Tax Revenues and Political Parties Financing

At a recent forum held at the Institute of Economic Affairs (IEA, Ghana), it was proposed that every year two percent of revenue from the value added tax (VAT) be set aside in a ‘special fund’ to support the activities of political parties (Myjoyonline.com News, September 13, 2007). The argument goes something like this: Politics is for the public purpose. It takes money to organize political activities. Therefore politicians need committed state funding if democracy is to thrive.

I wish to point out that although there is a case for state support of political activities, the proposal on the table needs careful scrutiny before it evolves seriously into a legislative instrument. There are a number of concerns. It presumes too much first about the needs of political actors, and second, about the links between the scale of political activities and good governance. It provides perverse incentives for political entrepreneurship. It limits fiscal flexibility in the use of tax resources. It makes politicians vulnerable to the charge that their behaviour is unshaped and uninformed by the needs of the governed. There ought to be a fairer and efficient way to achieve the same ends.

1. The Case for Public Funding Before I turn to my arguments, let me make a case for some form of funding for political activities. Public funding of political activities recognizes that political activity is essential for a democracy to thrive. And for a young democracy badly in need of building society’s institutions, a vibrant and a level playing field for politics is essential. This is especially so if we are to curb the emergence of governments controlled by a small group of rich people. Competitiveness in the political marketplace is desirable. It provides the electorates choices among politicians. Their choices, however, must be informed.

It is reasonable to expect that political parties make choices. They define the scale of their activities. And do so in ways that are best for the party, and hopefully, in ways that will best communicate their vision to the electorates. How much resources a party spends on political activities depends on the party’s perception of the ‘rewards’ for winning. If a party’s vision of social and economic choices is in the best of interest of the majority, the party earns the privilege to run the affairs of the state. The goal of public support is to guarantee a minimum level playing field for all duly recognized parties and provide equitable access to the electorate.

But should public support be partial or full cost? Let us bear in mind that first, politicians, not the state, define the scope and scale of their campaigning activities. Second, political activity is not predominantly a public good. There is a public goodness about politics. But, like plumbing, there are also private gains. In fact, political parties are merely associations that wish to take turns at ruling and running the affairs of the state. It is in error to suppose that any group which professes to such ends necessarily must be publicly funded in part or in whole. Clearly, there are many other associations that could lay similar claims because they too aim at some good or at some public purpose.

It is only fair to expect that those who aspire to be political actors see a part of this process as a necessary private investment. On their own, they must develop and communicate their vision. Those who share this vision will be expected to endorse it through electoral votes before parties become eligible for public support.

2. The Objections The IEA meeting was essentially an opportunity for politicians to make their case for public support. As different as their preferences may be, they were on common ground in setting aside 2 percent VAT revenue every year for this purpose. For example, an annual 15 percent rise in VAT revenues means an automatic 15 percent rise in political funding. The proposal amounts to what is essentially a cartel of politicians setting a built-in annual total tax price for political activities based on their perception of the public’s ability to pay. Proponents of the two percent rule may not have thought about it this way. But it certainly feels that way. And that way surely violates the principle of fair pricing.

Let us keep in mind that political actors are not only potential lawmakers. In office, they must also allocate resources for the public good, and, more crucially, can vary the allocation of tax burden among citizens. It is in this light that the allocation into a ‘special fund’ of a fixed percent of VAT to finance the vocation of choice of a very small segment of the population must be seen as unethical. Politicians must not be seen as laying a prior claim to a vital resource, tax revenues, before the ordinary citizen. That is worrying.

The proposal creates wrong incentives for the proliferation of political parties and political entrepreneurship as an end in itself. Earmarking will not necessarily bring out the best of civic minded men and women to serve the state. In fact, having a protected ‘special fund’ is more likely to attract those inclined to political opportunism than those inclined to seek the public good selflessly.

Let us assume for the sake of illustration that the two percent VAT rule was put in place in the year 2000. How much would have been allocated to the ‘special fund’ from the budget? In equivalent GH¢ terms, the ‘special fund’ would have grown from GH¢0.77 million in 2000 to GH¢2.8 million in 2004, and to GH¢4.72 million in 2006. Between 2000 and 2006, the average annual growth of the ‘special fund’ of 36.2 percent would have been greater than the average nominal growth in national output of 28 percent for the same period. No public interest argument can adequately justify such arithmetic.

