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Paying TaxesThe global picture


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01

For urther inormation, or to discuss any o the ndings in this report please contact:

World Bank Group PricewaterhouseCoopers

Simeon Djankov Bob Morris+1 202 473 4748 PricewaterhouseCoopers LLP, [email protected] +1 202 414 1714

[email protected]

Caralee McLiesh Susan Symons+1 202 473 2728 PricewaterhouseCoopers LLP, [email protected] +44 20 7804 6744

[email protected]

Rita Ramalho John Whiting+1 202 458 4139 PricewaterhouseCoopers LLP, [email protected] +44 20 7804 4422

[email protected]

Contacts


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02Foreword

The World Banks Doing Business Project and PricewaterhouseCoopers are delighted to sharewith you the results o a survey which has been conducted as part o the World Bank DoingBusiness report (www.doingbusiness.org/taxes) to look at and compare tax regimes aroundthe world. The results ocus on the need or governments to ensure the eectiveness o the taxsystems they implement, and or companies to appreciate the benets o making tax reportingmore transparent.

The eectiveness o a tax system relies on well-inormed policy decision-making and the abilityo businesses to comply with legislation. This publication considers improvements rom the

perspective o both government and business.

The conclusions are based on the ndings o a survey on paying taxes which looked at the positiono a standard modest-sized company in each o 175 countries. The work was carried out by theWorld Bank during the months o April to July 2006, with the support o PricewaterhouseCoopersin terms o tax technical data and the methodology to be applied or the calculation o total taxrate. The survey represents a signicant step orward in acilitating a comparison o the worldstax regimes. We aim to build on the oundation laid, and to urther improve this inormation inthe uture.

This publication sets out the results o the survey. It provides commentary by the World Bank andby PricewaterhouseCoopers on the ndings and presents some thoughts on the way orward orgreater transparency in tax reporting.

We hope you will nd this interesting and would welcome your eedback.

World Bank and PricewaterhouseCoopers.

Simeon Djankov Susan SymonsManager, Monitoring and Analysis Tax PartnerWorld Bank Group PricewaterhouseCoopers LLP

United Kingdom

Foreword

In this Paying Taxes - The Global Picture report, the terms PricewaterhouseCoopers and PwC are used to reer to the network o member rmso PricewaterhouseCoopers International Limited, each o which is a separate and independent legal entity.


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Contents

04Contents

Foreword 02

Executive summary 05

Survey methodology 06

Section 1: Paying taxes around the world

Who makes paying taxes easy and who does not? 07

Corporate income taxes versus the total tax contribution 10

Section 2: Is there a need or reorm?

Why reorm tax systems? 13

The increasing burden o tax administration and compliance 16

The eect o the tax system on the economy 18

Employment taxes scope or scourge? 19

Section 3: How to reorm

The options or reorm? 21

VAT/GST: The win:win taxation systems o the uture? 25

Section 4: The way orward

Understanding the total tax contribution 29

Appendix 1

PwC Total Tax Contribution ramework 31

Appendix 2

Data notes and tables 33

Reerences 50

Caveats and disclaimers 51


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05

Executive summary

Taxes are essential to nance public services but thereare good and bad ways to collect them.

The design o the tax system can have signicanteconomic impacts and can infuence multinationals indeciding where to invest. Tax regimes with relativelyhigh marginal rates and which include a number oexemptions and allowances tend to be less economicallyecient in relation to encouraging employment, savingand investment. Such regimes generally also impose

higher tax compliance and administration costs. Evidencesuggests that simpler tax systems promote economicgrowth and can help achieve a win:win or governmentsand industry.

Burdensome tax systems can be a deterrent and can leadto tax evasion. Companies in 90% o surveyed countriesrank tax administration among the top ve obstacles todoing business. The main actors contributing to this are:

the large number o business taxes to pay; lengthy and complex tax administration; complex tax legislation; and

high tax rates.

To help with paying taxes and implementing reorm,governments and tax authorities need to consider allaspects o a tax system. All taxes borne and collected bybusinesses should be recognised along with the relatedtax compliance costs - the Total Tax Contribution.

Currently there is too much ocus on corporate incometaxes alone when considering reorm. The DoingBusiness survey data shows that on average corporate

income taxes only account or 36% o the Total Tax Rate,11% o the number o tax payments made and 25% othe compliance time. The reason or this is that there isinsucient inormation available in the public domain onthe Total Tax Contribution. Corporate reporting standardsare geared towards corporate income taxes and thereis little or no inormation available on the other businesstaxes which impact on companies.

The risk is that in discussions on reorm these other

business taxes are neglected or at worst overlooked.The increasing global trend to replace direct with indirecttaxes underlines this issue.

This survey seeks to better inorm the debate on reorm.Better inormation around the Total Tax Contribution willencourage a clearer understanding rom governmentsand help acilitate the appropriate steps that need tobe taken.

Transparency is key. Governments need to beaccountable or how taxes are spent. Businesses willpotentially be more willing to pay taxes i they can see the

benets o improved public services and inrastructure.Businesses need to understand and communicate theirTotal Tax Contribution, so that they are more able tomanage and control it and demonstrate the ull extent othe contribution made to public nances.

Better inormation can be achieved through thesystematic collection and reporting o data on the TotalTax Contribution, combined with regular consultationand dialogue between businesses, government and thetax authorities.

Executive summary


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06

Survey methodology

The Paying Taxes survey is carried out as part o theWorld Banks Doing Business report, which comparesbusiness regulations in 175 countries. It was originallylaunched in the 2006 report (published in September2005). The results o the second survey (2007) werepublished in September 2006. PricewaterhouseCoopersprovides the tax technical data or the survey.

The concept o the Total Tax Rate has been a keyelement o both o the surveys. In the 2007 report the

methodology applied to calculate the Total Tax Rate oreach country has been updated so that it is aligned withthe broad principles rom the PricewaterhouseCoopersTotal Tax Contribution ramework (see Appendix 1or urther details). Two additional indicators o taxcontribution are measured by the Doing Business Project,which are related to administration and compliance.

The study involved gathering inormation on all businesstaxes borne by companies in 175 countries, by reviewingthe nancial statements and a list o transactions o astandard modest-sized business called TaxpayerCo. (See

Appendix 2 Data notes, or a urther explanation othe methodology).

In outline, the business started with the same nancialposition in every country. Respondents were asked ordetails o the total tax that the business must pay and theprocess or doing so. All taxes - rom corporate incometax and mandatory social security contributions paid bythe employer to advertising or environmental tax - andall applicable deductions and exemptions are taken intoaccount in determining the total tax contribution. Salesand consumption taxes are not included as part o theanalysis to calculate the Total Tax Rate, as they are not

considered to be borne by the business.

The recognition o Total Tax Rate as a key component othe ease o doing business, is a signicant enhancementto the Doing Business report. It enables companiesand governments alike to appreciate the ull extento businesses tax contributions globally. This in turnenables both governments and businesses to makebetter inormed policy and risk management decisions.

Survey methodology


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Tax collection has long been a despised activity. Buttaxes are essential. Without them there would be nomoney to build schools, hospitals, courts, roads, airportsor other public inrastructure that helps businesses andsociety to be more productive and better o.

Still, there are good ways and bad ways to collect taxes.Imagine a modest-sized business TaxpayerCo thatproduces and sells consumer goods. In Hong Kongthe business pays one income tax, one labour tax, one

property tax and one uel tax totalling 29% o prots.It takes 80 hours to comply with tax requirements.Meanwhile, in Belarus TaxpayerCo is subject to 12taxes, including an income tax, sales tax, value addedtax (VAT), transport duty, three labour contributions,land tax, property tax, ecological tax, uel tax and aturnover tax where taxes are paid on inputs and againon outputs. Despite many deductions and exemptions,required payments add up to 186% o prots - whichin an extreme case could lead to business ailure or taxevasion. The business would make 125 tax payments tothree agencies, all by paper, and spend 1,188 hours doing

so. Tax reunds would take two years to process. Thiscomplexity and delay make Belarus tax system amongthe worlds most burdensome. Most companies cantaord to declare all their output, and 42% o businessactivity thereore goes unrecorded.

The results o the Doing Business survey on PayingTaxes show the ull breakdown o taxes that anaverage business pays. For example, in Tunisia socialsecurity contributions paid by the employer amount to16% o gross salaries, which is equivalent to 18.6%o commercial prots (Table 1.1). On top o that, thecompany pays jointly with social security contributions,and an accident insurance o 3.8% o gross salaries,that is 4.4% o prots. There are two additional labourtaxes paid by employers o 1% gross salaries each the

FOPROLOS (social housing tax) and the TFP (proessionallabour tax). Both taxes amount to 2.4% o prots.Ater taking into account deductions and exemptions,the corporate income tax is 35% o taxable income equivalent to 11.1% o prots. The company also paysFODEC (industrial development competitiveness tax),which is 1% o turnover and thereore 18.2% o prots.Additionally the business pays TCL (local municipalitytax), and small taxes such as vehicle tax and stamp duty,which amount to 4.3% prot. Thus tax payments total59% o prots, leaving TaxpayerCo with only 41% toinvest in new products and distribute to shareholders.

Section 1: Paying taxes around the worldWho makes paying taxes easy and who does not?


