A Stochastic Frontier Estimation of Tax Efficiency in the Economic Community of West African States (ECOWAS))

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Korsu, Robert Dauda
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The objective of this study is to investigate the determinants of non-natural resource tax revenue and estimate its efficiency in ECOWAS countries. A stochastic frontier tax function was estimated using annual data from 2001 to 2015 by use of Maximum Likelihood Procedure. The results show that trade openness, financial deepening and urbanization matter for tax revenue mobilization in ECOWAS, with the first two variables having a positive effect and the latter having a negative effect; tax inertia is found to be strong. The estimated non-natural resource tax efficiencies show that during the period 2001-2015, the tax efficiencies of ECOWAS countries were above 90.0% of their potential, except for Nigeria, which had 67.7%. The losses in non-natural resource tax revenue due to inefficiencies were generally low, ranging from 0.6% of GDP in Sierra Leone to a maximum of 1.8% in Liberia, followed by 1.7% in Cabo Verde, Ghana and Guinea Bissau. In addition, countries with high natural resource taxes tend to have low efficiency on non-natural resource taxes, and this efficiency tends to be high where non-natural resource tax is high. Tax revenue mobilization in the ECOWAS countries should therefore be strengthened through continued policy efforts to improve financial deepening, trade openness and decentralization that can reduce urbanization. It is also imperative for ECOWAS tax authorities to consider the level of their tax potential in setting targets for non-natural resource tax mobilization. In addition, more efforts should be put on raising non-natural resource tax revenue than the volatile natural resource tax. Tax restructuring policies that favour direct tax revenue, especially business income tax, and domestic indirect taxes such as Value Added Tax or Goods and Services Tax should be given priority, as the African tax structure and performance review shows that countries with high shares of direct and domestic indirect tax led on tax GDP ratios.