VII

TAX REFORM AND IMF

PoLICY ADVICE

Tax Reform in Market Economies and Economies in Transition: Principles and Experience

ANGELO G.A. FARIA

• Wbat bave been tbe principles of tax reform in ment and efficient functioning of market forces over market versus transitional economies, in the longer term. 1 In this context, "tax neutrality" has particular as tbese relate to tbe role oftbe state been invoked by fiscal experts as the prime guide for a and tbat of taxation as an instrument of tax system designed to work with market forces. policy? Where, however, "market failure" is manifested be­ • How does recent experience in tax reform­ cause of public goods, externalities, natural monopoly, and asymmetric information, state intervention is ob­ widening of tax bases and lowering of tax served to be warranted. In these cases, however, the rates-in market economies compare witb state is called upon to facilitate the provision of, rather tbat ofgradual movement away from exdusive reliance on wage wttbboldtng and than to produce, such goods and services, thus neces­ turnover in transition economies? sitating an explicit transfer of financing resources be­ tween the private and the public sectors. It is this • Sbould tax reform in transitional economies limiting view of the financing role of government ema­ employ tbe gradual versus "big bang" nating from both the tax and expenditure sides of the approaches? budget which helps to support a restrictive view of the desirable tax burden. Hand in hand with this shorter­ term revenue-enhancing role of is its per­ The dramatic recent political and economic disinte­ ceived contribution to short-term economic stabiliza­ gration of the centrally planned economies of Eastern tion. This older Keynesian view of taxes, however, Europe and the former Soviet Union points to the im­ particularly as automatic stabilizers, has given way, be­ portance of examining, inter alia, the economic reform cause of the shorter lags to a greater emphasis on sta­ issues that have arisen, while at the same time high­ lighting the direction and sequencing of prospective re­ bilization through monetary policy instruments. There remain, however, recognized longer-term functions for form, as these economies undergo economic transition the tax system represented by its allocative function, into market economies. An important subset of issues relates to tax reform considerations and, in particular, primarily in influencing the aggregate consumption/in­ the insights that may be drawn from the experiences of vestment resource balance through tax/price wedges market economies, not only to Continental Europe but and, to a lesser extent, its redistributive function in re­ also to East Asia and Latin America. These will be illus­ ducing socially skewed distributions of income and trated in this section using a stylized approach reflect­ wealth. A more recently emerging role for tax sys­ ing standard characteristics, which contrasts for the two tems-at least in some industrial countries-is through broad groups the role of tax policy, their recent experi­ adjustment of energy taxes to reflect environmental ences with reform, and the directions of prospective re­ concerns. This is discussed more fully in Chapter III. In form in transition economies. The latter aspect presents the last analysis, however, the need to finance bur­ special difficulty when dealing with transitional econo­ geoning government expenditure without recourse to mies because experience is limited and because, for tax inflationary bank financing or augmenting the govern­ reform to be fully effective, it must emerge as a natural ment debt burden means that, in the short term, the outgrowth of, rather than anticipating, more wide-rang­ revenue-enhancing objective is more important than ing economic policy and structural reform. other objectives. By contrast, in economies in transition from central Role of Tax Polley planning, the role of taxation hovers uneasily between its former function as a passive system of predeter­ In market economies, the roles of tax and fiscal poli­ mined transfers and a more modern role as an instru­ cies follow from the view of the role of government in ment of macroeconomic policy that influences the organizing economic activities. The earlier view of an behavior of economic agents. 2 The public sector still activist role for governments appears to be giving way to a more restrictive view that in a market economy, 'See OECD (1993). governments exist essentially to promote the develop- 'See lllnzi (1992).

