The VLTP 1. Purpose of Discussion Paper 1. Current wood flows and the future harvest level under VLTP 2

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1 VLTP Discussion Paper # 4 Review of the current taxation system relevant to the forest sector in Ghana Content The VLTP 1 Purpose of Discussion Paper 1 Current wood flows and the future harvest level under VLTP 2 Institutional roles, costs and direction of institutional reforms 2 Current fiscal regime and fiscal reforms 4 The VLTP / TVA and its financing 6 The VLTP To revert the trend of inadequate forest control operations and loss of revenue, the FC is implementing a "Validation of Legal Timber Programme (VLTP) since early This involves physical inventories of trees and the labelling and tracking of logs and lumber from forests through to the mill gate and onwards to the domestic market, harbour and/or overland border crossings. Combined with an improved system of certification the VLTP will enhance the FC s capacity to control illegal activity. The VLTP also involves establishment of an independent Timber Validation Agency (TVA). The FC has contracted SGS Ltd. as a technical partner to assist to define the modalities of the VLTP and to establish the TVA. Purpose of Discussion Paper During the first half of 2006 VLTP has undertaken a study of the forest fiscal regime. The study analyses the current fiscal regime, assess current wood production, value chains, industry revenues and costs as well as the roles and costs of regulation and management by state institutions. It provides recommendations on the direction of fiscal and institutional reforms, including the financing of the TVA. This Discussion Paper presents the main results and recommendations of the study with the purpose of facilitating informed discussions among the Ministry, FC, the industry, land owners and civil society. 1

2 Current wood flows and the future harvest level under VLTP The actual timber harvest in 2005 is estimated to be 3.3 million m 3 of roundwood, which is more than three times the officially recorded harvest of 935,000 m 3. Accordingly, 70% of the harvest is illegal because it is not recorded. The formal sector used about 1.6 million m 3, and the informal sector (chainsaw operators and cottage dimension mills) approximately 1.7 million m 3. The total log harvest supported an export of 464,000 m 3 final products and a domestic production (formal and informal sector) of 569,000 m 3 final products. There was a flow of intermediate materials to be used in final wood products of 472,000 m 3 in Imports, primarily sawn wood, amounted to 292,000 m 3. The total wood flow (roundwood, intermediate materials and final products) in 2005 was thus approximately 5 million m 3. A continued annual harvest of 3.3 million m 3, where a limited number of high and medium demand species make up the majority, would lead to commercial extinction of many valuable species over the next decade, both off- and on-reserves. The significant drop in the recorded off-reserve harvest over the past 3-4 years is a clear indication that the resource is indeed being eroded at a fast pace, and commercial extinction is approaching. Projections carried out as part of this study suggest that the annual harvest level under VLTP would be 600, ,000 m 3 of roundwood, which is 11-35% below the officially recorded 2005 harvest and approx. 50% below the formal sector s estimated actual 2005 harvest. More than 50% of the harvest would be in the low demand species group, which accounted for only 20% of the recorded 2005 harvest. This gloomy resource availability scenario has important implications on future revenue, and the options for regulation of the sector, and stresses the urgent need for institutional and fiscal reforms. Institutional roles, costs and direction of institutional reforms FC has essentially retained a traditional forestry control system. Although the Forest Services Division (FSD) and the Timber Industry Development Division (TIDD) have downsized by 45% and 75%, respectively over the past decade, there has been relatively less shedding of functions. FSD has maintained its multiple roles of regulating, managing and monitoring the forest resource, as well as collecting and distributing revenue, while TIDD operates a partially relaxed regulatory framework in trade, commerce, industry development and overseas market intelligence service. There are inherent conflicts in FSD acting both as regulator and manager of the forest resources. FSD has a 1:20 ratio between professional and technical staff, and is unable to provide appropriate technical inputs into field-level activities. The private sector, particularly the medium and large sized companies with higher levels of management and technical skills, appears to be up to three times more cost-efficient than FSD in their undertaking of certain forest management activities (compartment demarcation, enumeration and stock mapping). Hence, the study recommends a shared responsibility with the private sector in forest regulation and management. Within forest reserves, FSD s functions could in the future concentrate on (a) verifying and vetting strategic management plans (at the level of the forest management unit/forest reserve), (b) validation of operators stock surveys, (c) validation of yield allocation, (d) approval of 2

