Towards Taxation for Development: Challenges and Opportunities; The case of Uganda.

SEATINI UGANDA November 2010

Strengthening Africa in World Trade

Table of Contents
List of Abbreviations Preface Introduction
i. ii. iii. iv. v.

Ugandas Social Political Profile Economic and Fiscal Environment A History of Ugandas Tax System Key Players in Tax Policy Formulation and Implementation The Relationship between Aid Dependency and Accountability to Citizens 1.1 1.2 Tax Systems in Uganda Level of Revenues Generated and the Relative Importance of Ugandas Revenue Sources 1.2.1 At the Central Government Level 1.2.2 At the Local Government Level 1.2.3 At the International Level 1.3 Tax Categories in Uganda; Advantages and Disadvantages of Each. A. Personal Income Tax. (PIT) B. Corporate Income Tax (CIT). C. Value Added Tax (VAT) D. Excise Tax. 1.1 Ugandas Tax System; Fair or Not? 1.2 Recommendations on Addressing the Challenges above 2.1 2.2 2.3 2.4 3.1 3.2 3.3 4.1 Challenges of Broadening the Tax Base in Uganda Opportunities in Broadening the Tax Base in Uganda Implications of Regional Integration on Broadening the Tax Base in Uganda Recommendations on addressing the Challenges identified above Implications of Operations by Multi National Corporations on Ugandas Tax Base Impact of Trade Agreements on the Countrys Tax Base Recommendations on meeting the Challenges above Overall Recommendations

1.0

Chapter 1

2.0

Chapter 2

3.0

Chapter 3

4.0

Chapter 4

References List of Tables

Table 1.0: Trends in Major Fiscal Aggregates Table 1.1: Composition of Local Revenues in Uganda Rural and Urban Combined (Including KCC) Table1.2: Tax Contributions by Households Table 1.3: Current Excise Tax Rates in Uganda Table 1.4: Evidence on Tax Progressivity/ Regressivity from dominance testing in Uganda and Ghana. Table 4.1: A Summary of Recommendations from the Chapters above

List of Figures

Figure 1.0: Trend in Local Revenue Collections in Uganda Figure 1.1: Budget Support disbursements to Uganda 1993 to 2003

Abbreviations
AfDB African Development Bank BIT Business Income Tax BOP Balance of Payments BOU Bank of Uganda CIT Corporate Income Tax CSOs Civil Society Organizations DFID British Department for International Development EAC East African Community EME Emerging Market Economies EPAs Economic Partnership Agreements EPS Early Production Scheme FDI Foreign Direct Investment GDP Gross Domestic Product GOU Government of Uganda GNI Gross National Income HIPC Highly Indebted Poor Countries IMF International Monetary Fund IFAD International Fund for Agricultural Development IDA International Development Agency ICC International Criminal Court LRA Lords Resistance Army MFPED Ministry of Finance Planning and Economic Development MTEF Medium Term Expenditure Framework MDRI Multilateral Debt Relief Initiative MNCs Multi National Corporations NRM National Resistance Movement NDP National Development Plan ODA Overseas Development Assistance PAF Poverty Action Fund PIT Personal Income Tax PAYE Pay as You Earn PSC Production Sharing Contracts PEAP Poverty Eradication Action Plan SSA Sub-Saharan Africa TNCs Trans National Corporations UMA Uganda Manufacturers Association URA Uganda Revenue Authority UPE Uganda Primary Education UNCTAD United Nations Committee on Trade and Development UNDP United Nations Development Programme UBOS Uganda Bureau of Statistics VAT Value Added Tax WTO World Trade Organization

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Preface:
Uganda just as many other developing countries continues to grapple with the challenges of escalating poverty levels as well as the need to promote sustainable development. Over a long period now, developing countries have continued to depend more and more on external financial flows and less on domestically generated resources. The irony of it all is that these increases in external financial flows, mainly aid, continue to exist side by side with increasing poverty levels. In Uganda, 75 percent of the population still lives on less than 2 dollars a day, yet the population is increasing at an estimated 3 percent every year. Worse still, research has shown that the amount of resources flowing out of developing countries far outweighs those flowing in. Christian Aid estimates that just two forms of tax evasion, transfer mispricing within multinational corporations (MNCs) and falsified invoicing between apparently unrelated companies, cost the developing world US$160 billion a year in lost revenue. That figure alone represents more than 150 percent of the combined aid budgets of all donor countries. It is also no doubt that Uganda and other developing countries alike have yet to fully utilize their domestic resources in addressing the challenges that they face. It is also worth noting that aid which usually fills the tax gap may not be always reliable as it tends to be highly volatile and conditional. A case in point is the current global financial crisis that has taken a direct toll on aid flowing to developing countries in general and Uganda in particular. According to Sennoga et al. (2009) foreign aid to Uganda decreased from US$223.29 million during Quarter 4 of 2007 to $178.9 million in Quarter 4 2008, with budget support recording a greater reduction relative to project support. Since 2001, donor budget support has surpassed project aid, largely as a result of an emphasis on basket funding. That said, donor budget support has been declining over time. In 2008, it stood at 40.3% of total foreign aid, compared with 59.8% in 2007. Broadly speaking, donor inflows continued to come in as loans rather than grants. The share of grants in total aid was almost half in 2006/07 but increased to about 62.3% in 2007/08, mainly in project support. The share of budget support in total loan aid

reduced from 44.2% in 2006/07 to 24% in 2007/08. Overall, Uganda is more likely to register further declines in Official Development Assistance (ODA), although there is no indication of this as yet from donors. The importance of taxation to any economy cannot be overstated. While taxation plays the important traditional roles of raising government revenue, discouraging activities that may be deemed socially undesirable, redistributing wealth and income and the allocation of resources among the population, it has a major role of ensuring good state-society relations through accountability and good governance. Citizens of a country entrust the government with a share of their incomes through taxation and in return expect efficient delivery of services. Whichever direction this relation goes, will have a profound effect on good governance. Taxation can also be a tool to achieve trade policy objectives. One of the objectives of trade policy is to nurture and protect the economy in general & specific sectors in particular from premature exposure. Import tariffs and export taxes are some of the taxes that may be used for this purpose. Developed countries have also used tariff peaks and tariff escalation on top of export and import taxes to protect their economies. Never the less, Uganda is faced with a number of challenges raising revenue. These include among others: 1) the biggest population of the workforce is found in agriculture or in small and informal enterprises which makes it difficult to impose taxes: 2) tax evasion and avoidance practices contribute greatly to shrinking the countrys taxable base: 3) the limited capacity of revenue collecting agencies both at the central and local levels: 4) poor quality of basic data. All these challenges are compounded by a general limited discussion among the different stakeholders (Government, Civil Society, Media and the general public) on tax issues and the contribution that taxes have on poverty eradication and sustainable development. Tanzi and Zee (2001) argued that tax policy in developing countries is often the art of the possible rather than the pursuit of the optimal given such circumstances. Never the less, the ideal tax system in

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developing countries should raise essential revenue without excessive government borrowing, and should do so without discouraging economic activity and without deviating too much from tax systems in other countries. While there has been increased discussion on tax issues at the global level over the years through organizations like the Tax Justice Network (TJN) and Tax Justice NetworkAfrica, the discussion at the national level is still mainly limited to government and a few players like the Uganda Manufacturers Association (UMA) on the part of the public.

The study begins with an introduction to Ugandas social, political and economic profile, a brief history of Ugandas tax system, as well as the key players in tax policy formulation, followed by an analysis of the relationship between aid and accountability. Chapter 1 assesses the nature of the tax system in Uganda, the revenue levels, and the importance of different revenue sources. It then assesses the different taxes giving their advantages and disadvantages. Next is an analysis on Ugandas domestic tax policies and practices and whether they promote fair policies for development, accountability and equity. The chapter assesses the fairness and unfairness of the tax system and the implication on poverty eradication with a focus on the agriculture, education and health sectors. Recommendations are then given at the end of the chapter on addressing the challenges posed by the tax policies and practices.

Civil Society therefore has an important lead role to play in raising awareness on tax issues and encouraging debate on these issues. Civil Society is an important player in development as it constitutes the full range of formal and informal organizations that are outside the State and market. Civil Society also doubles as a watch dog to make sure that government policies get implemented. The success of the campaign on taxation towards development will in a Chapter 2 analyses the challenges and opportunities in significant way depend on both a robust State and an active broadening the tax base in Uganda. It specifically analyses civil society with healthy levels of civic engagement. ways to broaden the tax base and also analyses the implications of regional integration on broadening the tax It is against this background that there are increased base. The chapter ends with recommendations on ways calls for African countries and other developing countries to deal with the challenges of broadening the tax base in to seek more sustainable sources of revenue to meet Uganda. their development challenges. These calls focus on the importance of taxation in raising domestic revenue, Chapter 3 assesses the implications of operations by contributing to poverty eradication and to sustainable Multi National Corporations on the countrys tax base. development. Theres also a focus on encouraging debate Assessment is done on the impact of such factors as capital on taxation and development. flight, mispricing and operations in tax havens. The chapter also assesses the impact of relevant trade and investment The Overall objective of the study is therefore to raise agreements on the countrys tax base. It concludes with awareness among policy makers, civil society organizations recommendations on addressing the implications of the as well as the public about the dangers of tax competition, MNCs on the economy at both the regional and global tax holidays and a poor tax culture versus development. level. The specific objectives of the study are: 1) To analyze domestic tax policies and practices in Uganda and establish whether they promote fair policies for development, accountability and equity. 2) To assess the challenges in broadening the tax base in Uganda. 3) To make recommendations on how tax can be used as a development tool especially in the key Ugandan sectors of agriculture and health Chapter 4 summarizes the recommendations in the first 3 chapters and gives general recommendations on how taxation can be used to achieve poverty eradication and sustainable development in the key sectors of agriculture, education and health.