275 effectively covers virtually the whole economy, and sense for administrative feasibility in developing tax enterprise activity and employment are largely public systems that foster compliance and reduce disincen­ in character, with output and prices at both the sectoral tives to private sector investment. Tax systems reflect­ and individual firm level only gradually being freed ing such overall features have been broadly evolving in from centralized controls. In this system, taxation of OECD countries, East Asian economies, as well as Latin employees has taken the form of withholding taxes on American countries.45 individual earnings, and of payroll-based social secu­ The personal has remained, for most rity contributions, in a controlled wage-setting environ­ Western countries, the tax choice because of its impo­ ment. For enterprises, a system of regulated volume, sition of a tax burden in line with the individual's abil­ price and profit differentials operate, with the result ity to pay, although they have recognized that effective that no tax laws had to be legislated and that a wide variety of arbitrarily established nominal-and more progressivity depends not only on the rate schedule importantly effective-tax rates operated in practice. but also on the comprehensiveness of the tax base. There was thus no room for unplanned explicit taxa­ This has led to a movement from a schedular system tion, although implicit taxation probably existed to the with income differentiation by source and a rate struc­ extent that planned product prices did not match ac­ ture associated with each source, toward a global sys­ tual factor payments and other operating costs.3 In tem based on aggregating income from all sources place of compulsory explicit transfers between the pri­ (including fringe or noncash benefits from employ­ vate and public sectors through taxation, as in market ment, and also short-term capital gains) and a progres­ economies, there was a centralization of revenue and sive marginal rate structure. At the same time, its subsequent allocation or earmarking through trans­ considerations of supply-side gains and administrative fers to other levels of government and to state enter­ simplicity have brought about a flattening in rate struc­ prises-in essence, a process of cash management tures, representing a substitution of linearity based on based on priorities established under a central plan horizontal equity for progressivity based on vertical and modified from time to time. Moreover, other state­ equity. This has taken the form of a lesser number of controlled subsystems (e.g., monetary, wage setting, rates; in addition, there has been a significant reduc­ prices) also carried out quasi-taxation functions. In ad­ tion in the top marginal rate so as to align it more dition, the operations of this all-encompassing public closely with the corporate rate and thereby reduce its sector were also financed through credit obtained on disincentive effects and the associated scope for tax easy terms from the state-controlled banking sector. avoidance. Contemporaneously, and to sustain revenue yield, the tax base has been broadened by eliminating built-in erosions and rationalizing personal exemption Recent Experiences in Tax Reform limits in relation to per capita GOP or by family size based on notions of minimum income levels. Finally, to •Market economies. The recent evolution of the make tax administration more simple and selective, structure of the tax system in market economies reflects there has been an extension of withholding taxes as fi­ a fundamental shift in taxation philosophy away from nal taxes beyond wages to investment income. interpersonal equity objectives and toward economic efficiency objectives. Efficiency is best secured when it In the area, reform has taken the form can be established for both and tax adminis­ of stressing the importance of an objective definition trations with certainty and transparency. Thus, in forc­ of profits based on generally accepted accounting ing transfer of resources through taxation, the thrust principles but taking account of inflation in the valua­ has been to produce lower burdens or deadweight tion of assets and their amortization, and permitting losses. Against this background, there has evolved, carryforward of losses. There is general agreement on over several decades, a complex system of ad per­ a low, single, , aligned to the top marginal rate sonam direct taxes on income and wealth focusing on of personal income tax. While some countries, notably considerations of horizontaVvertical equity and redis­ the United States and japan where public companies tribution, and ad rem indirect taxes (notably the sales are more common, still maintain classically oriented tax, VAT, and selected ) which, although possi­ corporate tax systems that delink the taxation of cor­ bly regressive in their effects, do implicitly favor sav­ porations and their shareholders, the general drift has ings and investment. As one might expect, tax reform been toward the full integration of corporate and per­ in advanced market economies has at least in spirit for­ sonal income tax. saken efficiency optimization in a narrow technical 4See Shome 0992). 'See 'Ilmzi (1991). SSee Tanzi and Shome (1992).

