Tax Reform in CIS Countries: MultiStage Transition and a Few Political Economy Lessons

1
Tax Reform in CIS CountriesMulti-Stage
Transition and a Few Political Economy Lessons

• Core Course on Governance and Anti-Corruption
• April 24, 2007
• Luca Barbone

2
Model Multiple party, multistage transition

• Tax reform the result of interaction among
  several parties
• State apparatus
• Old industrial/state interests
• New Industrial interests
• Foreign advice/influence
• Multistage, as it mimicks the change in power
  relations among groups

3
Four Conceptual Stages

• Stage zero Meltdown of old system
• Stage 1 The arrival of the consultants and the
  set-up of the formal system
• Stage 2 Economic interests take over
• Stage 3 Return of growth, yearn for a better
  system, mature politics

4
Stage Zero Institutional-Economic Setting

• Incomplete Institutionsmix of old and new rules
  and substantial lacunae
• Economic declinedrastic drop in GDP
• Dramatic decline in revenues
• Disappearance of the old compliance/control
  mechanisms.

5
Stage 1 Arrival of the Consultants

• Early adoption of a western-style tax system
  (VAT, CIT, PIT)
• Depending on the country, quick implementation
• But complications appear, due to multiple levels
  of government, lack of fiscal discipline,
  enforcement, use of tax administration as a
  political weapon, etc.
• It becomes clear that the binding constraint is
  not legislation

6
Stage 2 Economic Interests Take Over

• Early winners seek to establish rights, and later
  on to protect them, but to protect them they have
  to access the state.
• Hence, economic interests seek direct
  representation in the political process and
  borderline between political and economic
  interests becomes blurred. Political parties
  directly created by economic interest groups.

7
Example UkraineTax Arrears and Amnesties

• In every year between 1996 and 2003 tax amnesties
  were implementedeither sector specific or
  general.
• The combined amnesties issued in year 2001
  amounted to 10 percent of GDP
• Amnesties favored the energy complex and
  agriculture, but also regional interest,
  industries, the works
• Tax arrears were the adjustment variable (in
  parallel with generalized arrears in payments)

8
Example UkraineTax Exemptions and Free Economic
Zones

• Besides tax amnesties, tax exemptions likewise
  became popular.
• Tax exemptions proliferated to cover agriculture,
  industry.
• Emergent practice of tax free zones linked to
  regional political pressure.

9
Stage 3 Self-propelled Modernization

• As growth resumes and economic interests become
  established, demand for rules increases
  endogenously
• Ownership appears, but with unusual country
  characteristics

10
The Faces of the Protagonists
11
Politics in Stage 3 Contrast Ukraine and Russian
Federation

• Ukraine Fractionalized political system,
  resulting in a lot of special-interest
  legislation, and very strange bedfellows
• Russia Stronger control by the executive,
  suppression of opposition, capacity to pass
  legislation.

12
How to approach?

• Avoid innocents-abroad syndrome
• Understand where you stand
• Who are your friends?

13
Lessons Learned (a Partial List)

• Tax legislation is not necessarily the main
  obstacle or even concern for tax reform
• Need to understand the institutional environment
  before offering technical assistance or
  conditionality
• Tax reform is hampered by events that happen
  outside the tax arena need to address those
  (non-payments, regional disputes)
• Tax reform, or more precisely tax incentives,
  make very strange bedfellows
• The workers in the tax complex matteryou need to
  buy them
• Beware of the foreign advisors
• Hire local expertise