Document of

The World Bank

Report No: 23565-RU

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED LOAN

IN THE AMOUNT OF US$100 million

TO THE

RUSSIAN FEDERATION

FOR A

SECOND TAX ADMINISTRATION MODERNIZATION PROJECT

September 19, 2002

Poverty Reduction and Economic Management DepartmentEurope and Central Asia Region

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CURRENCY EQUIVALENTS

(Exchange Rate Effective July 31, 2002)

Currency Unit = RubleRuble I = US$0.0317

US$ I = 31.5

FISCAL YEARJanuary 1 -- December 31

ABBREVIATIONS AND ACRONYMS

APL Adaptable Program Loan MoEDT Ministry for Economic Development and Trade

CAS Country Assistance Strategy MOF Ministry of FinanceCBR Central Bank of Russia NN Nizhniy Novgorod (TAMP I pilot site)CFAA Country Financial Accountability Assessment NPV Net Present ValueCIS Commonwealth of Independent States OECD Organization for Economic Cooperation and

DevelopmentConOps Concepts of Operation (report) PCU Project Coordination UnitDPCs Data Processing Centers PIP Project Implementation PlanERR Economic Rate of Retum PIT Personal Income TaxEU-TACIS European Union-Technical Assistance for PIU Project Implementation Unit

Commonwealth of Independent StatesFCPF Federal Center for Project Finance POM Project Operations Manual

FDPC Moscow Interregional Inspection for RDPC Interrayon Inspection for Centralized Data ProcessingCentralized Data Processing

FMR Flnancial Monitoring Report RF Russian FederationGDP Gross Domestic Product SAL (I/II/III) Structural Adjustment Loan (I1I/III)

GPN General Procurement Notice STS State Tax ServiceHR Human Resources TA Technical AssistanceIBRD Intemational Bank for Reconstruction and TAMP (I/Il) Tax Administration Modemization Project

Development (first/second)ICR Implementation Completion Report TIN Tax Identification Number

ILO Intemational Labor Organization UNDP United Nations Development ProgramIMF Intemational Monetary Fund USAID US Agency for International Development

IT Information Technology UTA Unified Treasury Account

LTU Large Taxpayer Unit VAT Value Added TaxMinTax Ministry of Taxes and Fees VG Volgograd (TAMP I pilot site)

Vice President: Johannes F. Linn

Country Director: Julian F. SchweitzerSector Director: Cheryl W. GraySector Manager: Helga W. Muller

Task Team Leader: Carlos D.C. Ferreira

RUSSIAN FEDERATIONSECOND TAX ADMINISTRATION MODERNIZATION PROJECT

CONTENTS

A. Project Development Objective Page

1. Project development objective 22. Key performance indicators 2

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 32. Main sector issues and Government strategy 5

3. Sector issues to be addressed by the project and strategic choices 7

C. Project Description Summary

1. Project components 92. Key policy and institutional reforms supported by the project 133. Benefits and target population 144. Institutional and implementation arrangements 15

D. Project Rationale

1. Project alternatives considered and reasons for rejection 162. Major related projects financed by the Bank and other development agencies 173. Lessons learned and reflected in the project design 194. Indications of borrower comnmitment and ownership 195. Value added of Bank support in this project 21

E. Summary Project Analysis

1. Economic 212. Financial 22

3. Technical 23

4. Institutional 23

5. Environmental 24

6. Social 25

7. Safeguard Policies 27

F. Sustainability and Risks

1. Sustainability 27

2. Critical risks 27

3. Possible controversial aspects 30

G. Main Loan Conditions

I. Effectiveness Condition 30

2. Other 30

H. Readiness for Implementation 30

I. Compliance with Bank Policies 31

Annexes

Annex 1: Project Design Summary 32Annex 2: Detailed Project Description 40

Annex 3: Estimated Project Costs 48

Annex 4: Cost Benefit Analysis Summary 49

Annex 5: Financial Summary 54

Annex 6: Procurement and Disbursement Arrangements 55

Annex 7: Project Processing Schedule 70

Annex 8: Documents in the Project File 72

Annex 9: Statement of Loans and Credits 74

Annex 10: Country at a Glance 76

Annex 1 1: Summary Diagnostic of Ministry of Taxes and Fees' Constraints 78

Annex 12: Institutional Analysis 83

Annex 13: Supervision Plan 92

MAP(S)IBRD Map No. 32112

RUSSIAN FEDERATIONSecond Tax Administration Modernization Project

Project Appraisal Document

Europe and Central Asia RegionECSPE

Date: September 19, 2002 Team Leader: Carlos D. C. Ferreira

Sector Manager: Helga W. Muller Sector(s): Central government administration (100%)

Country Director: Julian F. Schweitzer Theme(s): Tax policy and administration (P)

Project ID: P066155Lending Instrument: Specific Investment Loan (SIL)

Project Financing Data -_[X] Loan [ ] Credit [ Grant [1 Guarantee [ Other:

For Loans/Credits/Others:Loan Currency:: United States DollarAmount (US$m): $100 million

Borrower Rationale for Choice of Loan Terms Available on File: 3 Yes

Proposed Terms (IBRD): Variable-Spread Loan (VSL)Grace period (years): 5 Years to maturity: 17Commitment fee: 0.75 Front end fee (FEF) on Bank loan: 1.00%

Payment for FEF: Borrower to Pay from Own ResourcesFiniancing Plari (US$m): Source- . Local Foreign TotalBORROWER 58.00 0.00 58.00

IBRD 10.00 90.00 100.00

Total: 68.00 90.00 158.00

Borrower: RUSSIAN FEDE'RATIONResponsible agency: MINISTRY OF TAXES AND FEESAddress: Ministry of Taxes and Fees of the Russian Federation23 Neglinnaya StreetMoscow, Russia 103381Contact Person: Mr. Mikhail Mishustin, Deputy MinisterTel: (095) 209-2918 Fax: (095) 209-7507 Email: Mns000lNalog.Ru

Other Agency(ies):Ministry of Finance

Address: 9 Ilyinka StreetMoscow, Russia 103097Contact Person: Mr. Sergei Shatalov, First Deputy MinisterTel: (095) 298-9137 Fax: (095) 921-8624 Email:

Estimated Disbursements ( Bank FY/US$m):.Q. :2Q- - 05 -. 2006'.''268- 20- ;lFY -5-......-: 2003-.- 200!4 . _ ' 2005-.7i............ 06., Kf 2 07:' ;200 : 09_

Annuao 1.88 28.16 37.44 17.77 9.47 4.08 l.2uCumulative 1.88 30.04 67.48 85.25 94.72 98.80 100.00

Project implementation period: 2003-2008Expected effectiveness dalte: 01/01/2003 Expected closing date: 06/30/2008

DCS PAO Fo- .V Ul1W

A. Project Development Objective

1. Project development objective: (see Annex 1)

The development objective of the Project is to carry out a systematic reform and modernization of the taxadministration of the Russian Federation (RF), so as to: facilitate voluntary compliance, increaseadministrative efficiency, strengthen enforcement capacity, enhance professional integrity and skills, andimprove tax legislation and fairness in the implementation of tax laws. As a result, the project wouldsupport the strategic goals of promoting macro-economic stability, improving the environment for privatesector development, and strengthening public institutions.

The project wouldfacilitate voluntary compliance by: (a) instilling a service culture within the taxadministration; (b) improving the quality of taxpayer services; (c) fostering the development of taxpayeradvisory services both in the tax administration and the private sector; (d) simplifying forms andprocedures; (e) developing e-Government capacity to enable filing of tax declarations, payment of taxes,and provision of information and services to taxpayers electronically; and (f) promoting understanding ofthe tax system by the general public through communication campaigns and possible inclusion oftax-related topics in school curricula.

The project would increase administrative efficiency by: (a) supporting the development of a functionalorganizational structure at the headquarters of the Ministry of Taxes and Fees (MinTax) and in regionaland local offices; (b) creating Data Processing Centers (DPCs) at the federal and regional levels toexploit economies of scale in routine data processing; (c) consolidating local offices; (d) standardizingworkflows based on re-engineered business processes; and (e) automating key operational andmanagement processes.

The project would strengthen enforcement capacity by: (a) implementing a third-party informationsystem to enable improved monitoring of taxable transactions; (b) enhancing tax audit and investigationcapacity; (c) improving collection of tax arrears; and (d) increasing effectiveness in management of largetaxpayers.

