Strengthening Somalia’s Fiscal Stability under New Sales Taxes
A tax regime refers to the laws, regulations, and policies promulgated by any government to aid in the assessment, collection, and management of different types of taxes. It acts as the fulcrum of the economy, giving the state sufficient tools and instruments for raising revenues through various means of taxation, such as income tax, corporation tax, value-added tax, and other customs duties. An effective tax regime ensures compliance through audits, penalties for non-compliance, and legal remedies; hence, it forms the backbone of any country’s socio-economic development.
Of the myriad types of taxation, Value-Added Tax has, of late, assumed the role of one of the mainstays of the modern tax system and, more so, in developing economies. VAT is a consumption tax levied on the value added to goods and services at each stage of production or distribution. Its design generates revenue up and down the supply chain and is, therefore, a very solid and stable base for government revenues. These intrinsic advantages of VAT, in terms of fairness, adequacy, simplicity, transparency, and administrative ease, are what catalysed its adoption worldwide.
Conceptually, and historically, VAT was conceived as a solution to the cascading effects of gross turnover and sales taxes. It was introduced at the turn of the 20th century independently by Wilhelm Von Siemens of Germany and Thomas S. Adams of the United States and caused one of the significant changes in tax structures. By the 1960s and 1970s, VAT had been adopted by most European countries as a more efficient alternative to traditional sales taxes, easily qualifying it as one of the most important developments in global tax systems in the second half of the 20th century.
Today, VAT is in operation in over 160 countries, including nearly all in the developing world, where it has been the mainstay of resource mobilisation. In Sub-Saharan Africa, 80 %of countries operate a VAT, now contributing approximately one-quarter of all tax revenue.
As Somalia embarks on regime reforms in taxation, the coming on board of VAT presents a meaningful step toward improving revenue generation, reducing dependency on external aid, and improving public services. Experiences of regional neighbours in implementing value-added tax bring out lessons for Somalia in its efforts to have in place a more viable and equitable tax system.
Somalia Introduces a New VAT
Effective on April 1, 2024, the Federal Government of Somalia began implementing an expanded version of its Value Added Tax (VAT), which is capped at 5%, in the hope of enlarging the country’s revenue base. As a result, the implementation of this new directive will see the tax regime broaden to capture even wider sectors targeting (telecommunications, financial services, utilities, and digital transactions) a very critical shift away from the previous focus on imports, wholesalers, hotels, and manufacturing.
This tax broadly applies to businesses such as telecom firms, banks, traders, and service providers, and for the first time, mobile money transfers—a service used by over 70% of Somalia’s adult population. Minister Egeh pointed out that this new VAT rate is far below the 15% to 18% imposed in neighbouring countries, including Kenya, Rwanda, Ethiopia, Tanzania, and Uganda, to make it more feasible for compliance to ease the burden in Somali citizens’ pockets.
Despite the optimism by the government, reaction has been mixed from the public towards the introduction of this tax. On the one hand, the tax could be what Somalia needs for fiscal sustainability that reduces its dependence on external aid. On the other hand, there are huge concerns over the effect of the tax on the cost of living in a country riddled with poverty and dominated by the informal economy.
Public concerns have been raised, particularly regarding the new tax on mobile money transactions, which are a critical financial tool for many Somalis. There are concerns about the possibility of double taxation, as import taxes may have already been paid on goods before they reach consumers who will now also be charged VAT. In response to these concerns, the Council of Ministries implemented a serious of steps to eliminate or reduce various import taxes charged at the point of entry.
The more fundamental challenges are the lack of adequate country-wide regulatory frameworks and the requisite institutional capacity to enforce VAT collection. While a Revenue Collection Authority to oversee tax administration is stipulated by the National Consultative Council in the Baidoa Agreement, operationalisation remains at an infant stage.
