## _afr1601 - Chapter 1. Growth Performance and Constraints

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### Overview and objectives
- Benin announced in 2014 a major increase in public investment equivalent to about 12.5 percent of GDP until 2019, complemented by investments that could be financed by private sources, including public-private partnerships (PPPs), of about 20 percent of GDP.
- Investment focus: energy and transportation infrastructure as main bottlenecks to growth.
- Core questions:
  - What is the growth potential of this scaling-up of investment?
  - How can the government generate the necessary fiscal space to increase investment without jeopardizing macroeconomic performance?

### Growth performance and main drivers
- Recent acceleration: per capita GDP growth gap with SSA closed in the past three years after lagging in 2005–2011.
- Main recent growth drivers: agriculture and services, reflecting strong demand in neighboring countries (in particular Nigeria) and good harvests, partly related to the recovery of cotton production since the government took over the sector in 2012.
- Exports: rising and diversified exports noted as evidence of firm-level innovation.

### Growth accounting (2000–10)
- TFP contribution to growth:
  - Benin: –0.1 percentage points.
  - Comparator countries: 0.4 to 3.4 percentage points.
- Physical capital accumulation contribution:
  - Benin: 1.7 percentage points.
  - Comparator countries: about 1.9 to 3.1 percentage points.
- Labor and education contribution: negligible differences between Benin and comparators.
- Interpretation:
  - Lower TFP growth explains about three-quarters of the growth gap; lower capital stock explains about one-quarter.

### Diagnostic framework (HRV decision tree)
- Two primary branches analyzed:
  - Cost of finance: domestic interest costs and access to international capital markets.
  - Return to economic activity: social returns (geography, human capital, infrastructure) and private returns (public sector failures, market failures).

### Cost of finance: key findings
- Domestic financial costs:
  - Lending rate and lending spreads in Benin are on par with comparator averages; lending rate declined faster than peers.
  - Credit to the private sector grew significantly from 2000 to 2012 and reached levels similar to fast-growing comparators.
  - Microfinance sector: among the largest in WAEMU, but most institutions operate without adequate supervision.
  - Financial access/inclusion remain challenges (adults with accounts indicator noted).
- International finance and public debt:
  - Average current account deficit about 7 percent in 1995–2010, close to comparator average.
  - Benin has attracted stable net foreign direct investment inflows on par with comparators (excluding resource-driven investments).
  - Public debt: remained low, about 10 percentage points below the WAEMU average.
  - Risk of debt distress: low in recent years per the joint World Bank–IMF Debt Sustainability Framework referenced.

### Returns to economic activity: key findings
- Social-return factors:
  - Geography and human capital are not binding constraints: coastal location, good soil, proximity to Nigeria, and average schooling in line with comparators.
  - Infrastructure is a binding constraint: poor road quality on major transport corridors and energy shortages cited as key constraints.
  - Estimated infrastructure financing need: US$712 million per year over 2006–15 (about 10.5 percent of GDP) for investment and operation and maintenance, mostly in water and sanitation, power, and transport.
- Private-return factors:
  - Macroeconomic indicators favorable and comparable to peers.
  - Microeconomic constraints prominent:
    - Business environment poor: Doing Business rank improved from 167th in 2014 to 158st in 2016, far below comparator average rank of 120.
    - Subindicators reveal constraints in electricity, paying taxes, and enforcing contracts.
    - Corruption perceived as a severe obstacle by nearly 85 percent of surveyed firms.
    - Informal sector size: estimated between 30 percent (INSAE 2011) and 56 percent (World Bank 2015) of total trade.
    - Employment in informal sector: estimate of about 93 percent of nonagriculture employment (Benjamin and Mbaye 2014) versus about 75 percent average in other West African countries.
  - Market failures (information and coordination externalities) affect growth but do not appear binding: firms have been reasonably innovative; regional integration efforts and participation in regional infrastructure projects exist, but infrastructure and nontariff barriers limit within-region trade.

### Synthesis: main constraints to growth
- Binding constraints identified:
  - Infrastructure, particularly power and transport, limiting the realization of Benin’s geographic and human capital advantages.
  - Weak business environment and microeconomic constraints (electricity supply, taxation administration, contract enforcement, corruption, large informal sector).
- Cost of finance and access to international finance do not appear to be primary binding constraints given comparable lending rates, credit growth, FDI inflows, and low public debt relative to WAEMU.

