Tax evasion: Pressure to end tax evasion grows as the Global Forum publishes new reviews

05/04/2012 - The Global Forum on Transparency and Exchange of Information for Tax Purposes has just completed peer reviews of another 11 jurisdictions.

Reports on Brazil, Chile, Costa Rica, Cyprus, the Czech Republic, Guatemala, Malta,Mexico, Saint Vincent and the Grenadines and the Slovak Republic evaluate whether their national laws allow transparency and international exchange of tax information (Phase 1). The review of Korea also looked at the effectiveness of Korea’s exchange of information in practice (Phase 1 plus Phase 2). These reports bring to a total of 70 the number of peer review the Global Forum has completed since March 2010.

The Global Forum also issued 3 supplementary reports - for Barbados, Bermuda and Qatar – which assess the whether these jurisdictions have acted upon the Forum’s recommendations to improve agreements and legislation. All three jurisdictions’ compliance with the international standards has progressing significantly. The Phase 2 reviews for Bermuda and Qatar will take place in the second half of 2012 and for Barbados in the first half of 2013.

These in depth reviews identify deficiencies and make recommendations on how the jurisdictions should address these concerns. The legal and regulatory framework is improving quickly in many jurisdictions. Previously, 11 jurisdictions were not able to move to the second phase in the review process. As a result of work by Barbados to establish a network of international agreements to underpin information exchange in tax matters, Barbados can now move to its Phase 2 review.

The reports of Costa Rica and Guatemala, however, conclude that they will not yet move to the next stage of the review process because the deficiencies in their legal frameworks are serious. This will be reconsidered once reports on their progress are received.

Outcomes of the 14 Reports

Report on the legal framework and on its application (Phase 1 and 2)

Korea: Korea has long been negotiating tax treaties and now has an extensive network of bilateral agreements that provide for exchange of information (EOI) in tax matters with 86 jurisdictions. Korea’s legal framework ensures the availability of banking information as well as ownership and accounting information for companies, partnerships and trusts, although improvements are needed for information pertaining to holders of bearer shares. Korea’s network of EOI agreements, as well as its tax authorities’ broad powers to gather information, ensure effective exchange of information with a large number of jurisdictions. The report also highlights steps taken by Korea over the last two years which have lead to  measurable improvements in Korea’s capacities to answer incoming requests received from other jurisdictions in a timely manner. See the EOI Portal page for Korea: http://www.eoi-tax.org/jurisdictions/KR.

Reports on the legal framework (Phase 1)

Brazil: The legal and regulatory framework for the exchange of tax information in Brazil is in place. Brazil has a network of EOI agreements with 34 jurisdictions, but some gaps remain with regards to older treaties due to restrictions in the conventions, combined or not with restrictions in its treaty partners’ domestic laws. The review recommends that Brazil move more quickly from signing EOI agreements to bringing them into force, speeding up the process which at present can take up to 2 years. Brazil also signed the multilateral Convention on Mutual Administrative Assistance in Tax Matters during the G20 Summit in November 2011, confirming its commitment to the internationally agreed standard. Brazil’s response to the recommendations made in this review, as well as the application of the legal framework in practice, will be considered in detail in the Phase 2 Peer Review of Brazil which is scheduled for the first half of 2012. See the EOI Portal page for Brazil: http://www.eoi-tax.org/jurisdictions/BR.

Chile: The legal and regulatory framework for the availability of information in Chile is in place to a large extent. Though some procedural aspects need improvement, legislation passed in 2009 allows full exchange of bank information so  Chilean tax authorities have access powers to all relevant information. Chile has a network of agreements that provide for exchange of information in tax matters to 27 partner jurisdictions of which 25 meet the standard. Chile also continues negotiating new DTCs and recently started negotiating TIEAs. Chile’s response to the recommendations in this report, as well as the application of the legal framework to the practices of its competent authority will be considered in detail in the Phase 2 Peer Review of Chile, which is scheduled for the second half of 2013. See the EOI Portal page for Chile: http://www.eoi-tax.org/jurisdictions/CL.

