ANALYSIS: Kurdish State-building and the Struggle for Natural Resources in Iraq

The Kurdistan Region of Iraq has large deposits of natural resources, and its economy largely depends on these. With an immensely excessive public sector, management of oil and gas revenues is therefore crucial for the sustainability of Kurdish state-building. However, the political struggle with federal authorities in Baghdad makes this difficult. While the Kurds want to develop an independent oil and gas sector, Iraq considers this a threat to the country's territorial integrity and sovereignty.

The fact is that the Kurdish struggle for independence is as real today as when they were divided between Turkey, Syria, Iraq and Iran after the collapse of the Ottoman empire. The closest they have come to a Kurdish state formation in the Middle East is the semi-autonomous Kurdish Region of Iraq (KRI), ruled by the Kurdish regional government (KRG). Although Iraqi Kurds have had de facto autonomy since 1991, this is largely a result of the US-led invasion in 2003, which led to constitutional anchoring of the KRG in 2005.

Since then, the KRG’s headquarters has been in Erbil (locally called Hawler), where it has its own ministries, directorates and agencies. Equally important is the monopoly on violence the Peshmerga has over Kurdish territory – according to the Iraqi constitution, Iraqi military and security forces have no authority in the KRI.

However, after the Kurdish referendum on independence which was held on 25 September 2017, the relationship between Baghdad and Erbil has reached an all-time low in the post-Saddam era. At the core of this is the struggle for control of the country’s large deposits of natural resources, located in the disputed areas of northern Iraq.

In October, Iraq formed a new government after months of intensive negotiations on who to appoint as prime minister. This month, the Kurds are also likely to welcome their new political leadership. Together, they will be tasked to stabilize and rebuild a country that has been ravaged by war and conflict since the 1980s. Before that can happen, finding a way to cooperate will be imperative.

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Natural resource management and the disputed territories

The conflict over the disputed areas in northern Iraq is central to the strained relationship between the federal government in Baghdad and the Kurdish regional government in Erbil.

Article 140 of the Iraqi Constitution from 2005 states that the fate of these areas will be decided by a local referendum within a period of seven years. Thirteen years later, this is yet to take place. Given the highly demanding situation in Iraq the past decades, this is perhaps not that startling. At the same time, the Kurds argue that the federal government is unwilling to clarify the situation as they have no intention to give these areas up.

 The large deposits of natural resources are, not surprisingly, the main reason why it is so difficult to find a political solution to this issue. For the Kurds, income from the oil and gas sector is crucial for Kurdish state building; for Iraq, Kurdish control of northern Iraq's major natural resources is a threat to the country's territorial integrity and sovereignty.

If the KRG gains full control of the country's largest natural resources, this will serve the Kurds with far more power than Baghdad is comfortable with. It should also be mentioned that Iraq equally dependent on the oil and gas sector: in 2015 it was estimated that 85 per cent of the state's total revenues came from here.

Article 111 also states that natural resources are not exclusively controlled at federal level, and that oil and gas "is owned by the entire people of Iraq". The Kurds interpret this paragraph in their own favor, while federal authorities argue that this means that any revenues collected from the natural resource sector in Kurdistan belongs to all Iraqis, not KRG.

KRG's goal of developing an independent oil and gas sector has therefore encountered resistance from Baghdad. In 2014, the Kurds were caught exporting oil to Turkey without the permission of federal authorities, which was considered a violation of Iraqi sovereignty. As result, several companies had to withdraw.

IS' advancement and the battle for Kirkuk

Another important challenge for resource management in the disputed areas is the demanding security situation. Although former Iraqi Prime Minister Haider Al-Abadi declared military victory against IS last year, there has been an increase in activity in Kirkuk and the disputed territories, with lethal attacks being carried out frequently.

When the IS occupied large parts of Iraqi territory in 2014, Kirkuk was at risk of falling under the control of the jihadists. As major cities like Mosul fell and Iraqi security forces proved unable to prevent this, it was the Kurdish Peshmerga who came to the rescue. The Kurds then took advantage of this situation to retake control of the disputed territories.

However, this proved to be short-lived. On 25 September 2017, former President Massoud Barzani (KDP) decided to hold the fateful referendum on Kurdish independence. Federal authorities responded by launching a military offensive that led to the restoration of Iraqi control. This also resulted in a return to pre-2003 borders as Iraqi forces recaptured territory in the south of Iraqi Kurdistan which had been controlled by the Kurds since the US invasion.

According to sources in Kirkuk, Iranian military advisors and Iranian-led Shi’a militias from al-Hashd al-Sha’abi were at the forefront of this operation. General Major Qassem Soleimani, Head of the Iranian Revolutionary Guards’ Quds force, was allegedly central in the operation.

A senior official in the Ministry of Natural Resources (MNR) claims that after this incident, KRG lost the sales revenue of 150,000 barrels a day according to their own estimates. The referendum also resulted in Baghdad’s decision to remove the KRG’s entitlement to 17 per cent of the federal budget. Losing this income has been devastating to the economy of the KRI.

