot Accra sky on January 7, 2017, his New Patriotic Party (NPP) government had the daunting task of bringing the IMF-supported program back on track after the 2016 derailment.

This entailed significant expenditure tightening and more buoyant tax collection. Set against the grand promises to the electorate—such as tax cuts, free public senior high school education and a factory per district—on which the NPP rode to power, it became obvious that a cautious fiscal policy balancing act was required. The government’s first budget balanced the conflicting demands relatively well, as it cut taxes while reining in spending to check the deficit, which fell to 4.8% of GDP.

The expenditure retrenchment slowed the roll-out of the government’s major policies. For example, free public senior high school education was offered to new, but not continuing, students when the government introduced it in 2017, and coverage for all students is still not expected until September 2019.

Provisional fiscal data indicate that the government continued its policy of fiscal restraint in 2018, enabling the macroeconomic gains the economy has enjoyed since 2017 to be consolidated. Consumer price inflation, which stood at 15.4% at the end of 2016, decelerated to 9.4% last December, and the exchange rate has been relatively stable as well.

Interest rates have been trending downwards, sliding from the twenties to the teens, although the cost of credit to the private sector remains prohibitive. Thanks to this stability, as well as an increase in oil production, the economy is growing much faster than in the recent past, with real GDP climbing by 8.1% in 2017 and 5.6% in 2018. There is a less glossy side of things, though, which is the bank failures that have occurred due to considerable bad debts in the sector, poor corporate governance, and slack regulation over a long period of time.

The central bank, under new management since 2017, has taken gallant steps to fix the problems. Shareholders have been made to inject fresh capital into banks, some lenders have been consolidated, and more stringent corporate governance rules have been established. Nonetheless, confidence in the financial sector is not at its best and will take a while to be restored fully.

When all is considered, the economy today is in a healthier state than at the beginning of the IMF-supported program and before the current administration’s term began. That explains the IMF chief’s positive assessment and praise of the government. Ms. Lagarde was equally open about the outstanding challenges and risks, identifying, in particular, the still-high public debt burden, fiscal risks from the substantially-indebted energy sector, and weak revenue mobilization.

So far, both the rhetoric and actions of the government signify that these and other important challenges are not lost on it. However, there is a sense of quiet trepidation among many economists over whether the flame of reform would be kept alive after the program with the Fund terminates.

 

A feeling of déjà vu

The IMF has had a dominant influence on Ghanaian policymaking for more than half a century. By one count, the country has had an extraordinary 16 programs with the IMF since signing up as a member in 1957. This implies a program every four years, on average.

The first call for assistance happened in 1965, when the first post-independence government, led by Kwame Nkrumah, decided to seek an external rescue from run-down foreign reserves and onerous external debts. It transpired that Nkrumah was not at ease with the terms of the assistance package and consequently drew back from the plan.

After he lost power through a military coup in 1966, the successor government, the National Liberation Council (NLC), went back to the IMF for loans and stabilization programs to help fix the macroeconomic problems inherited from the previous regime. So did the civilian Progress Party (PP) government, which succeeded the NLC from 1969-72. Although the country turned inward after that, the Fund provided financial help a couple of times again before the end of the 1970s. In the 1980s, following a decade of precipitous economic decline, the IMF, together with the World Bank, came to Ghana’s rescue with the Structural Adjustment Program (SAP), which succeeded in reviving the economy. The relationship has developed during the Fourth Republic (1993-date), with every government having either inherited or arranged its own Fund-assisted program.

In general, economic performance has tended to improve whenever the IMF is around. However, the inevitable tension between the Fund’s conditionality and national economic sovereignty means that Ghanaian governments are always eager to regain full control of their policies. That accounts for the current administration’s stance against procuring further loans or programs from the Fund.

One is reminded of a similar decision by the previous NPP administration, led by President John Agyekum Kufuor, in 2006 at the end of an IMF program supported by loans and debt reliefs. Within two years of exiting the program, economic management discipline collapsed and the IMF was sent for again. The lesson for Mr. Akufo-Addo and his government is obvious.

 

Three S’s

Two types of crises lead countries to seek the assistance of the IMF, which exists as a global lender of last resort. The first is a domestic economic crisis, invariably caused by a government’s economic mismanagement. The second is an external or imported crisis, which may be due to trade shocks (such as a drop in export earnings) or capital flow shocks (investor flight) that leave a hole in the balance of payments. In Ghana, both types of crises typically accompany and reinforce each other. What’s more, the all-too-frequent trips to the IMF reflect the fact that these crises have been taking place all too frequently.