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Introduction: i. Ugandas Social Political Profile

Uganda has gone through a series of political social and economic reforms since her Independence in 1962. These can be placed under four major periods of government. The first three periods that run from 1962 to 1986 were marred by a change in governments, each introducing a new form of rule that relied mainly on abolishing the status quo. The country saw authoritarian regimes in this period that relied on military rule. Generally in the 1970s and 1980s, Uganda was notorious for its human rights abuses, first during the military dictatorship of Idi Amin from 1971-79 and then after the return to power of Milton Obote in 1979-86, who had been ousted by Amin. The country also went from low aid levels in the first Obote regime (1962-71) to high levels of borrowing in the 1970s under Idi Amin. The situation of debt accumulation in the 1970s was as a result of Idi Amins policies that included the expulsion of almost all of Ugandas 80,000 Asians in September 1972, followed by other policies of nationalizationof businesses and industry, and the expansion of the public sector. These policies had led to a sharp decline in the productivity and efficiency of the countrys business sector, with public expenditure falling from over 20 percent of GDP in 1972 to below 10 percent by 1979 (Fagerns and Roberts, 2004).With the public uncertain about the government rule and their declining confidence in the stability of the formal sector, they sought solace in the informal sector thereby by-passing the State and its revenue collecting agencies, leading to a big decline in State revenue.

to a process of nation building with many development programmes put in place. Three general elections have been held successfully in the last two decades with taxation policy having a part to play in some of the outcomes of the elections. In 2001 for example, the contested Graduated Tax was used as a campaign issue. While Uganda enjoys relative peace for much of the country to date, it still grapples with the challenges of a war in the North against the Lords Resistance Army (LRA), as well as unsafe borders with Sudan and Congo. Of critical concern too is the challenge posed by the HIV/AIDS epidemic. While it is fundamentally a health issue, the impact of HIV/ AIDS goes far beyond health because of its widespread human, social and economic effects. Both of these factors have contributed greatly to increased deaths of adults in their productive prime thus constraining the tax base. This has potentially devastating consequences on the economy, labor supply and productivity, overall production, revenues, and impact on families and communities. ii. Economic and Fiscal Environment With the NRM government in power, the country saw a continuation of free market reform given that the new government had insufficient funds domestically to pursue its development programmes and goals. The country fully embraced the Structural Adjustment Programmes (SAPs), which entailed whole scale economic liberalization.

From 1987-2000, Ugandas per capita GDP grew at an average annual rate of just 3 percent and this rate rose to about 4 percent in 2001 and 8.7 percent in 2007/08. Generally, over the past 8 years, Ugandas economy has remained robust through several exogenous shocks. The countrys real economic growth averaged 7.8 percent between 2000 and 2008. Some of the reasons for this With the return of Obote II between 1979-86, the country growth are strong export growth, stable macro-economic took on more borrowing mainly from the IMF and World environment, increased private investment and high Foreign Bank. And to get more aid, the IMF and the World Bank Direct Investment (FDI) (World Bank, 2009).The recent called for the liberalization of the economy. External official GDP growth can be attributed to good performances of the debts were rescheduled and limited economic reforms services and industry sectors. Construction, in particular, undertaken. This ushered in a short-lived period of budget which constitutes about 50 percent of industry, has grown discipline, but to be later followed by a highly unstable, at an average of 15 percent since 2000. The services sector inflation-prone situation with a sharply falling demand for grew by 13 percent in 2008, with the financial services money. sector contributing the highest growth (World Bank, 2009). Performing well too is wholesale and retail trade, hotels 1986 on-wards saw the coming into power of a new and restaurants, transport and communication (particularly government under the NRM led by Yoweri Museveni that posts and telecommunications). ushered in a sense of peace and stability. This was a start

But while this is the case, the countrys economy remains more reliant on subsistence agriculture and less on high productivity manufacturing. One of the main reasons for this is the countrys poor infrastructure. It is for this reason also that the government has increased investment in the transport sector. In 2008/09 for the first time in many years, the Road sector overtook the Education sector in terms of revenue allocations. Also, despite being the main stay of the economy and employing the largest proportion of Ugandans, the agriculture sector has been declining over the years, accounting for just 15 percent of GDP in 2008 compared to 27.5 percent in 2000. Fiscal policy has focused on controlling budget deficits since the NRM government came into power in 1986. Fiscal policy also continues to grapple with supplementary expenditures that exceed the regulatory level of three per cent of the total approved budget, in turn leading to budget deficits. These fiscal deficits often are a result of the taxation system not raising the target revenue. Ugandas revenue to GDP ratio remains low, even by African standards. In 2008/09 it stood at only 11.9 percent. Revenue (including grants) and expenditure are projected to decrease as percentages of GDP over the next two years, and the overall fiscal deficit should increase slightly from 1.3% in 2009/10 to about 1.7% in 2010/11. Such fiscal deficits have persisted for the last decade and are a source of concern. However, Uganda has just entered a threshold of fiscal transformation, following the discovery of substantial oil deposits, which have attracted considerable investments in the last few years (African Development Bank Group, 2010). Initial yields of oil production are anticipated in 2011, with full commercial potential and thereby revenue streams for government financing are expected in 2015.President Museveni ascribed the discovery of oil partly to divine providenceand partly to his Governments foresight, planning and patience.This is the biggest economic opportunity ever to come Ugandas way. Its bigger than all the aid it ever had and ever will get, says Paul Collier, director of the Centre for the Study of African Economies at Oxford University. The country expects to earn US$ 2 billion a year from oil by 2015 (The Economist, 2010). This could be one of the best chances for the country to widen its tax base. But for now, it is not clear what the full implications for Ugandas economic structure and development prospects will be given the imminent substantial oil revenues.
 OREA Knowledge Series: No. 1(2009):Managing Oil Revenue in Uganda: A Policy Note.  Wachter Sarah: Oil Precious Bane, Emerging Markets, May 27, 2010.

iii. A History of Ugandas Tax System Taxation is the only practical means of raising the revenue used to finance government spending on the goods and services that most of us demand. (Tanzi and Zee, 2001). Taxation as a practice dates back to early civilization. In Biblical times for example, people were required to pay one tenth of their crops to the king to be spent on helping the poor. In Uganda, taxation traces its roots in the Hut Tax (Okello, 2006) that was introduced with the signing of the 1900 Buganda Agreement between the locals and the British colonial masters. The Hut Tax (of 3 rupees per annum and a gun tax of 3 rupees) was a local government tax whose principle objective was to attract citizens into monetary production, and to mobilize voluntary labor for the production of cash crops and minerals for export (Ibid). With the advent of colonialism, the payment of taxes had to be in cash. The first tax legislation in Uganda was introduced in 1919 under the Local Authorities Ordinances, later followed by the Income Tax in 1939 (Ibid). This was collected jointly with the tax from the governments of Tanzania, then Tanganyika, Zanzibar, and Kenya. This tax was mainly paid by the European and Asian residents who were in business or who were employed while the majority of natives remained tax-exempt since they were peasants. After the creation of the East African High Commission, the states shared a number of tax departments and were jointly governed by Acts like Pay As You Earn (PAYE) till the collapse of the East Africa Community (EAC) in 1977 (Ibid). After the collapse of the EAC, each country had to develop its own tax system. Ugandas tax system will be looked at more broadly in the next chapters. It should be noted that developing countries often inherited the tax system that was in place under their (former) colonial master. Today, one can still observe a major influence of former colonial masters in the tax systems of developing countries. What is important too but often not given due attention is the link between taxation and good governance. Taxation is a determinant factor in state-society relations. In a well functioning tax system a government should be able to account for tax revenue entrusted to it by its people and the people in return should be able to hold their government
 See for instance Bodin and Koukpaizan (2008) pp 121-31

accountable in demanding the provision of goods and services.

