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CABO VERDE: PUBLIC FINANCE REVIEW - ENHANCING FISCAL SUSTAINABILITY IN THE FACE OF SHOCKS

Core Content Overview

This report provides an in-depth analysis of Cabo Verde's fiscal landscape, focusing on three key areas: fiscal sustainability, revenue mobilization, and state-owned enterprise (SOE) reform. It outlines challenges and opportunities to enhance fiscal resilience and support sustainable economic growth.

Main Fiscal Challenges

• High Public Debt: Public debt remains elevated, with debt servicing absorbing over a third of revenues. Although external debt distress risk has improved, debt sustainability depends on maintaining growth above the cost of borrowing, which is increasingly difficult due to reduced concessional financing and vulnerability to exogenous shocks.

• Budget Rigidity: Over 70% of the budget is considered rigid, particularly interest payments and the wage bill, which severely limits fiscal maneuverability and reduces the capacity for expenditure rebalancing.

• Low Domestic Revenue Mobilization: Domestic revenue mobilization has consistently fallen short of spending needs. Tax effort is below peer averages, and significant fiscal gains could be achieved through tax reforms and better revenue collection.

• Fiscal Risks from SOEs: SOEs continue to be a source of fiscal pressure and risk, with ongoing liabilities and inefficiencies that add to public financial strain.

Key Fiscal Opportunities

1. Improving Domestic Revenue Mobilization

• Tax Potential: Cabo Verde's tax potential is estimated at 30% of GDP, indicating a significant tax gap of about 11 percentage points.

• Tax Reforms:

  • VAT Exemptions: Large shares of tax revenues are lost due to VAT exemptions, especially for essential goods. Reducing these could generate fiscal gains of 1–1.5% of GDP.
  • Corporate Income Tax (CIT): CIT productivity is well below average, and reducing investment incentives could improve revenue collection.
  • Personal Income Tax (PIT): PIT collections have declined since 2017, despite a brief recovery in 2020. Reforms to increase tax productivity and reduce regressive tax structures are needed.
  • Excise Taxes: Tobacco and alcohol excise taxes are relatively low compared to peers, especially for wine and spirits. Increasing these could yield modest gains of 0.15% of GDP and improve public health outcomes.

• Environmental Taxes: Aligning fuel taxes with carbon content could generate significant revenue and support renewable energy investments. A carbon tax equivalent to CVE 10,500 per liter could yield near 1% of GDP by 2035.

• Tax Administration: Strengthening tax administration through measures such as the OECD/G20 BEPS Pillar 2 analysis, implementing a domestic top-up tax, and enhancing transfer pricing auditing will help close the tax gap and improve revenue collection.

Enhancing Expenditure Efficiency

• Public Spending Trends:

  • Public expenditure remains below both structural and aspirational peers, at around 28% of GDP.
  • Spending is heavily skewed towards current expenditures, particularly the wage bill, goods and services, and social benefits, while capital spending has declined significantly, negatively affecting growth.

• Procyclicality: Expenditure is highly procyclical, limiting its effectiveness as a stabilization tool.

• Efficiency Gains:

  • Infrastructure: There is potential to improve the efficiency of public investment in infrastructure, particularly in ports, roads, and transport.
  • Education: Public spending efficiency in education trails some peers, but eliminating inefficiencies could improve outcomes in secondary education.
  • Health: Public health spending is efficient compared to peers, and improving service costing could lead to gains in life expectancy.
  • Gender Equality: Public spending on gender equality has increased by 30% since 2018, but more needs to be done to ensure equitable access to services.

• Fiscal Gains from Expenditure Reforms: Potential fiscal gains from expenditure reforms are estimated at 3.65–4.15% of GDP (see Table E.1).

SOE Reform Agenda

• SOE Landscape: SOEs are a significant fiscal burden, with liabilities averaging 1% of GDP over the last five years. They also contribute to market distortions and inefficiencies.

• Key SOE Issues:

  • Wage Bill: The SOE wage bill has fallen, but operational efficiency remains a concern.
  • Fiscal Costs: SOEs account for a large share of public spending, and their fiscal costs are substantial relative to the budget.
  • Operational Efficiency: There is a need to improve the efficiency of SOEs, particularly in the electricity and water services, maritime travel, and other key sectors.

• Policy Recommendations:

  • Streamline SOE operations and reduce their fiscal footprint.
  • Improve corporate governance and accountability mechanisms.
  • Enhance transparency in SOE transactions with the government.
  • Address the fiscal costs of SOEs through structural reforms and improved performance.

Policy Recommendations Summary

Conclusion

Cabo Verde has made progress in fiscal consolidation, but structural challenges persist. To achieve long-term fiscal sustainability and growth, the government must implement reforms to improve tax administration, reduce revenue leakages, enhance expenditure efficiency, and reform the SOE sector. These measures, if effectively implemented, could generate additional fiscal space of up to 4.15% of GDP, supporting critical investments and reducing vulnerabilities.