276 Such integration could be achieved through exemp­ Finally, taxation in advanced market economies has tion of distributions from corporate tax in favor of tax­ been carried out in the presence of an evolving envi­ ing distributions on a gross basis at the shareholder ronment characterized by an open relationship be• level; alternatively, distributions could be taxed gross at tween taxpayers representing the private sector and the corporate level, and on a grossed-up basis at share­ the tax administrations representing the public sector, holder levels but with full imputation or based on a mutual recognition of their respective rights against shareholder liability for the corporate tax levied and duties. It reflects a clear acceptance by govern­ thereon. Increasingly, considerations of world effi­ ments that complex tax systems function effectively ciency and capital neutrality have led to the only if large segments of the population respect and adoption of the full imputation approach, and even comply with their obligations under the tax code. For "tax sparing," within the framework of their part, taxpayers have tacitly accepted their compli­ conventions. These considerations have also contrib­ ance obligations of filing tax returns, paying their tax uted to the view that at the margin, a single low statu­ liabilities, and responding to requests for information tory tax rate and other noneconomic factors (e.g., from tax administrations in a timely fashion. In turn, political stability, good infrastructure, a lower-paid but tax administrations have learned to respect the rights educated work force) are more important elements in of taxpayers to be informed, assisted, and heard; to re­ reducing the risk premium for the prospective foreign ceive fair treatment; to have all their matters treated investor than taxation by itself. with confidentiality; to have their tax liabilities deter­ mined with certainty; and to be able to appeal freely There has been a structural shift in tax structures, against administrative decisions before independent with increasing shares for taxes on consumption rela­ administrative tribunals and/or the courts. tive to taxes on income and wealth. With the notable exceptions of the United States, which does not have it, • Centrally planned economies. The basic forms of and Japan, which has a different production-based taxation in formerly centrally planned economies (in variant, it has been generally recognized that a con­ order of importance) included various individual levies sumption-type, destination-based, invoice-backed VAT on enterprises, turnover taxes, payroll taxes, and wage represents the best general tax on consumption for taxes. Enterprise taxes were essentially levies that were market economies. In this form, only minimal tax base presumptive in character, because they were negoti­ exemptions (e.g., health, financial services, and owner­ ated for each enterprise in terms of its production and occupied housing, and, perhaps, some professional distribution expenses rather than as a predetermined services) are retained based on administrative consid­ share of operational profits established by using objec­ erations; tax is levied at a single rate; and there is pro­ tive accounting indicators. Such levies related to, inter vision for zero-rating of and taxation of alia, the enterprise's use of resources, rents, amortiza­ imports. This is because of its positive revenue and tion funds, and wage levels. Enterprises were also neutrality/efficiency characteristics, although it could subject to turnover taxes, again established on an indi­ be adverse in its redistributive consequences. To miti­ vidual enterprise basis, levied on a tax base as a per­ gate these regressive effects, countries (especially in centage of retail prices that represented the difference Western Europe) have attempted to provide substantial between planned levels of producers' costs and retail tax base exemptions and/or differentiated tax rates for prices. Because retail prices were fixed while costs var­ essential and nonessential foodstuffs and other con­ ied, this produced multiple effective tax rates but insig­ sumption items. VAT systems have been reinforced for nificant cascading and avoidance of tax charged. One sumptuary consumption items (e.g., alcohol, tobacco, factor increasing the price of labor as a production in­ and transport and petroleum products) by prior ad va­ put was payroll taxes (including social security contri­ lorem duties, which, being price inelastic, gen­ butions) levied at a proportional rate on the gross erate stable revenue. The structural shift mentioned wage bill. By contrast, workers paid a withholding above is especially visible as regards external wages tax at a proportional rate as a final tax on their taxes, which are no longer viewed as revenue "han­ earnings adjusted for family size. Taxes on foreign dles" and, indeed, even as instruments of effective pro­ trade, together with quantitative restrictions, were de­ tection. Rather, the modern view accepts the need to signed to capture foreign exchange earnings and to accommodate some protectionist pressure while secur­ insulate the domestic economy from foreign influ­ ing minimum revenue, by adopting a low uniform ences. Finally, although interest on deposits with state supplemented by border tax adjustments to eliminate/ banks was not taxable, the state collected specific ser­ reduce tariff costs for exported products. vice fees and charges.