### Policy direction and reform progress
- Government priorities align with identified constraints: announced large public investment in power and transport to address infrastructure bottlenecks.
- Comprehensive reform plan to improve business environment includes reducing red tape, improving tax and customs administration, enhancing the judicial system, and facilitating access to financing.
- Implementation status: investment acceleration central in recent activity; reforms to enhance the business environment have advanced more slowly, though reforms facilitating business registration contributed to the improvement in Doing Business ranking.

### Macro-fiscal impact of scaling-up public investment (DSGE analysis)
- Model features:
  - DSGE with endogenous fiscal adjustments; differentiates tax rates on domestic consumption, labor, and capital; endogenizes labor supply; introduces government inefficiency in tax collection; introduces windfall revenues.
  - Stylized agents: optimizers and hand-to-mouth consumers; production with traded and nontraded sectors; public capital complements private capital.
  - Government finances: taxes on labor, capital, consumption; user fees; windfalls; spends on debt service and public investment; issues domestic, external concessional, and external commercial debt.
  - Government inefficiencies: spending inefficiency (effective government investment is a fraction of expenditure) and tax collection inefficiency (only a fraction of collected taxes enter the budget).
- Baseline calibration to Benin; baseline assumes access to concessional external resources and adjustment of all taxes to close financing gaps. Comparative scenario allows nonconcessional external borrowing. Analysis includes adverse scenario of lower custom revenues from trade liberalization with Nigeria.

### Baseline scenario (taxes and concessional borrowing only): key quantitative results
- GDP per capita growth:
  - Increases to 2.5 percent on impact.
  - Remains between 2.5 and 2 percent during most of the scaling-up period before reverting toward steady state.
- Debt-to-GDP ratio:
  - Peaks at about 37 percent and then reverts to pre-scaling-up levels.
- Tax rate adjustments:
  - Increase relatively small (about 1 percentage point) and short-lived.
  - VAT on domestic consumption increases by 0.8 percentage points.
  - Tax on capital goods increases by slightly more than 2 percentage points.
  - Tax on labor increases by slightly less than 1 percentage point.
  - After scaling-up, tax rates decrease and settle slightly above starting point to cover interest payments, then converge back.
- Factors supporting fiscal sustainability:
  1. Presence of fiscal space because of low initial stock of debt.
  2. Assumption that most scaling-up is financed by concessional resources.
  3. Adjustment of tax rates.

### Allowing external nonconcessional borrowing
- Effects:
  - Smoother and lower increases in tax rates.
  - Private consumption increases more rapidly and less crowding-out of private investment.
  - Total debt reaches about 45 percent of GDP but declines relatively quickly.
- Caveat:
  - Result relies on assumption that interest rate on newly contracted commercial debt does not respond to higher debt-to-GDP ratio; this is unlikely in distressed markets where sudden stops and reversals can occur.

### Welfare analysis and fiscal instrument preferences
- Allowing some external nonconcessional borrowing raises consumers’ welfare (steady-state consumption) by 8.9 percent compared with not allowing it.
- Preferences over tax instruments (welfare losses measured as fraction of steady-state consumption):
  - Labor tax: 0.057 (when tax only), 0.101 (when tax and public debt).
  - Consumption tax: 0.069 (when tax only), 0.117 (when tax and public debt).
  - Capital tax: implied preferred by consumers in the model (table lists no loss).
- Long-term caveat of capital-only taxation:
  - Assumes capital immobility across countries.
  - Higher taxes on capital produce lower future output and consumption, slowing decline of debt-to-GDP and increasing vulnerability to shocks.
  - Removing immobility assumption likely overturns capital-only optimality; smoothing via higher external debt remains preferable.

### Tax collection efficiency and fiscal space
- Baseline calibration of tax collection efficiency: 0.4 (1 = perfect efficiency) from stochastic frontier estimation.
- Marginal improvement from 0.4 to 0.5:
  - Yields welfare gains: slightly lower taxes, higher long-term consumption and private investment.
  - Debt-to-GDP stock lower; decline in debt-to-GDP ratio (especially commercial debt) faster due to larger tax bases.

### Risk from liberalization of Nigerian trade regime (windfall revenues)
- Estimated revenue gain from informal re-exports: 2 percent of GDP based on customs data on Benin-Nigeria trade.
  - Assumption: 80 percent of goods cleared at "adjusted value" destined for final consumption in Nigeria.
  - Average tariff on goods in international transit: 2.9 percent.
  - Revenue split estimate: approximately two-thirds VAT, one-third customs revenues.
- If Nigeria liberalizes trade or curtails informal re-exports:
  - Scaling-up becomes much more detrimental to public finances.
  - Simulation results:
    - Tax rates would have to increase substantially and remain persistently above initial steady state.
    - Output would increase by 3 percentage points less than in baseline.
    - Consumption and private investment would not increase above original steady state.
    - Total public debt would increase up to 55 percent of GDP and remain persistently above initial level, exposing Benin to debt distress risks.
  - Lower share of concessional funding or allowing interest rates to respond endogenously would worsen outcomes and could make debt-to-GDP unsustainable.