Three conditions are needed to reverse the stop-go cycle in economic performance and the recurring associations with the IMF. First, sound economic management needs to be entrenched through strong and independent domestic institutions that serve as a bulwark against the abuse of policymaking discretion by politicians.

This is the role that the IMF has traditionally played in Ghana, and it is time that institutions responsible for restraining excesses in government, especially the country’s parliament, lived up to their mandate. A strong civil society is also crucial to increase the checks on politicians. This has already emerged in Ghana, albeit with weaknesses. A strong civil society would not only contribute to an enhanced public debate over policy choices, but deepen scrutiny of those policies and enhance accountability.

It is equally vital that the country addresses the boom and bust cycles associated with its dependence on mostly commodity exports for external sustenance. This requires structural transformation that will shift the economic base towards more value-added manufacturing, which will also accelerate job creation. To this end, the government’s intent to diversify the economy through industrialization is well-judged.

The priority should not be to ensure that every district gets a new factory—whatever it takes—but to facilitate the emergence of competitive and efficient industries which can plug themselves into global supply chains to diversify and boost export earnings. The day that this materializes, Ghana will have taken a significant leap forward towards realizing the economic self-reliance that it has perpetually hankered for.   

 

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Economy

Mobilising Taxes for Development: The Case of Tax Expenditures

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Prudent fiscal policy is critical for the development of economies around the globe and government uses its expenditures and revenues to manage the fiscal space. Government’s ability to implement its development agenda is largely dependent on the mobilization of revenue and prudent use of its resources. Thus, tax policy and administration are imperative to economic growth and development, especially emerging and developing economies.

Currently, Ghana’s tax policies are aimed at enhancing and promoting increased economic activities in the private sector, mostly through tax exemptions and cuts for firms operating in the sector. Given the quantum of these exemptions and cuts, it is prudent to analysis the effectiveness of the policy these current or scheduled tax exemptions and cuts and ascertain whether the policies have achieved their stated objectives as well as the value of revenue lost.

The effectiveness or otherwise of tax policies can be evaluated in using four approaches – an assessment of the effect tax policies on macroeconomic variables such as: economic growth and growth in incomes; an evaluation of the incidence of tax; how changes in the marginal tax rates impact on behavior of taxpayers; and an evaluation of tax exemptions and tax cuts. An assessment of the impact of tax policies on the macroeconomy does not seem to be critical for the Ghana Revenue Authority (GRA) and the Ministry of Finance (MOF) currently, given the present peculiar situation that the country finds itself (inability to mobilize enough revenue to meet its developmental agenda as well as reckless spending of government).

Tax incidence analysis is complex and requires the application of micro simulation modeling, with its relevance realized when the marginal tax rate is rightly determined and majority of the citizens honor their tax obligations. However, currently the situation in Ghana does not allow the implementation of such assessment. Further, in the absence of a good tax paying culture as assessment technique based on the changing marginal rates is extremely difficult and Ghana is bedeviled with such challenge. The reliability or validity of the analysis would also be significantly limited. In a gist the approach of evaluating current or scheduled tax exemptions and cuts by government is a more effective approach.

The Ghanaian economy over the past 3 decades have experienced rapid economic growth, however, it is faced with major macroeconomic challenges. Chiefly among these challenges among others are the large debt overhang and associated rising interest payments resulting from massive government borrowing; expenditure overruns and accumulated arrears caused by fiscal indiscipline; revenue under performance caused by leakages, loopholes and tax exemptions; and declining credit to the private sector, high cost of borrowing and the lack of reliable power supply to support private sector growth.

The high debt overhang and rising interest payments has left government with limited fiscal space to implement its developmental agenda. All these have hindered government’s efforts at mobilizing revenues over the years, as declining commodity prices reduces revenue of the amount of taxes these companies pay, as well acute power supply and high cost of borrowing which have slowed growth in business activities. The situation is made worse on high tax exemptions regime, revenue mobilization leakages, low compliance and poor taxpayer information.

Subsequently, the government of Ghana’s tax policies prior to 2016 sort to address the challenges of revenue shortfalls by enhancing revenue mobilization. The Ghanaian tax authorities have aimed at tax modernization programs, and these for instance have enabled the GRA to recover unpaid taxes, plug leakages and loopholes in the tax administration, conducted a comprehensive tax audit of the entire system and broaden the tax net.

The GRA has further strengthened reconciliation process for the various taxes such as taxes on import and export duties as well as value added tax and improvement in payroll tax auditing system. In respect to the tax modernization programs, number of tax policy and administration initiatives have been implemented designed to enhance efficiency and effectiveness in tax administration and better promote good governance.