The project would promote professional integrity and skills by: (a) establishing a clear code of ethics andconduct; (b) improving the incentive structure; (c) implementing strategies and business processes thatreduce the opportunity for breeches in professional ethics; (d) strengthening human resourcemanagement; (e) training managers and staff in different functional areas; and (f) creating a professionaldevelopment infrastructure for continuous upgrading of skills.

The project would improve tax legislation and equity andfairness in the implementation of tax laws by:(a) assisting MOF in proposing changes to tax legislation and regulatory acts; (b) educating taxpayersabout the tax code, administrative procedures, taxpayer services, and taxpayer rights and obligations; (c)improving the tax administration's capacity to administer the tax laws uniformly and consistentlythroughout the country; (d) increasing the objectivity, impartiality, and efficiency of dispute resolutionmechanisms; and (e) enhancing the responsiveness of the tax administration through improvedinteraction with taxpayers and other stakeholders.

2. Key performance indicators: (see Annex 1)

The following are broad performance indicators for the project. During project appraisal baselinevalues have been established and project targets agreed with MinTax on those indicators, information

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on which was available at appraisal. In addition, and as a complement to these indicators, Annex Ilists more detailed indicators that would be used to validate the achievements of each projectcomponent.

Macro-economic Stability and Private Sector Development

* Average time taken by new businesses to register with tax authorities

Voluntary Compliance* Number of tax declarations received on time/Total number of tax declarations filed* Change in a ratio "Tax revenues paid voluntarily/Total tax revenues collected" in each

project region as compared to its change for Russia average

* Average time taken by selected categories of taxpayers to prepare their tax declarations* Perception of taxpayers regarding the quality of service provided by the tax administration,

as measured through periodic surveys

Efficiency* Average number of days taken to identify and notify registered taxpayers who fail to file

tax declarations or pay taxes* Change in a ratio "Amount of taxes collected in a project region (adjusted for large

taxpayers migration)/Number of tax administration civil servants" in each project region ascompared to its change for Russia average

* Change in a ratio "Total current expenditure of regional departments of the Ministry ofTaxes and Fees/Total amount of tax revenue collected in all project regions (adjusted forlarge taxpayers migration)" as compared to its change for Russia average

Enforcement Capacity* Ratio "Additional taxes collected after tax audits/ Number of tax audits conducted" in each

project region as compared to Russia average

Professional Integrity and Skills* Perception of taxpayers and other stakeholders regarding the level of honesty of tax

administration staff, measured through periodic surveys* Perceptions of managers and staff regarding the level of professional skills in selected

functional areas, measured through periodic surveys

Equity and Fairness* Perception of taxpayers and other stakeholders regarding impacto of tax policy on business

climate, its predictability, uniformity and consistency in administration of tax laws, andimpartiality and fairness of administrative appeals mechanisms, measured through periodicsurveys

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1)Document number: 24127-RU Date of latest CAS discussion: June 6, 2002

This project supports the objective of strengthening public sector management, one of three pillars of the

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joint Bank-IFC CAS approved in June 2002, and fits well with overall country objectives. The projectaims at improving govemance and increasing transparency within the tax system and will supportsystemic reforms for economic recovery and private sector development as an integral part of an overallpublic sector management reform program. Necessity of modernization of the tax service was reflected inthe 1999 CAS, and subsequently endorsed by the 2001 CAS Progress Report, as a priority area for theBank support to the reforms in the public sector.

The Bank has adopted a phased approach to these reforms. The objective of the first Tax AdministrationModernization Project was to demonstrate the applicability of key modern tax administration concepts inthe Russian environment. The project consisted of pilot operations in the Volgograd and NizhnyNovgorod regions (for business taxes) and in Moscow (for personal income taxes), and supported theintroduction of Large Taxpayer Units. The second project includes the national deployment of theinstitutional development instruments resulting from the the first project, but go much further bystrengthening the whole institution of tax administration and its systems. Since the fiscal crisis of 1998,the Bank has been reformulating its strategic approach to country assistance in Russia. One dimension ofthis has been to place more emphasis on developing the institutional basis for effective macroeconomicstabilization, and within this effort to concentrate on effective implementation of reform efforts. Tax andcustoms administrations, on the revenue side, along with the Treasury system on the expenditure side, arethe three key elements of building government capacity for fiscal management.

In this respect, the Bank loan to strengthen the National Treasury is intended to ensure effectiveimplementation of the budget, and enable the Ministry of Finance (MOF) to maintain budget oversight. Italso is meant to provide a transparent system of accounting that accurately depicts the use of financialresources to the country, and facilitates management and auditing of these resources. It includes, amongothers, a revised budget classification structure and chart of accounts; effective public expenditurecontrol regulations to manage the levels and timing of expenditures; and a fully functional automatedTreasury and associated systems to serve as instruments for budget execution and cash management, aswell as staff trained in Treasury/MOF and line agencies to use and maintain the new systems. Taxliability payments made by taxpayers would flow efficiently into the appropriate revenue accounts andsub-accounts. The project would enable timely electronic communication between the Treasury andMinTax after receipt of tax payments, thus allowing MinTax to identify the lack of payment for knowntax liabilities quickly.

A customs administration reform project being prepared would seek to promote a comprehensiveinstitutional reform to facilitate international trade, reduce compliance costs, and promote a level playingfield for trade agents, while ensuring that the budget receives the amount of customs duties and othertaxes on international trade in compliance with the legislation. This is to be achieved by implementingorganizational, procedural, legal, and human resources reform of the State Customs Committee,supported by the deployment of modem customs technologies and techniques.

In addition, a Bank-financed project on Fiscal Federalism and Regional Fiscal Reform was approved bythe Board in January 2002 and became effective in June 2002. This project will create incentives anddevelop the capacity for fiscal reform at the regional level in the Russian Federation. The objectives areto: (i) improve the overall framework for intergovernmental finance; and (ii) support the regions in thedevelopment and implementation of fiscal reform programs at the sub-national level that promotefinancial transparency, budgetary accountability, and strengthened fiscal management policies andpractices. An important component of the project is to develop a modem debt management system,smooth Treasury budget execution, clear and stable assignment of revenue and expenditureresponsibilities, and the development of an intra-regional equalization transfer formula. The Governmentand the Bank are now preparing projects to address the need for public service reform, including policies,

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practices, and regulations, an anti-corruption-focused project, and a project to develop e-governmentbased on internet technology.

Under an earlier assistance strategy, the Government prepared the first Tax AdministrationModernization Project (TAMP I), with Bank and IMF assistance, which became effective in mid-1995.The IMF and the US Treasury were essential partners in the implementation of TAMP I and areproviding key technical advice and cooperation in the preparation of TAMP 11. The IMF has appointed asenior tax administration advisor who previously worked closely with and is highly trusted by MinTax.He is providing technical assistance at a strategic level, in cooperation with the Bank. The US Treasuryhas a resident team in Moscow, and has assigned short-term consultants, as needed, for projectpreparation. The UIS Treasury has been very helpful in the re-engineering of business processes,developing an overall IT strategy, and in the area of project management. The IMF and the US Treasuryparticipated in the development of the first strategic plan for MinTax, as well as the project identificationworkshop, hosted by MinTax in November 2000, which convened international technical experts anddonors in an exchange of views about the project concept and technical details of TAMP 11.

In addition, EU-TACIS has launched three projects to assist MinTax in three areas: (i) human resourcemanagement and development, (ii) internal and external information exchange, including a taxpayerservice component., and (iii) tax policy advice. In this respect, TACIS activities dovetail nicely with theoverall project design of TAMP II.

2. Main sector issues and Government strategy:

Fiscal reforms are central to the Government's medium-term agenda of structural reforms.Notwithstanding improvements in fiscal performance over 1999-2001, serious institutional weaknessesand fiscal risks undercut the sustainability of these improvements. Tax administration reforms arecritical to addressing these weaknesses and risks, and contribute to sustaining macroeconomic stability.The importance of timely and accurate collection of revenue cannot be understated, as the total revenuecollection for 2000 is about 38 percent of GDP, including federal, regional and local tax and non-taxrevenues, as well as social contributions. MinTax is currently responsible for the collection of socialcontributions and all tax revenues--except the revenue collected by Customs, which represents about 5percent of GDP.