By Caralee McLiesh and Rita Ramalho, Doing Business Project, World Bank

Table 1.1: Paying taxes in Tunisia

Source: Doing Business 2007

a) - Data not collectedb) - VAT is not included in the Total Tax Rate because it is a tax levied on consumersc) - Very small amountd) - Paid jointly with another tax

Tax Payments Time Statutory tax Tax base Total Tax Rate(number) (hours) rate (% prot)

Value added tax (VAT) 12 96 18% value added 54.5 b)

Social security contributions 4 36 16% gross salaries 18.6

FODEC (development o industrial 12 - a) 1% turnover 18.2competitiveness tax)

Corporate income tax 1 136 35% taxable income 11.1

Workers compensation (accident insurance) 0 d) - a) 3.80% gross salaries 4.4

TCL (local municipality tax) 12 - a) 0.20% turnover including 4.3

VAT

FOPROLOS (social lodging tax) 1 - a) 1% gross salaries 1.2

TFP (proessional training tax) 1 - a) 1% gross salaries 1.2

Stamp duty 1 - a) xed ee c)

(0.15 cents)

Vehicle tax 1 - a) various rates c)

Totals: 45 268 59


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08Section 1: Paying taxes around the world

Arguments or business tax reorm usually emphasisecorporate income tax rates. But corporate incometaxes are only a small share o the total business taxcontribution close to a third on average. For example,Argentinas prot tax is 9% o total taxes, while socialsecurity contributions paid by employers account or26% and turnover and nancial transaction taxes accountor almost 62%. Moreover, the corporate income tax isjust one o 34 required payments. Simpliying the other33 payments spread over 11 separate taxes would go a

long way towards reducing the tax burden on businesses.Latvia is another example: social security and otherlabour contributions account or 66% o the tax burden,whereas prot taxes account or 21%.

Around the world, corporate income taxes account oran average o 36% o the tax burden on businesses.They also account or only our o 35 business taxpayments (Figure 1.1). In several Eastern Europeancountries simplication has not had the desired impact onperceived business obstacles, in part because it ocusedon income tax only1.

Figure 1.1: Corporate income tax accounts or only parto the tax burden

Administrative requirements are also a burden in manycountries. Firms in 90% o surveyed countries rank taxadministration among the top ve obstacles to doingbusiness. In several including Bangladesh, Cambodia,the Kyrgyz Republic, Russia and Uzbekistan working

with the tax bureaucracy is considered a bigger problemthan tax rates2.

To measure these administrative burdens Doing Businessand PricewaterhouseCoopers LLP recorded the numbero payments TaxpayerCo would have to make to tax

authorities, as well as the time required to prepare and letax payments. Norway collects 46% o companies grossprot using three taxes led electronically. In contrast, ittakes 16 taxes and 59 interactions with the tax authoritiesto collect 53% o gross prot in the Philippines. In Ukraineit takes 98 payments and 2,185 hours a year, comparedwith only 11 payments and 104 hours in Estonia.

To comply with tax regulation, businesses in the 175economies covered in this study submit, on average, 35

pages o tax returns a year equivalent to 100,000 treesa year, even ater accounting or the ew countries wherebusiness taxes can be led electronically3. In Cameroonthe average annual tax return or businesses is 172pages, in Ukraine, 92 and in the United States, 64.

Such complicated tax systems can lead to high evasion,even when rates are low. For example, although taxesin Peru are low by Latin American standards, evasion isa problem because it takes 74 days and 53 paymentsto ull tax requirements. In Brazil, the average businessspends 455 days a year to comply with taxes because

there are, on average, 55 changes to tax rules a day

4

.Keeping up to date on tax law isnt easy.

Table 1.2 on page 09 ranks countries on the ease opaying taxes and is based on the average o the countryrankings on total taxes, number o payments and timerequired to comply. Some countries at the top o the listare o no surprise tax havens like the Maldives and StLucia, and Middle Eastern countries like Oman, UnitedArab Emirates and Saudi Arabia, where the governmentrelies on oil revenue to und spending. However others,such as Ireland, Singapore, Switzerland and NewZealand, are less expected. Several Nordic countries

perorm better once all business taxes are taken intoaccount and administrative burdens are considered Iceland ranks 13th, Denmark ranks 15th and Norwayranks 16th. Perhaps this refects the eorts already madeby Nordic countries to push an overall government-to-business simplication agenda to reduce regulation, usinga Standard Cost Model (SCM). The UK has embarked ona similar exercise.

1

Engelschalk (2004).2World Bank Investment Climate Survey database, available at http://rru.worldbank.org

3A grown tree produces, on average, 80,500 sheets o paper. There areabout 250 million ormal businesses in the world.

4Folha de So Paulo, Pas edita 55 normas tributarias por dia, May 7,2006.

Share of tax burden

0%

50%

100%

Total tax rate (%

of profits)

Number of

payments

Time (hours per

year) Other taxesLabour taxCorporate income tax

19.3%

17.6%

16.8%

4

14

17 125

120

84

Source: Doing Business database


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09

On average, Middle Eastern and East Asian countriesmake paying taxes the easiest. Latin American countriesimpose the heaviest burdens, mainly because o highcompliance costs. Arica ollows, largely because o hightaxes. The Organisation or Economic Co-operation andDevelopment (OECD) countries impose the smallestadministrative burdens and charge moderate tax bills.

Richer countries tend to have lower business taxes and

less complex tax administration processes. Simple,moderate taxes and ast, cheap administration meanless hassle or business as well as higher revenues.In contrast, poorer countries tend to use business as acollection point, charging higher business taxes.

Table 1.2: Where is it easy to pay taxes and where not?


Source: Doing Business databaseNote: Rankings on the ease o paying taxes are the average o thecountry rankings on the number o payments, time and total tax rate.See the Data notes (Appendix 2) or details.

Who makes paying taxes easy - and who does not?

Easiest Rank Most dicult Rank

Maldives 1 Bolivia 166

Ireland 2 Venezuela 167

Oman 3 China 168

United Arab Emirates 4 Algeria 169

Hong Kong, China 5 Congo, Rep. 170

Saudi Arabia 6 Central Arican Republic 171

Switzerland 7 Colombia 172

Singapore 8 Mauritania 173St. Lucia 9 Ukraine 174

New Zealand 10 Belarus 175

Payments (number per year)

Fewest Most

Maldives 1 Jamaica 72

Aghanistan 2 Bosnia and Herzegovina 73

Norway 3 Montenegro 75

Hong Kong, China 4 Dominican Republic 87

Sweden 5 Kyrgyz Republic 89

Mauritius 7 Romania 89

Portugal 7 Congo, Rep. 94

Spain 7 Ukraine 98United Kingdom 7 Belarus 125

Ireland 8 Uzbekistan 130

Time (hours per year)

Least Most

Maldives 0 Azerbaijan 1 ,000

United Arab Emirates 12 Vietnam 1 ,050

Singapore 30 Bolivia 1 ,080

St. Lucia 41 Taiwan, China 1 ,104

Oman 52 Armenia 1 ,120

Dominica 65 Nigeria 1 ,120

Switzerland 68 Belarus 1 ,188

New Zealand 70 Cameroon 1 ,300

Saudi Arabia 75 Ukraine 2 ,185

Ireland 76 Brazil 2 ,600

Total tax rate (% o prot)

Least % Most %

Maldives 9.3 Tajikistan 87.0

Vanuatu 14.4 Mauritania 104.3

Saudi Arabia 14.9 Argentina 116.8

United Arab Emirates 15.0 Uzbekistan 122.3

Oman 20.2 Belarus 186.1

Samoa 22.1 Central Arican Republic 209.5

Zambia 22.2 Congo, Dem. Rep. 235.4

Cambodia 22.3 Sierra Leone 277.0

Mauritius 24.8 Burundi 286.7Switzerland 24.9 Gambia 291.4


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+300% +200% +100% +100%

Other business taxes as a percentage o prot beore business taxes Corporate income tax as a percentage o prot beore business taxes

As mentioned in the previous chapter, arguments orbusiness tax reorm usually emphasise corporate incometax rates. However, corporate income taxes are only asmall share o the total business tax contribution.

Figure 1.2 below illustrates that the dierential betweenthe total tax rate and the corporate income tax rate exists

or most countries covered by the survey, while Figure1.3 identies the 20 countries where this dierentialis greatest.

It is interesting to note that while some o the largestdierentials can be ound in Arica (in countries like SierraLeone and the Congo Democratic Republic), the biggestexamples also extend to other continents in countrieslike Argentina, India, China and notably in Franceand Belgium.

Figure 1.3: Countries with the largest dierential Total TaxRate (TTR) versus corporate income tax

Corporate income taxes versus the total

tax contributionBy Susan Symons, PricewaterhouseCoopers LLP , United Kingdom


Countries with the largest differential TTR vs corporate income tax

Belgium

Kenya

Italy

France

China

Bolivia

Kyrgyz Republic

Algeria

India

Tajikistan

Costa Rica

Eritrea

Mauritania

ArgentinaUzbekistan

Belarus

Congo, Dem. Rep.

