Foreign Financed Projects in Developing Countries and VAT Exemptions Gérard Chambas CERDI Université d’Auvergne Fra

1. Foreign Financed Projects in Developing Countries and VAT ExemptionsGérard Chambas CERDI Université d’Auvergne Franceemail G.Chambas@u-clermont1.fr

2. I Introduction • II Overview of tax exemptions on Foreign Financed Projects (FFPs) • III Consequences of VAT exemptions on FFPs • IV Orientations to prevent the harmful effects of tax exemptions on FFPs

3. I Introduction For many LDCs, foreign aid represents a major source of revenue • Aid = 2 to 5 percent of GDP in Burkina Faso, Benin, Togo • Aid = 70 percent of the government revenue in Mozambique

4. FFPs are an important component of foreign aid Tax exemptions on FFPs lead to substantial tax expenditures* For WAEMU, tax exemption amount = 5.4% of tax revenue* For Mali and Niger = 9.9% and 9.7% of tax revenue (Source : c. de Mariz Roseira, 2004)

5. II Overview of tax exemptions on FFPs • 1 Some facts • 2 The donors rationale • 3 Tax exemptions: a high cost • 4 Tax exemptions: weak justifications

6. 1 Tax exemptions on FFPs. Some facts • Current practice: tax exemptions on FFPs • Various opportunities for frauds: • by overreporting the prices • by diverting goods and services from their initial purpose, … • To prevent fraud, control tax exemptions on FFPs • Tax exemptions certificate (no ceiling) • Direct cash payments from the government budget • Voucher systems

7. 2 Tax exemptions on FFPs the donors rationale • Tax exemptions help to reduce project’s costs • Project aid is seen as more efficient than budgetary supports (poor governance, corruption) • Project aid ensures more visibility

8. 3 Tax exemptions result in a high cost • Tax revenue losses and tax distortions. • Projects implementation problems. • Significant administrative burden for tax and customs administrations. • Lack of transparency

9. Tax revenue losses and tax distortions • In all cases, tax revenue losses (tax expenditures) • First hypothesis, without fraud: tax exemptions are adverse to tax neutrality • Tax exemptions are easier to get for imported goods than for locally produced goods • Distortion between exempted and non exempted activities • Tariffs exemptions can lead to a negative effective protection

10. Tax revenue losses and tax distortions • Second hypothesis, with fraud: • Fraud is stimulated by weaknesses in the administrative control • Consequences • Tax revenue losses • Economic distortions

11. Projects implementation problems • Tax exemptions procedures are complex: high administrative costs for FFPs • Some tax or customs administrations refuse the vouchers and ask for a net payment • Unavailability of public resources for direct payments

12. Significant burden for tax and customs administrations • Tax exemptions are not applied to every FFP or donor (conventions ad hoc…). Hence, monitoring tax exemptions is complex • Heavy administrative burden for tax and customs administrations (one specialized unit in Benin)

13. Lack of transparency • Management of vouchers is often weak • The system of FFP tax exemption leads to numerous and heavy costs: costs evaluations are not available

14. 4 Tax exemptions: weak justifications Case 1 : donors finance both projects and budgetary support Paying for taxes on FFP is equivalent to a budgetary support

15. 4 Tax exemptions: weak justifications Case 2 : donors finance exclusively projects • Aid is fungible • Efficiency argument: projects are not efficient in a country with poor governance • No evidence that a project is more efficient than a budgetary support

16. III Consequences of VAT exemptions on FFPs • 1 VAT, focal point of tax transition • 2 Inefficiency of voucher schemes for monitoring VAT exemptions on FFPs • 3 An harmful hole in the VAT system

17. 1 VAT, focal point of tax transition • Constraints upon a tax transition through direct taxes • A dramatic decrease of tariffs revenues

18. 1980-82 T 2000-02 T 1 Developing Countries 28,0 90 16,8 76 1.1 Sub-Saharan Africa 34,1 41 22,2 42 1.2 Latin America 23,9 22 7,9 13 1.3 Asia 26,9 19 12,4 12 Table 1 International trade taxation in developing countries Unit: % of public revenue  T: sample size. Source: Chambas (2005).

19. 1 A tax transition through VAT The relative share of domestic taxes in the government revenue is increasing

20. 1980-82 T 2000-02 T 1 Developing Countries 22,4 90 36,1 76 1.1 Sub-Saharan Africa 22,3 41 36,7 42 1.2 Latin America 21,8 22 40,4 13 1.3 Asia 26,2 19 28,5 12 Table 3 Indirect domestic taxes (VAT and excise taxes) in developing countries Unit: % of public revenue  T: sample size. Source: Chambas (2005).

21. 1 VAT, focal instrument of tax transition • Substantial progress towards increasing VAT revenues are possible • Economic neutrality of VAT

22. 2Inefficiency of voucher systems for monitoring VAT exemptions on FFPs • For traditional taxes as sales taxes a voucher scheme is not so complex. • Issued vouchers amount = sale tax amount • For VAT on imports • Issued vouchers amount = VAT amount

23. 2 Inefficiency of voucher systems for monitoring VAT exemptions on FFPs • For VAT on local products and services, the system is getting complex • Issued vouchers amount = VAT due on output minus VAT charged on inputs • Difficulties with VAT refunds

24. Difficulties with VAT refunds: consequences • Projects contractors ask for extensive VAT exemptions • Hence, VAT exemptions undermine the whole VAT system

25. 3 VAT exemptions magnify the harmful effect of the other tax exemptions • Bias against locally produced goods • Often, FFPs definitively beat the VAT burden • VAT exemptions break the chain of deductions and undermine the basic logic of VAT • Hence, VAT exemptions on FFPs are a major constraint on the tax transition

26. Which choice for tax exemptions on FFPs? • Eliminate all FFPs tax exemptions and especially VAT exemptions on FFPs

27. By eliminating tax exemptions on FFPs • Reduction the costs of transaction • Tax revenue reinforcement • Strengthen the VAT consistency • Reduction of the negative impact of new projects on the budget deficit

28. New facts and decisions • Multilateral donors: World Bank April 2004 • Bilateral donors: France • Debt reduction contracts (C2D), France is already financing taxes on FFPS • A recent report (Chambas et al. 2005) at the request of the French Ministry of Foreign Affairs recommends the elimination of most tax exemptions, including tax exemptions on foreign financed projects .

29. THANK YOU