The recent improvement in fiscal discipline has been possible largely because of a sharp increase infederal revenue, which rose to 16 percent of GDP in 2000 and accounts for 17.6 percent of GDP in 2001,compared to 13.4 percent in 1999-despite a substantial reduction in tax rates. The increase in revenueswas, in large part, due to higher revenues associated with the oil and gas sectors, some increase inintensity of the tax collection effort (particularly with respect to monitoring financial conditions of thelargest taxpayers), and tax buoyancy from a rebound in growth. Furthermore, all revenues collected at thefederal level since 2000 have been in cash. With federal expenditures kept in check at under 15 percentof GDP, the federal budget for the first time showed an overall surplus of over 1.5 percent of GDP. Theregional budget also showed a surplus of 0.7 percent of GDP, with total revenues equivalent to 16percent and expenditures 15.1 percent of GDP, respectively.

While the improved fiscal position also reflects a renewed Government emphasis on establishing controlover Russia's public finances-and recognition that strong fiscal discipline is essential for industrialrecovery-the sustainability of the fiscal position remains vulnerable for several reasons. First, prospectsfor sustainable growth and the resulting revenue buoyancy remain questionable in view of the timeneeded for implementation of structural reforms. Second, given the huge agenda of reforms and the

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accompanying fiscal costs, the budget needs to plan for a well-sequenced, integrated, and affordable

program of structural reforms; otherwise, fiscal stability may be at risk. Third, budget revenues are

highly sensitive to changes in the international price of Russian oil. Fourth, the dynamics of Russia's

external outflows are onerous, with peaks in debt repayments in 2003, 2005, and 2008. In the absence of

an integrated fiscal strategy, the debt dynamics pose a serious risk to budgetary outcomes and

macroeconomic management. Andfinally, institutional arrangements for budgetary management remain

underdeveloped, particularly in the regions, which undermine effective budget preparation,

implementation, and evaluation.

Recent government initiatives to address the above risks in the short run include the development of a

Program of Priority Measures for 2000-2001 (Directive No. 1072-p dated July 26, 2000), which seeks to

accelerate a program of macroeconomic, social, and structural reforms in an integrated manner. The

implementation of the fiscal components of this program already has resulted in improvements in

inter-governmental fiscal arrangements, strengthening of treasury management, a substantial reduction in

budgetary arrears and nonpayments, and initiation of detailed analyses of expenditure efficiency. Tax

policy and tax administration reforms are key elements of this program. The main objectives of

reforming the tax system are: (i) improving the investment climate and creating conditions for achieving

a balanced budget; (ii) lowering tax rates and sharing them more equitably; (iii) simplifying the taxsystem; and (iv) improving tax administration.

The Government objectives for development of the tax system in the long-run have been described in

detail in the so-called "Gref II" strategy report, Basic Trends in Social and Economic Policy of the

Government of the Russian Federation over the Long Term, 2001, and further developed in the

medium-term program of social and economic development of the Russian Federation for 2002-2004

(Government Order #910-r, July 10, 2001). Both reports describe the govemment aim of substantial tax

policy reforms and the necessity of these reforms to simplify the tax system and eliminate features of the

system that create obstacles to private sector development. The importance of fairness and neutrality of

the tax system for private sector development and of reducing the overall tax burden for law-abiding

taxpayers is emphasized. This requires a balanced and comprehensive approach to tax reform. Tax policy

reform objectives, which reduce the revenue potential of the tax system--such as the reduction of the

VAT rate, and the phasing out of the sales tax-must be supplemented by measures to increase the

efficiency of tax administration so as to avoid overall revenue losses. The Gref H strategy report-in

addition to proposing a number of legal changes to facilitate the detection and prosecution of tax evasion

cases and adjusting the balance between taxpayers' rights and obligations in Part I of the Tax Code-goes

into considerable detail outlining a number of specific tax administration reforn requirements, and

directly supports a number of key initiatives proposed by the TAMP II project. These include calling for

organizational changes, such as the creation of regional inspectorates, reform of the dispute resolution

mechanisms, better cooperation and information exchange with other government agencies, and creation

of efficient data processing centers.

The Government strategy recognizes, partially as a consequence of TAMP I outputs, that current taxadministration organization, management, and operations do not facilitate an efficient and fair collectionof tax revenues, and have led to widespread tax evasion and frustration in the business community. Thisis the perception of the general public as well, which was revealed in a recent taxpayer survey carried outin Moscow and Nizhny Novgorod (Taxpayer and Tax Inspector Survey, PricewaterhouseCoopers, June2001). The results showed that on average more than 50 percent of taxpayers are convinced that anytaxpayer can easily hide his income, and that tax inspectors are unable to detect tax evaders.

It is generally recognized that the tax policy has a direct impact on budget revenues and tax compliance.The Russian Government is engaged in a comprehensive program to reform the tax code that is now

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producing improvernents. In general, tax policy issues will be addressed in the context of theGovernment's own tax policy program and corresponding IMF and Bank operations. As a result of thetax policy reform, P'art II of the Tax Code came into effect in 2001, introducing significant changes in

and reducing statutory tax burdens. The Government is committed to support fundamental tax

administration reform, and reforming the Ministry of Taxes and Fees, building on the results of the

TAMP I project, by developing a full-scale tax administration reform based on the Russian FederationResolution 25.05.1995, No. 527, to improve tax administration, as well as the Program of Cooperationbetween the Russian Federation and the World Bank for the calendar years 2002-2004. MinTax hasprepared, with assistance from the IMF and US Treasury, an initial strategic plan to strengthen the tax

admini stration. The strategic plan was revised in March 2001 and incorporated the new priorities of the

Government, taking full account of the experience and lessons of TAMP 1, and the results of the project

identification seminar organized in November 2000.

This strategic plan forrned the basis of a federal earmarked program for development of tax

administration, which was approved by the Government. The Government is already actively reformingthe tax system and its administration. Corresponding tax policy reforms to improve and simplify tax

legislation are on-going and will reinforce the results of the tax administration reform. The adoption ofPart 11 of the Tax Code, implemented from January 1, 2001, contains a number of substantialadministrative reforms, such as the introduction of a unified social tax collected by the Ministry of Taxes

and Fees, and new 'VAT thresholds to ease the compliance burden on small businesses, which willsignificantly enhance operational efficiency. Adoption of chapters of Part II of the Tax Code oncorporate profit tax and tax on extraction of mineral resources, which became effective January 1, 2002,further simplifies the tax system and moves it towards internationally accepted tax accounting practices.

The Government enacted changes to Part I of the Tax Code in 2001 to remove a number of administrativeobstacles to efficient tax administration.

3. Sector issues to be addressed by the project and strategic choices:

Sector Issues. TAMP I focused on demonstrating the feasibility and advantages of key tax administrationconcepts in the Russian environment. It did so by implementing pilots to improve the organization,processes, procedures and automation at the operational level. It demonstrated the effectiveness of a

number of tax administration concepts in the Moscow, Nizhny Novgorod, and Volgograd regions, whichwere imnplemented under the jurisdiction of the State Tax Service (STS) of the Russian Federation, withfinancial and technical assistance from the Bank and the IMF, starting in 1996. The specific objectivesof TAMP I were to: pilot tax administration reforms in two regions with about 110 local offices through

(i) reorganization of structures and processes, (ii) automation of tax systems, and (iii) staff training; andto assist in the institutional development of tax administration by (i) building the technical capacity of thetax administration, (ii) preparing for nationwide implementation of tax administration reforms, and (iii)

providing support for project management.

The tax administration as an institution, however, is still characterized by uneven regional revenuecollection performance, significant tax arrears, and insufficient efforts to improve revenues and the

investment climate. The IMF observed that based on the experience of tax administrations inindustrialized market economies measures to improve tax payment compliance and reduce the incidence

of arrears should include some or all of the following in the Russia context: (i) improving taxpayereducation and services to prevent debt from arising; (ii) amending the tax code to limit deferrals to

exceptional situations, and making directors personally liable for debts of legal entities; (iii) more timely

and systematic follow-up actions where nonpayment is detected; (iv) greater emphasis on direct contactwith delinquent taxpayers to ascertain capacity to pay and to enforce payment; (v) the use of modemtelephone and information technology equipment for large-volume direct contact with taxpayers; (vi)

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eliminating offset schemes/barter arrangements in the tax payment process; and (vii) more use of modemtechnology systems to support the overall debt collection process.

