Moving on to tax administration............
In addition to the maxim that tax administration is tax policy, there is a second quite relevant adage: the pursuit of the perfect is the enemy of the good. If the administration is not up to the job, then taxes will not be collected. If taxes are too complex, they cannot be administered efficiently. A critical aspect of any tax review is to ensure that any recommendations for reform are consistent with the ability of the administration to carry them out. In other words, even if a country accepts a set of recommendations regarding changes in policy, one also needs to ask whether the administration is in sufficiently good shape to meet the demands placed upon it. If not, then effective tax policy suffers as a result.
The primary function of the tax system is to generate revenue; its first goal is to ensure that this function is discharged effectively. A second goal is to raise the economic efficiency of the taxation system. This requires that, for a given level of revenue, it interferes as little as possible in decisions made by firms (about production, trade and investment) and by households (about consumption and savings). A third goal is to lift the tax burden off the poorest households and to ensure that actual tax structures are both horizontally and vertically equitable. This is likely to be carried out with some degree of progression.
Reform or redirection of the tax system is likely, as its main aim, to simplify tax policy and strengthen tax administration to achieve these objectives in the most efficient manner.
The design of the tax system is thus critical to achieving the objectives set out for taxation. In this regard, it is perhaps easier to indicate what a "good tax" should not be:
• It should not be complex, difficult and costly to administer.
• The number of rates should not be many (they should be kept to a minimum)
• It should not provide strong incentives for evasion so that enforcement costs are increased. This mainly argues for avoiding excessively high rates, but would also encompass the relationship between ease of evasion and severity of penalties.
• It should not introduce serious economic distortions.
• It should not treat taxpaying individuals and businesses in similar circumstances differently - horizontal equity.
• Its administration and enforcement should not be selective or skewed in favour of those with the wherewithal to defeat the system - elements of vertical and horizontal equity.
• The system should not be heavily dependent on one or two particular taxes, as changes in the tax base will have serious implications for revenue collection. and
• A “not-not”: the scope for granting or receiving exemptions should be minimised.
Avoiding all of these “nots” will ensure that the tax system will be elastic - that is responsiveness to growth in the economy. As GDP becomes larger and particularly as the formal cash economy grows, the absolute amounts of revenue collected will increase.
The "good" tax rules are complemented by the "good" tax administration rules. The following are indicative of these rules :
• organise the tax machinery to get the most returns by concentrating scarce resources on the major issues;
• see that the law is properly drafted and codified and changed if necessary to support sound administration;
• see that the administration is properly organised, staffed, and trained, and has sufficient numbers and the wherewithal to do their job;
• locate the tax payers, place them on rolls (computerised where appropriate), and examine returns and audit them;
• obtain relevant information from government departments and elsewhere and use it to back up the tax collection process;
• ensure that taxes due are collected; and
• ensure that appropriate penalties are set and are properly applied.
The combination of the "good" tax and the "good" tax administration provides the basis for an evaluation of the way taxation is conducted in any country.
There is also one important feature of a tax system that has to be added to the above: that of stability. Unfortunately, a stable "bad" tax system is not desirable. Stability can only be justified when the system has been adequately established and/or reformed. Once the system has been through an appropriate and adequate reform process, then it should be left substantially unchanged.
My experiences in observing these principles in action and indeed in applying them are varied. One of the most dramatic impacts on tax administration was when the Minister of Finance in Uganda removed his ability to grant discretionary exemptions in the early 1990s. The substantial and daily queues outside his office disappeared and officials were freed up to do other work. Any exemption that was not in the tax code had to be approved by Parliament so transparency was improved. This applied to NGOs and when approved the expenditure equivalent to the tax paid was treated as a government contribution to the project. Public expenditure prioritisation became a factor in decision making. Similarly, the discontinuation of duty free shops in Kampala ended significant leakages even if it meant diplomats had to go to Entebbe!
