Supporting the Policy Enabling Environment for Development

Is a Flat Tax Right for Mozambique?

There is widespread concern in the business community in Mozambique that the tax system is a serious impediment to private investment and business expansion, particularly for companies that do not benefit from special fiscal incentives. Under the standard fiscal regime, Mozambique imposesa 32 percent tax on corporate profits plus a 32 percent tax on dividend income, creating an onerous combined tax of 53.8 percent on profits that are distributed to shareholders. 1 At the same time, investors who qualify for fiscal incentives face much lower effective tax rates, varying by sector and region (Kuegler 2008). By narrowing the tax base, these preferences necessitate higher tax rates on other activities. In addition, many local businesses find the income tax code too complex (Nathan Associates 2004a).

To remedy these problems, some stakeholders have expressed a keen interest in following the lead of a growing number of countries that have adopted a flat tax in place of a traditional income tax. The basic proposition is that a simple, uniform income tax with low tax rates could generate more revenue and also stimulate more investment and faster growth.

Is the flat tax right for Mozambique?

As a step toward answering this question, this note has been prepared at the request of USAID to provide the government, the business community, donor agencies, and the public with an explanation of the flat tax concept and observations on its suitability for Mozambique.

The note explains the basic characteristics of a flat tax, emphasizing that in practice there are many variations on the theme; outlines the advantages of the flat tax in general terms; and summarizes the main counter arguments. The final section discusses implications for consideration in Mozambique.a

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