277 One important distinguishing chara<.1eristic of tran­ go for a "big bang" comprehensive approach in adopt­ sitional economies was the very marginal function ing a Western-type tax structure or to proceed more performed by tax administration, reflecting the im­ gradually. In practice, they have adopted elements of plications of dominant state ownership and control of both approaches, in the process saddling themselves economic activities. Thus, the tax administration was with complex distortionary features. 6 Experience in not engaged in the traditional functions of assessment, East Germany in bringing its tax system more in line collection and enforcement of taxes. Assessment was with that of West Germany, and of reforming tax sys­ essentially plan-determined, with no scope for appeal. tems in other East European economies has shown that Collection took place through transfers between ac­ significant adjustments become much more difficult to counts held with the state banking sector. Enforcement implement in the second round as opposition to them through general or selective audits, fines, and penalties builds up. Moreover, the economies in Eastern Europe was virtually nonexistent because most are recognizing after more than a decade that reformed was obtained through a few taxes only, paid compulso­ tax systems are difficult to legislate, and once legis­ rily in one form or another by a relatively small num­ lated, even more difficult to implement unless comple­ ber of state enterprises. As a result, the role of the tax mented by institutional, administrative (including administration was limited to merely verifying the ar­ legal), and attitudinal changes within the tax adminis­ ithmetical correctness of tax-based transfers between tration and taxpayers. The Baltic countries (Estonia, bank accounts. Latvia, and Lithuania) have formally introduced West­ ern-based tax systems by decree in 1991/92, but their implementation is proceeding very slowly. Prospects for Tax Reform in Transitional Economies The overall record in transition economies is, at best, mixed. Their VAT systems remain complicated to All transitional economies have accepted the need operate because of the retention in the CIS countries of for a fundamental restructuring of their tax systems as the origin principle and a cash rather than accruals ba­ they evolve from being controlled economies to be­ sis of assessment; multiple rates; excessive exemptions; coming market economies. This restructuring is neces­ and mixes of invoice- and accounts-based methods of sary to take account of the microeconomic efficiency establishing tax liabilities. Similar multiple rates and ex­ effects of taxation applied to newly independent eco­ cessive exemptions, especially for agriculture, charac­ nomic agents. Also, in the short run, macroeconomic terize the schedular personal income tax and profits considerations call for maintaining fiscal stability in the taxes. Land taxes remain primitive, in part reflecting face of contracting tax bases and rising demands for the uncertain situation regarding land titles and thus significant social welfare and public infrastructural out­ land values. lays. Moreover, the opening of the economy to the out­ side world brings in its wake an increased domestic Clearly, the normally difficult and drawn out process susceptibility to external economic developments. of tax reform is likely to prove even more so in transi­ tion economies. While legislation can often be put in While tax reform in transitional economies to be ef­ place by fiat, for a modern tax system to take root re­ fective cannot be long delayed, it also cannot precede quires a structural sea change of institutions, laws, pro­ underlying structural change. The central dilemmas for cedures and, not least, in the thinking of tax authorities policymakers are how to balance longer-term concerns and taxpayers. of equity and allocative efficiency with the shorter­ term concern with declining revenue, and whether to 6See Shome and Escolano (1994).

278 Summary of IMF Tax Policy Advice

}ANET STOTSKY

• Wbat are standard IMF recommendations on IMF has also suggested interim measures that may de­ tax policy? viate from the long-term goals of tax reform. • Wbat elements are common to all countries To illustrate patterns and trends in taxation, a data and wbat elements are unique to specific base on tax strU< ..ture for IMF member countries is pre­ countries? sented for 1975-1992 in the Appendix (Tables 1-36). Countries are grouped by geographic region and level of development into six country categories: OECD, Af­ The Fiscal Affairs Department (FAD) of the IMF has of­ rican, non-OECD Asian, Middle Eastern, non-OECD fered advice on tax policy to many countries. This chap­ Western Hemisphere, and Eastern European and tran­ ter provides an account of the nature and scope of sition economies. recent IMF advice given to countries in response to their requests for technical assistance on tax policy. It identi­ The following section examines in greater detail the fies in this advice both common themes applicable to all scope and nature of IMF advice on tax policy. countries and special elements designed to address is­ 7 sues unique to a specific country or countries. Nature and Scope of Recommendations Reforming the tax system in any country is a compli­ cated undertaking, with its scope and direction fre­ OveraU tax revenue quently circumscribed by many political and economic Most countries rely on tax revenue as the main factors. One unmistakable common goal of tax reform source of funding for the public se<.tor. The size of the is the simplification of existing tax systems in recogni­ public sector-including social insurance-tends to be tion that overly complicated tax systems tend to gener­ positively related to the per capita income of the coun­ ate inefficiencies, inequities, high compliance costs, try. Hence, the share of tax revenue in GOP also tends and . With the fundamental tenets of tax pol­ to increase with per capita income. The share of tax icy as described in this Handbook as a basis, the IMF revenue in GOP is largest in OECD countries and is has also advocated the need to enhance the neutrality smaller in developing countries.8 In 1986-92, this share of the tax system and to lessen the demands on tax ad­ averaged 30.4 percent of GOP in the OECD countries, ministration. In general, the IMF has recommended 17.7 percent of GOP in the African countries, 14.1 per­ achieving these goals through either the simplification cent of GOP in the non-OECD Asian countries, 13.6 of the structure of existing taxes or the introduction of percent of GOP in the Middle Eastern countries, 16.5 new and simple taxes to replace old and complicated percent ofGDP in the non-OECD Western Hemisphere ones. countries, and 27.3 percent of GOP in the transition economies (Tables 1-36 (in percent of GOP)). Many of the countries that seek advice are engaged in IMF structural adjustment programs. One critical Domestic consumption taxes component of many of these programs is the alleviation Domestic consumption taxes are a critical compo­ of fiscal imbalances that threaten macroeconomic sta­ nent of most tax systems. They comprised from 19.4 bility. IMF advice has therefore frequently taken into ac­ percent to 36.6 percent of tax revenues in the different count the need for additional revenues. It has been regions of the world in that same period (Tables 1-36 guided by the principle of designing tax policy mea­ (in percent of tax revenue)). sures that would generate adequate revenue to meet In most countries, the largest proportion of con­ budgetary needs in as economically neutral a manner sumption tax revenues comes from broad-based sales, as possible. Nevertheless, in countries where revenue turnover, or value-added taxes. The overall objective of needs were particularly severe or where existing ad­ domestic consumption taxes is to tax the consumption ministrative capacities were seriously inadequate, the of a broad base of goods and services at a low rate, so

