Does increasing domestic borrowing, have an impact on tax collections?

It is now common knowledge that domestic revenue both tax and non-tax is collected by the Uganda Revenue Authority, as the discussion on targets has been commonly referred to in mainstream media. In the recent past, URA has struggled to meet its tax revenue targets.

There are several challenges that could be attributed to the current Revenue collection performance. However, the centre of focus today will be on whether increased domestic borrowing by the government has also impacted on Revenue Collection by URA.

Every Financial year (FY) in June, the minister of Finance reads out the budget speech on behalf of the President to the country. The total resource envelope for the FY is detailed. For example, the total resource envelope for the financial year ending June 2024 is Shs52.7 trillion.

The minister then goes ahead to detail the various sources for funding the budget, among these include the two primary funding sources that is Domestic revenue both tax and non-tax, as well as borrowing either externally or domestically.

Whereas in most cases these sources will function independently, there are instances where one affects the performance of the other. Often the action of state borrowing will reduce the performance of the tax collections.

Firstly, increased domestic borrowing also increases the risk of crowding out the private sector from financing through rising interest rates that are offered by Government, and as commercial banks end up preferring to lend to Government as opposed to the private sector since Government securities are risk free unlike the Private sector.

This preferential treatment has an adverse multiplier effect on the economic performance of the private sector as many companies are not able to access the much-needed operational funding and the little available is at a very high cost. This in turn negatively impacts the possible revenue that would have been realised from taxes like VAT, excise arising from increased production and corporate income tax arising from company profits.

Due to the high cost of finance to the private sector created by government domestic borrowing, the growth of the private sector is constrained resulting in less employment, less production (output) and less tax revenue payments by the private sector. 

 In my opinion, government domestic borrowing should be considered as a last resort to minimise the negative impact it creates on the growth of the private sector as well as tax revenue.

Robert Mbaziira, Senior Tax Manager, Ernst & Young