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IN PRACTICE

A well-unctioning tax administration isundamental in promoting ormal businessactivities, investment, and economic growth. In

many countries, however, tax administration israted by businesses as a key constraint to doingbusiness. A malunctioning tax administrationraises the cost businesses incur in complying

with the governments tax requirements. Tisleads to rms and tax ocials colluding outsidethe system at the micro level and a high degree omistrust between business and government atthe macro level.

Corruption is oten viewed as a predatory act:government ocials prey on businesses thatbecome the victims. However, tax corruption is

a win-win situation or both tax ocials andrms. A bribe is not necessarily an administrativeextortion, but rather a business transactionyielding a lower tax payment or the companyand unocial, tax-ree income or the taxocial at the expense o national income.Collusive corruption among rms is exhibited innon-compliance o tax payments, misreportingo business activities, inormal negotiations ontax obligations, unocial payments to thecollectors, and revenue loss or the government.

ax corruption raises black money, hiddenincome used or briberies related to othergovernment regulations, procurement, and

inormal economic activities.

What drvs th dmad or

tax corrupto?

A business is willing to bribe i it reduces the taxpayment and saves the time involved in taxaudits. For instance, in Yemen, businesses reportthat paying a bribe o 25-40 percent o the taxassessment can lower the assessment by 50percent. In many developing countries, largerms take this opportunity (and exploit theloopholes in tax laws) to inormally negotiate

and le tax returns under the presumptiveregime designed or small businesses, withoutdisclosing the accounts.

Weak enorcement oten means there is nosignicant risk o detection and punishment,

which urther encourages corrupt behavior. Ahigh tax burden and compliance cost canexacerbate the situation. Moreover, the inevitablequestion remains: Why would I pay tax? In theabsence o any tangible benets o public

Tacklg Corrupto through

Tax Admstrato Rorm

A weak tax administration encourages corruption that benets both

government ocials and businesses at the expense o overall tax revenue.

Collusive corruption is at the heart o most, i not all, problems relatedto tax administration. Tis note examines the drivers o corruption

and suggests good-practice measures or reorming tax administration.

It is one in a series addressing issues that governments o developing

countries ace in reorming their tax systems.

BUSINESS TAXATION

investment climate

Aminur Rahman

Aminur Rahman (arahman@

ic.org) is an investment

policy ocer in the World Ba

Group and a member o theInvestment Climate Depart-

ment (CIC) business taxation

product team. He advises cli-

ent governments in developin

countries on implementing ta

reorms that will reduce barri

ers to compliance, investmen

and economic growth.

This note, one in a series on

business taxation reorm, wadeveloped as part o a joint

program between the United

Kingdoms Department or

International Development

(DFID) and CIC. The program

ocuses on operational issues

in tax reorm, particularly tho

related to micro-enterprises

and small businesses.

The IN PRACTICE note series

discusses practical consid-

erations and approaches or

implementing reorms that

aim to improve the business

environment. IN PRACTICE i

published by the Investment

Climate Department o the

World Bank Group.

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IN PRACTICE BUSINESS TAxATIoN 2

spending, taxpayers in many countries do not eel acivic obligation to pay tax, believing their income istaxed to pay the salaries o corrupt public ocials.

What drvs th supply o

tax corrupto?

Despite the oten robust demand, the key driverso tax corruption are on the supply side. In manycountries, oering a bribe is the only way to avoidharassment rom tax ocials. Reusal to pay bribesmay result in endless inspections (and require-ments) that can last or months and wastesignicant senior management time.

Similarly, while appeal procedures exist in many

countries, they are not credible. Firms usually donot try to appeal; they view the decisions in mostcases as avoring the tax authority and penalizingbusinesses with heavy nes and imprisonment.During the long period o settlement, the rmmay also ace pressure rom tax ocials toinormally settle with a bribe. Consequently,companies oten decide not to enter into a dispute.

Te underlying causes that drive corruption amongtax ocials include: complex and unclear tax laws

and procedures; non-transparent hiring andreward mechanisms; a low level o skills; a lack oproessional ethics and integrity; low pay and alack o incentives; conficts o interest; the get

rich-quick syndrome; and insucient checks andbalances within the administration.

Good-practc rorm

masurs

ax reorm measures should tackle both thedemand (businesses) and supply (taxadministration) side drivers o corruption. Techallenges o weak administration and pervasivecorruption are closely related and mutuallyreinorcing. Tus, good-practice reorm measures

aimed at tax corruption also refect the key eatureso modern tax administration.

