Fiscal consolidation to accelerate growth and support inclusive development: Ghana Public Expenditure Review
Ghana has experienced an extended period of robust growth since the early 2000s, supported by a favorable external environment and large investment inflows, particularly in the extractive industries. In 2011, as the start of oil production drove a surge in per capita income, Ghana graduated from low-income to lower-middle-income status. Despite the key role of the extractive industries, recent growth has been relatively inclusive, and Ghana achieved its Millennium Development Goal of halving the poverty rate by 2015.
However, macroeconomic conditions have deteriorated since 2012, giving rise to substantial domestic and external imbalances. Although external shocks have underscored Ghana’s vulnerability to global commodity and financial markets, the recurring nature of its imbalances reflects deeper structural deficiencies in its macroeconomic policies and public financial management (PFM) framework. A heavy focus on commodity exports has accelerated Ghana’s recent growth, but the country’s economic outlook increasingly hinges on a narrow range of volatile commodity prices. Sustained increases in education and health spending have enabled the government to make important progress in improving key social development indicators, but steadily rising public expenditures in a context of persistently weak revenue performance has undermined the stability of the fiscal accounts. Intensifying global headwinds have revealed the extent to which recent macroeconomic and public expenditure trends have exposed the country to unsustainable fiscal and current-account deficits.
In an effort to stabilize the economy and shore up the public finances, the government adopted a multiyear fiscal stabilization plan in mid-2015, with support from the International Monetary Fund (IMF), the World Bank, and Ghana’s other development partners. After achieving a substantial degree of fiscal consolidation in 2015, Ghana missed its 2016 fiscal target by a large margin. The budget numbers indicate that the fiscal slippage was due to the public revenue shortfall and rising expenditure pressures in the run-up to the December 2016 elections, which also caused the government to accumulate large amount of new arrears. The consolidation program is expected to get back on track in 2017 and continue through 2018, with further fiscal adjustments focused on both public revenue and expenditures. Progress on the structural reform agenda has been uneven, and in order to achieve its objectives the government will need to refocus its attention on measures to improve PFM. Lessons learned from previous reform efforts underscore the critical importance of a credible and enduring political commitment to the full implementation of the reform agenda.
Ghana’s recent transition to lower-middle-income status complicates its fiscal consolidation efforts, as the county now faces diminished inflows of external assistance and limited access to concessional borrowing. Meanwhile, the emerging oil sector presents both opportunities and challenges, as it is projected to provide a strong but temporary boost to economic growth and fiscal revenue. These factors highlight the critical importance of macroeconomic management and structural fiscal reform. Addressing Ghana’s macroeconomic vulnerabilities while sustainably expanding the available fiscal space for capital investment and social spending will be pivotal to broad-based growth, job creation, and the achievement of the government’s development objectives.
This Public Expenditure Review (PER) focuses on the policy areas most relevant to Ghana’s ongoing fiscal consolidation and medium-term macroeconomic outlook. Its subject areas are designed to reflect and complement the government’s commitment to strengthen PFM in preparation for the anticipated surge in oil revenues. Chapter 1 assesses options for sustainably reducing non-discretionary expenditures and enhancing the efficiency of public investment. Chapter 2 explores strategies for improving domestic revenue mobilization by streamlining tax exemptions and other fiscal incentives. Chapter 3 analyzes the government’s wage bill, its largest recurrent budget item, and considers measures to better manage the size and compensation structure of the public sector workforce. Chapters 4 and 5 focus on policies that will enable Ghana to leverage its positive medium-term economic prospects – including rising oil revenues – to achieve a more sustainable and inclusive development pattern. As a healthy, educated labor force is crucial to meet the evolving demands of a dynamic economy, Chapter 4 evaluates public spending in the education and health sectors and its impact on human capital formation. Finally, Chapter 5 examines public spending in the agriculture sector, which despite its diminishing economic size will remain crucial to employment and poverty reduction over the long term, particularly after the anticipated boom in oil production runs its course.
Ghana provides a wide range of tax exemptions and incentives designed to reduce the tax burden on certain economic sectors and income groups. These “tax expenditures” are not fully recorded in the budget and are far less visible than more traditional forms of public spending, yet they impose a steep fiscal cost. The foregone revenue from Ghana’s tax expenditures amounted to an estimated 5.2 percent of GDP in 2013. Value-added tax (VAT) exemptions and preferential VAT treatment alone reached 4.2 percent of GDP, while customs exemptions represented another 0.9 percent. While statistical issues complicate comparisons between years, similar data for 2014 suggest that the foregone revenue from tax expenditures has remained broadly stable at about 5 percent of GDP. Moreover, as their purpose is to realign incentives in favor of certain types of firms and taxpayers, tax expenditures inevitably create economic distortions and give rise to vested interests. Once established, tax expenditures often prove difficult to eliminate, as their beneficiaries will strive to defend and expand them regardless of their social or economic value.
Accurate cost estimates are essential for effective oversight and the analytical basis for reforming tax expenditures. The government needs to build its capacity to estimate regularly all foregone revenues arising from tax exemptions and incentives by improving the data collection in all areas of tax administration and closing significant gaps in the data on income-tax expenditures for mining firms and free-zone enterprises. Accurate cost estimates are essential to assess the cost effectiveness of the tax exemptions and to form the analytical basis to improve the tax-expenditure policies.
Ghana’s tightening fiscal envelope presents a critical opportunity to assess the cost-effectiveness of its tax expenditures and evaluate potential policy alternatives. Reforming tax expenditures could enable the government to boost domestic revenue generation and enhance the efficiency of fiscal policy without compromising its expenditure priorities. Tax-expenditure policies that advance worthwhile social or economic objectives should be reformed to enhance their effectiveness, while those that serve no clear policy purpose should be eliminated.
Some tax expenditures are designed to alleviate the tax burden on lower-income households, while others attempt to incentivize the consumption of goods and services that generate positive externalities. When reviewing tax expenditures targeted to low-income households, policymakers should evaluate the impact of VAT exemptions and zero-rating, as some of these tax benefits also go to middle and high income consumers who could afford to pay the VAT. A socially optimal option would be to collect the VAT on all consumption and use the revenue to directly subsidize consumption of the poor through cash transfers. However, such consumption that results in significant externalities such as preventive health care like bed nets and vaccines and primary education may be relieved of any VAT burden ideally through zero-rating. Tax expenditures on consumer goods that produce no significant positive social or economic spillovers should be identified and eliminated.
Trade-related tax expenditures should be consolidated into a holistic export-promotion strategy. While this strategy may include a narrow range of tax incentives, it should focus on measures to promote domestic competition and foster regional integration. Tax expenditures can bolster the export competitiveness of targeted sectors, but they can also prop up industries that are structurally uncompetitive. Moreover, tax expenditures frequently accrue to industries and sectors that would be viable without them. Customs exemptions on manufacturing inputs and capital goods may be retained if they contribute to a clear sectoral development strategy, but exemptions on most consumer goods should be phased out. The special exemption permits approved by Parliament should also be eliminated, and exemptions should not be applied to individual firms, but only to classes of goods and services.
Policymakers should evaluate the impact of tax holidays and location-based incentives such as “free zones,” as both policy types are inherently inefficient and prone to abuse. The government should investigate the behavior of businesses that benefit from these policies and develop a strategy to reduce economic distortions and curb tax avoidance. All commercial and industrial tax expenditures should be routinely evaluated to determine which firms and sectors are benefitting from preferential tax treatment and to assess the extent to which supporting these industries is consistent with Ghana’s strategic development goals.