Summing up: performance, lessons, and recommendations

The past 2 decades of fiscal reform in EMC have provided a remarkable laboratory in tax policy design and practice. Although the diversity of experiences and countries involved make it hard to draw comparisons and general conclusions, we attempt, in this section, to gauge theperformance of CITs in the transitional tax reform experiment. We conclude by extracting several lessons from the first 2 decades of reform and offering several recommendations.

 

Three different approaches can be taken to measure performance.

First, we can ask whether the new tax systems comply with the basic principles in normative tax theory. In light of certain of the applicable normative principles, some progress has been made in EMC's tax systems. For example, the taxation of intermediate goods has, for the most part, been discontinued; the VAT has been universally adopted as the main consumption tax; progress was made on treating imported and domestic goods alike; and excises have been largely adopted with the objective of alleviating negative externalities generated by the consumption of alcohol, tobacco, and petroleum products. However, as we have seen, EMC' tax systems still raise revenues with significantly more distortions than are necessary, by providing, for example, tax holidays and other numerous tax incentives, or by disallowing as deductions ordinary business expenses.

A second approach to measure tax reform performance is to ask whether EMC's tax systems have been able to raise adequate tax revenues, and whether they have done so with a fair distribution of tax burdens among income groups. Tax revenues in all EMC declined significantly in the initial transitional slump. In general, however, CEE(central European economies) countries and the Baltic

 

states, which moved sooner to reform their tax systems and where tax reforms went deeper, were better able to maintain revenues or to increase them vis-a-visGDP. What constitutes an adequate level of revenues depends ultimately on how much income a country decides to spend on public goods and services vis-a-vis private consumption, and there is, of course, no uniform or absolute standard for this division. There are two alternate approaches to examine the adequacy of revenues. The first is to make international comparisons. With the possible exceptions of some EMC, such as Georgia, Kazakhstan, and Tajikistan, revenues as percent of GDP are not lower in these countries than in other countries with similar levels of income. In fact, as is the case of most CEE countries, revenues as percent of GDP would appear to be higher than in other countries of similar incomes. The second approach to examining revenue adequacy is to look at the balance between overall revenues and expenditures.

 

With a few exceptions, the general government deficit decreased significantly during the transition. However, the general persistence of government deficits could be taken as a sign of revenue inadequacy of EMC' tax systems. The question of whether EMC' tax systems have raised revenues in a fair manner is more difficult to address. Most of these countries have experienced significant increases in poverty and income inequality during the transition. To determine whether the tax systems have contributed to or offset these trends requires data and analysis well beyond the scope of this paper. For the case of Russia, the vertical distribution of tax burdens under conventional assumptions on the final incidence of taxes is proportional or mildly progressive, although strongly regressive for the poorest income groups. There is no general information on the performance in terms of horizontal equity in EMC, but several features of these tax systems, such as wide tax evasion, uneven enforcement, and special tax privileges, are likely yielding significantly different tax burdens for taxpayers with equal bases.

 

A third possible method of gauging tax policy reform performance is to look at how the private sector has reacted — in particular, how Foreign Direct Investment (FDI) has flowed into EMC. While there are many determinants of FDI flows, such as political stability, a tax system that is inefficient, unfair, costly to comply with or unpredictable can become a major obstacle to FDI. There is some indication that tax climate may have played a role in attracting and retaining FDI in EMC.

 

Several lessons emerge from the tax reform experiment in EMC. First, a country's history and starting point significantly influence the process of tax reform. This is no surprise given the experience with tax reform in Western countries. But for EMC there was a big gap between the philosophy, practices, and institution of tax systems of centralized planning and those of market economies. There still can be no complete understanding of the current problems of tax systems in EMC without a good knowledge of the institutional and behavioral legacies of centralized planning.

Second, tax systems are as good as their enforcement. The experience of EMC clearly confirms that effective tax reform cannot be accomplished in isolation from the current capabilities of the tax administration systems and taxpayers' culture. In retrospect, the most serious mistake EMC collectively made was to focus primarily on modernizing tax policies and relegating tax administration and taxpayer compliance issues to a remote second place.

 

Third, tax policy reforms often did not measure up to the desirable standards because they did not carefully assess different options against explicit economic objectives, or because they were not comprehensive, or because they were not swiftly enacted by parliament (after careful preparation) and were not left unmodified for a sufficient length of time. With the exception of a few EMC, short-cutting the preparation stage led inevitably to greater difficulties with passing the laws and to continuous ad hoc patching of the system. The rapid succession of changes created confusion among tax administrators and taxpayers alike and added to the uncertainty for domestic and national investors. As illustrated by the experience of Kazakhstan and Georgia, deliberate preparation for tax reform can be conducted in a reasonable period of time, providing opportunities to educate policymakers and practitioners on the intricacies of the reform and building consensus for the reform program. Careful preparation and consensus building made possible the swift passage of the tax codes by the parliaments in these two countries.