Gambia

Burundi

Sierra Leone

Other business taxes as a percentage of profit before business taxes

Corporate income tax as a percentage of profit before business taxes

100% 100%200%300%



Figure 1.2: Corporate income tax as a percentage o prot beore business taxes compared to other business taxes asa percentage o prot beore business taxes


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11 Section 1: Paying taxes around the world

Figure 1.4 below analyses the data rom a regionalperspective, and urther demonstrates that this is not justa eature or developing countries but applies similarly toother regions both geographically and economically. Theull details by country or this comparison are shown inFigure 1.2 (See also data tables in Appendix 2).

Figure 1.4: TTR versus corporate income tax theregional perspective

According to the survey data overall, corporate incometaxes in act account on average or only 36% o the totaltax rate, 11% o the number o payments made, and 25%o the compliance time.In this connection it is also interesting to take note o thenumber o business taxes that there are. For example,according to the survey, companies in Switzerland have

11 business taxes, and Belarus 9, and these numbersare o course limited by the assumptions made or thecompany used in the model.

Recent independent empirical work conducted byPricewaterhouseCoopers LLP in the UK shows that thereare up to 21 UK business taxes that companies may haveto bear in addition to corporate income tax, with labourtaxes, property taxes and irrecoverable value added taxbeing the most signicant o these as illustrated in Figure1.5. The other taxes include various sector-specic leviesand an increasing number o environmental taxes aimed

at behavioural change, including the congestion chargelevied in London. The work has shown that on averagethe largest UK companies each bear 9 business taxes.

Figure 1.5: UK business taxes

In Australia PricewaterhouseCoopers studies undertakenshow that companies may have to deal with many more

business taxes, in some cases more than 50, because othe various taxes each State levies in addition to thoseoperating at Federal level and those applied locally orexample the Fire Brigade levy.

In addition countries that appear to be tax havensbecause o the lack o corporate income tax rangingrom Estonia to the Marshall Islands usually ensure thatbusinesses contribute signicantly to government coersin other ways, typically high employment taxes (employercontributions) or operating licence ees. The World Banksurvey shows a Total Tax Rate o 50.2% or Estonia and66.6% or the Marshall Islands.

So ar, this section has drawn attention to the otherbusiness taxes which companies have to bear thetaxes which directly aect their protability and whichthereore contribute to the calculation o the TotalTax Rate. But the taxes which companies collecton behal o governments should not be orgotten.These are taxes which companies are obliged to collectbut which are not ultimately borne by companiesbut which are instead borne by the consumer. Forcompanies their impact is in relation to administrativeand compliance cost, and is also commercial to the

extent that they impact on the companys prices. TheUK work reerred to above ound that in the UK there arepotentially 13 taxes collected by the largest companiesand the experience is that on average 5 have to becomplied with.

Total Taxes borne 2004/05 by percentage

Property taxes; 11.4%

Other; 9.9%

Sector taxes - f inancial sector;

8.6%

Corpo rate taxes; 50.3%

Employment taxes; 19.9%

Source: PwC survey or the Hundred Group

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

East Asia &

Pacific

Middle East &

North Africa

South Asia Latin America

& Caribbean

OECD: High

Income

Eastern

Europe &

Central Asia

Sub-Saharan

Africa

TTR Corporate income tax



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Among the most prominent examples o such otherbusiness taxes are employment taxes (levied on theemployee), and indirect (or consumption) taxes suchas value added tax (VAT)/goods and services tax (GST),and environmental taxes. These taxes are increasinglybeing used by governments to collect the revenues thatthey need to und public services and the trends indicatespecically that governments are looking towards VAT/GST5 as the major source o tax revenue or the uture.I this trend continues and indirect taxes become the

most prominent orm o taxation in the next 10 to 20years, then there is clearly a need or governments toconsider these taxes as part o the reorm agenda. Asa key role or businesses is to collect these taxes onbehal o governments, so the costs o administrationand compliance need to be actored into the decisionover whether reorm is necessary. Consultation withbusiness is essential.

So the evidence clearly suggests that it would be shortsighted or the tax reorm agenda or government toocus only on corporate income taxes. To do so ignores

the act that there are many other business taxes whichtogether (and oten even in isolation) represent signicantcomponents o the total tax contribution. Focusing solely

on corporate income tax can lose sight o the value thatthe country gets rom the multiplier eect o the widertax contribution.Currently, corporate income taxes are the primary ocuso government decisions over reorm. This is largely dueto the act that todays corporate reporting standardsgenerally home in on corporate income taxes and,typically, the disclosures in the company accounts arearound corporate income taxes paid or provided on

business prots. There may also be some disclosurearound employers social security costs. However, untilrecently there has been little data in the public domainabout other business taxes borne or collected bycompanies. There has certainly been nothing that bringsthem all together. The risk is thereore that these otherbusiness taxes are neglected in the reorm debate or atworst, overlooked.

The onus is thereore on businesses to increasetransparency around their total tax contribution, includingall the taxes they pay and collect, as well as the time

taken and cost o administration and compliance. In thisway, governments (and other stakeholders) will be able totake on board the ull picture when considering reorm.


5This concept includes VAT and GST but does not cover sales taxes,customs duties or excise type taxes


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Governments impose taxes to nance public services.But taxes must rst be collected and high tax ratesdo not always lead to high tax revenues. Between1982 and 1999 the average corporate income taxrate worldwide ell rom 46% to 33%, while corporateincome tax collection rose rom 2.1% to 2.4% o nationalincome6. This outcome was achieved because morebusinesses entered the ormal economy and becausetax exemptions and other tax incentives were reducedor eliminated.

Poorer countries try to levy the highest amount o tax onbusinesses. Some claim that these high taxes are neededto und public services and correct scal decits. Theevidence suggests otherwise. Higher rates typically donot lead to higher revenues in poor countries (Figure 2.1).Instead they push businesses into the inormal economy.As a result the tax base shrinks and less revenueis collected7.

Figure 2.1: Taxes and revenue unrelated in poorcountries

A better way to meet revenue targets is to encourage taxcompliance by keeping rates moderate. Russias largetax cuts in 2001 did exactly that. Corporate tax rates ellrom 35% to 24%, and a simplied tax scheme loweredrates or small business. Yet tax revenue increased - by

an annual average o 14% over the next three years.One study showed that the new revenue was due toincreased compliance8.

Reducing tax rates has been a trend in other EasternEuropean and Central Asian countries. Most reormers Armenia, Bulgaria, Estonia, Kazakhstan, Slovakia have

seen tax revenues rise. The larger the share o inormalbusiness activity beore reorm, the higher the revenuegrowth ater.

More recent reormers have shown similar results. Ghanaexceeded its mid-year revenue targets despite signicantcuts in corporate tax rates in the last two years. Albaniascorporate tax revenue rose 21% ater the rate was cut,while in Moldova it jumped 28% and in Latvia, 37%.In Romania, budget revenues grew 8% in real terms

in the rst quarter o 2005 relative to the same periodin 2004, despite the new fat tax. Economic growth inthese countries is a actor in the increased revenues.But compliance is also up.

Lower rates work best when their administration issimple. They are undermined by exemptions that shrinkthe tax base. Tax revenue has allen in Uzbekistan, wherethe enthusiasm or income tax cuts was not matchedby eorts to improve tax administration and expand thetax base.

Businesses are more willing to pay taxes i they see thatthe money is used to improve public services. Yet manydeveloping countries with high tax rates ail to improvebusiness inrastructure or education and training twothings that employers care about (Figure 2.2). Acrosscountries, higher taxes payable are not associated withbetter social outcomes, even allowing or country incomelevels. They do not increase government spending onhealth and education, raise literacy or lie expectancy orlower child mortality, nor are they associated with betterinrastructure and other public services9.

Section 2: Is there a need or reorm?Why reorm tax systems?By Caralee McLiesh and Rita Ramalho, Doing Business Project, World Bank

0

10

20

30

0 10 20 30 40 50 60 70 80 90

Tax Revenue as % of GDP

Tax rate payable by business

Poor Countries

Rich Countries

6Hines (2005)7A similar result holds between scal regulation and economic growth.See Loayza, Oviedo and Serven (2004)

8Ivanova, Keen and Klemm (2005)9Based on analysis o Doing Business indicators with health, educationand inrastructure indicators in the World Banks World DevelopmentIndicators (2005) and Global Competitiveness Report 200405 (WEF2004). The results hold controlling or income per capita

Source: Doing Business database, IMF (2005), WDI (2005)



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Figure 2.2: Burdensome taxes, and still poor publicservices

Burdensome taxes do however generate otherundesirable outcomes. They are associated with moreinormality, as entrepreneurs oten choose to avoid theormal system altogether and operate underground(Figure 2.3). They also breed corruption. Businessesranking in the bottom 30 countries on ease o paying

taxes are twice as likely as those in the top 30 to reportthat inormal payments are a problem. Every point ocontact between a bureaucrat and an entrepreneur couldpresent a danger o bribery and conusion on voluminous,oten contradictory rules which may create roomor discretion.

Figure 2.3: Burdensome taxes are associated with moreinormality

Simpliying the tax regime by reducing tax ratesand eliminating exemptions is the main way toreduce corruption in tax administration. Georgia which introduced major reductions in tax rates andsimplications to the tax system in 2004 has seen adrastic all in perceived corruption o tax ocials. In2005 only 11% o surveyed businesses reported thatbribery was requent, down rom 44% in 2002. Thatwas the sharpest drop in perceived corruption amongthe 27 transition economies10. Romania, another majorreormer in 2004, and Slovakia, which introduced

large tax reorms in 2003, also saw alls in perceivedcorruption: rom 14% to 8% o surveyed businesses androm 11% to 5%, respectively.

