How East Africa can circumvent the plunder and resource curse of Oil producing nations

As East Africa countries looks forward to upscaling of the mid-stream and downstream of its oil and Gas sectors, governments of these countries have cardinal obligation to manage this Resource not only for the present but also for the future generations. I will look at taxation avenue in this article as a means through which to avoid pitfalls, of what I will refer to as the plunder by the present generation of what should benefit the future generation.

Taxation is one variable in the policy mix that offers solutions to circumvent a resource curse phenomenal that has affected most of the traditional oil and Gas producing countries especially in Africa, by establishing a separate Tax regime that captures the unique interest of the natural resource industry, governments of east African countries ought to take cognizance of the fact that, in their pursuit for resource management in different jurisdiction their fundamental compulsion will be to avoid this phenomenal.

So how can a resource curse be avoided by the new emergent economies in oil and gas sector using tax as a policy tool?

Taxation systems and regimes

Natural resources have an aspect of exclusivity and governments of East African countries need to establish taxation systems that captures these unique interest in natural resource. Economic Rent is a concept that often economists apply when establishing taxation systems for natural resource extraction, this is what makes taxation in natural resource different or require different and special tax regime from the traditional tax regime, for example corporate tax which applies say in the manufacturing industry, is calculated or determined from profits earned by a firm.

Taxation is one variable in the policy mix that offers solutions to circumvent a resource curse phenomenal that has affected most of the traditional oil and Gas producing countries especially in Africa

Distinction between profit’s and Economic rent

Economists make a short simple distinction between profits and Economic rent, profits are referred to as surplus earned after total cost are deducted from revenues generated by a given firm. it’s from this surplus that taxes are determined. A company that doesn’t make profit doesn’t pay corporate tax which is 30% in East African countries.

Economic Rent on the other hand is a reward to a factor of production (labour or land) over and above what is necessary to keep it at that present factor occupation, in simplistic terms, it’s the income gained by beneficiaries of other contrived exclusivity or scarcity, and the best way to understand this distinction is by looking at a barrel of oil.

I choose to use data as at 2013 since by this period of time the global oil and gas industries was fairly stable and somewhat free from the volatility in prices of oil and gas that has affected the industries globally in recent times.

In 2013 the price per barrel of oil was 120$ and the cost of extracting a barrel of oil on global average was 7$, this included the cost of labour, capital cost, risk cost etc. generally it’s the Total cost of production per barrel.

If you negate 7$ from 120$ what one gets is 113$ this is what is referred to as Economic Rent, note that it’s not profit since it’s over and above what is required by the extractive company. You will agree with me even if companies were to include a mark-up or margins to the total cost, the profits would not be so high as 113$. To understand it better I will give Another example in labour market if the supply of labour in this case doctors in a country is inelastic, meaning it does not vary (increase or decrease in quantity) and the demand for doctors service increases, the doctors presently working will command a higher pay as a result of increased demand of their services, therefore the difference in wage rate (which is higher from the initial pay) as a result of increased demand of their service is what is referred as Economic Rent.

What is important to note is that Economic rent is not earned, its basically an intrinsic value, which arise as a result of scarcity and exclusivity. Now in respect to oil and gas who should get the economic rent? Remember Economic rent is not earned, should it be the extractive company or the general public to which the resource is extracted from?

Rationally the intrinsic value of the natural resource belongs to the general public, the populace and governments being the custodians of people interest should therefore then get the Rent on their behave, hence the need for a specific and special tax regime systems that gets off the Economic rent in Natural resource.

A number of model countries in resources extraction have taken into account the aspect of Economic rent in their taxation regime. A case in point is Trinidad and Tobago, Norway, Canada and Australia. Economic rent is much more important to a resource poor country like Kenya or Tanzania than it is to an oil rich country like Norway or Australia.

So why is integration of Economic rent into the tax system that leads to an increase in tax to an extractive company more important to a resource poor country than it is to resource rich country?

In 2013 political intrigues in Austrian government led to the resignation of the prime minister Julia Gillard, among the reasons for her resignation was an attempt to increase tax of the natural resource by her government and as a result there was a lot of push back from the Australian mining company that costed her job, this was because most all extractive companies in Australia are Australian owned not foreign, and thus the Economic rent would trickle down to higher wages to workers who are Australian as well as other industry players that support the mining industry in that country.

In Uganda or Tanzania, the extractive and production companies are most likely going to be foreign owned companies and experts working in the oil and gas sectors are most likely going to be foreigners (expatriates) which is not the case in Australia as they do not experience capital flight, hence the scenario that lead to Austrian prime minister resignation.

Its therefore imperative for the East African Policy makers to adopt tax policy that captures this aspect and avoid capital-flight and will benefit the general public both present and future generation.