World Bank Expert Calls for Rethinking Tax Incentives as Revenues Lag in Africa
The session reflected ATAF's growing focus, alongside domestic revenue mobilisation, on reforms for more efficient and equitable tax systems across Africa.
Cape Town, South Africa - The World Bank Group’s Global Director for Macroeconomics, Trade & Investment, Manuela Francisco, says tax incentives play a limited role in attracting foreign direct investment compared to broader investment climate reforms, writes Winston Mwale.
Speaking on Tuesday during the annual African Tax Administration Forum (ATAF) meetings held in Cape Town, in a session titled "Incentives and Investment: Navigating Tax Breaks for Foreign Direct Investment," Francisco elaborated on the complex balancing act developing countries face between using tax incentives to attract foreign investment and managing the effects on much-needed domestic revenue generation.
Francisco explained that factors like political stability, security, legal certainty and infrastructure quality play a far greater role in influencing investment decisions than targeted tax incentives.
While incentives can tip decisions between similar locations, they tend to be less effective when the broader investment climate conditions in a country are weak.
Developing countries also tend to rely more on tax holidays and reduced tax rates, which disproportionately benefit larger firms rather than small and medium enterprises.
Evidence shows that incentives targeted at investment costs, like accelerated depreciation and investment allowances, are generally more efficient.
With tax revenues critically low in many African countries, generous tax incentives strain budgets needed for critical development spending.
The average tax-to-GDP ratio in Africa was just 17.2 percent in 2022, with many countries still below 15 percent. This leaves massive gaps in health, education and infrastructure.
"There is a clear and pressing need to raise more revenues equitably to finance development," Francisco emphasized.
Reforming tax incentives will be an important part of the solution.
In her presentation, Francisco pointed out that with tax collection already so low in many countries, generous tax incentives strain budgets and space needed for development spending.
She highlighted the sharp differences in tax-to-GDP ratios between income groups:
- An average of 33.5 percent for high-income countries
- 17.2 percent for Africa
- 15.9 percent for middle income countries
- Just 11 percent for low income countries
Even within Africa, lower income countries lag further behind with tax revenues under 15 percent of GDP in the vast majority of low-income countries and about half of lower-middle-income countries. "This leaves massive gaps in health, education and infrastructure," Francisco said.
As one of the consequences, debt burdens are high and rising across Africa. By 2022, 17 countries in sub-Saharan Africa were already in debt distress or at high risk. This further threatens budgets, as growing debt service costs crowd out development spending.
Against this backdrop, Francisco echoed ATAF's call for African countries to continue strengthening and diversifying domestic resource mobilization. However, she also cautioned against an over-reliance on tax incentives to boost foreign investment.
While incentives have a role in attracting high-quality foreign investment, broader reforms to improve the investment climate and business environment are even more important. These range from strengthening physical infrastructure to reforms around red tape, transparency, and legal certainty.
Francisco presented evidence from investor surveys showing political stability, and legal and regulatory certainty consistently rank above tax incentives as drivers of investment decisions. Incentives only play a material role once decisions are being made between similar locations.
The World Bank and others have also advocated for stronger monitoring and evaluation of tax incentives and expenditures. Many countries do not publish regular tax expenditure reports. Clearer measurement and transparency around costs and benefits can inform reforms.
Finally, Francisco suggested that the incoming global minimum tax of 15 percent under Pillar 2 of the OECD tax deal provides a pivotal moment for countries to re-evaluate tax incentive regimes.
The deal requires the elimination of related party exemptions and profit shifting that may overlap with other incentives.
Rather than a constraint, the deal presents an opportunity to streamline incentives, reduce distortions and leakage, and liberalise reforms that strengthen broader investment climate conditions.
Paired with expanded tax treaty networks under Pillar 1, this can ultimately support more and higher-quality investment.
In closing, Francisco said the World Bank is committed to supporting tax incentive reforms and capacity building across client countries.
She highlighted channels like public finance reviews, development policy financing, technical assistance, and global knowledge sharing.
The session reflected ATAF's growing focus, alongside domestic revenue mobilisation, on reforms for more efficient and equitable tax systems across Africa.