"'bis discussion draws upon previous work of the Fiscal Affairs Department, including IMF, Thx Policy Division 0993), Tait 0989), "For various discussions of tax revenue structures in a cross-section llmzi (1990), Shome 0993), Shome and Escolano 0993), and Shome of countries, see Mendoza, Razin, and Tesar (1993), Sidgwick (1991), (1995). Tail, Gratz, and Eichengreen 0979), and Thnzi 0987).

279 that maximum revenue is obtained and the burden is ommended the adoption of a consumption-type VAT, widely spread. Efficiency is achieved through equal although this narrows the base of the VAT relative to a treatment of different sectors and activities. gross- or net-income-type VAT. To maintain interna­ tional competitiveness, the IMF has also recommended Although many countries make use of multilevel the adoption of a destination-based VAT. For interstate turnover taxes, this results in cascading. Hence, these trade among the countries of the Commonwealth of In­ taxes are inferior to a VAT. Retail sales taxes avoid the dependent States (CIS), the IMF did not object to the problem of cascading but are more prone to tax eva­ adoption of an origin-based VAT, because of the ab­ 9 sion than a VAT. As a result, the VAT is a good tax. IMF sence of border controls and other administrative advice in the area of domestic consumption taxes has reasons. generally focused on the VAT. The IMF has provided extensive assistance to countries engaged in both the The IMF has recommended that the VAT cover the introduction or restructuring of an existing VAT. Many manufacturing stage. In some countries with stronger countries have introduced a VAT in recent years (most administrative capacities, it has recommended that the notably in the transition economies). Other countries VAT cover the retailing stage as well, with this as the have reformed and simplified their existing VATs (most ultimate goal in most countries since this results in the notably in the Western Hemisphere). In arriving at broadest and most efficient VAT. The IMF has been a their recommendations, the IMF has frequently used firm advocate of using the invoice-credit method of ac­ the experience of the countries of the European Union counting. It has frequently recommended that the VAT (EU) as a guide. have a threshold level based on turnover for exempting small traders. This threshold eases the administrative The IMF has typically recommended that the VAT burden with little loss of revenue. In some cases, this have a single rate within the range of 10 percent to 20 recommendation has been coupled with a provision percent, depending on revenue needs (with a zero rate for allowing small traders to opt into the VAT if they for exports) and that exemptions be kept-to a mini­ wish to credit VAT on their purchases. mum. In countries where a single-rate VAT seemed po• litically infeasible, the IMF has proposed a dual-rate The introduction of a VAT requires considerable structure (a normal rate coupled with a reduced rate effort in educating taxpayers and training tax adminis­ on a limited number of items). FAD has argued trators. For this reason, the IMF has sometimes recom­ strongly against the adoption of a VAT with more than mended that countries first reform and improve the three rates. FAD has also urged against taxing certain strU(.ture of turnover or sales taxes before introducing goods, principally necessities, at low rates or exempt­ the VAT. The recommendations for reform of these ing them. It has favored redistributing income on the taxes are similar to those for the VAT in that they have spending side rather than on the tax side. emphasized broadening the base and simplifying the rate structure. As regards the base of the VAT, the IMF has focused on limiting the scope of exempted items to a few stan­ The IMF has also offered considerable advice on re­ dard ones that are difficult to administer under a VAT, form of excise taxes, which most countries already such as rental incomes from housing, financial ser­ have. Excises have many uses in a system of taxes, in­ vices, and the agricultural sector, and on taxing all cluding revenue generation with little excess burden, other goods and services, including construction mate­ correcting for negative externalities, and enhancing rials, professional and personal services, sales of new vertical equity. It has generally recommended a five­ buildings, and purchases by government, other public, pronged strategy for excise tax reform: first, to limit the and nonprofit entities. In selected transition econo­ list of excisable goods to a few traditional ones, such as mies, the IMF has departed from typical practice and tobacco products, alcoholic and nonalcoholic bever­ recommended that the VAT be applied to farmers, be­ ages, and petroleum products (and perhaps vehicles cause, compared to many countries, the farms are large and some luxury goods); second, to replace specific and few in number. with ad valorem rates to prevent the erosion of revenue by inflation; third, to choose excise tax rates that are In a few countries, the IMF has expressed a prefer­ internationally comparable; fourth, to tax imports as ence for taxing essential items at a reduced rate over well as domestic production so as not to disadvantage exempting them, but if they were to remain untaxed, it domestic production; and fifth, to levy VAT on the recommended exemption rather than zero-rating. To price inclusive of excises. The IMF has also at times promote capital formation, the IMF has uniformly rec- recommended that countries maintain a combination of specific and ad valorem rates if tax administrative 9See Thil (1988). capacities are too weak to ensure that goods are val-

