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Harmonization of monetary & fiscal policies for economic integration in Africa

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'1 ••

• UNITED NATIONS

AFRICAN INSTITUTE FOR ECONOMie

DEVELOPMENT :AND PLANNING

IDEP/ET/R/2395-8

DAKAR

HARMONISATION OF

MONETARY

& FISCAL

POLICIES

FOR ECONOMie INTEGRATION IN AFRICA

BY

BURAI YOUSIFGALAL

ELDIN

UOVEMBER, 1971.

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Harmonisat:r'~n of Monetary & Fiscal Policies for Economie Integration in Africa

The objectives of monetary and fiscal policies are, ultimately1 the same. This is true at least in theory because both policies have to exert certain influences upon economie variables such as output, priees, employment level etc. etc. For this reason monetary and fiscal policies have to supplement each other in arder to accvm- plish their overall objectives of high level of ~mployment and f;t;.~­

bili ty.

In this introduction to the subject it is convenient t.o é.1Ssume that fiscal and monetary policies in eaoh country in the economically integrated area are harmonised. The question is how to harmonize the different policies adopted by the member countries in orcier to have a more or less unified approach to the common problems.

The concept of harmonization in a context of economie integr<.:.tion has been defined as the measures that lead ta finfmcial systems that do not disturb the static marginal conditions of welf<1re theory. This definition ignores the fact that the sta..tic ma.rginal conditions of welfare theory;are difficult ta maintain undisturbed even in a single country.

Sorne economists propound~d that. harmonization shoulli aim ut the avoidance of additional disturbance, But this is based on a presump- tion that there is little divergence between the policies ·of the member countries ~ it is expedient ta take measures that preserve this· situation. The Neumark Report descrïbes harmonisation as mensure<:

necessary ;~ta establish candi tions Of taxation and public expcmcli tm:·0s similar ta those that 1-wuld exist wi thin a unified economy. 11

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IDEP/ET/R/2395-8 Page 2.

This concept of harmonization is conoeived by a group of ecol.lorr.ists to aim at the construction of financial systems that would be responsible for the goals of the Union. But this may not be-feasible because each country preserves certain national institut ions especially in the fieL:s of money and

.

"""

finance. Also beoause thë welfare funotions are different in the member countries.

The contention of the different approaches is to raise the economie effi- ciency of the union by eliminating as muoh as possible the dist"LITbÜ"l6 -~'-ct ;:;s which are (to large extent) attributable to the differences in th0 .:;::)t:Lu_:i.-~: __ ._-;

and the tax structures of the member countries as v1ell as tho varia.tic:lc :i.l· ..

the monetary policies adopted.

The national taxes and subsidies should not vary substantially from one country to another unless they are needed to offset sorne other imperfecticns

-..~. in the market mechanism. This condition is a corollary to the custor.:s 1.'n: . .;n

...: thaory which emphasizes that in order to have a succes:.:::ful cu::;tc;ms un:.on, rrkl_-;;'jc:c countries have to give up or reduce to the minimum the ir interf'erence wi th

international trade and adopt similar national monetary and fiscal policies with regard to intra- and inter-country trade.

Tax Harmonisation in an economically integrated area

Taxes usually exert certain influences upon consumption~ production and the allocation of resotœees in general. For this reason taxes me.y be usecl to cushion out inflationary or deflationary pressure. This very fact entails tha'b ta.x policies should be harmonized in order to strengthen the economie

• union. Beoausa inflation in one country can ha~ impact on the other' members especially if their currencies are convertible at par. This means that infla- tion or deflation in a union partner will be transmitted to other partners. If excha.nge rates variation is used to ad·just the balance of payments or t o the propagation of inflation other disturbances within the marlcet wi-1.::.. ~-e

created.

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Differences in tax structures between the member oountries may distort the efficient allocation of resources in the following manner.

(i) Lower taxes rates or exemptions or special concession in one country may attract industries and businesses to operate in that country even if the other pa.rtners need that industry badly or it is m'ore economie to be established their.

(ii) High differences in income taxes may lead to migration to the territa:ry where lower tc:..xes are imposed. The movement of labour due to this can have considerable eff8cts on the manpower planning in the whole market beoause this may oreate a sh~sge in the labour force required for certain industries.

(a) As it is olear now, there are certain advantages of having har- monized tax polioies. In East Africa the uniform oustoms and eocise

t

systems allowed the complete 'absence of fiscal frontiers which avoids nuisance and delay. As these taxes are uniform smuggling is reduced to the minimum. In East Africa smuggling is almost limited to export crops.

This is because export taxes are not harmonized. Smuggling may also be initiated by restrictions in shipment of ~ooal food crops which give rise to differences in priees.

(b) The joint administration of cust·oms and excises lead to a more economie utilization of manpower. This joint administration facil H · --,s proper management of the taxes because there are no difference.a in_interpre- tati'on of ta.x laws and regulations. Also there are no differences in the degree of effectiveness of enforcement.

{o) Taxpayers benefit of the uniformity of tax laws. They are, at least not troubled by oomplianoe with different tax systems. Becuuse of this uniformity of taxes business concerna have no inoentive to attempt to reallocate profits or sales among the three countries for tax purposes.

Also there is no danger of double taxation.

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IDEP/ET/R/2395-8

Page 4.

In East Africa there is a high degree of tax harmonisation.

Tho customs duties are uniform except in few instances when the member countries fail to agree on certain items usually those con- cerns protection of industry. The principlo agreed on is that an item imported into one country and then transfered to another, the rate of the latter applies.

