Are digital-payment tax incentives delivering on the promise of increased tax revenue? A comprehensive comparative compilation of experience across Africa, Asia and America.
Electronic or digital payments hold great potential for tax administrations in low- and middle-income countries (LMICs), particularly in Africa where the percentage of adults in LMICs that made or received digital payments more than doubled in less than 10 years reaching 57 per cent in 2021. Enabling robust digital payment systems is also a key pillar to build digital public infrastructure (DPI) and to bolster tax revenues. How would this come about?
- The expansion of digital payments promises to ease taxpayers’ tax compliance, as transactions are digitally recorded.
- Effective sharing of payments data with tax authorities has the potential to create a ‘paper trail’ of economic transactions which could in turn help tax administrations to not only enforce tax compliance but also to better identify taxable incomes.
- Business formalisation spurred by digital payments could potentially increase tax revenues.
Unsurprisingly, governments worldwide strongly encourage – through fiscal incentives – the adoption digital payments.
But what do we know on how effective these incentives are? And what are the key lessons for Africa?
Tax rebates
Amongst the main tax incentives are value-added tax (VAT) or income tax rebates on digital transactions. In Asia, South Korea pioneered VAT incentives for digital payments, thereby boosting cashless transactions and net revenue by around USD 1.3 billion. This involved primarily tax deductions for purchases made with credit or debit cards, or other electronic means of payment. Greece introduced the Electronic Consumption Tax Discount in 2016, offering a 22 per cent tax discount on electronic transactions, resulting in increased card usage and revenue. In 2004, Mexico mandated digital receipts for income tax deductions for amounts equivalent or above 2,000 Mexican pesos (about USD 107). Argentina and Colombia both offered VAT refunds on card purchases. Although the policy was highly successful in Colombia increasing card transaction by 35 per cent on average, both countries ended up abolishing the programmes as they were highly regressive and costly. Uruguay’s VAT discount of up to 40 per cent for card payments led to a 50 per cent rise in card transactions, which remained high despite a 2015 rebate reduction. Yet it did not boost revenue mobilisation, with no VAT liability change and a fiscal cost of about 1.5 per cent of VAT revenues, largely from firms’ low point of sale (POS) adoption.
POS subsidies
The Uruguayan example shows that tax incentives for electronic payments fail without the right infrastructure, justifying policies to expand POS adoption alongside tax incentives on transactions. For example, in 2016, Argentina mandated merchants to accept debit cards by offering fiscal credits and waiving POS rental fees. Neighbouring Uruguay unsuccessfully attempted to expand POS infrastructure through tax credits and rental fee subsidies. Further north, Mexico provided subsidised tablets with mPOS systems to small registered firms.
Demonetisation
Policies that accelerate demonetisation have also been used to promote electronic payments. In 2016, India led a dramatic demonetisation effort by declaring 86 per cent of its currency in high-value notes illegal. Restrictions on new note printing caused a cash shortage and boosted electronic transactions. Research found that a 10 per cent increase in electronic payments in West Bengal led to an average increase in reported sales of 0.3 per cent. The government itself declared a 15.7 per cent increase in tax collection. In addition, demonetization has boosted digital payments, creating significant transaction data, which in turn allowed the Reserve Bank of India’s Open Credit Enablement Network (OCEN) to expand affordable credit access. Other countries like Mexico have tried to demonetise by ‘punishing’ cash through a 2 per cent tax on cash deposits. Estimates suggest that cash deposits are extremely elastic: in evidence, a 1 per cent tax led to a 60 per cent reduction in cash deposits. However, people started holding cash outside of the banking sector. Nigeria withdrew large-denomination bills to move a projected 85 per cent of cash outside banks into the formal sector, thereby boosting digital currency use and tax collection. The policy has since been repealed.
Mobile money tax exemptions
Other types of tax incentives have become commonplace due to a recent shift towards mobile money in Africa. New mobile money tax packages often include exemptions for digital merchant payments, that is, payments made to registered merchants. For example, in May 2022, Ghana implemented an e-levy that exempted digital payments to formal merchants. Recent DIGITAX research indicates that the exemption significantly shapes clients’ behaviours, and usage of digital payments from merchants, even improving tax attitudes and perceptions of merchants.
Regarding providers’ fees on digital payments, recent DIGITAX research explores the Rwandan case where telecommunication companies (telcos) waived digital payment fees during the pandemic, boosting digital payments and reducing cash use by 20 per cent. When fees returned at half the original rate in September 2021, cash use increased by 10 per cent and digital payments dropped by 5 per cent, showing temporary exemptions can boost adoption but might have short-lived impacts.
Lessons learned
The transition to digital payments presents both challenges and opportunities. Countries have implemented a variety of incentive policies, often with mixed results.
There are three key lessons for African governments:
- Success hinges on addressing both sides of the market, as witnessed in South Korea and Mexico. The goal should be to create a virtuous loop where supply and demand of electronic payments reinforce each other.
- The potential of higher adoption of digital payments remains limited if data is not shared with tax administrations, which must also have the capacity to make best use of it.
- Finally, taxpayers could react perversely to fiscal incentives, trying to avoid taxes. Thus, traditional monitoring and enforcement are crucial.