Costa Rica: Though Costa Rica has signed 13 new TIEAs and a Mutual Convention is in effect with Guatemala and Honduras, it’s domestic laws might hamper effective exchange of information.  In particular, ownership and accounting information related to companies, partnerships and trusts is not always available and the tax administration has insufficient powers to access information requested by foreign counterparts. As none of Costa Rica’s EOI agreements therefore meet global standards and a number of elements crucial to effective exchange of information are not yet in place, Costa Rica will not move to a Phase 2 Review until it acts on the recommendations made in this review. Costa Rica will report back on the steps taken to address the recommendations made in this review within 6 months. See the EOI Portal page for Costa Rica:http://www.eoi-tax.org/jurisdictions/CR.

Cyprus: Cyprus has a network of DTCs covering 44 jurisdictions and it also exchanges tax information with other EU members. Its DTCs generally contain provisions which allow Cyprus to exchange all foreseeably relevant information. However, deficiencies have been identified regarding the availability of ownership and accounting information, and the review recommends changes to address these. The report also recommends improvements in the EOI network to ensure Cyprus has agreements to the standard with all relevant partners and will enact appropriate legislation to give effect to these agreements in all cases. Cyprus’ response to the recommendations made in this review, as well as the application of the legal framework and the implementation of the international standard in practice, will be considered in detail in the Phase 2 review of Cyprus, which is scheduled to commence in the second half of 2012. See the EOI Portal page for Cyprus:http://www.eoi-tax.org/jurisdictions/CY.

Czech Republic: Almost all the Czech Republic’s large network of 87 agreements are in force and in line with the international standard. In addition, it exchanges tax information with other EU members under EU instruments. Some gaps exist however with regards to the availability of ownership information on foreign companies in the Czech Republic. More significantly, there is insufficient information on the owners of bearer shares issued by public limited companies. The Czech Republic’s response to the recommendations made in this review, as well as the application of the legal framework and the implementation of the international standard in practice, will be considered in detail in the Phase 2 review of the Czech Republic, which is scheduled to commence in the first half of 2013. The Czech Republic will report back on the steps taken to address the recommendations made in this review within 6 months. See the EOI Portal page for the Czech Republic http://www.eoi-tax.org/jurisdictions/CZ.

Guatemala: Guatemala is party to a Multilateral Convention which provides for exchange of information on request in tax matters between Guatemala, Costa Rica and Honduras and it is in the process of negotiating agreements with 15 other jurisdictions. However, due to restrictions in Guatemala’s domestic law, it has no agreements that provide for effective exchange of information with its partners. The tax authority does not have adequate powers to access information and ownership information is not always available for foreign companies, foreign partnerships or foreign trusts active in Guatemala. As a number of elements which are crucial to achieving effective exchange of information are not in place, Guatemala will not move to a Phase 2 Review until it has acted on the recommendations made in this review. Guatemala will report back on the steps taken to address the recommendations made in this review within 6 months. See the EOI Portal page for Guatemala: http://www.eoi-tax.org/jurisdictions/GT.

Malta: The legal and regulatory framework for exchange of information in Malta is in place. Ownership and identity information, as well as accounting information, is maintained by entities in line with the international standard. In addition, a lot of information must be filed with the government authorities, in particular the tax authorities and the commercial register. Full banking information is available in Malta, including records of all transactions. Malta has committed to the international standards of transparency and effective exchange of information. It has  a broad network of 66 treaties, almost all of which conform to the international standard, and continues to expand its network of agreements. Malta’s response to recommendations made in its review as well as the application of its legal framework in practice, will be considered in detail in the Phase 2 Peer Review which is scheduled for the second half of 2012. See the EOI Portal page for Malta:http://www.eoi-tax.org/jurisdictions/MT.