President Hassan Sheikh Mohamud and Finance Minister Egeh are hailed the VAT as a key milestone in building a resilient and self-sufficient economy. They said it was everyone’s civic duty to pay taxes and contribute toward nation-building. This, quite frankly, shall be the linchpin that finally decides the success or failure of this very ambitious tax reform. This means it all depends on the seriousness that the government is willing to take in meeting the challenge of structural problems within the taxation system of Somalia over the years, and how well it has set up strong institutions and corresponding legal frameworks likely to guarantee a just and effective collection process.
Regional Context
Somalia’s introduction of a 5% Value Added Tax (VAT) marks a significant step in its fiscal policy, but how does it compare to its neighbors in the Horn of Africa and beyond? Let’s take a closer look at the regional landscape.
In the immediate neighborhood, Somalia’s VAT rate stands out as significantly lower compared to its East African counterparts. Kenya has implemented a 16% VAT rate, while Ethiopia operates with a 15% VAT. Uganda and Tanzania have even higher rates, both applying an 18% VAT. This stark difference in rates potentially offers Somalia several advantages in the regional context.
Firstly, Somalia’s lower rate could provide a competitive edge, making the country more attractive for businesses. This could potentially encourage foreign investment and stimulate economic growth. Secondly, the lower VAT rate may ease the burden on consumers, a particularly important consideration in a country still grappling with poverty and economic challenges. Lastly, starting with a lower rate allows for a smoother transition, giving both businesses and consumers time to adapt to the new tax system.
In the broader African context, Somalia’s approach aligns more closely with some of the continent’s largest economies. South Africa, one of the continent’s strongest economies, applies a 15% VAT rate. Nigeria, Africa’s largest economy, operates with a 7.5% VAT, which is closer to Somalia’s rate. On the other end of the spectrum, Algeria has one of the highest VAT rates in Africa at 19%. This diverse range of VAT rates across the continent reflects the varying economic strategies and fiscal policies adopted by different African nations.
Major PFM Reforms under HPIC Bearing Fruits
The recent implementation of a 5% VAT in Somalia comes within the framework of larger economic reforms that have been pursued as part of the Heavily Indebted Poor Countries initiative, a program spearheaded by the International Monetary Fund and the World Bank to bring about full debt relief for countries with very high debt levels so they can rechannel monies to poverty alleviation and sustainable economic development. The HIPC initiative for Somalia came as part of a long reform process of good governance, financial management, and improvements in domestic revenue mobilisation. The international community provided enormous support to Somalia in its pursuits to rebuild state institutions and the economy, which had been left devastated by the civil war. This has since left the country with a weak institutional capacity and narrow tax base, whereby the cost of the state’s collapse during the civil war depleted many human and physical capitals. The turn of events came with the coming of the 2012 Provisional Constitution, which established the Federal Government of Somalia and the Federal Member States. With the strong support of the international community, Somalia has taken extensive reform measures aiming to strengthen key economic and financial policy institutions and improve governance.
The road to debt relief for Somalia under the HIPC initiative was long and arduous, taking the country almost a decade. This involved not only state reconstruction and rebuilding state institutions, but the country also exonerating institutional weaknesses and greatly enhancing trust in the government by reinforcing public finance management. Key to these developments in financial management and transparency was reform on better budget planning and execution and rigorous monitoring of public expenditures. Specifically, the government paid much attention to building private sector competitiveness through digital identification, federal-state cooperation in health and education, and statistical capacity building.
One of these key steps was clearing the arrears of the International Development Association (IDA), which is the world’s largest source of development finance for low-income countries. This allowed the IDA to re-engage with Somalia in 2020, thus increasing its portfolio in the country to $2.3 billion in grants and technical support. IDA re-engagement, supported by the IMF and the African Development Bank, however, was the necessary condition for Somalia to move its case forward for debt relief.
