25063 Tax Systems in Transition Pradeep Mitra* and Nicholas Stern** World Bank October 2002 * Chief Economist, Europe and Central Asia Region ** Senior Vice President, Development Economics and Chief Economist An earlier version of this paper was prepared for a conference on "Beyond Transition: Development Perspectives and Dilemmas" in Warsaw, Poland on April 12-13, 2002. We thank Daniel Daianu, Yegor Gaidar and Alari Purju, who were the discussants at the conference, for their comments, Jit Gill for a written communication on tax administration in transition countries, Andriy Storozhuk for putting together the tax ,revenue data for the transition countries and for his invaluable assistance to us with the data, calculations, and charts and Lodovico Pizzati, Afsaneh Sedghi, Giedre Tarbuniene and Ekaterina Vashakmadze for compiling the public expenditure data base for the transition countries under the supervision of Bernard Funck. Views expressed are the authors' and do not necessarily reflect those of the World Bank. ABSTRACT Public expenditures which, as a proportion of GDP, were 45 to 50 percent at the beginning of transition in the countries of Eastern Europe and the former Soviet Union, fell during the 1990s, and ranged from 29 percent in the Commonwealth of Independent States (CIS) to over 40 percent in the countries of Central and Eastern Europe and the Baltics (CSB) in the year 2000. How did tax systems, whose primary role is to raise resources to finance those public expenditures evolve during this period? The paper compares tax systems as they have developed over time - from the onset of transition to the end of its first decade-in the CIS and CSB countries as well as in cross section with those in the high income OECD countries. These comparisons show: * a fall in the tax revenue-to-GDP ratio, a significant part of which was accounted for by a decline in revenue from the corporate income tax, the latter arising from the loss of revenue from profits of publicly-owned enterprises; * a decline in the importance of income taxes, mainly accounted for by the fall in the share of corporate income taxes; * a decline in the importance of social security contributions-cum-payroll taxes in the CIS countries; * a rise in the share of individual income taxes; and ii a sharp increase in the importance of domestic indirect taxes in tax revenue-both VAT/sales/turnover taxes and excises- reflecting in part the decline in the role of direct taxes. With the exception of the increase in the importance of personal income taxation, these movements, which are associated with an unraveling of the command economy, go in a direction opposite to those observed in poor countries as they get richer. They reflect two sets of developments. First, the loss of traditional profit, turnover and payroll tax revenue from erstwhile captive state enterprises rendered uncompetitive by price liberalization and either downsized by hardening budget constraints or kept afloat by tax exemptions and a tolerance of tax and other arrears. And, second, the inability to institute quickly a well- administered tax system covering a broad base with low rates which would encourage tax compliance among new and restructured enterprises rather than driving them underground. These two considerations illustrate a key aspect of transition , viz., a movement from a system where the government exercised a preeminent claim on output and income before citizens had access to the remainder, to one with a greatly diminished role for the public sector, where the government needs to collect revenue in order to spend. The paper then asks whether current levels of public expenditures in the transition countries, arrived at in part through socio-political as well as economic judgments about the role of the state, can be financed by the basic instruments available in a modern tax system, viz., a personal income tax, a corporate income tax, social security contributions and payroll taxes, a value added tax on consumption and excises on items such as tobacco, alcoholic beverages and petroleum, without creating significant distortions in the private sector. On the basis of broad efficiency considerations and consistency with comparative evidence on public expenditure shares for countries at comparable income levels, it is suggested that the iii transition countries, depending on their stage of development, should aim for a tax revenue- to GDP ratio in the range of 22 to 31 percent or so, comprising VAT (6 to 7 percent), excises (2 to 3 percent), income tax (6 to 9 percent), social security contribution-cum-payroll tax (6 to 10 percent), and other taxes such as on trade and on property (2 percent). Tax revenue could be supplemented by nontax sources, which usually account for roughly 2 to 3 percent of GDP. The paper concludes by raising the following questions: * What is the level and composition of tax revenue that raises enough resources to finance public expenditures without introducing excessive distortions in the private sector? Is tax revenue as a share of GDP "too high" in the CSB countries and "too low" in the CIS countries? * Is it generally understood that hardening budget constraints for all firms and improving the investment climate to create new firms and stimulate entrepreneurship, without the state dispensing special favors, must go hand in hand? * What is the appropriate tax treatment of small firms, which have been the key to growth and generation of employment? What political strategies are available to eliminate tax exemptions that benefit powerful special interests and to lower tax rates and simplify tax administration that would benefit and encourage compliance by small firms? * Is it generally understood that in many states the tax authorities are a major source of bureaucratic harassment and weakness in the investment climate? What can be done to overcome these problems? * Are the right partnerships in place or being constructed between the government, private sector and civil society in order to foster a culture of voluntary tax compliance in transition economies? iv * How important is it to use corporate tax regimes in transition countries to compete for foreign direct investment as compared to harmonizing taxes and focusing on broader reform of the investment climate? TABLE OF CONTENTS Pages 1. INTRODUCTION 1-3 2. PUBLIC EXPENDITURE IN THE TRANSITION COUNTRIES 4-8 3. TAX SYSTEMS IN TRANSITION 8-23 4. BENCHMARK LEVELS AND COMPOSITION OF TAX REVENUE 23-28 5. TAXATION AND THE INVESTMENT CLIMATE 28-37 6. ADMINISTERING THE TAX SYSTEM 37-40 7. TAXATION AND FOREIGN DIRECT INVESTMENT 40-44 8. CONCLUSION 44-45 9. APPENDIX TABLES 46-5 1 10. REFERENCES 52-53 2 1. INTRODUCTION The transition economies of Eastern Europe and the former Soviet Union which most successfully resumed growth and made progress towards a market economy by the end of the first decade of transition (i) imposed market discipline on the enterprise sector and (ii) established an investment climate conducive to the creation of new firms. These firms became the most dynamic sector of the economy and they flourished without special favors dispensed by the State. Figures 1 and 2 show that countries such as Hungary, the Czech Republic, Poland, Lithuania and Latvia, which witnessed a quick return to growth, following the "transitional recession" which affected all countries, were those where small enterprises defined as those employing fewer than 50 workers provided-by the end of the 1990s- over half of all employment and value added generated in the economy. Moreover, imposition of market discipline and creation of an attractive investment climate must go hand in hand: Figure 3 shows that countries where budget constraints on enterprises were softened, usually through tax exemptions, fiscal and financial subsidies and tolerance of arrears on payments of taxes and energy bills to utility companies, and which thereby created barriers to exit, for unviable firms also saw a low share of aggregate employment in small enterprises'. 'For more details, see World Bank (2002a) 2 Figure 1. Share of Employment in Small Enterprises, 1989-98 60 -luungary -t 4 Czech Rep 40 - - Poland O inL - ~ < Lithuania 20 0 -0 Latvia 20 - ' ~Russia -u Ukraine 0 - - Belarus 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 lazakhstan Note: Small enterprises are defined as those employing 50 or fewer workers Source: World Bank database on SMEs. Figure 2. Share of Value Added in Small Enterprises, 1989-98 To 60 -Hungary -Czech Rep. 50 //-Poland 430 -Lithuania -Latvia a. 30 -Russian Fed. 20 -Ukraine 10 -Georgla -Kazakhstan 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Note: Small enterprises are defined as those employing 50 or fewer workers Source: World Bank database on SMEs. 3 Figure 3. Soft Budget Constraints and Employment in Small Enterprises, 2000 60 0 -- - - - -- - - - Czech Republic 5440Estonia w orgia . Q 30 - - - - - - - - - - - - - - - - - - E - -20 - -RQmania. -cuss ti n eu £Kazakhstai Uk e co 1 0 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 0 I 0 1 2 3 4 5 6 Soft budget constraints Index Source: EBRD (2000); World Bank database on SMEs. What implications do these findings have for tax systems in the transition countries of Eastern Europe and the former Soviet Union? And, looking ahead, what are the reforms in tax policy and administration on which attention should be focused? These are the issues with which this paper is concerned. Section 2 outlines changes in levels of public expenditures and their current structure in order to provide a background for the tax analysis that follows. Section 3 sets out the stylized facts regarding tax systems in transition and relates them to the characteristics of public expenditures noted in Section 2. Section 4 appeals to comparative evidence to suggest in what combination different tax instruments might be used to finance public expenditure without introducing serious distortions in the private sector of the economy. Section 5 reviews the impact of tax systems on the investment climate in transition economies. Section 6 contains a brief review of outstanding issues in the reform of tax administration. Section 7 considers foreign direct investment. Section 8 concludes by bringing together the questions raised by the analysis of the paper and put to its commentators to stimulate discussion at the conference. 