Mexico: Mexico has signed DTCs and TIEAs with 60 jurisdictions, the large majority of which are currently in force and allow Mexico to exchange information in line with the international standard. Mexico is in advanced stages of negotiation of DTCs and TIEAs with further jurisdictions, mostly Global Forum members, including OECD and G20 members. Mexico has a strong legal framework which ensures the availability of banking information as well as ownership and accounting information for companies and partnerships, though information is not always available for those foreign trusts which are administered in Mexico or in respect of which a trustee is resident in Mexico. Mexico’s response to the recommendations made in its review, as well as the application of its legal framework in practice, will be considered in detail in the Phase 2 Peer Review of Mexico, which is scheduled for the second half of 2013. See the EOI Portal page for Mexico: http://www.eoi-tax.org/jurisdictions/MX.

Saint Vincent and the Grenadines: The legal and regulatory framework for transparency and exchange of information for tax purposes is largely in place for Saint Vincent and the Grenadines with regard to the availability of ownership and bank information and authorities have the power to access such information. It has also built up a good network of EOI agreements and can currently exchange information with 22 relevant partners. The review notes one main deficiency - the unavailability of accounting information for international business companies. Saint Vincent and the Grenadines’ response to the recommendations made in its review, as well as the application of its legal framework in practice, will be considered in detail in its Phase 2 Peer Review, which is scheduled to commence in the second half of 2013. See the EOI Portal page for Saint Vincent and the Grenadines: http://www.eoi-tax.org/jurisdictions/VC.

Slovak Republic: The Slovak Republic has a well developed legal framework for exchange of information for tax purposes. It has also built up an extensive network of EOI agreements, most of which are in line with the international standard, allowing it to exchange information with 62 jurisdictions. The review’s key concerns relate to the unavailability of ownership and accounting information for foreign trusts with Slovak-resident trustees and the wide scope of professional privilege for tax advisors and lawyers which may limit the tax administration’s access to needed information. The Slovak Republic’s response to the recommendations made in its review, as well as the application of its legal framework in practice, will be considered in detail in its Phase 2 Peer Review, which is scheduled to commence in the first half of 2013. See the EOI Portal page for the Slovak Republic: http://www.eoi-tax.org/jurisdictions/SK.

Supplementary Reports

Barbados: This supplementary report assesses the new exchange of information instruments signed by Barbados since its Phase 1 review report. As of January 2012, Barbados has EOI instruments with 37 partners, of which 16 meet the standard and another 9 will meet the standard once in force. Barbados also signed a protocol to its DTC with Canada in November 2011. Thus, Barbados now has EOI instruments to the standard with both of its prominent EOI partners and it continues to develop its exchange of information network. Given the progress made by Barbados since October 2010 to its legal and regulatory framework for transparency and exchange of information, in particular in respect of the elements that were found to be “not in place”, the Phase 2 review of Barbados will take place, in accordance with the schedule of reviews adopted by the Global Forum, during the first half of 2013. See the EOI Portal page for Barbados:http://www.eoi-tax.org/jurisdictions/BB.

Bermuda: This report assesses the new exchange of information instruments signed by Bermuda as well as steps it has taken to clarify existing agreements and some legislative amendments. As of January 2012, Bermuda has 30 EOI agreements, 20 of which are in force, the large majority of which are in line with the international standard. Bermuda has passed legislation to ensure that search and seizure powers are available to obtain information requested by  its EOI partners. Bermuda is encouraged to continue to review and update its legal and regulatory framework in line with the remaining recommendations made in the 2010 Report, particularly as concerns the availability of ownership and accounting information. All further developments in the legal and regulatory framework, as well as the application of its framework in practice, will be considered in detail in the Phase 2 Peer Review which is scheduled to commence in the second half of 2012. See the EOI Portal page for Bermuda: http://www.eoi-tax.org/jurisdictions/BM.

Qatar: Qatar’s authorities have responded to the recommendations of the Phase 1 report by clarifying their access powers through a new regulation to the tax law and by providing a legal opinion from the QFC authority regarding the scope of their trust laws. Consequently, the recommendations made in the Phase 1 report are considered to be addressed in their entirety. As the only concerns with Qatar’s EOI agreements arose from this access powers issue, Qatar is now considered to have EOI agreements which provide for international exchange of information in line with the international standard. Since the Phase 1 report was prepared, Qatar has signed 7 double tax agreements and one protocol to one of its existing agreements. Any further developments in the legal and regulatory framework, as well as the application of its framework in practice, will be considered in detail in the Phase 2 Peer Review which is scheduled for the second half of 2012. See the EOI Portal page for Qatar: http://www.eoi-tax.org/jurisdictions/QA.

