Somalia’s Tax Gap: Why Closing It Matters for the Country’s Future

Somalia’s Tax System: Challenges and Revenue Gaps

Somalia’s tax system faces a significant challenge, with a tax-to-GDP ratio of around 3%, one of the lowest globally, highlighting a substantial gap between potential and actual revenues.

• The tax gap—the difference between what should be collected under full compliance and optimal policy, and what is actually collected—was estimated at 34% in 2023.
• Actual revenue reached $329.5 million, while potential revenue exceeded $500 million.
• The largest shortfalls were found in:
  • Income tax, with a gap above 60%.
  • Sales tax, with a gap above 60%.
  • Customs duties, which remain the largest revenue source but face leakage due to administrative fragmentation and evasion.

Key Factors Behind Low Tax Collection

The main causes include:

• The collapse of state institutions after the 1990s weakened tax administration.
• Insecurity and armed groups such as Al-Shabaab have limited government reach and tax enforcement.
• The informal economy dominates many economic activities and reduces the taxable base.
• Weak fiscal arrangements between the federal government and Federal Member States (FMS) reduce coordination.
• Low public trust and limited visible public services discourage voluntary compliance.
• The absence of broad-based taxes such as VAT and excise duties limits domestic revenue growth.

Federal and Regional Revenue Challenges

The federal structure creates additional challenges in revenue collection and distribution.

• Federal Member States such as Puntland and Jubbaland collect and retain their port revenues.
• Inland states remain underfunded due to limited revenue sources.
• Regional disparities continue because of unequal revenue collection capacity.
• Informal taxation and regressive local levies create additional burdens on citizens and businesses.

Reform Strategy

The proposed Domestic Revenue Mobilization (DRM) strategy focuses on:

1. Tax policy reforms

   • Enacting a comprehensive VAT law.
   • Implementing the new Income Tax Act.
   • Introducing excise duties.
   • Reducing unnecessary tax exemptions.

2. Tax administration improvements

   • Expanding the Integrated Tax Administration System (ITAS).
   • Modernizing customs systems.
   • Introducing digital tax payment systems through mobile money.
   • Using third-party data and analytics to improve compliance.

Customs Revenue-Sharing Framework

Establishing a national customs revenue-sharing framework is critical for national equity and effective state-building.

• Ensuring fair distribution of customs revenues.
• Reducing regional fiscal disparities.
• Improving transparency and accountability.
• Strengthening cooperation between federal and regional authorities.

Building Trust and Improving Compliance

Trust-building is essential for sustainable tax reform.

• Improving public services funded through tax revenues.
• Increasing transparency in government spending.
• Demonstrating visible benefits of taxation.
• Supporting phased formalization of the informal sector.
• Investing in governance and security.

Long-Term Goal for Somalia’s Tax System

The aim is to increase Somalia’s tax-to-GDP ratio from its current 3% toward a long-term goal of 15%.

1. Reduce reliance on foreign aid.
2. Increase government capacity for service delivery.
3. Strengthen state institutions.
4. Support sustainable economic development.
5. Build a stronger social contract between citizens and the state.

Conclusion

The findings of the Institute of Public Finance – Somalia (IPFS) emphasize that fiscal reform is not merely technical but foundational to peace, development, and legitimacy in fragile states like Somalia.

Strengthening domestic revenue mobilization will help Somalia build a capable state, improve service delivery, increase accountability, and create a sustainable path toward economic independence.