Introducing a value added tax : lessons from Ghana

The World Bank DECEMBER 2001 NUMBER 61 PUBLIC SECTOR Introducing a value added tax: lessons from Ghana Because the introduction of a value added tax (VAT) can be highly sensitive, steps must be taken to ensure that public concerns are fully addressed. In 1998 Ghana's government successfully modern methods based on documen- introduced a VAT. But this success followed tation, reducing the potential for a failed attempt in 1995, when the country's corruption. first VAT was repealed after just three and The VAT also provided an opportunity Ghana offers lessons a half months. Ghana's experience provides to introduce modern tax administration several lessons for the successful introduc- techniques-though limited to adminis- on what should be tion of a VAT-particularly the importance tration of the VAT-especially self- of recognizing public sensitivity to changes assessment, done-and in the tax system and of securing public acceptance when introducing a VAT. Introducing the value added tax avoided-when A VAT's introductory rate has a big influ- In preparing for the introduction of the ence on public opinion, but so do public VAT, Ghana created a new revenue collec- introducing a value education and management of public expec- tion agency, the VAT Service, recruited and tations. In addition, political commitment- trained staff, and developed computer sys- added tax in terms of both an enabling macroeconomic tems to administer the tax. Legislation was environment and the enactment of prepared and enacted, and a public edu- legislation-is crucial for securing popular cation campaign was implemented. The support and ensuring the timely introduc- VAT was introduced at a rate of 17.5 per- tion of a VAT. cent-higher than the standard 15.0 per- cent rate of the previous sales tax. Why a value added tax? The introduction of the VAT provoked With assistance from the World Bank and civil unrest, with demonstrations and riots the U.K. Department for International resulting in several deaths. In response, Development, Ghana introduced a VAT in the government announced a review of March 1995 to remedy the deficiencies of the tax. Although the government was existing consumption-based taxes. Those expected to lower the VAT rate and raise deficiencies included: the registration threshold, in June 1995 * An excessively narrow tax base, which Parliament passed two bills that ended the resulted in low buoyancy and unstable short life of the VAT. The sales tax was rein- revenue because it excluded fast-grow- troduced with the same rate, scope, and ing sectors of the economy. coverage as before, and the base of the ser- * Weaknesses in the tax collection system, vice tax was expanded from 5 to 15 activ- with inadequate checks and controls lead- ities, covering mainly professional services. ing to revenue leakages. Still, the service tax base was narrower than * A need to move away from collection what was envisaged in the repealed VAT based on physical surveillance toward law. FROM THE DEVELOPMENT ECONOMICS VICE PRESIDENCY AND POVERTY REDUCTION AND ECONOMIC MANAGEMENT NETWORK Reintroducing the value added Sufficient time is needed between enacting tax legislation and implementing the tax As part of the Public Financial Management In 1995 the preparation and implementa- Reform Program, and with technical assis- tion of the VAT were hindered by delays tance from the U.K. Department for Inter- in passing relevant legislation. The passage national Development, the government of primary legislation was delayed from May reintroduced the VAT at the end of 1998. to December 1994, yet the VAT's introduc- Although a single rate of 15 percent was rec- tion was postponedjust three months. Thus ommended-and included in the VAT there was not enough time for key activities, bill-the rate was lowered to 10 percent after including appointing senior managers and extensive consultations between Parliament staff to the VAT Service, implementing pro- and the executive branch. cedures and programs to facilitate training The second reform The lower rate increased public accep- and publicity, and starting taxpayer regis- tance of the tax, but it made revenue lower tration. And because of further delays, sec- effort placed special than it could have been-especially given ondary legislation-on exemptions, tax the tax's comparatively narrow base. Still, rates, and registration threshold levels-was emphasis on revenue from the VAT exceeded the targets not passed until two days after the VATwent set for the initial phase of its operation. into effect. facilitating public In contrast, when the VAT was reintro- Lessons duced in December 1998, its legislation was acceptance of the The second attempt to introduce the VAT enacted 10 months before-providing drew on lessons from the negative experi- enough time for the key activities noted new tax ence with the first, with special emphasis above. As a result the VAT Service was bet- placed on facilitating public acceptance of ter prepared, with trained staff and offices the new tax. Comparing the two reform open in all regions. Education campaigns efforts offers several important lessons. addressed people's questions on compli- ance, resulting in a better-informed public. Strong, clear political management is And taxpayer registration began in August crucial 1998. The introduction of a VAT may face strong resistance by groups lobbying for prefer- The tax administration must be prepared ential tax treatment. Thus clear, top-level The decision to establish a separate VAT political commitment is needed to intro- Service to administer the new tax was made duce a VAT, combined with efficient man- in August 1994, just seven months before agement of the legislative process to ensure the tax became effective. Until then the Cus- that lobbying and political opposition do toms, Excise, and Preventive Service (CEPS) not undermine the implementation strat- was supposed to be responsible for collect- egy. When Ghana first tried to introduce a ing the VAT. The new arrangement led to VAT, political support was weak and politi- substantial rivalry between CEPS and the cal opponents influenced public opinion VAT Service; staff transfers from CEPS to against the reform. the VAT Service were delayed and senior The situation was completely different CEPS managers were no longer fully com- when the VAT was introduced the second ritted to supporting the new tax. One result time. At an early stage of the reform process, was the delayed appointment of the VAT strong messages supporting the VAT were Service's governing board, which was not delivered by the president and members of in place when the tax became effective. Thus government. In addition, technical work- the VAT Service began operating with no shops organized for members of