More information about the Global Forum:

• Background Information Brief for Journalists
• Website of the Global Forum: www.oecd.org/tax/transparency 
• Exchange of Information Portal: www.eoi-tax.org –

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Towards a one stop shop for cross-border VAT compliance

European Commission. Common rules are proposed for the one stop shop which will be in place as of 2015. It will first apply to telecommunications, broadcasting and electronic services and could be extended to other sectors in the future.

Article 397 of Council Directive 2006/112/EC1 (hereinafter “the VAT Directive”) provides that “the Council, acting unanimously on a proposal from the Commission, shall adopt the measures necessary to implement this Directive”.

On that basis, the Council adopted Council Regulation (EU) No 282/20112, which provides binding rules on the application of certain provisions of the VAT Directive and – inter alia – gave legal certainty to a number of non-binding guidelines agreed by the VAT Committee since 1977.

Large elements of Regulation No 282/2011 are composed of provisions which relate to the adoption of Directive 2008/8/EC3. Article 5 of that Directive contains legal changes concerning the special schemes for telecommunications, broadcasting or electronic services supplied to non-taxable persons by suppliers not established in the Member State of taxation.

Regulation No 282/2011 currently does not provide for any implementing measure related to those provisions which will come into force as of 2015. Therefore it is necessary to adapt that Regulation in order to establish binding rules on the application of the respective provisions of the VAT Directive.

These measures should be adopted by Council as soon as possible and in any case by the middle of 2012, in order to enable the Commission and the Member States to agree on the functional and technical specifications of the IT systems that need to be built for the implementation of these special schemes.

The proposed measures only relate to those aspects (definitions, scope of the schemes, reporting obligations, identification, exclusion, VAT returns, currency, payments, records) for which a common understanding is needed before designing the IT systems. Other measures, notably relating to the determination of the location of the customer, will be proposed by the Commission at a later stage. 

Only Section 2 of Chapter XI of Regulation No 282/2011 needs to be amended.

Proposal for a COUNCIL REGULATION amending Implementing Regulation (EU) No 282/2011 as regards the special schemes for non-established taxable persons supplying telecommunications services, broadcasting services or electronic services to non-taxable persons x

Federal Government’s Health Care Spending Continues Rapid Increase, Shifting Costs to Taxpayers

The Centers for Medicare and Medicaid Services today released an annual report on national health expenditures that revealed health care spending increased by 3.9 percent in 2010, continuing the upward trend in health care costs. But the news that shouldn’t be overlooked in the report is the federal government’s share of total national health expenditures.

In 2010, the federal government’s share increased to 29 percent. This means the American taxpayer will bear the brunt of this rapidly rising health care spending. And there's no relief in sight. In fact, in 2014 as the health care law’s Medicaid expansion and cost sharing subsidies take effect, taxpayer funding of health care is expected to rise even further.

Proponents of the health care law promised the reforms would decrease costs, but the law fails to actually address the rising cost of health care.  The law ignores the problem, and instead places additional expensive mandates on states, individuals, and businesses. Health care costs are going nowhere but up, and it's taxpayers who are footing more and more of the bill. 

The National Health Expenditure Accounts (NHEA) are the official estimates of total health care spending in the United States. Dating back to 1960, the NHEA measures annual U.S. expenditures for health care goods and services, public health activities, government administration, the net cost of health insurance, and investment related to health care. The data are presented by type of service, sources of funding, and by type of sponsor.

U.S. health care spending accelerated slightly in 2010, increasing 3.9 percent compared to growth of 3.8 percent in 2009. Total health expenditures reached $2.6 trillion, which translates to $8,402 per person or 17.9 percent of the nation's Gross Domestic Product, the same share as in 2009.