in the budget process and the public policy process more broadly (OECD, 2009). According to Brutigam and Knack (2004), evidence suggests that in low income countries with weak governance particularly those in sub-Saharan iv. Key Players in Tax Policy Formulation and Africa (SSA) sustained aid dependence has had primarily negative impacts on domestic accountability and the quality Implementation: of governance. Also there is a strong consistent connection In the context of Africa, little is known about the actors between the ways in which governments are financed involved in determining tax policies, the institutional channels and the ways in which they govern.Uganda is one of the applied, the conflicts arising, and the outcomes arrived upon countries that depend heavily on external funding and (Rakner and Gloppen, 2002). In Uganda, the Parliament on aid in particular. Uganda has had one of the highest is mandated through the Constitution to impose taxes but sustained flows of budget support of any developing its amendment power on taxation policy is still determined country (Williamson, 2008). And with aid standing at over by the effectiveness of the Committee on Finance and 10 percent of GDP and taking up about 50 percent of public Economic Development which suggests amendments to expenditures, theres no doubt that it plays a major role in the House. The Ministry of Finance Planning and Economic the economy and in a more skewed relationship between Development (MFPED) is charged with the formulation of the government and donors. tax and non-tax policies. The Uganda Revenue Authority (URA) then assesses and collects the specified revenue. While Uganda and many other developing countries It is crucial to note that participation in the taxation debate in Uganda and in many other African countries is still noninclusive. Among the public, only a few groups like the Uganda Manufacturers Association (UMA) on the part of manufacturers and the Uganda Debt Network (UDN) on the part of CSOs are invited to the taxation policy discussions. v. The Relationship between Aid dependency by Government and accountability to Citizens To be able to understand the impact of aid on a governments accountability to its citizens, its necessary to know how much aid comes into the country, how it is delivered, managed and spent. It is also important to trace the capacity of different stakeholders to hold the government accountable. While theres no question about the positive effect that aid has on a country, it may on the other hand also undermine state-citizen relationships in such ways as: sustained aid dependence skews accountability outwards towards donors by creating incentives for governments to be accountable to donors rather than to their own citizens (Brutigam, 2000); aid may retard the emergence of a more legitimate and sustainable tax-based social contract between citizens/ voters/tax-payers and the state; a lack of transparency as regards aid will limit the scope for domestic accountability undertook tax reforms on economic restructuring in the past years as a requirement by the IMF and World Bank, the reforms have only to a limited degree resulted in closer links between governments and citizens.These reforms for the most part have been formulated and imposed by the international donor community. It is not surprising that the IMF has maintained a leading role in advising the Ugandan government on major issues of design of tax policies.

 Samuel Fakile, Mobilizing Tax Revenue for Development in Africa-Way Forward.  Ibid

of the tax system and tax structure to address the domestic Chapter 1 challenges. Ugandas tax system is comprised of excise duties, import duties, VAT, income taxes, and a number of taxes with small 1.1 Tax Systems in Uganda. yields e.g. fees and licenses, drivers permits, airport tax, Considerable effort and attention in most developing and freight charges. Uganda relies mostly on indirect taxes countries is devoted to policies best suited to the promotion for its revenue, particularly those inclined to international of economic development, where the major focus of trade. This dependence on indirect taxes is mainly due to these efforts is the search for desirable fiscal policies with the fact that income taxes are limited by administrative and considerable stress being placed on the role of taxation as other constraints. an instrument of economic development. The way tax systems are designed, both in developed and Since 1987, fiscal authorities have instituted a number developing countries, is the result of what is feasible given of efficiency and revenue enhancing discretionary tax the need for revenue to finance expenditures, administrative measures. These include; changing all customs duties and and fairness considerations, historical developments excise duties from specific to adverse, reducing the number and broader political economy considerations (Volkerink, of customs duty rates, and raising sales tax rates and excise duties on the major revenue generating domestic products 2009). e.g. soft drinks, beer, and cigarettes. Taxation policy has always been an important instrument for augmenting revenue. This is as true in developing countries There have been efforts to broaden taxation through the as it is in developed countries, where tax revenue is the introduction of a uniform rate-VAT as a standard model of major source of domestic revenue. Thus the most important commodity taxation, and also the restructuring of income tax. motivation for fiscal policy in most developing countries is Attempts to protect the poor have been through exempting or zero rating foods under VAT, and by raising the threshold the need to raise more revenue. In Uganda, the tax system has been one of the victims of of personal income. In addition, the corporate tax rate was numerous economic crises that have plagued the country lowered from 60 percent in 1987/88 to 30 percent since since 1966. Tax collections are still very low leading to large 1997, and the maximum taxable income reduced from 60 fiscal deficits. The country has also suffered from over- percent in 1978/88 to 30 percent since 1993/94. dependence on a small number of sources of tax revenue, Box 1. Major Tax Reforms 1990-2009 which are vulnerable to external shocks and remain a crucial problem in the tax system. Since May 1987, 1. Established URA (in 1991) in an attempt to better coordinate Ugandas tax system has undergone fundamental reform tax administration and enhance tax revenue collection in response to the need for funds to support economic and 2. Introduced the Value Added Tax (VAT) (in 1996) despite social development. The government intensified efforts in popular resistance the area of tax administration and expenditure cutting to 3. Promulgated a new Income Tax Act (in 1997) with the objectives of levying tax on a residence basis, ensuring simplicity and attain fiscal discipline. A combination of good governance, improved tax administration, credible macroeconomic policies and other discretionary tax measures has resulted in an improved tax to GDP ratio, when compared to the 1980s. However this ratio is still very low compared with other countries. The failure of the tax systems to generate sufficient revenue has led to the government running unsustainable deficits. Consequently, and/or unfortunately, the government has turned to external funding to finance these deficits. But as experience has shown, this kind of financing can only be temporary and thus a great need for a thorough examination
 Teera Joweria: Determinants of Tax Revenue Share in Uganda

promoting a flat tax rate scale 4. Abolished export taxes and embarked on tariff reform whose policy objectives evolved around simplification of the tax structure 5. Introduced major policy changes in the decade up to 2007/08 primarily around VAT and income tax.

Source: African Development Bank Group (2010) Ugandas tax system has comprised taxes with a rate schedule that could be adjusted quickly and also alter the purchasing power available to the private sector with a high degree of certainty. These taxes have been used to increase or cut back private spending to achieve stabilization goals

related to growth, prices, or the balance of payments. Because Ugandas tax system is cluttered and the tax base is narrow, adjustment of revenue for stabilization purposes has come about by piece meal measures in general through the raising of rates on indirect taxes such as import duties, excise or sales tax because these taxes are considered to increase revenue with greater certainty and speed. For over a decade now, the main tax policy objective in Uganda has been to raise revenue- and indeed the tax to GDP ratio has risen from about 4.5 percent in 1987 to about 12.5 percent in the past few years. Unfortunately this has been achieved through ad hoc increases in tax rates to achieve the revenue target with little regard for the potential supply side effects. The reduced tax compliance from the public may be one of the consequences from the rapid increase in taxation in the recent years. 1.2

government has a target of raising the tax/GDP ratio by 0.5 percent each year. However, due to the few tax policy handles, this has not been realized in the past. Government has therefore embarked on amending and revising the existing tax laws as well as the introduction of new measures to improve revenue collection and administration.

The budget for 2008/2009 was USh 6,142.9 billion, up from USh 5,025 billion in 2007/2008. It is broken down into: a) USh 3,994.5billion financing from domestic revenues comprising tax revenues of 3,850.7 billion, non-tax revenues of 103.9billion and loan repayments from government parastatals of USh 39.9 billion. Its important to note that Ugandas non-tax revenue collections are still small at about 0.2 percent of GDP compared to its neighbors with an average of 4 percent. Financing from Level of Revenues generated and the domestic banking system amounts to USh the Relative importance of Ugandas 269.8bn. The domestic resources make up 70% of Revenue Sources. the budget.(Budget Speech, 2009) b) USh 1,878.6 billion which is the difference in the budget after domestic revenue contributions are deducted is support from external sources; including both budget support and project aid. External revenue to support the budget was projected to increase to US$ 419.9 which is equivalent to USh 672.3 billion. External support therefore makes up 30% of the national budget, and it comes in the form of budget support loans, budget support grants, project loans and grants to support development projects.

The main sources of government revenue include tax and non-tax components, grants from foreign governments, multilateral, bi-lateral financial and non-financial institutions. Tax revenue is generated from taxes on income, profits and capital gains, taxes on goods and services which include value added tax (VAT) and excise duty and taxes on permission to use goods or to perform certain activities for example operating a casino or lottery organizations. Specifically at the local government level prior to 2006, the major source of revenue in Uganda was the Graduated taxa presumptive taxlevied on each adult in Uganda. Other revenue sources for local governments in Uganda included property taxes, user fees and charges such as tourism taxes (for instance on recreational facilities such as beaches), taxes on the transportation of produce, urban authority permits, license fees and market dues. 1.2.1 At the Central Government Level

For fiscal year 2008/2009, the countrys objectives for financing the budget were to continue enhancing domestic revenue mobilization and reduce external dependence while mobilizing adequate external resources to finance the countrys fiscal deficit (MFPED, 2009). Domestically
 Sennoga E: Local Government Revenues and Expenditures in Uganda: A VAR Approach.