3 operators logging plans, (e) issuing log measurement and conveyance certificates, and (f) post-harvest and compartment closure inspection. Functions where the private sector could assume responsibility comprise (a) writing of strategic management plans, (b) development of operational plans at TUC and compartment level, (c) conducting stock surveys and producing digital stock maps, (d) yield allocation and (e) forest protection activities. Concerning the regulation of off-reserve timber resources, the study recommends devolution of responsibility to local governments and local communities (stools). They could assume responsibility for pre-felling inspection and collection of revenue, while the responsibility of enumeration and felling could be left with the operator. FSDs offreserve focus would be on endorsement of local government recommended yield and operators harvesting plans, log measurement and conveyance certification in order to validate the source of logs. To a large extent, TIDD operates on the assumption that things are not right. Through 14 core functions, including commerce, marketing, grading and inspection, market intelligence, training and registration of processors, traders and exporters, and buyers, TIDD holds a high degree of monopoly in service delivery to the industry. VLTP and proposed fiscal reforms would make the current TIDD engagement in contracting and pricing void, and point towards a revised role in grading and inspection. TIDD s future roles are thus expected to be (a) control of grading, (b) port inspection, (c) domestic market regulation, (d) market intelligence, (e) international trade promotion and (f) facilitating industry development. The roles of TIDD, in the long term, should be gradually adjusted in accordance with the strengthened capacity of the private sector and trade associations to take over responsibility and fulfil devolved functions. The study estimates that the FC (FSD and RMSC) spent approx. 46 billion (US$ 5.1 million) on commercial timber regulation and management in 2005, of which 85% is spent in forest reserves. On average, the cost of regulating and managing the timber harvest in forest reserves is US$ 7.5 m -3 while the corresponding off-reserve cost is US$ 2.0 m -3. The weighted average cost is approximately US$ 6 m -3. Since the average stumpage collection in 2005 was US$ 9.3 m -3 FC required 65% of total stumpage fees to finance its current forest regulatory and management functions. TIDD spent 23 billion (US$ 2.6 million) in 2005 and secured revenue of 65 billion (US$ 7.2 million). Accordingly, the total cost of institutional regulation of timber amounted to US$ 7.7 million, which is 49% of the US$ 15.7 million collected in timber-related revenues. Sharing of responsibilities and shedding of functions, as suggested by the study, may reduce future costs of on-reserve forest management and regulation to US$ m -3 and US$ m -3 off reserve, depending on the harvest level (cf. above). In the short to medium term, TIDD s budget is estimated to be US$ 1.6 million, or 65% of its 2005 expenditure. This budget expectation foresees TIDD s increased engagement in regulation of the domestic market, and industry service delivery carried out under cost recovery principles. The budget projection also foresees elements of natural wastage, re-training and internal redeployment as well as new recruitment. No significant change in numbers of staff is expected over this time perspective. If the study s recommendations are implemented, the forest industry will save approximately US$15 m -3 in transaction costs and informal payments. Further, the suggested devolution of functions would create a redundancy of about 1,400 personnel, 3

