Tax Revenue Effects of Sectoral Growth and Public Expenditure in Uganda

• DOI: http://doi.org/10.1111/saje.12127
• Date: 01 December 2016
• Author: Joseph Mawejje,Ezra Francis Munyambonera
• Published date: 01 December 2016

TAX REVENUE EFFECTS OF SECTORAL GROWTH AND

PUBLIC EXPENDITURE IN UGANDA

JOSEPH MAWEJJE*

†

AND EZRA FRANCIS MUNYAMBONERA

†

Abstract

This paper contributes to a growing strand of literature on the determinants of tax revenue per-

formance in developing countries, particularly in Sub-Saharan Africa. More specifically we esti-

mate the tax elasticities of sectoral output growth and public expenditure. The unique features of

this paper are twofold: First, we develop a simple analytical model for tax revenue performance

taking into account some structural features pervasive in most developing countries with large

informal sectors. Second, we test the model predictions on Ugandan time series data using

ARDL bounds testing techniques. Results indicate that dominance of the agricultural and infor-

mal sectors pose the largest impediments to tax revenue performance. In addition development

expenditures, trade openness, and industrial sector growth are positively associated with tax reve-

nue performance. We propose policies to support the development of value added linkages

between agricultural and industrial sectors while emphasizing the need to unlock the potentially

large contributions of the informal sector with a view of widening the tax base.

JEL Classification: H - Public Economics, H2 - Taxation, Subsidies, and Revenue <H – Public

Economics

Keywords: Tax revenue, sectoral growth, public expenditure, Uganda

1. INTRODUCTION

Interest in improving tax revenue performance has gained increased momentum in recent

years across many developing countries (AfDB, 2010a; IMF, 2011; Drummond et al.,

2012). This has been on account of increased financing needs for service delivery, con-

cerns over debt sustainability, and waning donor support across many countries. In

Uganda, the Government has over the years implemented reforms in tax policy and tax

administration aimed at boosting revenue performance (Cawley and Zake, 2010; Ulrik-

sen and Katusiimeh, 2014). The major reforms included the institution of the Uganda

Revenue Authority – meant to improve tax administration; the introduction of VAT; the

new income tax act; and the abolition of graduated tax. Additional reforms included:

abolition of road license fees except for charges on first registration; ten year tax holiday

to companies engaged in value exports; alignment of the Income Tax Act with the pro-

duction sharing agreements; tax on imports and other supplies for companies undertak-

ing petroleum exploration, development and production. In addition Government

proposed reforms in the administration of Kampala city that would help in mobilization

of city revenues to finance social development in the city (Ulriksen and Katusiimeh,

2014).

* Corresponding author: Research Analyst, Economic Policy Research Centre, 51 Pool Road,

Makerere University Campus, P.O BOX 7841, Kampala, Uganda. Tel: 1256 414 541023/

541024. E-mail: jmawejje@eprcug.org

†

Economic Policy Research Centre, Makerere University Campus

V

C2016 Economic Society of South Africa. doi: 10.1111/saje.12127

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of Economics

These reforms were initially successful and helped to improve the tax revenue per-

formance from 6.8% of GDP in 1991–1992 to 12.7% in 2006–2007 (Cawley and

Zake, 2010). However, the abolition of graduated tax constrained local government reve-

nue mobilization thus undermining service delivery at the lower levels of Government

(Ulriksen and Katusiimeh, 2014). The graduated tax was a major source of revenue espe-

cially for local governments and contributed on average 10% of local government reve-

nues (Bahiigwa et al., 2004). The graduated tax has since been replaced with the Local

Service Tax and the Hotel Tax in the 2008–2009 financial year. However, the early

momentum in tax revenue performance improvements has not been sustained. Over the

last decade tax revenues have not been responsive to overall GDP growth with the result

being that tax revenue performance measured as the tax-to-GDP ratio has stagnated at

about 12–13% (MFPED, 2015). Consequently the government expenditure has contin-

uously exceeded revenue leading to widening budget deficits with deleterious macroeco-

nomic effects (Lwanga and Mawejje, 2014).

The literature on tax revenue performance has put across two major schools of

thought that explain the determinants of tax effort: (i) Structural factors which include

the composition of economic activity; (ii) Institutional factors which include the govern-

ment policies and political economy constraints. Structural factors that influence a coun-

try’s tax effort include: agriculture share in GDP, per capita income, urbanization, trade

openness, and the shares of direct and indirect taxes (Gupta, 2007; Baunsgaard and

Keen, 2010; Pession and Fenochietto, 2010; Hisali, 2012; Moore, 2013); the extent of

dependence on windfall revenues such as from natural resource endowments (Bornhorst

et al., 2009; Botlhole et al., 2012; Trevi~no and Thomas, 2013); as well as aid (Gupta

et al., 2003; Clist and Morrissey, 2011; Crivelli et al., 2012; Hisali and Ddumba-

Ssentamu, 2013; Thornton, 2014).

Institutional factors impact the ability and efficiency of revenue mobilization and they

include government quality and corruption (Bird and Martinez-Vazquez, 2008). Indeed

institutional weaknesses have been shown to affect tax revenue performance in Uganda

(Robinson, 2006). Ulriksen and Katusiimeh (2014) argue that the stagnation in Uganda’s

revenue growth as a percentage of GDP is to due to, among others, the erosion of the

tax body’s institutional autonomy, political interferences and deficiencies in tax adminis-

tration engendering corruption and organizational inefficiency.

Moreover, efforts to improve tax–revenue performance in Uganda have been under-

mined by citizens’ poor attitudes towards government commitment to the provision of

quality public goods (Ali et al., 2014). However, the literature examining the roles that

fiscal policy, such as targeted public expenditure, plays in supporting improved tax reve-

nue mobilization is limited. Aschauer (1989) provides early insights on the extent to

which productive public expenditure on physical infrastructure can stimulate private sec-

tor productivity and profitability. Sennoga and Matovu (2010) used Computable Gen-

eral Equilibrium (CGE) approaches on Uganda to show that efficient public

expenditures are important in promoting growth and poverty reduction.

More recent analyses have used micro-econometric foundations to investigate firm-

level tax evasion behavior arising out of perceived limited government provision of public

capital. For example Mawejje (2013) shows that inadequate provision of quality public

goods is associated with tax evasion in Uganda. These results suggest that, other things

being equal, productive public expenditure would improve tax effort on two fronts: (i)

more taxes can be raised from increased productivity and profitability of the private

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C2016 Economic Society of South Africa.