 

Fourth, most EMC found it difficult to internalize the lessons from their own past and those from western countries on the need for simplicity, economic neutrality, and stability. The majority of EMC continued to favor an interventionist stand providing special regimes and tax treatment, which, in turn, have led to tax erosion, distortions, abuses, increased compliance and administrative costs, and taxpayer inequities and resentment. In many cases, compliance costs for taxpayers have been kept high by needless complexity in the tax laws, and unnecessary requirements, such as filing balance sheets and income statements every quarter or physically queuing for a long time to pay taxes.

Fifth, the reform of tax policy, the reform of the system of intergovernmental fiscal relations, and the modernization of tax administration are closely intertwined in most EMC. Therefore, the reform of revenue assignments at different levels of government to increase efficiency and accountability of subnational governments needs to be integrated with the reforms of tax structure and administration. Similarly, no tax policy and administration reforms are likely to succeed without taking into account their interplay with intergovernmental fiscal relations. Sixth, to be effective and successful, tax reform needs to be accompanied by institutional and structural reform throughout the economy. EMC that moved deliberately to restructure their economies and institutions also fared better fiscally over the past decade (Czech Republic, Estonia, Hungary, Latvia, Poland, and Slovenia). These EMC reduced the need for piecemeal reform later on in the transition, thereby creating a climate more favorable to domestic and foreign investment. In particular, institutional reform in areas complementary to fiscal reform, such as accounting systems and enforcement of bankruptcy laws, have proven critical.

 

What recommendations can be made based on these lessons for future tax reform in CEE, the FSU, and Southeast Asia?

First, for those countries still lagging in comprehensive tax policy reform, it will be critically important to develop a strategic plan of tax reform with explicit objectives and explicit means to achieve them. A strategic plan for tax reform should seek to build consensus among stakeholders, including policymakers, practitioners, and taxpayers, regarding the objectives of the tax system and the means of achieving those objectives in the simplest and most efficient and equitable manner. Implementing a strategic plan adequately will require investing resources in the development of data bases and the methodologies required to analyze the potential effects on revenues, resource allocation and tax burden distributions of alternate tax policies.

 

Second, practically all EMC should simplify their tax systems, and at the same time increase revenues and horizontal and vertical equity, by reducing or eliminating tax holidays and other forms of preferential tax treatment. In particular, EMC should avoid competitive races to the bottom, granting additional tax preferences to attract foreign investors. There is no proof whatsoever that these tax preferences are more effective than stable and certain tax environments in attracting investment. Tax preferences induce higher taxes and further distortions in other areas of the economy.

 

Third, EMC must move aggressively to plan the modernization and reform of their tax administrations. The past decade has illustrated that without the comprehensive reform of the tax administrations, EMC's gains in the area of tax policy reform will not be fully realized. EMC should take advantage of the lessons learned from tax administration reform around the world and move to simplify tax administration procedures, reduce compliance costs, and increase taxpayer services. The modernization of tax administration will require political commitment to unsettle «old ways», considerable resources in training and equipment, and focused persistence on the mundane and relatively unexciting tasks of improving collections, audits, and taxpayer services. Without these reforms, it is likely that tax evasion will continue to erode revenues during the following decade of transition.

 

Fourth, EMC, especially those in the FSU, should forego the use of tax offsets and take any other possible steps to discourage the use of barter and other non-monetary means of payment in the economy. No good tax policy structure and tax administration can be effective in an economy dominated by non-monetary means of payment.

 

Fifth, the reform of the tax systems should be accompanied by aggressive reform of those institutions that frame the effectiveness of tax systems, including the introduction and enforcement of bankruptcy laws, development and implementation of modern accounting standards, and the general enforcement of contracts.

 

3. Understanding main points.Answer the following questions:

1. Why has the reforming of most taxes been slow and tortuous?

2. What approaches can be taken to measure the performance of emerging market countries?

3. Is Russia an exception in the general reforming process? Please expand.

4. What changes have different taxes undergone?

5. What progress has been made in the tax systems of the emerging market countries?

 

4. Understanding details. Find facts to support or refute the following statements:

1. The transitional countries’ tax reform was no more than an experiment.

2. One of the methods of gauging tax policy performance was to look at how the private sector reacted.

3. The current structure of tax systems in EMC largely resembles the

structure of tax systems in western countries.

4. The trend over the past several years in EMC has been toward the

consolidation of rates into a lower basic or general rate.

5. Building an effective tax administration is a difficult task anywhere.

 

Summarizing