4 among technical and vocational grade staff, but to some extent it would be compensated by new job opportunities in the private sector, and an increase in FC professional staff. Current fiscal regime and fiscal reforms The key instruments under the current fiscal regime are the stumpage fee, the concession rent, the Timber Rights Fee (TRF), the 1% and 2% TIDD export levies and the export levy on air-dried lumber. In addition, the industry is subject to corporate taxes, a 2% (temporary) reconstruction levy on net profits and value-added tax (VAT). These latter instruments are features of the general national taxation framework and, hence, not of immediate concern to the forest fiscal study. A National Reconstruction Export Levy (NREL; 7% on lumber and 3% on veneers and plywood) was introduced in 2001 and lifted in Presently, the most important instrument (revenue-wise) is the stumpage fee. It is a volume based fee charged on harvested timber. The revenue is used to finance FC s forest regulation and management costs, and to pay land-owning communities their constitutional share of stool land revenue. FC faces problems in fully capturing the tree information data which form the basis for invoicing stumpage fees. In addition, low efficiency in collection of invoiced stumpage fees has resulted in cumulative stumpage arrears of 44 billion (status 1 January 2006). Since their introduction in 1999, stumpage fee rates have been revised only in April and July 2003, meaning that the real value of fees has been considerably eroded by inflation from 1999 to 2003, and again from mid 2003 to today. The concession rent is an area-based fee. It is considered a land rent to the landowners, who receive the full proceeds. The fee is of minor importance in the fiscal regime because of its low size ( 1,200 ha -1 in forest reserves and 1,000 ha -1 offreserve). The fee was adjusted in 1998 (for forest reserves) but the last significant revision dates back to The TRF is an area-based fee, additional to stumpage fees and concession rent, set by public bidding. The objective is to capture additional willingness to pay for rights to standing timber. It was introduced in late 2003, but so far it has proven difficult to allocate rights to natural timber through competitive bidding, partly due to a general lack of acceptance of the TRF in industry circles. Furthermore, the sharing of TRF revenues among landowning communities and state institutions is an unsolved issue. The 1% and 2% TIDD export levies were introduced in 1985, when the Forest Products Inspection Bureau and the Timber Export Development Board were established, to pay for industry and trade services rendered by the two entities. Today the export levies are an important source of financing not only for TIDD, but for the entire FC. Finally, the airdried lumber levy, introduced in September 1997, promotes kiln-drying and has slowed down exploitation of the 7 species covered. The revenue is paid into the Forest Plantation Development Fund and used for re-forestation activities. The total forest fee revenue in 2005 amounted to US$ 16 million. This originated from: Stumpage fees (US$ 8.7 million 54%), 1 & 2% TIDD export levies (US$ 7.2 million 45%) and air-dried lumber levy (US$ 0.12 million 1%). 54% is forest level or upstream charges (stumpage fee and concession rent) and 46% is trade level or downstream charges (TIDD export levies and air-dried lumber levy). In 2003, when the NREL was still in operation, downstream charges constituted 70%. The upstream charges, 4

5 alongside generation of revenue, serve an environmental (growth) objective because they provide for a pricing of the standing timber. The downstream charges fulfil a revenue objective, but not an environmental (growth) objective as they function through a reduction of the net revenue/profit of the wood processing industry, not through increased costs (increased costs of raw material). Being deducted at the trade negotiation point, downstream charges are fairly transparent and relatively easy to collect. The present forest fiscal regime is thus dictated more by a revenue objective than by an environmental (growth) objective. In this sense, the fiscal regime in Ghana resembles forest revenue systems in most other timber exporting African countries that also focus on easily collectable export fees. In contrast, forest fiscal regimes in e.g. Malaysia (Sabah) and Indonesia apply almost exclusively upstream fees, thereby promoting an environmental and growth objective alongside revenue generation. Economic rent is the surplus value after deducting all felling, transportation and processing costs as well as normal profits from the price of timber in its highest valued market. The study conservatively estimates the economic rent of the 2005 harvest to approx. US$ 70 million (US$ 45 m -3 ). Compared to the total economic rent appropriated in 2005, the total revenue from forest fees (US$ 16 million) constitutes only 25%. The 25% share is divided between FC and constitutional stakeholders, the latter appropriating a mere share of 13% of the economic rent. In the 2005 model presented by the study, the major share of the economic rent (59%) is dissipated as economic waste due to low industry recovery rates. Millers appropriate 21% and loggers a negative share of -1%, i.e. loggers operate below normal profit rates. Government and its constitutional stakeholders also appropriate 21%. Under a reduced harvest and changed species mix scenario under VLTP, the economic