280 ued accurately and if the excises are intended to be ex­ nonmarket-related or multiple exchange rates, market­ ternality-correcting. ing boards that set below market prices, or surrender requirements on hard currencies. The IMF has also dis­ International trade taxes couraged export subsidies. International trade taxes are generally a more im­ portant part of the tax system in developing countries Income taxes than in industrialized countries. The lowest-income Income taxes are a critical component of tax reve­ countries tend to rely most heavily on international nues in all regions of the world, ranging from 23.0 per­ trade taxes, primarily import taxes or duties. Trade cent to 36.5 percent of tax revenues, in 1986-92 (see taxes comprised only 2.5 percent of tax revenues in Appendix tables). Most countries levy both personal OECD countries and 9.3 percent of tax revenues in and corporate income taxes, although the breakdown transition economies in 1986-92 while these taxes between them varies across countries. ranged from 24.9 percent to 36.6 percent of tax reve­ Personal income taxes are the mainstay of tax reve­ nues in other regions during that period. Among devel­ nues in industrialized countries, while they are consid­ oping economies, the transition economy countries erably less important in developing countries. Personal were an exception, with a relatively low reliance on in­ income taxes are a valuable component of a balanced ternational trade taxes, reflecting their relative isolation until the past few years and the lack of tax system; nevertheless, they require greater tax ad­ administration. ministrative capacity than is found in many developing countries. The last two decades have witnessed many in­ stances of successful growth strategies in developing The IMF's recommendations with regard to the re­ countries. All of them involved the implementation of form of personal income taxes have generally been in line with recent international trends in personal in­ outward-oriented trade strategies-lowering trade bar­ come tax reform. These reforms have emphasized re­ riers, removing disincentives to exports, and imple­ menting currency convertibility. Among developing ducing the graduation of the marginal rate schedule countries, those that have adopted strongly outward­ and broadening the base by limiting deductions, ex­ oriented trade policies seem to have shown better eco­ emptions, and other tax preferences. The IMF has typi­ nomic performance than those whose policies were in­ cally recommended a structure with no more than ward-oriented or only moderately outward-oriented.10 three brackets, with a top marginal tax rate of no more than 40 percent. Along with changes in the rate struc­ As a consequence, the IMF has generally advised ture, the IMF has in many instances advocated raising against reliance on import and export taxes. With re­ the threshold for incurring a tax liability (i.e., standard gard to import taxes, the IMF has acknowledged that deduction) to remove lower-income taxpayers from the there may be some role for temporary import taxes, tax roles, to enhance the progressivity of the tax with primarily to provide protection to domestic infant or little loss in tax revenue and simplified administration. restructuring industries, and secondarily, to provide In other instances, it has advocated lowering the revenue. The IMF's recommendations have typically in­ threshold, especially in Western Hemisphere countries, volved simplifying and rationalizing the structure of to expand the base. It has also recommended limiting import taxes, eliminating ad hoc exemptions, setting a deductible items, such as the number of dependents, uniform minimum tax on all imports (often well below mortgage interest and other consumer interest pay­ the existing rate), adopting ad valorem rates, and valu­ ments, insurance and pension contributions, savings, ing imports on the basis of market-related exchange and charitable contributions. It has also advocated lim­ rates. iting income exempted from the tax, such as certain in­ come transfers and interest earned on government The IMF has strongly opposed reliance on export debt. The IMF has also in many cases recommended taxes since they are almost always shifted back to pro­ reforms to make the tax system neutral to inflation, by ducers. It has viewed export taxes as having a limited indexing brackets, credits, standard deductions, and role in generating revenue; proxying for an income tax other nominal amounts to inflation. on sectors, such as agriculture, that are difficult to tax; and capturing windfall gains, usually on oil or extrac­ The IMF has typically favored the adoption of a glo­ tive minerals. Often, export taxes are present in the bal income tax to achieve equity goals; nevertheless, it form of implicit taxes. The IMF has strongly advocated has at times favored the retention of schedular income the elimination of implicit taxation on trade through taxation in economies in which tax administration is weak and taxpayers tend to earn income from only 10 See International Monetary Fund 0993). one source. In countries with a schedular income taxa-

