VAT is the only tax that involves the government not only in collecting substantial money from the private sector but also in paying a good deal of it back to them in the form of input tax credits. 136 countries now have a VAT of some sort and remain at least 63 countries that do not have VAT’s, 41 of which now have some other form of general consumption tax and 23 of which appear to have thus far been able to avoid facing the problem.Over the last decade, VAT has arrived in Albania. The principal reasons for arrival of this form of taxation were, first, the early adoption of this form of taxation in the European Union (EU) and, second, the key role played in spreading the word to economic transition countries by the International Monetary Fund (IMF) in particular and by international agencies and advisors more generally. The success of VAT in the EU showed that VAT worked. The consistent support and advocacy of this form of taxation by the IMF and others in a variety of countries, encouraged and facilitated the adoption of VAT by countries with much less developed economic and administrative structures than those in the original EU member states, like Albania.The VAT, it’s invariably among the most important sources of government revenue. Not all is so good for VAT, however. Some of problems have always been inherent in the structure and operation of VATs but are exacerbated by the increased fiscal weight being placed under pressure for new fiscal revenues for example to offset revenue losses from tariff reductions needed to accord with WTO requirements. It is thus perhaps time for a new look at the role of VAT in Albania.I want to make some question that can be a referent point for this discussion.Can VATs be adapted to cope with the rising demands for more access to revenues by local and regional governments?
Can tax administration deal with such new problems as those arising from changes in business practices with financial innovations and e- commerce?
Does VAT provide a way to tap the informal sector or does it instead tend to expand that sector?The answers to such questions are not only critical to the fiscal stability of Albania, but also to her economic growth and development. Not only do we as yet have surprisingly little solid empirical knowledge of some critical factors but the relevant economic theory also remains rather sketchy and we know even less about the relevant political economy context.VAT in real lifeAs we said, VAT works. Despite some doubts by various analysts, for the most part it remains true that, if a country needs or wants a simpler tax, it is well to have a VAT. Nonetheless VAT does not always work well, principally because we yet are so tax educated society ready for “self-assessment”. VAT is by no means necessarily the ‘money machine’ for every government.. Indeed, the equally conventional conclusion that a VAT is the most economically desirable and administratively effective way in which to collect a given share of national income through a general consumption tax also holds — provided, again, that the capacity exists to administer VAT adequately. Similarly, as with any tax, although increasing the rate of an existing VAT rates will neither necessarily increase revenues proportionately nor be costless, it may nonetheless be the economically most sensible way to expand revenue shares in economy, if that is the policy goal.Recently, however, some have begun to explore in more detail the theoretical framework linking VAT, tariff reform, trade and welfare, turning up some interesting and to some extent disquieting results. Analysts have also recently begun to discuss the implications for VAT of the considerably larger underground or shadow economies found in Albania as compared to developed countries. Some analysis suggests that in the presence of a substantial ‘informal’ sector, a tax like VAT that falls on the formal sector acts to deter the growth and development of the economy as a whole. Increasing consumption taxes definitely fosters the expansion of the hidden economy if the labour-intensity of production in that sector is greater than in the formal sector. The present government need for revenues suggest that even government aware of such problems may have nonetheless choose to impose higher taxes, including VAT, on the formal sector of the economy because with their relatively weak tax administrations the best way for them to raise revenue may be to increase barriers to entry to the formal sector, thus creating ‘rents’ that may then be taxed.Does VAT Work Well for Albania?How far Albania still seems to be from being able to run their tax systems on this basis?
While there are many different reasons for this conclusion in different countries, only two points will be mentioned here. First, the policy process appears, almost inevitably, always to leave some problems in VAT design, and such problems are more likely to be exacerbated over time in the circumstances of Albania than those of developed countries. Secondly, the right way to implement a VAT is through “self-assessment”.Potential taxpayers have many ways to escape the fiscal system. They (or at least their tax base) may, for instance, flee abroad. They may remain but hide in the shadow economy. They may secure some form of favourable treatment by exerting influence in various ways to have changes made in the law or its interpretation. If somehow trapped within the taxation system, they may finally seek relief by forgiveness of arrears through partially amnesty laws. Indeed, in some cases they may combine all of these methods of avoiding taxation.
In some routine work of our tax administration the record over the years suggests that such processes have been at work, given the discouraging picture of repeated erosion of the base of the VAT through concessions at many levels as well as general administrative weaknesses.
