Public Disclosure Authorized Report No: AUS0000782 Liberia

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Public Disclosure AuthorizedReport No: AUS0000782.LiberiaPublic Disclosure AuthorizedDomestic Revenue Mobilization Policy Notes.May 20, 2019.GOVPublic Disclosure AuthorizedPublic Disclosure Authorized.Document of the World Bank

. 2019 The World Bank1818 H Street NW, Washington DC 20433Telephone: 202-473-1000; Internet: www.worldbank.orgSome rights reservedThis work is a product of the staff of The World Bank. The findings, interpretations, and conclusions expressed in this work do notnecessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank doesnot guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown onany map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or theendorsement or acceptance of such boundaries.Rights and PermissionsThe material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work maybe reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given.Attribution—Please cite the work as follows: “World Bank. 2019. Liberia Domestic Revenue Mobilization Poolicy Notes. WorldBank.”All queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World BankGroup, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@worldbank.org.These policy notes have been prepared by the World Bank team comprising Oleksii Balabushko (SeniorPublic Finance Specialist and Task Team Leader, GGOAS), Moses Wasike (Senior Public Sector

Specialist, GGOGT), Svetlana Budagovska (Consultant, GGOAS) and Dusan Vujovic (Consultant,GGOAS). Aibek Uulu (Consultant GGOAS) carried out estimates for distributional analysis of VAT.ContentsDomestic Revenue Mobilization in the Context of Fiscal and Development Challenges . 4Taxation of Natural Resources. 7Natural Resources in Liberia . 7Revenues from Natural Resources in Liberia . 10Extractive Industry Transparency Initiative (EITI) . 13Conclusions and Recommendations . 15Tax Concessions (Incentives) in Liberia . 17Defining Tax Concessions . 17Tax concessions for Income Tax in Liberia . 18Tax concessions for GST in Liberia . 20Conclusions and Recommendations . 21Introduction of VAT: Revenue and Distributional Impact Considerations . 22Impact of Transition to VAT . 23Considerations for Introduction of VAT . 26Conclusions and Recommendations . 29Liberia Revenue Code: How to Ensure Clarity and Comprehensiveness . 30Key Recommendations on Raising Tax Revenues in Liberia . 33Annexes. 35Annex 1. Liberia Tax and Non-Tax Revenues, 2009-2018, USD million. 35Annex 2. Liberia Mining Fiscal Terms . 36Annex 3. List of Tax Exemptions as Presented in the Revenue Code of Liberia . 38Annex 4. Components of the Benchmark System . 41

Domestic Revenue Mobilization in the Context of Fiscaland Development Challenges1. Following general elections in Liberia in 2017, a new government was formed with amandate to achieve ambitious development objectives. Following a nationwideconsultative process, the new medium-term national development plan, Pro-Poor Agendafor Prosperity and Development (PAPD)-2019-2023 was developed focusing on:a. strengthening public institutions;b. accelerating infrastructure investments for productive capacity;c. improving productivity in the real sector through enhanced economic diversification;d. increasing investment in human capital (youth employment, health, and education);ande. improving competitiveness, while safeguarding macroeconomic and debtsustainability.2. Such a comprehensive approach and strong pro-poor orientation is understandablegiving the living conditions of the majority of the population. In the presence ofinevitably declining aid flows from the elevated levels during 2014–16 period, thegovernment will face a daunting task of pursuing a demanding development agenda tomeet high expectations generated during the last electoral cycle, while safeguardingmacroeconomic fiscal and monetary stability, securing investment resources for futuregrowth, and ensuring debt sustainability in the medium-to-longer run.3. At the same time, Liberia is a challenging fiscal position. It heavily depends onexternal grants as a source of revenue. Recent IMF Article IV mission to Liberia (February25 – March 8, 2019) concluded that macroeconomic stability has proved elusive and fiscalstance has loosened significantly during the second half of 2018 calendar year despiteimproved revenue collection. At the same time GDP growth estimate for 2018 has beenreduced from 3.2 to 1.2 percent, while the forecast for 2019 has been revised down evenmore dramatically from 4.7 to 0.4 percent. This will inevitably reduce the projected taxbase and put additional pressure on revenue reforms to compensate for slower GDPexpansion and sufficiently expand the resource envelope to enable a much-neededincrease in social spending.4. Macro fiscal situation threatens successful implementation of PAPD. Officialnumbers for the July 1 – December 31, 2018 period (Q1 and Q2 of FY 2018/19) releasedby the Ministry of Finance do not reveal the full extent of ensuing macroeconomicimbalances: growing fiscal deficit financed by accommodative monetary policy of theCentral Bank, depreciation of the exchange rate by 26 percent and accelerated inflationwhich reached 28 percent at end-December. This level of inflation markedly erodes theliving standards of the most vulnerable social groups and threatens the success of the propoor agenda of the Government.

