U4 Helpdesk Query

U4 helpdesk reply

1. Background (what are the typical opportunities)

In this area of public service the incentives to engage in corrupt behaviour are high for both officials, who can enrich themselves, and bribe payers, who evade taxes. At the same time, taxation regulations are often so complex, that opportunities for corruption abound. The complicated regulations create opportunities for public officials to exercise discretionary powers, thus giving a push to corruption.

Indeed, reduction of opportunities for corruption in tax administration and the change of the incentive structures for tax officers while keeping tax policies simple is one of the most important entry points for curbing corruption in revenue administration. An often quoted successful example is Korea where reform of tax administration led to a drop of reported corruption cases from 45 to 9 over a year, while the tax revenue increased.

For examples of specific measures aimed at reducing public officials' opportunities for corruption (such as standardisation, tax simplification, checks and control, etc.), please see below under "Prevention".

On a general note, a distinction is worth keeping in mind between the public officials being collusive (colluding with non-payers) and abusive (extorting from the compliant tax payers) when discussing the issue of corruption in the tax field.

Another general comment to be made is that the query does not raise the issue of tax evasion per se but relevant discussion points are included, where relevant.

2. Indicators

Several indicators can be used to determine the probability of corruption in a state's tax administration.

Indicators Related to the Institutional Context

Institutional features, such as excessive taxes on income, red tape and inadequate enforcement of regulations are, if not indicative of corruption, definitely a factor that increases the likelihood of corruption in the tax system.

• In a highly corrupt environment, tax evasion is more likely to occur than in a regulated environment with generally functioning institutions. While tax evasion is, by itself, not necessarily linked to corrupt activities, it can, nevertheless, create the opportunity for illicit deals when it is detected. An assumption of a connection between perceived corruptibility of public officials and the underreporting of income by private persons can thus be made.
• Along the same lines, corruption (and certainly inefficiency) in tax administration can - but does not have to - be suspected if there is an unexplained discrepancy in the ratio between the estimated amount of cash in circulation and the actual tax revenue.
• The lack of effective access to information provisions (which would ensure taxpayers are aware of their rights and less exposed to discretionary treatment by corrupt officials) and the absence of credible review mechanisms increase the risk of corrupt dealings.
  " Personal contact between tax officials and tax payers, and discretion in the interpretation of unclear regulations, are conducive to illicit practices.

Staff-related Indicators

• As is the case in any public sector environment, the evidence of public officials living beyond their means - i.e. living to a higher standard than their income would normally enable them to - is an indicator for the existence of corruption.
• The absence of measures designed to maintain the integrity of staff, such as the promotion and enforcement of ethical standards, merit-based recruitment and promotion procedures and regular staff rotation schemes to prevent the building of networks, increases the likelihood of staff exploiting corrupt opportunities.
• Low ethical standards among professions linked to the tax system, such as accountants, are an indicator for the existence of corruption among those in charge of protecting the system against abuse.

Finally, the perception of the corruption of tax officials among members of the public is certainly suggestive of corruption actually taking place. The perception of additional income to be made from illicit deals is highly likely to attract the wrong kind of people into tax administration.

3. Prevention

There are often direct measures in anti-corruption programmes focusing on tax administration, which can include:

Standardisation of procedures
Procedural manuals and electronic forms, made widely available to the tax payers, make the services more transparent, reduce discretion of officials and strengthen accountability and possibilities for controls. Standardised procedures should limit one-on-one contacts between officials and customers and reduce the number of forms/approvals needed (for example through the introduction of "one-stop procedures").

Simplification of the tax system
Tax regulations are often highly complex and include exemptions for many, often poorly defined, cases. This makes the system difficult to understand and gives officials discretionary powers. To prevent corruption, tax systems should have simple and clear rules, few exceptions and clear definitions. If the tax system is perceived to be fair, the incentives for corruption and evasion are diminished.

Professionalism of service
A number of factors can increase the professional standards of tax administration, starting with the appointment of a professional management, instead of politically appointed heads of administration. Staffs need to be recruited and promoted on merit, compensation needs to be sufficient and regular training, adapted to the needs of the staff members, and should be provided. In addition, responsibilities should be clearly defined and functions duly separated. Staff rotation schemes should be put in place to prevent clientelism.

