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TAX SYSTEMS AND TAX REFORMS IN SOUTH AND EAST ASIA: THE CONTROL OF TAX EVASION AND THE ROLE OF TAX ADMINISTRATION
JEL CLASSIFICATION: H24, H25, H26, H83, H87, N45 KEYWORDS: Tax Administration, Tax Evasion, Computerization, Tax Policy, Asia, China, INDIA
società italiana di economia pubblica dipartimento di economia pubblica e territoriale – università di Pavia
TAX SYSTEMS AND TAX REFORMS IN SOUTH AND EAST ASIA: THE CONTROL OF TAX EVASION AND THE ROLE OF TAX ADMINISTRATION
by Parthasarathi Shome Ministry of Finance, Government of India
This paper is part of a wider research on South and East Asia countries’ taxation, carried on at this Department, under the direction of L. Bernardi, A. Fraschini and P. Shome, and the supervision of. V. Tanzi. Tax evasion is explained through individual taxpayer behavior and his reaction to the tax structure, social norms and psychological effects. Tax evasion has become more possible with advancements in technology and with globalization that has witnessed the spread of global economic activity and a rise in the possibility of hiding incomes worldwide. Tax evasion has been measured indirectly and directly, but its measurement remains difficult. Nevertheless, the tax administration has to confront it, reduce it, and enhance the revenue productivity of taxes. There has to be adequate administration resources but, since it typically forms a part of general government administration, it has to develop strategies well within the limited resources that it receives. Typically the cost of tax collection is about 1 percent of revenue collection. Modern tax administrations increasingly use third-party information returns to cross-check returns from large taxpayers, while large taxpayer units allow them to conveniently pay all taxes through one window. Potential taxpayers are required to file returns even if taxable income is zero, as long as they are captured under specified expenditure criteria. Tax deduction at source is another third-party instrument that is used for many sources of income. Tax administrations in Asia have become increasingly cautious about arms length applications in the setting of transfer prices for cross-border and intra-company transactions. Tangibles and intangibles such as price setting in the case of services provided are also being scrutinized. Over and above audit and scrutiny, investigation wings are being mobilized, leading to large tax recoveries. Computerization forms a pillar of support in successful tax administration. The focus has been on cross-checking different sources of information to minimize tax evasion. Rapid technological change in the information technology industry poses a continuing challenge for government bureaucracies to complete projects before new technologies appear, making earlier ones redundant. New tax policy options such as the financial transactions tax and the fringe benefits tax are appearing on the horizon, mainly to combat tax evasion and increase revenue. However, it is important not to design new taxes that are distortionary or inequitable just to enhance revenue in the short run.
JEL Classification numbers: H24, H25, H26, H83, H87, N45 Key words: Tax Administration, Tax Evasion, Computerization, Tax Policy, Asia, China, India E-mail Address: email@example.com Tel. 91-11-23092947 – Fax. *2145 Department of Public and Environmental Economics University of Pavia - Italy - May 2005
1. Introduction, contents and main conclusions1
The role of tax administration in maximizing revenue generation and minimizing tax evasion cannot be over-emphasized. These remain challenging tasks at every stage of development of a tax administration. This is because it is not just a matter of maximization or minimization but, rather, one of optimization. Thus, there has to be a genuine threat and actual carrying out of audit, scrutiny, investigation, penalty and punishment for an errant taxpayer while, at the same time, his compliance costs must be minimal, and he should be guaranteed an avenue for redressal of genuine grievances for payment of tax, with robust systems of adjudication, appeal and final decision. And, to minimize lengthy adjudication processes, there should be practical avenues such as advance rulings or tribunals that would cut back on undue delay and facilitate speedy administration decisions. Computerization has become a mainstay in efficient administration that can successfully curb tax evasion. For example, for income tax, forms should be downloadable electronically. Electronic filing should be made possible. If there is tax deduction at source (TDS), the mechanisms - including filing at banks - and transfer of data and revenue to further points in the system should be computerized. For indirect taxes, for example the value added tax (VAT), there has to be a computerized method for cross checking invoices that is precise and incisive, and certainly not cumbersome, for both domestic and international transactions. An increasingly recognized element in controlling tax evasion is to reduce, as much as possible, the likelihood of interface between taxpayer and tax administrator. Computer assisted processes have assisted in this objective. Thus, selection of audit or scrutiny cases should be primarily random and computer assisted except in the case of criminal suspicion. The outcome of a fully developed tax administration is, therefore, one that is essentially invisible and that ensures due process of law to the taxpayer, yet fully enables the efficient collection of revenue for the exchequer.
The opinions expressed in this paper reflect entirely those of the author and not of any institution or government unless specified. The author appreciates helpful information support from Monica Bhatia and Chandrajit Singh.
However. VAT credit cannot be taken against exempted items. and (iii) not remain aloof from tax policy but assist in every way possible to help design. However.is attempted. But as soon as one introduces exemptions for individual goods or services. a discussion of the problem of tax evasion . in order to keep tax evasion in check.in juxtaposition to its variants. In the following sections. therefore. Similar administrative problems emanating from faulty income tax design arise all the time. if a VAT has three rates but no exemptions. the tax administration must: (i) incorporate genuine threat of penalty but ensure due process.irrespective of tax rates .The role of appropriate tax design in assisting efficient tax administration is equally important. The final section concludes. tax avoidance and corruption . of course the tax administration should be adequately financed and structured. before embarking on that journey. then it should not create too many problems. An inequitable or highly burdensome tax structure will not be tolerated. It is. first. In particular. we summarize below the main conclusions from the analysis that follows. Emphasis is on actual experiences drawn from South and East Asia. A taxpayer would just need to subtract total taxes paid by him on his purchases . and transfer the difference to the administration. globalization seems to have led to 2 . So the administration would have to devise a mechanism to keep track of any excessive credit that may be taken by a tax evader. these three major tax administration elements in the control of tax evasion and the generation of revenue are examined individually. in the next section. in reflection of its field experience. However. since tax administration reform has taken up speed in India. therefore. the VAT structure assumes complexity since it breaks the VAT chain. For example. imperative for the tax structure to be comfortably administrable and the tax law to be easily interpretable. the lessons from this process are universal and are cited where found to be useful. (ii) computerize as many administrative processes as possible to minimize the interface between taxpayer and tax official. • There are various sources and causes of tax evasion. as most countries do. easy to evade. In sum. a simple tax structure and its commensurate tax law. in order to do this. A complex tax structure or tax law is difficult to administer and.from all taxes collected by him on his sales.
