The potential effect of the continental trade agreement on fiscal revenues
Francois Fouche another instalment on the series of AfCFTA-related content from a recent IMF Staff Discussion Note, “the African Continental Free Trade Area: Potential Economic Impact and Challenges”.
The reduction in trade barriers stemming from the AfCFTA would affect tax revenues via 4 channels:
- A direct reduction in tax revenue is to be expected from the removal of tar- iffs on intra-continental imports.
- Trade diversion owing to lower tariffs would also reduce fiscal revenues.
- Higher GDP, owing to increased efficiency, and larger economies, would lead to more fiscal revenue.
- Higher consumption, because of increased imports and income, would also raise fiscal revenue.
Importantly, the last 3 channels would reflect the impact not only of tariff removal but also of (Non-Tariff Belated) NTB removal.
In summary, the net impact of the AfCFTA on tax revenues would depend on the combined effect of the 4 channels.
Most studies estimate AfCFTA-induced tax revenue losses from tariff reduction using CGE models. Estimates tend to focus on tax revenue losses from tariff removal. These losses range from 0.03% – 0.22% of GDP (or about US$1 billion to US$7 billion) for the continent.
These relatively small estimates reflect the already low level of intraregional tar- iffs in Africa and the modest level of intra-regional trade. Results also reflect limited trade diversion.
When both tariff and NTB reductions are considered, general equilibrium analysis yields different results.
In this setting, tax revenue increases for virtually all countries; the modest revenue losses from import tariff removal are more than offset by increases in revenue from higher consumption and income (Abrego and others 2019).
In addition, revenue increases tend to be proportional to welfare gains and feature relatively large differences across the continent.
However, given that income gains may take time to materialise, revenue in- creases may not compensate for tariff removal losses in the short term. Therefore, adequate revenue mobilisation reforms may still be needed, even if the AfCFTA’s net effect on revenue is positive in the long term.
The AfCFTA presents opportunities and challenges.
It has the potential to increase welfare significantly for its member countries in so far as NTBs are substantially reduced. That said, the implementation of the AfCFTA could also result in costs, including potentially higher income inequality and transitional unemployment.
Therefore, to reap the benefits of the AfCFTA fully and mitigate its related costs, African countries need to pursue a concomitant ambitious and broad-based reform agenda.
So what can member countries do to maximise the economic benefits of the AfCFTA?
To tap the potential benefits of the AfCFTA, there are 2 areas that need to be tackled urgently.
- Reducing the infrastructure deficit (notably roads & ports); and
- Reducing other critical NTBs, such as customs and administrative requirements, that directly affect the capacity of economies to move traded merchandise within and outside their borders.
Reducing Africa’s large infrastructure deficit in roads and ports can increase competitiveness across the continent.
With relatively low road density (IMF 2019), African countries need to extend their road network — while upgrading existing roads — to improve access to African and global markets. This should be ac- complished by scaling up existing continental infrastructure initiatives within a strategy aimed at strengthening rural-urban links, developing trade corridors, and incorporating a continental perspective. This effort could be particularly important for reducing trade costs in landlocked countries. Improving ports and their efficiency would also help reduce trade costs. Port development should be part of a co-ordinated African transportation strategy to ensure efficient use of resources and reduce costs and time at customs. It is also important to eliminate bottlenecks faced by many landlocked countries in reaching their transit ports. At the same time, regulatory frameworks and institutional capacity should be strengthened to attract private sector participation in the construction, operation, and maintenance of transportation infrastructure. That said, efficient public investment in areas unlikely to receive private financing (for example, rural roads and rural telecommunications) should continue, along with improvement of public investment management.
Improving trade facilitation is another priority area for reform.
Addressing onerous customs procedures and boosting efficiency could reduce costs and facilitate trade.
African countries could take a number of steps to achieve this, including:
- making sure that all customs locations have information technology systems that support core processes and are adequately used by traders and officials;
- adopting and enforcing effective governance policies for customs and other border agencies;
- enhancing customs control of preferential origin rules to prevent revenue losses and build trust among trading countries;
- introducing modern risk-analysis techniques and appropriate equipment for nonintrusive inspections and faster turnaround in laboratory sample testing; and
- deepening modernisation efforts, with a focus on reducing costs and delays faced by international traders.
This will require pressing forward with modernisation processes, intensifying training, and implementing quality-based management.
Other deficiencies in customs procedures and operations could be addressed by in- creasing the professionalisation of customs agencies.
Ensuring a strong governance framework for the AfCFTA is also important.
The resolute implementation of the provisions of the AfCFTA could help improve the business environment in Africa, if it reduces uncertainty over trading rules and market access. Making the AfCFTA a framework that reduces trade uncertainty within and among African countries is an essential ingredient to unlocking private sector decisions to expand existing and start new businesses to take advantage of the agreement.
Francois Fouche is a Director at the Growth Diagnostics (in collaboration with the North-West University Business School)