Among HIPC reform programs included the adoption of the National Development Plan 9. This, along with the launch of the Extended Credit Facility (ECF)-supported program, was considered strong enough to put Somalia back on the path of macroeconomic stability despite a host of adversities, including the global pandemic of the COVID-19 epidemic, the worst drought in decades, desert locust infestations, and serious security risks. This is a testimony of the ownership by the Somali administration of these reforms, as it succeeded in triggering thirteen triggers out of the fourteen that were required to reach the floating Completion Point under the HIPC initiative. Some of the triggers included public financial and expenditure management, improvement in domestic revenue mobilisation, governance, social sectors, and statistics.
According to the FGS Minister of Finance, Bihi Iman Egeh, the government implemented numerous reforms that improved financial policy, public financial management, and capacity in revenue mobilisation, such as introducing automation and digitalisation for revenue. According to him, the reforms have increased revenues by 25 % every month for the last eight months. He further adds that Somalia is also expecting a 3.7 % economic growth in 2024 from 2.8 % last year (2023).
Some may consider this as a very important initiative that gives room to improve the status of internal revenue using VAT. It would help in lowering the budget deficit and achieving fiscal sustainability. Somalia has made significantly important efforts in this regard during recent years: domestic revenue collection has increased from $229.56 million in 2021 to $262.67 million in 2022, higher than the target of $250.10 million. However, despite these improvements, Somalia’s revenue-to-GDP ratio remains low compared to neighbouring countries and other fragile and conflict-affected states in the region.
The federal government’s budget for 2024, just adopted by parliament in December 2023, continues to rest on donor support, with 66.7% of the budget to be expected from donors. The theme of the budget for 2024, “Relying on Our Domestic Revenue,” on the other hand, underscores the commitment of the Government to enhance the collection of internal revenues. Twenty % of the budget will be allocated to social service delivery, 24.5% will go to defence and security, and 22.3% of the budget will be for economic development. This speaks volumes about strategic focus on the improvement of public services and infrastructure.
In recent times, Somalia has closed the gap between revenue and expenditure through donor funds, which are important yet certainly not a long-term solution. Indeed, according to Kristina Svensson, the head of the World Bank office in Somalia, although there have been improvements, the low levels of domestic revenue are still very low for delivering visible results to the citizens. Grants currently finance a significant share of Somali government spending, and these are expected to decline over time. She said, on the other hand, IDA had delivered budget support amounting to US$175 million over the past two years, part of which was shared with Federal Member States in the form of intergovernmental transfers. The government, therefore, realises the need for sustainability and is currently working on modernisation and clarification of the legal framework for revenue collection. One such initiative includes the enactment of the Somalia Revenue Administration Act in 2019, aimed at enhancing domestic revenue collection and reducing donor dependency.
As Somalia undertakes its reform agenda further with the HIPC initiative, the introduction of VAT and other fiscal reforms shall contribute much toward enhancing internal revenue collection. This is aimed at not only reducing budget deficits but also increasing the ability of the government to provide services necessary for the people of that country—a foundation for having a more viable and self-sustaining economy.
Looking Ahead
As Somalia implements its new 5% VAT, the nation stands at a critical economic juncture. This bold move, hailed by President Hassan Sheikh Mohamud and Finance Minister Egeh as a key milestone, represents more than just a new tax; it’s a testament to Somalia’s progress in economic reforms and its commitment to financial self-reliance.
The success of this ambitious tax reform hinges on several factors. The government must effectively implement the VAT system, address public concerns, and navigate the complexities of Somalia’s largely informal economy. The coming months will reveal whether this new system can strike the delicate balance between increasing government revenue and supporting economic growth without overburdening citizens.
As Somalia moves forward with its commitment to “Relying on Our Domestic Revenue,” the world watches with interest. Will this new VAT system pave the way for a more self-reliant Somalia, catalysing improved public services and infrastructure? Or will it present new challenges in an already fragile economic environment?
The answers to these questions will unfold in time, potentially offering valuable lessons for other developing nations on the path to fiscal independence. As Somalia stands at this economic crossroads, the introduction of VAT marks a significant step in the country’s ongoing journey towards economic resilience and self-sufficiency.