Foresight Africa viewpoint: Revenue mobilization in commodity-rich countries: Challenges and opportunities

Editor's note:

Below is a viewpoint from Chapter 1 of the Foresight Africa 2017 report, which explores six overarching themes that provide opportunities for Africa to overcome its obstacles and spur inclusive growth. Read the full chapter on mobilizing financial resources here.

Since the fall in commodity prices in 2014, most commodity-rich countries have been facing a growing fiscal challenge. The large decrease in commodity prices has increasingly been perceived as more permanent than temporary. This issue is particularly pressing in African countries whose fiscal revenue structure depends “excessively” upon commodity revenues.

Excessive dependence on commodity revenues occurs when the share of revenues from commodities greatly exceeds their contribution to GDP. For example, between 2010-2013, some of Africa’s biggest economies such as Nigeria and Angola have had fiscal revenue structures that depend “excessively” upon commodity revenues, while others, such as Guinea, Mauritania, and Zambia have been much more balanced. For example, in Nigeria, hydrocarbon revenues represent about 75 percent of total revenues while hydrocarbon only constitutes about 20 percent of GDP. This “excessive’’ dependence on the revenue from commodities naturally leads to important fiscal vulnerabilities in the current period of, apparently, permanently low commodity prices.

In the near future, most of these countries will still be able to finance their way out of growing fiscal deficits by increasing their public debt. However, larger spreads as well as the prospect of interest rate hikes by the U.S. Federal Reserve severely limit the continuation of this strategy in the medium run.

How should these fiscally vulnerable commodity-rich countries proceed in 2017? One option is to reduce the fiscal deficit by reducing government spending and increasing efficiency. While tough times provide the political will to increase efficiency and carry out medium- to large-scale spending reforms, there are limits to how far spending can be cut considering important social, developmental, and infrastructure gaps in the region.

Another option is to use the political space provided by these difficult times to enact much-needed tax reforms which, among other things, may involve increasing tax rates, especially in those “excessive’’ commodity revenue dependent countries.

As shown in Gunter, Riera-Crichton, Vegh, and Vuletin (forthcoming),[1] increasing taxes may be a smart option because tax changes have nonlinear effects on economic activity. Under low or moderate initial tax rate levels, the negative impact of tax hikes on long-run economic activity is very small (or virtually zero), while the impact increases in a non-linear way as the initial level of tax rate rises. Naturally, more revenue collection is not the only answer to complex fiscal problems and increasing government efficiency and targeting will always go along in improving the overall effect of fiscal policy. Interestingly, countries with high dependency on commodity revenues such as Nigeria and Angola often have low tax rates (e.g., with standard VAT rates of 5 percent and 10 percent, respectively). In contrast, countries that are less dependent on commodity revenue, like Mauritania, Guinea, and Zambia, have relatively higher VAT rates of 16 percent, 20 percent, and 16 percent, respectively. This new policy research insight indicates that countries like Nigeria and Angola could quickly mobilize revenues from non-commodity-related activities by increasing their VAT rates with relatively small side effects on economic activity. In other words, the fiscal challenges currently faced by African countries with “excessive” dependency on commodity revenues may provide not only the chance to reduce a growing structural fiscal deficit and debt problem, but also an opportunity to help balance their revenue composition in a manner that is more in sync with their economic structure.

[1] Gunter, S., Riera-Crichton, D., Vegh, C., and Vuletin, G. Non-linear Effects of Tax Changes on Output: A Worldwide Narrative Approach. Forthcoming.