Table 1.0: Trends in Major Fiscal Aggregates

Source: Macroeconomic Policy Department, MFPED Databases The final amounts of total revenue in the governments coffers should be assessed on the actual revenue realized

against the targeted revenue. For fiscal year 2008/2009 tax revenues (excluding government tax and tax refunds) were USh 3,662.3 billion against the targeted 3,850.7 billion. Despite a shortfall of 188.4billion in 2008/2009, the country recorded a rise in collections by 501.2 billion

from the previous year. The shortfall in tax revenue can be attributed to the poor performance of VAT, Excise duty, and Fees and Licenses. The countrys revenue collection increased slightly from 11.3 percent of GDP in 1995/96 to 13.1 percent in 2007/08. Direct taxes contributed USh 1,028.9 billion to total revenue, recording a surplus of 8.8 billion. This was mainly driven by PAYE, and which is currently contributing 54 percent of direct domestic taxes. 1.2.2 At the Local Government Level

Box 2. Major Local Revenue Sources in Uganda

Prior to its suspension, the Graduated Tax was levied on adult men and those adult women in gainful employment (in practice only women with regular salaries paid the tax). The amount of the Graduated Tax varied across income bands, from USh 3,000 on incomes below USh 288,000 per annum up to USh 100,000 on incomes over USh 1,560,000 per annum. Property taxes in Uganda are payable by the owners of residential buildings in urban areas (from 2006 owner occupiers are exempt), and commercial and industrial building in both rural and urban areas. Property rates typically range from 7 to 10 percent applied to the annual rental value of the property. Prior to 2006, market vendors were required to pay daily market dues calculated on the basis of goods brought into or sold in the market. Market fees are now structured as a daily fee for using market facilities. Parking fees are payable in many urban jurisdictions for the use of public parking bays.

Local governments receive transfers from the central government as well as grants from the international community. These make up almost 90 percent of funds made available to local governments to execute local responsibilities. Local governments then supplement these with own source revenue raised at the local level .Local authorities account for a significant share of government spending, and therefore play a fundamental role in the implementation of national growth and poverty reduction strategies. In Uganda it is one in every three shillings spent at the Local Government Units (LGU) level. According to Sarzin (2007) own source revenues in Uganda have declined significantly relative to total local government finances. A recent IMF study suggests that local revenues as a percentage of total local government resources has declined from approximately 80 percent in the early stages of the decentralization process (1997/98) to about 20 percent in 2004/05. Two main factors account for this trend. Firstly, is the rapid increases in central government transfers to the local level, largely donor financed, which have undermined incentives for own source revenue mobilization. Secondly, recent changes to the framework for local taxation have undermined the revenue raising authority of Local Government Units (LGUs) and have led to a narrowing of the local tax base.

or suspending several local taxes (Bahiigwa et al, 2004). The suspension of the Graduated Tax from FY 2005/06 significantly reduced own source revenues especially in rural areas. One of the reasons for its abolition was the disproportionate burden of the tax on poorer households. While the Government provided LGUs with compensation of USh 34 billion in 2005/6, this was not sufficient to fill the funding gap arising from the suspension of the tax, which was in the order of USh 45 billion in 2004/05. (Sarzin (2007) argues that there is a significant difference, in decentralization and political terms, between an LGUs own source taxes and a transfer from the Central government).

In 2006, changes to the framework for property taxes and market fees further increased the fiscal pressure on LGUs. While property taxes were levied on commercial and industrial buildings (in both rural and urban areas) and residential buildings in urban areas under the 2005 Local Government (Ratings) Act, this changed in 2006 Many local taxes were criticized for being regressive and for when the Act was amended to exempt owner occupied having a negative impact on economic growth. Local taxes, residential housing, which accounts for a significant share particularly the Graduated Tax, market dues and business of residential property in urban areas. (According to the licenses, were criticized for having a negative impact on 2006 National Household Survey. 78 percent of Ugandan income distribution due to the steep regressivity of tax households are owner occupiers. In Kampala, however, 28 instruments. percent of household live in owner occupied housing.)This Moreover, local taxes, particularly market dues, have been amendment also significantly undercuts the local tax criticized for having a negative impact on economic growth base, and also removes a key accountability link between by distorting the relative prices of goods and services. These taxpayers/voters and their elected councilors. Moreover, in concerns reinforced the momentum towards modifying 2006, the framework for market fees was amended so that

market vendors are only required to pay a monthly rental. (Previously vendors were charged daily fees calculated on the basis of goods brought into or sold in the market, with rates varying across different types of market goods).Wholesalers bringing in foodstuffs and other items in bulk are only charged a one-off fee each time they supply the market and market vendors buying those items are not required to pay any dues on those items. While these changes mitigate concerns that market fees were regressive and distorted relative prices, the changes also minimize a key remaining source of revenue for LGUs. The significant reductions in own source revenues undermine the accountability of LGUs to their constituents and weakens the linkages between local taxes and service delivery. As a consequence of budget shortfalls, local councils are meeting less frequently, are failing to meet their co-financing obligations, have limited resources to finance operations and maintenance costs, and are failing to meet their pension obligations (Sarzin 2007). This has obvious implications for the quality of services provided. There is a growing imperative to find alternative sources of local revenue that support the fiscal sustainability of LGUs.

Fig 1.0 Trend in Local Revenue Collections in Uganda

Source: Zara Sarzin (2007) Table 1.1 Composition of Local Revenues in Uganda-Rural and Urban Combined (Including KCC)

Source: Zara Sarzin (2007)

According to Sarzin (2007), several recent studies suggest options for expanding local revenue collection by introducing new local taxes or making changes to the tax base for existing local revenue instruments. Four specific proposals currently being considered by the Government of Uganda include: (1) a local service tax to be levied on salaried individuals, practicing professionals and business people; (2) a local government hotel tax to be levied on all room occupants, chargeable per room per night; (3) a local fee on motor vehicles to be paid by motor vehicle owners; and (4) a livestock tax to be levied on all farmers who own livestock. 1.2.3 At the International Level

control over the monetary base and an appreciation of the real exchange rate (Nkusu, 2004). Notwithstanding these effects, aid has been closely linked to development. Its effectiveness however, in this regard is still a contentious topic for debate. According to Nkusu (2004) surveys of empirical analyses on aid effectiveness can be found in Tsikata (1999) and Hansen and Tarp (2000). Findings have varied from the more categorical stances of the relationship between aid and growth being nonexistent, negative, or positive to the more recent results suggesting a nonlinear relationship. 1.1 Tax Categories in Uganda; Advantages and Disadvantages of Each

Until the year 1999, Budget Support flows to Uganda were relatively small, averaging less than USD 200 million per annum (Figure 1.1 below). This represented about 3 percent of Ugandas total GDP (Atingi-Ego, 2005). With the country qualifying for HIPC, and developing its first PEAP and subsequently the PAF, resources started to flow in on a high and sustained level.

Ugandas principal taxes are income tax, both personal and business, and value added tax (VAT). As earlier noted, Ugandas taxes continue to raise lower revenue as compared to other sub-Saharan African nations. A. Personal Income Tax. (PIT) Residents of Uganda are required to pay personal income tax on their worldwide income. Additionally non-residents

Figure1.1: Budget Support Disbursements to Uganda 1993 to 2003

Source: World Bank of Uganda whose income comes from sources in Uganda are required to pay the tax. For the purpose of the tax, people are considered permanent residents of Uganda if they have a permanent home in the country, and if they are Uganda employees or officially posted abroad, if they are present in Uganda for 183 days out of the tax year or if they are present in Uganda for an average of 122 days per year for three consecutive years (Caitlin Wasley, 2010). In most developing countries its widely accepted as the While massive financial inflows bring some benefits to most suitable source of income (Tanzi and Zee, 2000) and recipient countries, they are usually associated with side still remains the most effective way of reaching aboveeffects like; a risk of reversal that could lead to BOP problems subsistence incomes. Personal income tax is the same as or currency crises, upward pressures on inflation or loss of Pay As u Earn (PAYE). It is the tax that is obtained from civil Loans constituted the largest share (about 56 percent) of budget support until 1996, when grants became the main and preferred form of budget support. The ratio of grants to total budget support increased from an average of 44 percent to 73 percent partly to address the increasingly worrisome high growth of Ugandas stock of external debt and partly to address the future debt sustainability of the country (ibid).

servants, employees, business executives and professional people (Tanzi and Zee, 2001). Table 1.2 Tax Contributions by households

non-resident companies are taxed only on income sourced in Uganda. The tax rate for all business other than mining companies is 30percent. Income tax for mining companies

Source: Sennoga et al (2009) It is also noteworthy that the PAYE threshold has been stagnant at USh 130,000 (or US$ 57) per month for over ten years, suggesting that government has not taken account of inflationary effects on wages for low income workers. As a result, low and fixed income earners are unlikely to be able to save. In addition, the tax rates by bracket are progressive up to a relatively low threshold of USh 410,000 (US$ 182) per month (after which income tax is levied at a flat rate of 30%). (Sennoga 2009) Advantages of the PIT. 1. It makes people aware of their responsibilities to the government. 2. The PIT conforms to widely accepted standards of equity because its more difficult for employees to evade since it is collected by employers. 3. It can be used to improve income distribution. Limitations of the PIT. Despite the fact that the PIT is generally very successful in mobilizing revenue when compared with other tax instruments, it suffers from obvious limitations in the context of developing countries. 1. It yields little revenue in most developing countries because of its ineffective tax administration. 2. Due to the effect of graduated rate structures on tax payer behavior there is inherent narrowness of the tax base. B. Corporate Income Tax (CIT)/Business Income Tax (BIT). Uganda also levies income tax on the worldwide income of resident businesses. As with the personal income taxes,

is calculated using a formula and is dependent upon the chargeable income and gross revenue for the company, but the tax rate must be at least 25 percent and at most 45 percent. Uganda has determined special tax rates for small businesses with annual sales between 5million and 50million Ugandan shillings. These special rates are determined based upon the gross income of the business. This is also known as the corporate tax(CIT).Its popularity is its ability to pay, due to the fact that most corporations are separate legal persons and most of them have a lot of money. Advantages of the CIT 1. The taxpayers are easily identifiable, hence they are easily taxed. 2. Its convenient to utilize corporation agents to collect the taxes i.e. Kampala City Council (KCC) 3. BIT is progressive to the extent that it reduces the income of shareholders who, compared to nonshareholders are on average rich. Limitations of the CIT Business income taxes in developing countries tend to be inefficient. In Uganda, BIT revenues are in decline. For example, the 2005/06 revenue performance report reveals that the annual BIT collections posted a cumulative deficit of Ush.10.29 billion. 1. Failure to target small businesses, which are the most in Uganda and at the same time informal leads to missing potentially large source of growth in the economy which are also sources of revenue. 2. Ignores the opportunity to assist women in joining the formal economy and thus accessing resources to support the growth of their enterprises.