MinTax now has a strong desire to deal with the issues that constrain its performance and many measurescurrently are being taken to improve it. To this end, the Ministry prepared a Strategy for the Developmentof Tax Authorities for the Period 2002-2006, which elaborates a reform agenda for dealing with thenumerous issues that need to be addressed through a comprehensive institutional developmentframework. TAMP II draws on and incorporates the MinTax strategic framework as well as IMFrecommendations into a comprehensive tax administration reform. Focus will be on organization,management, and operational weaknesses at the federal, regional, and local levels. It is expected that theinstitutional reforms promoted by the project will strengthen the tax administration countrywide, whilethe implementation of modernized systems will initially taking place in 13 regions, representing over 35percent of total tax revenues. All project components are closely related to the goals and objectives of theFederal Targeted Program Development of Tax Authorities (2002 - 2004) approved by the RussianFederation, Resolution No, 888, December 21, 2001.

Other sector issues to be addressed by the project include: (i) putting in place a uniform functionalorganization structure in 13 regions; (ii) improving resource allocation; (iii) improving supervision,management, and performance evaluation systems; (iv) implementing modem information systems andIT infrastructure; (v) improving coordination with external agencies, e.g., customs and financial police;(vi) increasing adequacy of tax policy and compliance analysis; (vii) creating a more adequate humanresource management system; (viii) promoting taxpayer services; (ix) creating an integrated taxpayerregistration system; (x) creating the capacity to consolidate taxpayer accounts; (xi) improving processingof tax declarations; (xii) improving data processing capacity, including regional and federal dataprocessing centers to consolidate information processing, and the capacity to manage informationcountrywide; (xiii) developing and enhancing the capacity of specialized inspectorates dealing with thelargest taxpayers; (xiv) implementing systematic collection of arrears; and (xv) improving the appealsmanagement system and requisite administration. (A summary diagnostic of MinTax constraints andactions under the project to deal with them appears in Annex 11.)

Strategic Choice. Although it might have been desirable to extend the modernization effort to all areas ofthe Russian Federation, indications are that such an approach would not be feasible given the time andresource constraints of a Bank project environment, staff limitations of the Ministry, and the sheer size ofthe country. A strategic decision was taken to employ a two-pronged approach to modernization: (i)countrywide institutional development and (ii) selected regional automation (DPCs). Five inter-rayonDPCs will be created in centers of federal districts (i.e., Moscow, Nizhniy Novgorod, Yekaterinburg, St.Petersburg, and Volgograd). The shares of federal revenues collected respectively are 70 percent inMoscow (central federal district), St. Petersburg with 40% in the Northwest federal district,Yekaterinburg with 12.5 percent of the Urals federal district collection, Nizhniy Novgorod 9.83 percentof the Volga federal district collection, and Volgograd 16.7 percent in the Southern federal district.Some of the key elements of institutional development including reorganization of offices, training, andmany business procedures would be adopted countrywide so as to establish a reasonable level of businessstandardization and taxpayer equity. Meanwhile, the investment in automation would place priority onthe regions that contribute the most to revenue collection, while ensuring that most of the federal districtsare covered so that eventually the reform can be expanded. The investment in automation and automatedprocedures would have direct impact on collection, audit, and enforcement activities, and hence fiscalpressure. Considering the lessons learned during the first project, the Ministry currently estimates it cancarry out the modernization of 12-16 regions.

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C. Project Description Summary

1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed costbreakdown):

The project will provide consulting services, training and goods to support activities under the threegeneral areas of Tax Administration Management, Tax Administration Operations, and ProjectManagement. These are divided into 11 components: Organization and Management; HumanResources and Training; Infrastructure; Legal, Regulatory and Appeals Framework; Unified StateRegister of Taxpayers; Development of Electronic Filing and Tax Payment Accounting Systems;Audit and Investigation; Arrears Management; Taxpayer Services Development; Largest TaxpayerUnits; and Project Management.

I. Tax Administration Management

A. Organization and Management - US$ 3.6 million (base cost, including US$ 0.01 millionrecurrent cost)

Sub-component 1: Organizational structure - US$ 0.4 million (base cost)This sub-component will support the implementation of the functional structure at the regional, and locallevels including the reorganization of territorial and local tax offices and the refurbishment of offices tosupport the reorganization. The sub-component would also support further development of the federallevel structure based on the findings of the organizational structure analysis.

Sub-component 2: Management System - US$0.4 million (base cost)This sub-component will support activities aimed at reviewing and strengthening the organizational unitsin MinTax and at the regional level for formulation of operational strategy, setting targets for differentoperational areas, developing indicators to measure performance, preparing annual business plans,preparing budgets, assessing workload and allocating resources. It will also assist in strengthening theInternal Audit Department and review and improve communication systems between and within MinTaxand tenitorial offices and between MinTax and other related government agencies.

Sub-component 3: .Development of standardized workflows in tax administration at all levels - US$0.2million (base cost)This sub-component will support the re-engineering of business processes for organization andmanagement in inter-regional, regional and local offices including the development of manualsdocumenting standard processes to be followed by all offices.

Sub-component 4: Revenueforecasting and tax modeling - US$ 1.0 million (base cost)This sub-component will assist in developing and implementing a revenue forecasting and tax modelingsystem.

Sub-component 5: Change Management - US$1.6 million (base cost)This sub-component will support activities aimed at developing and implementing appropriate strategiesfor managing organizational change at all levels of the tax administration, including communicationstrateg:ies to explain the rationale and potential impact of proposed changes to all managers, staff,taxpayers and other stakeholders.

B. Human Resources and Training - US$11.9 million (base cost, including US$ 0.2 millionrecurrent cost)

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Sub-component 1: Human Resource Management - US$0.6 million (base cost)The sub-component will support, as a long-term objective, the development of transparent and standardprocedures for the recruitment, selection, hiring and dismissal of personnel and developing career pathsbased on the new functional organization occupational categories. In the short-term, this sub-componentwill assist MinTax in development of a salary and benefits reform package to the extent possible,including building in performance incentives based on transparent criteria for wage setting and benefits.

Sub-component 2: Training Delivery - US$11.0 million (base cost)This sub-component will assist in developing the actual training that will be delivered to the projectregions and headquarters during project implementation. Training will be focused on the implementationneeds of each technical component of the project and will be provided in packages by experts andsubsequently delivered to the regions.

Sub-component 3: Improve Professional Ethics - US$0.3 million (base cost)This sub-component will assist in improving the Ministry's capacity to manage professional ethics bydeveloping legislation and other regulatory and legal acts related to the protection of tax officials fromillegal encroachments, and provision of technical assistance in developing and implementing a strategyfor the prevention of potential offences on the the part of certain tax authority officials and developingmethods for assessments of staff integrity and the fair treatment of the taxpayers, including developmentof the code of ethics.

C. Infrastructure - US$111.0 million (base cost, including US$ 7.7 million recurrent cost)

Sub-component 1: Establishment of the FDPC - US$14.9 million (base cost)This sub-component will assist in establishing a FDPC in Moscow through legislative changes,preparation of physical facilities, procurement and implementation of adequate hardware, software andtelecommunications equipment, and optimization of the number of personnel and redistribution offunctions among the FDPC, RDPCs and territorial tax authorities.

Sub-component 2: Establishment of RDPCs - US$28.0 million (base cost)This sub-component will assist in establishing RDPCs through legislative changes, preparation ofphysical facilities, procurement and implementation of adequate hardware, software andtelecommunications equipment, and optimization of the number of personnel and redistribution offunctions among the FDPC, RDPCs and territorial tax authorities.

Sub-component 3: IT Infrastructure - US$50.5 million (base cost)This sub-component will assist in the design of a corporate telecommunications network and the design,development and implementation and maintenance of an advanced information technology system tosupport all aspects of tax administration. This component will also assist in the design andimplementation of a human resource management information system and a Financial Management andFinancial Asset Management Information system to enable MinTax to manage its administrativeresources effectively.

Sub-component 4: Physical Infrastructure - US$10.1 million (base cost)This sub-component will adapt the current physical infrastructure of the tax administration to thestandards necessary to support automation and functional distribution of work. It will assist inrefurbishment and overhaul of administrative buildings, buildings of interregional inspectorates;improvement of storage facilities for tax documents, as well as carrying out activities to establish securitysystems for facilities of the tax administration, including fire protection and protection of data from

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criminal actions.

II. Tax Administration Operations

A. Legal, Regulatory and Appeals Framework - US$3.5 million (base cost; no recurrent costs are

planned for this component)

Sub-component 1: Legal and Regulatory Framework - US$3.0 million (base cost)This sub-component would support Ministry of Finance in the development comprehensive tax policy in

Russia. It would also assist the Ministry of Finance and the Ministry of Taxes and Fees in reviewingcurrent tax legal and regulatory framework and preparing proposals for introducing amendments to legaland regulatory acts, as well as drafting new legislative and regulatory acts to take into account short- and

long-term policy priorities. The component would assist in improving consistency between various legal

and regulatory acts and in harmonizing laws and rules at federal, regional and local levels. It would alsoassist in simplifying procedures and ensuring the tax administration has sufficient powers to administertax laws.

