Revenue administration and corruption:

2. At the root of adjustment and growth problems

Huge amounts of revenues cannot be accounted for

Studies in various developing countries indicate that it is not uncommon that half or more of the taxes that should be collected cannot be traced by government treasuries due to corruption and tax evasion. This tax-base erosion is particularly damaging since insufficient domestic revenue mobilisation is considered the root of the adjustment and growth problems faced by many developing countries. These are some examples of the adverse effects of corruption in a country's revenue administration:

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• Significant revenue leakages impacts on the funding available for public service provision (Examples from Guatemala, Ecuador, and Tanzania)
  
  
• Reduction of voluntary compliance with tax laws and regulations through bribe-paying for tax evasion (Example from Uganda showing correlation between firm-size and bribe-paying)
  
  
• Resistance to reforming the tax structure (Example from Indonesia)
  
  
• Erosion of public trust and confidence in government institutions - undermining the legitimacy of government

Other effects of corruption in revenue administration (not further explained on this page):

• Increased costs for individual taxpayers and businesses are often borne by the poorest sectors of the community
  
  
• Maintaining barriers to international trade and economic growth
  

Significant revenue leakages impacts on the funding available for public service provision

For 2003, the Guatemalan revenue administration (SAT) estimated the total tax evasion to more than two-thirds of actual collections. However, the tax evasion rates varied across revenue bases, and represented 29% for VAT, 63% for income taxes, 56% for excises on tobacco, and 46% for tobacco. Another study made on Ecuador, estimated VAT and business income tax evasion in 2001 to be at 21% and 43%, respectively.

In Tanzania, extensive corruption and embezzlement of public funds are documented in a number of reports from both private and official sources. According to a study by the Economic and Social Research Foundation (ESRF) in 1996, official import statistics underreported the value of imports by as much as 70%. One indication of the extent of this problem was that some types of textiles (including those used in the most popular type of clothing, the 'khanga') were sold for 30% less than the value of the customs duty per metre of the textile. Official statistics on reported revenue from customs duties also indicated large leakages. While the most commonly applicable import duty rate at the time was 30%, the customs tariff generated a revenue equivalent to less than 6% of the official import value during that period.

For further details on the extent of revenue leakages in Guatemala see Are semi-autonomous revenue authorities [SARAS] the answer to tax administration problems in developing countries? - a practical guide.

On Tanzania, see the the paper Fighting fiscal corruption: The case of the Tanzania Revenue Authority.

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Reduction of voluntary compliance with tax laws and regulations through bribe-paying for tax evasion

Bribe payments to tax officials are a means of gaining favours in the form of reduced tax obligations or payments. Bribe payments to public officials lead to inequities and inefficiencies in tax administration, since they result in a transfer of a public resource to private agents - reducing government revenues. Bribes also constitute a major impediment to equitable and efficient tax administration, placing firms that do not engage in such practices at a competitive disadvantage.

In a business survey conducted in Uganda in 1998, which covered 243 firms, as many as 43% said they were paying bribes to tax officers occasionally or always, while 38% reported paying bribes to customs officials. The frequency of bribe-paying increased with firm size. However, the actual burden of bribe extraction by public officials was the heaviest for medium sized firms (26-75 employees). These firms paid 3.5% of their sales in bribes, equivalent to 60% of what the average-sized firm actually paid in taxes. This was 29 times more per unit of sales than larger firms, and 9 times more than smaller firms.

For more details see Shifting tax burdens through exemptions and evasion - an empirical investigation of Uganda.

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Resistance to reforming the tax structure

Extensive corruption may have negative impacts on the possibilities for reforming the tax system. For instance, important stakeholders, including bureaucrats and politicians, as well as powerful taxpayers, may resist changes in an attempt to protect their influence and control of the tax system. The strongest resistance to tax reforms in Indonesia in the early 1990s came from the tax officials themselves, since they had the most to lose from the depersonalisation and simplification of the tax system. Tax collectors actively opposed simplifications in property tax administration, income tax laws, and tariff structures. Indonesia is not unique in this sense, and some observers argue that the extensive public sector regulations and complicated tax systems observed in many poor countries are the result of a deliberate strategy by civil servants, including senior tax officials, to facilitate corruption.

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Erosion of public trust and confidence in government institutions - undermining the legitimacy of government

Taxation is essential for shaping state-citizen relations. It almost goes without saying that fiscal corruption is counterproductive to establishing productive state-society relations. Survey research from a number of countries concludes that citizens in general view corruption negatively, including in countries where it is widespread. A study of bribery in the Czech Republic, Slovakia, Bulgaria and Ukraine, for instance, found that public opinion in all four countries is against corruption. The morality of public office holders is therefore an important source of government trustworthiness.

Fiscal corruption is likely to undermine government trustworthiness and thereby the legitimacy of the government. When the institutions are legitimate, citizens have a predisposition to consider obedience to them as reasonable and appropriate. A government's lack of legitimacy on the other hand diminishes almost by definition the perceived moral justification for obeying its laws. Of particular importance in this context is that citizens' disrespect for tax laws may initiate disrespect for other laws, leading to a vicious circle where distrust breeds distrust. In contrast, government trustworthiness and widespread public support tends to legitimise the public sector, and may so impose some social norm for paying taxes.

These issues are further elaborated in the paper Fiscal corruption: A vice or a virtue?

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