Fiscal policy mistake version 2019

Raise, Remove, Repeat Tax Hikes

Dec 17, 2018

Lets face it, the economy is not in best shape. Debt sustainability lacks credibility. Import cover is below two months. The government is running a large fiscal deficit. The Kwacha is down 20% in the recent quarter.

Zambia has just recovered from a commodity-driven slump of 2015-16 when copper prices collapsed. In 2014, it had not fully recovered from the global financial crisis. It now risks a policy-driven mistake going into next year just as geopolitics, global trade tensions, central banks and commodity prices threaten to retreat growth.

The government badly needs more tax revenue to repay mounting debt. To rake in more taxes, it has targets companies and citizens alike to pay more. As in every battle, the plan will not survive the first encounter with the enemy. The real economy will suffer. And people will be poorer.

If there's one thing we can learn from Zambia's economic history, it is that the government will reverse its ill-thought tax hikes but not before damage has been done to confidence, investment and jobs.

Policy risk 1: to mining, the core of the economy

Miners operating in Zambia will cut at least $500 million in capital expenditure over the next three years as investors in Africa’s second-largest copper and cobalt producer deal with recently raised mineral royalties claims the Chamber of Mines.

The tax changes, which include a 1.5% royalty increase and a 5% tax on copper- and cobalt-concentrate imports, might force miners to cut as many as 7,000 direct jobs and “more than double this number of indirect jobs” Goodwell Mateyo, the president of the country’s Chamber of Mines, said last week.

First Quantum Minerals announced a 1,000 person lay-off at Zambia's newest and largest mine at Kalumbila in North Western Province in the new year. The Home Affairs minister is prepared to retaliate with threats to cancel work permits of foreigners in his bid against "arm twisting" by investors. 

Policy risk 2: to consumers and small businesses

Consumers and businesses will be hit in their pockets next year with the introduction of a non-refundable sales tax in April if it goes to plan. Government sources suggest that the current 16% VAT be replaced by a 20% sales tax on all good and services not just those chargeable today.

This will have an immediate effect on all food and non-food prices. Consumption will drop. Inflation will soar. Bank of Zambia will raise policy interest rates and debt servicing costs will skyrocket.  We have been here before (see chart below showing 10-year inflation data).

The government will realise too late that its tax policy has had an adverse effect. Ordinary Zambians will pay the price of rash and harsh tax hikes. 

So what's the alternative?

While it is true that Zambia and Africa suffer from an infrastructure deficit running into billions. However, extraordinary spending beyond its means is not the answer.

Zambia's fiscal policy aims to raise more tax revenue rather than to moderate its spending. Its rhetoric of austerity has not taken root in practice. All projects that were not 80% complete were supposed to have been halted. Yet we see no evidence of this.

Experience around the world shows that tightening tax squeezes economic growth and lowers tax receipts. Paradoxically, relaxing taxes have the opposite effect of boosting growth. Consumption and investment both pick up. Savings grow. Look no further for evidence than Trump tax give-aways that boosted US growth to above trend.

Clearly the sales tax will hit the poorest hard despite a recent dramatic rise in minimum wages which only applies to the employed, a small proportion of workers. As we are seeing in France, the populace can rise if injustices are felt by those with the least.

The government risks social unrest and stagflation if it carries through with its tax plans. It risks repeating and repealing damaging policy. It needs to think again.