281 tion, the IMF has advocated unifying the schedules that tive to other forms of tax preferences or as an offset to apply to different kinds of income so as not to distort high rates of inflation. It has also recommended ratio­ incentives and generate inequities. Although the nalizing inventory valuation and loss carryforward choice of filing unit is an important issue, the IMF has rules. In economies beset by high inflation, as in some tended not to recommend changes in prevailing Western Hemisphere economies during the 1970s and practices. 1980s, and the transition economies, the IMF has advo­ cated indexation of and revaluation of Corporate taxes are a mainstay of the tax system in assets and liabilities. The IMF has also in some coun­ many countries, though they typically constitute a tries focused on taxation of the financial and minerals larger share of tax revenue in developing countries extraction sectors, since there are many special tax is­ than in industrialized countries. Nevertheless, their sues relevant to them. complexity in industrialized countries has made them an important focus of tax reform efforts, even though The IMF has also advocated the use of a minimum their revenue yield is modest. corporate tax in economies where corporate tax revenues have been seriously eroded as a result of var­ The IMF has generally emphasized the importance ious factors, including political forces that have led to of adopting a single, proportional rate for the corpo­ excessive issuance of tax preferences, high inflation rate income tax, typically within the range of 30-40 combined with large nominal interest deductions, and percent (higher in some regions as revenue needs de­ high rates of tax evasion. The most common recom­ mand) to enhance the efficient allocation of capital. It mendation is for a minimum tax on assets, defined has frowned upon graduated marginal tax rate sched­ variously as gross, net, or fixed assets, as in some ules for the corporate tax as a means to increase the Western Hemisphere and other countries. An alterna­ progressivity of the corporate income tax. Moreover, it tive is a minimum tax on turnover or gross receipts, has frequently recommended that personal and corpo­ as recommended in several Middle Eastern and African rate income taxes have the same top marginal rate to countries. prevent through the choice of corporate or noncorporate form. Capital gains taxation is an issue relevant to both personal and corporate income taxes. The IMF has The IMF maintains a widely held view that tax in­ taken different views on this issue, in some cases rec­ centives of all sorts have proved to be largely ineffec­ ommending that capital gains be taxed as regular in­ tive, while causing serious distortions and inequities in come, and in other cases, that they receive preferential corporate taxation. The IMF has recommended broad­ treatment. This ambiguity in IMF advice reflects the ening the base of the corporate income tax by elimi­ general uncertainty in the economic profession as to nating sector- or activity-specific tax incentives in the the effect of capital gains taxes on capital formation form of tax deferrals or tax exclusions. The IMF has and economic growth. In a few anglophone African also typically recommended that all domestic enter­ countries, the IMF has favored taxing only the real por­ prises, including state and private ones, receive uni­ tion of capital gains. form treatment under the corporate income tax. In most cases, it has advocated uniform treatment of do­ Other taxes mestic and foreign enterprises. Nevertheless, leveling Payroll taxes are generally much simpler than in­ the playing field has proved to be one of the most in­ come taxes. IMF recommendations in this area have tractable corporate income tax problems. generally focused on broadening the base to include The IMF has recommended the need to base income all forms of compensation, including in-kind compen­ sation, when this is feasible; maintaining a simple rate on an accruals basis. It has also recommended the schedule; and choosing rates that are internationally adoption of clear rules on deductible costs. It has ad­ vised that deductible costs be limited to direct business comparable. costs, instead of including charitable contributions, The IMF has dealt less extensively in the area of payments-in-kind to workers, and other ancillary costs. wealth-related taxes since these raise relatively little It has also recommended limiting deductions on bor­ revenue as a proportion of overall tax revenues. Never­ rowed capital to short-term and long-term interest, but theless, in many countries, taxes on property and land not including debt amortization, since this results in a may be important, particularly for financing local pub­ double deduction for capital costs. The IMF has advo­ lic services. The IMF has recommended reforming cated rationalizing the treatment of capital by formulat­ these taxes by instituting regular revaluation of prop­ ing simple depreciation rules. At times, it has erty or adjustments in the tax rate so as to maintain suggested using accelerated depreciation as an alterna- their yield in inflationary economies.