Downloads

Highlights [PDF, 50 KB]  NHE Web tables [PDF, 566 KB]  National Health Expenditures by type of service and source of funds, CY 1960-2010 [ZIP, 43 KB]  NHE summary including share of GDP, CY 1960-2010 [ZIP, 3 KB]  Sponsor Highlights [PDF, 376 KB]  Definitions, Sources, Methods [PDF, 420 KB]  Summary of benchmark changes (2009) [PDF, 167 KB])  Summary of benchmark changes (2004) [PDF, 35 KB]  Quick Reference: National Health Expenditure category definitions [PDF, 94 KB]  Nation's health dollar - where it came from, where it went [PDF, 352 KB]

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Social Media Technologies and Tax Administration

Social media technologies  (SMTs)  are the new and personalized face of the Internet.  As described in this note, their arrival and development  bring promises of stratified personal contact and new forms of communication and interaction with potentially large and growing numbers of tax system stakeholders.  This note provides a fairly concise description of emerging SMTs, a brief account of their deployment by the private sector and related experiences, and an overview of how these technologies are starting to be used by revenue bodies in their day-to-day operations.  Clearly it is early days but there are some emerging directions, drawing on revenue body and others‘ experiences:

While the breadth of revenue body experience with SMTs to date and described in this note is relatively limited, it  appears overwhelmingly  positive:  1) they offer  virtually free online word-of-mouth marketing; 2) they enable  positive dialogue;  3) they facilitate the  recruitment of  users for  product testing/  innovation; and 4) they can contribute to revenue administration image building.

Like any new technology, there are challenges and risks to be managed (e.g. provision of misleading information);  however,  these  appear manageable by adopting a properly considered and co-ordinated strategy built on the philosophy of……  start small, monitor, evaluate and build on from there in a similar manner. 

The business case for SMT deployment for the moment largely rests on the potential benefits envisaged from using SMTs to advertise revenue body news, products and developments and/ or conducting dialogue for various purposes (e.g. product testing) relevant to conducting day-to-day tax administration while the up-front investments required are, for the most part, relatively limited and contained. 

The incidence of negative experiences with SMTs reported to date by revenue bodies has, for the most part,  been  minimal and of  relatively little  consequence;  much of what has been experienced can be linked to  weaknesses in setups,  challenges in resource availability, and negative feedback (some tax policy-related).  

As for any technology deployment, there should be a sound business case for SMTs; however, the newness of SMTs and the incremental and exploratory nature of their deployment suggests that such a business case should be viewed more as a medium term objective for revenue bodies, given the need to learn and gain experience around how such technologies can best be utilised for day-to-day administration.  

Successful deployment of a social media strategy lies in the right and purposeful implementation of specific social media tools; this stresses the need to consider the characteristics and relevance of each SMT, insights to which are provided in this note.

Overall development and management of a revenue body‘s channel strategy for service delivery should pay regard to the actual and potential role of SMTs, in particular how they can support and possibly reduce demand for traditional channels.  

OECD. FORUM ON TAX ADMINISTRATION: TAXPAYER SERVICES SUB-GROUP.Information note. October 2011

Social Media Technologies and Tax Administration

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Tax: Uruguay’s tax transparency improving, says OECD’s Gurría

OECD. Newsroom.15/12/2011- Uruguay has signed 7 new agreements providing for the exchange of tax information, showing its willingness to implement the global standards. This brings to a total of 18 (1) the number of agreements Uruguay has with other countries, allowing it to move up to the OECD’s list of those that have ‘substantially implemented the standard for exchange of information’.

Uruguay’s actions follow the progress report delivered by the Global Forum on Tax Transparency and Exchange of Information to the Cannes G20 Summit, which suggested that Uruguay still had to address a number of issues for the effective exchange of information.

“The signing of these new agreements shows that Uruguay is committed to moving quickly towards full transparency and effective information exchange,” said OECD Secretary-General Angel Gurría. “I congratulate the government for swiftly acting on one of the Global Forum’s recommendations and encourage it to fully implement the global standard.”

