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investment climate

April 2009

IN PRACTICE
BUSINESS TAXATION
no. 3

Tackling Corruption through


Tax Administration Reform Aminur Rahman

Aminur Rahman (arahman@


A weak tax administration encourages corruption that benefits both ifc.org) is an investment
government officials and businesses at the expense of overall tax revenue. policy officer in the World Bank

Collusive corruption is at the heart of most, if not all, problems related Group and a member of the
Investment Climate Depart-
to tax administration. This note examines the drivers of corruption ment (CIC) business taxation

and suggests good-practice measures for reforming tax administration. product team. He advises cli-
ent governments in developing
It is one in a series addressing issues that governments of developing countries on implementing tax
countries face in reforming their tax systems. reforms that will reduce barri-
ers to compliance, investment,

A well-functioning tax administration is Tax corruption raises “black money,” hidden and economic growth.
fundamental in promoting formal business income used for briberies related to other
activities, investment, and economic growth. In government regulations, procurement, and This note, one in a series on
many countries, however, tax administration is informal economic activities. business taxation reform, was
rated by businesses as a key constraint to doing
developed as part of a joint
business. A malfunctioning tax administration What drives the demand for
program between the United
raises the cost businesses incur in complying tax corruption?
with the government’s tax requirements. This Kingdom’s Department for
leads to firms and tax officials colluding outside A business is willing to bribe if it reduces the tax International Development
the system at the micro level and a high degree of payment and saves the time involved in tax (DFID) and CIC. The program
mistrust between business and government at audits. For instance, in Yemen, businesses report focuses on operational issues
the macro level. that paying a bribe of 25-40 percent of the tax
in tax reform, particularly those
assessment can lower the assessment by 50
related to micro-enterprises
Corruption is often viewed as a predatory act: percent. In many developing countries, large
government officials prey on businesses that firms take this opportunity (and exploit the and small businesses.
become the victims. However, tax corruption is loopholes in tax laws) to informally negotiate
a win-win situation for both tax officials and and file tax returns under the presumptive The IN PRACTICE note series
firms. A bribe is not necessarily an administrative regime designed for small businesses, without discusses practical consid-
extortion, but rather a business transaction disclosing the accounts.
erations and approaches for
yielding a lower tax payment for the company
implementing reforms that
and unofficial, “tax-free” income for the tax Weak enforcement often means there is no
official at the expense of national income. significant risk of detection and punishment, aim to improve the business
Collusive corruption among firms is exhibited in which further encourages corrupt behavior. A environment. IN PRACTICE is
non-compliance of tax payments, misreporting high tax burden and compliance cost can published by the Investment
of business activities, informal negotiations on exacerbate the situation. Moreover, the inevitable Climate Department of the
tax obligations, unofficial payments to the question remains: “Why would I pay tax?” In the
World Bank Group.
collectors, and revenue loss for the government. absence of any tangible benefits of public
spending, taxpayers in many countries do not feel a and procedures; non-transparent hiring and
civic obligation to pay tax, believing their income is reward mechanisms; a low level of skills; a lack of
taxed to pay the salaries of corrupt public officials. professional ethics and integrity; low pay and a
lack of incentives; conflicts of interest; the “get-
rich-quick” syndrome; and insufficient checks and
What drives the supply of balances within the administration.
tax corruption?