A typical technical assistance program or taadministration reorm addresses several reormmeasures in strategic sequence. In the short term(within 18 months), the program aims to simpliytax instruments and processes; acilitate underlyinglegal reorms; consolidate subnational taxes andees; and provide training and capacity buildingor tax ocials and the private sector to successullyimplement the streamlined, consolidated tax

instruments and processes. In the medium-term(within 36 months), the program will redesign taxadministration architecture that involveinstitutional autonomy; reorganize the system andservices based on types o taxpayers; and implemenhuman resource management policy, automationincentive mechanisms, and checks and balances.

Short- to mdum-trm

rorm mplmtato

Simpliy, standardize, and harmonize tax

procedures. A simpler process reduces tax ocialsdiscretionary power and abuse o tax laws, lesseningthe burden or rms to comply. For exampleColombia recently carried out a systematic studyo important business processes and prepared amap o corruption risks to guide procedurachanges. Latvia and Jamaica reormed their tax andcustoms codes to reduce the discretion o revenueocials and simpliy procedures.

Sx Rasos to Rorm Tax Admstrato

ax administration is a critical determinant in the investmentclimate. Improving it can help attract more investment to increase

growth and reduce poverty.

ax reorm reduces the compliance cost and broadens the tax net,enabling the government to raise revenue with a lower tax rate and to

equitably distribute the tax burden.

For any given tax policy, a well-unctioning administration raisesmore revenue than a malunctioning one.

ax policy reorm without administrative reorm is not ruitul in anenvironment o mistrust; the good intentions o either tax ocials or

businesses are cynically viewed by the other party.

ax corruption propels corruption in other areas; reorm is essentialto cut the supply lines o corruption.

A modern tax administration is necessary to keep up withthe increasing sophistication o rms operations in the era o

globalization.

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IN PRACTICE BUSINESS TAxATIoN

Enorce compliance and target corruption witha strengthened legal ramework and adminis-tration. A lower tax burden will not increasecompliance without an eective enorcement

mechanism. Te laws should enorce recordkeeping, return ling, voluntary registration, andarrears collection. Under sel-assessment, complianttaxpayers should be ree to conduct business

without abusive auditing, and those considerednon-compliant should be penalized. Te legalramework should refect zero tolerance orcorruption. I proven guilty o corruption, theoenderswhether they are tax ocials or rmsshould be punished.

Conduct taxpayer outreach and education.Educating taxpayers reduces rms misconceptions

and conusion about tax policies and procedures,and raises their awareness on the benets o properrecord-keeping, such as quick assessments and lesslikelihood o being audited (and less intrusively, iaudited). It also works to instill trust between theadministration and business. In Uganda, Rwanda,and South Arica, outreach activities have includedV and radio coverage, advertising, and tax-themed school programs to help childrenunderstand the civic responsibility o paying taxes.

Institutionalize an efective control and audit

system. Experience suggests that most rms willcomply in paying taxes i they understand theirobligations, and i they see the tax administration isair in handling non-compliance. Te risk-basedauditing system enables eective auditing andecient management o the administrationsresources. A number o countries, including Chile,Colombia, and Hungary, have implementedsystems that compile inormation rom varioussources to create risk proles. Hungary has importeda system that guides auditors through the steps oan audit. Other measures include: streamlining thereporting arrangement or audits; rotating auditors

to prevent corrupt aliations between auditors andaudited rms; and implementing a system tomonitor individual auditors.

Mdum- to log-trm rorm

mplmtato

Institutionalize e-services and automation.Reducing ace-to-ace interactions betweenbusinesses and tax ocials limits opportunities or

corruption, as has been demonstrated in thePhilippines and Nepal. Automation is a key eatureo modern tax administration. It eciently collectsinormation rom taxpayers and other parties (such

as banks and government agencies) andelectronically supports clerical unctions. It enablesbusinesses to le returns and to easily and quicklydeclare and pay taxes. Automation is also essentialor risk-based management approaches.

Introduce an efective human resourcemanagement policy. Te administration shouldhave a transparent, air, and streamlined policy orrecruitment, perormance appraisal, careerdevelopment, and compensation includingincentives. Sta proessional development needs toinclude an anti-corruption ocus, ethics, and code

o conduct. Employee achievements in detectingtax raud, attaining client satisaction, andimproving revenue collection should be recognized.Latvia, the Russian Federation, and Colombia haveocused on strengthening their tax administrationmanagement. Many countries have used revenueadministration restructuring to establish humanresource management principles and terminatecorrupt ocials. In Guatemala, Peru, and Jamaica,a rigorous process o psycho-metric tests, job-specic skill tests, interviews, and personal recordreviews was used to weed out corrupt and under-

perorming employees. o improve tax ocialspay (thus lowering the incentive or corruption),some countries have disassociated revenueadministration sta salaries rom general civilservice pay. In Guatemala, the salaries o topmanagers were increased signicantly. Jamaicacreated a separate pay scale or tax administrationsta. Russia and Albania allowed managers to giveperormance-based bonuses.