Integrity Systems
Services should be subject to regular internal and external controls. In order to make controls effective, performance standards (relating to revenue targets and service standards) as well as codes of conduct, providing for principles such as conflict of interest, confidentiality of information, etc., should be in place. These codes need to be backed up by effective sanctions, which should include internal disciplinary measures for minor offence and the involvement of law enforcement agencies for more serious cases of fraud and corruption. The establishment of special vigilance units can support internal controls. Customer (tax payer) surveys are useful tools to diagnose problems and monitor the ongoing effects of reforms. A credible, independent and accessible appeals mechanism should be available to the tax payers.

Incentive Reforms
There are a number of studies available on the role of incentive reforms (particularly salary incentives) for public officials in preventing corrupt behaviour. No consensus has yet emerged in literature as to the direct relationship between pay incentives and corruption levels. However, all studies are in agreement as to the fact that pay incentives as a stand-alone measure will not yield much result and have to be viewed as one element of a carefully tailored strategy. If this sub-area is of interest, two papers can be consulted: Dilip, Mookherjee (1997): Incentive Reforms in Developing Country Bureaucracies: Lessons from Tax Administration, World Bank; and Timothy Besley and John McLaren (1993): Taxes and Bribery: The Role of Wage Incentives.

Independence/Autonomy
Establishment of semi-independent Revenue authorities: in some countries, revenue authorities largely independent of the civil service have been set up in order to improve tax collections. These semi-independent revenue authorities have been the subject of various reviews. For one such review, which particularly focuses on measures aimed at the integrity management of officials in such bodies please refer to the TI paper Review of Integrity Management of Staffin the Ghana, Tanzania and Uganda Revenue Authorities.

In the countries studied there had been noted a significant increase in tax revenue in the initial year but the gains were not sustained at a steady level possibly for at least two reasons: a) although staff was carefully selected, there were no integrity management policies put timely in place and b) the initially assigned difference in salaries between the revenue authorities staff and other civil servants was quickly eroded and the special incentive status of the former was diminished.

4. Extent and Effects of Corruption in the Tax System

The effects and consequences of rampant corruption in the tax system are very serious. It reduces state revenues and thus diminishes the capacities of the state to fulfil its obligations. The losses in revenues and thus subsequently in public spending are often completely out of proportion to the amounts paid as bribes. One of the other effects of corruption in this field is that it reduces the distributive function of tax collection and hence contributes to increasing income inequality. Another major impact area is that by driving resources away from public spending, corruption in this field exaggerates scarcities and contributes to growth of corruption across whole of public sector.

In general, the level of corruption and tax evasion in the economy both depend on similar structural and institutional features, such as the degree of risk aversion, the wealth of taxpayers and the wage of public officials, the overall tax burden of the economy, and the organization and the efficiency of the enforcing authorities.

Concrete Facts/ Data

We can provide you with facts (reports/studies) about the extent of corruption in tax administration. However, given the vast range of sources, it would be most helpful if you could specify any specific country or regional preferences for this. As samples, we have compiled below some examples, mainly focusing on Central and Eastern Europe/CIS:

Extent of corruption in the tax field has been found very far-reaching in most transitional economies. Data analysis of registered firms in Poland, Slovakia and Romania show that higher levels of bureaucratic corruption is associated with underreporting of revenue which results in forgone tax revenue for the state. In transition economies and in many developing countries corruption may reduce revenue collection by driving firms (or their most profitable activities) out of the formal sector and by providing a moral justification for widespread tax evasion. Likewise, businesses in the informal sector do not report revenue and therefore do not pay taxes.

A report addressing Tax collection and corruption in fiscal bodies in Russia, states that tax evasion is widespread in the country and the "grey economy" in which no taxes are paid, is estimated to amount to 40% of Russian GDP. It then discusses various auditing strategies as one of the cures to the problem.

