Does VAT work well for Albania?

Over the two decades, VAT has arrived in Albania. The principal reasons for arrival of this form of taxation were, first, the early adoption of this form of taxation in the European Union (EU) and, second, the key role played in spreading the word to economic transition countries by the International Monetary Fund (IMF) in particular and by international agencies and advisers more generally.

The success of VAT in the EU showed that VAT worked. The consistent support and advocacy of this form of taxation by the IMF and others in a variety of countries, encouraged and facilitated the adoption of VAT by countries with much less developed economic and administrative structures than those in the original EU member states, like Albania.

The VAT, it’s invariably among the most important sources of government revenue. Not all is so good for VAT, however. Some of problems have always been inherent in the structure and operation of VATs but are exacerbated by the increased fiscal weight being placed under pressure for new fiscal revenues for example to offset revenue losses from tariff reductions needed to accord with WTO requirements. It is thus perhaps time for a new look at the role of VAT in Albania.

Let’s make some question that can be a referent point for this discussion.

Can VATs be adapted to cope with the rising demands for more access to revenues by local and regional governments?

Can tax administration deal with such new problems as those arising from changes in business practices with financial innovations and e- commerce?

Does VAT provide a way to tap the informal sector or does it instead tend to expand that sector?

The answers to such questions are not only critical to the fiscal stability of Albania, but also to her economic growth and development. Not only do we as yet have surprisingly little solid empirical knowledge of some critical factors but the relevant economic theory also remains rather sketchy and we know even less about the relevant political economy context.

VAT in real life

As we can confirm by the two decades of experience, VAT works. Despite some doubts by various analysts, for the most part it remains true that, if a country needs or wants a simpler tax, it is well to have a VAT. Nonetheless VAT does not always work well, principally because we yet are so tax educated society ready for “self-assessment”. VAT is by no means necessarily the ‘money machine’ for every government. Indeed, the equally conventional conclusion that a VAT is the most economically desirable and administratively effective way in which to collect a given share of national income through a general consumption tax also holds provided, again, that the capacity exists to administer VAT adequately. Similarly, as with any tax, although increasing the rate of an existing VAT rates will neither necessarily increase revenues proportionately nor be costless, it may nonetheless be the economically most sensible way to expand revenue shares in economy, if that is the policy goal.

Recently, however, some have begun to explore in more detail the theoretical framework linking VAT, tariff reform, trade and welfare, turning up some interesting and to some extent disquieting results. Analysts have also recently begun to discuss the implications for VAT of the considerably larger underground or shadow economies found in Albania as compared to developed countries.

Some analysis suggests that in the presence of a substantial ‘informal’ sector, a tax like VAT that falls on the formal sector acts to deter the growth and development of the economy as a whole. Increasing consumption taxes definitely fosters the expansion of the hidden economy if the labour-intensity of production in that sector is greater than in the formal sector.

The government need for revenues suggest that even government aware of such problems may have nonetheless choose to impose higher taxes, on the formal sector of the economy because with the relatively weak tax administration the best way to raise revenue may be to increase barriers to entry to the formal sector, thus creating ‘rents’ that may then be taxed.

Concessions thus feed on themselves, encouraging taxpayers to lobby for still more concessions, just as tax amnesties create an incentive to defer payment in anticipation of future amnesties. Little assistance in coping with these complexities is offered in the way of taxpayer services. Nor is much done to guard against abuse, with most so-called VAT “audits” amounting to little more than simple numerical checks. Widespread base erosion facilitates both evasion and also, when taxpayers are subject to audit, corruption.

The governments hard-pressed for revenues are driven sometimes to discretionary and unpredictable enforcement efforts. Those unnecessary ways are used in form of collecting money where they can and (as the common problem with refunds suggests) keeping it when they get it.

On the other hand, they have sometimes resorted to introducing still more legislative changes to close gaps arising from previous political and administrative decisions.