4 2. PUBLIC EXPENDITURE IN THE TRANSITION COUNTRIES The purpose of taxation is to raise resources to finance government expenditures on key public goods (such as a stable macroeconomic environment and legal and judicial systems to secure property rights) and the provision of basic social services. Taxation and expenditures should ideally be analyzed together. Figure 4: Public Expenditures and Income Level Per Capita, 2000 X. 55 - CIS 92u &SB 92 45 ^ ~~~~~~~~CSB 00 t ' 35 - t E 25 - 0 5 2.5 3 3.5 4 4.5 5 LOG of Per capita income PPP based Trendline: Y=12.7 X -18.0, with R'=0.3 Based on a sample of 49 developed and developing countries with comparable fiscal data. Source: Alam and Sundberg (2002) CSB refers to Central and Southeastern Europe and the Baltics and includes: Albania, Bosnia, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Macedonia, Poland, Romania, the Slovak Republic and Slovania CIS refers to the Commonwealth of Independent States and includes: Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Russian Federation, Tajikistan, Turkmenistan, Ukraine and Uzbekistan. Figure 4, reproduced from Alam and Sundberg (2002), plots countries' shares of government expenditure in GDP against the log of their per capita income (adjusted for purchasing power parity) across a sample of developed and developing countries for which comparable fiscal data were available in 2000. The figure allows the following two points to be made. 5 The magnitude of expenditure adjustment during the 1 990s was much greater in the CIS countries. Starting from levels of 50 percent or more in the pre-transition years [Tanzi (1991)] and between 45 to 50 percent in 1992, the latter comparable to those in the industrial countries, the share of government expenditure in the CIS countries, fell to levels comparable to those in countries at similar per capita income levels. In contrast, the share of government expenditure in the CSB countries was almost a third higher than that indicated by the figure for countries at similar per capita income levels. This does not necessarily imply, pending further analysis, that public spending in the CSB countries is excessive, since the size of government here, as elsewhere, is shaped, inter alia. by both views about the role of the state and the costs of the tax systems needed to support public expenditures at different levels. * The size of government rises with level of income per capita. Public expenditure as a proportion of GDP is on average 29 percent in the CIS countries, a group of countries with a PPP-based per capita GDP of $3,850 that have made limited progress with transition to a market economy, compared with just under 41 percent in the CSB countries, a group of countries with a PPP-based per capita GDP of $9,350 that are further advanced in the transition. These may be compared with an average of 42 percent in the high-income OECD countries2 3 However, it should be noted that these numbers do not include spending that was moved out of the budgetary arena in the form of implicit and contingent liabilities which softened 2 Simple averages are used to arrive at figures for country groups 3 The high income OECD countries include Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Japan, Luxembourg, New Zealand, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, United Kingdom and the United States of America. 6 budget constraints4. But these do not affect the thrust of the conclusions about tax systems drawn in this paper. Table 1 displays the functional structure of public expenditure both as a share of GDP and as a share of total public expenditure in these groups of countries: the high income OECD, the CSB and the CIS countries. 4 Examples are provided in World Bank (2000a) Table 1 Functional Structure of Public Expenditures: Country Groups (1999-2000 average; in percent of GDP)' Economic Affairs and Services GDP per Total General Defense Public Order Education Health Social Housing & Recreational, Fuel Agriculture, Mining, Manufacturing, Transportation Other Interest Other capita in 2000 Expenditures Public & Safety Security & Community Cultural, & & Forestry, & Construction & Economic Expenditures (PPP US$) Service Welfare Amenities Religious Energy Fishing, & Communication Affairs & Affairs Hunting Services High-Encome 42.4 2.9 1.6 1.2 5.3 5.4 15.6 1.5 0.8 0.2 0.8 0.3 2.2 1.0 4.6 -0.9 CSB3 9,300 41.9 2.9 1.9 2.3 4.8 5.2 14.0 1.8 1.0 0.2 1.2 0.3 2.3 1.2 2.7 0.0 CIS4 3,850 29.1 1.8 1.7 1.5 4.3 2.2 7.8 1.3 0.6 0.5 1.5 0.6 1.5 0.5 1.9 1.3 Functional Structure of Public Expenditures: Country Groups (1999-2000 average; in percent of total expenditures)' Economic Affairs and Services GDP per Total General Defense Public Order & Education Health Social Housing & Recreational, Fuel Agriculture, Mining, Manufacturing, Transportation Other Interest Other capita in 2000 Expenditure5 Public Safety Security & CommunityA Cultural, & & Forestry, & Construction & Economic Expenditures (PPP US$) Service Welfare menities Religious Energy Fishing, & Communication Affairs & Affairs Hunting Services High-Income 26,200 100.0 6.8 3.9 2.7 12.5 12.7 36.7 3.4 1.9 0.5 2.0 0.7 5.1 2.3 10.8 -2.1 OECD' CSB3 9,300 100.0 7.0 4.5 5.5 11.6 12.3 33.3 4.2 2.4 0.5 2.9 0.7 5.6 2.8 6.8 0.1 CIS 4 3,850 100.0 6.3 5.7 5.1 14.9 7.6 26.9 4.5 2.2 1.8 5.3 2.2 5.1 1.6 6.4 4.5 1 Consolidated budgetary, extrabudgetary and social security accounts of central, state/provincial and local govemments. For High-Income OECD countries years of observations vary. 2Austria, Belgium, Denmark, Finland, France, Gemiany, Greece, Ireland, Italy, Luxenbourg, Netheriands, Portugal, Spain, Sweden, United Kingdom, Australia, Canada, Iceland, Japan, New Zealand, Norway, Switzerland, United States 3 Albania, Bosnia, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Siovak Republic, Slovenia, Yugoslavia. For purposes of expenditure, the CSB exdudes Macedonia where a comparable disaggregation into functions was not available and indude Yugoslavia, for which the data pertains to 2001. 'Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Russian Federation, Tajikistan, Turkmenistan, Ukraine, Uzbekistan Excluding grants and transfers between budgets of different leveis. Souve: GFS, IMFstaff reports 8 Social security and welfare account for over a third of public expenditure in the high income OECD and CSB countries and for roughly a quarter of public expenditures in the CIS countries. Public expenditures on health and education make up a quarter of public expenditure in the high income OECD and CSB countries and a little under 22 percent in the CIS countries. They are split roughly evenly between health and education in the OECD and EU accession countries , but health expenditures are around twice as much as those for education in the CIS countries. Altogether expenditures on education, health and social protection account for nearly 60 percent of public expenditures in the high income OECD and CSB countries and nearly a half in the CIS countries. It will be recollected however that both GDP and the share of public expenditures in GDP are significantly lower in the CIS countries, so that public expenditures on education and health, for example, have each fallen to $10 per capita or less in the poorest CIS countries such as the Kyrgyz Republic and Tajikistan. 3. TAX SYSTEMS IN TRANSITION What are the characteristics of the tax systems which raise resources to finance those public expenditures? This section sets tax systems in transition countries in comparative international perspective. Cross sectional comparisons We begin by comparing features of the tax systems in the CIS countries with those in the CSB countries and the high income OECD countries. The stylized facts emerging from 9 such a comparison at the end of the first decade of transition, 1999-2000, are as follows (see Table 2, Figure 5 and, for country details, Appendix tables 1-6). * The share of tax revenue in GDP rises from 22 percent in the CIS countries through 33 percent in the CSB countries to 37 percent in the high income OECD countries. * The share of direct taxes, viz., personal and corporate income taxes plus social security contributions-cum-payroll taxes, in total tax revenue rises from 43 percent in the CIS countries through 54 percent in the CSB countries to 63 percent in the high income OECD countries. While the share of personal income taxes in total tax revenue increases, that of corporate income taxes falls sharply reflecting in part the integration of personal and corporate taxes, with collection at the corporate level counting as advance payment for the personal income tax. It should also be noted that the share of social security contributions-cum-payroll taxes in total tax revenue is significantly higher in the CSB countries at the end of the decade compared, not only to the high income OECD countries but also to the European Union where, social security contributions are higher than in the non-EU countries of the high income OECD group5. 5 It may be noted that social security in the USA generally refers only to pensions whereas social security in Europe covers the area called social protection in the USA. 10 Table 2. Tax Structure of Industrial and Transition Countries (in percent of GDP) Total Tax Other Taxes on Income, Profits, and Social Domestic Taxes on International Trade Wealth Other Revenue Revenue Revenue Capital Gains Security Goods & Services: of Taxes & Tax & & & which Property Revenues Grants Grants Of which Payroll General sales, turnover Of which Taxes Total Individual Corporate tax Total VAT Excises Total Import Export I________ duties duties High 42.9 36.6 6.3 14.4 10.1 2.6 8.9 10.7 6.1 3.1 0.1 0.1 0.0 1.8 0.7 income OECD _ European 45.2 39.4 5.8 14.3 9.6 2.6 10.8 11.9 6.7 3.7 0.0 0.0 0.0 1.5 0.9 Union'2 II I CSB 40.8 35.0 5.8 9.7 5.3 4.3 11.2 11.0 8.4 2.2 2.0 2.0 0.0 0.3 0.8 (early traition) CSB (late 37.7 33.0 4.7 7.4 5.2 2.1 10.6 12.4 8.7 3.4 1.3 1.3 0.0 0.4 0.7 transition)_ CIS 29.3 24.4 4.9 8.0 1.7 6.2 6.2 9.0 6.2 2.5 0.7 0.5 0.1 0.2 0.3 (early transition). CIS (late 25.5 22.2 3.2 5.3 2.0 3.1 4.5 9.7 6.1 2.5 1.2 1.1 0.1 0.8 0.6 transition) I I_ II I Tax Structure of Industrial and Transition Countries ' (in percent of tax revenues) Total Tax Other Taxes on Income, Profits, and Social Domestic Taxes on International Trade Wealth Other Revenue Revenue Revenue Capital Gains Security Goods & Services: of Taxes & Tax & & & which Property Revenues Grants Grants Of which Payroll General sales, turnover Of which Taxes Total Individual Corporate tax Total VAT Excises Total Import Export ___l l_l__duties duties High 117.4 100.0 17.4 39.6 28.2 7.6 23.3 29.6 16.8 8.9 0.5 0.4 0.0 5.3 1.8 income OECD I . I I I I European 114.9 100.0 14.9 36.0 24.2 7.0 26.6 31.3 17.8 10.0 0.0 0.0 0.0 3.9 2.2 Union 2 _ _ __ _ __ _ __ CSB 117.7 100.0 17.7 27.5 14.7 12.6 31.5 31.7 24.0 6.5 6.2 6.2 0.0 0.7 2.4 (early transition) l l l _l_l CSB (late 114.9 100.0 14.9 22.5 15.6 6.5 31.6 37.9 26.6 10.3 4.3 4.3 0.0 1.3 2.4 transition) I l l l l ciS 126.8 100.0 26.8 33.1 7.7 24.6 23.9 37.0 28.1 9.7 3.2 2.4 0.3 0.8 2.1 (early transition) _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ CIS (late 115.3 100.0 15.3 23.9 9.8 12.6 19.4 44.0 31.0 11.6 5.9 5.4 0.4 3.3 3.4 transition) I__ _ _ _ __ _ _ _ _I _ _ _ _ I__ _ _ I__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 1 Consolidated General Government unless indicated otherwise. For those latter indications, see Appendix Tables I to 6 2 Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxemburg, Netherlands, Portugal, Spain, Sweden, United Kingdom 11 Figure 5 Tax Revenues In High Income OECD and Transition Eronomles (% of GDP) -, - -r 7 .' ; r : - in - .; . 42~~~~~~Z 1* _ ~ .J ES'>+Zrt 4 rt' U ... _ . OS(19U-W) cs (190)EM Tax Revenues in High Income OECD and CSB Eronomies (% of GDP) }~~~~~~~~~~~~~ '" -;rm '' ; t 1~~~~~~~~~~~~~~~~~~~~, j k f SA1 ~~~~~~~~~1 , _ _ _ _ _ _ _ _ _ _ _. ' 5J _ _ __ = J _ i_;_ 1 L cf(wlytrnilwPvirM Cw(1v7 " CEM Tax Revenues In CSB and CIS Etonomies (% of GDP) Ou~~~~~~~~~~~~~~~~~~~~~~~~~~~A g _2~~~~~~~~~~aab>.