Tax Reform in Market Economies and Economies in Transition: Principles and Experience
Angelo G.A. Faria
What have been the principles of tax reform in market versus transitional economies, in particular as these relate to the role of the state and that of taxation as an instrument of policy?
How does recent experience in tax reform—widening of tax bases and lowering of tax rates—in market economies compare with that of gradual movement away from exclusive reliance on wage withholding and turnover taxes in transition economies?
Should tax reform in transitional economies employ the gradual versus “big bang” approaches?
The dramatic recent political and economic disintegration of the centrally planned economies of Eastern Europe and the former Soviet Union points to the importance of examining, inter alia, the economic reform issues that have arisen, while at the same time highlighting the direction and sequencing of prospective re-form, as these economies undergo economic transition into market economies. An important subset of issues relates to tax reform considerations and, in particular, the insights that may be drawn from the experiences of market economies, not only to Continental Europe but also to East Asia and Latin America. These will be illustrated in this section using a stylized approach reflecting standard characteristics, which contrasts for the two broad groups the role of tax policy, their recent experiences with reform, and the directions of prospective re-form in transition economies. The latter aspect presents special difficulty when dealing with transitional economies because experience is limited and because, for tax reform to be fully effective, it must emerge as a natural outgrowth of, rather than anticipating, more wide-ranging economic policy and structural reform.
Role of Tax Policy
In market economies, the roles of tax and fiscal policies follow from the view of the role of government in organizing economic activities. The earlier view of an activist role for governments appears to be giving way to a more restrictive view that in a market economy, governments exist essentially to promote the development and efficient functioning of market forces over the longer term.1 In this context, “tax neutrality” has been invoked by fiscal experts as the prime guide for a tax system designed to work with market forces. Where, however, “market failure” is manifested because of public goods, externalities, natural monopoly, and asymmetric information, state intervention is observed to be warranted. In these cases, however, the state is called upon to facilitate the provision of, rather than to produce, such goods and services, thus necessitating an explicit transfer of financing resources between the private and the public sectors. It is this limiting view of the financing role of government emanating from both the tax and expenditure sides of the budget which helps to support a restrictive view of the desirable tax burden. Hand in hand with this shorter-term revenue-enhancing role of tax policy is its perceived contribution to short-term economic stabilization. This older Keynesian view of taxes, however, particularly as automatic stabilizers, has given way, because of the shorter lags to a greater emphasis on stabilization through monetary policy instruments. There remain, however, recognized longer-term functions for the tax system represented by its allocative function, primarily in influencing the aggregate consumption/investment resource balance through tax/price wedges and, to a lesser extent, its redistributive function in reducing socially skewed distributions of income and wealth. A more recently emerging role for tax systems—at least in some industrial countries—is through adjustment of energy taxes to reflect environmental concerns. This is discussed more fully in Chapter III. In the last analysis, however, the need to finance burgeoning government expenditure without recourse to inflationary bank financing or augmenting the government debt burden means that, in the short term, the revenue-enhancing objective is more important than other objectives.
By contrast, in economies in transition from central planning, the role of taxation hovers uneasily between its former function as a passive system of predetermined transfers and a more modern role as an instrument of macroeconomic policy that influences the behavior of economic agents.2 The public sector still effectively covers virtually the whole economy, and enterprise activity and employment are largely public in character, with output and prices at both the sectoral and individual firm level only gradually being freed from centralized controls. In this system, taxation of employees has taken the form of withholding taxes on individual earnings, and of payroll-based social security contributions, in a controlled wage-setting environment. For enterprises, a system of regulated volume, price and profit differentials operate, with the result that no tax laws had to be legislated and that a wide variety of arbitrarily established nominal—and more importantly effective—tax rates operated in practice. There was thus no room for unplanned explicit taxation, although implicit taxation probably existed to the extent that planned product prices did not match actual factor payments and other operating costs.3 In place of compulsory explicit transfers between the private and public sectors through taxation, as in market economies, there was a centralization of revenue and its subsequent allocation or earmarking through transfers to other levels of government and to state enter-prises—in essence, a process of cash management based on priorities established under a central plan and modified from time to time. Moreover, other state-controlled subsystems (e.g., monetary, wage setting, prices) also carried out quasi-taxation functions. In addition, the operations of this all-encompassing public sector were also financed through credit obtained on easy terms from the state-controlled banking sector.
