ABSTRACT
Many donors that provide funds for infrastructure projects in developing countries do not accept the payment of fiscal charges which recipient governments would impose under normal circumstances. Since recipient governments are trying to limit exemptions in the fiscal regime in order to broaden the tax base and reduce the scope for fraud and tax avoidance, many countries apply the normal fiscal rules and regulations to donor-funded investment projects and pay these taxes out of general government funds in order to comply with the donors’ rule. Mozambique has also adopted that approach. In theory, and assuming that donors would not disburse and execute pro-
jects unless there was a sufficient provision for the payment of the tax-related part of contractors’ invoices in the budget, the full amount of these indirect taxes paid by the state flows back to the revenue authorities swiftly as revenues, which would provide the funds for the payment of these project-related charges. Thus, the availability of funds for other areas of public expenditure would not be affected. In effect, from the fiscal point of view, it makes no difference whether the government spends more on taxes and thereby collects more revenues, or whether it exempts the respective projects and contracts from tax. Due to the mechanisms and phasing of the budget process and widespread
incomplete understanding of the VAT mechanism, however, provisions for the payment of taxes in the budget tend to be grossly inadequate. The shortfall is dramatic in Mozambique. Instead of scaling down project execution and disbursements, however, most donors continue to disburse. The projects go on, while the state is accumulating arrears. Various special rules and partial exemptions have been put into place in order to alleviate the effects on contractors’ liquidity and profits. This temporary solution is not sustainable, but can actually go on for a considerable period of time. A solution is actually not too difficult. If the administration paid fiscal
charges on donor-funded public works swiftly and in full, most of the additional payments would flow back to the revenue authorities. If government
exempted such projects from taxes (in the sense of zero-rating), similarly to how exports are treated, the revenue loss would be small. It is important to assess the potential revenue loss, which has not been done so far. The author’s best guess is that the net effect on the availability of funds for other purposes will be quite small. This chapter, after an analysis of mechanisms and scenarios, argues that
most of the VAT which the state is not paying is also not received by the revenue office. The part that is received essentially stems from involuntary credits of contractors to government – and thus domestic financing – or is born by donors via inflated prices. The chapter looks at alternative solutions, such as zero-rating of contracts
and invoices of which donors finance the non-tax part, or an improvement of the budget process, which would ensure that the state’s obligations to pay the VAT and import charges receive the funding that it reserves. In the final section, the wisdom of the current practice of many donors
under which they insist on not paying taxes is questioned. After all, the principles and rules were instituted at a time when public finance in recipient countries was generally not transparent and where the focus of aid organizations was on balance-of-payment gaps rather than budgetary constraints. It is proposed that in addition to government changing its budgeting procedures, donors start paying taxes for the infrastructure projects which they support. This would speed up implementation, avoid special rules and their potential for abuse, and probably also reduce the cost of public works in those cases where contractors make bids which include a safety margin to cover the event that payments of the tax part of their invoices to public sector clients may take a long time to materialize.