£w C83190D <~~2 LII i Os(w IytraMfnicr0icw OS(igsW)1v97 12 * The share of domestic indirect taxes, viz., VAT/sales/turnover taxes and excises in total tax revenue decreases from 44 percent in the CIS countries through 38 percent in the CSB countries to 30 percent in the industrial countries. With the share of excises remaining broadly unchanged, this reflects a decline in VAT/sales/turnover taxes. * Trade taxes are relatively unimportant in transition countries and their contribution to tax revenue is negligible in the industrial countries. Comparisons over time The stylized facts presented above, involving a comparison both in levels and in composition of tax systems in the CIS, CSB and industrial countries from the lowest to the highest levels of GDP per capita, are broadly similar to those observed in comparisons of developing with industrial countries.6 However, in understanding why tax systems in transition countries look the way they do now, it is also necessary to compare the evolution of tax structures of the CIS countries as well as those of the CSB countries from the early years of transition to those prevailing at the end of its first decade. The stylized facts emerging from this comparison may be summarized as follows (see Table 2, Figure 5 and for country details, Appendix tables 1-6) * The share of tax revenue to GDPfell from 24 percent to 22 percent in the CIS countries and from 35 percent to 33 percent in the CSB countries between the beginning and end of the 1990s, paralleling the reduction in public expenditures noted 6 Burgess and Stern (1993) 13 in Section 2. This left the CSB countries and, a fortiori the CIS countries in 1999- 2000 with a lower tax revenue to GDP ratio than the 37 percent prevailing in the high income OECD countries. * The share of direct taxes, viz., personal and corporate income taxes plus social security contributions-cum-payroll taxes, to total tax revenue fell from 56 percent to 43 percent in the CIS countries and from 59 percent to 54 percent in the CSB countries. This left the transition countries with a share of direct taxes in total tax revenue in 1999-2000 much lower than the 63 percent obtaining in industrial countries. The decline was primarily due to a sharp fall in the share of the corporate income tax-from 25 percent to 13 percent in the CIS countries and 13 percent to 7 percent in the CSB countries-and reflected the elimination of a captive source of revenue, viz. taxes on profits of publicly owned enterprises. This more than offset an increase in the share of the individual income tax in total tax revenue in both groups of transition countries. The share of social security contributions-cum-payroll taxes to total tax revenuefell in the CIS countries to levels below that in the high income OECD economies but remained broadly unchanged in the CSB countries. * The decline in the share of direct taxes is reflected in movements in the share of domestic indirect taxes, viz., VAT/sales/turnover taxes plus excises, which rose from 37 percent to 44 percent in the CIS countries and from 32 percent to 38 percent in the CSB countries. There was an increase in the share of both VAT/sales/turnover taxes as well as excises. - This left the CIS and, a fortiori the CSB countries in 1999-2000 with shares of domestic indirect taxation to GDP higher than the corresponding share 14 of 30 percent in the industrial countries. Moreover, this observation applied equally to the shares of both VAT/sales/turnover taxes and excises in total tax revenue. Graphing the tax transition A visual perspective on how the composition of tax revenue varies between high income OECD, CSB and CIS countries in cross section and over time is provided, following Burgess and Stern (1993), by Figure 6. With trade taxes accounting for a very low proportion of total tax revenue, the figure focuses on the shares of income tax, social security contributions- cum-payroll taxes and domestic indirect taxes in non-trade tax revenue (total tax revenues less trade tax revenue). The points A, B, and C in the triangle represent 100 percent of (non- trade) tax revenue from personal and corporate income taxes, 100 percent from social security contributions cum-payroll taxes and 100 percent from domestic indirect taxes respectively. A point on the line BC corresponds to a zero level of income taxes, while a point on the line AC corresponds to a zero level of social security contributions-cum-payroll taxes and a point on the line AB corresponds to a zero level of domestic indirect taxes. Figure 6, where the three points show unweighted averages for the high income OECD, CSB and CIS country groups, allows the following points to be made. Figure 6: Breakdown of Non-trade Tax Revenue by Type: High Income OECD, CSB, and CIS Economies (unweighted group averages) Individual and Corporate Income Taxes A 90 10 x High Income OECD 80 20 o CSB 70 0 a CIS 60 40 50 50 40 60 30 70 200 \ 80 10 90 Social Security and Payroll Taxes B 0 8 0 6 0 4 0 2 0 c Domestic Indirect Taxes Taxes B 90 80 70 60 50 40 30 20 10 C The high income OECD countries are on average closer to the income tax corner and towards the axis AB compared to the transition countries. The CIS countries are on average closer to the domestic indirect tax corner and towards the axis AC compared to the industrial and CSB countries. The CSB countries are closer to the social security contribution - cum- payroll tax corner and towards the axis BC compared to the CIS countries. Figure 7 shows the scatter for the countries in each group. 16 Figure 7: Breakdown of Non-trade Tax Revenue by Type: High Income OECD, CSB, and CIS Economies Individual and Corporate Income Taxes A 90 10 80 20High Income OECD 0 CSB 7 ~~~~~~~~~A CIS 60 40 50 50 40 60 30 70----------------- 0 0 00 '& A a 20 c o \ 80 Social Security and Payroll A'R Taxes 10 0 90 Domestic Indirect Taxes B 90 80 70 60 50 40 30 20 10 C * More than 95 percent of industrial countries derive 30 percent or more of (non-trade) tax revenue from income taxes, while more than 75 percent of transition countries derive less than 30 percent of tax revenue from income taxes. * More than 80 percent of CIS countries derive 40 percent or more of (non-trade) tax revenue from domestic indirect taxes, while more than 80 percent of industrial countries derive less than 40 percent of tax revenue from domestic indirect taxes. * More than 75 percent of CSB countries derive 30 percent or more of (non-trade) tax revenue from social security and payroll taxes, while more than 80 percent of CIS 17 countries derive less than 30 percent of tax revenue from social security and payroll taxes. Figures 8 through 11 compare the characteristics of tax system in the CSB and CIS countries as between the early years of transition and the end of its first decade. Figures 8 and 9 show that, on average the CSB and CIS countries in 1999-2000 were further away from the income tax corner and closer to the domestic indirect tax corner than they were in early transition. This was a move away from the composition found in high income OECD countries. While the share of social security contributions- cum-payroll taxes (non-trade) tax revenue remained broadly unchanged in the CSB, so that the points representing the CSB countries in early transition and 1999-2000 are equally far away from the AC axis, the CIS countries moved away from the social security contributions-cum-payroll tax corner during the first decade of transition. Figure 8: Breakdown of Tax Revenue by Type: High Income OECD and CSB Economies During Early Transition and in 1999-00 (unweighted group averages) Individual and Corporate Income Taxes A 90 10 High Income OECD o CSB, 1999-00 70/ \~~~~30 60/ \40 + CSB, Early Transition 40 \60 30 +\7 0 Social Security and 80 Payroll Taxes 10 90 Domestic Indirect B C Taxes 90 80 70 60 50 40 30 20 10 Figure 9: Breakdown of Non-trade Tax Revenue by Type: CSB and CIS Economies during Early Transition and in 1999-00 (unweighted group averages) Individual and Corporate Income Taxes 90/ 10 o CSB, 1999-00 80 20 A ClS, 1999-00 70 30 x CIS, Early Transition 60 40 50 50 40 60 x 30 70 0 20 80 Social Security and 10 Payroll Taxes 1 Domestic Indirect Taxes B 90 80 70 60 50 40 30 20 10 C Figure 10: Breakdown of Non-trade Tax Revenue by Type: High Income OECD and CSB Economies during Early Transition and in 1999-2000 Individual and Corporate Income Taxes xc High Income OECD 90 10 8 CSB, 1999-00 80 20 70/ \30 + CSB, Early Transition 60 40 50 50 40 '5':'a'++++,+ ;:' \\60 30 70 Social Security and 20 + + O \80 l Te 10 90 Domestic Indirect Taxes B C 90 80 70 60 50 40 30 20 10 Figure 11: Breakdown of Non-trade Tax Revenue by Type: CSB, and CIS Economies during Early Transition and in 1999-2000 Individual and Corporate Income Taxes A O CSB, 1999-00 90 10 * CIS, 1999-00 80 20 x CIS, Early Transition 60 40 x 50 50 40 x 60 30 XX AX AA 70 OD A A 0 Domestic indirect Taxes Social Security and 2A A 0d Payroll Taxes 10 0 90 B C 90 80 70 60 50 40 30 20 10 20 Figures 10 and 11 show the scatter for the individual countries. * More than 50 percent of the CSB countries and more than 80 percent of the CIS countries in early transition derived 30 percent or more of (non-trade) tax revenue from income taxes, while more than 90 percent of the CSB countries and nearly 60 percent of the CIS countries in 1999-2000 derived less than 30 percent of non-trade tax revenue from income taxes. * More than 75 percent of the CSB countries and more than 55 percent of the CIS countries in early transition derived 40 percent or less of (non-trade) tax revenue from domestic indirect taxes, while more than 60 percent of the CSB countries and more than 80 percent of the CIS countries in 1999-2000 derived 40 percent or more of (non-trade) tax revenue from domestic indirect taxes. What happened and why ? The results of these comparisons, in cross-section between the CIS, CSB and the high income OECD countries, and for two time periods between the CSB and itself as well as the CIS and itself, illustrate the challenges that transition countries have faced in developing a tax system appropriate for a market economy. The opposing movements in key ratios describing levels and composition of taxes (i) between the onset of transition and the end of its first decade in the transition countries and (ii) in cross-section compared to the industrial countries at end-decade suggest that the evolution of tax systems in transition countries is "U-shaped", with regard both to the share of tax revenue to GDP as well as the shares of 21 major taxes in tax revenue. The comparison across the same subgroups of transition countries between the onset of transition and the end of its first decade, inter alia. reflect two sets of developments. First, the loss of traditional profit, turnover and payroll tax revenues from erstwhile captive State enterprises rendered uncompetitive by price liberalization and either downsized by hardening budget constraints or kept afloat by tax exemptions and a tolerance of tax and other arrears. And, second, the inability to institute quickly a well- administered tax system covering a broad base with low rates which would encourage tax compliance among new and restructured enterprises rather than driving them underground. Both considerations illustrate a key aspect of transition, viz. a movement from a system, where the government exercised a preemptive claim on output and income before citizens had access to the remainder to one with a greatly diminished role for the public sector, where the government needs to collect revenue in order to spend. These developments led to * a fall in the tax revenue-to-GDP ratio, a significant part of which was accounted for by a decline in revenue from the corporate income tax, the latter arising from the loss of revenue from profits of publicly-owned enterprises; * a fall in the public expenditures to GDP ratio caused by the need to reduce fiscal deficits in order to stabilize inflation; * a decline in the importance of income taxes, mainly accounted for by the fall in the share of corporate income taxes; * a decline in the importance of social security contributions-cum-payroll taxes in the CIS countries; 22 * a rise in the share of individual income taxes; and * a sharp increase in the importance of domestic indirect taxes in tax revenue-both VAT/sales/turnover taxes and excises- reflecting in part the decline in the role of direct taxes. What needs to be done The cross-sectional and intertemporal comparisons between the CIS, the CSB and the high income OECD countries show, that viewed from the perspective of taxation, outcomes associated with an unraveling of the command economy in the early transition and those that occurred subsequently were different, the latter being analogous to those seen in the development of poor countries. With the exception of the welcome increase in the importance of personal income taxation, the former set of developments needs to be reversed in order to move towards a market economy. However, this needs to be done, not by reclaiming the traditional bases and instruments of central planning but instead by accessing bases in the emerging private sector not under direct state control and using the apparatus of a modern tax system, viz., a personal income tax, a corporate income tax with deductions for the costs of generating those incomes, social security contributions and payroll taxes, a value added tax levied on consumption, excises on items such as tobacco, alcoholic beverages and petroleum and low customs tariffs and implemented by a rule-based tax administration. The developments to be brought about through tax reform are * a rise in the share of tax revenue to GDP; * an increase in the share of direct taxes in tax revenue; 23 * a continuing rise in the share of revenue from personal income taxes; * a decline in the share of revenue from domestic indirect taxes; and * a decline in the contribution of trade taxes to revenue to negligible levels. 