To mention, but a few, some of the tax policies include Permits and Exemptions; Introduction of Sliding Scale Excise Duty; Implementation of the Tax Identification Number (TIN) system; Removal of import VAT on specific raw materials; Review of Tax Laws on ECOWAS Common External Tariff (CET); Introduction of the National Single Window at the port of entry; Amendment of the National Health Insurance Scheme.

Since 2016 the government has shifted from the pursuance of a tight tax regime to a more flexible tax policy regime in which the tax system aims at encouraging and enhancing growth in the private sector economic activities in order to promote rapid economic growth. Government by these policies sort to reduce some types of taxes and abolish others it labeled “nuisance” and these taxes reliefs were to improve the welfare of ordinary consumers.

These policies saw the abolishing of some taxes including one percent Special Import Levy imposed on imported raw materials and machinery; 17.5 percent VAT/NHIL on Financial Services; 17.5 percent VAT/NHIL on domestic airline tickets; Excise duty on Petroleum; Import duty on specified vehicle spare parts etc. Other taxes were also reduced and these include Special Petroleum Tax reduced from 17.5 percent to 15 percent; Energy sector levy rates for National Electrification and Public Lighting also reduced from 5 percent to 2 percent and 5 percent to 3 percent respectively; Exemption from tax, gains from realization of securities listed on the Ghana Stock Exchange for a period of 5 years and Replacement of the17.5 percent standard rate with a 3 percent flat VAT/NHIL rate for supplies by retailers and wholesalers.

Government has also in 2018 introduced a comprehensive tax exemption system based on a paperless system for implementing guidelines for granting and monitoring tax exemptions. Also, government has launched the Excise Tax Stamp policy, which involves sticking of a specially designed digital stamp with security features on specified excisable goods whether locally manufactured or imported to indicate that taxes and duties have been paid or will be paid on them.

In several developing countries, policies to attract Foreign Direct Investment have largely centered on tax exemptions and cuts. These exemptions and cuts have been used as effective tools in the conduct of fiscal policy as well as the pursuance of various social goals and promote economic growth. These strategies have been beneficial to the economies (though questionable), however, exemptions have varying costs resulting from lost in tax revenue; referred to as tax expenditures.

The propensity for tax authority to overlook the effect of tax expenditure on their economies is relatively high, as it is not viewed as part of actual government expenditures but rather forgone revenues. Assessment of tax expenditure is critical and there is the need for a comprehensive cost benefit analysis of such tax policies to apprise government policies. In several cases these incentives have been used as a political tool rather than an economic tool to drive economic growth and development, especially in developing economies.

All the major tax types in Ghana have some form of tax incentive built into it in the form of tax holidays, exemptions and reliefs, with income tax incentives being most prominent. These incentives are granted in the form of lower tax rates and in some cases complete exemptions and this is dependent on the sector in which the organization operates in and its location. Various reasons are assigned for income tax incentives, ranging from stemming the flow of rural-urban migration; improving spatial distribution of industries; and promote investment or redirect investment into prioritized sectors of government.

Exemptions and reliefs from VAT are provided for certain kinds of supplies and to mitigate regressive effect of the tax on some type of taxpayers, and under some circumstances a fulfilment of international agreements. Tax authorities provide exemptions and reliefs from customs duties for importers of intermediate inputs.

The major challenge with these exemptions and reliefs in Ghana is the fact that until 2011 there was the absence of a comprehensive effort to estimate the countries tax expenditure. It’s not until 2011 when OECD through its Tax & Development Program that the first estimate of tax expenditure study was undertaken in Ghana, and estimated revenue loss through tax incentives at 6.13% of GDP. However, the Ministry of Finance and GRA employed the same methodology as OECD and estimated that tax expenditure from 2008 – 2011 averaged 1.9% of GDP and increased to an average of 2.6% from 2011 – 2015. This discrepancy was attributed to data challenges and limitations.

Oppong and James (2016) have pointed out that data aggregation in the estimation of VAT expenditure by the GRA and the Ministry of Finance resulted in underestimation of the tax expenditure. Using firm level data for direct and custom tax expenditures and VAT tax expenditures from the supply and used tables in 2013 estimates an overall tax expenditure of 5.2% of GDP for 2013. Their results further indicated tax expenditures on VAT constitute 4.2% of the overall tax expenditures. In brief tax expenditure is high in Ghana and has been on the rise since 2008 and it is imperative Ghana starts changing the narrative if the country is to mobilize enough revenue so as realize the Ghana Beyond Aid agenda.

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