Growing evidence shows that tax reorm creates morevibrant businesses. A smaller tax burden encouragesrms to invest (Figure 2.4). One recent study ound thata 10% cut in indirect taxes, such as VAT, may imply arise in investment o up to 7%11. Businesses are happywith the change and responding by investing more, saysKenneth, an accountant, about corporate tax reorm inGhana. Moreover, such investment yields higher returns

when taxes are streamlined. A study in India estimatesthat tax reorm can increase productivity by up to 60%12.

Countries ranked by ease of paying taxes

(quintiles)

higher

higher

lower

lower

Size of the informal sector

10World Bank (2006)11Desai, Foley and Hines (2004)12World Bank (2004)

1st 2nd 3rd 4th 5th


(quintiles)

low

high

Overall infrastr ucture quality

Source: Doing Business database, WEFNote: Relationships are signicant at the 1% level and remain signicantwhen controlling or income per capita

Source: Doing Business database, Schneider (2005)Note: Relationship is signicant at the 1% level and remains signicantwhen controlling or income per capita


1st 2nd 3rd 4th 5th


(quintiles)

low

high

Quality of educational system


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Figure 2.4: Burdensome taxes are associated with lessinvestment

It is not just businesses that gain rom reorm.Streamlining taxes also brings savings or government.A complicated tax system costs a lot o money to run unds that could be better spent on education, healthcare and inrastructure. In Denmark, one kroner spent ontax administration generates 113 kroner o tax revenue. InHungary, one orint produces only 77. In Mexico one pesoproduces only 33.

Overall growth is also higher with lower taxes and better

collection13. And with tax incentives aligned to encouragework, more rms and more jobs are created. One studyshows a cut o one percentage point in corporate taxrates is associated with up to a 3.7% increase in thenumber o rms and up to 1.1% higher employment14.Tax reorms inspire political debate and can be hotlycontested. But both business and government benetwhen taxes are simple and air and set incentivesor growth.



(quintiles)

higher

higher

lower

lower

Investment as % of GDP

Source: Doing Business database, Schneider (2005)Note: Relationship is signicant at the 1% level and remains signicantwhen controlling or income per capita

13Engen and Skinner (1996), Lee and Gordon (2004) and Slemrod (1995)14Goolsbee (2002)


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16Section 2: Is there a need or reorm?

The increasing burden o tax administration

and complianceBy Peter Cussons, PricewaterhouseCoopers LLP, United Kingdom

Tax administration and compliance can be a signicantobstacle to businesses and need to be considered as parto the decision on reorm.

A recent study by PricewaterhouseCoopers looked atthe burden o ederal tax administration or the top 20

countries ranked by gross domestic product (GDP). Therelative tax administration burden in each country wasmeasured by the number o pages o primary ederal taxlegislation, as shown in Table 2.1.

Country GDP ranking GDP $m Number o pages o primary tax legislation (ranking)

United States 1 11,711,834 5,100 (5)

Japan 2 4,622,771 7,200 (4)

Germany 3 2,740,551 1,700 (10)

United Kingdom 4 2,124,385 8,300 (2)

France 5 2,046,646 1,300 (13)

China and Hong Kong 6 1,931,710 2,000 (9)

Italy 7 1,677,834 3,500 (7)

Spain 8 1,039,927 530 (17)

Canada 9 977,968 2,440 (8)

India 10 691,163 9,000 (1)

Korea 11 679,674 4,760 (6)

Mexico 12 676,497 1,600 (12)

Australia 13 637,327 7,750 (3)

Brazil 14 603,973 500 (18)

Russia 15 581,447 700 (=15)

Netherlands 16 578,979 1,640 (11)

Switzerland 17 357,542 300 (20)

Belgium 18 352,312 830 (14)

Sweden 19 346,412 700 (=15)

Turkey 20 302,786 350 (19)

Source: PwC study June July 2006. GDP inormation is based on 2004 gures taken rom World Bank data as at April 2006, or more inormationvisit: http://www.worldbank.orgNote: The study does not measure state and local taxes. Countries levy taxes at dierent political levels, which will aect the relative ranking.

Table 2.1: Federal tax administration burden


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17 Section 2: Is there a need or reorm?

The smaller but signicant and growing economies oIreland and Luxembourg were also surveyed and revealedequally interesting results. Ireland (GDP ranking 30/$181,523m) had 4,250 pages o primary tax legislationand thereore a ranking o seven i incorporated into theabove table. Luxembourg (GDP ranking 67/$31,864m)had 2,200 pages o primary tax legislation and thereore aranking o 10 i incorporated into Table 2.1 (on page 16).

A rst important nding to note is that the volume o

primary ederal tax legislation is not directly proportionalto economic size. For example, the US, ranked numberone in GDP terms, being almost three times the size othe next nearest economy (Japan) has just 5,100 pageso primary ederal tax legislation compared with Japans7,200 pages. Or India, with a lower GDP ranking o 10but which has the most pages o primary ederal taxlegislation at 9,000.

Secondly, the volume o primary ederal tax legislationis on the increase i.e. more new legislation is beingenacted than repealed. In the UK over the past 10

years, the number o pages has more than doubled romapproximately 3,700 to 8,300.

There are a number o reasons or this. In the UK,or example, the Tax Law Rewrite committee hasrewritten most o the UKs income tax provisions inmore user-riendly language. The necessity or this isperhaps best illustrated by a quote rom Section 704,Income and Corporation Taxes Act (ICTA) 1988, as yetunreconstructed: That in connection with the distributiono prots o a company to which this paragraph applies,the person in question so receives as is mentionedin Paragraph C (1) such a consideration as is therein

mentioned. (Paragraph D (1) o the arcane Section 704prescribed circumstances provisions in relation toanti-avoidance regarding transactions in securities).Nonetheless, it is arguable that this process is responsibleor a 50% increase in the length o the legislation that isbeing rewritten, and it should be noted that the Tax LawRewrite process has as yet probably rewritten under ahal o all UK primary tax legislation.

The Government may consider tax advisers (and perhapsbusiness) as responsible by virtue o tax avoidance ormuch recent legislation. However, with the extension

o the UK Tax Avoidance Disclosure (TAD) rules toall income tax, corporation tax and capital gains taxtransactions as well as VAT and stamp duty/stampduty reserve tax/stamp duty land tax, it is arguable thattinkering with the tax system by introduction o layer uponlayer o anti-avoidance is leading to a situation whereone transaction (e.g. borrowing in the UK) may require

consideration o up to hal a dozen diering blocks oanti-avoidance legislation or case law15.

A particularly worrying consequence is that with the sheervolume o tax legislation no one individual can possiblyread all o it; and so the days o a tax director beingcondent o spanning all the relevant parts o the taxcode seem to have all but disappeared. Similarly, at leastas regards advising large to medium-size corporates,the ability o a single tax adviser to span all the relevant

tax legislation is circumscribed, hence the increasingrelevance o specialists and sub-specialists. This leadsto an at least two tier market those who can aord thenecessary advice, and those or whom such advice maybe o only marginal benet on a cost/benet analysis.

It is also leading to a situation where the primary taxlegislation is being read by ewer and ewer people,and on the HM Revenue & Customs (HMRC) side inthe UK, where there are nominated specialists or notonly particular areas but nowadays even or a particularsection or schedule.

On a brighter note, other countries such as Germanyand France with economies that are comparable to(France) or even larger (Germany) than the UKs, appearto manage with considerably ewer pages o primaryederal tax legislation. The PricewaterhouseCoopers LLPsurvey shows Germany with 1,700 pages putting thecountry in tenth place and France with 1,300 pages andin 13th place.

To conclude, many countries need to refect on the likelydeterrent eect o the ever increasing complexity o theirtax legislation and the resulting probable reduction in

their international competitiveness. Ultimately, when taxlegislation becomes too voluminous, compliance dropsmore through ignorance than deliberate evasion, as thePaying Taxes survey illustrates.

15 Section 209 ICTA 1988: whether interest dependant on the

results o the business and thereore a distribution; Paragraph13 Schedule 9A FA 1996: loans or unallowable purposes;Schedule 28AA ICTA 1988: thin capitalisation and transerpricing; Sections 24 to 31 Finance (No. 2) A 2005 andSchedule 3: anti-arbitrage provisions; Section 349 ICTA 1988and SI1970/488: treaty clearance rom UK 20% withholdingtax; Ramsay/Furniss, post BMBF and SPI.


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19

Employment taxes scope or scourge?By John Whiting, PricewaterhouseCoopers LLP, United Kingdom


Companies know that they pay many taxes over andabove the tax on their prots. In almost every country inthe world, those taxes include some orm o levy relatedto their payroll bill sometimes directly, sometimes linkedto the employees. Its questionable whether the extento these charges is ully appreciated or ully controlledby either the company that pays them or the governmentthat levies them.

I tax reorm is in the air, taxes on employment are usually

a part o that mooted reorm. Is this an area where thereis scope or countries to extract more or is it an areathat damages employment prospects?