4. BENCHMARK LEVELS AND COMPOSITION OF TAX REVENUE Could the current levels of public expenditure in the transition countries arrived at in part through socio-political judgments about the role of the state, be financed by these taxes without creating significant distortions in the private sector? The following considerations are relevant in answering this question. * The value added tax, a very successful innovation in tax practice, raises on average around 7 percent of GDP in the high income OECD countries. Empirical evidence based on those countries suggests that in all countries where the VAT collects more than 7 percent of GDP, there is a clear tradeoff between a higher tax rate and a broader tax base. Countries facing such a tradeoff have rates of 14 percent to 22 percent on bases between 60 percent and 40 percent of GDP. The evidence also suggests that the longer a VAT has been in place, allowing taxpayers and administrators more time for improved compliance and enforcement, the higher is the rate of compliance with the tax.7 It therefore seems reasonable to suppose that transition countries, which have limited experience with the VAT, could not, for the next few years, expect to raise more than around 6 to 7 percent of GDP, depending on the quality of their tax 7 Agha and Haughton (1996), IMF (2001) 24 administration, without encountering problems with compliance or introducing significant distortions into their economies. The other major item of indirect taxation, viz., excises, which are generally levied on alcohol, tobacco and petroleum, can be expected to yield around 2 to 3 percent or so of GDP. Given that these products are associated with 5% or so of total expenditure, this implies high rates of taxation. With trade taxes becoming less important, the share of indirect taxes in GDP can thus be expected to yield roughly 8 to 10 percent of GDP. * Income taxes as a share of GDP, average around 15 percent of GDP in the high income OECD countries. Within the category of income taxes, personal taxes are usually about three to four times as important as corporate taxes in the industrial countries. Corporate taxes typically account for between 2 and 3 percent of GDP, partly reflecting the fact that, with a well-functioning tax administration, there is less need to use income taxes on corporations as a withholding device for collecting personal income taxes. Furthermore, a high corporate income tax rate has the potential for discouraging investment in a world where capital is very mobile across national boundaries. The base for income taxation is assumed to be roughly half of non-agricultural income. The latter as a share of GDP ranges from below 50 percent in Albania to over 90 percent in the Central European countries depending on the country's per capita income level, yielding a range of 25 percent to 45 percent for the tax base. With average rates of income tax in the range of 20 to 25 percent, and taking into account tradeoffs between a higher tax rate and a broader tax base, it may then be expected that the income tax could eventually raise between 6 and 9 percent of GDP depending on a country's per capita 25 income, with the relative share of personal taxes compared to corporate taxes increasing with the level of economic development and the quality of the tax administration. * Social security contributions and payroll taxes as a share of GDP average 11 percent in the EU CSB countries which, despite the significantly lower per capita income in these countries, is comparable to the share prevailing in the European Union. This reflects in part their socialist legacy, and, in part, the successful use of social expenditures to cushion the impact on the poor of downsizing in the early years of transition8. In fact, payroll taxes in the EU accession countries range from 33 percent in Estonia to 50 percent in Slovakia, while Italy, Spain and Sweden have rates about 30 percent and in no case higher than 40 percent.9 Evidence from a recent empirical analysis of Slovakia, where the unemployment rate averaged 19 percent in 2001, suggests that while the unemployment insurance, social assistance and social support schemes have been effective in alleviating poverty, they have exerted significant disincentive effects on labor supply. Reforms of the benefit program designed to "make employment pay" rather than penalizing unemployment, have the potential to reduce double digit unemployment and lower social spending, thereby making possible an eventual reduction in payroll taxesl'. This is also broadly consistent with the findings from other OECD countries and argues for reforms in social expenditures and a reduction of the distortions arising from payroll taxes. The situation is, however, quite different in the CIS countries where social security contributions on average 8 For a further discussion of this point, see World Bank (2000) 9 Riboud, Sanchez and Silva (2002) 10 The analysis is reported in World Bank (2001) 26 account for less than 5 percent of GDP. Turning to the role of these taxes in an overall revenue package, with the wage bill in the formal sector of the economy as a share of GDP ranging from 20 percent to 50 percent or more across countries of the region, and taking into account tradeoffs between a higher tax rate and a broader tax base, a payroll tax rate averaging 20 percent to 30 percent could yield between 6 percent and 10 percent of GDP. Table 3: Benchmark Levels and Composition of Tax Revenue Base, % of Rate Yield, % of GDP GDP VAT 40%-60% 12%-22% 6%-7% Income tax 25%-45% 20%-25% 6%-9% Social Security contribution cum payroll tax 20%-50% 20%-30% 6%-10% Subtotal 18%-26% Excises (tobacco, alcohol, petroleum) 2%-3% Other taxes (trade, property, etc.) 2% Total tax revenue 22%-31% Adjusted downward by one percentage point from 7%-8% for inexperience with the tax On the basis of these broad efficiency considerations and consistency with comparative evidence on public expenditure shares for countries at comparable income levels, it is suggested that the transition countries, depending on their stage of development, aim for a tax revenue-to-GDP ratio in the range of 22 to 31 percent or so, comprising VAT (6 to 7 percent), excises (2 to 3 percent), income tax (6 to 9 percent), social security contribution-cum-payroll tax (6 to 10 percent), and other taxes such as on trade and on property (2 percent)". * While the upper end of this suggested range is lower than the 33 percent of GDP that tax revenue represented in the CSB countries in 1999-2000, it is close enough to the ' A similar analysis for China is presented in Hussein and Stem (1993) 27 expenditure to GDP ratio of 33 percent, typical of countries at comparable per capita income levels, to be fmanceable with non tax revenue sources, which usually account for roughly 2 to 3 percent of GDP. In any event, most EU accession countries, as part of their 2000-2004 Pre-Accession Economic Program, are aiming to cut taxes on the order of 2 percent of GDP and incur incremental expenditures on the order of 3.5 percent of GDP to comply with the requirements of the EU's acquis communautaire, while at the same time improving budget balance by around 0.5 percent of GDP'2. These ambitious goals can only be accomplished through a sharp reduction in the share of regular public expenditures to GDP, together with a tight prioritization within that envelope, which requires a thorough going reappraisal of the role of the state in the economy. The lower end of the 22 to 31 percent range for tax revenue to GDP is equal to the average for the CIS countries. However, the average tax revenue to GDP ratio for the low income CIS countries which face the most acute development challenges (Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Moldova, Tajikistan and Uzbekistan) is only 18 percent. Raising this share in order to finance public expenditures, especially in the social sectors, where they have fallen to extremely low levels in those countries (for example, on education $4 per capita in Tajikistan, $9 per capita in the Kyrgyz Republic and $11 per capita in Armenia in 1999, compared to $180 per capita in the EU accession countries, and on health $1 per capita in Tajikistan and $7 per capita in the Kyrgyz Republic and Georgia in 1999, compared to $176 per capita in the EU accession countries) together with appropriate prioritization of those expenditures, is an important policy priority. 12 Funck (2002) 28 This motivates our first question for the commentators: * What is the level and composition of tax revenue that raises enough resources to finance public expenditures without introducing excessive distortions in the private sector? Is tax revenue as a share of GDP "too high" in the CSB countries and "too low" in the CIS countries? 5. TAXATION AND THE INVESTMENT CLIMATE As noted earlier, small enterprises employing fewer than 50 workers, many of them de novo but also some firms spun off from state enterprises, have been key to generating employment and creating wealth in transition economies. A major policy-cum-institutional challenge facing governments across the region has been the creation of an attractive and competitive investment climate in which restructured and new enterprises have incentives to absorb labor and assets, rendered inexpensive by the downsizing of old and unviable enterprises, and invest in expansion. This challenge includes reducing excessively high marginal tax rates, simplifying regulatory procedures, establishing security'of property rights, and providing basic infrastructure, while maintaining a level playing field among old, restructured and new enterprises. The Business Environment and Enterprise Performance Survey, covering a large number of enterprises in over 20 transition economies, and conducted jointly by the European Bank for Reconstruction and Development and the World Bank in 1999, 29 unbundled factors influencing the investment climate into microeconomic variables (including taxes and regulations), macroeconomic variables (including policy instability, inflation and exchange rates) and law and order (including functioning of the judiciary, corruption, street crime, disorder, organizational crime, and mafia)13. According to the respondents, taxes and regulations were consistently among the most important impediments to expansion by new enterprises. Table 4 reports the number of taxes and the average rates that are imposed on businesses'4 . The number of national taxes-profit tax, VAT/sales tax, income tax and social security taxes (in the form of payroll taxes, the latter here consisted as one tax), together with turnover taxes to support various special funds -which is shown in column 5 of the table, is a rough indicator of the complexity of the tax system 5. On this measure, Poland and Hungary have the least complex national tax systems, as contrasted with Belarus, Turkmenistan and Uzbekistan. However, the last four columns of Table 4 also report the extent to which countries attempt to relieve the burden on small firms through tax breaks or simplified arrangements 1617 Whatever the merits of rules and legislation, the arbitrary bureaucratic harassment to which the administration of taxes and business licensing gives rise continues to be a significant problem. For example, a survey of some 2000 predominantly small and medium 13 For details, see EBRD(1999) 14 We thank Kjetil Tvedt for producing Table 4, which updates Table 8.3 in EBRD (1999). Definitions on SMEs and micro businesses are those used in national tax codes. 