rent will drop to a level estimated to approximately US$ 10 million (US$ 14 m -3 ). The study recommends fiscal reforms that in a phased manner and aligned with institutional reforms - eliminate economic waste and capture the full economic rent in the form of official forest fees. Fiscal reforms should provide a sustainable financial basis and economic incentives for (a) enhanced industrial efficiency, (b) a fair share of economic rent to landowners, (c) FC as an efficient regulator under institutional reforms, (d) TIDD as an appropriate service provider and (e) financing of the VLTP/TVA. The study identifies stumpage as the key fiscal instrument under reforms, but in a different form compared to at present. The study recommends a fixed stumpage charge (55-60% of the total stumpage level) to be paid up front as an annual payment for a specified area and yield. It will be equivalent to an area-based fee, and will reflect market conditions and changes in species. The fixed stumpage should remain unchanged in real value terms. For timber rights being allocated through competitive bidding, the TRF will take the form of the fixed stumpage charge. This should be complemented by a remove and pay stumpage fee ( stumpage appendage ) as known presently, which will be subject to a phased increment over time until the full economic rent is captured. The fixed stumpage will act as an incentive for better environmental management (e.g. use of lesser utilised species), while the progressive increment of the stumpage appendage will allow operators to adjust efficiency rates in the transition period. Moreover, the study suggests a relaxation of the current suspension of log export, implemented through a managed log export quota system covering between 20 and 35% of the controlled annual harvest and a 20% log export tax. This would introduce competition on the domestic log market, lead to higher domestic log prices, improve profitability of loggers 5

6 and create an incentive for improved (less wasteful) domestic processing. As domestic log prices raise and domestic milling efficiency improves the log export tax should be gradually reduced, until a stage where milling efficiency has improved and domestic mills are able to pay international comparable prices. At this stage, there would be no need for a log export tax or a ban on log export. In the process of fiscal reforms, the 1% and 2% TIDD export levies should be abolished, its waiver synchronised with the increment of the stumpage appendage. The VLTP / TVA and its financing The study suggests that the revenue from the fixed stumpage is considered as payment to the land owning communities. A certain share of the fixed stumpage revenue should be used to finance the VLTP/TVA, which is also suggested financed from a 50% share of the log export tax. The stumpage appendage is suggested for financing of FC s recurrent and investment costs under institutional reforms (training, human resource development and enhancement of logistics and infrastructure). The VLTP/TVA will not duplicate FC s mainstream regulatory functions, but serve as a monitoring agency providing services to the various divisions of the FC and the private sector, on the one hand, and verifying and validating both industry and FC performance, on the other. The TVA through its partnering with an independent third-part verifier will be able to issue certificates of legal origin and legal compliance which are market instruments requested by the international timber trade. In order to secure its long-term financial sustainability, the study recommends that VLTP/TVA has an independent financing, provided from the revenue sources indicated above. The study estimates an annual average recurrent cost of US$ 1.1 million over 5 years, in addition to capital costs of US$ 4.3 million. The results of a cost-benefit analysis taking into consideration the negative livelihood impact (redundancy in industry employment) and the positive impacts of a reduction in industry transaction costs and prevention of timber resource depletion indicates a clear positive overall impact of the VLTP/TVA, both in the short and longterm. Implementation of the VLTP/TVA and further institutional reforms would result in total annual institutional costs for timber and trade regulation of approximately US$ 4 million, comprising: Forest (timber) regulation (FSD & RMSC) US$ 1,275,000 Trade (TIDD) US$ 1,600,000 VLTP / TVA US$ 1,100,000 Total US$ 3,975,000 These costs should be considered in light of current institutional costs of approximately US$ 7.7 million, current transaction costs incurred on the industry and a total economic rent that, under a sustainable harvest level under VLTP, is likely not to exceed US$ 10 million (US$ 14 m -3 ) in the absence of the implementation of radical forest fiscal reforms recommended under this study. 6