how can the government improve tax collections without imposing much taxes on the consumers
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A typical developing economy collects just 15 percent of GDP in taxes, compared with the 40 percent collected by a typical advanced economy. The ability to collect taxes is central to a country’s capacity to finance social services such as health and education, critical infrastructure such as electricity and roads, and other public goods. Considering the vast needs of poor countries, this low level of tax collection is putting economic development at risk.
How can policymakers tackle this challenge? A look at successful reforms between 2004 and 2015 in five low-income and emerging market economies—which achieved some of the largest revenue gains after tax reform—offers some answers. The experiences of this diverse set of countries—Cambodia, Georgia, Guyana, Liberia, and Ukraine—show that, regardless of the constraints they face, countries can strengthen their capacity to collect tax revenue by pursuing reform strategies with certain distinct features. We focus here mainly on Georgia. By analyzing what worked in that country we can draw lessons for what strategies other countries should consider.
Georgia offers a striking example of successful tax revenue reform. Following the collapse of the Soviet Union, the government struggled to collect tax revenue. By 2003, rampant corruption involving tax evasion, illegal tax credits, and theft of government tax revenue had left public finances in shambles. The government was no longer able to honor its obligations to public servants and pensioners, even though salaries and pensions were very low.
Georgia’s sweeping tax reform was made possible after the 2003 Rose Revolution, which gave the new government a mandate to reform the economy and fight widespread corruption. The country’s new leaders adopted a policy of zero tolerance for corruption, and the culture began to change, along with the laws. A revised tax code, passed in 2004, simplified the tax system, reduced rates, and eliminated a series of minor local taxes that had been generating little revenue (on pollution and gambling, for example). Only 7 of 21 taxes remained, and many of the rates were reduced.
Have a clear mandate. Governments with a clear mandate to reform the tax system often succeed. Georgia’s comprehensive tax reform was feasible only after the country had reached a high degree of dysfunction, triggering a revolution. Similarly, in Ukraine, the 2004 Orange Revolution was a catalyst for tax reform. And in 2003, Liberia initiated reform after the civil war had ended.
Secure high-level political commitment and buy-in from all stakeholders. While a clear mandate is necessary, it is not sufficient. Many newly
elected governments do have such a mandate, but not all of them reform. Therefore, political commitment at the highest level and broad buy-in are needed. Social dialogue enhances the likelihood of reforms being implemented and sustained. Effective communication with stakeholders that emphasizes the intended benefits of reforms can help overcome resistance of vested interests. And compensating the losers has proved effective in winning public support for tax reform initiatives.
Reducing exemptions figured prominently in nearly all five countries. Guyana, for example, implemented a comprehensive exemption reform with main elements that included eliminating the power of the finance minister to grant discretionary exemptions, publishing exemptions annually, and limiting income tax holidays to every 5 or 10 years, depending on the sector.
Guyana successfully introduced a VAT on January 1, 2007, despite significant challenges in the preparatory work, including setting up the new VAT department with fully trained staff, putting in place the supporting IT system and procedures, and training potential registrants and practitioners. The VAT was broad-based, with a single rate of 16 percent and a limited number of exemptions for financial, medical, and educational services. As part of its reform, Ukraine also curbed VAT exemptions and revised the regime for agriculture by reducing the rate and eliminating refunds.
Increases in excise and sales taxes are the simplest measures because they can raise revenue fairly quickly without fundamental changes to the tax system. For example, Guyana in 2015 took advantage of the decline in the international price of oil to raise fuel excise taxes. This step buoyed revenue during the country’s economic slowdown. Similarly, Liberia broadened the scope of its goods and services tax while raising excise taxes on alcoholic beverages and cigarettes.