Sub-component 2: Appeals - US$ 0.5 million (base cost)This sub-component will assist in strengthening the overall appeals system through carrying outinformational campaigns for taxpayers relating to the new system; conducting experiencing-sharingmeetings with the judiciary to improve the efficiency and effectiveness of the court appeals system,specifically what court procedures can be undertaken when tax decisions are appealed; and thedevelopment of a database of precedents from court decisions of tax cases that can be used to help

MinTax decide what cases to pursue in court and and how to prosecute them.

B. Unified State Register of Taxpayers - US$1.1 million (base cost, including US$ 0.1 million

recurrent cost)

This component will support the software development and implementation to improve the Unified State

Register of Taxpayers, including reviewing and proposing changes to legislation and regulations to

require the application of a taxpayer identification number (TIN) to specific economic transactions.

C. Development of Electronic Filing and Tax Payment Accounting Systems - US$ 6.7 million (basecost, including US$ 0.3 million recurrent cost)

Sub-comiponent 1: Electronicfiling - US$5.1 million (base cost)This sub-component will support preparing requirements analysis and specifications, developing andimplementing a system for e-filing. The component will also assist in devising incentives for taxpayers to

use e-filing, and carrying out conmmunication campaigns and training of taxpayers to encourage e-filing.

Sub-com ponent 2: Tax Payment Accounting Systems - US$ 1.3 million (base cost)This sub-component will assist in the development of the architecture of the system for data interchange

with the treasury system, as well as the procurement of software, hardware, and telecommunicationsservices.

D. Audit and Investigation - US $7.9 million (base cost, including US$ 0.1 million recurrent cost)

This component will help strengthen the audit capacity of MinTax through the development of athird-patty information system, development and implementation of computerized desk and field auditsystems, development and implementation of a computerized system for selection of field audit cases,

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piloting the system for checking VAT invoices, strengthening intelligence and investigation operationsand cooperation with financial police, as well as implementing a system for processing and accumulatingdata on citizen incomes and property.

E. Arrears Management - US $1.1 million (base cost; no recurrent costs are planned for thiscomponent)

This component will support activities to improve the techniques and procedures for recovery of taxarrears, assist in improving the data exchange system with the Bank of Russia to retrieve data on theamount of arrears accumulated by problem banks, review and implement the arrears managementinformation system and policy, and develop guidelines and procedures to write off uncollectible arrears.

F. Taxpayer Services Development - US $1.8 million (base cost, including US$ 0.01 millionrecurrent cost)

Sub-component 1: Develop the conceptfor a comprehensive tax education system for RF citizens -US$ 0.1 million (base cost)This sub-component will assist in designing a national strategy for production and dissemination ofeducational materials related to taxation.

Sub-component 2: Taxpayer information and consultancy service - US$1.6 million (base cost)This sub-component will support the development of taxpayer information and consultancy servicesincluding the development of service standards for the whole country and explanatory materials to guidetaxpayers in compliance with tax laws. It will further assist in the design and implementation of portalsand web sites of MinTax and its regional departments for disseminating materia's on current taxlegislation issues.

Sub-component 3: Introduction of the self-assessment principlefor thefiling of tax returns andrelated documents - US$0.1 million (base cost)This sub-component will assist in simplifying and unifying tax forms while ensuring that data necessaryfor auditing and reconciliation of tax returns is provided by taxpayers, and in developing easilyunderstandable tax return filing instructions for taxpayers.

G. Largest Taxpayer Units - US $0.7 million (base cost; no recurrent costs are planned for thiscomponent)

This component will develop methodologies for effective management of the largest taxpayers, includingan analysis of the organizational characteristics of these enterprises and the impact of their restructuringon the tax base and tax revenues, as well as develop and implement methods and software for forecastingthe revenues and tax burden of these taxpayers.

111. Project Management - US $4.0 million (base cost; no recurrent costs are planned for thiscomponent)

Sub-component 1: Project Management - US$3.7 million (base cost)This sub-component will assist in managing project implementation and cover the costs of projectmanagement, including Project Advisor.

Sub-component 2: Development of an evaluation system to assess the effectiveness of activities carriedout in the Tax Administration Modernization Project - US$0.4 million (base cost)

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This sub-component will assist in analysis of the implementation progress based on the referenceassessments and introduction of proposals aimed at increasing effectiveness of the activities. Periodic

surveys of taxpayers, managers and staff of MinTax, and other stakeholders will also be conducted to

solicit their perceptions about improvements made in the tax administration, to identify continuing

problems, and to propose measures that might be taken to improve agency performance.

. , - $ a i Fi-. - --J S idicative Bank- %of

~~ ~~~ ~ ~ ~ :SJ~~~~~ ~~cost~ 7%1f. &anifcinig ~Bink-6.ra,.jt '~ I t-~4j~

management and training strategy and capacity, increasing the motivation and technical knowledge ofstaff, and reducing motives and opportunities for corruption.

In particular, TAMP II will support:

* Improvements in the organizational structure of the tax administration to increase the efficiencyand integrity of revenue collection

* Improvements in taxpayer advisory services to create the necessary conditions to introducevoluntary compliance-based declaration of tax liabilities

* Strengthened institutional accountability mechanisms, increased administrative integrity, andimproved appeals and dispute resolution environment to promote an honest, fair, and equitablerelationship between the tax administration and society

* Improvements in tax policy and tax legislation to ensure predictability and consistency of taxlaws and regulations and contribute to better the business development climate

* Strengthened institutional capacity to carry out the key functional tasks of taxpayer audit andarrears collection as part of a compliance management strategy

* Improved exchange of information and dialogue with other stakeholders in the public and privatesector to reduce the opportunities for tax evasion and improve both feedback mechanisms and theability to respond to taxpayer concerns

* Improved ability of MinTax headquarters, regional and local managers to ensure a moreeffective, results-oriented operation of the tax administration

* Introduction of more efficient tax payment processing, which will be supplemented by thecountry-wide automation of govermment financial transactions to be implemented under theTreasury Modemization project

3. Benefits and target population:

The benefits of TAMP II will accrue to the citizens of the Russian Federation in the form of more stableand predictable revenue flows. This, in tum, should promote better economic and financial managementof public resources based on improved collection of social expenditures, as well as stimulation ofproductivity through stronger business incentives, accompanied by a commensurate reduction in informaleconomic activity.

Taxpayers will benefit from reduced compliance costs and a possible overall reduction of the tax burdenfor honest or complying taxpayers as a result of increased compliance rates. The project is intended tospread the tax burden more evenly, and the burden for noncompliant taxpayers actually increasing, asevasion becomes more costly and time-consuming. Development of tax policy will improve businessclimate by increasing predictability of tax legislation and reduction of inconsistencies between differentlaws and regulations that would make it easier for the taxpayers to understand and apply tax laws.Taxpayers will also benefit from improved taxpayer services, access to better information from the taxadministration, and elimination of time spent in queues to file tax retums. Taxpayers' rights will bestrengthened through more efficient and equitable appeals processes.

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In addition, compliant businesses and the self-employed will benefit from quicker processing of taxrefunds, faster registration processes, and by suffering less from competition from underground businessactivities. Honest tax inspectors also will benefit from improvements in internal integrity andprofessional development opportunities created by the project. In addition, there will be greaterincentives for private sector development in light of clearer "rules of the game" that should lead to a morefavorable investment climate.

4. Institutional and implementation arrangements:

TAMP II will change dramatically the way MinTax conducts its management and operations, as well asthe way it relates to taxpayers and other economic agents. Because it will impose extensive changemanagement requirements affecting all areas of MinTax business, the project will be personally led bythe Minister of Taxes and Fees, who will chair a Steering Committee consisting of key members of hisstaff, regional representatives, and representatives of key government agencies, including the Ministry of

Finance (MOF) and the Ministry of Economic Development and Trade (MOEDT). The Minister ofTaxes and Fees will nominate as Project Director one of the Deputy Ministers, who will have overallresponsibility for project implementation.