• A review of Asian countries reveals an increase in administrative action and followup in the administration of international taxation. The objective here is to cross-check such information with large taxpayer income tax returns. The more inefficient a tax administration is. if such transactions are over a certain threshold. A more direct way is to estimate tax potential through a country’s input-output matrix and comparing it with actual revenue collection. Typically. • Large taxpayer units are being used in many countries to reduce tax evasion by requiring all taxes to be paid through one window by large taxpayers. reflecting income sources from many countries and increased possibilities to hide income from any individual country tax administration. investigation. compete for scarce resources. The potential taxpayer is being required to file returns even with zero taxable income as long as he is captured under specified expenditure criteria. Tax deduction at source is also a third-party device to facilitate tax collection and is increasingly used for many sources of income. However. • Tax evasion has been estimated in many ways. An indirect way is to estimate the underground economy since tax evasion directly generates it. tax administrations should have adequate resources. they form part of general government administration and must.a growth in tax-evasive behavior. the literature has discussed the impact of incentive schemes for tax officers. the less effective would be the use of a dollar in revenue collection. half the income tax may be evaded and one-third the VAT or consumption taxes may be evaded. however. the cost of collection is about 1 percent of revenue collection. Under the circumstances. • Thus tax administrations are requiring third-party information returns in which a third party is asked to submit returns on transactions with others. 3 . tokenism is being avoided and focus is shifting to critical areas of intervention through the development of robust practices in operations. It could be concluded that in many developing countries. • To combat tax evasion. Ineffective tax administration will exacerbate tax evasion under these circumstances. In most countries. therefore. The small taxpayer is being assisted with the establishment of help centers external to the tax office to reduce his inherent fear of tax officers. and judicial processes. This facilitates crosschecking across all taxes while providing a single window facility to the taxpayer.
• It is. but it remains a challenge to make such systems user-friendly.• Given the growth in cross-border transactions and the quantum increases in international capital flows involving transfer pricing. tax administrations are increasingly training officers and applying arms length rules in the setting of transfer prices by multinational companies in both international transactions and domestic transactions among multiple subsidiaries. innovations in tax design are appearing to buttress tax administration to reduce evasion and improve revenue productivity. They have been introduced in Latin America and the Asia-Pacific region. Such audits focus on transfer pricing behavior and use a wide variety of indicators for selection and examination. be deleterious to revenue productivity. but these can be resolved with time and a full understanding of the underlying needs of the tax administration to implement the tax structure. • Nevertheless. While they have been rather controversial. • In an increasingly complex world faced by the tax administration. 4 . there is no gainsaying the fact that they are turning out to improve information flows to the tax administration and to assist in additional revenue mobilization. Two recent examples are a financial transactions tax and a fringe benefits tax. computerization is of the essence. crucial to design tax policy that is implementable. in particular. • Joint audits by central and local governments are being carried out to facilitate matching of information across a wide geographical area. At the same time. Audits can be of various types: random audits. they will affect economic growth adversely in the medium term and. Experience reveals that computerized systems for tax collection may be successfully put in place. audits of evasion-prone sectors. emerging service sector activities. and of high-income individuals identified through information and intelligence. taxes should not be devised merely to accommodate tax administration. There are likely to be quite a few initial glitches. A review of Asian countries reveals an increase in administrative action and follow-up in the administration of international taxation. consequently. The latter remains limited in scope and is reserved usually for cases of repeat offenders. therefore. if they increase inefficiencies in resource allocation and inequity among taxpayers. For.
its forms and effects Tax administration is closely linked with the three concepts of tax avoidance. if detected. It involves flouting of the tax law. In this sense. it normally leads to civil rather than criminal penalties. claimed that the underground economy minimizes the government’s reach over the private sector and. Therefore. however. They are sometimes used interchangeably. mainly reflecting the degree of malpractice involved. tax avoidance as a matter is mostly addressed in the context of tax policy reform that is the focus in last section. This argument essentially ignores the fact that it leads to distorted growth inasmuch as one part of the economy grows faster at the cost of the other part. Some authors whose views have been summarized by Brooks (2001) have. Transparency International’s (2001) Corruption Perception Index (CPI). criminal connotations. assists in unfettered economic growth. Tax avoidance is obviously facilitated by complex tax statutes in which opportunities exist to interpret the tax law in the taxpayer’s favor when it was not so intended by the drafters of the law. on the other hand. It generates an underground economy in the form of income that is not reported or accounted for in tax returns. thus. As a result. It has been defined as the “abuse of power for private gain” (World Bank 1997). and that the latter could have been more efficient and productive in an even playing field. on the efficiency of resource allocation. tax evasion and corruption. Tax evasion. however. often. is illegal though. corruption involves collusion and. Unlike tax avoidance and tax evasion. Its ramifications are grave since it burrows into the very foundations of society and the institutional framework of government. Thus. bribery is a form of corruption since it involves at least two parties (Asher 2001).2. in vogue for 5 . and on the stability of revenue collection and the macro economy (Tanzi and Shome 1993). Tax evasion . a subterranean economy begins to function in parallel to the organized economy with generally deleterious effects on equity among taxable persons. Corruption goes one step further. Tax avoidance is not illegal in the sense that it usually results from the creativity and planning of tax accountants and lawyers within the gambit of existing tax laws in aiding taxpayers to minimize their tax. there are essential differences among the three.
These include professional services including the usually highly paid medical profession. Without the adroit cooperation of both providers and recipients of such resources. Nevertheless. Difficult-to-tax taxable 6 . banking and use elsewhere. in particular. Across the world. 2. To begin with. taxpayers are likely to find ways to evade tax. is essentially misconceived. This paper does not attempt to go further into the criminal aspects that are centered around the issue of corruption.citation in cross-country studies. Indeed. Even in developed countries such as the United States. medical practitioners. if marginal rates are too high. tax evasion tends to arise also from other factors. A similar fallacy appears when the illegal outflow of money from developing countries is considered corrupt but not its acceptance.of government. It appears to recognize the demand and acceptance of bribes rather than the offer and supply of bribes. The role of tax administration in curbing corruption is through its investigative wings but it has to be supported by the crime control wings . and the outcome of international tax harmonization has been a lowering in the rate structure (to improve incentives) and attempts at broadening the tax base (to reduce inequities).1 Sources and causes of tax evasion Tax evasion is the outcome of individual taxpayer behavior and social norms on the supply side. comprise a difficult sector to tax. assigning the perception of corruption to one party leads. Both arms of corruption are pernicious. and the construction industry. fuelling the underground economy. to name a few. in international contracts. thereby missing the quid pro quo nature of corruption. enforcement and internal security . the tax structure has to be perceived as equitable across various groups of taxpayers. For example. the web of international money laundering could hardly have spread so far. Also. to far higher CPI’s in developing countries than in developed countries. expectedly. and shortcomings in tax administration on the demand side. these aspects are well recognized today. They tend to receive fees and make payments in cash.such as intelligence. Individual behavior in certain sectors is known to be highly tax-evasive. a number of Western authors have dubbed the individual income tax a voluntary tax.
An assessment that the use of revenue is inefficient or ineffective or. technological advances have. therefore. With the emergence of East Europe and the former Soviet Union (FSU). translated into tax evaders’ computer capabilities running well ahead of the administrator’s. For example. the taxpayer roll has multiplied but revenue intake is not reflected commensurately. Social norms have been changing in many economies.increases evasion and hurts revenue. the globalized economies of East Asia are demonstrating their conservatism in international (Pricewaterhouse Coopers 2003). Increasingly.to smaller units. worse. the real . that becomes an example to be emulated by all and sundry. As capital becomes increasingly fungible. and their entrance into the international market economy. Ineffective administration can exacerbate tax evasion. if eminent persons do not pay their fair share to the exchequer. With globalization. extremely punitive penalties encourage taxpayers to appeal tax demands easily since it gives them time until final determination of the tax. this phenomenon has assumed challenging dimensions. suffers from unacceptable leakages.value of the revenue in the hands of government is likely to diminish. sources of income and expenditure are spread across the globe and difficult to track or even identify since they often leave little trace in any one national tax jurisdiction. or its ineffective use by the administration. In traditional economies. Indeed.one that is traditionally difficult to tax . as large public corporations have been privatized in Latin American and South Asian countries.perhaps in reflection of social norms . By that time. the small service sector . Slow development of information technology (IT) due to its complexity.through work contracts . provides grounds for society to evade tax. Bureaucratic lethargy in applying the law . taxation rules and practices 7 . in particular instances. signals taxpayers that tax evasion carries low risk. exacerbating the problem.persons may even include large corporations that typically contract out . Since the 1990s.has grown.as opposed to nominal .