Despite the often robust demand, the key drivers Good-practice reform
of tax corruption are on the supply side. In many measures
countries, offering a bribe is the only way to avoid
harassment from tax officials. Refusal to pay bribes Tax reform measures should tackle both the
may result in endless inspections (and require- demand (businesses) and supply (tax
ments) that can last for months and waste administration) side drivers of corruption. The
significant senior management time. challenges of weak administration and pervasive
corruption are closely related and mutually
Similarly, while appeal procedures exist in many reinforcing. Thus, good-practice reform measures
countries, they are not credible. Firms usually do aimed at tax corruption also reflect the key features
not try to appeal; they view the decisions in most of modern tax administration.
cases as favoring the tax authority and penalizing
businesses with heavy fines and imprisonment. A typical technical assistance program for tax
During the long period of settlement, the firm administration reform addresses several reform
may also face pressure from tax officials to measures in strategic sequence. In the short term
informally settle with a bribe. Consequently, (within 18 months), the program aims to simplify
companies often decide not to enter into a dispute. tax instruments and processes; facilitate underlying
legal reforms; consolidate subnational taxes and
The underlying causes that drive corruption among fees; and provide training and capacity building
tax officials include: complex and unclear tax laws for tax officials and the private sector to successfully
implement the streamlined, consolidated tax
instruments and processes. In the medium-term
(within 36 months), the program will redesign tax
Six Reasons to Reform Tax Administration administration architecture that involves
institutional autonomy; reorganize the system and
❏❏ Tax administration is a critical determinant in the investment services based on types of taxpayers; and implement
climate. Improving it can help attract more investment to increase human resource management policy, automation,
incentive mechanisms, and checks and balances.
growth and reduce poverty.
❏❏ Tax reform reduces the compliance cost and broadens the tax net,
enabling the government to raise revenue with a lower tax rate and to Short- to medium-term
equitably distribute the tax burden. reform implementation
❏❏ For any given tax policy, a well-functioning administration raises
more revenue than a malfunctioning one. Simplify, standardize, and harmonize tax
procedures. A simpler process reduces tax officials’
❏❏ Tax policy reform without administrative reform is not fruitful in an
discretionary power and abuse of tax laws, lessening
environment of mistrust; the good intentions of either tax officials or the burden for firms to comply. For example,
businesses are cynically viewed by the other party. Colombia recently carried out a systematic study
❏❏ Tax corruption propels corruption in other areas; reform is essential of important business processes and prepared a
to cut the “supply lines” of corruption. map of corruption risks to guide procedural
❏❏ A modern tax administration is necessary to keep up with changes. Latvia and Jamaica reformed their tax and
customs codes to reduce the discretion of revenue
the increasing sophistication of firms’ operations in the era of
officials and simplify procedures.
globalization.

IN PRACTICE BUSINESS taxation 2


Enforce compliance and target corruption with corruption, as has been demonstrated in the
a strengthened legal framework and adminis- Philippines and Nepal. Automation is a key feature
tration. A lower tax burden will not increase of modern tax administration. It efficiently collects
compliance without an effective enforcement information from taxpayers and other parties (such
mechanism. The laws should enforce record as banks and government agencies) and
keeping, return filing, voluntary registration, and electronically supports clerical functions. It enables
arrears collection. Under self-assessment, compliant businesses to file returns and to easily and quickly
taxpayers should be free to conduct business declare and pay taxes. Automation is also essential
without abusive auditing, and those considered for risk-based management approaches.
non-compliant should be penalized. The legal
framework should reflect “zero tolerance” for Introduce an effective human resource
corruption. If proven guilty of corruption, the management policy. The administration should
offenders—whether they are tax officials or firms— have a transparent, fair, and streamlined policy for
should be punished. recruitment, performance appraisal, career
development, and compensation including
Conduct taxpayer outreach and education. incentives. Staff professional development needs to
Educating taxpayers reduces firms’ misconceptions include an anti-corruption focus, ethics, and code
and confusion about tax policies and procedures, of conduct. Employee achievements in detecting
and raises their awareness on the benefits of proper tax fraud, attaining client satisfaction, and
record-keeping, such as quick assessments and less improving revenue collection should be recognized.
likelihood of being audited (and less intrusively, if Latvia, the Russian Federation, and Colombia have
audited). It also works to instill trust between the focused on strengthening their tax administration
administration and business. In Uganda, Rwanda, management. Many countries have used revenue
and South Africa, outreach activities have included administration restructuring to establish human
TV and radio coverage, advertising, and tax- resource management principles and terminate
themed school programs to help children corrupt officials. In Guatemala, Peru, and Jamaica,
understand the civic responsibility of paying taxes. a rigorous process of psycho-metric tests, job-
specific skill tests, interviews, and personal record
Institutionalize an effective control and audit reviews was used to weed out corrupt and under-
system. Experience suggests that most firms will performing employees. To improve tax officials’
comply in paying taxes if they understand their pay (thus lowering the incentive for corruption),
obligations, and if they see the tax administration is some countries have disassociated revenue
fair in handling non-compliance. The risk-based administration staff salaries from general civil
auditing system enables effective auditing and service pay. In Guatemala, the salaries of top
efficient management of the administration’s managers were increased significantly. Jamaica
resources. A number of countries, including Chile, created a separate pay scale for tax administration
Colombia, and Hungary, have implemented staff. Russia and Albania allowed managers to give
systems that compile information from various performance-based bonuses.
sources to create risk profiles. Hungary has imported
a system that guides auditors through the steps of Institutionalize a streamlined and transparent
an audit. Other measures include: streamlining the appeal procedure. An unbiased, quick, and
reporting arrangement for audits; rotating auditors transparent appeal process helps firms develop
to prevent corrupt affiliations between auditors and trust in the overall system. In shortening the
audited firms; and implementing a system to process, the tax authority can limit abuse by firms
monitor individual auditors. that appeal in order to defer paying taxes over an
extended dispute period. The Revenue Appeals
Tribunal, a process widely used in the United
Medium- to long-term reform Kingdom, Canada, and Uganda, can be expedient
implementation in moving trials to conclusion.

