The Impact of Tax Hikes on Debt Burden and Economic Development in Africa: Analysing the Trade-Offs and Implications for Sustainable Growth

The Impact of Tax Hikes on Debt Burden and Economic Development in Africa: Analysing the Trade-Offs and Implications for Sustainable Growth

Wellington G. Bonga

Independent Researcher, Zimbabwe  

DOI: https://doi.org/10.51244/IJRSI.2024.11120033

Received: 06 December 2024; Accepted: 11 December 2024; Published: 10 January 2025

ABSTRACT

This explanatory paper explored the complex relationship between tax hikes, public debt burden, and economic development in Africa. It argued that while increasing taxes can generate vital revenue for governments, it can also exacerbate debt levels and hinder economic growth if not managed effectively. Through a comprehensive analysis of the trade-offs involved, including case studies from various African countries, this paper aims to inform policymakers about the delicate balance needed for sustainable economic development. Through the findings, the study suggest that optimal tax policies, combined with effective governance, are crucial for enhancing economic resilience and addressing the challenges of public debt. More specifically the study recommends the strengthening of governance structures, engagement of stakeholders in policy making, assessing economic context before implementing tax hikes, diversifying revenue sources rather than solely relying on tax increases, and continuous monitoring and evaluation of tax policies to ensure sustainable economic growth.

Key words: Africa, Debt Burden, Economic Development, Fiscal Policy, Governance, Public Finance, Sustainable Growth, Tax Hikes

JEL Codes: D78, E62, F34, H20, H63, H71, O23, O55

INTRODUCTION

In recent years, many African nations have faced significant economic challenges, including rising public debt, stagnant growth, and increasing demands for public services. Africa’s public debt has risen sharply in recent years, totaling $1.8 trillion in 2022 and this represents a 183% increase since 2010 and is four times greater than the continent’s GDP growth rate (UNCTAD, 2023). Economies with high public debt tend to grow slowly. In response, governments often resort to tax hikes as a means to generate additional revenue. For instance, Fraser (2024) narrates that the South African government desperately needs more revenue, with potential tax hikes on the cards for the wealthy. Pertaining Kenya, Bahl (2024) indicates that the cash-strapped government says the tax increases are required to service the nation’s massive debt of some 10 trillion shillings ($78 billion), equal to roughly 70 percent of Kenya’s Gross Domestic Product (GDP). However, the implications of such tax policies are multifaceted and can lead to unintended consequences, particularly concerning the debt burden and overall economic development. In 2020, 27 African countries had a debt-to-GDP ratio exceeding 60%, a benchmark considered critical for sustainability (UNCTAD, 2023). Africa is a promising continent due to its vast population and untapped natural resources (Bonga & Mahuni, 2018). This study posits that while tax increases can provide necessary funds for development projects, they may also intensify the existing debt crisis and stifle growth if they are not strategically implemented. Thus, understanding the trade-offs involved in tax policy decisions is critical for achieving sustainable growth in Africa.

In some cases, as indicated by Bonga, Chirowa & Nyamapfeni (2015) the government borrows to postpone challenging yet essential reforms, such as implementing taxes that may be needed to raise revenue for development. Moreso, the increased demand for personal protective equipment (PPE), pharmaceuticals, medicines, vaccines, and other essential goods may trigger borrowing (UNCTAD, 2023). In many African countries, phases of tax reforms have been motivated by various objectives, chiefly revenue and economic growth considerations (Kim & Kim, 2018). Evidence from many studies points that developed countries generally prefer natural resource related revenues over taxation (Semboja et al., 2023). Therefore, tax efforts in resource-rich nations are usually lower compared to non-resource nations (Bornhorst, Gupta & Thornton, 2009; Coulibaly & Gandhi, 2018). The thesis of this study is that tax hikes, while essential for revenue generation, must be carefully balanced with considerations of public debt and economic growth. The argument is structured around three key points: first, that excessive taxation can deter investment and economic activity; second, that governance quality plays a crucial role in determining the effectiveness of tax policies; and third, that a nuanced understanding of the fiscal landscape is necessary to formulate effective tax strategies that promote growth while managing debt levels.

The paper is organised in five sections. First, is the introduction section. Second section discuss the trade-offs of tax hikes, that is detrimental effects on economic activity, public debt dynamics, and governance and tax issues. Third section presents some case studies from selected African countries. Fourth section, justify the study methodology. Final, section is the conclusion and policy recommendation for the study.