### Summary policy implications (scaling-up and fiscal sustainability)
- Scaling-up public investment can raise total investment, long-term output, and consumption but entails major fiscal risks.
- Preserving fiscal sustainability requires tighter fiscal policy achieved through:
  - Higher tax rates;
  - A mix of higher tax rates and higher external borrowing; or
  - Higher efficiency in tax collection.
- From a welfare perspective, mixing higher tax rates and higher external borrowing increases consumer welfare and smooths fiscal adjustment over time, provided fiscal policy remains responsible.
- Loss of windfall revenues (about 2 percent of GDP) from Nigerian trade liberalization could wipe out gains from scaling-up by imposing onerous fiscal adjustments.

### Benin’s revenue performance and potential
- Benin increased total tax revenue from 14.1 percent to 16.2 percent of GDP between 2000 and 2011, exceeding averages for WAEMU and sub-Saharan African low-income non-resource-rich economies.
- Benin lags the WAEMU convergence criterion of a minimum tax-to-GDP ratio of 20 percent.
- Increase is significantly affected by taxing informal re-exports to Nigeria (about 2 percent of GDP), making Benin vulnerable to Nigeria’s economic activity and trade policy changes.
- Methodology: cross-country econometric analysis using determinants including GDP per capita, consumption, gross fixed capital formation, inflation, imports and exports as share of GDP, share of agriculture in GDP, share of urban population, natural resource rents, and broad money as share of GDP. Potential revenue is predicted value from a standard fixed-effect panel regression using cross-country data for 1995–.

### Tax gap and tax administration findings (2011 analysis)
- Tax gap: percentage deviation of actual revenue from potential revenue.
- Since 2011 total tax revenue performance in Benin has been above its potential, mainly owing to overperformance of customs revenue.
- After correcting for revenue collected from the Nigerian consumption (distributed as one-third for customs revenue and two-thirds for goods and services tax revenue as an empirical estimate), total tax revenue is below its potential.
- Negative tax gap mainly driven by underperformance of domestic tax revenue.
- Scope to increase domestic tax revenue by at least 1.5 to 2 percent of GDP, depending on country sample used.
- Stochastic Frontier Analysis (SFA) confirms panel regression findings:
  - Benin performs relatively well in total tax collection driven by trade taxes.
  - Benin is less efficient in income taxes than sub-Saharan African and WAEMU countries.

### Tax policy and administration recommendations
- Tax policy reforms to broaden the base:
  - Eliminate VAT exemptions not included in the WAEMU code.
  - Prevent granting new tax exemptions for newly created enterprises.
  - Increase excise tax rates for some products (tobacco, cigarettes, luxury cars) in line with WAEMU directives.
- Tax administration reforms:
  - Secure single taxpayer identification numbers and reinforce fiscal controls of large firms to combat fraud.
  - Finalize segmentation of enterprises according to turnover.
  - Reinforce control of VAT credits.
  - Improve services to taxpayers by introducing simple, transparent, and digital options for paying and declaring taxes (Internet, credit cards, mobile devices).
- Cross-country econometric analysis suggests substantial room to improve domestic tax collection by up to 2 percent of GDP through a combination of tax policy and administration reforms.