however. it ranges between 1/3 and 1/2. is likely to yield significant estimates. the size of the underground economy. The indirect method links tax evasion to the underground economy since the latter could be thought of as the size of economic activity that would be taxed if reported in tax returns. Authors have discussed the issue of optimal auditing in a context of audit probability and penalty (Mookherjee and Png 1989.usually the income tax in this context . Schneider and Enste (2000) have grouped countries into regions and shown that. there is no gainsaying the fact that. In a recent cross-country survey. if one considers how the underground economy is generated in a globalized world economy. Chander and Wilde 1998).2. southern Europe was at 1/5 and others at 1/10. comprising the effects of tax avoidance. Nevertheless. these analyses tend to reflect some double counting in developing countries and undercounting for others. in the representative Asian. the underground economy could be as large as 3/4 of the reported economy though. Otherwise the estimated tax gap may turn out to be too large for corrective policies that are practical and implementable. 8 . or linking growth in electricity consumption to the growth in economic activity because of their observed close relationship. Latin American and FSU countries. as argued above in the context of the CPI. even if distributional adjustments are made. one school of thought is that the tax rate . tax evasion. or estimating discrepancies between national expenditure and income statistics. However. tax evasion and corruption. Among OECD countries. Estimating tax evasion can be indirect or direct. the tax gap is referred to as estimated tax evasion. Typically. However. derived through indirect methods. It is an estimate of total leakage. The estimate of the underground economy is essentially indirect in that it is attempted through estimating the demand for currency in the economy.to be applied to an estimated underground economy to arrive at an estimate of tax evasion would have to be perspicacious.2 Estimating tax evasion The difference between actual revenue collection and an estimation of potential collection is the tax gap. in a few.
in the last two decades the volume of internationally mobile global capital has increased by leaps and bounds and its flows keep increasing. VAT productivity is low.A more direct method of estimating the tax gap. This method was developed for Mexico by Aguirre and Shome (1988) and later applied to other Latin American countries (Shome 1995). the services sector has been growing phenomenally in many countries. is to estimate potential VAT revenue from the country’s input-output matrix and to compare it with VAT revenue collection. not a static one but one that is dynamic and remains ever challenging. Many factors account for it. Second. Opportunities for tax evasion abound and increase before even well developed and astute tax administrations can understand or confront them. Among the significant reasons is that. These methods have revealed that as much as 1/3 of potential VAT collection and 1/2 of income tax collection may remain uncollected. manufacturing faces stiff international competition under new World Trade Organization rules and swift economic growth shifts the comparative balance towards the specialized 9 . Its dimensions . If it collects less than 1/3 x percent of GDP in VAT revenue. it should ideally be able to collect 1/2 x percent of GDP in VAT revenue. in particular for VAT. The VAT structure possibly suffers from many exemptions and breaks in the VAT chain. Thus if a country has a general VAT rate of x percent.3 Growth in tax evasion There is a prevalent view that tax evasion has grown in recent years and is growing. The role of tax administration in the control of tax evasion is. 2. therefore.also transmute and grow. This is VAT productivity. A next section will draw upon the experience of Asian countries in addressing tax evasion in international taxation. as agriculture loses its comparative advantage.both direct investment and financial capital in the latter’s many diverse forms . Another concept of VAT evasion has emerged in the discussions and practices of international tax experts. first. and the VAT administration is unlikely to be combating tax evasion successfully (Shome 2002). in particular in the Asian region.
and a common global cultural denominator represented by Music Television (MTV). that will be addressed further in this paper. Among the sociological are factors such as the premise that the younger generation are less concerned about social or national responsibilities. in that the new generation is perceived to possess utility functions that are more individualistic . for the tax administrator it adds another dimension to his work in the control of tax evasion. if they have emerged as colossal public sector units . or high class restaurants serving the nouveau riche. These new types of economic agents are notoriously difficult to tax. Cullis and Lewis 1997).services sector. and the fashion ramp. fast foods. the arrival and advancement of the information super-highway. then the loss to revenue collection could be significant. highly skilled medical practices catering to a primarily foreign clientele. compulsory return filing. and other methods. 10 . And. necessarily the outcome of increased global mobility.have disappeared. Third.” While fascinating to the economist and posing a challenge as to how to incorporate such factors in economic analysis (Roth and Scholz 1989. “famous for fifteen minutes.the go-getter .that is explicable in the context of a much faster moving world in which there is cut-throat competition and where they have to run to be at the same spot. The psychological takes off from there.producing deficits but having nevertheless been a source of guaranteed revenue for government . their goal increasingly represented by the famous metaphor. Such instruments comprise third-party information sources. The services sector is often represented by micro units whether they are business processing offices (BPO’s) covering a host of service oriented activities. a mix of sociological and psychological hypotheses of tax evasion has received some attention. The challenge for the tax administration here is to develop precision instruments that are able to aim directly at newly emerging revenue sources. Slemrod 1992.
there need to be some mention of the negative effects of tax evasion on the economic environment. In sectors that are less subject to the administrator’s scrutiny. one blue-collar worker gains at the expense of the other. In sum. Capacity 11 . A wage earning factory worker pays tax. tax evasion distorts economic efficiency. Small taxpayers have remained very difficult to tax and maintain a constant presence in the list of administrative concerns (Shome 2004). in the VAT where there is usually a threshold level below which taxpayers are not expected to keep detailed accounts. efficiency and effectiveness suffer because of tax evasion. A restaurant worker whose income is the same but who receives part of his income in tips does not reveal it for tax purposes. in non-pecuniary terms. This is not reported on his income tax return. Similarly. the unorganized sector may evade taxes much more easily than the organized sector. the tax rates would have been lower under the premise of revenue neutrality. Thus. there is a clustering of registrants just below this threshold. A salaried employee in the organized corporate sector earns the same reported income as the barrister. Their incomes appear to be the same for tax purposes. Sanchez and Sobel (1993) conclude that only incomes below some threshold level should be audited with a probability that is positive and less than unity.have grown so phenomenally as companies move across national barriers in a globalized world economy. in part. allowing them to pay a small percentage of their turnover as tax (termed compounding). the higher-taxed person pays for the lower-taxed person since. This is vertical inequity since the barrister’s actual taxable income is higher (it should have included the value of his foreign trip).2. Second. as both inequity and inefficiency lead to lower revenue intake for government. for both forms of inequity. Based on a theoretical model. had there been no tax evasion. all expenses paid. It is no wonder that. a foreign trip for his family. A barrister charges his fees. That may be one reason why certain service sector activities . Its most important adverse effect is perhaps on equity.4 Effects of tax evasion Despite erring on the side of brevity.for example. the construction industry . its functional capacity. for example. Third. there will be more investment. This is horizontal inequity.