The Trade-offs of Tax Hikes

Detrimental effects on economic activity

Tax hikes can significantly impact economic activity, particularly in developing economies where businesses operate on thin margins. According to Elbadawi (1997), high tax rates can discourage investment, leading to a reduction in economic growth. This sentiment is echoed by Mawejje and Odhiambo (2022), who found that increased taxation in East Africa correlates with a slowdown in economic expansion. Furthermore, Comelli et al. (2023) argue that when businesses face higher tax burdens, they may reduce their workforce or limit expansion plans, ultimately hampering job creation and economic dynamism.

Public debt dynamics

The relationship between tax hikes and public debt is intricate. While increasing taxes can provide immediate revenue, it may also lead to higher debt levels if the funds are not utilized efficiently. Ndung’u, Shimeles & Manda (2021) highlight that many African countries have resorted to borrowing to finance budget deficits, often exacerbated by inadequate tax collection systems. Kassouri and Altıntaş (2021) further emphasize that without effective governance and fiscal discipline, tax increases could lead to a vicious cycle of debt accumulation, ultimately undermining economic stability.

Governance and tax efficiency

The effectiveness of tax hikes in generating revenue largely depends on the quality of governance. Adedeji et al. (2024) argue that poor governance and corruption can erode the potential benefits of tax increases, as funds may be misappropriated rather than invested in developmental projects. Accordingly, Bonga (2021) indicated that corruption derails success and development, and the costs are borne by the citizens. The African Development Bank (2023) notes that countries that have successfully tackled tax evasion and improved governance have seen significant increases in revenue without resorting to higher tax rates. Thus, enhancing governance structures is crucial for maximizing the benefits of tax hikes while minimizing the risk of increased debt.

Case Studies from selected African countries

The study picked Kenya, South Africa, Nigeria, Ghana, and Tanzania for a deeper analysis of the subject. However, each country in Africa has some related stories, and same lessons can be derived from the selected nations. According to African Tax Administration Forum (ATAF) 2023 African Tax Outlook, regionally, the Southern African Development Community (SADC) recorded the highest average tax-to-GDP ratio at 17.49%, followed by the East African Community (EAC) at 14.20%. In the same report, the Economic Community of West African States (ECOWAS) and the Economic Community of Central African States (ECCAS) had ratios of 13.83% and 12.18%, respectively. African countries currently generate very low tax revenues and fall behind other regions, including other developing areas like South Asia, Southeast Asia, and Latin America. The most frequently referenced factor is the nature of the state-society relationship (Gwaindepi, 2023). This suggests that states need the expertise, administrative capabilities, and ability to persuade taxpayers of the significance of tax contributions. In an effort to match tax ratios with other countries outside Africa, Africa nations should do it with due diligence not to negatively impact sustainable growth.

Kenya has implemented various tax reforms aimed at increasing revenue. However, these reforms have often met with resistance and criticism. According to Ndung’u, Shimeles & Manda (2021), the introduction of higher VAT rates in 2018 led to public discontent and protests. While the government aimed to boost revenue, the result was a decline in consumer spending, ultimately affecting economic growth. This case illustrates the delicate balance between revenue generation and maintaining public support for tax policies.

South Africa presents another example of the trade-offs involved in tax increases. The government has raised taxes to address rising public debt, but these measures have led to slower economic growth. Devarajan, Gill & Karakülah (2021) note that higher corporate tax rates have deterred foreign investment, which is crucial for economic recovery. The South African experience underscores the importance of considering the broader economic context when implementing tax hikes.

Nigeria’s reliance on oil revenues has shaped its tax policies significantly. While the government has sought to diversify its revenue base through tax hikes, the effectiveness of these measures has been limited by poor governance and corruption. This is in tandem with the works of Bonga (2021a) who narrates that many of the economic and social challenges facing African countries are attributed to high levels of corruption, which manifest in various forms and degrees. Manasseh et al. (2022) argue that despite increasing tax rates, Nigeria continues to struggle with high levels of public debt and underinvestment in critical sectors. This case highlights the need for comprehensive reforms that address both tax policy and governance challenges.