Institutionalize a streamlined and transparentappeal procedure. An unbiased, quick, andtransparent appeal process helps rms develop

trust in the overall system. In shortening theprocess, the tax authority can limit abuse by rmsthat appeal in order to deer paying taxes over anextended dispute period. Te Revenue Appealsribunal, a process widely used in the UnitedKingdom, Canada, and Uganda, can be expedientin moving trials to conclusion.

Reorganize tax administration by type otaxpayer. o increase eciency and eectiveness,the tax authority headquarters and local oce

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network should be rationalized and streamlinedbased on the dierent sizes o taxpayers. Mostrevenue administrations are moving toward thissort o institutional restructuring. Segmented

service delivery enables the tax authority to betterunderstand each category o rms, allowing orinormed monitoring o taxpayers and tax ocials.For instance, under a size-specic structure, it ismore dicult or larger rms to hide prot orincome and le as small rms. A unctionalorganization structure has been implemented inLatvia, Jamaica, and Russia. A large taxpayersoce has been successully established in South

Arica, most transition countries, and in manycountries in Latin America.

Ensure the tax authoritys autonomy. Although

the tax authority is oten attached to the Ministryo Finance, measures should be taken to strengthenthe administrative autonomy o tax services. Teeectiveness o the measures discussed aboveincentives and penalties, streamlined operations,management and controlcrucially depends onboth organizational and budgetary autonomy.

Autonomy increases the transparency o the taxadministration and its budget and the eectivenessand eciency o its expenses. It is important inpromoting merit-based recruitment, perormance-based career development, and proessional skill

development. Autonomy minimizes the chances othe administrations involvement in politicalcorruption and client avoritism.

Cocluso

An important lesson in tax administration reorm,as experience around the world indicates, is thatundertaking reorms on a piecemeal basis does notyield the desired results because each reormmeasure is critically interlinked with others.Tereore, designing and enacting a comprehensive

reorm package requires continued and strongpolitical will over time.

Understanding how reorm measures work togetheris key in addressing challenges on the ground intheir implementation. For instance, simpliying

processes does not automatically ensure complianceBusinesses can still evade tax without a strongenorcement mechanism. Enorcement should bematched with appropriate checks and balances in

administration or tax ocials will abuse theirpower. Similarly, in an atmosphere o mistrust (andlack o condence in the judicial system), rmseldom use an appeal mechanism and complainhotlines because they believe the decisions wilpenalize them and avor tax ocials.

Pay raises and bonuses or tax ocials, orinstitutional autonomy or that matter (which ipolitically challenging to achieve), are not a panaceato stop tax ocials rent-seeking behavior. Aevidenced in Uganda, Ghana, and anzania, theinitial gain in terms o improved revenue collection

due to pay raises or institutional autonomy is notalways sustainable without checks and balances andpunitive measures against corruption. In anenvironment where corruption is a way o lie andthe tax authoritys higher tiers share the proceeds othe lower tiers bribery, these sorts o administration-

wide measures against corruption are dicu without support at the highest levels o thgovernment (which is also not prone to electionresults and changes in political leadership).

Te key to sustainable progress against corruption

lies in sequencing the measures o an overalstrategy or reorm. While each measure addressea specic driver o corruption and a ull reormpackage must be implemented over the longeterm (or widespread corruption will prevaithrough the weaker links in the system), amanageable and logical sequencing rst addressesthe shorter-term implementation components (taxinstruments and processes, taxpayer awarenessand the underlying legal and administrativeramework). It does not make sense, or instanceto address human resource policy beore an auditand control system is in place. Tus

implementation o the shorter-term measureprovides a basis or longer-term structural andinstitutional reorm, such as reorganization o thetax administration architecture.Further reading on this topic is available from theauthor upon request.

The World Bank Groups Investment

Climate Department (CIC) is the op-

erational center or IFCs Business En-abling Environment Advisory Services

and FIAS, the multi-donor investment

climate advisory service. CIC assists the

governments o developing countries

and transition economies in reorm-

ng their business environments, with

emphasis on regulatory simplication

and investment generation. The nd-

ngs, interpretations, and conclusions

ncluded in this note are those o the

author and do not necessarily refectthe views o the Executive Directors o

the World Bank or the governments

they represent.