Strengthening the underpinnings of VAT administration

One statement that can be made with certainty in any developing country like Albania or Serbia is that its tax administration should be improved.

As does much conventional wisdom, this one hides some deeper truths. One truth about VAT is that many countries do not meet the preconditions necessary to run a good self-assessment system.  In addition, the degree of policymaker and even public support needed to improve VAT administration seldom exists.

The few large formal-sector firms that account for most VAT revenues may support measures to extend the weight of the tax to their relatively untaxed competitors in the informal sector, but they react adversely to any measures that tighten the system as it applies to them. Small firms caught in the system complain both of the untaxed competition and, often with justice, of the high compliance costs imposed by VAT.

Those who are outside the VAT net are usually happy with their status. The public at large could not care less about the problems of the tax administration. Often, VAT has a bad name as being an unfair tax, and anything government does to improve it may be seen as being done to the people rather than for them.

The conditions for improving VAT administration are thus far from propitious. There is no magic formula for creating public support for better tax administration. At some basic level, what is really required is to strengthen the legitimacy of the state. This is not a process that happens overnight anywhere.

Nonetheless, there are some promising experiences around the world and some feasible ways in which the critical and difficult job of collecting adequate revenue for public purposes can be improved from within, as it were.

The creation and development of a modern tax administration are always and everywhere difficult and time-consuming tasks. It took centuries for Western countries to get to where they are today, and where they are being hardly fiscal nirvana.

Improvements need not occur at a geological pace, however. The experience of a few countries, such as Chile, show that, when political conditions are right and the will to effect serious change exists, the process of putting into place a substantially better tax administration can be accomplished in a decade or so.

Unfortunately, many countries began their modern tax systems with an unpromising legacy of state-private relations, with almost no trained officials, and in a very difficult political and economic setting. It is not surprising that there is still much to do in most such countries.

Moreover, all too often developments over the years have made the task facing even the most motivated, competent, and honest tax administration difficult: the lack of consistent support from political leaders, constant changes in tax legislation, fundamental problems with the legal and judicial system, the rapidly shifting level and structure of private activity, and so on and on.

Nonetheless, there are always things that can be done to improve VAT administration.

One obvious but unduly neglected issue in most countries, for example, is that good administration of any tax requires serious analytical foundations based on sound information and intelligent analysis. One must understand a problem in order to solve it.

Virtually without exception, major change and improvement in both tax policy and administration in any country require a solid analytical foundation in the form of a more systematic approach to assembling and analyzing data.

The beginning of wisdom is to identify the size and nature of problems as carefully and fully as possible.

Tax administrations in all countries operate within hard budget constraints: to get the most from what they have, they need to allocate resources as efficiently as possible.

Efficiency is not a luxury in countries like Albania and neighbor countries with us. It is an essential tool in the fight to become, as citizens richer than before. To administer VAT efficiently, one needs not only to estimate the VAT gap but also to decompose that gap by both the sector of economy (energy, agriculture, services, etc.) and the nature of the problem (nonregistration, false registration, non-filing, under reporting of sales, over reporting of purchases, nonpayment, etc.).

Once the relative magnitude of the various problems facing VAT administration is better understood, the first and easiest step is to change the tax law to reduce the scope of these problems as much as possible, even at the expense of violating conceptual purity and economic logic. Examples are the suggestions for exempting agriculture and raising thresholds. Few VAT problems can be solved by such containment measures, however.

If studies are done on an industry basis (as they should be), they may help to establish industry norms (such as e.g., refund claim levels), deviations from which should give rise to further examination of such firms. Comparative information of this sort is essential in determining the risk profile (with respect to noncompliance) of taxpayers who are of different sizes, operate in different lines of business, and have different patterns of tax-relevant activity. Taxpayers in stable, well-established businesses with good compliance records are, by definition, much less likely to offend than those in new, variable businesses with no established record of good compliance.

On the other hand, it is important not to impose unnecessary and unreasonable barriers to new businesses simply because they are new although it must be recognized that newness is definitely a risk factor from a fiscal perspective.

A delicate line has to be walked in this respect. Of course, all such risk profiling of taxpayers is simply a guide to the proper allocation of administrative resources. It is an ingredient in good tax administration, not a substitute for it.

Even in the relatively few such countries in which detailed VAT data are available in an accessible form, two characteristics are noticeable. First, considerable effort is generally required to put such data to any useful purpose, whether to analyze and improve the effects of VAT structure or to monitor and improve VAT administration. Secondly, few developing or transitional countries have the resources or, it seems, the desire to make such an effort.

This situation is curious.

Tax administrations need to keep a close watch on trends and changes in taxpayer behavior to be able to allocate administrative resources effectively and to develop appropriate audit strategies. Data gathering and analytical capacity are clearly essential to do this. Yet not only do units devoted to such purposes seldom exist but even those most concerned with improving VAT administration seldom place much emphasis on the need to improve matters in this respect.

One reason may be that those at the top of the tax administration give higher priority to other apparently more pressing needs such as dealing with issues concerning specific taxpayers or involvement in policy design. Good administrators may have useful, even essential, input into policy design.

But they should not be given major responsibility for policy design. That is not their job. Nor should good managers be involved in specific taxpayer issues. Their task is to set up the system correctly, including appropriate dispute settlement mechanisms, not to become involved in particular cases.