What are human resource taxes?

The employers tax costs related to the human resource(HR) unction are usually threeold:

(1) Taxes borne the employers social securitycontributions, contribution to pension benets (orexample employer pension contributions in Australia)

or payroll taxes.(2) Taxes collected deductions made by the employerrom employees pay in respect o social security andincome tax.

(3) Tax administration the cost o running all o thiseectively on behal o governments.

There may also be involvement by employers in whatare essentially benets laid down by governments.Some may be unded by governments, imposing onlyan administrative burden on employers. Some are actualcosts and become part o taxes borne. Examples willinclude areas such as sick and maternity/paternity pay

and levies to support particular industries or trainingschemes. It is arguable how much these represent intaxes in the purest sense o the word it will come downto whether these are payments to tax authorities whichare then used as general revenues. But, however they areregarded, they need to be borne in mind when the burdeno employment taxes is considered.

Pros and cons

There is a lot to be said or taxing employees via theemployer at least rom a governments point o view.

Employers may be more likely to pay; there is potentiallyone employer as against many employees; addingto payroll costs emphasises the employers widerresponsibilities and may ensure that the employer putsadditional monies into some orm o social welare.Incentives can be given or particular actions orexample, reduced social security contributions or new

employees in Finland. Checking compliance can bevia employer visits rather than many individual reviewso employees.

The contra argument has to be one o cost. Imposingextra costs onto employers in respect o their employeeswill undoubtedly increase the cost o employment. Theadministrative burden shouldered by employers mustnot be orgotten either: particularly where returns requirecopious data, as is normally the case.

Is this a signicant burden?

It is noticeable that some countries with modest (or inthe case o Estonia, no) corporate income taxes evidentlymake up the lost revenues via employment taxes, inparticular employer social security charges. But it isnot just countries with low rates o corporate incometaxes: countries such as France and Belgium imposehigh employer social security charges. This has ledto some employment perceptibly moving to the southeast o the UK where services can easily be rendered to

France/Belgium while staying out o their social securitynet. Whether it also contributes to unemployment is anissue or the economists but evidence rom businessesmakes it clear that these high costs are actors inbusiness planning.

Within a country, sectors can dier. This can result romadditional (or reduced) levies or particular industries,depending on the countrys attitude to the sectors inquestion. Even with the same rates on tax, dieringemployment patterns (and rates o pay) can mean verydierent impacts on the companies concerned. Forexample, in the UK Financial Services sector, employers

national insurance contributions (NICs) are one-third ocorporate income tax bills, whereas in Industrial Products,the position is reversed employers NICs are three timesthe corporate income tax bills16.

All this emphasises the need to actor employmenttaxes into any tax strategy both at government andcompany level.

Cost or benet?

Many countries will argue that the employer actually

benets rom the cash that they deduct and retain romemployees pay. This cash can be managed positivelyor the period that it is in the companys hands beore

16Source: PwC Total Tax Contribution survey or The HundredGroup 2005


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20Section 2: Is there a need or reorm?

it is passed on, and can oset, to a greater or lesserextent, the tax administration costs. This may work orlarger employers; however the smaller employer willoten struggle.

The question then arises as to whether employers areproperly ocused on managing these signicant tax costs.Bear in mind that risks in the tax arena generally come inmany guises, and employment tax risks are no dierent.For example:

Operational risk the possibility o processing errors,which because o the volumes involved could lead tosignicant additional costs;

Compliance risks the possibility o late submission,with consequent penalties; and

Reputational risk making errors in the employmenttax arena is unlikely to lead to adverse externalpublicity but it could impact on sta relations.

Some might argue that these risks have always beenpresent. However, it is apparent that tax authorities see

the employment tax compliance arena as a ruitul areaor their eorts.

A bigger HR bang?

This section does not argue or or against employmenttaxes, but simply suggests that companies andgovernments alike need to consider them and make surethat they actor them properly into planning.

Many countries in the developing world may seeemployment taxes as an attractive route to obtainingadditional revenues, particularly or the perceived ease

o collection. That can be a very valid argument; thedownside can be pricing sta out o the market. Aparticular actor within this will be whether local staare to be taxed in the same way as expatriates. Ater all,expatriates may not draw on social costs in the sameway, i that is part o the rationale or employment taxes.But allowing them a discount which may come via a taxtreaty may cost the country more than it had envisaged.

There is a long way to go beore taxes, particularlyemployment taxes, are harmonised. In the meantime theimplication is that it is becoming ever more important to

ensure there is transparency around employment taxesand that they are properly managed and reported.


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21

January 1st 2006: law eff ective for corporate income

Jun 05: Parliament approves new law

Nov 04: Private sector rev iew and public discusion of new law

Nov 04: Government sends law to par liament

Nov 04: Cabinet approves new law

Oct 04: Government announces intention to change tax code

July 04: New reform-minded cabinet takes off ice July 2004

Jul 2004 Jan 2006

The cabinet sets custom and tax reform as the

major pr iorities

Little opposition, except f rom beneficiaries of

tax breaks under old system

New law takes

effect, retroactive

for all 2005

Tax officials trained on new audit and

record system

Media campaign informs the public about new law

In 2004-06, reducing prot tax rates was by ar themost popular change to tax systems (Table 3.1).Corporate income tax cuts swept through EasternEuropean countries, sealing the regions rank as the toptax reormer. Western European countries also joinedthe trend, partly in response to competition rom newEuropean Union members. Such reductions are possiblewhen reorms target increasing compliance and the taxbase. Here are three ways to start:

Simpliy tax law. Ease ling requirements. Consolidate taxes.

Simpliy tax law

The boldest reorm is to simpliy tax law so thatevery business aces the same tax burden with noexemptions, tax holidays or special treatment or largeor oreign businesses. Many tax laws start that way. Butwhen hard times come and governments need revenue,tax rates are oten raised. This is unpopular, and large

or well-connected businesses usually obtain specialtreatment. Soon the tax law becomes riddled withexceptions, generally at the expense o small businesses,which have the least ability to lobby. Oten they arepushed into the inormal sector.

Few reormers dare eliminate exemptions. Egypt isan exception: since 2005 all businesses have paida 20% corporate income tax rather than 32% or

40%, depending on the sector. All sector-, location- orbusiness-specic tax holidays and exemptions wereeliminated, about 3,000 in all. Businesses can leand pay taxes electronically. As a result two millionEgyptians led taxes in 2005, double the number in2004 (Figure 3.1 demonstrates the process undertakenby Egypt).

Section 3: How to reormThe options or reorm?By Caralee McLiesh and Rita Ramalho, Doing Business Project World Bank

Reorm Country

Reduced prottax rates

Aghanistan, Albania, Algeria, Antiguaand Barbuda, Austria, Bulgaria, CzechRepublic, Denmark, Egypt, Estonia,Finland, Ghana, Greece, Guinea-Bissau, Hungary, India, Israel, Latvia,Lesotho, Mexico, Moldova, Montenegro,Netherlands, Pakistan, Paraguay, Poland,Rwanda, Senegal, Sierra Leone, Sudan,Switzerland, Turkey, Uzbekistan

Reduced numbero taxes

Belarus, Egypt, Ghana, Georgia, Lithuania,Russia, Yemen

Revised tax code Aghanistan, Albania, Egypt, El Salvador,Georgia, Honduras, Mexico, Morocco,Romania, Spain, Tanzania

Introduced valueadded tax

Bosnia and Herzegovina, India, Serbia

Introducedelectronic ling

Bulgaria, Latvia, Lithuania

Table 3.1: Reducing prot tax rates: the mostpopular reorm in 2004-06


Figure 3.1: How Egypt created a fat prot tax




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22Section 3: How to reorm

Special exemptions erode the tax base. Businesseslet in the system end up paying more. The systembecomes less transparent and more costly to run. Itdistorts resource allocation. And incentive schemescreate possibilities or rent seeking and arbitrage asbusinesses seek to minimise their tax with legal ways omanipulating income17.

Estonias 1994 reorm replaced its concession-ladensystem with a single fat tax o 26% oering no

exemptions. We could not aord to maintain a morecomplex system, said a representative o the Ministryo Finance. The countrys tax base broadened, andrevenues have not suered. Its success sparked a rushby other Eastern European countries to do the same.In 2003, Slovakia streamlined its convoluted incentiveschemes into a single fat tax, with similar results18. In2004, Romania and Georgia became the latest. Romaniaintroduced a 16% fat tax and cut payroll taxes - thoughat 33.25%, they are still high. Georgias new tax codelevies a 20% corporate income tax on businesses anda 12% fat tax (down rom 20%) on personal income. In

addition, social taxes were cut rom 31% to 20% andthe number o taxes rom 21 to nine, and invoices andreceipts were simplied.

I radical changes are not easible, reorms can bephased in. In 2005, Ghana, Israel, Mexico and Paraguayintroduced gradual reorms. For example, Ghana cutits corporate income tax rate by 4.5 percentage pointsin 2005 and by another three points in 2006. This waythe Government can deuse lobbying. But this waslearned the hard way: Ghana tried to introduce a VATin 1995, only to withdraw it two months later aterpublic demonstrations scared reormers. It took our

more years or its eventual introduction. Without majoroverhauls, Colombia, El Salvador, Indonesia, Jamaicaand Mexico have eliminated some distortions by cuttingineective incentive schemes and increased revenues inthe process19.