282 The IMF has also dealt with a variety of smaller excessive compensation. The IMF has also recom­ taxes and taxes that are specific to certain countries or mended the elimination of a variety of small, nuisance regions. In transition economies, one component of taxes that yield little revenue but require substantial re­ the enterprise income tax (i.e., the corporate income sources to administer. In Western Hemisphere coun­ tax) is often a tax on excess wages. The IMF has ad­ tries with serious environmental problems, the IMF has vised against using this form of tax, while acknowledg­ encouraged consideration of environmental taxes, such ing it may have some role to play in public enterprises as a on emissions, and a tax on the use of in the short run since, in the absence of competitive certain natural resources. markets, it may prevent managers from paying workers

283 References 91/1 (Washington: International Monetary Fund, August 1991). International Monetary Fund, World Economic Outlook, May Tail, Alan A., Value Added Tax: International Practice and 1993 (Washington: International Monetary Fund, 1993). Problems (Washington: International Monetary Fund, __, Staff of Tax Policy Division, Technical Assistance on 1988). Tax Policy: A Review, IMF Working Paper No. WP/93/65 (Washington: International Monetary Fund, August 1993). __, IMF Advice on , IMF Working Paper No. WP/89/87 (Washington: International Monetary Fund, Oc­ Mendoza, Enrique G., Assaf Razin, and Linda L. Tesar, A tober 1989). Comparative Analysis of the Structure of Tax Systems in Industrial Countries, IMF Working Paper No. WP/93/14 __,Wilfrid L.M. Gratz, and Barry J. Eichengreen, "Interna­ (Washington: International Monetary Fund, February tional Comparisons of Taxation for Selected Developing 1993). Countries, 1972-76," Staff Papers, International Monetary Fund (Washington), Vol. 26 (March 1979), pp. 123-56. Organization for Economic Cooperation and Development, Taxation in OECD Countries (Paris: OECD, 1993). Tanzi, Vito, "Quantitative Characteristics of the Tax Systems of Developing Countries," in 7be Theory of Taxation for Shome, Parthasarathi, "Trends and Future Directions in Tax Dele/oping Countries, ed. by David M. Newbery and Policy Reform: A Latin American Perspective," Bulletin for Nicholas H. Stern (New York: Oxford University Press, International Fiscal Documentation, Vol. 46 (September 1987), pp. 205-41. 1992), pp. 452-66. __, 7be IMF and Tax Reform, IMF Working Paper No. WP/ __, 7be Taxation of High Income Earners, IMF Paper on 90/39 (Washington: International Monetary Fund, April Policy Analysis and Assessment No. PPAA/93/19 (Wash­ 1990). ington: International Monetary Fund, December 1993). __, "Tax Reform and the Move to a Market Economy: __, ed., ComprehensiL!f! Tax Reform: 7be Colombian Expe­ rience, IMF Occasional Paper No. 123 (Washington: Inter­ Overview of the Issues," in 7be Role of Tax Reform in Cen­ national Monetary Fund, March 1995). tral and Eastern European Economies (Paris: OECD, 1991), pp. 19-34. __, and Julio Escolano, "The State of Tax Policy in the Central Asian and Transcaucasian Newly Independent __, ed., Fiscal Policies in Economies in Transition (Wash­ States (NIS)," Bulletin for International Fiscal Documen­ ington: International Monetary Fund, 1992). tation, Vol. 48 (April 1994), pp. 159-66. __ ,and Parthasarathi Shome, "The Role of Taxation in the Sidgwick, Eric, Tax Reamue Structures: A Cross-Section Statis­ Development of East Asian Economies," in 7be Political tical Analysis for 1980-88, FAD Working Paper No. FAD/ Economy of Tax Reform, ed. by Takatoshi Ito and Anne 0. Krueger (Chicago: The University of Chicago Press, 1992), pp. 31-65.

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