### Creating fiscal space by improving spending efficiency
- Spending efficiency assessed via data envelopment analysis (DEA) for education and health.
- Education:
  - Public education spending increased from 3.7 to 4.7 percent of GDP between 2003–07 and 2008–12.
  - Primary enrollment rates increased from 106.0 to 124.2 (in percent).
  - Adult literacy rate increased from 38.5 to 42.4 (in percent).
  - DEA shows Benin well below the efficiency frontier in education; scope for improvement between 10 and 65 percent relative to most efficient WAEMU peers.
  - Efficiency scores and estimated savings:
    - Baseline Efficiency Score relative to WAEMU: 35 (percent); Estimated saving: 2.2 (percent of GDP).
    - Alternative Efficiency Score 1 relative to WAEMU: 42 (percent); Estimated saving: 2.0 (percent of GDP).
    - Alternative Efficiency Score 2 relative to WAEMU: 90 (percent); Estimated saving: 0.4 (percent of GDP).
- Health:
  - Public health spending remained at 2.3 percent of GDP between 2003–07 and 2008–10.
  - Life expectancy increased from 57.1 to 58.6 (in years).
  - Child survival rate increased from 879.8 to 903.4 (per 1,000).
  - DEA shows Benin closer to the efficiency frontier in health than in education; estimated scope of improvement by 30 to 42 percent relative to the most efficient WAEMU countries.
  - Efficiency scores and estimated savings:
    - Baseline Efficiency Score relative to WAEMU: 68 (percent); Estimated saving: 0.4 (percent of GDP).
    - Alternative Efficiency Score 1 relative to WAEMU: 54 (percent); Estimated saving: 0.6 (percent of GDP).
    - Alternative Efficiency Score 2 relative to WAEMU: 70 (percent); Estimated saving: 0.4 (percent of GDP).
- Methodology notes:
  - Input efficiency scores calculated based on low-income sub-Saharan African countries and converted to relative scores based on the highest WAEMU score.
  - Three input–output specifications used for robustness in both education and health.
  - Potential savings estimated as (Xi – Xmin)*(1 – Ei), where Xi is spending in percent of GDP and Ei is the relative efficiency score.

### Expenditure-side priorities and debt management
- Expenditure-side priorities:
  - Potential savings in education and health of about 1–3 percent of GDP by improving efficiency to highest WAEMU levels.
  - Implement Public Expenditure and Financial Accountability (2014) priorities: enhance budget credibility, transparency, and audit.
  - Strengthen the government’s investment expenditure chain:
    - Better monitoring to timely identify problems leading to arrears.
    - Enhance cash forecasting and management, including a treasury single account.
    - Develop multiyear project planning.
  - PPPs: regulatory framework not yet in place; priority actions warranted.
- Debt management:
  - Enhance capacity for integrated debt monitoring and management, including mechanisms to assess fiscal risks from guarantees on infrastructure projects (including PPPs).
  - Develop a medium-term debt strategy to specify objectives and a borrowing strategy to achieve an appropriate cost–risk tradeoff.

### Conclusion
- Benin’s strategy to scale up public investment addresses binding growth constraints (infrastructure and business environment), but needs complementary improvements in the business environment and fiscal management to maximize growth impact.
- Fiscal and debt sustainability risks require complementary fiscal measures:
  - Enhanced domestic revenue mobilization given limited scope for external, nonconcessional financing.
  - Enhancing spending efficiency to deliver expected results from infrastructure investment and to create fiscal space.
- Combining prudent tax policy, improved tax collection efficiency, selective use of external borrowing (with attention to cost–risk tradeoffs), and better spending efficiency is central to preserving macroeconomic stability while pursuing the announced investment scaling-up.

*Source: _afr1601 - Chapter 1. Growth Performance and Constraints*

### Chapter 1. Growth Performance and Constraints .................................................... 5

### _afr1601 - Chapter 1. Growth Performance and Constraints

### Overview and objectives
- Benin announced in 2014 a major increase in public investment equivalent to about 12.5 percent of GDP until 2019, complemented by investments that could be financed by private sources, including public-private partnerships (PPPs), of about 20 percent of GDP.
- Investment focus: energy and transportation infrastructure as main bottlenecks to growth.
- Paper’s two core questions:
  - What is the growth potential of this scaling-up of investment?
  - How can the government generate the necessary fiscal space to increase investment without jeopardizing macroeconomic performance?

### Growth performance and main drivers
- Recent acceleration: Per capita GDP growth gap with SSA closed in the past three years after lagging in 2005–2011.
- Main recent growth drivers: agriculture and services, reflecting strong demand in neighboring countries (in particular Nigeria) and good harvests, partly related to the recovery of cotton production since the government took over the sector in 2012.
- Exports: rising and diversified exports noted as evidence of firm-level innovation.

### Growth accounting findings (2000–10)
- Total factor productivity (TFP) contribution to growth:
  - Benin: –0.1 percentage points.
  - Comparator countries: 0.4 to 3.4 percentage points.
- Physical capital accumulation contribution:
  - Benin: 1.7 percentage points.
  - Comparator countries: about 1.9 to 3.1 percentage points.
- Labor and education contribution: negligible differences between Benin and comparators.
- Interpretation: Lower TFP growth explains about three-quarters of the growth gap; lower capital stock explains about one-quarter.

### Diagnostic framework (HRV decision tree)
- Two primary branches analyzed:
  - Cost of finance: domestic interest costs and access to international capital markets.
  - Return to economic activity: social returns (geography, human capital, infrastructure) and private returns (public sector failures, market failures).