A Modernization Department, responding directly to the Minister, has been created at Headquarters with27 staff to concentrate exclusively on the day-to-day management of modernization of the Ministry. Toensure adequate coordination of project activities, a Project Coordination Unit (PCU) will be created inthe Ministry. The PCU will be chaired by the Head of the Modernization Department and comprise headsor deputy heads of other MinTax functional departments responsible for implementation of differentprojeclt components, as well as regional representatives and representatives from MOF and MOEDT. ThePCU will be responsible for the design and overall administration of the project including, inter alia,project monitoring and evaluation, and quality assurance, and will have the authority to executeadministrative actions necessary to implement the project. To date, no special administrative authorityhas been given to either the Modernization Department or its Head. This will be included in theprovision for the PCU, and approved by the Steering Committee. The Modernization Department willalso be the focal point for internal and external relations with respect to the project. Last, it will beresponsible for benchmarking and tracking agreed project indicators, some of which will be based onperiodic taxpayer and staff surveys, and tracking day-to-day progress in project implementation together

with the PIU.

It was decided, that no special implementation arrangements will be created in MOF for managementactivities on legal policy development. Instead, organizational structures created within MinTax will be

used for this purpose.

Federal Center for Project Finance (FCPF) will be contracted as a Project Inplementation Unit (PIU) to

execute the back-office project functions of procurement, accounting, and project reporting activities.FCPF will report to the Project Director and will discharge its responsibilities in close cooperation andcoordination with the Modernization Department. The FCPF's responsibilities will include maintenanceof the financial management system, including preparation of periodic financial monitoring reports(FMRs) and ensuring the annual audit of project accounts, annual reports, the mid-term review and theImplementation Completion Report (ICR).

Actual project implementation entails the execution of a large number of project activities in manyfunctional areas of headquarters, regional offices, and local tax inspectorates. Accordingly, specialproject implementation arrangements have been created at all three levels of MinTax's structure. Theexecution of implementation activities is coordinated through the Project Coordination Unit.

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The responsibility to implement the modernization of headquarters functional areas activities has beengiven to those areas of MinTax responsible for the specific tax administrative function being modernized.This was done to promote the internalization of the modernization process. Thematic groupscorresponding to these functional areas have been created at headquarters with the participation ofregional staff. The heads of the Thematic Groups belong to the Project Coordination Unit.

Similarly, each regional office has created a special structure to manage the modernization process in theregion. A deputy regional director heads the regional modernization structure. The structure includes aRegional Coordination Committee that coordinates the modernization activities at the regional office andat the tax inspectorates. It also includes a Project Management Unit that provides the logistical andtechnical support to all modernization activities in the region, with an average of 10 to 12 staff.

At the local level, each of the targeted tax inspectorates has also created a special structure to manage themodernization process. The head of the local inspectorate has been put in charge of the localmodernization activities. The project modernization management structure at the local level consists ofsix staff per local inspectorate.

Access to international best practice is of fundamental importance to the success of the project. Duringthis process, every effort will be made to seek technical assistance from donors, particularly those withtax administrations that exhibit pockets of excellence. The Modernization Department will coordinatewith donors operating within the context of the project to ensure consistency of approach and avoidduplication. Donors currently include, among others, the EU, US Treasury, Denmark, and USAID. InApril 2002, MinTax has organized a Donors' meeting, when assistance and conmnitment was sought in amanner fully consistent and coordinated within the project concept and framework. The ModernizationDepartment will be fully involved in coordination of resulting technical assistance, calling on the Bankfor quality assurance as needed.

The project organization arrangements necessary to support the operation will be presented in detail inProject Operations Manual to be prepared and agreed with the Bank prior to the Board Presentation.

D. Project Rationale

1. Project alternatives considered and reasons for rejection:

The Ministry and the Bank considered four alternatives, three of which were rejected.

First alternative considered: The first alternative considered was to continue along the lines of the firstTax Administration Modernization Project. Under this alternative, the project would concentrate oncreation of an adequate automation infrastructure for the Ministry, based on RDPCs, by deploying thenew business processes successfully developed and implemented in Volgograd, throughout the country.This alternative had a strong appeal to the Ministry because, as a natural extension of the first project, itwould have been well focused and relatively easy to manage. Moreover, the Ministry already had inplace an effective project management structure that could be easily upgraded to manage further regionaland local tax office modernization. Also, there was evidence that automation was an effective tool topromote overall modernization. This alternative was rejected because the TAMP I pilot projectdemonstrated that a full reorganization of headquarters was required to support the functionalorganization model adopted by pilot local and regional offices. Moreover, the Ministry and the Bankwould forego the opportunity to address a number of serious systemic weaknesses of the tax

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administration management system pointed out in Section 2, above.

Second alternative considered: The second alternative called for full countrywide modernization. Insome sense, this alternative was at the opposite range of options from the first alternative, and had quiteappealing characteristics. First, it would have enabled a more uniform and egalitarian tax regime for allRussian Federation citizens at the earliest time. Second, it would have reduced the risk of neverachieving a countrywide uniform system because of future inability of MinTax to access further funds forautomation. Third, it would have avoided the political problem of several regions being left out of thefull modernization process. This alternative was rejected because the time and financial resourcesrequired would be beyond the normal scope of a World Bank project. Moreover, the project size wouldhave greatly diluted management attention, and scarce existing financial and human resources would notnecessarily have been allocated to the areas of maximum return.

Third alternative considered: During project concept discussions and considering the long-terminstitutional building characteristics of the project, it was suggested that the project team consider anAdaptable Program Lending (APL) approach for the loan structure and financing. The two mainadvantages of such an approach would have been, first, to provide a stable long-term financial strategy toachieve full countrywide modernization in the long run, and, second, to permit a slower pace ofinstitutional reform of the tax administration. This alternative was rejected as inadequate for theRussian Federation context because the proposed project is already itself the second stage of theprocess of modernization of the tax administration. The institutional development being sought underTAMP II is part of a coherent package, and lack of advancement in any of its constituent parts wouldseverely reduce the anticipated gains, therefore precluding the breakdown of activities across multiplestages of an APL. The advantage of a guarantee of financing for the countrywide deployment of thecomputer systems developed during the first two TAMP projects would remain valid (note thatmanagement systems are being deployed to all regions as part of the proposed project). Nevertheless, theadded value of Bank involvement in an APL stage consisting primarily of the deployment of computerinfrastructure to low revenue regions would be questionable. Also, the Government has indicated that itdoes not anticipate the need for further Bank loans for the tax administration five years hence.

The selected alternative is that of modernizing the headquarters organization so that it can provide thebest possible guidance to all regions, and strengthening the central data processing and analyticalcapacity to promote improvements in taxpayer compliance countrywide. To improve countrywide equityand promote similar levels of fiscal pressure, some key tax administration policies--such as officeorganization, taxpayer services, and appeal procedures-would be promulgated in all regions. To focusthe substantial investment required for automation, the project would concentrate most of the automationinvestment on the tax processing operations of the regions that represent significant contributions to thefederal budget.

2. Major related projects financed by the Bank and/or other development agencies (completed,ongoing and planned).

Listed below are projects focusing on revenue collection that were carried out in the 1990's and thatfollow to some extent the same modernization direction included in the proposed project. (Projects are inRussia unless otherwise noted.)

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1f | Latest SupervisionSector Issue Project (PSR) Ratings

(Bank-financed projects only)Implementation Development

Bank-financed Progress (IP) Objective (DO)

Low tax compliance, narrow tax base, Tax Administration Modem- S Sinequitable tax rates, out-of-date tax ization Project I (TAMP I)policy framework; inadequate taxpayer (completed)information systems; and lack of afunctionally organized taxadministration

Rapidly expanding tax base, lack of Hungary: Tax Administration S S

taxpayer information systems Modemization Project (TAMP)(hardware, software), low compliance (completed)rates, lack of functionally organizedtax administration

Inadequate budget classification Treasury Development Projectstructure, a need to revise public (approved by the Board)expenditure control regulations and tomanage the timing of expenditures,and a need to fully automate Treasuryand associated systems for betterbudget execution and cashmanagement

Thematic issues (focused on, e.g., Bureau of Economic Analysis S Staxation) where basis for significant Project (ongoing)policy decisions that are likely toimpact savings, revenues, andexpenditures are identified; includes acomponent to improve nationalaccounts

Improvement of budget management SAL I S Sand revenue collections

Fiscal management SAL II S S

Fiscal management and reform of the SAL III U S

tax structure

Need to rationalize and bring Public Service Reformtransparency to public service policies, (planned)practices, and regulatory framework

Other development agencies

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Danish Technical Assistance Agency Tax AdministrationAutomation in St. Petersburginspectorate

US Treasury Department Workflow Processes andTransfer to FunctionalStructure

EU-TACIS Tax Administration TrainingInformation Exchange

IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

SAL Ill project was implemented at a time when Russian Government was struggling with the consequences of amajor financial crisis of 1998. The project's design included too many conditions that could not been fulfilled at thetimeframe specified, including the conditionality related to introducing legislative amendments in the area of privatesector development ancl financial sector reform. As a result, the outcome of the project was rated unsatisfactory.3. Lessons learned and reflected in the project design:

The project incorporates lessons learned from tax reform efforts in other regions of the world, includingthose in transition economies. The following figure among the most important:

(i) A tax administration reform can succeed only with the strong will and commitment of theBorrower and the Tax Administration.