or the imposition of distortive taxes. Fourth. to the cost of revenue collection. tax evasion being under-reporting of income.suffers due to lower availability of resources. leading to suppression of the organized economy and exacerbating a vicious cycle of less revenue generation and higher tax rates. the escalation in property tax rates or the imposition of entry taxes by many municipalities. Since the denominator is underestimated. turnover taxes in addition to the sales tax at the level of states or provinces. therefore. The result could very well be an increase in tax rates. 3. thereby initiating a vicious cycle of inequity and inefficiency. or inventive surcharges and cesses at the level of the central government are cases in point. and public debt to GDP are all under-estimated.will also be overemphasized. The first ingredient is whether tax officials are remunerated appropriately in order to check the incidence of tax evasion and corruption. Policy could thus turn pro-cyclical. feel increasingly comfortable in joining the rest in the act of tax evasion. Authors have discussed these matters in stylized 12 . we now look at particular aspects in the formation and functioning of an effective tax administration. but exaggerated deflationary action may be taken to rein back an exaggerated fiscal deficit or public debt ratio. The perceived higher tax/GDP ratio leads to false comfort. therefore. the fiscal deficit to GDP. If the underground economy absorbs labor. both organized and underground. Clearly. the ratios of tax to GDP.by focusing primarily on the organized sector . implies under-estimation of GDP and all its commensurate macro-economic ramifications. then the adverse impact of unemployment . Cost and design of tax administration Having traversed the causes and effects of tax evasion. This is inherently linked to the cost of tax administration and. Efficiency declines since important functions may have to be given less priority than others. Inflation estimates would be similarly distorted unless care is taken to include all segments of the market economy. And effectiveness declines as compliant taxpayers realize that government is unable or unwilling to take corrective action and.
or giving bonuses to tax officers in relation to their individual tax collections (Bardhan 1997). as compared to indirect taxes. and 1.21 in Japan. 13 . More important perhaps. a more direct preoccupation is the matter of cost of revenue collection. 1. at best.1 Cost of tax collection Over and above incentive schemes that could raise revenue collection. Indian data indicate that the cost of collection ratio of customs and excise is about 0. the cost of collection seems to vary a good deal across countries. larger number of income taxpayers. the issue of increasing inspectors’ salaries (and increase in the opportunity cost of firing them for poor job performance) by Vasin and Panova (1998). What is certain is that resources for the tax administration should be adequate. for customs and VAT. 3. both domestic and spread internationally. 0. This is because the tax administration is usually placed well within the framework for overall government administration expenditure allocations and does not enjoy any special dispensation. 3. it has to compete for scarce resources. A theoretically correct tax policy and expenditure structure may be set up.84 in Australia. the cost of collecting income tax.37 for the UK (Inland Revenue). it is much lower.frameworks. though. 1 in the Philippines. is higher reflecting the relative complexity of an Income Tax Act. Therefore.72 in Thailand.2 A framework for administration resources An essential element in the control of tax evasion is the adequacy of administration resources. and the wider sources of revenue. But.86 while that of the income tax is near 1. Highfield (2001) demonstrates that. they need to be efficiently spent. In a recent cross-country study. far more points at which the income tax has to be collected.04 in Singapore. 1. Overall. Attempts to set up tax administrations as autonomous agencies external to the ministry of finance have had.1 in Hong Kong. the cost of collection as a ratio of revenue has been 0. In general. in 1998-9. mixed success across the world. for example. 1.
the tax law or expenditure allocations by themselves would not yield the national income or economic growth envisaged (Shome 2002).without sufficient tax administration resources and mechanisms or expenditure management systems. For simplicity. ta. This is demonstrated in the top left quadrant of Figure 1. ep. The underlying tax administration coefficient is ta and the underlying expenditure control coefficient is ec. as sketched in the top right quadrant of Figure 1. Conventionally. There has been no role specified for tax administration or government expenditure control in constraining revenue generation or its expenditure by government. TP can then be consumed or invested by government in its expenditure programs EP. The expenditure-income relationship is: TP = EP = ep (Y2 – Y1) where ep is the expenditure/income ratio. ep and ec are equal. incorporating both tax and expenditure sides. ta and ec are given an equal role in the generation of the economy’s income flows. we have related tax policy and expenditure policy in the top two quadrants of Figure 2. They would simply lie underneath or veiled as it were. Thus the diagrammatic schemata refers to a wider fiscal context. The same type of constraint applies also to the expenditure side between expenditure policy and expenditure control. just as the oil to grease the wheel of revenue generation 14 . leading to income in the next period of Y2 – Y1. expenditure policy and expenditure control variable. and ec to denote the tax policy. we shall use tp. tax administration. respectively. To make the concept of correspondence clearer.1. To put it another way. diagrammatically tp and ta are shown to be equal. if tp is the tax rate and Y1 – Y0 is income. then tp (Y1 – Y0) = TP is the tax revenue that is collected. This influence is depicted in the bottom quadrants of Figure 1 and is explained below. Similarly. That framework is delineated below. The achievement of Y2 subsumes a given state of tax administration and expenditure control which is usually not recognized in policy circles to the extent that it should. So far. The objective of the framework is to demonstrate that there is a binding constraint that tax administration may pose on tax collection over that predicted by the structure of taxes.
Figure 1 Tax and expenditure: policy and administration. if the underlying assumptions were not correct. however. given income (Y1 – Y0). Problems would arise. This is shown in the bottom left quadrant of Figure 1 as the distance AB. This is elaborated further. The role of tax administration could be specified as: TA = ta (Y1 – Y0) where TA would be the imputed resources .and concomitant expenditure. Tax and expenditure policy and resources TP = EP Y0 ) ) ta tp A Y1 ep ( Y2 Income variable B ec ( C D C Tax administration and expenditure control 15 .reflecting the efficiency with which its available finances are administered and utilized .that tax administration would require to generate revenue TP.
to generate the same income flows (Figure 2). Obviously. if administrators are simply not able to target the universe of potential taxpayers. and the resultant sequence of incomes to take effect. are depicted by the distance AB + BD. Thus. K is determined as follows. administration has to be enhanced. Essentially.The expenditure control side. the minimum resource requirement translates to C = C. In that case. follows directly. however. Figure 2 Tax and expenditure: gaps in administration and control. ec. Tax and expenditure policy and resources TP = EP Y0 ) tp ) ta ep ) ta* ( Y 1 2 A Y1 Y2 Income variable B B1 C D ec1 ( ec ( ec* ( C K Tax administration and expenditure control D1 K 16 . the overall imputed resources needed for government’s tax-expenditure policies as designed and projected. a higher underlying requirement K = K would apply. This may not represent reality. or greater administrative resources made available to administrators. its role is added on: EC = ec (Y2 – Y1) This is depicted in the bottom right quadrant of Figure 1 as the distance BD. Equivalently.