Ghana’s attempt to increase tax revenue through reforms has shown mixed results. Revenue generation for the nation has been enhanced through tax reforms since 1984 (Owusu-Gyimah, 2015), and from then numerous reforms have been implemented over the years. Addison & Osei (2001) narrates that tax reform has been highly controversial in Ghana. While the introduction of new taxes aimed to enhance revenue, it has also led to public backlash. Nyoni and Bonga (2018) point out that the government’s failure to communicate the benefits of these tax hikes effectively has resulted in decreased public trust. This situation illustrates the importance of stakeholder engagement in tax policy formulation to ensure successful implementation.

Tanzania tax regime consists of a number of direct and indirect taxes including income tax, Value Added Tax, import duty, excise duty, and stamp duty (Mrema, 2018). Like many other African nations, there are also taxes levied at the local government level. Tanzania has pursued aggressive tax policies to finance its development agenda. However, the results have been uneven. While tax revenues have increased, the burden on businesses has also grown, leading to concerns about competitiveness and growth. The Tanzanian experience demonstrates that without a careful assessment of the economic environment, tax hikes can have counterproductive effects.

Summing up, the economic lessons derived from the tax reform experiences in Kenya, South Africa, Nigeria, Ghana, and Tanzania highlight the complex interplay between revenue generation and public support. Kenya’s VAT increase resulted in public backlash and decreased consumer spending, illustrating the importance of maintaining public trust. South Africa’s tax hikes aimed at reducing public debt led to slower economic growth and deterred foreign investment, emphasizing the need to consider the broader economic context. Nigeria’s reliance on oil revenues and the challenges of corruption demonstrate that governance issues can undermine tax policy effectiveness, necessitating comprehensive reforms. Ghana’s mixed results from tax reforms since 1984 reveal the critical role of effective communication and stakeholder engagement in fostering public acceptance. Finally, Tanzania’s aggressive tax policies show that without a thorough economic assessment, tax increases can burden businesses and hinder growth, underscoring the need for a balanced approach to tax policy.

Justification of Research Methods used

As indicated by Bhat (2024), explanatory research seeks to clarify how and why certain variables influence one another, making it ideal for investigating complex phenomena such as the impact of tax hikes on economic development. In this study, the aim was to establish causal relationships between increased taxation and its subsequent effects on public debt and economic growth. Through identifying these relationships, the research provides insights into the underlying mechanisms at play, which is essential for effective policymaking.

Further, the methodology incorporated case studies from various African countries, a characteristic feature of explanatory research. This approach allowed for in-depth analysis and comparison of different contexts, enhancing the understanding of how tax policies can yield differing outcomes depending on local governance, economic structure, and public policy (George & Merkus, 2021). Through examining specific instances, the research highlighted successful strategies and potential pitfalls in tax policy implementation.

Through emphasizing the delicate balance needed for sustainable economic development, the study’s findings informed policymakers about optimal tax strategies and governance frameworks. This practical application of research aligns with the goals of explanatory research, which aims not only to understand phenomena but also to provide actionable insights that can enhance economic resilience (Trymata, 2024).

In summary, the explanatory research methodology used in this paper is justified by its focus on causal relationships, and the incorporation of diverse case studies. These elements collectively contributed to a comprehensive understanding of the impact of tax hikes on debt burden and economic development in Africa, ultimately guiding policymakers toward sustainable economic growth.

CONCLUSION AND POLICY RECOMMENDATIONS

In conclusion, tax hikes in Africa present a complex interplay between revenue generation, debt burden, and economic growth. While they are essential for financing development, policymakers must navigate the associated trade-offs to avoid adverse economic consequences. Effective governance plays a crucial role in ensuring that tax revenues are utilized efficiently and that public trust in the system is maintained.

The study offers the following policy recommendations;

• Strengthening of governance structures. Enhancing transparency and accountability in tax administration is critical. Governments should invest in capacity building for tax authorities to improve efficiency and reduce corruption.
• Engagement of stakeholders. Effective communication and stakeholder engagement are essential for gaining public support for tax reforms. Policymakers should involve citizens and businesses in the tax policy formulation process to foster trust and acceptance.
• Assessing economic context. Before implementing tax hikes, governments should conduct thorough assessments of the economic environment to understand potential impacts on investment and growth.
• Diversifying revenue sources. Rather than solely relying on tax increases, countries in Africa should explore alternative revenue sources, such as improving tax compliance and reducing tax evasion.
• Monitoring and evaluation. Continuous monitoring and evaluation of tax policies are necessary to assess their effectiveness and make adjustments as needed to ensure sustainable economic growth.

Through the above recommendations, African countries can navigate tax policy challenges while fostering economic development and managing public debt effectively.

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