### Cost of finance: key findings
- Domestic financial costs:
  - Lending rate and lending spreads in Benin are on par with comparator averages; lending rate declined faster than peers.
  - Credit to the private sector grew significantly from 2000 to 2012 and reached levels similar to fast-growing comparators.
  - Microfinance sector: among the largest in WAEMU, but most institutions operate without adequate supervision.
  - Financial access/inclusion remain challenges (adults with accounts indicator noted).
- International finance and public debt:
  - Average current account deficit about 7 percent in 1995–2010, close to comparator average.
  - Benin has attracted stable net foreign direct investment inflows on par with comparators (excluding resource-driven investments).
  - Public debt: remained low, about 10 percentage points below the WAEMU average.
  - Risk of debt distress: low in recent years per the joint World Bank–IMF Debt Sustainability Framework referenced.

### Return to economic activities: key findings
- Social-return factors:
  - Geography and human capital are not binding constraints: coastal location, good soil, proximity to Nigeria, and average schooling in line with comparators.
  - Infrastructure is a binding constraint: poor road quality on major transport corridors and energy shortages cited as key constraints.
  - Estimated infrastructure financing need: US$712 million per year over 2006–15 (about 10.5 percent of GDP) for investment and operation and maintenance, mostly in water and sanitation, power, and transport.
- Private-return factors:
  - Macroeconomic indicators favorable and comparable to peers.
  - Microeconomic constraints prominent:
    - Business environment poor: Doing Business rank improved from 167th in 2014 to 158st in 2016, far below comparator average rank of 120.
    - Subindicators reveal constraints in electricity, paying taxes, and enforcing contracts.
    - Corruption perceived as a severe obstacle by nearly 85 percent of surveyed firms.
    - Informal sector size: estimated between 30 percent (INSAE 2011) and 56 percent (World Bank 2015) of total trade.
    - Employment in informal sector: estimate of about 93 percent of nonagriculture employment (Benjamin and Mbaye 2014) versus about 75 percent average in other West African countries.
  - Market failures (information and coordination externalities) affect growth but do not appear binding: firms have been reasonably innovative; regional integration efforts and participation in regional infrastructure projects exist, but infrastructure and nontariff barriers limit within-region trade.

### Synthesis: main constraints to growth
- Binding constraints identified:
  - Infrastructure, particularly power and transport, limiting the realization of Benin’s geographic and human capital advantages.
  - Weak business environment and microeconomic constraints (electricity supply, taxation administration, contract enforcement, corruption, large informal sector).
- Cost of finance and access to international finance do not appear to be primary binding constraints given comparable lending rates, credit growth, FDI inflows, and low public debt relative to WAEMU.

### Policy direction and reform progress
- Government priorities align with identified constraints: announced large public investment in power and transport to address infrastructure bottlenecks.
- Comprehensive reform plan to improve business environment includes reducing red tape, improving tax and customs administration, enhancing the judicial system, and facilitating access to financing.
- Implementation status: investment acceleration central in recent activity; reforms to enhance the business environment have advanced more slowly, though reforms facilitating business registration contributed to the improvement in Doing Business ranking.

*Source: _afr1601 - Chapter 1. Growth Performance and Constraints*

### 2016. After long delays, the opening of a functioning credit bureau is now expected to move

### _afr1601 - 2016. After long delays, the opening of a functioning credit bureau is now expected to move

### Macro-fiscal impact of scaling-up public investment
- Ambitious scaling-up can remove growth bottlenecks and may have high rates of return due to capital scarcity and complementarity with private investment.
- Risks to fiscal sustainability include:
  - Inefficient public spending where only a fraction of investment is productive.
  - Hurdles in implementing fiscal adjustment (lack of political support for higher tax rates or difficulty broadening the tax base).
  - Unexpected large shocks affecting growth and/or revenues.

### Analytical framework and model features
- DSGE model with endogenous fiscal adjustments, based on Ghilardi and Sola (2015) and medium-scale open-economy structure à la Buffie and others (2012), extended to:
  - Differentiate tax rates on domestic consumption, labor, and capital;
  - Endogenize labor supply;
  - Introduce government inefficiency in tax collection (calibrated using estimation);
  - Introduce windfall revenues.
- Stylized economy agents:
  - Households: optimizers (access to financial markets, own capital) and hand-to-mouth consumers (consume all income within the period), generating non-Ricardian effects typical of low-income countries like Benin.
  - Production: two sectors producing traded and nontraded goods; Cobb-Douglas production using labor, private capital, and public productive capital; public capital complements private capital.
  - Government: collects taxes on labor, capital, and consumption, levies user fees, receives windfalls; spends on debt service and public investment; issues domestic, external concessional, and external commercial debt.
  - Government inefficiencies:
    - Spending inefficiency: effective government investment is a fraction of government investment expenditure.
    - Tax collection inefficiency: only a fraction of collected taxes enter the budget.