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C. Value Added Tax (VAT) Before the introduction of the VAT in 1996, it was observed that the existing patterns of sales taxes and the commercial transaction levy at the time were ineffective in collecting revenue, worsened by the fact that the taxes met a lot of public resistance because they were selective and based on too narrow a range of transactions. VAT would instead be a general consumption tax that falls more evenly on a much wider range of consumer spending in the domestic economy (Kayaga 2007). VAT is required on every taxable supply made by a taxable person, every imported good and the supply of any imported services by any person. Taxable supplies are goods or services made under the business activity of a taxable person. Taxable persons are people who make, or expect to make, taxable supplies valued at one quarter of the annual registration threshold during 3 calendar months of the year. Taxable persons must register. As of 2010, the annual registration threshold is 50 million Uganda shillings. The standard rate for VAT in Uganda is 18 percent. Advantages of the VAT. The VAT is generally believed to be non-distortionary, provided there are few exemptions and little zero-rating. However, it is increasingly accepted that zero-rating is necessary to achieve social justice and security in harsh economic conditions (Ibid). 1. When VAT on investment is fully credited, it is an improvement over older taxes on capital goods. 2. It has helped to facilitate trade by exempting exports, removing hidden subsidies and placing the taxation of imports and domestic production on the same level. 3. In many countries, activities taking place in the informal sector of the economy generally escape the direct tax system. An indirect tax like VAT may be able to generate revenue from invisible tax payers such as non-reporting plumbers and other home repair enterprises that buy supplies from registered tax payers due to the fact that its an indirect tax (Bird and Gendron, 2006). Limitations of theVAT. VAT has become the workhorse of the revenue system in Uganda because direct taxation continues to be relatively inefficient (Kayaga, 2007). However, Ugandas VAT has

become clearly less efficient as a revenue producer. 1. VAT is incomplete in one aspect or another, leading to less revenue being collected. Some of the reasons for the VAT not meeting its revenue targets include; an incomplete design of the VAT; the complexity of VAT assessments; the existence of numerous exemptions; the presence of the informal sector; and the use of multiple VAT rates (Ibid). 2. It is not understood by most taxpayers and tax authorities alike because it is a complicated tax. And in Uganda and other developing countries where even basic record keeping abilities may be limited, this presents a problem in VAT implementation. 3. Governments inability to give prompt refunds of excess credits to certain taxpayers, particularly exporters, reduces the effectiveness of VAT because it is zero-rated. With a contribution of about 40 percent of GDP from agriculture, VAT takes a heavy toll on this sector, which it should be remembered produces mainly for subsistence. This is because many important sectors, most notably services, wholesale sales, and retail sales, are all exempt from the VAT (Ibid). D. Excise Tax. Excise tax is usually imposed on the consumption of goods and services that bear some externalities or are considered to be luxurious. Currently in Uganda, all excise taxes are according to the value of the good ranging from 5 percent to 100 percent. Excise taxes in Uganda are imposed on the following goods; tobacco, soft drinks, mobile phones, and petroleum products. Table 1.3: Current Excise Tax Rates in Uganda. Product Beer Spirits. Soft drinks Cigarettes Airtime/service fees Source; Uganda revenue authority 2007 Duty rate% 60 45 15 130 7

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Excise taxes are also levied on a selected list of imports generally as a way of protecting local producers of similar goods or import substitutes and on imports that are considered luxuries such as sugar, beverages, cosmetics, certain textiles and garments. Advantages of the Excise Tax. 1. Traditional excise taxes are quite simple to administer because taxpayer units are easily identifiable and generally operate in the formal sector, making it easier to collect revenue. 2. Selective taxes on luxury goods may be more effective in reaching high-income groups than poorly enforced direct taxes income. Limitations of the Excise Tax. 1. Excise tax is inappropriate in broad coverage of products, which is driven by the search of revenue. 2. Weak administration makes it difficult to raise sufficient revenues due to having unskilled tax administrators with no knowledge of accounting.(Kayaga, 2007) 1.1 Other taxes The most common form of additional revenue could be through the taxation of property and/or land, a more inclusive concept of (net) wealth, or through other specific taxation such as that of mineral extraction [cf. Musgrave and Musgrave (1989), Sunley et al. (2002), Bird and Slack (2003)]. (Volkerink, 2009). The prevalence of property, land and (net) wealth in developing countries is often limited as the basic infrastructure to properly administer these taxes. Without a cadastre, these taxes cannot be levied in a comprehensive way.

These range from user charges, registration fees, and administrative fees to social security contributions. Often these taxes raise a substantial amount of revenue, although most would be classified as earmarked taxes, requiring a balance between revenue and related expenses. 1.4 Ugandas Tax System; Fair or Not?

In developing countries where market forces are increasingly important in allocating resources, the design of the tax system should be as neutral as possible so as to minimize interference in the allocation process. The system should also have simple and transparent administrative procedures so that it is clear if the system is not being enforced as designed. (Tanzi and Zee 2001) When the government is deciding to use a tax system that targets incomes of individuals, or one that taxes the goods and services that are consumed, it needs to be mindful of the various effects and the nature of the tax base. For developing countries some studies (Mintz, 2003)have argued that taxes on consumption are a better source of revenue for developing countries, they are easier to collect and more consistent with achieving economic growth objectives. Meanwhile, the URA has considered tax policies as equitable, fair and transparent because they depend on consumption and some basic items (education and health) are not taxed. The difference between what to tax is that with the income taxes, the tax burden increases with an increase in income, while with the taxes on goods and services, the more one consumes, the more tax they have to pay. Because the poor must spend a large share of their income to purchase most of their basic necessities, taxing consumption can impose a heavier burden on the poor than on the rich. (UDN 2008)

Any tax policies should support poverty reduction through creating growth and reducing the cost of goods mainly consumed by the poor. Unfortunately, the taxation system Volkerink (2009) further argues that mineral extraction, in Uganda and many other developing countries is still on the other hand, can and often is taxed, and mostly on inefficient and is yet to address the income gap between higher than the standard statutory CIT rate. There are good the poor and the rich. Tax policy in Uganda has mainly grounds for this as in this way the location rents can be concentrated on simplifying the tax system, revenue generation and restricting people from consuming certain taxed without affecting the level and place of investment. commodities rather than protecting the poor. (ibid). One often observes, however, that multinational investors are in such a powerful position vis--vis the governments It should be noted however that the tax policy talks of being of developing countries that the tax conditions are quite in line with the PEAP and that it uses instruments such favorable to these companies. as tax exemption, zero rating of commodities and several incentives to support human development and raise A number of other taxes and quasi taxes are often applied. production. In agriculture where the majority of the poor

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are, the government has removed taxes on inputs (such as on pesticides and fertilizers) and outputs. Also loans to the agriculture sector were exempted from taxes since 2006. In other sectors of the economy like education and health, most taxes have been done away with.