The Global Forum will continue to monitor Uruguay’s progress and report on further developments in line with Uruguay’s commitment to full transparency and effective information exchange for tax purposes.

For more information, journalists are invited to contact Pascal Saint-Amans at + 331 45 24 97 46 or e-mailPascal.Saint-Amans@oecd.org

More information about the Global Forum on Tax Transparency and Exchange of Information:

Exchange of Information Portal: www.eoi-tax.org – Follow the latest news on exchange of information networks and peer reviews for all jurisdictions, including Uruguay.

Background Briefing on the Global Forum

The progress report

More information about the Global Forum: www.oecd.org/tax/transparency

(1) Denmark, Ecuador, Faroe Islands, Finland, France, Germany, Greenland, Hungary, Iceland, Liechtenstein, Malta, Mexico, Norway, Portugal, Republic of Korea, Spain, Sweden, and Switzerland.

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Coordinating tax reforms in the poorest countries: can lost tariffs be recouped?

A revenue-neutral switch from trade taxes to domestic consumption taxes is fraught with implementation challenges in countries with a large informal sector. It is shown for a sample of low-income countries over 25 years that they have had a mixed record of offsetting reductions in trade tax revenue.

The paper then analyzes the specific case of Nepal, using a unique data set compiled from unpublished customs records of imports, tariffs and all other taxes levied at the border. It estimates changes to revenue and domestic production associated with two sets of reforms: i) proportional tariff cuts coordinated with a strictly enforced value-added tax; and ii) proposed tariff cuts under a regional free trade agreement.

It is shown that a revenue-neutral tax reform is conditional on the effectiveness with which domestic taxes are enforced. Furthermore, loss of revenue as a result of intra-regional free trade can be minimized through judicious use of Sensitive Lists that still cover substantially all the trade as required by Article XXIV of the GATT.

World Bank.Author: Wagle, Swarnim.Document Date: 2011/12/01.Document Type: Policy Research Working Paper.Report Number: WPS5919

Coordinating tax reforms in the poorest countries: can lost tariffs be recouped?

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Undeclared economic activity in Central and Eastern Europe,how taxes contribute and how countries respond to the problem

Undeclared work is commonly defined as employment, which according to the law should be declared but is kept fully or partially outside the scope of taxation and social insurance (European Commission, 1998). There are several reasons why people work in the informal sector or – when working in the formal sector - declare only part of their income. In an environment where formal sector jobs are scarce, the informal sector is often the only place individuals can find work, and thus survive. Work opportunities in the formal sector may be lacking because of weak labor demand due to low economic growth or overburdensome regulations, including high taxes, red tape, and strict labor market regulations. 

Further, some individuals may choose an informal sector job because the net income is higher – employees don‘t have to factor in taxes and social benefits in their wages so they can keep more of it. This may result in a decline of labor supply to the formal sector. Indeed, high taxes and other regulations for formal sector activity are often the main reasons why firms and individuals shift activities to the informal sector or declare only part of their income. Some people also feel that the poor quality of government services is a valid reason to work in the informal sector, since they believe that money given to the government is wasted. Under such conditions, tax enforcement is difficult. Furthermore, tax administration may not be adequately equipped with skilled and dedicated staff nor with adequate technical facilities, and the will to enforce the law may be weak due to corruption or a lack of autonomy.   

2. The societal approach to tax compliance may also differ between countries. Informality and tax evasion are more widespread  when tax systems are complex; paying taxes entails high administrative costs for firms and individuals and the burden of tax enforcement is too high. From this perspective, widespread and sustained informal work can be seen as a warning signal that something is wrong within the framework under which formal sector activity operates. The root causes may include excessive taxes and other regulations in labor and product markets, as well as inefficient bureaucracy. 