15 Column (4) of the table also reports the maximum rate of personal income tax since businesses registered as sole proprietors and often subject to personal income tax. 16 The column for 'tax incentive for new start-ups/investments' emphasizes tax breaks either in favor or disfavor of SMEs. Incentives disfavoring SMEs would be all incentives promoting large investments. Tax breaks for FDIs are interpreted in disfavor of SMEs, based on the assumption that foreign investors normally faces some initial obstacles in form of administrative problems or lack of information, which are in the nature of fixed costs and which play a more significant role for small start-ups firms. 17 General SME tax break is here to be understood as cases when SMEs face a discount in the profit tax because of their size. Simplified tax in form of a gross turnover tax or lump sum tax may cause a reduced tax burden as well. However, the information is not clear on the tax burden following simplified arrangements, and such procedures are never interpreted as an SME tax discount. 30 enterprises (with a mean firm size of 22 workers and a median firm size of 10 workers) done in Russia in March-April 2002 by the Center for Economic and Financial Research (CEFIR) and the World Bank found that in 2001, between 5 and 21 percent of those who had been in business before and after the passing of legislation designed to improve the investment climate, were visited between 2 and 3 times each by sanitary, police and fire safety inspectors, which is in excess of that prescribed by the law 18. 1 CEFIR and World Bank (2002) Table 4. SME Taxation Country GENERAL TAXATION TAXATION RELATED TO SMES Standard Standard Max. Number of VAT tumover tax incentives for new General Simplified tax for SMEs and profit tax VAT personal national threshold (US$) start-ups/investments SME tax sole Income tax taxes break proprietors (lump sum or presumptive) Favouring Favouring large SMEs firms Albania 25% 20% 25% 5 57000 No No No Lump sum or gross tumover tax' Armenia 20% 20% 20% 4 17200 No Yes" No Lump sum Azerbaijan 27% 18% 35% 4 6400 No No No gross tumover tax' Belarus 30% 20% 30% 8v 6000 No No Yes Lump sum Bosnia & Herzegovina 30% 24% sales 50% 4 No No Yes Vill No No (Federation) tax Bosnia & Herzegovina 20%-10% 18% sales 25% 5 No No Yesx No No (Rep) (regressive tax Bulgaria 23,5% 20% 29% 4 33000 No No Ye's Lump sum x, Croatia 20% 22% 35% 4 6000 No Yes x, No Lump sum Czech Republic 31 % 22% 32% 4 91000 No Yes " No Lump sum Estonia 26% 18% 26% 4 No No No No No Georgia 20% 20% 20% 5 11000 No No No Lump sum v Hungary 18% 25% 40% 4 No YWv No No No Kazakhstan 30% 16% 30% 4 25000 No No No Lump sum or gross tumover tax Kosovo 200/a 15% 20% 4 92000 No No No gross tumover taxxv Kyrgyzstan 20% 20% 20% 6 2100 No No No ross tumover tax xv,, Latvia 22% 18% 25% 4 16000 No Yes xvIII Yes x No Lithuania 15% 18% 33% 4 2600 No No Yes5- Presumptive tax"xx (FYR) Macedonia 15% 19% 18% 4 76000 No Yes'ox No Lump sum Moldova 25% 20% 35% 4 No Yes'"l Yes a,r No Lump sum Poland 28% 22% 40% 4 9000 No No No Lump sum Romania 25% 19% 40% 6 1500 Yes m" Yes"I No Gross tumover tax Russia 20-24% 20% 13% 5 (4 from No No No No Gross tumover tax 2003) Slovak Republic 25°/a 23% 38% 4 16000 No YesxX No Lump sum Slovenia 25% 20% 50% 4 20000 No No No No Tajikistan 30% 20% 20% N.A. N.A. N.A. N.A. N.A. N.A. Turkmenistan 25% 20% 25% 6 Small-scale firms No Yesom' Yes "m, Lump sum xxW1 exempt. Ukraine 30% 20% 40% 5 11500 No No No Gross tumover tax xmN Uzbekistan 26% 20% 36% 6 Small firms are No Yes No Gross tumover tax or lump _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ~exem pt. sum___ urn i FRY Montenegro 20% 8-17% Sale 40% 4 No N.A. N.A. N.A. N.A. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ~~~~~tax _ _ FRY Serbia 20% 20'/" sale 20% 4 No YesxXv" No No No tax Albania iLump sum for mkico businesses = annual tumover under 2 million leks (US$14000), 4% gross tumover tax for small businesses = annual tumover 28 million leks (US$57000) 32 FDI Ever ADM 500 million (US$ 860,000) w Fixed payment for small scale acivties such as hairdressers, gas stations, commercial fishing, and trading adcivies conducted in loals with trading area less than 30 square meters. kerbailan iv 2% gross turnover tax when turnover less than 300 times the minimum tax-exempted wage (US$ 6400). Bebrus v In addition to the standard 4, there is Road tax, Chemobyl fund, Public housing fund, and R&D fund. '1 50%/O discount on profit tax for small enterprises = profit less than 5,000 MMW (5000-BYR3600=US$10,000) and having number of staff as mentioned below; for industries - less than 200 people; in science and scientific services - less than 100 people, for oDnstruction and other productive sectors up to 50 people; for nonroduive sectors up to 25 people. i Lump sum tax for stores that are single owned and total trading space less than 25 square meters, plus public caterng enterprises, and at markets and sales exhibRdbns. Bosnia & Herzeoovina (Federation) profd aenerated by foreign capital Bosnag Herzaovina (Republic) I profit generated by foreign capital Bulgaria ' 20°h profi tax for small businesses defined by taxable profit less than BGN 50,000 (US$22,200). i for sole traders. Croatia X Newly established companies qualify for reduced tax rates and the reduction is higher for larger investments. Czech tRepublic li for inv. Over CZK 350 million (US$ 10 million) Georgia for enterprises wit tunmover less than GEL 24,000 (US$ 11,000) Hungary " SMEs can write off its tax by interest on ban used for investment in assets. Kosovo 3°b gross tumover tax for SMEs = tumover under 200,000 DEM (US$ 92,000) Kyrgystan SMEs(total revenue up to 3 million soms or approximately US$63 000) may pay from 5 tol0%/o gross tumover tax instead of all national taxes above (apparently SMEs find this system unfavourable and rather use the general system). Individual entrepreneurs can optionally get a patent and pay a monthly gross tumover tax, i.e. in retail trade - 4%0. Latvia r inv. over US$ 16 million. Xi 20% profit tax for SMEs meeting at least two of the following three oDnditions: book value of tangible assets- 70 000 lats (EUR 123 700);nettumover -200 000 lats (EUR 353 400);average number of employees -25 persons. LUthuania 13%/. profit tax for small businesses with less than 11 employees and a gross annual income less than LTL 500,000 (US$ 130,000). I' Optional for firms with gross income less than 100,000 LTL (US$ 26,000) Macedonia (FYR) i tax holiday for tax generated by foreign capital SMEs may benefit from a 35% discount on profit tax for two years. ħV 50°h tax discount given the first five years if foreign investments exceeds US$ 250,000 w Individual entrepreneurs can buy patent which involve a monthly fee. ERomania for reinvested profit for large FDI micro enterprises with less than 10 employees and an annual tumover less than Euro 100,000. Russia Pianned from 2003; Small enterprises with annual tumover of 10 million roubles (US$320,000) and up to 20 employees will be entitled to choose between 8%h tumover tax or 20°h profdt tax (standard 24%). Slovak Repubfic 5 years tax holiday for FDI over EUR 5 million ETaxbreas subject to negotiations. It is assumed that large firms have more negotiation power. 20-24% profit tax, depending on nature of activity, for small legal entities defined by annual tumover less than TMM 72 million (US$ 14,000), or less than 50 persons in producing firms, or less than 10 persons in trading firms, or less than 25 persons in all other types of firms. ~ Lump sum lIcense for entrepreneur without a legal entity and with annual turnover less than 72 million manats (US$14,000). Ukraine Firms with up to 50 employees and turnover less than UAH 1 million (US$ 190,000) can pay a 6% gross tumover tax which does not exempt actor from VAT, or 10°h gross tumover tax which do exempt firms from VAT. Uzbekistan mfor FDI Optionally, small trading enterprises can pay 25% and small production enterprises can pay 10°h tax of gross tumover instead of entire set of national taxes. Lump sum tax for individual entrepreneurs without a legal entity. tRY Serboa tax discount amounting 30% of new investinents for SMEs ( in comparison to IO% of new investinents for non-SMiEs). 33 While steps to improve the investment climate are important, the hardening of budget constraints on all enterprises has also been key to the resumption and sustenance of growth in successful transition economies. The experience of the transition economies in the 1 990s suggests that a sharp and early decline in aggregate employment preceded the rapid growth of new firms. This made assets cheaply available to new enterprises, which was useful when financing was not readily available and new investment was not forthcoming. When the proportion of employment in small firms reached a threshold of around 40 percent, the sector evolved from being a passive receptacle for absorbing resources into an active competitor, rapidly increasing its share of employment (see figure 12a). In countries where aggregate employment picked up, it did so after the recovery of aggregate output. When the threshold was not reached, people remained "unemployed on the job" as in the CIS and some countries in southeastern Europe. Aggregate employment started to fall only late in the process (see figure 12b). These observations suggest a sequence where hard budget constraints are imposed and the old sector declines before the new sector can grow. The complementarity between hardening budget constraints and improving the investment climate has been extremely important. Our next question for the commentators is: * Is it generally understood that hardening budget constraints for all firms and improving the investment climate to create new firms and stimulate entrepreneurship without the state dispensing special favors to old or new firms must go hand in hand? 34 Figure 12a. Index of GDP and Shares of Value Added and Employment Accounted for by Small Enterprises, 1989-98 Czech Republic Russian Federation Indiex Percent Index Percent 120 60 120 60 -.- GDPirdex 100 60 s 100 so !E Valueaddeby 80 x f40 srral _ _y - 40 _eterpises as _ 30 perenge d 30 60 _ 30 kJ~~~~~~~~~~~~~~~~~~~~ttalvalie60_ _ 3 adodd 40 20 40 20 . Preriagt d 20 10 - esploys s in 20 10 smIl firrm 00 0 0 1989 199 1991 1992 1993 1094 1995 1996 197 1998 1M 1990 191 1992 1990 1994 1995 1999 19g7 1998 Ukraine Lithuania Index Pe9er90 Index Percent 120 60 20 60 --GDP Index 100 50 s 100 50 Value added by 80 40 amal 80 40 antarp isas as percentage of 60 20 80 30 total value 60" /added 40 20 40 20 Percentage of 20 -o employees In 20 10 small firms o. .0 0 0 1989 1990 1991 1892 1993 1994 1998 i9s 1997 19% 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Hungary Kazakhstan Index Percent Index Percent 120 s TO GDP ~~~~120 so 100 a w-8 80 index 60 Vue dded by1 50 small 80 40 40 -1enterprtses 8s 60 percentage of 20 total vatue 60 30 40 - 20 Perrentage of 40 20 -employees In 20 10 small flnrls 20 - -10 o 0 o . 0 1989 1990 1991 1992 1993 1994 1999 1996 1997 1998 1999 1990 1991 1992 1993 1994 1998 1998 1997 1999 Source. World Bank database on small and medium-size enterprises. 