Evidence from studies using dominance testing that have been conducted on Uganda show that taxes on paraffin and exports are regressive. The findings on excise taxes in Uganda have been inconclusive (see Table above). Taxes However, while this is the case, the tax system has not on tobacco, alcohol, non-alcoholic beverages and gasoline done enough to support the poor, as many of the goods have been found to be progressive. It has also been argued and services mainly consumed by the poor are being taxed, that comprehensive VAT is regressive since lower income which in turn reverses some of the gains achieved in some taxpayers consume a higher proportion of their income of the pillars under the PEAP. Sugar, soap, matchboxes than do middle and upper income taxpayers. Imports and and paraffin are goods still being taxed, with various taxes VAT/Sales taxes in Uganda have also been found to be attached to them. Soap in Uganda attracts import duty, progressive. excise duty and VAT of 25 percent, 10 percent and 18 percent respectively. Sugar attracts import duty, excise Further still, at the local government level, many tax payers duty and VAT of 25 percent, 25 percent and 18 percent respectively. An additional USh 50 per kilogram of sugar find the taxation system unfair. According To Magala and was introduced in 2006. Paraffin (kerosene) has attracted Rubagumya (2007) the taxpayers in Uganda felt that the excise duty of USh 200 per litre since 1998. Tax on iodized amount of market dues charged was unfair compared to salt is remitted and there is a proposed exemption of VAT their level of earning and profits made. This became more on table salt. It should be noted that while there have been complicated for the permanent vendors who were required increases in excise duty for other petroleum products; excise to purchase annual trading licences paid separately to duty on paraffin has remained at USh 200; the intention the Revenue Authorities, on top of paying market dues may have been to make it more pro-poor. The government whenever one went to the market to sell. would make paraffin more pro-poor by abolishing the excise tax imposed on it. The estimated tax expenditure out of this action would be USh 6.3 billion using the 2005 paraffin According to their study, 62% of the respondents considered the rates paid as unfair. This was true for all age categories sales estimates of 31,367 cubic metres (BOU, 2006). and in all three locations that were sampled. They also Table 1.4: Evidence on tax Progressivity/Regressivity found that in Uganda, there was no systematic criterion used to set the market rates demanded from the vendors from Dominance Testing in Uganda and Ghana on different commodities but also across location/districts thereby creating spatial distortions in markets and prices. Examples of such variations in percentage rates discovered that larger quantities or sizes of all products (bags, sacks and larger animals) attracted lower tax rates than smaller quantities (tins and small stock). These variations when applied in practice meant that market dues are steeply regressive in character. (Bahiigwa, Ellis, Fjelstad and Iversen, 2004).This therefore encouraged exploitation since collectors could charge different rates as they so pleased. Recommendations to address the Challenges above Theres a need at both the local government and the central government to improve the collection of market dues so as to enhance revenue. Theres need for transparency in the award of revenue collection tenders at the Local Government level. This will improve the taxpayer

Source: Gommell& Morrissey (2005).

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perception of the tax system and improve their tax paying attitude. Research is needed to establish the real profitability or actual revenue potential of the markets at the local government level so as to fully optimize the collections. Constant provision of information to citizens on how both central government and local government revenues are being used and how they contribute to delivery of services. This will improve taxpayers commitment to paying taxes. To stimulate production in the agricultural sector, all agricultural activities should be fully exempted from VAT. This would make the tax system more progressive as most of the low income households depend on the agricultural sector. Excessive excise taxes (like on petroleum) indirectly impact poor households through other intermediary sectors like transport. Therefore, there should be a balance between excessive taxation of a few commodities considered to be luxury goods and the quest for revenue.

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the urban labor force in Africa. As they are seldom paid a regular, fixed wage, their earnings fluctuate, and many Chapter 2 are paid in cash, off the books. (Tanzi and Zee, 2001). The base for an income tax is therefore hard to calculate. Nor do workers in the informal sector typically spend their 2.1 Challenges in Broadening the Tax Base in earnings in large stores that keep accurate records of sales Uganda and inventories. As a result, modern means of raising Uganda has initiated several tax reforms to address the revenue, such as income taxes and consumer taxes, play fiscal challenges that have plagued its economy for a long a diminished role in these economies. The inability of time. There has been a concerted effort to widen the tax governments to establish systems to detect incomes in the base to the extent that the financing of the budget shifts informal sector has resulted in overburdening those in the away from foreign to domestic financing, and in turn there official sector with high tax rates to make up for revenue has been some significant improvement in the collection of shortfalls (Kayaga 2007). revenues (from a dismal 6.5 percent of GDP in 1989/90 which led to large deficits and a budget mainly funded by Second, it is difficult to create an efficient tax administration external financing to 13 percent in 2007). The remarkable without a well-educated and well-trained staff, when growth in tax revenue was a result of policy measures, all money is lacking to pay good wages to tax officials and of which were meant to streamline the administration of tax to computerize the operation (or even to provide efficient collection and to expand the tax base. The most notable telephone and mail services), and when taxpayers have policy changes include the establishment of the Uganda limited ability to keep accounts. While the URA is developing Revenue Authority (URA) in 1991, the replacement of sales computerized systems of operation for example the e-tax, tax with VAT in 1996, the introduction of the new income such operations are still not widely appreciated by the tax structure in 1997, in which personal income tax rates public. As a result, the government has often taken the were reduced, and the replacement of tax holidays with tax path of least resistance, developing tax systems that allow concessions in 1999. them to exploit whatever options are available rather than In spite of the efforts by the government to improve the establishing rational, modern, and efficient tax systems. countrys revenue picture and URAs tremendous progress Because of the informal structure of Ugandas economy made in tax collections, Uganda continues to depend more and because of financial limitations, statistical and tax and more on external financial flows and less on domestically offices have difficulty in generating reliable statistics. This generated resources. The tax revenues collected remain also means that national income statistics cannot be relied way below the required financing to support the budget, with upon to define the state of the countrys economy. This about 31 percent of the budget still financed from external lack of data also prevents policymakers from assessing sources. The 2007/08 tax to GDP ratio was still below the the potential impact of major changes to the tax system. Sub-Saharan Africa average of about 20 percent. This As a result, marginal changes are often preferred over makes the economy vulnerable to the actual realization of major structural changes, even when the latter are clearly the funds obtained in addition to the political influence that preferable. This perpetuates inefficient tax structures comes with the providers of such funds (Sennoga et al. thereby affecting the broadening of the tax base. 2009). Below are a number of challenges to widening the tax base in Uganda. Third is the HIV/AIDS epidemic. While it is fundamentally a health issue, the impact of HIV/AIDS goes far beyond health because of its widespread human, social and economic First, most workers in Uganda are typically employed in effects. The impact of HIV/AIDS on mortality, morbidity, agriculture or in small, informal enterprises. Economic and the resulting demographic changes has the potential activities in these sectors of the economy is generally of eroding the economic benefits which Uganda has unrecorded which means that many people who work and achieved since 1986 (Kayaga 2007). Sub-Saharan Africa earn a livelihood here are not taxed thereby keeping a which has just over 10% of the worlds population, is home potential portion of the tax base out of the tax net. Also, to more than 60% of all the people living with HIV/AIDS informal urban employment absorbs as much as 61% of (UNAIDS; Report 2006). The magnitude of the epidemic and its devastating impact on every sector of the economy

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has led several developing countries to declare HIV/AIDS as a national disaster (Ibid). From another UNAIDS study, it is apparent that the ages of those affected are rising with the highest prevalence being concentrated in the age range of 30-34 and 35-38 for women and men respectively (UNAIDS Uganda Country Profile). This shift in the ages of new infections is alarming, because they are striking mainly adults, the most economically productive segment of the population and the sector of the population forming the majority of Ugandas taxpaying population (Kayaga 2007). HIV/AIDS through its impact on mortality, morbidity, and resulting demographic changes has had an adverse impact on the domestic tax base and thus on governments effort to widen the tax base.

84 percent of respondents to the 2005 Afro Barometer10 believe that tax officials are involved in corruption.11 Also when tax regulations are complex, which is a similar trend in Ugandas taxation system, opportunities for corruption and evasion arise. Complicated regulations create opportunities for public officials to exercise discretionary powers, which in turn fuels corruption.

In the same way, corruption leads to mistrust in the system by taxpayers which in turn de-motivates them from meeting their tax paying duties and instead encourages vices such as tax evasion and avoidance which further shrink the tax base. The fourth challenge to widening the tax base is the war in Lastly, Ugandas income is unevenly distributed, and so is the north against the LRA as it essentially turns the region the case within other developing countries. Although raising into an un-taxable region given the displacements of the high tax revenues in this situation ideally calls for the rich people and lack of any productive economic activities. to be taxed more heavily than the poor, the economic and Although no studies have been carried out linking the civil political power of rich taxpayers often allows them to prevent war in Uganda to its poor tax performance, studies carried fiscal reforms that would increase their tax burdens. This explains in part why many developing countries have not out in other developing countries suggest that this link is fully exploited personal income and property taxes and why unavoidable (Kayaga 2007). A government study noted that their tax systems rarely achieve satisfactory progressivity 70% of the population in Northern Uganda live in absolute (in other words, where the rich pay proportionately more poverty, with each adults consumption expenditure at less taxes). In the same way, the tax incidence of the income than US$1 a day and about US$11 per month (Ibid). This is taxes falling mainly on the richer households or businesses worsened by the fact that half the working-age population in mainly in Kampala is a motivator for tax evasion as these the camps is redundant anyway, because there are no job groups feel that the system is unfair. opportunities in the camps. 2.2 Opportunities in Broadening the Tax Base in Corruption is yet the fifth major challenge to broadening the Uganda tax base in Uganda. In the area of public service such as tax collection, the incentives to engage in corrupt behavior are high for both officials who can enrich themselves, and bribe payers who evade taxes (U4 Anti-Corruption Resource Centre). Corruption is still worrisome in the URA, and at the Local Government Units. An evaluation commissioned by DFID points to the continued public perception of a high level of corruption, reflected in the widespread availability of duty free goods on local markets and arrests of senior URA officers (EME 2000, p. 20). In March 2000 President Yoweri Museveni is reported to have called the URA a den of thieves (Therkildsen 2004, p. 82) and other surveys have also indicated that corruption is on the rise in the URA. A 2005 CMI report on corruption in tax administration indicates that 43 percent of firms in Uganda reported occasionally or always paying bribes to tax officers. Also
  Cited in Fjeldstad 2005 Ibid

According to analysis done by Sennoga et al. (2009), there is a lot of improvement where URA can be able to increase its tax effort. This study identifies specific areas which URA should target to improve its tax collection. The study estimated a total of 53 billion shillings which is untapped. This could be achieved by targeting businesses, commodities that are under-taxed and excluding food items for equity purposes. Increasing domestic tax collection would also result into less overreliance on taxing a few commodities especially fuel which is interlinked with a lot of other sectors and could indeed harm growth in the long run. The study also found that the tax effort on imports is sufficient. However, import duties on fuel remain very high and this could be a symptom of the poor domestic tax collection.
10 The Afrobarometer is an independent, nonpartisan research project that measures the social, political, and economic atmosphere in Africa. 11 Marie Chne, U4 (Anti-Corruption Resource Centre); Overview of Corruption in Uganda; http//www.u4.no/helpdesk/helpdesk/query.cfm?id=191Transparency International, March 2009.