Ease ling requirements

Good reorms also go beyond reducing tax rates. Makingelectronic ling and payment available to businessesis a start. Businesses can enter nancial inormationonline and le it with one click and no calculations.

Errors can be identied instantly, and returns processedquickly. Singapore led the way. In the early 1990s itstax department was plagued by a mounting backlogo unprocessed tax returns and the lowest publicsatisaction rating o all public services. In response,a new department the Internal Revenue Authorityo Singapore was created. In 1998 the department

launched an e-ling system. Filing taxes is now entirelypaperless (except or a verication receipt) and takesjust a day and 90% o corporate taxpayers expresssatisaction with tax administration20.

Another 45 countries have made e-ling possible, andthe list is growing. In Madagascar tax declarations werecomputerised in October 2005. I there is no change inthe inormation submitted previously, a business can lethe same declaration again with the click o a mouse.

This innovation is especially important or compliancewith labour taxes, where the inormation submitted bysmall businesses changes less oten. As a result the timeneeded to comply with taxes ell by 17 days.

In 2004, Armenia and Lithuania introduced online ling.Lebanon began automating its payroll tax. Businessesin Slovakia can now email tax returns, with no signatureor paper evidence. And South Arica is implementingan e-ling system. Such reorms pay o. In countrieswith online ling it takes less time to comply with taxregulations: 44 days compared with 58.

Simpliying paper ling is another way to make thingseasier. Doing so works everywhere but is especiallyimportant in poor countries, which may not have thedemand or capacity to support e-ling. In many countriesreturn and payment orms are cluttered with inormationrequirements that are never processed. In the 1990s, themonthly Polish VAT orm required 105 entries - including37 just or identication - and 38 calculations21. At onepoint entrepreneurs had to get a stamped VAT certicateor every business lunch. Things have improved, but it stilltakes two pages or each monthly ling and three days ayear to complete VAT ling requirements. In Switzerland

it takes one page per quarter and one day a year to dealwith VAT paperwork. Brazil still has a long way to go: sixorms are needed just to pay income tax. To completejust one o those orms, taxpayers must rst read 300pages o instructions. For the VAT at least three ormsare needed.

Eliminating excessive paperwork cuts the time thatbusinesses spend complying with tax laws. To increasecompliance, the UK shortened its VAT return to one page.In 2004, Pakistan did the same or its income tax return,signicantly shortening the time required to le. Croatia

simplied its tax orms in 2005, cutting eight pages o tax

17See, or example, Tanzi and Zee (2000)18Moore (2005)19World Bank (1991)20Bird and Oldman (2000) and Tan, Pan and Lim (2005)21Bird (2003)


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23 Section 3: How to reorm

returns and shortening the time required to comply withtax regulations by ve days.

Consolidate taxes

Consolidating taxes is also a worthwhile reorm. Forexample, most countries have more than one labourtax, yet such taxes are typically based on grosssalaries. Why not uniy them? Tax oces can thendistribute the revenues among government agencies.

Slovakia did just that: its single social contribution taxunds health insurance, sickness insurance, old agepensions, disability insurance, unemployment benets,injury insurance, guarantee insurance and reserve undcontributions. In many countries social security agencieswould be reluctant to part with their powers especiallyi there is a chance that tax oces wont give themtheir share o revenues. To gain their trust, an automaticseparation o revenues can be introduced so that there isno room or discretion.

Our system is characterised by a food o taxes that

overload business with administration. The primary taxesare income tax, VAT, import duty, export tax, excise dutyand special excise, provincial turnover tax and propertytax. There are taxes at dierent levels o government.There is also the social responsibility levy, debits tax,share transaction levy, economic service charge, nancialtransactions tax and various stamp duties. And thereis a whole host o industry specic taxes. It is way toocomplicated. So says Anil, an accountant in Sri Lanka.

Having more types o taxes requires more interactionbetween businesses and tax agencies. Businessescomplain that a higher number o taxes is cumbersome

(Figure 3.2). The problem is greatest in poor countries,which rely more on other taxes rather than incometax and VAT. In Tanzania, or example, local authoritiesimpose 50 business taxes and ees22. But the number otaxes is a burden in some rich countries too. In New YorkCity income taxes are levied at the municipal, state andederal levels23. Each is calculated on a dierent tax base,so businesses must keep three sets o books. Such anapproach costs governments more in collection costsas well.

Figure 3.2: More taxes and payments more hassle

Reormers can look to Georgia, which in 2004 cut thenumber o taxes rom 21 to nine. Businesses have praisedthe new, simpler system24. In 2001 Russia consolidatedseveral business taxes, cutting the number o taxes rom20 to 1525. And Iran recently merged three taxes intoone to ease payment. Improvements were also madein Senegal. Small businesses can now pay one tax thathas a lower rate and consolidates our previous taxes. Inaddition, several exemptions were abolished to widen thetax base. And the company income tax rate ell rom 33%to 25%.

Some taxes can be dropped altogether. Reorms should

target minor excises and stamp duties - which costmoney to administer but do not raise much revenue or particularly distorting taxes. An example is aturnover tax, which is levied on a rms inputs and againon its outputs, so tax is paid on tax. The main alternativeto a turnover tax a VAT levies tax only on thedierence between inputs and outputs (the value added),avoiding double taxation. Another alternative, a sales tax,does the same by taxing only outputs, as in the UnitedStates. Mozambique abolished its turnover tax in 1999,

Countries ranked by number of tax payments

(quintiles)

higher

higher

lower

lower

Perceived tax system eff iciency

22Fjeldstad and Rakner (2003)23Not all cities in the United States have a municipal business tax. In

addition, in several states the tax base is the same or ederal andstate income taxes

24Georgia Business Council interview25FIAS (2004)

Source: Doing Business database, GCR (2005)Note: Relationship is signicant at the 1% level and remains signicantwhen controlling or income per capita.


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Section 3: How to reorm 24

replacing it with a VAT. Georgia eliminated its turnover tax,which was levied on top o a VAT, as a part o its 2004reorm. In 2005, Yemen eliminated its production tax,reducing the total tax that businesses would pay rom170% to 48% o prots. Beore the reorms, businessespaid a 10% turnover tax on their sales. The reormsreplaced the production tax with a 5% sales tax, leviedon nal consumers. But another 44 countries maintaina turnover tax, including Argentina, Belarus and Tunisia.Almost all have a VAT or sales tax as well. In 2005,

Uzbekistan introduced a 1% tax on turnover, whichoutweighed reductions in corporate and labour taxes.

Small businesses have a particularly hard time dealingwith multiple tax payments. Why not help them bymaking their interactions with the tax agency simpler?This is what Brazil did. In 2001 it introduced the Simplessystem, which allows or one monthly tax payment orbusinesses with annual revenues below $1.1 million. Thepayment covers eight taxes, including our ederal andstate consumption taxes, two prot taxes, one labourtax and one municipal tax. Opinion surveys have oundthat nearly 90% o businesses think highly o this reorm

emboldening the government to plan more ambitiousreorms to collect taxes electronically. These are needed it takes larger businesses 455 days to comply withtaxes, the longest in the world.


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25

Actual trends in taxation show that there is a general andincreasing shit rom direct taxation to indirect taxation.More specically governments are looking towards VAT/GST26 as the major source o tax revenue or the uture.

However, this shit rom direct taxation to VAT/GSTneeds to be careully planned to ensure that the system

introduced delivers optimum levels o tax revenuewith the least possible adverse impact on individualsand businesses.

With VAT/GST systems the consumers are the taxpayerswhilst businesses are the unpaid tax collectors o thegovernments. Thereore, a joint approach betweengovernments and businesses is an essential ingredient inorder to achieve a win:win VAT/GST model.

VAT/GSTs contribution to national budgets is increasing

Consumption taxes are growing as a major source otax revenues or governments across the globe. Taxauthorities worldwide are gradually migrating rom directtaxation to the less visible indirect taxation, and thisreduced visibility reinorces the need or reporting on thetotal tax contribution.

VAT/GST models have been adopted by more than 130countries. The United States is the only OECD membercountry that does not have a VAT/GST. However, 45o the US states impose a retail sales tax. A variety oconsumption tax proposals have been discussed in theUnited States, primarily as a replacement or income

taxes, but a VAT/GST model is not expected in the nearuture27. Hong Kong has also opened a consultationperiod on a tax reorm proposal that includes theintroduction o GST28.

In 2004, consumption taxes (VAT, GST, Customs dutiesand excise) on average constituted approximately 30per cent o total tax revenues29 in the OECD countries,whilst in some individual countries these taxes constituteover 50 per cent o the total tax revenues collectedby governments.

It would appear that this relatively recent growth oconsumption taxes is not at an end. It is expected thatgovernments will continue shiting the burden o tax romincome tax (including labour tax) to indirect tax.