35 Table 12b. Employment and GDP, 1990-98 Hungary Czech Republic 110 110 100 0 90 e-- Efployrrent 90 _ 70 70 60 60 50 50 _ _ _ _ _ _ _ _ _ _ _ _ 40 40- 199019911992199319941995199619971998 19901991 1992199319941995199619971998 Poland Ukraine 140 110 100 120 90 100- _0. Bploynrent 80 80 60 - _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ~~~~~~50 60 4 4_0 ,_ ___ __ 30 19901991 1992199319941995199619971998 19901991 1992199319941995 199619971998 Russian Federation Kazakhstan 110 110 100 _ -phyrrDnt 100 80 80*-GDP 90 70 -70- 60 - 60 50 50 - 40 40- 1990 1991 19921993 1994 1995 1996 1997 1998 1990 1991 1992 1993 1994 1995 1996 1997 1998 Biulgaria Romnanla 110 110 100 En_BTploynent 100 90 - -GP90 80 -80 70 - 70 60 60 50 50 40 - 40 1990 1991 19921993 199419951996 19971998 1990 1991 1992 1993 1994 1995 1996 1997 1998 Source: World Bank database on small and medium-size enterprises. 36 In light of this discussion, a major element of the agenda of tax reform is therefore * to eliminate tax exemptions which reflect governance problems in tax administration rather than being equity-enhancing, as is the case, for example, in Georgia where it is estimated that an additional 2 percent of GDP could be collected from excise taxes on petroleum products and cigarettes'9, and * to devise a simplified tax regime for small businesses which relieves the administrative and reporting burden on the taxpayer and minimizes contact between the tax authorities and the taxpayer. The use of tax exemptions and tax relief for such firms is, however, not recommended, in part because potentially 50 percent or more of value added that is generated by small firms in successful transition economies would then escape the tax net, significantly worsening the government's fiscal position without targeting the particular failure, for example, insecurity of property rights or inadequate infrastructure responsible for impeding the development of small firms. This raises another question for the commentators: * What is the appropriate tax treatment of small firms, which have been the key to growth and generation of employment? What political strategies are available '9 World Bank (2002b) 37 to eliminate tax exemptions that benefit powerful special interests and to lower tax rates and simplify tax administration that would benefit and encourage compliance by small firms? 6. ADMINISTERING THE TAX SYSTEM The fundamental change which tax policy has undergone in transition as a result of changing bases and instruments has required the development of a tax administration capable of implementing those policies in countries where there was no such institution. While many countries now have modem tax legislation on their books, the development of the tax administration has lagged that of policy. This is due, not only to a greater focus on changes in policy rather than administration in the early years of transition, but also to the fact that demands on administration arising from changes in tax policy would usually precede development of supporting institutions. While tax administrations in transition countries share many problems with those in developing countries [Bird and Oldman (1990), Gillis (1989)], mention may be made of several unique features of the post-communist legacy, such as * A culture of mutual mistrust between tax payers and the tax authorities; * No tradition of voluntary compliance with tax legislation; * No tradition of appeals to the courts against the decisions of the tax authorities which, by enhancing trust in the fairness of the tax administration, would encourage voluntary compliance; * No tradition of self-assessment, which would shift the burden of appraisal to the private sector and reduce administrative demands placed on the tax authorities. 38 This implies that much attention has been paid, not only to strengthening enforcement, but also to developing taxpayer education and services in order to improve compliance and to maintain an appropriate balance between the two. The former has involved, inter alia. (i) making potential tax payers aware of the general concept of taxation and why they should pay their taxes; (ii) providing assistance, not readily available to any but large taxpayers in the private sector in transition countries, to taxpayers who wish to comply voluntarily; and (iii) reducing compliance costs through simplification of procedures. Strengthened enforcement is also an important factor in improving tax compliance. By way of example, the use of computer systems that can detect non-filers and those that have not paid the full amounts due, and notify them of the need to comply, sends a signal to delinquent taxpayers of the tax authorities' capacity to detect and punish evasion. Another example is the compilation of databases from third party information from multiple public sources (registrars of companies, land transactions etc.) and cross-checking of information between the VAT, income tax and excise tax authorities, as well as from private sources (sellers of luxury cars, banks and financial institutions etc.) about taxable transactions. These help provide independent checks on the veracity of tax returns and identify cases where tax may have been evaded. Yet another example is the selection of cases for auditing so as to target scarce auditing and investigation resources where they can be most effective. International constraints that impinge on tax administration require additional skills, such as implementation of tax treaties with other countries and the ability to detect transfer pricing which shifts income from high-tax to low-tax locations. Most transition countries have set up large taxpayer units to focus on those taxpayers from whom the vast bulk of tax revenue would be derived. These units, which have the most 39 qualified staff, have proved to be important in maintaining revenue collections while the rest of the tax administration is being modernized. Evidence from the first decade of transition shows that the most dynamic part of transition economies are new or restructured enterprises which employ fifty or fewer workers. As noted in Section 5, taxation is among the most prominent of the difficulties in the investment climate facing such firms. It is therefore extremely important that tax policy and its associated administrative requirements for such firms be simplified in order to improve the investment climate while minimizing interactions between them and the tax authorities. While many weaknesses in tax administration may be addressed through technical solutions, the importance of both development of civil society and political will to the administration of tax policy is critical. On the former, tax compliance will grow pari passu with the development of civil society, which is much further along in the CSB compared to the CIS countries. On the latter, political will is required on two fronts. First, political support for hardening budget constraints is essential in order to allow large tax payer units to go after the most prominent tax debtors. Second, a strong political commitment to a level playing field for small enterprises is essential to simplify the tax regime applicable to small enterprises. This sends a clear signal to foreign and domestic investors that the authorities are serious about creating an attractive investment climate. Revenue-sharing rules with subnational governments should also be structured in a way that generates incentives for the latter to encourage the creation of small and new firms rather than focus on old enterprises which are kept afloat through tolerance of tax arrears with implications for how the tax administration operates at the subnational level. However, political commitment to effective implementation of tax policy should be distinguished from the use of the tax administration 40 for political ends, such as selectively enforcing tax discipline on large tax payers. Politicization of the tax administration should be avoided. Our questions for the commentators are: * Is it generally understood that in many states the tax authorities are a major source of bureaucratic harassment and weakness in the investment climate? What can be done to overcome these problems? * Are the right partnerships in place or being constructed between the government, private sector and civil society in order to foster a culture of voluntary tax compliance in transition economies? 7. TAXATION AND FOREIGN DIRECT INVESTMENT During 1996-1999 more than US$70 billion in foreign direct investment flowed to the region, nearly 70 percent of it to the CSB countries (Table 5, which also presents gross domestic investment as a percent of GDP for comparison). In the CIS countries foreign direct investment has been largely confined to the energy-rich countries, with Azerbaijan, Kazakhstan and Russia receiving 75 percent of the total. Russia's share of FDI in GDP was even lower than that of several of the CIS countries, despite its considerable resource endowment. 41 Table 5. Main Recipients of Foreign Direct Investment, 1992-95 and 1996-1999 1992-95 1996-99 Memo item Memo item Gross Gross $ millions Percent of GDP Domestic $ millions Percent of Domestic Investment as GDP Investment as a percent of a percent of GDP GDP CSB 21,091 0.5 19.3 50,558 3.3 24.7 Czech Republic 4,821 2.9 29.4 10,104 4.6 31.5 Estonia 647 3.9 26.9 1,050 5.2 28.2 Hungary 9,399 5.7 20.5 6,979 3.8 28.3 Poland 2,540 0.6 17.9 17,096 2.9 24.8 CIS 8,272 1.0 26.2 22,001 2.5 20.8 Azerbaijan 237 4.2 15.1 3,222 20.9 30.8 Kazakhstan 2,357 2.7 25.0 4,971 6.4 15.1 Russian Federation 3,965 0.3 28.1 8,412 0.7 19.6 Turkmenistan 427 3.5 - 334 3.0 43.5a 'Averages of 1997-1999 Note: Shares of GDP are period averages of medians for the group. Source: World Bank staff estimates and country statistical offices. Much foreign direct investment was driven by the sales of assets to strategic foreign investors; indeed, cumulative FDI is highly correlated with cumulative privatization revenues.20 FDI brought with it two advantages: first, technology and skills and, in some cases, the governance capacity and standards of the home country and second, a source of foreign financing which, compared to bond and equity capital flows, was less prone to volatility in international capital markets. Figure 13 shows that higher cumulative foreign direct investment, often a good proxy for a more attractive investment climate in the host country (see World Bank (2002c)), was associated with a higher share of aggregate employment in small enterprises. 20 EBRD (2000) 42 Figure 13. Cumulative Foreign Direct Investment Per Capita and Employment in Small Enterprises, 1998 1,800 HUN 1,600H a 1,400- -e 1,200- EST CZE g 1,000- 800 LAT 600 Em 400 -KA Z LIT 4 200 - BUL ROM POL 200 UKR RUS EO E0 0 10 20 30 40 50 60 Contribution of small enterprises to employment (percent) Source: EBRD (2000); World Bank database on SMEs. Improving the investment climate for domestic and foreign investment alike remains an important issue for the CIS countries and those in southeastern Europe. In the advanced reformers where few large privatizations are left, a major challenge facing policy makers is to devise an investment climate that can continue to attract inflows of FDI into greenfield ventures and cross-border acquisitions of private sector assets, together with the associated entrepreneurial experience, without undermining the country's fiscal position through the provision of tax incentives. Many countries-Bulgaria, Estonia, the Czech Republic, Hungary, Romania and Slovakia-have offered tax incentives, employment subsidies and special economic zones to attract foreign investment. In fact, the provision of generous investment incentives in the Czech and Slovak Republics in 1996 and 1997 respectively was associated with a doubling of non-privatization-related FDI in those countries. 