PARPA 2 Tax

The TIP Project provided a review of tax policy in Mozambique as input into the evaluation of the second Action Plan to Reduce Absolute Poverty (PARPA).

This study is part of a wider evaluation of government performance in achieving the PARPA II objectives, with the ultimate goal of promoting rapid, broad-based and sustainable growth to improve standards of living and welfare for the people of Mozambique. In particular, the study examines the impact of the tax system on revenue mobilization, investment, savings, job creation, and private sector development, with special attention small and medium enterprises, as well as the issue of tax equity. The study draws on a review of the tax laws and other documents and studies relating to the tax system; an analysis of data on revenue performance, including international comparisons; and extensive field interviews conducted in July 2009.

Principal features of the tax system accord well with best practices for developing countries, including reliance on a broad-based value added tax, a modern income tax, with moderate import duties, excise taxes on selected products, and a simplified tax for small contributors (ISPC). The government has also made notable progress in improving tax administration since the establishment of the Revenue Authority (AT) in 2006. Nonetheless, serious challenges remain in the area of modernizing tax administration.

The study finds few opportunities to achieve sizeable revenue gains through changes in tax policy, but huge potential for improving the revenue yield by strengthening tax administration, through measures that will broaden the effective tax base, allocate AT resources more efficiently, and facilitate taxpayer compliance.

Based on the analysis, the study identifies 12 priority issues for the next PARPA period, and recommends corresponding measures for consideration by the government. On the central issue of establishing a medium-term revenue target, the study suggests options ranging from 16..5 to 18.5 percent of GDP depending on the desired balance between revenue enhancement and tax relief for the private sector. Other priority issues relate to reducing tax rates; tax policy analysis; functional integration of tax operations; e-taxation; risk management; simplification; taxpayer services; the tax culture; tax training; EITI implementation; and donor coordination.

Standard tax rates on businesses in Mozambique are now slightly above the regional and international averages, due to the global trend towards lower company taxes. Nonetheless, the prevailing tax rates should not be a deterrent to most investments, because other aspects of the business environment are far more important in determining the viability of most projects. Lower tax rates would, however, increase the capacity of existing firms to finance expansion and improve productivity by boosting net earnings and cash flow. One case where tax rates have a critical effect is on internationally mobile (“footloose”) investments that could easily go to other countries; these investments, however, should be covered by the fiscal benefits applying to IFZ enterprises, which are highly competitive. In contrast, the effective tax rate is very burdensome for investments that lack special incentives and face double taxation of dividend distributions to individual shareholders. This feature of the tax code creates a disincentive for incorporation.

The tax system affects the efficiency of investment, as well as the level. Special tax breaks under the Code of Fiscal Benefits tend to have the greatest impact on investments with relatively low rates of return, since projects with an intrinsically high return would be undertaken anyway. The fiscal benefits also tilt the playing field in favor of new investors who qualify for tax breaks, relative to existing businesses and other investors—especially small businesses. Similarly, tax benefits that lower the cost of imported capital tend to encourage capital intensity and import dependence, which inhibits the extent of job creation and domestic linkages. Business linkages to small enterprises are also hindered, in less obvious ways, by the need for registered entities to obtain proper tax receipts from suppliers under the VAT and income tax, as well as provisions for 20% withholding tax on various transactions.

The quality of tax administration also has an important effect on investment and business operations. Indeed, concerns about arbitrary and punitive enforcement practices by tax officials, complexity of the tax system, lack of taxpayer services, and difficulties in recovering refunds are far more prevalent than complaints about the level of taxes. These problems particularly affect small and medium size enterprises: the primary engine of job creation for the economy.

Tax rates, compliance costs and complexity of the tax system also affect decisions by small businesses to formalize. The Simplified Tax (ISPC) passed in 2009 should go a long way towards reducing these tax-related barriers, if effectively implemented. The VAT, too, creates incentives for formalization, for any small enterprises that wish to do business with VAT-registered companies. Incentives to formalize are also influenced by the cost of non-compliance, which is determined by the AT’s capacity to enforce registration requirements.

The effect of the tax system on saving is complex. Higher taxes could reduce business and household saving but increase government saving, leaving an ambiguous net effect in the short run. In the medium to long term, however, the most important consideration is how the tax system affects the growth of income, which is the primary determinant of saving.

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