resulting in a need for additional administrative resources. The gaps between tax policy and tax administration (and between expenditure policy and expenditure control). Then ta*>ta would be needed. Once this happens. Y2-Y1.of tax administration. The difference can take the form of lack of required resources for full implementation. Otherwise. AB1+B1D1>AB+BD. 3. 17 . or inadequacies in expenditure management and control. future income flows would be similarly adversely affected and. scrutiny. a lower income than Y2-Y1 (such as Y21 – Y1) will result. and judicial . whether along a tax administration’s functional lines (Bird and Casanegra 1992. audit. as indicated in the introductory section. It is not the purpose here to traverse those same grounds. have to be bridged if government’s objectives in formulating its tax-expenditure policy mix are to materialize. simply. The constraint can be broken up into tax administration and expenditure control constraints. or the inefficient use of allocated resources or. Next we look further into the role of modern tax administration methods in the control of tax evasion and at particularly designed tax policy measures for the control of tax evasion. Silvani and Baer 1997) or. we intend to take up three specific matters in the development of modern tax administrative practices that represent a movement away from tokenism and towards incisive facilitation of the primary operations . The essential lesson from this simple exposition can be useful. Say ta is inadequate. Only with these additional resources. Instead. it is easy to see how administration practices that is not able to address or cover the complete tax structure. with any combination of resources represented by coefficients lower than ta* or ec* (such as say ta and ec1).assessment. deficient expenditure management implies ec*>ec.Working backwards within Figure 2. ultimately. will the same income. would constrain the result depicted in Figure 1. along economic lines or as a firm maximizing its objective (Bagchi et al. Similarly. result. investigation.3 Design of modern tax administration controls The basic design of a tax administration is well known and has been widely discussed. 1995. an application of the law that does not completely reflect its original intent and purpose. Tanzi and Pellechio 1995). (Note that ta<ta* but ec1 is set to equal ec*). economic growth would suffer.
with the spread of international businesses across national boundaries. its instruments have become more precise. For example. or single-file examination of an income taxpayer. This has become a mainstay of a modern tax administration.3. where the emphasis is increasingly on third-party information. large taxpayer units (LTU’s). This allows the administration to cross-check the others (B) whether they have filed returns or. These two aspects will be examined in this section.as opposed to physical .1 Tax administration precision instruments As modern tax administration has moved to financial . how do tax administrations monitor arms length rules in the setting of transfer prices? Various Asian countries are dealing with it in different intensities but it is clear that they are all tightening their rules and implementing them more strictly. In the case of an annual information return (AIR). and compulsory filing of returns to enable non-tax information matching for those who have zero taxable income but fulfill certain expenditure criteria. in 2005. They are oriented towards crosschecking rather than merely unilinear checks of consignments leaving the factory in the case of domestic production (excises) and consumption (VAT) taxes. additional information (third party) returns for large transactions. among others. if they have filed. But the design of computerization itself is a challenging task as will be explained in next section. what are some of the incisive instruments that have been developed in terms of taxpayer information flow that could be usefully utilized by the administration to expand the taxpayer base and facilitate additional revenue mobilization? Such instruments include. 3. Third is the issue of computerization of the tax administration. the Indian income tax authorities have 18 . a taxable person (A) is asked to submit returns on transactions with others (B) over a certain threshold. to verify income.First. The ultimate success of a tax administration in collecting revenue rests squarely on a well-designed mainframe into which all information flows are channeled and based on which all cross-checks are possible.control methods. Second. tax deduction at source (TDS) or withholding.
Among the more traditional instruments involving two parties is tax deduction at source (TDS) that has borne the test of time. securities (though not dividends since they are not taxed in the hands of the shareholder) and inter-corporate interest payments. for example. This is just to illustrate the long arm of the tax administration that is increasingly intended for use in cross-checking and detecting tax evasion. and Reserve Bank of India (central bank) on investment in RBI bonds (0. winnings from lotteries. and commission on sale of lottery tickets. registrar or sub-registrar of properties on purchase or sale of immovable property (0.2 million INR). mutual fund managers on investments (0. rent. But effective administration of TDS requires the use of computerization. India utilizes TDS for a much wider set of income sources above designated thresholds.1 million INR). in effective utilization of such information for the intended objective. because the compliance cost for third parties in meeting AIR requirements is unlikely to be insignificant and cannot be ignored.5 million INR).5 million INR). It is no longer an issue of its use but.3 million INR). payments to nonresidents. to be reported to the income tax administration: banks on cash deposits of 1 million INR or above in any savings account. to how many sources of income it is applied. interest from banks. company or institution issuing bonds or debentures on investments (0. TDS for salary earners is most common in Asian countries. commission and brokerage (other than insurance). in particular. Another widely tested instrument is the large taxpayer unit (LTU) through which taxpayers whose tax contributions are above a threshold are required to file. payments to contractors and sub-contractors. rather.enacted AIR requiring a number of such transactions with respect to a person in one year. From the taxpayer’s point of view. crossword puzzles and horserace. the availability of an exclusive window for tax payment and 19 . insurance commission to corporations and firms (not individuals). More than 50 countries use this window (Baer 2002). of course. or shares through public issue (0. Its advantage from the administration’s point of view is that information exchange across taxes is a built-in feature of the framework. The challenge remains. credit card companies on payments (0. a matter that will be taken up in next section. payments on account of repurchase of Unit Trust of India and other mutual fund units.2 million INR).
The most applied method under the VAT is random cross-checking of invoices. automobile. and membership of a club with an entrance fee over INR 25. Here. Their fears of the tax administration may be reduced through the establishment of help centers in cooperation with private chambers of industry and commerce.000. if an individual meets any one of six criteria. But in evasion-prone environments . small potential taxpayers may be required to file returns even if they self-assess zero taxable income.such cross-checking may not be sufficient since it is not likely to reveal serious evasion (Mukhopadhyay 2005).the likelihood of speedy processing for dispute resolution are important attractions. Such an instrument requires persons to file returns irrespective of taxable income as long as they meet certain expenditure criteria. export/output ratio. India again has utilized such a scheme since 1997-8. the utilization of such data to achieve the originally intended purpose remains a major challenge. For indirect taxes. In her annual 2005-6 fiscal budget. On the other hand. 20-30 percent of total potential revenue may be represented by small taxpayers. sector-specific characteristics.where multiple account books are likely to be maintained by taxpayers . Again. credit card. Today it is known as the 1 x 6 scheme since. and others. Thus the best resources of tax administration cannot be focused on large taxpayers alone and small taxpayers cannot be ignored (Shome 2004). he is required to file. They usually include input/output ratio. Of course computerization is of paramount importance with appropriate systems applications for scrutiny selection based on predetermined indicators. effective cross-checking forms the crux of modern tax administration based on financial control methods.000. At the same time. Incisive carrot-andstick instruments are needed for garnering co-operation from the latter. undertaking of foreign trip. and have become a common feature in Asian countries. in particular with the objective of requiring non-taxpayers to file. second generation computer models 20 . credit availment. the India likewise announced her intention to set up LTU’s. These include ownership of property. annual electricity bill above INR 50. LTU’s have proved to have assisted in facilitating revenue generation and lowering compliance costs. even as the taxpayer register and information flows increase remarkably as a result.