Figure 3.3: Taxes on general consumption as apercentage o total taxation

Impact o taxation on GDP

The reasons or this continued increase in consumptiontaxes as opposed to direct taxes can be ound in theneed or governments to be seen to have a tax structurewhich is conducive to growth and employment and whichcan also maintain tax revenues. Tax competition betweencountries to help attract business and investment hasusually involved the lowering o direct taxes on income byreducing corporate income tax and other measures suchas exempting capital gains, tax deductions or dividendsor interest obtained amongst others. As a consequencethis reduction in corporate income tax necessitates anincrease in other sources o tax revenue or government

budgets to be maintained. This has maniested itsel in anincrease in consumption taxes, so reinorcing the trendollowed by governments in recent years.

Tax policy can have important economic eects throughits impact on incentives to work, save and invest.In particular, high levels o labour taxes and social

VAT/GST: The win:win taxation systems o

the uture?By Ine Lejeune, PricewaterhouseCoopers, Belgium bcvba

0

2

4

6

8

10

12

1416

18

20

1965 1985 2003

OECD America

OECD Pacific

OECD Europe


26This concept includes Value Added Taxes and Goods and ServicesTaxes but does not cover sales taxes, customs duties or excise typetaxes.

27On August 22 2006, the U.S. Congressional Research Service released

a report examining the merits o value-added taxation as a newrevenue source or the United States. The document can be ound athttp://www.opencrs.com/document/RL33619

28Broadening the Tax Base; Ensuring our Future Prosperity; Tax Reormand Households Consultation document can be ound at www.taxreorm.gov.hk/eng/document.htm

29OECD, Consumption Tax Trends, VAT/GST and excise rates, trendsand administration issues, 2005 edition, Paris, 2006, p.10.

Source: OECD


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contributions create disincentives to employment byincreasing the costs o employing sta and generate theso-called tax wedge. According to the OECDs gures,in 2005, single individuals without children earning theaverage wage in services and manuacturing industriesaced a tax wedge o 51.8% o the cost o their labourto their employers in Germany and 50.5% in Hungary,compared with 17.3% in Korea, 18.2% in Mexico and20.5% in New Zealand. The average tax wedge orOECD countries was 37.3%30.

In light o this, some policy makers consider that a dropin income tax o 1% o GDP together with an increase inconsumption taxes o 1% o GDP, would generate extragrowth o 1% o GDP31.

Regressive nature o the tax

The main criticism levelled at consumption taxes is thatthey are regressive in nature (which is inherently contraryto the commonly accepted principle o higher taxationor higher income earners). They also have an eect on

infation where there is an increase in consumption taxes.There are certain measures which can help to eliminate ormitigate the regressive nature o consumption taxes.

These measures include allocating revenues obtainedrom consumption taxes to policies which ensure acertain level o welare or lower income earners32and applying reduced rates to goods and servicessuch as ood and other basic necessities (like medicalsupplies and services) that represent the major types oexpenditure o lower income earners.

In addition, in order to maintain an individuals purchasingcapacity, an increase in VAT or consumption taxes willat least need to be accompanied by some reduction inpersonal income taxes, although the two types o taxeswill not necessarily oset as many lower paid workersdo not pay income taxes.

On the other hand, the impact on infation o VAT orconsumption tax increases will generally be as a one-o increase. Such an increase would not necessarilygive rise to a permanent increase in uture infation rateswhere compensating policies are applied, provided it

does not eed through into second round eects onwages. This could, however, be a risk or a large increasein VAT that is widely passed on to customers. A crediblemonetary policy regime would, however, reduce therisk o second round eects since trade unions andemployees will be aware that trying to push or higherwages could, in addition to direct negative eects on

employment, also cause the central bank to push upinterest rates in response.

Managing the compliance burden

This shit rom labour and income taxes to VAT/GSTmay trigger new compliance costs or businesses whichshould not be underrated. These compliance costsinclude not only human and IT costs or producing VATdocumentation (e.g. billing, archiving, proo o exemption

when not charging VAT/GST to customers), but alsothe costs associated with preparing VAT accounts/VATreports, and preparing and ling VAT returns.

Also errors regarding the application o the rules cantrigger penalties, joint and several liability, interest andother costs or businesses and their directors. Thelatter risks and related costs vary considerably betweendierent countries.

For businesses a pure VAT/GST should not generate anyimpact in their prot/loss accounts and should not result

in any double taxation. The VAT/GST should not generatedisproportionate compliance costs or risks which requirethe input o costly management time when collecting thetaxes on behal o governments33, 34.

In reality compliance costs and prot/loss accountimpacts have been growing jointly with the expansiono VAT/GST, as countries use VAT/GST as a tax raisingmeasure on businesses, e.g. non-deductible VAT onexpenditure such as travelling expenses.

An in-depth analysis o VAT compliance costs incompanies would challenge this view o VAT as being

a neutral tax or businesses. These compliance costs

30Taxing Wages, special eature, OECD 2006, document can be obtainedin www.oecdbookshop.org.

31A European Pentathlon, A Community growth strategy or theEuropean economy, Brussels 17 February 2005, as reerred to inI. Lejeune, QuoVATis, Where are we going with VAT/GST globally,PricewaterhouseCoopers, 2005

32See in this respect e.g. Chapter 6, consultation paper rom Hong-Kongtax Authorities, where the measures suggested include also VAT/GSThousehold credits or certain lower-income earners

33Some recent studies have been done by the University o Manchesterbusiness School Pro F. Chittenden on this subject where the

compliance cost burden varies considerably between large and smallbusiness. Excerpts o his studies can be ound at www.mbs.ac.uk.

34At the EU Commissions request, PricewaterhouseCoopers perormeda study making specic recommendations on the means o simpliyingand modernising VAT obligations (VAT registration, submission odeclarations, payments and reunds, and submission o recapitulativestatements). An executive summary o the nal report can be ound onec.europa.eu/taxation_customs/resources/documents/nal_report.pd


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27

and the risks or economic operators acting in good aithare mainly due to the lack o global common VAT/GSTprinciples on the treatment o the globalisation o thetrade in goods and services. In addition the growingcomplexity o VAT/GST oten laid down in unclear oroutdated legislation, as well as the lack o guidance romthe tax authorities, leads to uncertainty, therebyincreasing compliance costs and risks.

Global common VAT/GST principles

To create legal certainty, reduce compliance costs andacilitate proper risk management certain measuresshould be put into place such as the adoption o globalcommon VAT/GST principles, simpliying measures, betteruse o technology and also clear guidance and opencommunication between authorities and businesses.

The more advanced VAT and GST systems around theworld have, or some time, been looking at ways in whichto simpliy compliance. The need to simpliy VAT orcross-border business in particular is also high on the EU

Commissions agenda. The EU Commission is thereorecurrently proposing to introduce a rat o new measuresincluding the proposal or an optional centralised EUVAT compliance jurisdiction or taxpayers (the so-calledone-stop-shop)35 and a reorm o the VAT rules regardingthe place o taxation o services36.

The OECD has also pointed out the need orinternationally accepted principles on the consumptiontax treatment o cross-border services and intangibles toavoid double taxation or unintentional non-taxation37.

Use o technology

Another way in which tax authorities are attempting tosimpliy compliance or business is through the betteruse o technology. Tax authorities across the world aresimpliying compliance through the electronic lingo returns. An increasing number o taxpayers areavailing themselves o such acilities, a trend which willensure swit repayment on the investment made by taxauthorities through improved administration eciencies.

Electronic invoicing and archiving oers businesses theopportunity to reduce the cost o doing business at a

tangible unit cost level.

Notwithstanding the OECD guidance38 and a EuropeanVAT Directive39, the barriers to widespread adoption oadministrative simplications in the area o invoicinghave not been removed entirely. To ully reap the benetsoered by digitisation and to achieve adequate returns

on investment in back-end IT systems, more eort isrequired to increase the condence o the tax authoritiesin IT systems and to acilitate the maximum use byeconomic operators40.

Indeed, the digitisation o the VAT compliance o businesswill enhance the use o electronic auditing techniques bythe tax authorities as laid down in OECD guidance41, thusreducing the cost o collecting VAT/GST.

Communication and dialogue

Last but not least, it is in the interest o tax authoritiesto communicate their vision clearly to business, and tohave a simple and ecient communication system ortaxpayers. Some are better at doing this than others. Themajority o countries have an internet site which oersguidance to taxpayers on topical issues but the quality othe content and the regularity o updates on these sitesvaries rom country to country. On the other hand somecountries struggle on this ront.

As an example o good practice in this area, theAustralian Tax Oce has set up an internet portal or taxagents in order to communicate more eciently with theauthorities on taxpayers aairs. This portal allows theagent access to client activity statements and accountinormation whilst also providing an eective tool orcommunicating on topical tax questions. Clearly suchtools can only contribute to the eciency o any taxsystem, direct or indirect42.

There is o course a responsibility here on industryand advisers to constructively express the needs obusiness. I the views and needs o businesses are not

communicated, there is less chance o nding the win:winroute to ecient and eective tax policy.

Conclusions

Consumption taxes are going global. At just over 50 yearsold, VAT/GST is an adolescent tax; just as big as the moremature taxes, but with a great deal still to learn.

VAT/GST specialists rom industry and practiceneed to take the lead collectively through dialoguewith governmental tax policymakers to ensure the

implementation o win:win VAT/GST taxation models asthe tax matures.