5. The focus of fiscal policy should be twofold – raising revenues while sustainingdeficit at financeable level. In such a tight fiscal situation, the imperative is to secureequal or improved quality of public services by prioritizing and improving the compositionof expenditure, enhancing efficiency, and expanding the resource envelope by stepping upthe revenue mobilization efforts. Sustaining pro-poor development agenda, will likelyrequire a political resolve to reduce the share of government resources devoted to highpaid public servants and discretionary expenditures, as well as improve the efficiency andtransparency of government spending. Otherwise, the financing gap created by anannounced decline in grants and other forms of external assistance may be difficult toclose.6. The evolving fiscal pressures assign growing importance to revenue reforms in thecontext of Domestic Revenue Mobilization Strategy which envisages a number ofspecific reforms, including more focused excise taxes, rationalization of tax exemptions,and improved tax administration.7. Liberia has been embarking on tax reforms since 2013. Liberia’s main domestic taxesinclude corporate income tax, personal income tax, goods and services tax, and excisetax. The Liberia Revenue Authority (LRA), in charge of administering revenues in Liberia.The LRA was established on July 1, 2013 replacing a revenue department of the MFDP.Recently, LRA implemented a wide range of measures to improve tax compliance and toreduce leakages, such as introducing a desk audit system for large taxpayers andeducating taxpayers through workshops with support of development partners. A newcompliance management framework was introduced in the first half of 2017 for furtherimprovement of revenue mobilization.8. At the same time, the reliance on grant to finance expenditures has not decreasedand revenue performance remains weak. Despite relatively rich natural resource base,especially in iron ore, rubber, rubber-wood, gold, diamonds, and a range of other minerals,and a large share of sectors based on natural resources in GDP and exports, Liberiacollects minimal public revenues from these activities (see Annex 1 for detailed revenueperformance).

Figure 1: Liberia: Limited Revenue Mobilization and Dependence on GrantsSource: IMF9. While the administration processes to ensure compliance are under development,the tax administration seems to pose burden on taxpayers, which is perceivedhigher than in the region and has a particularly negative impact on small companies.Figure 2. Tax Rates and Tax Administration Perception by Businesses, 2017Source: World Bank Enterprise Surveys10. These policy notes provide a closer look in several important areas of the DRMagenda including natural resource taxation, introduction of VAT, tax exemptions, andstreamlining of the tax legislation.

Taxation of Natural Resources11. In the context of a need to increase revenues and create a fiscal envelope for a propoor development agenda, natural resource taxation deserves special attention as itmay offer a win-win vehicle to enhance revenues, improve country’s even regionaldevelopment, and boost its overall development capacity, without hurting domesticinvestment and doing-business conditions.12. Based on World Bank assessment, Liberia is one of 81 countries in the World inwhich natural resources play a dominant social, economic, and political role.According to the latest, albeit almost four year old, Liberia 2014-15 EITI report, extractiveindustries (in agriculture, forestry, mining, and oil and gas) contribute to around 15 percentto GDP, 26 percent of government tax revenue, and 49 percent of overall employment.The mining sector accounts for 52.7 percent of extractive industries revenue, followed byoil and gas which contributes 21.1 percent although still at exploration stage. Agriculturesector is third with 14.9 percent and forestry last with 11.2 percent. Out of ten largestcompanies in terms of contributions to government revenue, the Mining sector has fivecompanies (ranked 1st, 2nd, 4th, 8th and 9th) with combined share in revenues of 47.4percent. Oil and gas sectors have three companies (ranked 3rd, 6th and 7th) with 18.4percent combined share. Finally, agriculture has one company (ranked 5th) with 5.5percent share, and forestry has one (ranked 10th) with 3.3 percent share.13. Most of natural resource revenues in Liberia come from licenses and payroll taxes.In terms of tax instruments, the largest contribution (27.1 percent of total natural resourcerevenues) comes from licenses and various fees sectoral and administrative fees. Thesecond largest are taxes on wages (social contributions and payroll taxes) with 26.8percent share natural resource revenue. Ordinary taxes (including CIT, excise taxes, andvarious resource taxes) are third with 21.3 percent. Finally, royalties contribute only 11.6percent of natural resource revenues.14. Given the available information on natural resource endowments, unless there is abreakthrough in oil and gas explorations, it is very likely that the mining sector willcontinue to dominate the contributions to employment, production, GDP, exports,and government revenues. Forestry is likely to show strong growth in the coming yearsas demand for rubber-wood continues to increase, but its share in government revenuewill not change much due to low base.Natural Resources in Liberia15. Liberia has rich mineral deposits. Mineral extraction – particularly of iron ore, gold anddiamonds – has been one of the main sources of value added and exports. For the mostpart minerals are exported in a raw or semi-finished form. In addition to large iron ore

deposits, there are substantial diamond and gold deposits as well as potential deposits ofmanganese, bauxite, uranium, zinc and lead. Diamond deposits, primarily alluvial andartisanal diamond mining, are widespread in most parts of the country. The governmentcomplies with the Kimberly Process (KP) of Origin Certification, which enables Liberia tolegally trade rough diamonds with other KP member countries.Figure 3. Liberia: Natural resource endowmentSource: World Bank16. The country has substantial iron ore reserves. Mining largely ceased during the 1990’swith the onset of the civil war. Liberia’s iron ore reserves at grades of 30-70% are probablythe largest in Africa and there is renewed interest in the exploitation of the iron oredeposits. As indicated in the map and table below, Liberia has more than three billion tonsof iron ore with an average iron content of 38.9 percent. Presently Liberia ranks no 22 iniron ore production with 5.1 million tons or 0.2% of World production. Iron ore mining has amajor role in the economy and accounted for nearly 30 percent of total export earnings in2016.