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To identify the small informal businesses, it would require implementation of the National Identity where an individual or business (small or big) can easily be tracked (Sennoga et al. 2009). Just as was recommended earlier in chapter 1 for the Local Government level, URA would need to undertake a special survey to establish the potential revenue that is not currently tapped. While the current household surveys have some information, its not very sufficient as such surveys are known for respondents to under-report their income or exaggerating their costs.

of international services, removal or reduction of intra-EAC withholding taxes, common approach to transfer pricing and a common methodology for calculation of income tax. That notwithstanding, tax harmonization is likely to face challenges, for instance, the harmonization of excise duties will have to take into consideration the broader political and social aspect apart from the revenue aspect.

Yet still, there is a genuine fear that tax integration may lead to erosion of fiscal autonomy of the member countries through increased mobility in the tax base, as corporations For the income taxes, there is much room for improvement and individuals seek to migrate to more tax optimal by the URA (Sennoga et al. 2009). The bulk of this tax is locations within the region. Tax must be seen for what it being paid by the Kampala residents. In essence, with the really is: a cost of doing business and the price we pay for abolition of the Graduated income tax (which was a poll tax for every Ugandan), this implies that largely the tax base living in a civilized society. It is also understandable that financing the local governments is around Kampala. While governments will seek to protect their tax base and will not there are arguments that this is where richer households take kindly to any overtures leading to the opening of that and bigger enterprises are located, an effort should be base to competition. However, it must be remembered that made to expand the tax base beyond Kampala. freedom of establishment is a right of every business entity (eacol.com). 2.3 Implications of Regional Integration on Sennoga et al (2009) argues that regional integration at Broadening the Tax Base in Uganda the East African Community (EAC) Customs Union level Regional integration is a key cornerstone of today`s globalised economic order. The concept of intergovernmental integration has been embraced in most regions in the world as it offers attractions of enhanced regional co-operation through integrated institutions and infrastructure. For the purposes of this study, we use the integration of the East African economies into a Common Market as reference. is apparently a predominantly politically driven initiative. Evidently, many of the regional integration measures promulgated by regional political forums have been made before any rigorous assessment of both the feasibility of implementation, and Domestic Resource Mobilization (DRM) or widening of the tax base implications. Thus for example: (1) common external tariffs (CETs) were pronounced on the eve of the EAC Customs Union launch, and there is still a lot of haggling over them; (2) there is an absence of clarity on the appropriate classification of manufactured and semimanufactured goods; (3) the value of goods which [qualify] for exemptions and remissions has been growing (Mugisa, 2009) ; and (4) weak and poorly coordinated controls over the rules of origin continue to pose major problems for all the Revenue Authorities in the EAC member states.

The concept, at its very basic, provides the comfort of peaceful co-existence between neighboring states and a concerted effort in tackling the modern challenges (eacol. com). The East Africa Community (EAC) has made significant steps towards integrating East African states since its inception. One of the EACs milestones was the establishment of the Customs Union in 2005. It should also be noted and appreciated that the creation of an EAC It is noteworthy that there are demands by Uganda based common market is expected to result in the free movement businesses to extend the duty exemption period beyond 2010 for the importation of key inputs and materials (225 of labor, goods, services and capital. tariff numbers) given to 94 companies under the Duty Taxation which is a key fiscal tool has a major role to play in Remission Scheme. Yet businesses in other EAC member facilitating economic integration. It is also an area that has states are required to pay import duty at the applicable CET significant importance to each country as it is a source of rate. This is contrary to the spirit of the agreed position, revenue. With regional integration comes the need for tax and naturally, there is opposition to this from other members harmonization. Some of the priority areas that need to be and even in Uganda there is no unanimous support on this considered under tax harmonization include tax treatment matter. (Mugisa et al, 2009). In addition, Ugandas tax

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regime is not fully in synch with the systems in other EAC partner states. For example, VAT and excise duty are not harmonized, which could negatively impact on cross-border trade. The EAC explicitly recognizes the role of tax harmonization in East Africa integration. In fact the EAC Treaty clearly stipulates that the partner states will undertake to harmonize tax policies. According to the Treaty, tax harmonization will lead to the removal of tax distortions and bring about a more efficient allocation of resources within the Community. While it is important to remember that Uganda and indeed the other East African countries have a right to protect their tax systems, they must be willing to cede national ground for regional good. Insufficient tax harmonization between the East African countries has been, and will invariably continue to be a barrier to progress in regional economic integration. Uganda therefore needs to find various means of widening the tax base but taking into account that some sectors like the informal sector and agriculture have a big number of poor people with little incomes which would be negatively affected with an expansion of taxes to those particular sectors. Recommendations Addressing unofficial exemptions and smuggling would be key to reducing revenue loss. In the context of the implementation of the CU, the three countries should address the weaknesses in their customs administration, border control, and transit arrangements to reduce losses of customs revenue collection. Uganda and the other East African countries should address tariff leakage as well as VAT leakages which could be more significant. Furthermore, the three countries will have to harmonize their tariff exemptions regime to avoid trade deflection once internal border posts are dismantled for full CU implementation. Agreement on a stringent exemptions regime can also contribute to revenue increases The EAC needs to widen the scope of tax harmonization from the current common Customs Union to encompass the whole tax spectrum. It should aim at finding common ground in others

areas of taxation including corporate income taxes, employment taxes and VAT together with other taxes and levies as well as sharing of taxation information between the governments, and establishing common standards for tax administration.

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Chapter 3
3.1 Implications of operations by Multinational Corporations on Ugandas tax base. Multinational Corporations (MNCs) may be defined as corporations/companies that have assets and/ facilities in at least one country other than its home country (investopedia). Such corporations have a centralized head office where they co-ordinate global management. Very large multinational corporations may have budgets that exceed those of many small countries. The impacts of MNCs on Uganda and many other developing countries are many and can also be divided into those that may benefit or adversely affect the developing countries. This section will focus mainly on the latter. On the benefit side, MNCs have access to several of the factors of production which are not easily accessible to Uganda and many other developing countries. By bringing resources into the country, these corporations can widen the tax base of the country and thus boost its revenue considerably. They may also increase the foreign exchange available to the country from investment inflows, and as an exporter based in the country or through the production of formerly imported goods.

years, been deemed by revenue authorities to amount to tax evasion, and are therefore illegal. In the US for example, a US Senate Sub Committee report in 2008, reported US taxpayers losing some US$ 100 billion a year in lost revenues to banks located in tax havens. This only goes to show the magnitude of these practices on a global scale. Box 3. Tax Havens
A tax haven is a country or territory where certain taxes are levied at a low rate or not at all. For more than a century there has been an inherent contradiction in the attitude of Western legislators towards tax havens. Despite their muchvaunted regard for the rule of law (and more recent concern for human rights plus the desire to help the developing world) they have allowed a financial system to develop that is wide open to abuse (Christian Aid: Death and Taxes, 2008).We consider [the capital lost to tax havens] the most damaging economic condition hurting the poor, says Raymond Baker, director of the Global Financial Integrity Program at the Center for International Policy. Nothing hurts developing countries more. It is a permanent outflow ... and leaves poverty in its wake. (PBS; Tax Havens Hamper Development in Poor countries)