Indirect tax specialists also need to be at the orerontwithin companies tax and nance departments.They should ensure that businesses understand thatconsumption taxes are no longer minor taxes but are



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35Proposal o the EU Commission o 29 October 2004,COM(2004)728nal (http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2004:0728:FIN:EN:PDF); I. Lejeune, Simpliying Value-Added Tax Obligations in the EU, in X., Revenue Matters, A Guideto Achieving High Perormance under Taxing Circumstances, Volume1; I. Lejeune, B. MESDOM, New EU Proposal Aims to Simpliy VATObligations in Tax Planning International Indirect Taxes, Volume 2,number 12, December 2004.

36Proposal o the EU Commission o 20 July 2005, COM(2005)334amending Directive 77/388/EEC as regards the place o supply oservices (http://eur-lex.europa.eu/LexUriServ/site/en/com/2005/

com2005_0334en01.pd).37The application o Consumption Taxes to the Trade in International

Services and Intangibles, OECD 14 July, 2004 and OECD,Consumption Tax Trends, VAT/GST and excise rates, trends andadministration issues, 2006 edition, Paris, 2006.

38OECD Tax Guidance Series: Record Keeping, 5 May 2004 and OECDTax Guidance Series: Transaction inormation, 5 May 2004.

39EU Council Directive 2001/115/EC amending Directive 77/388/EEC

with a view to simpliying, modernising and harmonising the conditionslaid down or invoicing in respect o Value-Added Tax (required orimplementation in Member States national law since 1 January 2004and 1 May 2004 or the at that time joining Member States: Cyprus,Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Czech Republic,Slovakia and Slovenia. As o 1 January 2007 the Directive also needsto be implemented in the new joining Member States Romania andBulgaria. ).

40M.Joostens, I. Lejeune, P. Breyne, D. Evrard . Global (E-)Invoicing &(E-) Archiving, Increasing Eciency en Reducing Costs Including VAT/GST rules in 41 countries worldwide. PricewaterhouseCoopers, 2006.

41OECD Guidance or the Standard Audit File-Tax, May 2005and OECD Guidance on Tax Compliance or Business andAccounting Sotware, May 2005. Documents can be ound at www.oecd.org/dataoecd/51/33/34422641.pd and www.oecd.org/dataoecd/13/45/34910263.pd respectively;

42I. Lejeune, QuoVatis, Where are we going with VAT/GST globally,PricewaterhouseCoopers, 2005. Australian Tax Portal is on https://tap.ato.gov.au/

important, complex and sometimes cumbersome.The amounts at stake, and hence the risks, are high,and proactive management is essential.

A VAT/GST model should meet some generally acceptedcriteria in order to achieve the key results expected(see Table 3.2).

In the end, there is an opportunity or the perectVAT/GST to become a win:win taxation model or

businesses, governments and citizens, with the abilityor governments to achieve its dual goal o obtainingtax revenues and acilitating economic and employmentgrowth and welare without challenging the abilityo companies to make prots and the imposition ounnecessary additional compliance costs. This model canbe achieved by clear legislation, common global VAT/GSTprinciples, the better use o technology and an open andcontinued dialogue between authorities and businesses.

Table 3.2: VAT/GST model criteria

Criterion Key results or both the business community andthe tax authorities (government)

Simplicity Easy to implement and to apply

Eciency Low compliance costs high collections

Certainty Limited need or litigation high voluntarycompliance

Broad-based Limited special systems and exceptions

Proportionality Taxable amount not to exceed considerationactually paid

Appropriate exemptions

Non-distortionary

Neutrality in competition between the states andindustries

Source: Chapter 1 o OECD VAT/GST Guidelines

Use o technology to reduce cost ocollection

Equitable / ecient

Figure 3.4: VAT/GST systems as Win:win Taxation Models

Business Tax authorities

Total riskmanagement

RevenuesBusiness attractionand employment

Sustainable globalprot

Source: I. Lejeune, QuoVatis, Where are we going with VAT/GST globally, PricewaterhouseCoopers, 2005


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29 Section 4: The way orward

Key actions or governments and tax authorities:

Consider the need or tax reorm through a thoroughassessment o the total tax contribution, whichtakes into account all taxes borne and collected bybusinesses as well as the cost o tax compliance.

Increase their accountability and communicateclearly with businesses and taxpayers as to howtaxes are spent.

Consider clear tax education campaigns to explainthe taxes, how to pay them, and the benets to allstakeholders.

Consider how simplication o tax legislation,the easing o the compliance burden, and theconsolidation o taxes might generate benets orboth governments and businesses.

Most importantly, consult with businesses whendeveloping ideas or tax changes.

Key actions or businesses:

Gather inormation on the total tax contributionincluding all taxes borne and collected, as well as thecost o tax compliance. PricewaterhouseCoopers LLPhas developed a methodology and ramework whichcan help with this (see Appendix 1).

Ensure that inormation around the total taxcontribution is made accessible to governments andtax authorities to help inorm their decisions overreorm.

Communicate the total tax contribution to the widerstakeholder group (including employees, investors,the media and society at large) to demonstrate theextent to which they are supporting public nancesthrough taxes.

Engage in regular dialogue with governments and taxauthorities over the need or reorm and specic areaso concern.

Inorming the debate and evolving the model

Appreciation o the Total Tax concept is gainingmomentum and it is becoming more widely acceptedas a robust measure o taxes contributed bycompanies to national treasuries. Work undertaken byPricewaterhouseCoopers LLP in the UK with the HundredGroup (membership comprises the FTSE 100 companies)

has been positively received by all external stakeholders,and it can be expected that projects with similar groupso companies will be undertaken in other countriesaround the world.

The World Bank Doing Business in 2007 survey and theamendments made to align the Total Tax Rate calculationwith the PricewaterhouseCoopers LLP Total TaxContribution ramework methodology represents a goodway orward. It generates some useul tax indicators,

which enable countries to see how their tax regimes,or a standard modest-sized company, compare in 175countries around the world. However, the developmento a model to make such comparisons is a dynamicprocess with a constant need or improvement. It isexpected that urther adjustment will be necessary as theanalysis continues. There is also potential to extend theassumptions made in the model to include more taxes.For example, with the ongoing debate on climate change,environmental taxes are ripe or inclusion in some way.

The measures undertaken to estimate the time to comply

with administrative requirements o tax systems arerecognised as being somewhat subjective. It is intendedthat measures o administration and compliance willbe urther developed to be more representative o theeort that is required to comply with the tax legislation inorce. Additional questions on tax administration and theprocess o tax collection will be included in uture roundso the survey.

Additional issues may also be worthy o considerationaround the wider implications or society o taxes paidby business. Corporate responsibility has been aroundas an issue or some time in relation to the environment

and other ethical issues, but tax is increasingly importantin this arena and the reporting o total tax will be animportant step orward.

The issues discussed will be urther addressed as surveydata is updated and evolves in subsequent years. In themeantime, the data now available is useul in inormingthe debate around business taxation globally. Knowledgeo the Total Tax Contribution, the Total Tax Rate andthe costs o administration and compliance are keycomponents in acilitating constructive dialogue withgovernments and other stakeholders and to ensure that

there is better inormation available or tax managementinternally, and or governments to take decisions on thebasis o the ull tax picture o taxes in their countries.

Section 4: The way orwardUnderstanding the total tax contribution


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30Section 4: The way orward

For urther inormation, or to discuss any o the ndings in this report please contact:

World Bank Group PricewaterhouseCoopers

Simeon Djankov Bob Morris+1 202 473 4748 PricewaterhouseCoopers LLP, [email protected] +1 202 414 1714

[email protected]

Caralee McLiesh Susan Symons+1 202 473 2728 PricewaterhouseCoopers LLP, [email protected] +44 20 7804 6744

[email protected]

Rita Ramalho John Whiting+1 202 458 4139 PricewaterhouseCoopers LLP, [email protected] +44 20 7804 4422

[email protected]

Contacts


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31 Appendix 1

The act that there is usually little or no inormationon the business taxes which appear above theline in the nancial accounts disclosure promptedPricewaterhouseCoopers to design its Total TaxContribution (TTC) ramework (www.pwc.com/uk/ttc).The intention was to establish a methodology whichwould enable companies to collect and report totaltax inormation in a consistent manner, meeting theneeds o their various stakeholders and improvingtransparency. These stakeholders include governments,

and the total tax inormation generated by the rameworkis proving to be something that governments want tohear about. It is data that they currently do not have easyaccess to, and it is data that can potentially help themby inorming the process or determining appropriateuture scal policy. It is also considered to be somethingwhich is helpul in acilitating a constructive dialoguebetween government and industry. So to list the driversor Total Tax:

It is essential to provide a broad and consistentramework which can be used to calculate the total

tax contribution anywhere in the world. This acilitatesa true and robust comparison o the tax system invarious countries.

There is a need or more transparency so that allrelevant stakeholders, governments, employees,shareholders and investors, the media, and societyat large can see the contribution companies aremaking to their local economies and help them tocommunicate their positive economic impact.

Better inormation on all o the business taxesbeing paid, not just corporate income taxes, will

help companies improve tax risk management andcontrols, and or governments to make better inormedpolicy decisions.

To promote corporate transparency and disclosurein all states and territories. It complements and isconsistent with the guidelines set by the GlobalReporting Initiative and the Extractive