The selection of cases for TPA begins with desk-top analyses based on: low profits for extended periods pari passu with company expansion. They have stepped up field audits.has tended to restore revenue that earlier suffered from cross-border tax avoidance activities. The focus on transfer pricing practices of MNC’s even for intraChina transactions . On the one hand. 3. visiting business premises and factory sites.that limit the role of cross-checks by the tax administration and roll over the responsibility of credit availment flow within the VAT chain. One important effect of globalization is on taxation.” maintain that extreme caution is required regarding MNC tax avoidance and evasion because of greater opportunities to hide income across the globe. as cross-border related-party transactions overpower domestic transactions. tends to claim that geographically split tax attributions. the role of computer-assisted systems has become imperative in effective tax administration as physical forms have been essentially replaced by financial forms of control. In sum. Such audits seem to have facilitated the control of both tax avoidance and tax evasion. that will completely satisfy a tax administration. tax authorities that call the splitting “transfer pricing. an increasingly egregious feature that is discussed in this section is one that deals with emerging administration challenges for international taxation.3.so much so that these have essentially come to be called “transfer pricing audits” (TPA) .000 audits and a recovery of more than 39 billion RMB. sizeable 21 . a typical tax director of a multinational company (MNC). Some country experiences are summarized here. On the other hand. Such a method would automatically check availment of input tax credit claimed by a taxpayer (buyer) unless the credit appears on the scroll submitted by the depositor (seller) in the bank where the VAT is deposited. have become difficult to achieve. are being contemplated. In 2002.2 Tax enforcement in a globalized world economy If the previous section dealt with the means to improve the tax administration of domestic taxation. Pricewaterhouse Coopers (2003) has carried out an extensive survey of the East Asian region. China conducted more than 2 million “tax reviews” that resulted in more than 800. and imparting a more visible presence to enforcement activities.
in particular where the employee leaves China. Using field audits and investigation to control tax avoidance and evasion. Transfer pricing adjustments can be imposed by the administration within three years (in extraordinary cases. featuring simultaneous audits of Chinese subsidiaries of MNC’s are. audits now extend into the far reaches of the interior.drop in profits after expiration of tax holiday. Commensurately perhaps. Cooperation enables the latter to establish their own databases for audit targets while being supported by the former on transfer pricing adjustments. executives in the high-technology sector were scrutinized with respect to declarations on offshore stock-option benefits. Such audits tend to adversely affect goodwill of industry. After the TPA. Hong Kong follows the territorial principle of taxation.and prison sentence are both levied. informers . Import-export transactions are. profit consistently lower than industry average. pecuniary punishment . From just coastal areas.with rewards up to RMB 100. examined but intangible transactions such as licensing. financing and provision of services are increasingly scrutinized. For companies incorporated in Hong Kong. Controlling individual income tax evasion has been attempted through general investigations. In 2002. and inexplicably fluctuating profits. even ten years). a follow-up review could also be undertaken by the administration. taxing only Hong Kong sources of income. The audits require co-operation between national and local tax authorities. The joint audit approach obliges MNC subsidiaries to improve co-ordination in management and accounting. transfer pricing. the territorial principle attempts to tax profits arising in or derived from Hong Kong. resulting in additional taxes payable on the adjusted income. tax evasion is dealt with strictly. “National joint audits” (NJA). of course. therefore. criteria used include: whether deductions claimed reflect commercial basis.sometimes 100 percent of tax evaded . For audit. what portion of the profits are 22 .000 for appropriate information and tax recovery operations on a targeted industry basis. in particular.grossup tax rates applied to net-of-tax employment contracts .is often borne by the employer. for example. It also leads to financial consequences for industry since the resultant increased tax burden . made possible. to what extent a Hong Kong company’s expenses are incurred for a related offshore company (hence not deductible).
Comparable prices are difficult to find and their benefits not easy to evaluate. They apply both to MNC’s and domestic companies and include cross border and domestic intra-group transactions affecting profits. Based on a self-assessment system. While a field audit unit. Singapore has typically conducted tax investigation of local businesses. with an extension of another 60 days. They require documentation to justify that transfer prices are set at arm’s length. and repeated offence. the tax administration initiated a project to train 1. Failure to comply could result in a penalty of up to 30 million W and is likely to lead to a TPA. In Korea. following OECD guidelines on transfer pricing. thereby carrying the potential for abuse. Additional explanations may be asked for. penalties escalate over the stages of voluntary disclosure. Visits have resulted in MNC’s facing additional taxes and penalties. and transfer and use of intangibles and services. non-disclosure. and intra-company pricing policies for services provided internally.000 tax officers in transfer pricing during 2002-7. such as transfer of tangible goods and assets. with replies expected within 60 days. an incisive TPA could yield huge amounts through transfer pricing adjustments. The Law for Co-ordination of International Tax Affairs (LCITA) applies to cross-border transactions since 1996.with a target of auditing a company every five years . Its main objective is to ensure arms length application in price determination. investments and practices in Korea.unannounced visits for tax investigation are also conducted. A company has to submit a statement on transfer pricing choices made in overseas intercompany transactions. transfer pricing has occupied center stage in recent years.to verify tax returns 23 . usually carries out audits with advance notice .of which transfer pricing examination forms a part . Malaysia’s transfer pricing rules follow OECD guidelines. They increasingly attempt to cover management service fees that comprise fees for services provided from a central office to subsidiaries. Malaysia uses its investigation and intelligence branches for controlling tax evasion. established in 2001. Though random audits . Officer training has been received from both the United States and Japan. As a result.attributable to Hong Kong. TPA’s are based on a close watch over MNC’s and their polices. For administrative support.
QI required banks and financial institutions abroad to institute mechanisms to identify and inform on benefiting investors and account holders who should be subject to withholding.000 and imprisonment of up to five years.to evade tax. Germany and Belgium aggressively investigate and prosecute nationals and residents investing in foreign investment vehicles . A recent case of matching credit card expenses with the income tax returns detected huge tax evasion. in a manner. the experience of the developed economies since. It is pertinent to mention. third party information was stipulated through qualified intermediary (QI) regulations. claiming it had been established to evade tax (Zagaris 2001). Given that its chairman was a former head of the European Commission and Prime Minister of Luxembourg. and penalty. revealed determination and resolve on the part of the tax administration. from a 100 percent maximum earlier. Extensive 24 . In fact. investigation. for unwitting tax evaders. they had concealed half their income derived from commissions.to court in 2001. and seize suspicious files. the Asian economies emulate their experiences. This could be one explanation for the low number of investigation cases. It has focused on monitoring large taxpayers. In 2001. Punishment escalates . To combat tax evasion. France. But if evasion is determined. This resulted in a tax recovery of 20 million BDT from this sector in the city of Chittagong alone in 2003 (Kibria 2004).to 400 percent of amount evaded with a ceiling of S$ 50. The CIC can investigate income tax files. since the courts do not shy away from imposing maximum penalties.for incorrect return to fraud . on average. And case details may be put on the authorities’ website. detecting several cases of tax evasion involving significant sums.are carried out. The United States has also played a role in enforcement efforts in international taxation. check financial accounts. Bangladesh has set up a Central Intelligence Cell (CIC) in its revenue administration. the penalty was lowered in 2000 to 10 percent of underpayment.a subsidiary of Ohio-based Nationwide Global Holdings . tax investigation per se remains focused on those suspected to be repeat tax evaders. conviction could lead to severe pecuniary and non-pecuniary consequences. Examination of tax files of clearing and forwarding agents found that.life insurance and annuities . at least in passing. Voluntary disclosure of evasion reduces publicity. France took Pan Euro Life . gather evidence.