(ii) A medium to long-term strategic vision, owned by the agency, is needed to carry out a deep taxadministration reForm and build the requisite capacity.

(iii) For tax refonns to be successful they must address institutional constraints to tax administrationperformance, and not center reforms exclusively on information technology and systems solutions.

(iv) B3usiness process re-engineering and related automated applications must be fully integratedthroughout the tax administration, with appropriate management of the organizationaltransition-including human resource and training aspects-as a central part of this process.

(v) Development of application systems software is often a major bottleneck. Application systemssoftware should be developed and fully tested early in the project cycle, and equipment purchasesmade after the software is successfully piloted.

(vi) Performance benchmarks and indicators need to be established for the tax administration ingeneral as well as for staff to develop the technical skills needed to sustain reforms.

(vii) Modemnization of local tax offices requires their full participation and an adequate diagnostic oflocal capacity, taling into account technical and managerial constraints and local tax environments.

(viii) Efforts to control the potential for corrupt behavior by tax officials requires a comprehensivestrategy aimed at reducing the motive and opportunity for corruption, and providing incentives forintegrity to take hold.

(ix) Creation of a sustainable revenue collection system requires both tax policy and taxadministration reforn.

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4. Indications of borrower commitment and ownership:

The Govemment has requested the Bank's assistance to implement its project based on the positive

results of TAMP 1. The Government of the Russian Federation is fully committed to establishing a

modem tax administration based on proven methods to manage compliance, especially arrears, and

strong auditing and enforcement built on enhanced institutional arrangements that balance the rights and

obligations of taxpayers. The Ministry of Taxes and Fees is not only committed but also highly

enthusiastic about rapid development and modemization of its activities.

To this end, the Ministry of Taxes and Fees prepared a proposal and received Government approval for a

three-year Federal Target Program, Development of Tax Administration (2002-2004), to implement a

new national strategy, reform plans, modemized procedures, a new IT system, and training that would

culminate in an improved national tax service, which has been approved by the Govemment. The

government-developed project was conceived in four phases. First, an improved work environment

comprising improved institutional arrangements, revised legal and regulatory frameworks, and new work

procedures would be developed. Second, the basic conditions for modernization comprising educational

and training programs would be developed, a telecommunications infrastructure established, and new

computer systems developed, tested and placed in operation. Third, a countrywide institutional

development modernization process, not critically dependent on computers, would be deployed. Fourth,deployment of automation infrastructure would take place at headquarters and selected regions, whichwould carry out the modemization program based on the framework prepared under the first three

phases. The TAMP II project components are closely aligned to the goals and objectives of the Federal

Targeted Program.

In addition, the Government has prepared the Program of Social and Economic Development (Gref II

Report), which delineates a govemment-wide reformn strategy incorporating both tax policy and tax

administration elements. Expectations are high that the tax policy modemization strategy outlined in the

Gref 11 Report would be carried out independently of IMF and Bank balance of payments operations in

the country.

Although the second modemization project is still to be approved by the Executive Directors of the

World Bank, MinTax has already launched the following important activities, among others, that form

the foundation for project implementation.

(i) MinTax has created and staffed a Modemization Department that responds directly to the

Minister, formally appointed a dozen operational managers to manage the preparation and

implementation of the project's 11 components, and already created implementation organizations in

most regions and rayons that will be automated by the project. A total of some 500 staff countrywide

have been appointed and are being trained to implement the project.

(ii) MinTax has introduced a set of functional structures, using the TAMP I pilot regions as a model,

in all regions, commencing in the second half of 2001. The structures assume a minimum local tax

inspectorate office size of 40 staff. Inter-district tax inspectorate offices are being created to cover

tax administration needs of areas with smaller offices. As of February 2002, over 1,000 offices have

been closed with total staff reductions at about 16,000 systemwide. It should be noted that some

mobile offices will remain during the consolidation, local offices will have a taxpayer advisory unit,

and tax retums will be simplified.

(iii)A decision has been made to introduce, as part of the project, large data processing centers at the

regional level (with special arrangements for Moscow and St. Petersburg), to anchor modemizationof tax processing automation. RDPCs will enable the consolidation of information processing work

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and create the potential for major gains in efficiency, integrity, and equity in tax administration.

(iv) A server for information storage and processing has been installed in MinTax HQ as a first stepto the powerful federal computer center which will operate the national information infrastructure,including a countrywide telecommunications network, enabling comprehensive information ontaxpayers to be stored centrally for tax management, analysis, and policy evaluation purposes.

(v) MinTax has participated in preparation of the legislation necessary to support the adoption of keytax operations reform such as e-filing, electronic signature, a single tax identification number, andsimplified registration and filing procedures and is currently involved in development of the legalacts needed for establishment of DPCs.

5. Value added of Bank support in this project:

The Bank's comparative international experience will assist the Russian Federation and MinTax inparticular to benefit from the Bank's increasing institutional knowledge in the development of successfultax administration projects, both in countries with transitional economies as well as in countries in otherregions of the world. The momentum for reform engendered by TAMP I will also be sustained andwould provide further impetus to mount a much more comprehensive reform than otherwise would havebeen possible without this experience. The coordination of the Bank with the IMF and other donoragencies can be expected to provide a solid foundation of support and cooperation, thus addingsignificant value to the Bank's role in the ongoing process of tax administration reform in the RussianFederation. A special Donors' Conference was held in Moscow in April 2002 with donors from theFrench and Swedish governments, EU-TACIS, UNDP, OECD, and the US Treasury, which is expectedto provide the basis for on-going support, coordination, and cooperation to the TAMP II project.

E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8)1. Economic (see Aninex 4):*Cost benefit NPV=US$ 14869.2 million; ERR= % (see Annex 4)

! Cost effectiveness

' Other (specify)E. Summary Project Analysis

1. Economic (see Annex 4):

The project rationale is based on the gains the enlarged government and law-abiding private sector willobtain as a result of development of capacities of MinTax and application of modem tax administrationtechniques, which significantly reduce the taxpayer compliance burden.

The most significant economic benefits of the project will be reaped from widening the tax base,improving voluntary tax compliance rates, reducing taxpayer compliance costs, and leveling the playingfield for all taxpayers.

The quantifiable benefits include: (a) additional revenues generated by improvements in tax compliancerates; (b) tax revenues from reduction of the 'shadow' economy; (c) interest rate savings from earlypayment of tax arrears; and (d) private savings from reducing time spent by accounting staff of privatecompanies to comply with tax legislation.

There are many other positive outcomes of the project that have not been quantified. Among them the:

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(i) increase of legal business activity resulting from improvements in the business and investment climate

stemming from lower risks due to inconsistent interpretation of tax regulations and procedures by taxinspectors and to putting 'shadow' competitors out of business; (ii) improvement in the reputation of thetax administration and reduction of corruption; (iii) economic growth and growth of competitiveness,which will take place after possible reduction of statutory tax rates, generating higher overall taxrevenues; (iv) efficiency increase of MinTax from re-engineering business processes, better organizationof internal and external information flows, and improved professionalism and performance incentivestructure.

On the negative side, implementation of the project may require intra and interregional reallocation ofMinTax staff, its retraining and partial dismissal, especially in rural and less advanced regions. Thesefactors have not been quantified but are not believed to be significant.

The following table summarizes the annual economic benefits of the project for the Russian Governmentand the private sector (for details and assumptions see Anhex 4).

Annual economic benefits under TAMP II

Benefits,$ million

Total benefits 2622.3Including:

Tax revenues (government) 2428.8Interest rate savings (government) X0.5Savings on compliance costs (taxpayers) 193.0

It follows that the annual economic benefits exceed project costs, attesting to a very high public and

private return on investment. The table below presents results of the cost-benefit analysis, which support

this conclusion.