### Baseline calibration and scenarios
- Model calibrated to Benin.
- Baseline: government can borrow concessional external resources (exogenous) and adjusts all taxes (consumption, labor, capital) to close financing gaps.
- Comparative scenario: government can also borrow externally on nonconcessional terms to smooth fiscal adjustment.
- Analysis also considers lower custom revenues from trade liberalization with Nigeria affecting informal reexports.

### Baseline scenario results (taxes and concessional borrowing only)
- GDP per capita growth:
  - Increases to 2.5 percent on impact;
  - Remains between 2.5 and 2 percent during most of the scaling-up period before reverting toward steady state.
- Debt-to-GDP ratio:
  - Peaks at about 37 percent and then reverts to pre-scaling-up levels.
- Factors supporting fiscal sustainability:
  1. Presence of fiscal space because of low initial stock of debt.
  2. Assumption that most scaling-up is financed by concessional resources.
  3. Adjustment of tax rates.
- Tax rate adjustments:
  - Increase relatively small (about 1 percentage point) and short-lived.
  - VAT on domestic consumption increases by 0.8 percentage points.
  - Tax on capital goods increases by slightly more than 2 percentage points.
  - Tax on labor increases by slightly less than 1 percentage point.
  - After scaling-up, tax rates decrease and settle slightly above starting point to cover interest payments, then converge back.

### Allowing external nonconcessional borrowing
- Effects:
  - Smoother and lower increases in tax rates.
  - Private consumption increases more rapidly and less crowding-out of private investment.
  - Total debt reaches about 45 percent of GDP but declines relatively quickly.
- Caveat: result relies on the assumption that interest rate on newly contracted commercial debt does not respond to higher debt-to-GDP ratio; this is unlikely in distressed markets where sudden stops and reversals can occur.

### Welfare analysis and fiscal stabilization packages
- Allowing some external nonconcessional borrowing raises consumers’ welfare (steady-state consumption) by 8.9 percent compared with not allowing it—because smoothing tax adjustments raises private consumption.
- Preferences over tax instruments (welfare losses measured as fraction of steady-state consumption):
  - Levies only on capital preferred by consumers in the model.
  - Losses from imposing fiscal adjustment by levying:
    - Labor tax: 0.057 (when tax only), 0.101 (when tax and public debt).
    - Consumption tax: 0.069 (when tax only), 0.117 (when tax and public debt).
    - Capital tax: "-" (implied preferred; table lists no loss).
- Long-term caveat of capital-only taxation:
  - Assumes capital immobility across countries.
  - Higher taxes on capital produce lower future output and consumption, slowing decline of debt-to-GDP and increasing vulnerability to shocks.
  - Removing immobility assumption likely overturns capital-only optimality; smoothing via higher external debt remains preferable.

### Tax collection efficiency and fiscal space
- Baseline calibration of tax collection efficiency: 0.4 (1 = perfect efficiency) from stochastic frontier estimation.
- Marginal improvement from 0.4 to 0.5:
  - Yields welfare gains: slightly lower taxes, higher long-term consumption and private investment.
  - Debt-to-GDP stock lower; decline in debt-to-GDP ratio (especially commercial debt) faster due to larger tax bases.

### Risk from liberalization of Nigerian trade regime (windfall revenues)
- Benin benefits from taxing informal re-exports to Nigeria owing to transit trade of goods banned in Nigeria (rice, vegetable oil, used cars).
- Estimated revenue gain from informal re-exports: 2 percent of GDP based on customs data on Benin-Nigeria trade.
  - Estimate assumption: 80 percent of goods cleared at "adjusted value" destined for final consumption in Nigeria.
  - Average tariff on goods in international transit: 2.9 percent.
  - Revenue split estimate: approximately two-thirds VAT, one-third customs revenues.
- If Nigeria liberalizes trade or otherwise curtails informal re-exports:
  - Scaling-up becomes much more detrimental to public finances.
  - Simulation results:
    - Tax rates would have to increase substantially and remain persistently above initial steady state, causing long-term adverse effects on real variables.
    - Output would increase by 3 percentage points less than in baseline.
    - Consumption and private investment would not increase above original steady state.
    - Total public debt would increase up to 55 percent of GDP and remain persistently above initial level, exposing Benin to debt distress risks.
  - Lower share of concessional funding or allowing interest rates to respond endogenously would worsen outcomes and could make debt-to-GDP unsustainable.