Codifying legitimate exemptions in the tax laws was a principle that gained traction with improvements in tax policy. Doing away with tax holidays and reducing the level of high company tax rates and “earning” tax holidays through depreciation allowances and loss carry over freed up officials in the Investment Promotion Agencies to promote rather than vet applications for an investment licence that provided tax holidays. Indonesia did this in the 1980s and many other countries followed suite in the 1990s onwards. As part of the reforms import tariffs began to be seen as a tool for protection so items such as machinery became zero rated and General Sales Taxes and Excise Tax started to fill the revenue gap that this caused. The introduction of VAT became a feature of most taxation regimes given the cascading nature (tax on tax) of existing sales tax regimes and the narrowness of their coverage – on imports and domestic manufacturing. An early reform in Sierra Leone was to allow sales tax on inputs to be offset against sales tax on outputs for domestic manufacturers (a manufacturing level type VAT) with an increase in the nominal rate to make the change revenue neutral. A “proper” VAT followed at a later date once the SLRA was firmly established.
Customs Departments were the source of most revenue and often the most leakages. But broadening the tax base required strengthening the collection of domestic taxes – direct and indirect). The solution in many countries was to create a Revenue Authority that merged Customs and Domestic Tax Administrations: Uganda, Tanzania, Zambia, Rwanda and Sierra Leone were some of the first to be set up. The good tax administration rules were the basis of their development albeit at times slowly and unevenly. Large Tax Payer Units were established, Tax Identification Numbers adopted, self-assessment introduced; audit and tax information departments created and computerisation adopted. (Customs Departments had been typically the first users of computers through the use of ASYCUDA and adopted it though with some difficult at first due to the less than user friendly software but with the development of the successive versions and the associated hardware and internet, most tax administrations now use it successfully). One of – if not – the most important developments in the creation of RAs was the recognition that professional management and staff are crucial to their success. Tax administration is a career in its own right and does not depend on rent seeking opportunities.
Bilateral and multi lateral support for improvements in tax administration was triggered by the creation of Revenue Authorities. I had the good fortune to work with David Child in carrying out progress reports on DFID’s support to URA and SLRA and benefited greatly from his experience in UK Customs and the development of the combined Customs and Revenue but also working with South Africa RA and URA amongst others.
PEFA in the 2005/2011 methodology has three indicators (nine dimension) dealing with tax administration which has been collapsed to two indicators (seven dimensions) though essentially covering the same content in the revised 2015 methodology. These dimensions reflect the principles outlined above with respect to administration. From my own experience of PEFA assessments, the tax administration indicators scores have improved over time which reflects the efforts in addressing and improving tax administration. However one area that appears to be standing still is in tax arrears and often the reason for that is the lack of a legal basis for writing off uncollectable debts so the debt plus accumulating penalties and interest remains on the books. Bullet point two above needs to be applied!
Tax policy formulation and tax administration are best carried out by separate bodies to ensure the necessary skills are in the correct institution and to avoid potential conflict of interest. However, it is essential that they speak to each other and that tax policy must recognise the ability of the administration to implement. Two examples illustrate this important point. In The Gambia, I was tasked with assisting in the creation of the Development Act. The team developed an incentive structure that encouraged backward linkages to encourage hotels to source supplies from within the country (Gambia is a tourist country). On returning years later I was told that the part of the Act had to be rescinded as the tax authorities could not administer it as companies were abusing the provisions by falsifying documentation and generally using the provisions as loopholes. Nothing changes it would seem! The second example was more positive. In Zambia the design of a duty drawback system was developed alongside the ZRA and used the existing VAT refund procedures to implement the drawback.
Lessons? Keep tax policy simple, get rid of discretionary exemptions and eliminate loopholes! Apply the good tax principles. Oh, if life was so easy......................................................!
postscript: for those that can access it see
http://www.thetimes.co.uk/tto/business/columnists/ianking/article4608163.eceor his article in print in The Times 9 Nov 2015 railing again complexity