Costs, benefits and NPV of TAMP HI

$ millionCosts, present value (PV) 208.0Public benefits, PV 13851.3Private benefits, PV 1225.8NPV 14869.2

ERR 66.5

Results of cost-benefit analysis indicate that the project's success is largely independent of unfavorablechanges in assumptions or perfornance. Key risks for the project are mnainly implementation capacity aswell as those associated with internal resistance to change within MinTax, risks which will be offset by

mitigating strategies.

2. Financial (see Annex 4 and Annex 5):NPV-US$ 13640.3 million; FRR = % (see Annex 4)

Based on available data, the project's financial impact is evaluated for the consolidated budget only.Improvements in tax collection rates and broadening tax base in the Volgograd region under the TAMP I

- 22 -

project were used as a benchmark for the TAMP II financial impact assessment. The Table belowpresents key results of the financial analysis, highlighting high fiscal returns of the proposed TAMP IIproject-even if it does not go beyond the accomplishments of TAMP I.

Financial benefits and NPV of TAMP II

$ million

Fiscal benefits (annual) 2428.8Fiscal benefits, PV 13848.3NPV 13640.3FRR 61.0

It is very likely that factors not represented, i.e., positive GDP growth, real appreciation of nationalcurrency, will contribute to even higher fiscal benefits of TAMP II. Taking into account the governmentcommitment to prevent public expenditures from increasing relative to GDP, fiscal savings expectedunder the project will likely be shared with the law-abiding private sector through reduction of statutorytax rates. It also will decrease project financial benefits of the project while further increasing theeconomic benefits.

Project cash flows, assumptions, and details of the financial analysis are presented in Annex 4.

Fiscal Impact:

N/A

3. Technical:

To identify strengths and weaknesses of the tax administration as well as external constraints, a diagnosisbased on the Bank's diagnostic framework for revenue administration was carried out, a workshop withmanagers and senior technical staff was organized, and consultations with external stakeholders wereheld. Activities ultimately included in the project were those that the client identified as high priorityand attainable. They take into account the current level of technological and functional sophistication ofMinTax and its capacity to absorb planned project inputs. Project costs are based on best-judgmentestimates, guided by the actual experience of TAMP I. The modernization of 13 regions, thedevelopment of federal and regional Data Processing Centers, as well as the implementation of new workprocess re-engineering will require careful technical coordination and appropriately developed andadministered training. These activities will also require institution-building in such a way that initialefforts can be broadened to include all tax offices throughout the Russian Federation. For this reason,systems integration and management will be at the forefront of institutional development issues for theagency, including human resource and training requirements that the expansion of new systems willentail.

4. Institutional:

4.1 Executing agencies:

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Ministry of Taxes and Fees will be an Implementing Agency for the project. In the Ministry, day-to-day

project management will be carried out by a special Modernization Department, already legally created

in MinTax. It will be supported, as agreed with the Ministry of Finance and at the direction of the

Government, by FCPF, a specialized firm, experienced in managing World Bank projects, contracted to

execute procurement, accounting, and project reporting activities. Special departments have been created

to execute modernization in the regions and in the local offices. Change activities to modernize

functional areas of the tax administration will be managed by Project Coordination Unit comprising

functional area managers. The Modernization Department will be kept informed of the progress in

implementing their part of the modemization effort and, as needed, ensure coordination of all project

activities.

FCPF will report the progress in project implementation to the Bank and to the Ministry biannually prior

to and as a key input to supervision missions. Because this is a new arrangement, efforts will need to be

made to ensure that no unnecessary bureaucratic layers develop that could potentially lead to delays in

implementation. Proper staffing of the Modernization Department will be critical to successful project

execution.

Ministry of Finance, another beneficiary of the project, will participate in project management throughorganizational structures to be created in MinTax.

4.2 Project management:

At the highest level, the project will be personally led by the Minister of Taxes and Fees, who will chair

a Steering Committee consisting of key members of his staff, regional representatives, and possibly key

representatives of the Government. A Deputy Minister of MinTax has been appointed to concentrate

exclusively on the day-to-day management of the modemization of the tax administration and given the

authority to execute the administrative actions necessary to implement it. Cooperation and coordination

between FCPF, the Ministry of Taxes and Fees, Ministry of Finance, and the Project Manager (Deputy

Minister), component unit directors, and the tax agency staff at all levels will be critical to project

management. Full support will be needed to ensure that the many elements and activities of the envisaged

reforms receive appropriate oversight, with clear lines of accountability established. The Project

Operations Manual describes these arrangements in greater detail (see project files).

4.3 Procurement issues:

Procurement under TAMP I did not encounter major problems-with the notable exception of the

procurement of training, which, although eventually successfully implemented, was subject to repeated

delays. Because of the increase in the scope of TAMP II, and the commensurately large role of training

systems development, in addition to the critical sequencing of technical, human resources, and training

activities in the regions covered by the project, it will be important to carefully monitor procurement to

lessen possible implementation delays that could occur.

4.4 Financial management issues:

Financial management of the project, as is the case for procurement, will be the responsibility of the

Federal Center for Project Finance. This entity has a necessary capacity to implement

Bank-financed project. The FCPF is in compliance with its audit covenants of existing Bank-financed

projects. FCPF's previous and current project financial statements and auditing arrangements are

satisfactory and it has been agreed that these will be replicated for TAMP2. The annual audited project

and entity financial statements will be provided to the Bank within six months of the end of each fiscal

year and also at the closing of the project. In accordance with WB audit policy the first and final audits

can cover the period up to 18 months. In this context, however, coordination and supervision of the FCPF

work by the Ministry of Tax and the flow of project funds, including co-financing, are important and the

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procedures have been formalized.

5. Environmental: Environmental Category: C (Not Required)5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (includingconsultation and disclosure) and the significant issues and their treatment emerging from this analysis.

The project does entail some minor civil works. Any such construction will be carried out in compliancewith Russian environmnental standards. The Bank will ensure compliance in its supervision of theproject.

5.2 What are the main features of the EMP and are they adequate?

N/A

5.3 For C'ategory A and B projects, timeline and status of EA:Date of receipt of final draft: N/A

5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EAreport on the environmental impacts and proposed environment management plan? Describemechanisms of consultation that were used and which groups were consulted?

N/A

5.5 What mechanisms have been established to monitor and evaluate the impact of the project on theenvironment? Do the indicators reflect the objectives and results of the EMP?

The project includes minor civil works for refurbishment and upgrading of tax administration buildingsto the standards necessary to support a highly automated environment. Any such civil works will becarried out in compliance with Russian environmental standards. The Bank will ensure compliancethrough its supervision of the project.

6. Social:6.1 Sumrnarize key social issues relevant to the project objectives, and specify the project's socialdevelopment outcomes.

The project does not target social development per se, but the modemization of the Russian Ministry ofTaxes and Fees under the project will involve assistance to manage a revenue collection environment thatnow includes the new responsibility of collecting social tax contributions. The ultimate result should bea much more efficient collection of social contributions, which will benefit directly from improvementsin the tax paying culture and compliance sought by the project. Indirectly, this may lead to improvementsin the social benefits available to the population. The project, by promoting a stronger relationshipbetween taxpayers and the tax administration, will instill more confidence in government, lead to greatersocial inclusion, and increase equity and transparency.

6.2 Participatory Approach: How are key stakeholders participating in the project?

Key stakeholders are the Russian taxpaying public, Ministry of Taxes and Fees, Ministry of Finance,Ministry of Economic Development and Trade, and the Government of the Russian Federation. Specialattention has been given to the international and local chambers of commerce, which are key to privatebusiness development. Further details are given in section 6.3 below.

During project preparation, the project team consulted with the Ministry of Finance, the Ministry ofEconomic Development and Trade, as well as the Financial Police, and is coordinating activities with theBank-financed Treasury Project, recently approved by the Board. A cooperation agreement has beensigned between MinTax and the Ministry of Finance and the Ministry of Economic Development and

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Trade to better coordinate intergovernmental issues and concerns.

6.3 How does the project involve consultations or collaboration with NGOs or other civil societyorganizations?

During project preparation consultations were carried out with regional and local taxpayer associations,chambers of commerce, as well as tax accountants and private consultants, to better understand theproblems taxpayers face in their interactions with tax authorities. These consultations provided theproject team and MinTax with a better understanding of the issues and enabled a project design thatbetter reflects these concerns. For example, the lack of easily accessible and relevant taxpayerinformation has been identified as a major proble