### Summary policy implications
- Scaling-up public investment can raise total investment, long-term output, and consumption but entails major fiscal risks.
- Preserving fiscal sustainability requires tighter fiscal policy achieved through:
  - Higher tax rates;
  - A mix of higher tax rates and higher external borrowing; or
  - Higher efficiency in tax collection.
- From a welfare perspective, as long as fiscal policy remains responsible, mixing higher tax rates and higher external borrowing increases consumer welfare and smooths fiscal adjustment over time.
- Loss of windfall revenues (about 2 percent of GDP) from Nigerian trade liberalization could wipe out gains from scaling-up by imposing onerous fiscal adjustments.

### Creating fiscal space: Benin’s revenue performance and potential
- Benin increased total tax revenue from 14.1 percent to 16.2 percent of GDP between 2000 and 2011, exceeding averages for WAEMU and sub-Saharan African low-income non-resource-rich economies.
- Despite improvements, Benin lags the WAEMU convergence criterion of a minimum tax-to-GDP ratio of 20 percent.
- The increase is significantly affected by taxing informal re-exports to Nigeria (about 2 percent of GDP), making Benin vulnerable to Nigeria’s economic activity and trade policy changes.

### Methodology to estimate potential tax revenue
- Cross-country econometric analysis to estimate tax potential (projected tax revenue given macro fundamentals).
- Included determinants: GDP per capita, consumption, gross fixed capital formation, inflation, imports and exports as share of GDP, share of agriculture in GDP, share of urban population, natural resource rents, and broad money as share of GDP.
- Potential revenue obtained as predicted value from a standard fixed-effect panel regression using cross-country data for 1995–.

*International Monetary Fund*

### 2011. Stochastic frontier regressions were prepared to confirm the results. The tax gap is

### _afr1601 - 2011. Stochastic frontier regressions were prepared to confirm the results. The tax gap is

### Tax gap and revenue findings
- The tax gap is calculated as the percentage deviation of actual revenue from potential revenue.
- WAEMU and sub-Saharan African low-income non-resource-rich countries are used as reference groups.
- Analyses include total tax revenue and subcategories: goods and services, trade, and income.
- Key empirical findings:
  - Since 2011 total tax revenue performance in Benin has been above its potential, mainly owing to overperformance of customs revenue.
  - After correcting for revenue collected from the Nigerian consumption (distributed as one-third for customs revenue and two-thirds for goods and services tax revenue as an empirical estimate), total tax revenue is below its potential.
  - The negative tax gap is mainly driven by the underperformance of domestic tax revenue.
  - Depending on the sample of countries used, Benin has scope to increase domestic tax revenue by at least 1.5 to 2 percent of GDP.
- Figures referenced:
  - Figure 3.1: Benin’s Total Tax Revenue Collection Compared with WAEMU and Sub-Saharan Africa (Total tax revenue and Customs revenue in percent of GDP; time series 2000–2011).
  - Figure 3.2: Benin’s Tax Gap Indicators (Total Revenue, Customs Revenue, Income Tax Revenue, Goods and Services Tax Revenue: Actual vs. Potential; time series 2000–2011).

### Stochastic Frontier Analysis (SFA) and robustness
- SFA applied following Pessino and Fenochietto (2010) with a time-varying parameter of technical inefficiency.
- SFA confirms panel regression findings:
  - Benin performs relatively well in total tax collection, but this is mostly driven by trade taxes.
  - Benin is less efficient in income taxes than sub-Saharan African and WAEMU countries.
- Annex 1 presents the SFA model:
  - y_it = α_i + β X_it + ε_it
  - ε_it = v_it − u_it
  - v_it = N~(0, σ^2)
  - u_it ~ F^+(δ, σ_u^2)
  - Efficiency is calculated as 1 − u (higher u implies higher inefficiency).
- Annex Figure 1 shows time series tax efficiency indicators (Tax efficiency by category for SSA, WAEMU, Benin; 2000–2011).