3. In addition to these structural problems, undeclared work also has a cyclical component. When the economy is booming labor demand in the formal sector increases and workers are in a better position to fight employers seeking to underdeclare their wage, which reduces their unemployment and pension benefits. However, at the time of writing this report, the global economic crisis of 2009 has pushed most Central and Eastern European countries into severe recessions and unemployment has increased. It is very likely that this will lead to an increase in undeclared work in countries that have achieved some progress combatting informality in the past. Additionally, when taxes are raised to reduce fiscal deficits the problem of undeclared work could be exacerbated.

4. Undeclared work raises both equity and efficiency problems. Inequity arises as those who dutifully abide by the law have lower net incomes than dishonest evaders who receive the same gross income.  There is also unfair competition between honest firms and firms that underdeclare wages; the latter may also benefit from public procurement if open tendering focuses only on prices. A high incidence of non-declaration of work also creates a vicious cycle of lower government revenues, poor public services, a higher tax burden on fully declared work, and unfair competition between firms and individuals, thus reinforcing incentives for shifting activities to the informal sector. If evasion rises above a critical level it may also become a herd phenomenon leading to less moral qualms (as ―everybody does it- Hanousek and Palda, 2008). Furthermore, large informal sectors tend to restrain productivity and growth of the economy, as informal firms are generally less productive than formal firms because they prefer to remain small and ―invisible‖ and because informal workers tend to receive less training than formal workers. The incidence of informal activities should therefore be considered when making economic analysis and designing policies.

World Bank.Author:Leibfritz, Willi.Document Date:2011/12/01. Document Type:Policy Research Working Paper.Report Number:WPS5923

Undeclared economic activity in central and eastern Europe,how taxes contribute and how countries respond to the problem

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Coordinating tax reforms in the poorest countries: can lost tariffs be recouped?

A revenue-neutral switch from trade taxes to domestic consumption taxes is fraught with implementation challenges in countries with a large informal sector. It is shown for a sample of low-income countries over 25 years that they have had a mixed record of offsetting reductions in trade tax revenue.

The paper then analyzes the specific case of Nepal, using a unique data set compiled from unpublished customs records of imports, tariffs and all other taxes levied at the border. It estimates changes to revenue and domestic production associated with two sets of reforms: i) proportional tariff cuts coordinated with a strictly enforced value-added tax; and ii) proposed tariff cuts under a regional free trade agreement. It is shown that a revenue-neutral tax reform is conditional on the effectiveness with which domestic taxes are enforced.

Furthermore, loss of revenue as a result of intra-regional free trade can be minimized through judicious use of Sensitive Lists that still cover substantially all the trade as required by Article XXIV of the GATT

World Bank.Author:Wagle,Swarnim.Document Date: 2011/12/01.Document Type:Policy Research Working Paper.Report Number:WPS5919.Volume No: 1 of 1

Coordinating tax reforms in the poorest countries: can lost tariffs be recouped?

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Tax morale, eastern Europe and European enlargement

This study tries to remedy the current lack of tax compliance research analyzing tax morale in 10 Eastern European countries that joined the European Union in 2004 or 2007. By exploring tax morale differences between 1999 and 2008, it shows that tax morale has decreased in 7 out of 10 Eastern European countries. This lack of sustainability may support the incentive based conditionality hypothesis that the European Union only has a limited ability to influence tax morale over time. The author observes that events and processes at the country level are crucial to understanding tax morale. Factors such as perceived government quality and trust in the justice system and the government are positively correlated with tax morale in 2008.

More than 15 years ago, Baldwin (1995) wrote: “The gains from enlarging the EU eastward are potentially enormous. Indeed, it is easy to forget what is at stake. Until recently, millions of men and billions of dollars of equipment stood poised for combat in Europe. Communism‟s demise defused this situation by destroying the existing political and economic structures in the East. However, the outcome of this political creative destruction‟ is still uncertain. If all goes right, rapid Eastern growth would lock in democratic and pro-market reforms, fostering peace and stability throughout the continent. In particular, expanding the market to another 100 million consumers would be a bonanza for West European exporters.