The initial VAT legislation, usually close to standard international models, as time goes on tends to become both more complex and to some extent ad hoc in how it is actually applied. The structure of VAT becomes littered with privileges and exemptions that minimize its revenue impact and make it difficult to manage. Sometimes, once concessions enter the system, they have been subsequently enlarged surreptitiously without quick response from the tax administration, becoming in effect almost a “self- assessment” system without the necessary administrative systems and safeguards to support such a system. Concessions thus feed on themselves, encouraging taxpayers to lobby for still more concessions, just as tax amnesties create an incentive to defer payment in anticipation of future amnesties. Little assistance in coping with these complexities is offered in the way of taxpayer services. Nor is much done to guard against abuse, with most so-called VAT “audits” amounting to little more than simple numerical checks. Widespread base erosion facilitates both evasion and also, when taxpayers are subject to audit, corruption.The governments hard-pressed for revenues are driven sometimes to discretionary and unpredictable enforcement efforts. Those unnecessary ways are used in form of collecting money where they can and (as the common problem with refunds suggests) keeping it when they get it. On the other hand, they have sometimes resorted to introducing still more legislative changes to close gaps arising from previous political and administrative decisions. The result has been almost a continuous cycle of changes in the effective tax structure, subsequent erosion of the tax base, and unrelenting pressure on the tax administration to meet revenue targets. Those taxpayers who remain subject to the full rigor of the formal tax system face uncertain (and often increasing) tax burdens. Savings and investment are deterred and misallocated. Trade may be discouraged as VAT refunds to exporters are not paid out but are instead kept in the treasury and used to meet budgetary needs. The shadow economy expands. Revenues fall, with the result that tax pressure is again increased on those who cannot escape, and the cycle continues.I think that the trouble lie in poor tax design. The existence of a fundamental gap between the institutional requirements for good VAT administration and the real fiscal institutions in place in a country is yet not solved by governments. The extent to which the VAT is in effect being used to reward political supporters or perhaps, as an instrument of industrial or regional policy. As tax fiscalists have long argued, even the best-designed tax concession or incentive is likely to prove a useful tool of public policy only when a country has both a stable macroeconomic environment and a stable political and administrative system. Even if VAT is collected effectively at the border, the uneven and halting horizontal flow of information between border agencies and the VAT officials responsible for ensuring the validity of claims for input credits and refunds often puts the integrity of the tax at risk.Tax Administration: Growing into a Good VATMuch IMF experience suggests that first years are not nearly long enough to have a good VAT system up and running well. Ten years is perhaps closer to reality. As with respect to tax design, more thought seems needed with respect to what one really has to know about a country in order to devise the “right” implementation schedule for its particular circumstances.What matters most and in what ways?
Is it the size distribution of the potential tax base or:
- the relative importance of ‘key’ base components (such as imports and excise goods) and the degree of administrative control that can realistically be expect with respect to those components. – the level of accounting skills in the potential taxpayer population?
- the detailed industry-by-industry flow of ‘VATable’ items between different sectors and different sized firms?
- the capacity of tax officials to administer an accounts-based tax and in particular attention to audit such a tax?
- perhaps most fundamentally, the degree of existing ‘trust’ between officials and taxpayers and how quickly (and in what ways) that trust can be built up sufficiently to support a self-assessment system?
- is it all of the forgoing and more?Whatever one’s answers to such questions, what seems clear is that one cannot expect success simply by transferring experience from very different developed country settings to economic transition countries, like Albania with fragmented economy, large informal sectors, low tax morale, rampant evasion, and total distrust between tax administrators and taxpayers. Perhaps the most basic lesson that may be drawn from experience to date with implementing VAT in Albania is simply that doing it right is in most respects a matter more of art than of science. But even the most careful consideration of the experiences of other countries is of little use in the absence of close knowledge of how one’s own economy really functions. If, for example, the extent and behaviour of the informal sector depends, as some recent literature suggests (Gërxhani, 2004), largely on the interaction between formal institutions such as the tax administration and the prevalent norms and customs in a country, the “best” VAT design and implementation will undoubtedly be rather different from that suggested by experience to date in the EU and other developed countries.The critical political expression of the policy process must simply be accepted as given by those directly concerned with tax design and implementation. Nonetheless, it is obviously desirable that they are as fully aware as possible of the manner in which such factors may impact on, and are in turn affected by, such central elements of VAT design and implementation as exemptions. To be forewarned that a particular sector is politically ‘untouchable’ may, for instance, enable policy designers to be able to work around the problem in a way that does less damage to the tax as a whole than might otherwise be the case.A good tax administration keeps a close watch on trends and changesMany questions have already been raised about VAT in Albania, and some possible directions in which to search for answers have been tentatively suggested. A more systematic approach to assembling and analyzing data would help greatly in facilitating major improvements in VAT policy and administration. It is, obviously important for good tax administration to keep a close watch on trends and changes in taxpayer behaviour, in order for instance to allocate administrative resources effectively and to develop appropriate audit strategies. Any good revenue administration surely needs at least some data gathering and analysis capacity. Yet not only do units devoted to such purposes seldom exist, but even those most concerned with improving VAT administration seem seldom to put much emphasis on the need to improve matters in this respect, perhaps because they give higher priority to other, more pressing needs or, perhaps, less understandably, because of the almost certainly mistaken belief that the presumed ‘best administrative practices’ observed elsewhere can