Tax and governance in Tanzania : an econometric study of how various sources of revenue affect expenditure in local governments

Abstract

The history of the modern state is the history of its revenue raising capabilities (Levi, 1988). Viable democratic institutions first evolved when state and society entered into contractual arrangements with each other over revenue through taxation. A major obstacle for accountable and responsive government in African countries is that states are relatively independent of their citizens for revenue. Tanzania has a very narrow tax base. Taxation only accounts for 12 percent of its GDP. Most revenue to the state comes from foreign aid and the natural resource sector. Being almost independent of ordinary citizen taxpayers for revenue leads to a strong state, but also to much waste, mismanagement and corruption from the citizens point of view.

This thesis will analyze financial data of 115 local governments from 2002-2006 and examine whether different sources of revenue (central government transfers coming mainly from foreign aid, non-governmental transfers and local government taxes). influence the patterns of expenditures of local governments. Since I am only interested in how sources of revenue affect expenditure from 2002-2006, I have used a two-way fixed effects panel data model to remove any omitted variable bias. This thesis confirms that from 2002-2006 the full sample of local governments, amongst other things, did not provide an explicit exchange of tax revenues for public services. Not providing a sufficient exchanges for taxes leads to ‘negative reciprocity’ between citizen taxpayers and local governments which has severe consequences for local governance.

The local government system of financing currently obstructs a visible link between public services and taxes. I find that foreign aid is, as intended, mostly spent on public services. Taxes are not exchanged for anything much except administration costs. Citizen taxpayers incentives to pay for these taxes are thus extremely weak. The lack of a hard budget constraint, weak incentives to collect taxes, and to pay for them, may lead aid and intergovernmental transfers to substitute for revenue collection. There are indications of this in rural and disadvantaged areas.