The result has been almost a continuous cycle of changes in the effective tax structure, subsequent erosion of the tax base, and unrelenting pressure on the tax administration to meet revenue targets. Those taxpayers who remain subject to the full rigor of the formal tax system face uncertain (and often increasing) tax burdens. Savings and investment are deterred and misallocated. Trade may be discouraged as VAT refunds to exporters are not paid out correctly, but are instead kept in the treasury and used to meet budgetary needs. The shadow economy still is big. Revenues fall, with the result that tax pressure is again increased on those who cannot escape, and the cycle continues.

What matters most and in what ways?

A good tax administration keeps a close watch on trends and changes.

Many questions have already been raised about VAT in Albania, and some possible directions in which to search for answers have been tentatively suggested. A more systematic approach to assembling and analyzing data would help greatly in facilitating major improvements in VAT policy and administration.

It is, obviously important for good tax administration to keep a close watch on trends and changes in taxpayer behaviour, in order for instance to allocate administrative resources effectively and to develop appropriate audit strategies. Any good revenue administration surely needs at least some data gathering and analysis capacity.

An astoundingly small number of VAT registrants, less than 4% of total in number, account for 80 percent of VAT collections. What has proved much more troublesome in VATs around the world is the question of how best to deal with the “rebels” of the system small taxpayers.

At least three distinct questions may be distinguished in this respect. The first is the issue of where to set the threshold. The second, is what if anything, should be done to “simplify” VAT procedures for small registrants, with different countries reaching answers that range from providing some form of simplified accounting to subjecting them, in effect, to a tax other than VAT. The third is how to make sure that those who are treated as “small” by the VAT really are small.

Since good tax administration rests on information and for no tax is this truer than VAT it is obviously advantageous in principle to include as large a share of economic activity in the tax base as possible in order to be sure to capture the necessary information. Such an explanation would be more convincing, however, if there were more evidence that Albania put such information to good use and the very countries that set unduly low thresholds did not so often provide many of those thus caught in the VAT net with escape routes through various simplified systems or, in some cases, simple neglect.

Wherever the threshold is set, however, and for whatever reason, it is of course well recognized that compliance costs are relatively more burdensome for smaller firms.

Let make an example.

One country, has three alternatives to “simplify” fiscal system that may be used by small firms. Perhaps the most usual approach, however, is in effect to take out of VAT most of the very firms that the unduly low threshold has brought in, by applying some form of turnover or presumptive levy to firms below a (usually self-reported) threshold. The extreme version of this approach is the “simplified” or “unique” tax that has become popular in some economic transition countries in recent years. Moreover, not nearly enough attention seems to have been paid either to the details of the design and implementation of how they relate to the various forms of local business taxes. Again, there seems much useful research that can and should be done on such matters.

A quite different approach to the perceived and real problems of dealing with small taxpayers is the so-called “VAT withholding” found in some countries. In effect, this practice assumes that VAT will not be reported properly by small firms and hence requires those selling to such firms to “withhold” an additional VAT on such sales to make up for the VAT those firms are supposed to collect on their own sales. Such “dual price” systems are usually imposed at arbitrary rates and make no logical or administrative sense; nonetheless, they are sufficiently common, and are suggested sufficiently often in countries in which they do not now exist, to call for closer examination than they seem so far to have received. Most discussion of the appropriate treatment of small firms appears to assume that there is no difficulty in telling which firms are small.

VAT through the time

As a conclusion, however well designed and well administered it may be, will forever remain the same. Times change, and so do taxes. Life is more difficult for those concerned with tax matters in Albania. Keeping up in taxation requires an ability to read the fiscal winds to detect important emerging tax issues, to work out in detail how best they may be dealt with, and to devote time and energy to changing tax design and administration to cope with changing circumstances.

The basic question is not how to deal with new issues but rather how one can make a tax like VAT, which essentially depends on self-assessment, function adequately that in many instances do not appear to have satisfied the necessary preconditions for a self-assessment system.

The answer, as suggested earlier, may be to spend more time and effort trying to determine what kind of less than perfect VAT will function best in such countries and then working out in more detail the best way in which they can move over time from such unsatisfactory initial positions to a good VAT.