and should simply be copied.Since any VAT invoice constitutes a potential claim on the treasury, and falsifying such claims is perhaps the most common form of VAT fraud, it is critical from an administrative perspective to have a detailed knowledge of the “normal” or “expected” pattern of credits and liabilities for firms in all the different lines of business subject to VAT. Again, however, although the normal operation of an invoice-credit VAT generates such information, it is striking how seldom such data are either collected in usable form or used. Perhaps even more surprising is that this whole question has apparently not as yet received much attention from the international community of VAT experts.An astoundingly small number of VAT registrants, less than 4% of total in number, account for 80 percent of VAT collections. What has proved much more troublesome in VATs around the world is the question of how best to deal with the “rebels” of the system small taxpayers.At least three distinct questions may be distinguished in this respect. The first is the issue of where to set the threshold. The second, is what if anything, should be done to “simplify” VAT procedures for small registrants, with different countries reaching answers that range from providing some form of simplified accounting to subjecting them, in effect, to a tax other than VAT. The third is how to make sure that those who are treated as “small” by the VAT really are small.Since good tax administration rests on information and for no tax is this truer than VAT it is obviously advantageous in principle to include as large a share of economic activity in the tax base as possible in order to be sure to capture the necessary information. Such an explanation would be more convincing, however, if there were more evidence that Albania put such information to good use and the very countries that set unduly low thresholds did not so often provide many of those thus caught in the VAT net with escape routes through various simplified systems or, in some cases, simple neglect.Wherever the threshold is set, however, and for whatever reason, it is of course well recognized that compliance costs are relatively more burdensome for smaller firms. Let make an example: one country, has three alternatives “simplified” accounting systems that may be used by small firms. Perhaps the most usual approach, however, is in effect to take out of VAT most of the very firms that the unduly low threshold has brought in, by applying some form of turnover or presumptive levy to firms below a (usually self-reported) threshold. The extreme version of this approach is the “simplified” or “unique” tax that has become popular in some economic transition countries in recent years. Moreover, not nearly enough attention seems to have been paid either to the details of the design and implementation of how they relate to the various forms of local business taxes. Again, there seems much useful research that can and should be done on such matters.
A quite different approach to the perceived and real problems of dealing with small taxpayers is the so-called “VAT withholding” found in some countries. In effect, this practice assumes that VAT will not be reported properly by small firms and hence requires those selling to such firms to “withhold” an additional VAT on such sales to make up for the VAT those firms are supposed to collect on their own sales. Such “dual price” systems are usually imposed at arbitrary rates and make no logical or administrative sense; nonetheless, they are sufficiently common, and are suggested sufficiently often in countries in which they do not now exist, to call for closer examination than they seem so far to have received. Most discussion of the appropriate treatment of small firms appears to assume that there is no difficulty in telling which firms are small.VAT through the timeAs a conclusion idea that I suppose about this topic is no VAT, however well designed and well administered it may be, will forever remain the same. Times change, and so do taxes. Life is more difficult for those concerned with tax matters in Albania. Keeping up in taxation requires an ability to read the fiscal winds to detect important emerging tax issues, to work out in detail how best they may be dealt with, and to devote time and energy to changing tax design and administration to cope with changing circumstances.For example: consider the “digital revolution” and its implications for VAT around the world. Few subjects have given rise to more discussion among those concerned with tax matters in recent years than electronic commerce. Governments, international organizations, and pundits have poured forth reams of material on this subject. The general OECD line that taxation should be neutral and equitable between all forms of commerce, electronic or otherwise, while simultaneously minimizing both compliance and administrative costs and the potential for tax evasion and avoidance, seems both reasonable and persuasive.But what, if anything, does e-commerce imply for VAT in Albania?
Some tax specialists can argue, that real success in taxing e-commerce can be achieved satisfactorily only by increased co-operation between governments, and perhaps even by the adoption of explicit “base-sharing” arrangements. Fortunately, at least for the near and perhaps medium future this issue seems unlikely to be critical. In principle no special problem arises under any VAT with respect to the B2B (business-to-business) services that continue to constitute the bulk of all e-commerce transactions, since in effect the most difficult cross-border issues are handled simply by taxing buyers indirectly (since they receive no input credit to offset against output tax). To work well, however, this system, like all VAT administration, ultimately depends on the efficacy of tax audit, notoriously the weakest point of tax administration, so most will indeed face some problems in practice when it comes to taxing even B2B e-commerce. Moreover, Albania, like all countries, will face further problems in dealing with sales of digitized services to non-registered taxpayers – B2C (business-to-consumer) transactions. For the actual time it is difficult to compel non-resident sellers of such items to register or buyers to report their purchases. For the next few years, probably the main advice one should give to Albanian tax administration with respect to VAT and e-commerce, as with respect to such other “frontier” issues as the treatment of the financial sector and the public sector, is simply to concentrate on the difficult task of first getting an appropriate VAT into place and then running it effectively.The basic question is not how to deal with new issues but rather how one can make a tax like VAT, which essentially depends on self-assessment, function adequately that in many instances do not appear to have satisfied the necessary preconditions for a self-assessment system.The answer, as suggested earlier, may be to spend more time and effort trying to determine what kind of less than perfect VAT will function best in such countries and then working out in more detail the best way in which they can move over time from such unsatisfactory initial positions to a good VAT.