However, if all goes wrong, widespread economic failure in the East could have serious consequences for all of Europe. Even if this did not provoke a return to authoritarianism, serious political or economic turmoil in the East could lead to mass migrations and harm the confidence of investors throughout Europe. An intermediate outcome is the most likely, but these two extreme scenarios serve to illustrate an important fact. Europe is at a turning point in its history.” (p. 475) In the past two decades since this statement was made, Eastern Europe has experienced substantial changes.

Eight countries from that region joined the European Union (EU) on May 2004 (Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia) and two joined the EU in 2007 (Bulgaria and Romania). A democratization and marketization process (Haughton, 2007) has taken place in these countries, and such an enlargement was the most significant since the European Community was created in 1957. It was an important historical event for the EU, termed as the “big bang” enlargement (Noutcheva & Bechev, 2008), and required the building of a suitable tax system (Bernardi, Chandler & Gandullia 2005). However, it is unclear “when, why and how the EU shaped, directed and occasionally determined change in the CEE1” (Haughton 2007, p. 233).

Exploring the effect of the EU on these countries‟ policies and governance is challenging due to causality or internal validity problems: “Based on a counterfactual understanding of causality… the statement that EU causes a particular outcome implies that if the EU were to absent that particular outcome would not occur. (…) However, establishing the causal effect of the EU is far from easy even if one takes full account of alternative explanations. One problem is that factors and mechanisms we associate with European integration often generate similar empirically observable implications rather than rival implications for domestic developments. (…) Moreover, these developments might exhibit similar temporal patterns. European integration, globalisation, neo-liberal ideas, new public management, new information and communication technologies or the individualisation of society emerged in the second half of the last century and intensified in recent decades” (Haverland 2006, pp. 135, 137).

The CEE countries wanted to replicate the political system and economic success of Western Europe or the US, independent of the desire to prepare for EU membership (Haughton 2007). Our study will not be able to solve these problems as our research will be confined to the 10 EU member states mentioned beforehand who experienced the EU integration. One may attempt to disentangle potential factors through a better understanding of the EU‟s transformative power by studying, e.g., the countries and their development over time. Here we focus only on one aspect, namely citizens‟ social norms regarding compliance with tax responsibilities. In line with the literature, we refer to this as tax morale (Torgler 2007a). We will see that institutional and governance conditions are key factors in understanding tax morale. Tax administration reforms also play a key role in promoting tax morale.

However, it is interesting to check whether the EU makes a difference. Haughton (2007), for example, points out that the EU seemed to be extremely powerful, acting as a magnet in the first post-communist years, and as a gatekeeper in the path to the European Union. Noutcheva & Bechev (2008) stress: “EU‟s offer is important because it creates additional incentives to build a pluralistic democracy and pursue liberal economic reforms at home, and thus empowers political and social groups benefiting from Europeanization. On the other hand, the path of non-reform has advantages of its own for rent-seeking elites unwilling to undermine the sources of their domestic power by introducing accountability and transparency in policy making” (p. 115).

Martinez-Vazquez & McNab (2000) also argue that, in countries negotiating their accession to the European Union, the intention to accede acted as a catalyst for rapid tax reform shaped along western lines. On the road to integration with the EU, changes in the tax system were carried out to bring processes in line with developed countries (Owsiak 2007). Schimmelfenning & Sedelmeier (2004, pp. 671-676) developed different models of EU external governance. The incentive model suggests that a state adopts EU rules if the benefits of EU rewards exceed the domestic adoption costs. The effectiveness of rule transfer then increases if rules are set as conditions for rewards and the more determinate they are. The effectiveness of rule transfer increases with the size and speed of the rewards. Moreover, the likelihood of rule adoption increases with the credibility of conditional threats and promises but decreases with the number of veto players incurring net adoption costs from compliance. The social learning model on the other hand suggests that a state adopts EU rules if it is persuaded of the appropriateness of EU rules. Finally, the lesson-drawing model points out that a state adopts EU rule, if it expects these rules to solve domestic policy problems efficiently.

World Bank.Author: Torgler, Benno.Document Date:2011/12/01.Document Type:  Policy Research Working Paper.Report Number: WPS5911.Volume No:1 of 1

Tax morale, eastern Europe and European enlargement

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