REFORMING THE VALUE ADDED TAX IN ZAMBIA

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1 REFORMING THE VALUE ADDED TAX IN ZAMBIA PAMELA MAMBWE NAKAMBA-KABASO Dissertation Submitted for the Degree of Doctor of Philosophy, School of Economic and Business Sciences University of the Witwatersrand August 2010

2 ABSTRACT This study analyses the reform of value added tax (VAT) in Zambia. It does so by firstly, empirically establishing who pays VAT and secondly by investigating the economic impact of broadening the VAT base. Two options on reforms to broaden the VAT base are considered using a computable general equilibrium model which specifies a VAT with rebates. These are: (a) broadening the VAT base to all sectors and (b) broadening the VAT base to the agricultural sectors except the maize sector which is the source of the country s staple. The results in general suggest that VAT is mildly regressive. However, the VAT burden is borne more heavily by urban households compared to rural households. In particular, VAT paid on food is borne more heavily by urban households. The results also suggest that in the short-run broadening the VAT base to all sectors has the ability to raise additional revenue but has adverse effects on the economy, particularly on household welfare. Nevertheless, the adverse effects are muted if VAT broadening is accompanied by reduction in the VAT rate. Furthermore, results on the reform that extends the VAT base to the agricultural sectors except the maize sector, has minimal effects on the macro economy, raises some additional revenue and adversely affects the welfare of urban households compared to rural households. At sectoral level, results reveal that in the short-run broadening the VAT base engenders a resource allocation within value-added that is beneficial to the mobile factor, labour due to the impact of rebates on relative prices of intermediate inputs. In addition to this, results show the importance of a well functioning rebate system on the economy. The imperfections in the rebate system are likely to affect the welfare implications of changes to VAT. Results suggest that welfare losses from broadening the VAT base fall with an improvement in the functioning of the rebate system. The conclusions and recommendations from the foregoing are as follows. Given that that the burden of VAT is largely borne by urban households who are relatively better off compared to the rural households, VAT can be extended to cover some of the currently exempted items at low welfare cost. This would create fiscal space to undertake more activities as envisaged in the Fifth National Development Plan. Secondly, extending the VAT coverage to all sectors with very minimal or no exclusions should be accompanied with reductions in the VAT rate. Furthermore, contrary to the widely held view in the debate on VAT reform in Zambia, extending the VAT coverage to agricultural sectors apart from maize sector is not likely to hurt the worse-off socio-economic groups. The short-run welfare losses of such a reform appear to be more disproportionately borne by the urban households whose incidence of poverty is low compared to the rural households. Therefore, bringing more agricultural commodities under VAT coverage provides one of the viable options to reforming VAT in Zambia. 1

3 DECLARATION I declare that this thesis is my own unaided work except where due reference has been made. It is submitted in fulfilment of the requirements for the degree of Doctor of Philosophy in the University of the Witwatersrand, Johannesburg. It has not been submitted for any degree in any university. Pamela Mambwe Nakamba-Kabaso Date 2

4 DEDICATION I dedicate this thesis to my husband, for his unwavering support, encouragement and endurance throughout my PhD programme. 3

5 ACKNOWLEDGEMENTS I would like to thank my supervisor, Prof. Christopher Malikane for his invaluable guidance and support during my PhD programme. I especially thank him for believing in me and for his desire to see this work come to fruition through his constructive comments. I am heavily indebted to the African Economic Research Consortium (AERC) for the financial assistance rendered during my PhD programme. Special thanks go to Prof. Njuguna Ndungu, Prof. Marios Obwona, Prof. Mukwanason Hyuha and Ms. Lynette Onyango for ensuring that I received all the necessary financial support timely. I am also heavily indebted to my employer; the University of Zambia (UNZA) for granting me paid study leave to pursue my PhD programme. Special thanks go to Prof. Manenga Ndulo, Head of the Department (UNZA) for all the encouragement and support to my cause. I would like to thank the University of the Witwatersrand for facilitating my stay and research during my PhD programme. I specifically thank, Prof. Charles Simkins and Dr. Neil Rankin as co-ordinators of the programme. I cannot forget to thank Mrs Joyce Spence for working tirelessly on administrative matters during the programme. My special thanks also go to the School of Economics, University of Cape Town (UCT) for facilitating the coursework component of my PhD programme. I would also like to thank Prof. Margaret Chitiga of University of Pretoria for encouraging me to take on the topic of this thesis. I thank my family: my father and mother, brothers and sisters for believing in me and for laying a foundation for this PhD. I further extend my thanks to my fellow PhD colleagues both at UCT and Witwatersrand for stimulating ideas and discussions and for the friendship which kept me going. Lastly and most importantly, I thank God for allowing me to go through the PhD programme, for providing me with abundant energy and health. May the glory be to God! 4

RESEARCH DEGREES BY EXAMINATION AND DISSERTATION COURSE REGULATIONS 2001-2002

RESEARCH DEGREES BY EXAMINATION AND DISSERTATION COURSE REGULATIONS 2001-2002 TITLES OF RESEARCH DEGREES Research degrees (PhD, MPhil, MA/MSc by Research) normally take the title of the academic department in which they are studied. The following departments have received approval