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Reforming Tax Systems and Tax Administrations
The election of Francois Hollande as President of France has sparked a debate in the Euro-zone on austerity and growth. Those who argue for austerity or 'fiscal prudence' claim that debt management is key to restoring investor confidence and, therefore, long-term prosperity. Borrowing more is not an acceptable response to a crisis caused by over-borrowing and over-spending. In contrast, those who prefer greater stimulus claim that, without further investment, growth will simply not return, and without some government stimulus, no economy can pull itself out of recession to achieve long-term stability and growth. Taxand UK examines the current economic issues in the EU and discusses the role that tax reform can play in the road to economic recovery.
Whilst there is no clear 'right' answer, there is one aspect of government policy that is absolutely central to both the short-term repayment of debt and the medium-to-long term stimulation of growth - that is taxation. Now more than ever, governments must ensure a balanced system of taxation that provides the right incentives to business and citizens, whilst enabling the government to meet its debt and spending obligations. Getting this balance right can drive increased confidence among the investor community and stimulate economic activity, international competitiveness and long-term growth.
Recent experience with Ministers of Finance shows that they want to be able to increase tax revenues, if possible, without raising headline rates of taxation or, better still, while reducing them. A&M Taxand has been studying this problem with a number of governments and investors.
A New Approach
In the past, many states have relied on the support of international bodies such as the IMF, World Bank and other intergovernmental assistance of various forms to begin the process of tax reform, both in respect of designing the tax system itself and in respect of improving the ability to collect taxes. In the post 'credit crunch' world, it has become increasingly apparent that the operational ability of Ministries of Finance and Tax Authorities to increase tax revenues is somewhat limited. A new hands-on approach is required to assist the public sector, generating increased tax revenues and driving corporate activity without raising taxes or damaging international competitiveness.
Like any business, a government has costs (e.g, social security payments, health, education, etc.) and it has revenues (e.g, taxes). No business manages its affairs simply by focusing on costs, so why should a government operate any differently? A framework is required to help governments optimise the out-turn from their current tax system, balancing this need with the creation of the right incentives for citizens and businesses to stimulate the economy. This is a difficult balance to achieve, but it is possible to create tax systems that give governments the revenue they need, whilst providing citizens and businesses with the ingredients for long-term growth and economic success, including low rates of taxation.
To achieve this, our work with Finance Ministers and governments is typically structured around three core work streams:
- Tax Reform Design - Modeling the economy and designing a new system of taxation appropriate for the jurisdiction, with the emphasis on simplicity, fairness, participation and economic stimulus
- Tax Compliance - Building the taxpayer base to ensure all taxpayers have paid the correct amount of tax under the law and will continue to do so
- Tax Operational Improvements - Underpinning both streams, identifying and delivering detailed operational improvements, ensuring transparency of data and processes within the tax administration, across government departments and with taxpayers
Tax Reform Design
A tax system is at its best when it is at its simplest. Our approach is to simplify where possible, levying the minimal number of taxes, making compliance easy for taxpayers and the Tax Authorities. Headline rates should be minimized, often in exchange for the removal of reliefs or deductions. In addition, it is essential to improve the quality of the taxpayer base, where possible collecting tax from known reliable taxpayers (for example corporates or banks). Finally, following IMF recommendations, international trends are to shift the burden of taxation towards indirect taxes to ensure participation in the tax system, improve the reliability of collections and increase fairness.
Experience has taught us that an effective communications strategy is critical to the success of any Tax Reform project. This applies equally to internal government communications, key stakeholders and the wider taxpayer community. To succeed, these projects require a proactive approach to ensure that stakeholders are aware of progress and are fully informed about potential changes and the reasons behind them at every stage.
Tax Reform projects should have four key phases:
- Understand - Work closely with the Government and external bodies to gather and verify data. Quickly establish a detailed understanding of the current tax system, from tax technical, collections and practical / operational perspectives, along with any political and economic issues. By interacting with a wide range of corporate and other stakeholders, quickly understand issues with the current system from a number of different perspectives. At the same time, model the economy and current tax collections, benchmarking them against other jurisdictions.