43 Recent empirical studies in developed countries suggest that the location of investment, its modes of financing and associated tax avoidance respond more strongly to tax changes than had been previously thought to have been the case2 1. Moreover, candidate countries for EU accession-the Czech Republic, Hungary, Poland and Slovakia-and, indeed member countries of the EU, such as Ireland, have successfully engaged in tax competition to attract FDI within their borders. In such a situation, countries with high corporate tax rates face the potential for a reduction in FDI inflows and profit-shifting to lower tax locations through transfer pricing by multinationals, and may, therefore, be tempted to engage in a race to the bottom through competitive reductions in tax rates. Caution is, however, warranted here. It will be recollected that the tax system, although important, is but one ingredient of an attractive investment climate. Furthermore, the interaction of tax and nontax incentives on investment remains to be adequately explored in recent empirical work. Hence, if particular regions of a country experience stubbornly high double-digit unemployment as is the case in Central Europe, the solution may lie, not in a rush to tax holidays, accelerated depreciation and the like but instead in directly addressing the sources of the problem, which could include the provision of relevant education opportunities to match skills with labor demand, reducing disincentives to labor supply arising from overly generous social expenditures, cutting the cost of labor by lowering payroll taxes and removing impediments to labor mobility arising from infrastructure bottlenecks. This may still leave a role for tax policy but governments should avoid the temptation to pick winners and engage in activist industrial policy. That route can lead to poor choices, subsidized inefficiency and corrupt seeking after government favors. 21 Hines (1999) provides on useful survey 44 This discussion raises the following question for the commentators: How important is it to use corporate tax regimes in transition countries to compete for foreign direct investment as compared to harmonizing taxes and focusing on broader reform of the investment climate? 8. CONCLUSION To summarize, the discussion in the paper raises the following questions for the commentators: * What is the level and composition of tax revenue that raises enough resources to finance public expenditures without introducing excessive distortions in the private sector? Is tax revenue as a share of GDP "too high" in the CSB countries and "too low" in the CIS countries? * Is it generally understood that hardening budget constraints for all firms and improving the investment climate to create new firms and stimulate entrepreneurship, without the state dispensing special favors, must go hand in hand? * What is the appropriate tax treatment of small firms, which have been the key to growth and generation of employment? What political strategies are available to eliminate tax exemptions that benefit powerful special interests and to lower tax rates and simplify tax administration that would benefit and encourage compliance by small firms? 45 * Is it generally understood that in many states the tax authorities are a major source of bureaucratic harassment and weakness in the investment climate? What can be done to overcome these problems? * Are the right partnerships in place or being constructed between the government, private sector and civil society in order to foster a culture of voluntary tax compliance in transition economies? * How important is it to use corporate tax regimes in transition countries to compete for foreign direct investment as compared to harmonizing taxes and focusing on broader reform of the investment climate? 46 ADDendix Table 1. Tax structure of CSB and CIS countries during the Early Transition Period (average in percent of GDP) Taxes on Income, Profits, Social Jomestic Taexson Goods and Service: Inteernatinal Trade Taxes andCapitGalins Secuzity of which. 2000ODP Total Other and OeneralSales, of which. -Wealth and Other Sample per capita Revenue Tax Revenue of which. _ Payroll Turnover, Imkpost Export Property Tax size (USW9 and Grants Revenue andGrwans Total Individual Corporate Taxes Total VAT Excises Total duties duties Taxes Revenues Ceufral and Easfern Eunpe sand tlee Baltics Albaniia 1992-93 1,10) 24.6 17.6 7.1 3.4 0.1 3.3 3.1 7.2 4.2 3D 29 29 0.0 0GD iD Bulgazia 1992-93 1,470 37.8 31D0 62 917 5.2 4.5 11.9 62 3.6 32 2-5 2-5 0.0 GD0 02 Croatia3 1994-95 4,180 42.5 4028 12 45 3.7 0.9 13.7 12.1 14D0 4.1 4D0 4.0 0.0 0.1 0.4 CzechRepublic 1994-95 4,940 44A 40.3 4.1 102 SDO 5.3 15.8 3115 7.3 42 14 lA OD0 .. 13 Estonlia 1991-92 3,530 37.2 34.4 217 14.1 7.1 7.0 8.1 11.1 6.9 0.7 0.4 0.4 OD0 on 0.8 Hungary 1991-92 4,50 53.9 42.1 112 11.4 7.0 35 13.5 13.2 6.0 5.6 3D 3DO on GA4 0.8 Latvia 1994-95 3,010 36.7 33.7 3D 729 5.0 2.8 12D0 10.6 9.0 ii ino iD0 GD 1.1 1.2 Lithuania 1990-91 3,0A) 39.9 355 4-5 13D0 4,6 8.4 69 1317 10.5 3.1 0-5 0.5 GD 053 02 Macedoniia 1991-92 1,761 33.1 37.1 09 7D0 52 12 19.2 8.2 8.2 GD 2.6 2.6 GD0 0.1 GD0 Poland 1992-93 4,100 459 3738 82 32.6 82 44 9.6 10.2 9.2 lD0 2.6 2.6 on . 2.9 Romania 1990-91 1,640 4028 34.4 65 13.3 7.2 6.1 9.1 10.1 10.1 GD0 0.6 0.6 0.0 1. 2 Slovak Republic 1992-93 3,54 45.2 379 74A 132 5.5 717 10.3 124 10.4 2.1 14 14 on . 05 Slovenia 1991-92 9,160 4353 32.4 13.1 5.6 5D 0.7 12.5 10.4 10.1 GDo 3.4 3. AD .. 0.5 Unweigtted Averae -_ Central endEastemn 3_4 4028 flQ 51 9.7 5.3 4.3 jfl tn . 22 2D0 210 Q& 0.3 028 CIS Anmenia 1994-95 50) 2328 12.9 309 6.4 12 5.2 128 35 3D0 05 05 05 0.0 02 0.5 Azertaien 1992-93 660 4528 32.2 13.6 92 2.2 7.6 99 12.1 8.2 39 0.4 0.4 GD0 0.0 GD0 Belarus 1992-93 860 SOD0 4128 82 12.1 GDo 12.1 129 161 .7. 0.1 GDa 0.1 GD0 GD Georgia 1994-95 560 92 SD0 42 1i6 o6 in 0o9 19 128 0.1 0.2 0.2 GD . 0.6 Kazajkhstan 41994-95 1,230 18.2 1717 0.6 316 ... 6.3 3.6 ... 1.4 1.4 GD . 0.9 Kyrgyz Republic 1994-95 270 24.7 20.2 4-5 49 19 3.1 59 72 5.1 16 0.6 0.6 GD0 05 053 Moldova 1992-93 360 2117 1928 19 6.4 117 4.6 29 93 55 32 0.4 GDo GD 02 RussianFederation3 1992-93 1,730 3717 3328 39 114 22 9.1 917 92 85 028 29 017 1.1 GD0 0-5 TaJikistan 1991-92 160 34.2 32.4 12 12A 2.6 628 9.2 95 4.2 53 0.3 GDo 0.1 02 ID0 Tulmtefnistan 6 1994-95 850 1817 16.5 2.2 49 09 4.1 35 8.3 7.1 3D0 ....... G Ukraine 1991-92 640 34.1 33D0 1.1 11.3 3.2 7.9 11.4 10.6 lCD0 0.6 GD0 GD0 GD0 GD GD Uzbekitant 1992-93 .550 3317 27.3 62 9.1 2.6 6.4 017 16.3 89 7.2 12 12 0.0 0.2 OD0 Unwemtslad Averatge - m 7m 72~~~~1 24 49 EQ0 Li u2 G 2.2 U1 0.2 01 0102 OQranl Uaeigtbd MAnrge 2,1830 353 29.9 BA OAS 3.7 5.1 SE 10,1 7 5 23 IA 13 01 0,2 0.5 t Consolidated General Governmnent unle ss indicated otherwise. 2 At the official exchange rate. 3 Consolidated CentralGoyvernment. 4 Goveniment Budgetary Operations. 5llnlarged Government Budget. State Budget 1Excluding extrabudgetawy funds. Sowcces: IMP cousfrv documents: and IMPand World Bank staff ammetes 47 Apvendix Table 2. Tax structure of CSB and CIS countries during the Early Transition Period1 (average in percent of tax revenue) Tans on Income, Profits, Social Jomestic Taneson Goods andService: International Trade Taxes and Capital Gains Security of Whichir 2000 GDP Toal Other and GerrealSalee. of whicb. Wealth and Other Sample per capita Revenue Tax Revenue of whiht Payroll Tunove% Import Export Propeity Tax size (US$92 arnd Grants Revenue and Grants Total Individual CorporaLte Taxes Total VAT Excises Total duties duties Taxes Revenues Ceahiddw FastBm Earope and &. Balits Albania 1992-93 1,103 1402 100.0 40.2 19.1 0.3 198. 17-9 40.7 239 161 16.4 164 0.0 013 39 Bulgaria 1992-93 1,470 1219 1010( 219 31.3 16.8 14.5 323 21.2 115 10.3 8.1 8.1 0.0 013 0.6 Croatia 3 1994-93 4,180 104.3 100.0 4.3 11.0 9.0 2.1 335 44-4 34.4 99 9.2 918 0.0 0.3 0.9 CzechRepublic 1994-95 0409 110.2 100.0 10.2 23.6 12.3 13.2 39.3 28.4 18.1 103 3-5 3-5 0.0 ..32 Estonia 1991-92 3,310 108.0 100.0 8.0 409 20.5 20.4 23.5 32.2 199 2.0 1.1 1.1 0.0 013 2.2 Hungary 1991-92 4,530 1279 100.0 279 27.0 16.5 2.3 32.1 31.4 14.3 133 7.0 71) 0.0 Os 1.8 Latvia 199495 3,010 1089 100.0 89 23.2 1418 8.4 35.6 31-5 26.7 418 2.8 21 0.0 3.3 3.7 Lithuania 1990-91 3,040 1125 100.0 12.5 36.7 . 13.1 23.5 19.6 38.6 29.3 8.6 15 1.5 0.0 IA 23 Macedonia 1991-92 1,760 102.6 100.0 2.6 129 13.6 3.2 3118 22.0 22.0 0.0 7.1 7.1 0.0 0.1 0.1 Poland 1992-93 4,100 121.6 100.0 21.6 33.2 21.7 11.5 253 27.0 244 2.6 61 618 0.0 .717 Romanila 1990-91 1,643 1181 100.0 18.8 38.6 21.0 17.6 26.6 29.4 29.4 0o0 118 11 0.0 ..3.6 Slovak Repubhic 1992-93 3,343 119.4 100.0 194 34.7 14.4 20.3 273 3218 27.3 3.4 317 3.7 GD . 1.4 Slovenia 1991-92 9,160 134.3 100.0 34.3 17.3 133q 2.0 38.7 319 31.2 0.0 10.5 10-5 0.0 ..1.6 Unweighted Average- Central and Eastem 3- 117.7 100.0 17.7 27.5 147 12.6 31-5 3117 24.0 6-5 j2 6.2 0.0 017 2.4 CIS Armtenia 1994-93 300 18418 100.0 8418 491 917 40.1 13.6 2618 233 3.5 317 317 GD 2.0 4.0 Azerbaijan 1992-93 660 142.2 100.0 42.2 30.4 69 23.5 301 37.5 253. I2N 1.2 12 0.0 013 0.0 Belazus 1992-93 883 119.6 100.0 19.6 29.1 0.0 29.1 301 399 ... 0.1 013 0.1 0.0 0.1 Georgia 199493 5603 1833 1001) 833I 31.0 11.0 201) 171) 3710 36.0 1.0 317 317 0.0 ..11.2 KWAkbIstan 4 1994-93 1,230 103.1 100.0 3.1 31.7 ... 33.4 20.1 ... 718 71 0.0 ..49 Kyrgyz Republic 1994-93 270 12210 1001O 22.0 243 9.2 13.1 292 3817 23.0 79 3.0 313 0.0 24 2.4 Moldova 1992-93 360 109.3 100.0 9.3 32.1 817 23.2 14.6 4713 27.3 19.2 2.2 0.0 0.0 .4.1 RussianFederation5 1992-93 1,7310 111.4 100.0 11.4 3318 69 269 28.6 27.6 23.2 2.4 85 2.1 33 0.0 1.6 Talidstan 1991-92 160 3035 100.0 535 38.1 8.0 201 283 293 13.0 16.3 0.2 0.0 0.2 [0 3.0 Twimernistan6 1994-93 850 1133 100.0 133 2917 32 24.5 212 49.1 43.0 6.1 ......0.0 Uraine 1991-92 643 1033 100.0 3.3 33-5 917 2318 344 32.0 30.2 118 0.0 013 0.0 0.0 00 Uzb,ekistant 1992-93 532 123.1 100.0 23.1 33.1 9.6 235 2.6 38.7 32.4 26.4 4.8 41 0.0 018 0.0 Unweitrted Averge - CIS 700 12618 100.0 2u 33 717 24.6 239 37-0 28. 91 3.2 2-4 0.3 022.1 Oueral Umveightad Aver-ge 2,188 1221 1001) 22.1 302 11.5 18.1 278 34.2 258 7.9 48 44 0.2 as 2.2 1 Consolidated General Government unless indicated otherwise. 2 At the officia exchange rate. 3 Cosolidated Central Giovernment. 4Govemnment Budgetary Operations- ' Enlarged Government Budget. 6State Budget. Exlcluding extrabudgetary Rinds. 48 Appendix Table 3. Tax structure of CSB and CIS countries1 (1 999-2000 avenge; in percent of GDP) Taxes on Income, Profits, Social )omestic Taxes on Goode and Servicei InternaiionalTrade Taens andCapitdelGins Security of wbirkL 2000 GDP Total Other and GenerdlSales, of whick Wealt and Other Samploe per capita Revenue Tax Revenue of whichk Payroa Turnover, Impost Export Property Tax Size @582 andOGrants Revenue andIGrants Total Individual Coiporate Taxes Total VAT Excises Total duties duties Taxes Revenues Ceon! atud Eastern Eunvpean wrth Batic. Albania 1999-00 1,100 219 lian 3.9 2.4 0.8 1.6 317 8.1 6.5 1.6 2.4 2.4 0.0 0.0 IS5 Bulgasie t999-00 1,470 41.3 30.5 10.2 7.6 4-5 3.1 79 124 91) 3.6 1.0 in0 on 0.0 [.6 Croetia3 1999-00 4,120 41.3 39.3 210 4.3 29 I.4 13.4 18.4 139 453 2.7 2.7 on0 0.2 0.3 CzachRepublic 1999-0 4,940 41.1 37.2 3.8 9n0 512 3.8 149 11.4 7.6 3.9 0.7 0.7 on . 1.3 Estoniia 1999-00 3,510 32.7 36.1 2.6 99 8.3 1.6 1212 1246 9.1 3.3 01) ono on 0.4 1.1 Hungary 1999-00 4,550 44.0 36.I 79 9.3 7.0 2.3 10.0 14-6 846 4.0 1.2 1.2 01) 0.9 0.3 Latvia 1999-00 3,010 32.7 32.7 6.1 8.2 6.1 2.1 11.2 ii.a an 3.8 0.4 0.4 01) 1.1 01) Lithuania 1999-00 3,040 31.2 294 1.8 8.9 812 0.8 7.0 1210 79 3.6 0.4 0.4 on0 0.6 046 Macedomia 1999-00 1,760 36.1 324 317 61) 428 12 10.8 1146 6.1 512 3.7 317 o0 0a3 on Poland 1999-00 4,100 404 32.6 7S8 en0 5- 2-5 99 119 81) 3.9 09 09 01) . 21) Romenia 1999-00 1,640 324 30.5 2.0 7.8 3.4 3.0 109 10.5 63 2.8 1.3 1.3 on . ono Slovak Republic 1999-00 3,54 404 341) 6.4 8.1 512 2.9 1217 1017 74 312 13 15 0.0 .in Slovenia 1999-0 9,160 43.0 4303 2.8 746 6.4 1.2 134 1517 13.4 0.3 1.1 1.1 0.0 2.4 Unweigited Average - Central and E-astarnEurove and the Balticr 3--w 37.7 l 417 74 5.2 2.l 1046 12.4 8. . 13 13 on40. CIS Armeniia 1999-00 500 21.2 18.5 217 4.2 117 2.1 2.4 9.1 617 2.4 0.8 0.2 01) 0.4 117 Azerbaeijn 1999-0 660 199 144 5.5 453 212 2.3 2.4 4.7 41 046 19 19 01) 0-5 04 Belerus 1999-00 260 44.3 40.8 353 7.9 01) 79 ion0 1917 .. . i i.e on 0.8 017 Georgia 1999-00 560 15.4 14.1 13 31) 19 1.2 2.4 6.5 417 1.2 0.8 0.2 on . 