for example. how important the role of appropriate computerization is in its overall management and in the control of tax avoidance and evasion. the issue of computerization is addressed. raids. This case study is described below. for cross checking information on tax collection and crediting of taxpayer accounts for the income tax or the VAT. Successful administration is essentially based on the assimilation of a comprehensive information pool. combined with intelligent. Computerization and automation It is needless to emphasize at this point. use of investigation. result-oriented data mining. It is not the objective to provide a checklist for computerization needs as tends to appear in many an advisory report of tax and computer experts. India has recently computerized various processes in the income tax that provide a good illustration of lessons that could be learnt in computerizing a tax department. In sum. recent experience in Asia and the developed economies demonstrates an increasing awareness of tax effects of trans-national economic activity and follow-up action through joint audits of subsidiaries within national boundaries. In this section. Physical controls including raids for search and seizure can be used but they are mainly reserved for extreme circumstances. 25 . Let us take income tax.raids have also been carried out on promoters of tax evasion schemes using offshore banks and trusts. after describing the complexities that a modern tax administration encounters. 4. and pecuniary and non-pecuniary punishment. what is attempted is to provide an essence of the type of problems faced in developing a computerized system. if warranted. fine-tooth comb examination to ensure arms length application of transfer pricing in both domestic companies and MNC’s and. Rather.
and regular tax). Office (ZAO) Principal Chief Controller of Acts. For past return forms. Income tax payment can be made through one return form in banks. advance tax. would RCC’s scan from ZAO? Current framework of OLTAS Possible modifications to OLTAS One aspect of computerization of income tax processing is the On-Line Tax Accounting System (OLTAS) that was initiated in 2004 on the basis of a single hard-copy system. The form appears to be quite simple and well-designed. It has two “major heads” (individual income tax and corporate income tax) and four “minor heads”(self assessment. (PCCA) who is outside Income Tax Dept. It also has a block for “assessment year.Figure 3 Income Tax: Online Tax Accounting System (OLTAS) Money deposited Collecting Bank Branch Nodal Bank Branch Money & Data to Central Link Cell in central bank (RBI) Data to National Information Depository (NSDL) -Tax Information Network (TIN) Connected Connected to tAssessing Assessing Officer Officers (AO’s) online in 60 cities Data processed and sent to National Computer Center (NCC) Data sent to 36 Regional Computer Centers (RCC’s) Should copy of scroll and return forms go to RCC’s in the future? Single scroll & hard copy of return form sent to Zonal Acts.” 26 . TDS.
A supervisor tallies the entrance and approves it. The only hard copy of the return form is sent by the nodal bank branch to the Zonal Accounts Office (ZAO) where it rests with the Principal Chief Controller of Accounts.Let us take the case of TDS and track its processing. Here the monies are. Second. Ideally an AO will have ready online access to the information when he makes an assessment or undertakes an audit. This is illustrated in Figure 2. therefore. are sent electronically to a data depository and processing entity (NSDL) which is the pivot of the Tax Information Network (TIN). First. the fact that data entry is left to bank entry operators who may not be familiar with the Income Tax Act led 27 . The RCC’s are connected to Assessing Officers (AO’s) in 60 cities so far (to be extended to 510 cities when the project is completed). in effect. NSDL processes and transmits the data to a National Computer Center (NCC). and hard copy. the monies are sent to the RBI. the data are fed into 36 Regional Computer Centers (RCC’s). The receipts are sent for deposit in the central bank (RBI) that simply credits the government’s accounts. An employer who has withheld tax at source from his employees goes to any collecting bank branch and deposits the money. The data with the details on the return form. This results in three final destinations for the money.3. The bank keeps the form and gives him a receipt which is the portion below a perforated separation on the form. electronic data. Initial experience has unveiled such practical lacunae. separated from the information flows. a bank entry operator enters the details into the bank’s self-developed software that processes the form. The structure may be expected to function well except where human error in the previous stages of entering the data frustrates information matching. the electronic data are accessible by the AO at the RCC’s after some routing. The form was accordingly modified by separately identifying the corporate income tax. and the single hard copy of the return form rests with the ZAO. The bank passes the money through a nodal branch (clearing house) that is designated to receive all inflows in one day (T+1). the form was often filled wrongly so that collection showed a disproportionate individual income tax collection over corporate tax collection. At the end of the day. the term “income tax” covers both individual and corporate income tax in the Income Tax Act. as entered by the banks. Within three days (T+3). in India. the receipts are transferred to a central link cell. In sum. From the NCC. Initially.
Thus the system’s initial creases would need to be ironed out. or should that be perceived as an evil necessity for cross-checking electronic information that arrive at RCC’s from the NCC? Further. On the other side. Third. if forms are not correctly completed by depositors. For example. from the deductor. a certificate of deduction specifying the amount 28 . TDS in 2005-6 must necessarily relate to assessment year 2006-7. should banks be instructed to refuse them? These are carious considerations that would need to be weighed appropriately before arriving at a comprehensive solution to the teething problems. by insisting that bank data entry be done at the front end (rather than end-of-the-day entry) under the assumption that those who physically come to the banks to deposit the checks are more familiar with the return form so that their presence would minimize errors in data entry? But this may not be possible since data entry is carried out only after a bank’s clearing house has cleared a check. Even employers who turn in the return form sometimes commit this error. should the prevailing system itself be tightened up rather than trying to modify it? For example. Fourth. This tends to leave little trace of the bank-attested details of his deposit payments with him that he could usefully produce if summoned by an AO. or would it be more efficient and user-friendly for the income tax administration to make available (or insist upon) its own software to all banks that would cut out built-in inconsistencies? Alternately. the AO cannot easily access a hard copy on his own (for making corrections with respect to a return) since the only hard copy lies at the ZAO where the keepers of government accounts could rightfully be expected to be cautious about parting with the sole hard copy information. that would go from the nodal bank branch to the RCC’s be a retrograde step for modern computerization techniques. no hard copy of the return form remains with the TDS deductor/depositor (who only has a receipt).to errors of non-matching. The deductor deducts from his employee (the deductee) and deposits TDS in a bank as explained. Today the deductee receives. Another lacuna is with respect to the deductee in this system. But TDS entries have been found to be entered with 2005-6 as the assessment year (mistakenly interpreted to be the current financial year). Would the requirement of a second hard copy. should bank entry operators be trained to familiarize them with the basic relationships underlying the return form.
The medium term nature of the solutions. only when a taxpayer A in the VAT chain credits the account of another taxpayer B (from whom A has collected VAT) and this is reported in the bank (where credit scrolls would be maintained for different taxpayers). poses a related problem. However. This remains a constant challenge in environments where large projects are particularly subject to various checks and balances through expenditure control and management mechanisms. there is no option but to address issues as they emerge since its ultimate purpose to facilitate the process from both tax administration and taxpayer points of view. the deductee has been temporarily protected with continued issuance of TDS certificates to him. Just as in the case of the income tax. In this simplified method. in turn. would B’s account be credited. They are unlikely to be resolved in the short term. stoutly in place and actively operational. It is proposed to do away with this requirement (de-materialization of TDS certificates) under a fully-functioning OLTAS. the minutae of computerization can be challenging and are certainly interesting. 29 . it is imperative to develop information exchange systems to minimize tax evasion. A medium term framework is its essence. the onus of cross-checking is effectively passed on from the government to the universe of taxpayers. VAT computerization has been a topic of constant attention. Thus. While the focus is usually on software to facilitate cross-checking by the tax administration. A final point on the computerization theme that should be mentioned is the information relationship between the center and states (or provinces) in a federal fiscal system.deducted. therefore. computerization models of tax administration are in continuous development and represent one of the most dynamic areas in the taxation field. the newest proposals are being made in the direction of unilinear checking. and hardware and software changes are so rapid. As indicated above. In sum. both at departmental and political (cabinet) levels. that project proposals are likely to become dated faster than due process of government examination. In addition. contract tendering and actual implementation. until the remaining lacunae are fully plugged. Cooperation was already mentioned in the context of successful joint audits in China. The advancements in information technology are so overwhelming.