- Model - Develop an outline model for the proposed tax system, meeting regularly with stakeholders to develop and test ideas and model alternative taxation methods. Constantly refine and update the model, making it increasingly robust by concluding discussions on potential areas of concern. Produce a detailed proposal for the new tax system, including clear legislative and operational proposals, for political approval.
- Implement - Bring the approved model to life. This can include taking a lead drafting new legislation and guidance. A highly operational approach, working to ensure systems, processes and controls are best-in-class and fit-for-purpose is essential at this stage.
- Roll-out - Roll out the new system to the various groups of taxpayers and stakeholders and train the Tax Administration teams, including training on tax technical and operational / systems issues. Remain onsite with the team to provide hands-on support, at least in the short-term, ensuring a smooth transition and resolving practical issues as they arise.
In many developed economies, the incidence of tax evasion is small. However, this is not necessarily so in the rest of the world. Broadening the taxpayer base and ensuring current taxpayers are paying the correct amount of tax under the law helps keep taxes low.
Any review of tax compliance must begin with detailed legal analysis to understand the parameters around tax collection. To this, economic and forensic analysis must be applied to identify areas of the economy requiring particular attention. A range of techniques, from sophisticated IT data interrogation, detailed audits of taxpayer files and an analysis of publically available information (e.g, Yellow Pages, telephone directories and marketing materials) is typically required to provide a complete picture of the tax-paying community.
To deliver real change for the Tax Administration, forming a single team to identify taxpayers, initiating assessments, managing taxpayer responses and building IT databases is key. In this way, a process is focused on achieving results, whilst giving the Tax Administration the hands-on experience and knowledge they require to manage their taxpayer base in a proactive and controlled manner. Enhancements to processes and systems also drive improved service levels to taxpayers (whether this be speed or quality), which is vital to gain support for the tax system and for improving participation.
Tax Operational Improvements
Ministers of Finance and Tax Authorities recognise the benefits of making substantial improvements to the way they work with corporate and personal taxpayers. Real operational improvements are, therefore, essential to the successful delivery of any Tax Reform project. Compliance improvements typically require a variety of systems and process improvements. This may include improvements to existing IT systems to automate processes and controls and improve the way data is managed. From a process perspective, there is often significant scope for 'quick-win' benefits from relatively simple, straightforward, practical changes that can be swiftly implemented. This applies both to the Tax Administration's systems and the way it interacts with other government (and quasi-government) departments. For example, the Tax Administration should automatically be informed whenever a new business registers with the Company Registry.
In addition, when designing a new tax system, key interactions with other aspects of government expenditure, such as social security, should also be considered as a way to build participation. For example, individuals can be required to carry photo ID cards with taxpayer details - this could enable them to pay certain taxes or perform certain transactions, but could also be the basis for entitlement to social security payments or exemption from certain taxes. A culture of participation and compliance can therefore be encouraged and rewarded by careful system design.
On a practical basis, it is essential to ensure new tax documents and forms are produced where required, both in paper and electronic form. It makes sense to consider these as part of a wider program of improving taxpayer interaction, for example, with the implementation of a new website or the ability to file tax returns online. Key to the success of any new document is simplicity - both for the Tax Administration to review and process and for the taxpayer to understand.
No two jurisdictions have the same requirements for tax reform. Nor do they have the same stakeholder concerns, legacy issues or future aims. Some jurisdictions are concerned purely about their ability to collect tax, others about the appropriateness of the tax system to their economy, others still about the efficiency with which their Tax Administration operates. Many have a combination of these concerns.
The post 'credit crunch' world has generated a renewed focus on how a government raises its revenue - the right balance of fiscal prudence and stimulus is difficult to achieve. However, with a clear view on what taxes are levied, who pays them and how they are administrated, jurisdictions can drive real improvements in tax collections, real efficiency gains and, in doing so, drive the participation of the taxpaying community. This, in turn, can provide assurance for the investor community, enable the Government to meet its obligations and drive long-term growth for the wider economy, its businesses and citizens.
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