Parlia- oversight and substantial gaps in staffing, ment's Finance Committee improved especially among middle-level management. understanding of the tax and facilitated pas- By contrast, in 1998 sufficient time was sage of the law. allocated to prepare the tax administration PREMNOTE 61 DECEMBER 2001 for registering VAT taxpayers and collect- tor the tax's effect on prices before, during, ing the tax. In addition, experienced tax and after its launch. For example, the Ghana administrators were transferred from exist- Urban Traders Association-which had ing tax administration bodies to the VAT vociferously opposed the earlier attempt to Service, easing staffing gaps. introduce a VAT-was commissioned to sur- vey market prices. The association provided Introductory rates and registration independent verification of the modest thresholds strongly influence public price effects associated with the second VAT. opinion And along with groups such as the Chai- The initial VAT's introductory rate of 17.5 ber of Commerce and Institute of Chartered percent was one of the main reasons it Accountants, the association was repre- failed. This high rate was partly driven by sented on the VAT Oversight Committee. Ghana's worsening macroeconomic situa- The date for the tion and large budget deficit in 1995. The A well-designed public education public was especially angry because the ini- campaign is crucial reintroduction of the tial education campaign had said that the In 1995 a weak public education campaign VAT would be no higher than the sales tax. was a key reason for the public outcry over VAT was carefulty In contrast, at a basic rate of 10 percent the VAT. The campaign's coverage was lim- the VAT introduced in 1998 was much lower ited to professional and trade body offices chosen to avoid than the sales tax. Moreover, many basic and high-end manufacturers, with limited goods-unprocessed food, agricultural in- outreach to low-volume traders and con- inflationary puts, drugs and health services, utilities, sumers. Moreover, the campaign's content books, educational materials-were ex- was constrained by the delays in passing sec- phenomena empted from the VAT to further pacify pub- ondary legislation-which made it impos- lic opinion. sible to explain some of the tax's most Similarly, in 1995 small traders had a hard important details-and by the absence of time complying with the VAT's registration high-level support at the ministerial level. requirements. The second time around, this In 1998 the VAT Service put a lot more problem was avoided by setting a higher emphasis on public education, launching a threshold for the retail sector. In 1999 the well-designed, comprehensive campaign. threshold registration rate for the VAT was The campaign involved a wide range of 200 million cedi ($80,000), up from 25 mil- stakeholders and distributed different types lion cedi ($15,000) in 1995. of informational materials throughout Ghana. In addition, the campaign extended The tax's introduction should be timed to to low-volume traders and consumers, and avoid inflationary pressures it gained a high profile by attracting mi- The introduction of the VAT in 1995 coin- isterial support. cided with several factors that raised prices The campaign established national, in Ghana, including a higher excise duty on regional, and district public education com- petroleum products, a significant jump in mittees, drawing on the VAT Service, van- agricultural prices due to unfavorable rain- ous ministries, the private sector, and civil fall, the normal seasonal low volume of food society. Committee members included rep- production, and fast depreciation of the cur- resentatives of trade and commerce groups, rency, which made imported goods and ser- the Market Women's Association, the Trades vices more expensive. The VAT received Union Council, and the 31 December much of the blame for the higher prices, Women's Movement. fueling public opposition. As part of its efforts, the national public In contrast, the date for the reintroduc- education committee gathered public feed- tion of the VAT was carefully chosen to avoid back through a survey of 500 people across inflationary phenomena. In addition, exter- Ghana's 10 regions. Respondents included nal bodies were encouraged to help moni- opinion leaders, manufacturers, business- PREMNOTE 61 DECEMBER 2001 TABLE I FEATURES OF VALUE ADDED TAXES IN GHANA AND ELSEWHERE IN AFRICA, 2000-01 VAT revenues VAT revenues Standard rate Threshold as percentage as percentage Country or region (percent) (U.S. dollars) of GDP of total tax revenues C6te d'Ivoire 20.0 50,000 4.8 28.7 Ghana 12.5 80,000 3.8 23.5 Nigeria 5.0 1.6 19.7 Senegal 20.0 180,000 6.2 37.1 Sub-Saharan Africa 16.0 3.9 28.4 Source: IMF 200 1. people, traders, market women, farmers, to 12.5 percent (table 1). The government Pubtic feedback fishers, artisans, drivers, public servants, and is also giving thought to broadening the the unemployed. The survey found that the tax's base by cutting the registration thresh- aided the evotving initial stages of the public education cam- old from 200 million to 100 million cedi. paign had raised awareness but that peo- public education ple's knowledge of the VAT remained Further reading limited. The survey also identified key pub- IMF (International Monetary Fund). 2001. campaign lic concerns-such as suspicions about The Modern VAT Washington, D.C. abuse and corruption in the system and Terkper, Seth. 1996. "VAT in Ghana: Why skepticism about whether the public would It Failed." Tax Notes International 12(23): benefit from the extra revenue raised by the 1801-16. VAT. This type of feedback aided the evolv- . 2000. "Ghana Reintroduces VAT: ing public education campaign. Lessons Learned and Progress after a Year." Tax Notes International 20(11): Sustainability of the reform 1253-68. A VAT was seen as a way of improving the revenue performance of Ghana's tax sys- This note was written by Emma Chapman (Con- tem. Although the 1998 tax was introduced sultant, UK DepartmentforInternationalDevel- at a low rate, it generated 20 percent more opment, and SeniorEconomist, Emerging Market revenue than the sales tax it replaced. The Economics Ltd) based on an evaluation of rev- government's macroeconomic framework- enue projects sponsored by the UK Department which aims to reduce trade taxes and grad- for International Development. ually replace them with broadly based taxes Ifyou are interested in similar topics, consider such as the VAT and income taxes-now joining the Tax Policy and Administration The- requires increasing the VAT's role in the matic Group. Contact Michael Engelschalk, revenue system. Less than two years after x87764, or click on Thematic Groups on the tax was introduced, its rate was raised PREMnet. 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