Institutionalize e-services and automation. Reorganize tax administration by type of


Reducing face-to-face interactions between taxpayer. To increase efficiency and effectiveness,
businesses and tax officials limits opportunities for the tax authority headquarters and local office

IN PRACTICE BUSINESS taxation 3


network should be rationalized and streamlined processes does not automatically ensure compliance.
based on the different sizes of taxpayers. Most Businesses can still evade tax without a strong
revenue administrations are moving toward this enforcement mechanism. Enforcement should be
sort of institutional restructuring. Segmented matched with appropriate checks and balances in
service delivery enables the tax authority to better administration or tax officials will abuse their
understand each category of firms, allowing for power. Similarly, in an atmosphere of mistrust (and
informed monitoring of taxpayers and tax officials. lack of confidence in the judicial system), firms
For instance, under a size-specific structure, it is seldom use an appeal mechanism and complaint
more difficult for larger firms to hide profit or hotlines because they believe the decisions will
income and file as small firms. A functional penalize them and favor tax officials.
organization structure has been implemented in
Latvia, Jamaica, and Russia. A large taxpayer’s Pay raises and bonuses for tax officials, or
office has been successfully established in South institutional autonomy for that matter (which is
Africa, most transition countries, and in many politically challenging to achieve), are not a panacea
countries in Latin America. to stop tax officials’ rent-seeking behavior. As
evidenced in Uganda, Ghana, and Tanzania, the
Ensure the tax authority’s autonomy. Although initial gain in terms of improved revenue collection
the tax authority is often attached to the Ministry due to pay raises or institutional autonomy is not
of Finance, measures should be taken to strengthen always sustainable without checks and balances and
the administrative autonomy of tax services. The punitive measures against corruption. In an
effectiveness of the measures discussed above— environment where corruption is a way of life and
incentives and penalties, streamlined operations, the tax authority’s higher tiers share the proceeds of
management and control—crucially depends on the lower tiers’ bribery, these sorts of administration-
both organizational and budgetary autonomy. wide measures against corruption are difficult
Autonomy increases the transparency of the tax without support at the highest levels of the
administration and its budget and the effectiveness government (which is also not prone to election
and efficiency of its expenses. It is important in results and changes in political leadership).
The World Bank Group’s Investment promoting merit-based recruitment, performance-
Climate Department (CIC) is the op- based career development, and professional skill The key to sustainable progress against corruption
erational center for IFC’s Business En- development. Autonomy minimizes the chances of lies in sequencing the measures of an overall
abling Environment Advisory Services the administration’s involvement in political strategy for reform. While each measure addresses
corruption and client favoritism. a specific driver of corruption and a full reform
and FIAS, the multi-donor investment
package must be implemented over the longer
climate advisory service. CIC assists the
term (or widespread corruption will prevail
governments of developing countries Conclusion through the weaker links in the system), a
and transition economies in reform- manageable and logical sequencing first addresses
ing their business environments, with An important lesson in tax administration reform, the shorter-term implementation components (tax
emphasis on regulatory simplification as experience around the world indicates, is that instruments and processes, taxpayer awareness,
undertaking reforms on a piecemeal basis does not and the underlying legal and administrative
and investment generation. The find-
yield the desired results because each reform framework). It does not make sense, for instance,
ings, interpretations, and conclusions
measure is critically interlinked with others. to address human resource policy before an audit
included in this note are those of the Therefore, designing and enacting a comprehensive and control system is in place. Thus,
author and do not necessarily reflect reform package requires continued and strong implementation of the shorter-term measures
the views of the Executive Directors of political will over time. provides a basis for longer-term structural and
the World Bank or the governments institutional reform, such as reorganization of the
Understanding how reform measures work together tax administration architecture.
they represent.
is key in addressing challenges on the ground in Further reading on this topic is available from the
their implementation. For instance, simplifying author upon request.

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