15 Knalkhstan 1999-00 1,230 1946 ia.i IS 64 .6. 3.8 69 ... 017 017 01) 012 KyrgyzRlepublic 1999-00 270 21.1 1646 4.5 2.3 112 1.1 412 89 49 2.5 05 05 01) 0.3 0.3 Moldova 1999-00 360 27.3 223 512 312 15 146 546 104 71 34 15 15 01 - 13 Russian]Federation5 1999-0 1,730 371) 303 617 7.9 217 5.1 8.1 29 63 25 25 09 1I4 12 146 Tajldstan 1999-00 160 1346 129 017 212 112 11) 1.3 6.4 5.8 046 1.4 1.4 01) 0.5 Il Turkmentstan6 1999-00 850 23.4 20S8 217 5.8 246 3.2 5) 953 7.3 21 . 2.. 0.5 TJkraine 1999-00 640 3412 304 346 8.8 3.5 4.9 9.3 10.4 646 1.4 09 09 0.0 0.8 0.5 Uzbekistant 1999-00 550 2821 221) 0.7 7.9 39 41) 01) 15.3 74 79 046 046 01) 21) 2.3 Unweigtd Averaue -CIS 700 25.5 2212 312 5, 21) 3.1 4.5 91 6. 25 Li U. J.1 0.8 0~4 OvenalUmmigkted Average 2,110 315 275 4.0 dA 35 2.6 7.7 11.1 7.6 3.0 13 1.2 03 0.6 0.7 t C osohdaed GenualGovernmen unle ss indic ate d otherwis e. 2 A the official exchange rate. 3 Consolidated Central Government. 4Govermsrent Budgetry Op erations. 5Enlarged Governmyent Budget. State Budget. 'Excluding extrabudgetasy fdads. Somnces: IMP counhy docwnenft; and IMP and Woarld Bank st4efflamates 49 Appendix Table 4. Tax structure of CSB and CIS countries1 (1999-2000 avenge; in percent of tax revenue) Taxes on Income, Profits, Social )omestic Taxes onGoods andService: InternationalTirade Taxes andCapitdalGins Secuifty of which. 2000GOP Total Other and GeneralSiales, of which: Wealth and Other Sample par capita Revenue Tax Revenue Of WhCIck Payroll Tnmoves Import Export Proparty Tax size QJSV9 andOGrants Revenue and Grants Total individual Corporate Taxes Tota VAT Excises Total duties duties Taxes Revenues Caufr9 nld rmtnnEuny ani Om Balilcs Albania 199-00 1,100 12117 100.0 21.7 13.2 42 8.9 2021 442 36-2 8.6 13.4 13A4 0.0 020 8.4 Bulgaria 199-00 1.470 135.4 10020 35.4 24.8 1428 10.0 25.7 41.1 293 112 33 32 0.0 0.0 5.1 Croatia3 1999-0 4,180 105.1 10020 5.1 10.9 7.4 3.5 34.1 46.9 35.5 114 6.9 6.9 020 0.5 0.8 CzechRepublic 1999-00 4,94 1103 20020 102 24.1 133 10.1 40.1 30.6 20.3 102 19 19 02 . 3.4 Estonia 199-00 3,510 107.1 2002o 7.1 272 229 4.4 332 342 252 9.6 020 02 GD0 1.1 3D0 Hungary 1999-0 4,550 12117 2002 2117 25.6 194 6.2 2717 403 23.7 11.1 3.2 3.2 GD 2.4 0.8 Latvia 1999-0 3,010 118.5 200.0 185 25.0 1817 62 342 36.2 24.5 11.7 1.1 1.1 GD0 3.4 0.0 Lithuania 1999-0 3)04 106.1 100.0 6.1 302 2717 2.6 236 402 2617 12.1 1.4 1.4 GD0 220 1.9 MacadoniaL 1999-00 1,760 1112 10020 112 18.4 14.7 3.7 332 35.6 182 15.9 112 112 GD0 1.4 0.0 Poland 1999-00 4,10 12328 100 232 24.5 169 717 30.4 362 244 1220 228 22 0.0 .6.0 Romania 1999-0 1,640 1IN4 10020 6.4 25.6 11.2 9.7 3528 342 205 9.2 4.3 423 02 . 020 Slovak Repubhic 1999-CO 3,54 1189 1002o 189 23.7 15.2 8.5 37.4 31-5 222 92 4.4 4.4 02 . 29 Slovenia 1999-00 9.160 10628 10020 62 1828 152 3D0 332 389 38.1 017 217 217 02 . 52 Unwerigted Average - Central and Eastem Eurne and theflBltics 3-W4 114.9 10020 14-9 22-5 1516 6-5 31L6 379 26.6 1023 42 4.3 Q ~ 13 2.4 CIS Armenia 1999-00 500 114.3 1002o 142 2217 89 11.4 132O 489 36.2 1217 42 42 020 22 8.9 AzetbaMan 1999-0 660 13823 2002 382 31.4 152 1620 1617 322 289 32 132 13.2 020 3.1 228 Belawu 1999-00 8N0 108.6 10020 8.6 19.2 020 192 245 48.2 ... 42 42 02 220 1.8 Georgia 1999-0 560 1093 2002 92 21.4 13.2 8.2 1617 459 33.1 122 52 52 020 1 017 Kazakhstan 4 2999-00 1,230 1082 200.0 82 36.6 ... 202 38D . . 3.9 3 9 GD . 028 KyrgyzRepublic 1999-00 270 1272 10020 272 139 72 623 254 532 292 15.1 320 3D0 02 2.1 1.8 Moldova 1999-00 360 1232 100.0 232 14.2 69 723 252 4728 322 15.5 6.6 6.6 GD . 620 RussianFederation5 1999-00 1,730 122.1 10020 22.1 25.9 92o 169 269 295 214 8.1 8.4 228 45 420 5.2 Tajilstan 1999-00 160 10154 100.0 5.4 17.1 89 7.4 9.7 494 45.1 42 10.9 109 GD0 3.5 92 Turkmeenistan5 1999-00 850 112.8 1002o 122 2820 125 15.4 239 452 35.2 106 O.... 2.4 Ubmaine 1999-00 640 111.6 100.0 11.6 28.6 114 1620 30.4 332 21.6 4.6 29 29 020 2.6 1.6 Uxbeldstant7 1999-00 550 1025 100.0 2-5 28.3 132 142 0-0 54.7 26-5 282 22U 220 02 720 8.1 Unweighted Average- CIS 700 1152 j-Q 153 239 92 12.6 194 44kO 312J 11.6 59 5.4 0.4 3-334 OverafU Uwegtkd Aver-age 2,180 11521 lODE 154.1 23.2 129 9.3 25.7 403 28.5 101 5.1 419 0.2 2 3 2 9 Cono1ideled General Govennent usileec indicated otherwise. 2 At the official exchange rate. 31Consojidated Central Government. 4TGovernment Budgetary Operations. ' Enlarged Government Budget State Budgae. 7 Excluding extrabudgetary funds. Soa7es,: IMP country documents, and IMPand Worid Bank 5tairesilmates 50 AvDendix Table 5. Tax Structure of High-lncome OECD Counties' (average tbr Om laiest5 years anilble; inpercet.fGDP) Taxes on Income, Profits, Social Domestic Taxes on Goods and Services Intemnationel Trade Taxes and Capital Gains Secuity of which: Fiscal 200 GDP Total Other and OeneralSeles, ofwhicIh Wealth and Other Sample percapita Revenue Tax Revenue ofwhih Payrol Turnover Import Export Property Tax Size ( andGrants2 Revenue andCGrants Totea Individual Cosporate Taxes Tote VAT Excises Total duties duties Taens Revenues Austria 1995-99 23,300 50.2 432 7.0 13.1 .. .. 16.8 12.3 .. .. 0.0 0.0 0.0 0.1 0.9 BeltEum 1994-98 22,300 462 45D 1.8 169 13.8 2.8 141 12.1 73 2.4 00 0.0 0.0 13 0.0 Denmark 1995-99 30,100 57.2 49.2 8.0 29.4 25.7 2.2 1.S 15.9 9.6 3.8 0.0 0.0 G 1.7 0.4 Finland5 1994-98 23,300 47.6 383 9.4 19.1 7.6 1.6 4.1 13.8 8.2 4.6 0.1 0.1 0.0 0.6 0.6 France 1993-97 22,000 47.2 42.2 5.0 SD 6.3 1.7 IlO 119 7.7 2.7 GD 0.0 0.0 23 2.0 Germany 199498 22,700 47.6 37.8 9.7 ili 9.6 0.5 152 10.4 3.6 3.0 0.D 0.0 0.0 1.0 02 Greece6 199498 1O,800 24A 225 2.0 7.4 3.8 2.2 0.5 12.8 7.6 4.7 0.0 0.0 0.0 0.9 0.8 Ireland 1993-97 25,200 37.8 319 5.9 13.6 10.5 3.1 5.2 12.0 62 5.0 OD 0.0 0.0 1.1 00 Italy 1995-99 18,8O 472 422 4.4 143 11.4 2.7 13A 102 5.7 2.7 0.0 0.0 0.0 0.9 4.1 Luxmbourg 1993-97 43,100 47.7 421 4.9 165 11.1 5.0 11.1 11.1 6D 4.6 0.0 0.0 0.0 3.0 1.1 Netherlands 1993-97 23,200 50 43A 6.6 12.0 8.4 3.6 ISlO 10.2 6.6 2.8 On 0.0 0.0 1.8 15 Portugal 199498 10,600 41.7 333 8.4 9.4 59 29 8.7 13.3 7.4 4.7 0.0 0.0 0.0 0.6 13 Spain 1993-97 14,200 369 333 3.7 10.1 S.O 19 12D 9.0 43 2.7 0.0 0.0 0.0 1.9 02 Sweden5 1995-99 25,800 573 505 6.8 20S 1.9 2.9 163 11.4 7.1 3.8 0.1 0.1 0.0 1.8 0.1 UnitedKingdom 1995-99 23,900 38.6 34.7 39 13.6 9.7 39 62 11.4 6.7 39 0.0 0.0 0.0 3.6 GD EUunweinhtedaverage: 22f600 452 394 5S 143 9.6 2.6 101. 11.9 67on 0.0 G00 15 09 Australia 1995-99 20,300 36.0 2S9 72 159 11.7 4.0 0.6 7.6 2A 25 0.6 0.6 0.0 4.1 oD Canada 1996-00 22,800 4520 373 7.7 179 139 2.4 52 8.8 2.6 0.9 03 0 0.0 4.0 1.1 Iceland 199498 30,600 39.1 32.7 6.4 119 109 0.9 2.6 14.6 9.4 3.2 0A 0.4 0.0 25 0.7 Japan' 1991-93 37,600 21.1 17S 3A 82 5.1 3.0 5.4 2.9 1.4 13 03 0.2 0.0 0.7 03 NewZealand8 1996-00 13,300 37.1 325 4.6 202 14.8 3.1 02 92 63 19 0.7 0 0.0 1.9 02 Norway 1994-98 36,000 529 41.1 11.S 152 11.0 3.6 9.1 155 8S 5.4 022 02 0.0 1.1 0D Switzedelnd 1995-99 33,300 425 34.0 85 12.5 10.5 0.8 12-5 6.1 3.5 11. 02 02 0.0 2.6 OD UnitedStates 1995-99 35,600 34.4 27.6 6.9 132 101. 2.1 6.6 4.4 .. 0.6 02 02 0.0 3.0 0.0 Other OECD unweighed average7 20 3S au 7n 14A iu 2tu 5. f 6 49 22 OA OA D2I 2 Uwigelhdawerage: 24,700 42.9 36.6 63 14A 101 2A 99 10.7 61 3.1 01 01 0.0 1.8 0.7 1 Consolidated budgetary; extrabudgetery and social security accounts of centra, state/provincial and local governments. 2 Exdcluding grants and transfers between budgets of different levels. 3 In addition to individual and corporate taxes on income, profit and capital gain, the total includes other unaLocatedtaxes on income profit and capital. 4In addition to general sales, tumovex, VAT taxes, and excises, the totalincludes profits offiscal monopolies, taxes on specific services, taxes on activities and use/permissionto use goods (business and professional hcenses, motor vehicle taxes, atc), as weal as other taxes on goods and services. Individual and corporate taxes an income, profits and capital gains are for consolidated central government only. 6C entral government only. Excluding adjustment to tax revenue. 7Central government only. 8 Budgetwy accounts only. Sourc: IMF Governmentd nancal Staistfcs; OlgCD, Labor Staistfcs and Natonal Accounts of OCCD Counlries 51 Appendix Table 6. Tax Structure of High-Income OECD Counties' (aerage or the latest 5 years aflebk; in percent of tax nens) Taxes onlncome, Profits, Social DomesticTaxesonGoodsandServices InatenationalTrade Taes andCapitdlGains Secusity of wbicb Fiscal 2000 GDP Total Othef and GeneralSales, ofwhich: Weafth and Otuh Sample per capita Revenue Tax Revenue of whichr Payroll Tumover, Import Export Property Tax Size (USS) andGrantse Revenue andGrants TotS Individual Corporate Taxes Totd4 VAT Excises Total duties duties Taxes Revenues Austria 1995-99 23,300 1163 100.0 16.3 305 .. .. 389 28.5 .. .. 0.0 0.0 0.0 0.1 20) Belgium 1994-98 22,300 104.0 100.0 4.0 37.6 30.7 63 329 26.8 16.2 53 0.0 0.0 010 2.8 010 Denmark 1995-99 30,100 1163 100.0 163 59.8 523 4.5 3.7 323 19.6 7.7 0.0 0.0 00) 35 0.7 Finland' 199498 23,300 1245 100.0 245 49.8 199 42 10.8 36.0 21.5 12.1 0.2 0.2 0.0 1.7 1.4 France 1993-97 22,020 111.9 1000 11.9 189 142 4.0 428 28.1 18.2 6A 0.0 OD0 0.0 5.5 4.7 Germany 1994-98 22,700 125.8 1000 25.8 29.0 25.4 13 402 27.6 96 79 0.0 0.0 01) 2.7 05 Greece6 199498 10,800 108.7 100.0 8.7 33.1 17.0 9.9 2.1 57.1 33.7 21.0 0.1 0.1 0.0 4.1 35 Ireland 1993-97 25,200 118.5 100.0 185 42.6 330 9.6 163 37.7 195 155 0.0 0.0 0.0 3.4 01 Italy 1995-99 18,800 110.4 100.0 10.4 33.4 26.6 63 313 23.8 133 62 0.0 0.0 0.0 2.0 9.5 Luxembourg 1993-97 43,100 111.4 100.0 11.4 38.6 262 11.7 259 259 14.0 108 0.0 0.0 0.0 7.0 26 Nethertands 1993-97 23,200 1152 100.0 152 27.6 19.4 8.2 41.4 23.4 15.2 63 0.0 0.0 0.0 4.1 3.4 Portugal 1994-98 10,600 125.2 100.0 252 28.3 17.7 89 26.1 40.1 22.3 14.1 0.0 0.0 0.0 1.7 32 Spain 1993-97 14,200 111.1 100.0 11.1 305 24.1 5.8 36.1 272 12.8 8.1 0.0 0.0 0.0 5.7 0.6 Sweden5 1995-99 25,800 113.5 100D 135 41.2 39 5.7 322 22.7 14.1 75 03 0.3 0.0 35 0.1 UnitedKingdom 1995-99 23,900 1111 100.0 11.2 392 28.0 11.2 17.7 32.7 19.3 11.4 O1 0.0 01) 102 0.0 EU unweighted average: 22.600 1149 100 0 14.9 36.0 242 70 266 31.3 17.8 10) 0.0 01_ 0 39 22 Australia 1995-99 20,300 124.9 100.0 24.9 55.1 40.6 139 210 26.4 8.4 88 22 22 0.0 14.2 02 Canada 1996-00 22,800 120.7 100.0 20.7 48.1 372 6.4 14.1 23.6 7.0 2A 0.7 0.7 0.0 10.6 29 Iceland 1994-98 30,600 119.6 100.0 19.6 36.5 33.4 2.8 8.0 44.6 28.7 9.7 1.2 1.1 00) 7.7 20 Japan' 1991-93 37,600 1189 100.0 189 45.9 289 17.0 302 16.4 7.7 72 1.4 12 0.0 42 19 NewZealand9 1996-00 13,300 114.1 100.0 14.1 622 455 11.6 1.0 28.2 19.4 5.7 23 23 0.0 5.9 05 Norway 1994-98 36,000 1287 100.0 28.7 37.0 26.7 8.7 220 37.6 21.4 132 0.6 0.6 01) 2. 0n Switzerland 1995-99 33,300 1248 100.0 24.8 36.8 30$ 25 36.7 18. 10.3 5 3 0.7 0.7 01) 7.7 00 UnitedStates 1995-99 35,600 1249 100.0 24.9 4S.3 39.1 7.7 239 16.0 .. 2.1 0.8 0.8 01) 10.9 0.0 OtherOECDunweiOrted averLae: 28.700 122.1 100) 22.1 462 353 8$ 172 264 147 6$ 12 1.2 010 8.0 09 UTemightedaerage: 24,700 117A 1001 17A 396 282 76 233 296 16B S9 05 OA 0l 53 1B 1Consolidated budgetary, extrabudgetary and s ocial s ecurdty acc ounts of c entrat state/provincial and loc al governents. 2 Excluding grants and transfers between budgets of different levels. 3 In addition to individual and cotporate taxes on income, profit and capital gain, the total includes other unallocated taxes on income profit and capital. 4 In addiion to general sales, tumover, VAT taxes, and excises, the total includes profits of fiscal monopolies, taxes on specific services, taes on activities and uselpermission to use goods (business andprofessionalticenses, motor vehicle taxes, etc), as well as other taxes on goods and services. 5Individual and corporate taxes on income, profits and capital gains ae for consotidated central government only. 6Central goverrment only. 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