### Tax policy and administration recommendations
- Tax policy reforms to broaden the base:
  - Eliminate VAT exemptions not included in the WAEMU code.
  - Prevent granting new tax exemptions for newly created enterprises.
  - Increase excise tax rates for some products (tobacco, cigarettes, luxury cars) in line with WAEMU directives.
- Tax administration reforms could focus on:
  - (1) Combating fraud by securing the single taxpayer identification numbers and reinforcing fiscal controls of large firms.
  - (2) Finalizing the segmentation of enterprises according to turnover.
  - (3) Reinforcing the control of VAT credits.
  - (4) Improving services to taxpayers by introducing simple, transparent, and digital options for paying and declaring taxes, such as by Internet, credit cards, and mobile devices.
- Cross-country econometric analysis suggests substantial room to improve domestic tax collection by up to 2 percent of GDP through a combination of tax policy and administration reforms.

### Creating fiscal space by improving spending efficiency
- Spending efficiency in education and health is analyzed via nonparametric data envelopment analysis (DEA).
- DEA compares Benin with WAEMU and low-income African peers to assess technical efficiency of translating public spending into results.
- Education findings:
  - Public education spending increased from 3.7 to 4.7 percent of GDP between 2003–07 and 2008–12.
  - Primary enrollment rates increased from 106.0 to 124.2 (in percent).
  - Adult literacy rate increased from 38.5 to 42.4 (in percent).
  - WAEMU excl. Benin: education spending 4.0 to 4.3 percent of GDP; primary enrollment 74.9 to 88.9; adult literacy 35.4 to 46.0.
  - DEA shows Benin well below the efficiency frontier in education; scope for improvement between 10 and 65 percent relative to most efficient WAEMU peers.
- Health findings:
  - Public health spending remained at 2.3 percent of GDP between 2003–07 and 2008–10.
  - Life expectancy increased from 57.1 to 58.6 (in years).
  - Child survival rate (transformed from under-5 mortality) increased from 879.8 to 903.4 (per 1,000).
  - WAEMU excl. Benin: health spending 2.3 to 2.8 percent of GDP; life expectancy 53.2 to 55.1; child survival 856.4 to 85.5.
  - DEA shows Benin closer to the efficiency frontier in health than in education; estimated scope of improvement by 30 to 42 percent relative to the most efficient WAEMU countries.

### Efficiency scores and estimated savings (Table 3.3)
- Education:
  - Baseline Efficiency Score relative to WAEMU: 35 (percent)
  - Alternative Efficiency Score 1 relative to WAEMU: 42 (percent)
  - Alternative Efficiency Score 2 relative to WAEMU: 90 (percent)
  - Estimated saving (percent of GDP): 2.2 (baseline); 2.0 (alternative 1); 0.4 (alternative 2)
- Health:
  - Baseline Efficiency Score relative to WAEMU: 68 (percent)
  - Alternative Efficiency Score 1 relative to WAEMU: 54 (percent)
  - Alternative Efficiency Score 2 relative to WAEMU: 70 (percent)
  - Estimated saving (percent of GDP): 0.4 (baseline); 0.6 (alternative 1); 0.4 (alternative 2)
- Methodological notes:
  - Input efficiency scores calculated based on low-income sub-Saharan African countries and converted to relative scores based on the highest WAEMU score.
  - Three input–output specifications used for robustness in both education and health.
  - Potential savings estimated as (Xi – Xmin)*(1 – Ei), where Xi is spending in percent of GDP and Ei is the relative efficiency score.

### Conclusion and policy discussions
- Benin’s strategy to scale up public investment addresses binding growth constraints (infrastructure and business environment), but needs complementary improvements in the business environment to maximize growth impact.
- Fiscal and debt sustainability risks require complementary fiscal measures:
  - Enhanced domestic revenue mobilization is important given limited scope for external, nonconcessional financing.
  - Enhancing spending efficiency is critical to deliver expected results from infrastructure investment and to create fiscal space.
- Expenditure-side priorities:
  - Potential savings in education and health of about 1–3 percent of GDP by improving efficiency to highest WAEMU levels.
  - Implement Public Expenditure and Financial Accountability (2014) priorities: enhance budget credibility, transparency, and audit.
  - Strengthen the government’s investment expenditure chain: (1) better monitoring to timely identify problems leading to arrears; (2) enhance cash forecasting and management, including a treasury single account; (3) develop multiyear project planning.
  - PPPs: regulatory framework not yet in place; priority actions warranted.
- Debt management:
  - Enhance capacity for integrated debt monitoring and management, including mechanisms to assess fiscal risks from guarantees on infrastructure projects (including PPPs).
  - Develop a medium-term debt strategy to specify objectives and a borrowing strategy to achieve an appropriate cost–risk tradeoff.

*Source: INTERNATIONAL MONETARY FUND.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/dp/2016/_afr1601.pdf_