If such capital flight occurs in countries with regulatory frameworks commonly perceived as sound, then what magnitude would such evasive practices have in developing countries where the regulatory framework is often weak? According to OECD (2009), developing countries lose vital revenue through tax evasion and the siphoning of money to It should be noted that all these benefits are transferred these tax havens. The World Bank states that the illicit flow in the initial stages of operation of the MNCs. In spite of of cash from developing countries ranges between US$ all these benefits, MNCs can also cause great losses to 500-800 billion a year. These outflows are estimated at 7.6 the countrys economy especially in terms of revenue percent of annual GDP of the region, and in effect, make loss. After the initial stage of operation, a large part of the African countries net creditors of donor countries. earnings of MNCs in developing countries is generated without any net transfer of real resources to the latter Transfer pricing is another practice that Uganda and other being made (Persaud 1983). Coleman and Nixon argue developing countries have to be mindful of, particularly if that although in the short-run a positive effect on growth they want to avoid the risk of losing out on tax revenue may take place from MNCs raising investment through from cross-border transactions carried out by multinational higher capital availability, in the long-run the effect is likely enterprises. A lot of goods and services are exchanged to be negative as the repatriation of profits, negotiated tax between subsidiaries of the same multinational enterprises concessions, transfer pricing and intra-firm trading as well as part of world trade. These transactions within the as payments of royalties, technical, and managerial fees to same group are not exposed to the same market forces the parent company result in a negative outflow of capital. as transactions between independent enterprises. These Further, MNCs might lower the domestic capital availability are referred to as controlled transactions.13If the prices of these transactions are artificially lowered/increased they by borrowing on local capital markets. may lead to taxable profits being shifted from one count to 12 Christian Aid argued that even the legal ways of tax another. A subsidiary in one country may hike and report avoidance may have been compromised by the exchange royalties to its parent company in another country to try and of bribes for concessions between companies and reduce its tax liabilities and in effect shrinking the tax base government officials. They continue to state that some in the country where it is based. Silberztein Caroline: Transfer pricing: A challenge for ostensibly legal tax-avoidance schemes have, in recent 13
12 See their report entitled Death and Taxes (2008): the true toll of tax dodging developing countries; OECD Centre for Tax Policy and Administration

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The arms length principle is used to address such issues. Under the arms length principle, one compares the remuneration from cross-border controlled transactions within multinationals with the remuneration from transactions made between independent enterprises in similar circumstances. The arms length principle has become the international norm for allocating the tax bases of multinational enterprises among the countries where they operate. All OECD countries use this principle, as do an increasing number of non-OECD countries, such as Argentina, China, India, Russia, Singapore and South Africa. Uganda is aware of these practices by MNCs and needs to protect its tax base while not hampering foreign direct investment and cross-border trade. The arms length principle can help to achieve this goal. The key is to tailor the legislative measures and administrative effort to the strategic needs and resources of the country

to the IMF and World Bank. Uganda is part of the EPAs at a bilateral level and the WTO at the multilateral level. This means that it is required to cut tariffs at both levels. It needs to be remembered that tariffs in these countries contribute a big share of government revenue. According to Baunsgaard and Keen (2008), in some African countries, up to 30 percent of non-resource tax revenue (4 percent of GDP) is raised through tariffs and trade related taxes. As the figure above shows, trends of decrease in revenue from taxes may be indicative of the trade liberalization effects. With cross border trade becoming less significant, contributing only 10 percent of Africas total external trade, African countries need to rethink alternative revenue sources before tariffs can be phased out. This is very important as most of these countries prepare to sign bilateral trade agreements like the EPAs with the EU, given that the latter traditionally represents roughly two-thirds of African external trade (OECD, 2009).

3.2 Impact of Trade Agreements on the Countrys Recommendations tax base The East African States need to focus on less ambitious objectives and more limited instruments Uganda has extensively liberalized its trade. The philosophy during their integration and harmonization initiatives. behind the reform programmes therein was that the role For example, Uganda and the other States pursuing of government in making decisions on resource allocation regional integration need to protect tax revenue should be minimized and the incentive structure should and avoid harmful incentive practices by enforcing change in favor of exports through import liberalization in codes of conduct, and to foster cooperation among order to follow an export promotion path instead of import tax administrations (through efficient information substitution. Trade liberalization has a direct link to taxation exchange, for example) in order to control the as it requires cuts in tariffs both on exports and imports. rising number of transactions by multinational and With globalization a worldwide phenomena, and a need regional companies. to have a share of the international market, developing countries have opened up their markets to free trade as one of the pathways to achieving economic growth according

Figure 1.1: Trade tax in Africa as % of GDP

Source: OECD Development Centre

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Chapter 4
4.1 Overall Recommendations At the National Level 1. The informal sector needs to be formalized and commercialized so that there is record keeping, which will allow an assessment of the viability of the sector. This will ensure that that there is attention to management, financial management and profit making. 2. There is no law on Small and Medium Enterprises (SMEs). It should be noted that the recent investment code places SMEs under the Uganda Investment Authority (UIA). Theres need for sensitizing these SMEs found about taxation. 3. Income derived from new investments in agro processing need to be exempt from taxation which were undertaken with effect from 1 July 2008. This is in line with what the Finance Minister stated in the 2009 budget speech. Through this incentive, the Government would encourage investments that increase value addition in the agricultural sector through the production and processing of the agricultural products grown in Uganda. However, it is important that the existing investors who do not have new / additional investments be taken into consideration so as to address their competitiveness in the market place. 4. Widening the tax base is more than just collecting more taxes; its about going back to basic tax education so that more Ugandans are more aware of taxation and its use to national development. Tax education should therefore not stop at the SME level but to all Ugandans. 5. Before abolishing or suspending local taxes because they are perceived to be regressive or difficult for small businesses, options should be explored to improve the equity of the tax instrument. It is important to note that some local taxes that may be very regressive; particularly those that are applied as a flat amount irrespective of ability to pay (e.g. flat tax per adult, flat household head tax, and flat property tax), can be restructured to increase their progressivity, for example by applying exemptions for poorer households. Increasing the equity of a local tax can encourage greater tax compliance, enabling lower tax rates to be charged.

6. Tax resistance is likely to continue (and increase) if service provision does not improve, necessitating costly and coercive methods of tax enforcement that may continue to undermine the legitimacy of the government. Improvement in service delivery for the majority of citizens is therefore a necessary condition to improve tax compliance. The existence of positive benefits in the form of public services, security etc. may therefore increase the probability that taxpayers will comply voluntarily, without direct coercion. URA should do the following; 1. Make all taxes more understandable to people; encourage translations of tax information into local dialect. For example, the list of VAT exemptions should be kept to a minimum in order to broaden the tax base, facilitate compliance by taxpayers, and improve tax administration. Zero-rating should follow careful analysis of the level and form of relief that is best suited to the particular circumstance of Uganda. If the tax system is perceived to be fair, the incentives for corruption and evasion are diminished. 2. Make the modes of collection and audit procedures clearer and friendlier to the public 3. Make the tax refund process more understandable; for example, one group of tax payers should not bear the brunt of paying tax on behalf of another group 4. Tax laws and penalties need to be more realistic especially with tax payers registering for the first time. Calculating due taxes back to periods before tax payers were in the tax system may drive many of potential declarations out the window and thus affect the tax base. At the Regional Level: Intra-Africa Trade should be encouraged. Africa can only experience meaningful development through co-operation and trade in goods and services within its borders as well as the outside world. It is well documented that prior to introduction of borders by the colonialists, Africans were trading with their neighbors. Trade co-operation will obviously bring down trade barriers which would eventually erode custom duties which are the main source of domestic revenue for most African countries. It will therefore be important to strengthen internal trade when trade barriers are finally eliminated.

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Table 4.1 A Summary of the Recommendations from the Chapters above. Chapter 1 Theres a need at both the local government and the central government to improve the collection of market dues so as to enhance revenue. Theres need for transparency in the award of revenue collection tenders at the Local Government level. This will improve the taxpayer perception of the tax system and improve their tax paying attitude. Research is needed to establish the real profitability or actual revenue potential of the markets at the local government level so as to fully optimize the collections. Constant provision of information to citizens on how both central government and local government revenues are being used and how they contribute to delivery of services. This will improve taxpayers commitment to paying taxes. To stimulate production in the agricultural sector, all agricultural activities should be fully exempted from VAT. This would make the tax system more progressive as most of the low income households depend on the agricultural sector. Excessive excise taxes (like on petroleum) indirectly impact poor households through other intermediary sectors like transport. Therefore, there should be a balance between excessive taxation of a few commodities considered to be luxury goods and the quest for revenue. Chapter 3 The East African States Addressing unofficial need to focus on less exemptions and smuggling ambitious objectives and would be key to reducing more limited instruments revenue loss. In the context of during their integration the implementation of the CU, and harmonization the three countries should address the weaknesses in initiatives. For example, their customs administration, Uganda and the other border control, and transit States pursuing regional arrangements to reduce integration need to protect losses of customs revenue tax revenue and avoid collection. harmful incentive practices Uganda and the other East by enforcing codes of African countries should conduct, and to foster address tariff leakage as well cooperation among tax as VAT leakages which could administrations (through be more significant. efficient information Furthermore, the three exchange, for example) in countries will have to order to control the rising harmonize their tariff number of transactions by exemptions regime to avoid multinational and regional trade deflection once internal companies. border posts are dismantled for full CU implementation. Agreement on a stringent exemptions regime can also contribute to revenue increases The EAC needs to widen the scope of tax harmonization from the current common Customs Union to encompass the whole tax spectrum. It should aim at finding common ground in others areas of taxation including corporate income taxes, employment taxes and VAT together with other taxes and levies as well as sharing of taxation information between the governments, and establishing common standards for tax administration. Chapter 2

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