The two most common ones are taxes on financial transactions and on fringe benefits of employees.4 percent). but it appears that tax administrators are using them successfully without their commonly believed distortive effects coming into view. at the sub-national level. The center also has a VAT (called the CENVAT) up to the manufacturing stage. followed by Argentina (0. All countries are reporting an increase in revenue collection. The majority of Indian states introduced a VAT on 1 April 2005. Usually tax policy experts have considered them to be distortionary (Shome and Stotsky 1995). A computerized information exchange system (TINXSYS) is being developed on a cost-sharing basis between the center and states that will link various states in a common information exchange network. Brazil has experienced a 40 percent rise in tax assessments issued against taxpayers during the first nine months of 2004 as a result of the tax administration’s new strategy of cross checking taxpayers’ records of the financial transactions tax (CPMF) with information provided by credit card companies and real 30 . Design of tax policy to support tax administration Last. But its main benefit seems to be in the form of enhanced flow of information for the tax administration. While they do not yet feature in a large number of countries. on the other.75 percent).038 percent on an array of financial transactions. we touch upon some tax policy instruments that are being used as new innovations in tax administration control. but not least. and the states. there seems to be a spreading demonstration effect encouraging more countries to adopt such policies. or mainly. These are examined next. 5. A successful TINXSYS should be able to identify and check tax evasion more efficiently in the future. on the one hand. to revenue sharing with the center. information should be easily exchangeable if the states too are assigned important taxes that they themselves legislate. Financial transactions taxes have been introduced by Brazil at 0. Colombia (0. rather than being subject only. Peru and a few other Latin American countries. such information exchange should also be carried out between the center. Eventually.In particular. collect and appropriate.
An increase in assessments is projected for 2005. If a company is declaring losses anyway. With exactly the same objective. thereby requiring voluntary declaration by the taxpayer. the instrument could assist in tracking money laundering. mainly reflecting a new 0. The second method is through disallowance from expenses under the corporate tax. or a mix. I am concerned about large cash transactions.1 percent’ (Chidambaram (2005): 31). a record since the CPMF was begun to be used as a tax audit instrument. it can be taxed at the hands of the employee through his individual income tax return. assessments resulting from CPMF cross-checking totaled 28 billion BRL. and presumably become part of the black economy.1 percent on cash withdrawals from bank checking accounts above a specified threshold. the Finance Minister: ‘The National Common Minimum Program (NCMP) requires the government to introduce special schemes to unearth black money and assets. I am obliged to carry out the mandate. when there is no ostensible purpose to withdraw such large amounts of cash. way and would not yield revenue. if it could still be successfully used. This tax was created to cross-check stock sales with taxpayers’ tax returns (stock sales are exempt from CPMF). To quote Chidambaram (2005). it has come to stay in a scaled-back form with respect to its base. These cash withdrawals leave no trail. …I propose to levy a tax on withdrawal of cash…from banks at the rate of 0. A common form of money laundering appears to take place through false-account stock transactions and their subsequent channeling through multiple bank accounts. While initially it met with popular opposition. Therefore.estate brokers (Soares da Silva 2004). In the first three quarters of 2004. Taxation of fringe benefits (FBT) accruing to employees . in her annual 2005-6 central fiscal budget. the disallowance would not be binding. but without giving undeserved relief or amnesty. Most appropriately. India has just introduced a withholding tax of 0. however.005 percent capital gains withholding tax on stock sales in stock exchanges.can be carried out in one. especially withdrawals of cash.that comprise non-salary benefits that may be cash or non-cash . Despite its clipped wings. Developed countries use this method and tend to have stringent provisions to make it work. thereby legitimizing their existence without payment of tax. The third method is to have a positive list of fringe benefits 31 . of three ways.
education expenses. travel expenses. will equal its cost. the more he deducts. As in the case of the financial transactions tax. the larger would be his tax base for the FBT. the FBT is also a relatively new tax and not yet a la mode. India followed in the 2005-6 annual fiscal budget with initial sharp adverse reaction from the corporate and firm sectors that are subject to the tax. such as home-office expenses. and automobile expenses.and tax them at the hands of the employer at pre-specified presumptive rates. Almost inevitably the personal value of a business meal. some have extolled its virtues. drafters should be ruthless in drafting enforceable bright-line tests for distinguishing between personal and business expenses and disallowing all of the rest’ (Brooks (2001): 23). over 90 percent of Blue Jays’ (the cities National Baseball League team) season tickets are deducted as business expenses. To quote Brooks (2001): ‘A second obvious example of a technical rule that is unenforceable is one that allows business people to deduct the cost of business meals and entertainment. Allowing business people to deduct the cost of their business meals and entertainment makes absolutely no sense in terms of basic tax principles. While the employer would be allowed to deduct all such expenses from his income tax. The most basic tax principle is that taxpayers should not be allowed to deduct the cost of expenditures from which they derive personal value. for all so-called dual purpose expenses. Australia and New Zealand are two developed countries that have introduced the FBT. In Toronto. Nevertheless. and in every case the personal value of a business entertainment expense. these expenses should still be nondeductible since they are impossible to verify. The Indian version lists out fringe benefits that are primarily enjoyed jointly by employees. It has since been revised but is nevertheless in operation currently. Who knows what business people talk about while enjoying a meal at a fancy restaurant. from which people customarily derive some personal benefit. It is impossible for the tax department to verify that these tickets were in fact used to take business clients to baseball games. It also includes some benefits that are identifiable with individual employees but it has not been easy to collect tax on them (through a perquisites tax that falls on the employee). The new FBT assigns a presumed percentage of 32 . Basically. But even if in some cases business people do not enjoy the business meal or entertainment that they inflicted on their clients.
at the same time. 50 percent for entertainment and health club expenses. if not passed on. and 20 percent for most others. telephone expenses.’ National Tax Journal. travel. To conclude. tax administrators should be very cautious about introducing taxes that merely collect revenue but cause inefficiencies in resource allocation or are intrinsically inequitable. non-salary earners.as fringe benefits that do not represent business expenses. would have a dampening impact on tax revenue. (1988) ‘The Mexican value added tax (VAT): methodology for calculating the base. pharmaceuticals and construction in which travel forms a significant component of business expenses. References Aguirre. 10 percent for telephone. The Indian FBT has been introduced pari passu with a major simplification of and scaling up of individual income tax brackets that has reduced the income tax burden of the taxpayer across all income brackets and categories such as salary earners.health club membership. P. Certain business activities such as airlines and tour companies. These vary between 100 percent for the pension scheme. such taxes will arrest economic growth and. therefore.such benefits .A. C. tour and lodging. entertainment expenses. scholarships for children. In the medium term. optional pension schemes tailor-made for the upper end of the salary scale . the FBT is expected to improve the equity of the individual income tax: even though it will be collected from the corporate sector. its incidence is expected to be shared. 41: 543-54. The tax was essentially introduced as a devise to reduce tax evasion and is expected to be revenue productive. The corporate tax rate of 30 percent is applied on that fraction and is to be collected as an annex to the corporate income tax return. a word of caution must be provided here. In combination. are given special treatment. information technology. to the upperincome salary earner enjoying fringe benefits without being adequately taxed on them. therefore. While theoretically fine tax structures may not be too helpful in successful tax administration. and Shome. women and senior citizens. 33 .
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