Figure 4. Liberia -- Iron Ore DepositsSource: Ministry of Lands, Mines & Energy, Liberia. The Potential for Iron Ore in Liberia17. Liberia has a long tradition of producing and exporting natural rubber. Firstconcession was signed with Firestone in 1926 for a 99-year lease of one million acres ofland (at location to be picked by the company) at US 6 cents per acre. The lease has beenextended in 2005 and amended in 2008 yielding Liberia significant economic benefits,despite recent labor disputes. In 2013 the Government suspended the exports of rawrubber and requested all companies to do at least some processing in Liberia to increasevalue added (and hence GDP) leading to higher wages and better conditions for localworkers. Many rubber companies (Firestone, Bridgestone and Salala) responded byprocessing part of raw rubber and exporting latex and similar rubber products. Thisincreased the value of combined rubber exports to US 200 million, almost half ofmerchandise exports.18. Recently, Liberia further expanded the rubber value-chain when it started cuttingand selling rubber-wood from about 600,000 hectares under overgrown rubberwood farms with trees between 30 and 60 years old. Based on conservative FAOassessment of 100 cubic meters of rubber-wood per hectare (Non-forest tree plantations,FAO 2001), the volume of wood makes Liberia a possible competitor in the fast-growingrubber-wood products market with strong import demand from the US, EU countries,Australia and Japan. Asian countries (Malaysia, Thailand, and Philippines) currentlydominate exports but increasing labor cost and other factors affecting theircompetitiveness may open opportunities for Liberia and other competitors that can supply

competitive products and ensure adequate supplies. Rising consciousness amongconsumers about the environment will likely result in increasing demand for rubber woodand provide Liberia with a clear opportunity to enter this market and create productive jobsthat could help reduce poverty in the country.19. At the same time, dependence on natural resources comes at a price due tovolatility in commodity markets. After more than four decades (1960-2006) of moderategrowth, prices of Iron Ore and Natural Rubber sharply increased in response to highdemand driven by the unprecedented growth of the global economy (first and foremostChina). The initial boost to economies driven by natural resources (2006-2009) wasfollowed by a sharp reduction in prices following the global recession (2009-2010), anotherrevival (2010-2014) and a final return to price levels recorded in 2005-2006.Figure 5. Iron Ore and Natural Rubber prices, 1960-20197.00200.006.005.00150.00Rubber (RHS)4.00100.003.00US per kgUS per tonIron ore2.0050.001.000.000.00Source: World Bank, Commodity Prices database.20. This price volatility seems to be over for iron ore as has been following a strongupward trend since early 2016, with projected positive growing trend until 2025 andbeyond. Rubber prices experienced another cycle in 2017 and are now poised formoderate steady growth until 2025 and 2030. Both price forecasts are based on the latestWorld Bank commodity price projections.Revenues from Natural Resources in Liberia

21. The effective tax rates have changed significantly over the last five years (see tablebelow) due to world (export) prices and mix of applicable tax instruments with elements ofprogressivity and regressivity. For iron ore, effective tax rates are likely to recover fromthe lower levels recorded in 2018 and remain at above 6 percent level in the coming years.Effective tax rates in gold have been continuously falling since 2015 and are projected toremain low due to increased competition in the world markets. In rubber, the effective taxrates have been fluctuating around 10 percent in line with price movements in internationalmarkets. In the coming years effective tax rates are projected to gradually increase in linewith growing global demand for natural materials. In forestry, the declining trend ofeffective tax rates observed over the last four years is expected to be reversed and startincreasing due to new production and exports of rubber wood.Table 1. Liberia Effective Tax Rates of Selected Commodities, percent of the value ofproductionFY15Iron 14.315.67.6Source: IMF Staff Calculations22. Despite relatively rich natural resource base, especially in iron ore, rubber, rubberwood, gold, diamonds, and a range of other minerals, and a large share of sectorsbased on natural resources in industry value added, GDP and exports, Liberiacollects minimal public revenues from these activities. Allowing for errors caused byinadequate classification of tax revenues (since most public revenues from naturalresource activities come from CIT which cannot be appropriately allocated to sectors andsubsectors), it appears that Liberia still: Does not devote enough attention to enforcement of the applicable tax legislation;Grants tax exemptions in a discretionary and non-transparent way; and Does not apply fiscal transparency rules related to natural resources (see Box 1below).

Figure 6. Natural Resource Revenues (2000-2013 and 2014-2017), Percent of GDPSource: FAD Resource Revenue Database23. The over-reliance on payroll tax

Liberia has been embarking on tax reforms since 2013. Liberia’s main domestic taxes include corporate income tax, personal income tax, goods and services tax, and excise tax. The Liberia Revenue Authority (LRA), in charge of administering revenues in Liberia. The LRA was established on July 1, 2013 replacing a revenue department of the MFDP.

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