Earmarking also limits fiscal flexibility because those funds cannot be used for whatever purpose the government might deem necessary. Since the mid 1980s, portions of government revenues have been earmarked or assigned specific purposes. The District Assembly Common Fund assigned a 7.5% of government revenues to support decentralized local government financing. The Road Fund, the Ghana Education Trust Fund (GETFUND) and the National Health Insurance Levy (NHIL) are all assigned revenues from total revenues or from the value added tax. Some earmarking is justifiable on socio-economic grounds. Some are not. If increased flexibility, transparency, and accountability of public spending are desirable, then we should aim for less not more earmarking of public funds. There are many who would argue that Ghana’s public finances are already “over earmarked”.

Another vice here is that the link between annual VAT revenues and political party spending does not necessarily reflect taxpayers’ preferences for the kind of public services or wants that should grow with increased revenues. The IEA proposal assumes that increased political activity is what the public necessarily wants.

Moreover, on efficiency grounds, there is no clear connection between the benefits of increased political activities and the growth of VAT revenues. To tie political party funding so closely to the year-to-year growth in revenues presumes some identifiable linkages. Surely, politicians may have passed tougher tax laws, but they would have done no more in revenue mobilization than the tax officers who implement the law.

Why do some policy-makers prefer earmarking of revenues? Earmarking reduces taxpayer’s resistance to higher taxes. In this case, the two percent VAT rule is beneficial because it guarantees political parties automatic increase in funding in ways that are not related to their productivity or to their contribution to good governance. But, it also places political actors in a zone where the electorate can no longer place enormous trust in thier ability to imagine the deprivation of the many.

3. The Alternatives If some public support for political activities is needed in order to make democracy a reality, then all we need is find a formula that is fair, equitable, and tax neutral. The formula must encourage the democratic process. It must also guard against the persistence of political power. Here are two alternatives.

One-Step Allocation Rule A very simple allocation rule is to set a tax price per eligible vote. The amount of support a party receives from the public purse is simply the tax price per vote multiplied by the number of votes earned in the general election. In between elections, this fixed amount will be paid and charged annually to the budget.

How do we set the tax price? Here I use the same two percent VAT allocation rule but for entirely different fiscal and behavioral outcomes. Suppose society decides that the maximum charge on public funds to support political activities is two percent of total VAT collection in the election year. Then, for example, a simple arithmetic in post 2004 would have been to divide GH¢2.8 million (2 percent of VAT in 2004) by the total number of eligible voters, (10.354 million) as determined by the Electoral Commissioner. The result is a tax price per vote of GH¢0.27. Under this rule, the total GH¢2.8 million will be charged to the budget only when there is 100 percent voter turnout. If voter turnout in 2004 is 65 percent, then there is an annual charge of GH¢1.82 million to the budget. The tax price per eligible vote is revised once after every general election, in this case in 2009, using the 2008 VAT and the eligible voters as of December 2008.

2-Tier Allocation Rule The one-step allocation rule suffers a potential minor disadvantage. That is, it may create this long-term strategic effect where once a party is ahead, it receives more funds, which also increases its chance of being ahead in the next election.

The alternative rule works as follows. Again, take, say, the two percent VAT collection in an election year as the maximum charge to the budget for political funding. Using the numbers from 2004, first set aside, say, 30 percent of the total GH¢2.8 million. This gives a base amount of funding of GH¢0.84 million to be shared equally among parties winning at least, say, 5 percent of the popular vote cast.

The second part of the funding is to divide the balance of GH¢1.96 million (2.8-0.84) again by the number of registered eligible votes of 10.354 million to get a new tax price of GH¢0.189 per vote. The annual amount of support a party receives from the public purse is now a share of the base amount plus the tax price per vote multiplied by the number of votes earned in the general election.

The three key public choices are (a) what percent of VAT or tax revenue to use to determine the maximum charge to the budget, (b) what percent of the total to set aside as the base funding, and (c) what is the minimum threshold of votes to be eligible for the base funding. The one-step allocation rule only requires an answer to the first question.

4. The Benefits Unlike the de-facto annual two percent earmarking rule which de-links rewards from efforts or productivity, the above allocation rules have surprising benefits. They are simple, transparent, and tax neutral. They are untied to any specific year-to-year revenue path, except the election year VAT. The actual payouts are tied strongly to a party’s contributions to the democratic process. The maximum charge occurs only when voter turnout in general elections is 100 percent.

The first allocation rule determines in one step both the total annual charge to the budget (for the next four years) and the allocation to each party. The two-tier rule requires multiple steps and more decision variables. They both reward the efforts of politicians. By this rule, first time independent candidates or parties must first receive citizens’ validation by contesting and winning votes in a general election as a condition for eligibility for public support.

Voter turnout determines not only the election outcome but also validates the allocation of public funds to the parties. There is incentive for politicians to encourage large voter turnout on Election Day because, win or loose, every vote amounts to four times the tax price per election cycle. The allocation rules are fair, equitable, efficient, and reward efforts in strengthening democracy.