The differences in the excise taxes are minor. The mose notable examples are the differences in the rates imposed on sugar and

matches.

Thore are also sorne variations in other indirect taxes but they are neither significant in terms of revenue nor important for tax harm0nisa1;ion such as motor vehicle license, stamp duties, :r:urchase taxes upon motor vehicle etc. etc.

As far as direct taxes are concerned a wide r<:.,nge of harmoni•

zation is experienced. Incarne taxes are administerod by a com~on

agoncy. · These taxes are uniform. The only exception to this uni- formity is the additional exemption for elderly perosns in Kenya.

The ontire East African incarne accrue to any person is considered as a single sum for tax purposes. The revenue is allocated on the basis 1vhere i t is earned, but a certain portion is retained for the Distributable Pool of the Community.

There are sorne exceptions to the uniformity in the direct taxes.

Thoso ane the graduated personal income tax, estates and export duties.

PUblic Expenditure Harmonization

Generally, public expenditure affects the economy through the demand and coat fuctions. The expenditures that strengthen the economy as a whole and benefit all producers at the same time need not be harmonized.

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There are certain cases which really require harmonisation e.g. when the expenditure favours certain type of industry or

-

when public

e~terpriaes are allowed to charge priees lower than the marginal costs and the difference is subsidized through the budget. Such expenditures reduce the internal oost and disturb the optimal

allocation of resources in the economie union, Special expenditures of this kind are prohibited by article 92 of the Rome Treaty.

In practice there are so many difficulties facing harmonisation of special expenditures in the economie union. But this does not eliminate the possibility of harmonizing expenditures in one line of production~ For the economy as a whole, harmonization of special expendi tures it;l difficul t to attain. This is due to the f<:c.ct that thore are very insistent and extensive demands (in each rnember country) for GdVernment intervention in public and private sectors.

These demands ar~ initiated by the desire to achieve rapid economie growth.

In East Afri~ harmonization of public expenditures is relatively ueglected al though "the institut ions of the Communi ty would appe<J.r to be suitably designed to ensure effective means for consultations and coordination of €conomic and fiscal policies among tho partner states",

garmonization of-Monetary Policies for Economie Integration

As it is mentioned at the outset, the objectives of both monet<~y

and fiscal policies are ultimately the same. Despite this, the

instruments employed to carry out fiscal policy may influence monetary and credit conditions. Accordingly, moneta~y policy will have little or no effect especially when the treasury is pursuing a comple~tlY

divergent policy from the central bank. Sometimes, the treasury adopta an expansionary policy while the central bank attempts to restrict credit.

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IDEP/ET/R/2395-8 Page 6.

The above analysis shO:!fS. that conflicts may arise bGtw-eon the treasury and the central bank in a single country. But as the Government is ultimatcly responsible for all economie policies pur- sued, i t manigulatos both fiscal and monetary policies in ordur t o bring them into ha.rmony.

In an economically integrated area, monetary policies should be designed to suit the objectives of the economie union. Member countries have to co-ordinate their financial policies in order to preserve domestic equilibrium inside the union. This equilibriuli1 can be ·maintained if the member countries infla.to or defL:~to w·h:m . they are in an overall surpJus or deficit respec.tively. Conflicts

may arise when a member country, faced by inflat ionary pressure, adopts tight credit pcilicies while anothor membor pursues an expc::,nsionary policy in order to combat deflation.

In East Africa there vrere certain arrangemt:lr.ts vThich rostrictod the ability of any central bank to adopt a completely divergent

policy from the other two. The arrangements were :- 1. Th~ free intra-mark.et trade

2. Convertibility of currencies at par ~

3• The :1.bsence of exchange control on the intra-market trans2.ctions

"On May 3, 1970 Ug~da Exchange Control was oxtended ·(;0 c·.!Ver all transa,.C)tions wj, tb. Kenya and Tanzania. Uganda currGncy 1L-..s ü.ocLr-:;d no·t:

payable outside Uganda and i ts importation and exportation 1:er;:; prclü- bi ted. The Kenya and Tanzania currencies wero specified :J.r.:; :t'or.: igYl

currencies.11

This is a furthor move towards economie disintegration. The first one vras the failure to agree on an East African Central ~6ank.

Instead of a ·Common Central bank, sepexate centr~l b~nks wore ost~o­

lished and sepor ... ote currenoies vTere issucd convertible at pe.r.

Despitc this gloomy picture, much could be achi~vod throwsh the meetings of the Gov8rnors of the East African Central EankL,

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Bibliosras>&

1. J ,E, Meade

2, J .E. Meade, H.H.

Liesner & S.J. Wells

3. P. Marlin (ed,) 4• I.M.F.

Carls •. Shoup• (ed.)

6.

Carls. Shoup, (ed,)

Problems of Economie Union, London, George Allen & Unwin, 1953.

: Case Studies in European Economie Union.

The Mechanics of Integrntion. London, Oxford University Press 1961.

Financial Aspects of Development in East

Africa-Munchen~ Weltforum Verlag, 1970.

: Surveys of African Economies Vol. 2. IMF,

~lashington, D. C., 1969.

Fiscal Harmonization in Common Markets Vol. 1, Theory Columbia University Press,

1967.

Fiscal Harmonizntion in Common Markets Vol. II Practice Columbia University Press,

1967.

Bank of Uganda Annual Report 1969-1970.

8. Bank of Tanzania Economie Bulletin December, 1970

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