After federal authorities took over Kirkuk in October last year, they stopped all exports, but this was restarted after Erbil and Baghdad agreed on a deal in November this year. This is a positive development and indicates a step in the right direction for more constructive cooperation between the two. The decision was allegedly influenced by US pressure as Washington feared a rise of oil prices after the restoration of sanctions against neighbouring Iran.

State- and capacity-building through taxation

In addition to the abovementioned challenges, the socio-economic situation in Iraq is highly demanding. This also applies to the KRI, despite the fact that the region has been relatively stable compared with the rest of the country after 2003. Decades of war and conflict, from the Iran-Iraq war in the 1980s to the ongoing struggle against IS, have obviously been devastating for all sorts of development throughout the country. The fact that Iraq has its own directorate for mass graves says it all.

If stabilization and reconstruction of such a war-torn country is to take place, state institutions must be strengthened, and administrative capacity must be built. Taxation can be an important tool in Kurdish state-building, as it can promote the social contract between the KRG and its citizens. Furthermore, domestic revenue mobilisation can lead to improved welfare services provided by the KRG, which will not only foster socio-economic development but also political legitimacy.

Taxation in KRI is administered by the Tax Directorate, which does not necessarily have equivalent laws and practices as its counterpart in Baghdad. A challenge for the local tax administration is that there is no 'tax culture' or ‘tax morale’ in the KRI. An illustrative indicator of this is that in Iraq, income tax is 15 percent, while in KRI it is 5 percent. Corporate tax is somewhat higher - 15 percent.

As both residents and companies have a strenuous relationship with paying taxes, the political cost will be great for any government that wishes to increase the tax level. Considering the internal political fragmentation in the KRI, especially after 2017, it is not unreasonable to argue that there is either political will nor ability to implement such a potentially costly tax reform. While the Kurdish Democratic Party (KDP) has blamed the Kurdish Patriotic Union (PUK) for the chaotic situation after 2017, the PUK has blamed the KDP for losing control over Kirkuk and the oil fields.

At the same time, there are some signs that Kurdish politicians want change on this front. In October, KRG's Deputy Prime Minister Qubad Talabani (PUK) said that both effective taxation and diversification of the economy will be key in the future. Tourism and agriculture are among other things identified as important areas of focus.

Another important problem with taxation is that KRI is constitutionally bound to transfer a share of tax revenues to the federal government in Baghdad, which in turn will redistribute this to all of the country’s provinces. This is a problem for decision-makers in Erbil, especially after federal authorities cut support to KRG in the state budget. According to a senior official in the MNR, it is troubling for the KRG to transfer sums to Baghdad when they believe Iraq is indebted to them.

It should also be mentioned that corruption is widespread and thus another important obstacle to capacity building in KRI as well as Iraq in general.

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An alternative form for resource mobilization

Considering KRG's dependence on the oil and gas sector, efficient taxation of natural resources is an important source of funding for public spending and, consequently, socio-economic development. Well-functioning customs duties and taxes on exports and imports, as well as taxation of private companies, may be a good place to start.

On the MNR’s official website, it is stated that capacity building is an important part of Kurdish energy policy. Although tax is regarded as an important source of income in this area, a senior official in the Ministry says that it remains problematic to tax natural resource extraction.

First and foremost, as foreign investment is crucial to the regional economy, it is not desirable for the Kurds increase the cost - including through taxation and other fees - for companies operating in the oil and gas sector in Kurdistan.

Instead of taxing companies in this sector, they have opted to include a compulsory social contribution bonus in all contracts. This sum is earmarked for local capacity-building. The companies decide where this contribution will be invested, which varies from nature preservation to security or refugee camps.

According to the Ministry itself, they are satisfied with this approach, which is considered to be more effective and beneficial to the local community than to increase costs through taxation.

The table below illustrates investments from the oil and gas sector in community projects in 2013 (unfortunately missing figures since then).

Table 1. Breakdown of expenditure on community support projects

Source: KRG Ministry of Natural Resources, 2013

By earmarking contributions to local community projects, the MNR ensures that revenues go directly to the Kurdish region, and not to the rest of Iraq. At the same time, they make Kurdistan more attractive to foreign investors. As part of Iraq, Kurdistan is for natural reasons a risky area of engagement for multinational and foreign companies. According to the MNR, certain incentives must therefore be in place.

Still a long way to go

With lack of trust in federal authorities, self-determination and local ownership are considered important to increase administrative capacity and promote socio-economic development in the KRI. For the Kurds, decentralization is therefore high on the agenda. The situation surrounding the disputed territories also needs to be clarified. However, before this can happen, Iraq has to be stabilized after decades of bloody war and conflict. A decisive ingredient to achieve this is constructive dialogue and cooperation across the country's many divisions, including among the Kurds themselves as well as between decision-makers in Erbil and Baghdad. 

Do you want to learn more about NUPI's research on taxation in fragile states? Take a look at the research network TaxCapDev's website here. Read more about our research on development policies here, and on Middle East issues here.