- A study on Corruption in Georgia - Survey Evidence is a useful source. The report prepared by the World Bank, based on a survey conducted by the Georgian opinion research bureau international (June/200). Especially relevant for the topic of corruption in tax issues is chapter 7, under the section "Revenue Generation - Tax Service", where some actual figures are given about the extent of corruption found in the tax administration sector (pages 20-21).

A Corruption and Quality of Governance report by the Centre for Strategic Studies and Reform (CISR) TI-Moldova provides insights to the matter as well. The main purpose of this study is to assess the present situation regarding state capture and administrative corruption in the Republic of Moldova and identify priority measures for making a substantive advance in combating corruption. Special attention should be made to section 2.4, where the report presents specific figures about the perception of corruption on tax and customs services.

Some of the Resources Used and/or Recommended

Arindam Das-Gupta (1999): An Anticorruption Strategy for Revenue Administration, World Bank PREM Note 33

A. Acconcia, M. D'Amato, and R. Martina (2003): Tax Evasion and Corruption in Tax Administration

Stefanie Teggemann (2002): Corruption and Fiscal Stability, World Bank page

Michael Waller (2000): Review of Integrity Management of Staff in the Ghana, Tanzania and Uganda Revenue Authorities, TI

Additional Annotated Resources

Odd-Helge Fjeldstad (2003) Fiscal Corruption: A vice or virtue?
(see also author's curriculum page).
Abstract: Recent literature on tax administration in poor countries suggests that inducing more fiscal corruption may contribute to reducing tax evasion and increasing tax revenues. But does such an intriguing paradox justify policies that stimulate corruption? Our answer is no, and this note puts forward three arguments to support our view. First, while an increase in corruption may raise revenues in the short run, in general the opposite will be the case in the longer run. Second, the instrumental value of reducing corruption goes far beyond its effects on tax evasion and tax revenues. Accepting corruption as a policy strategy to increase tax revenues may undermine values of democracy and good governance. Third, eliminating corruption should be considered an end in itself. Thus, contrary to recent suggestions on incentive reforms in tax administration, the reasonable starting point for policy debates in this area should still be that an increase in fiscal corruption is not an appropriate instrument for raising tax revenues. Sustained development cannot grow from an institutional framework that fosters corruption and extra-legal tax enforcement.

Tax evasion, corruption, and the remuneration of heterogeneous inspectors
Abstract: In an economy where corruption is pervasive, how should tax inspectors be compensated? The optimal compensation scheme must take into account the strategic interaction between taxpayers and tax inspectors. Pure "tax farming" (paying tax inspectors a share of their tax collections) is optimal only when all tax inspectors are corruptible. When there are both honest and corruptible inspectors, the optimal compensation scheme lies -between pure tax farming and a pure wage scheme. Paradoxically, when inspectors are hired beforehand, it may be optimal to offer contracts that attract corruptible inspectors but not the honest ones.
URL: http://econ.worldbank.org/docs/1149.pdf

Shifting Tax Burdens through Exemptions and Evasion: An Empirical Investigation of Uganda
Abstract: Tax burdens vary for firms of different sizes due to their variable tendency to seek exemptions or evade taxes. Gauthier and Reinikka look at how prevalent tax exemptions and evasion are among businesses in Uganda, how they translate into actual tax burdens for firms of different sizes, and how the tax administration attempts to ensure compliance. Despite tax reforms undertaken in 1995-97 to increase the efficiency and equity of the tax system and its administration, exemptions and evasion during this three-year period remained widespread and the dispersion of the tax burden did not decrease. The analysis shows that tax evasion is more prevalent among smaller firms, that tax exemptions are more common among larger firms, and that medium-size firms tend to shoulder a disproportionate share of the total tax burden.

Corruption, tax evasion and the Laffer curve
Abstract: Bureaucratic corruption is introduced in a simple way and its effect is examined on government revenue when policies change. The authors show that a rise in the tax rate can lead to a fall in net revenue -- a Laffer curve result due to the proportion of auditors that are corrupt and enforcement costs. It may pay for the government to lower audit probabilities and induce cheating. If corruption is low enough, revenues garnered from capturing people cheating may exceed those from choosing an audit structure in which everyone declares their true income. The authors also examine a case in which corruption is endogenous.