Recent Experiences in Tax Reform
• Market economies. The recent evolution of the structure of the tax system in market economies reflects a fundamental shift in taxation philosophy away from interpersonal equity objectives and toward economic efficiency objectives. Efficiency is best secured when it can be established for both taxpayers and tax administrations with certainty and transparency. Thus, in forcing transfer of resources through taxation, the thrust has been to produce lower burdens or deadweight losses. Against this background, there has evolved, over several decades, a complex system of ad personam direct taxes on income and wealth focusing on considerations of horizontal/vertical equity and redistribution, and ad rem indirect taxes (notably the sales tax, VAT, and selected excises) which, although possibly regressive in their effects, do implicitly favor savings and investment. As one might expect, tax reform in advanced market economies has at least in spirit forsaken efficiency optimization in a narrow technical sense for administrative feasibility in developing tax systems that foster compliance and reduce disincentives to private sector investment. Tax systems reflecting such overall features have been broadly evolving in OECD countries, East Asian economies, as well as Latin American countries.4,5
The personal income tax has remained, for most Western countries, the tax choice because of its imposition of a tax burden in line with the individual’s ability to pay, although they have recognized that effective progressivity depends not only on the rate schedule but also on the comprehensiveness of the tax base. This has led to a movement from a schedular system with income differentiation by source and a rate structure associated with each source, toward a global system based on aggregating income from all sources (including fringe or noncash benefits from employment, and also short-term capital gains) and a progressive marginal rate structure. At the same time, considerations of supply-side gains and administrative simplicity have brought about a flattening in rate structures, representing a substitution of linearity based on horizontal equity for progressivity based on vertical equity. This has taken the form of a lesser number of rates; in addition, there has been a significant reduction in the top marginal rate so as to align it more closely with the corporate rate and thereby reduce its disincentive effects and the associated scope for tax avoidance. Contemporaneously, and to sustain revenue yield, the tax base has been broadened by eliminating built-in erosions and rationalizing personal exemption limits in relation to per capita GDP or by family size based on notions of minimum income levels. Finally, to make tax administration more simple and selective, there has been an extension of withholding taxes as final taxes beyond wages to investment income.
In the corporate tax area, reform has taken the form of stressing the importance of an objective definition of profits based on generally accepted accounting principles but taking account of inflation in the valuation of assets and their amortization, and permitting carryforward of losses. There is general agreement on a low, single, tax rate, aligned to the top marginal rate of personal income tax. While some countries, notably the United States and Japan where public companies are more common, still maintain classically oriented corporate tax systems that delink the taxation of corporations and their shareholders, the general drift has been toward the full integration of corporate and personal income tax.
Such integration could be achieved through exemption of distributions from corporate tax in favor of taxing distributions on a gross basis at the shareholder level; alternatively, distributions could be taxed gross at the corporate level, and on a grossed-up basis at shareholder levels but with full imputation or tax credit against shareholder liability for the corporate tax levied thereon. Increasingly, considerations of world efficiency and capital export neutrality have led to the adoption of the full imputation approach, and even “tax sparing,” within the framework of double taxation conventions. These considerations have also contributed to the view that at the margin, a single low statutory tax rate and other noneconomic factors (e.g., political stability, good infrastructure, a lower-paid but educated work force) are more important mixeds in reducing the risk premium for the prospective foreign investor than taxation by itself.
There has been a structural shift in tax structures, with increasing shares for taxes on consumption relative to taxes on income and wealth. With the notable exceptions of the United States, which does not have it, and Japan, which has a different production-based variant, it has been generally recognized that a consumption-type, destination-based, invoice-backed VAT represents the best general tax on consumption for market economies. In this form, only minimal tax base exemptions (e.g., health, financial services, and owneroccupied housing, and, perhaps, some professional services) are retained based on administrative considerations; tax is levied at a single rate; and there is provision for zero-rating of exports and taxation of imports. This is because of its positive revenue and neutrality/efficiency characteristics, although it could be adverse in its redistributive consequences. To mitigate these regressive effects, countries (especially in Western Europe) have attempted to provide substantial tax base exemptions and/or differentiated tax rates for essential and nonessential foodstuffs and other consumption items. VAT systems have been reinforced for sumptuary consumption items (e.g., alcohol, tobacco, and transport and petroleum products) by prior ad valorem excise duties, which, being price inelastic, generate stable revenue. The structural shift mentioned above is especially visible as regards external trade taxes, which are no longer viewed as revenue “handles” and, indeed, even as instruments of effective protection. Rather, the modern view accepts the need to accommodate some protectionist pressure while securing minimum revenue, by adopting a low uniform tariff supplemented by border tax adjustments to eliminate/reduce tariff costs for exported products.
Finally, taxation in advanced market economies has been carried out in the presence of an evolving environment characterized by an open relationship between taxpayers representing the private sector and the tax administrations representing the public sector, based on a mutual recognition of their respective rights and duties. It reflects a clear acceptance by governments that complex tax systems function effectively only if large segments of the population respect and comply with their obligations under the tax code. For their part, taxpayers have tacitly accepted their compliance obligations of filing tax returns, paying their tax liabilities, and responding to requests for information from tax administrations in a timely fashion. In turn, tax administrations have learned to respect the rights of taxpayers to be informed, assisted, and heard; to receive fair treatment; to have all their matters treated with confidentiality; to have their tax liabilities determined with certainty; and to be able to appeal freely against administrative decisions before independent administrative tribunals and/or the courts.
• Centrally planned economies. The basic forms of taxation in formerly centrally planned economies (in order of importance) included various individual levies on enterprises, turnover taxes, payroll taxes, and wage taxes. Enterprise taxes were essentially levies that were presumptive in character, because they were negotiated for each enterprise in terms of its production and distribution expenses rather than as a predetermined share of operational profits established by using objective accounting indicators. Such levies related to, inter alia, the enterprise’s use of resources, rents, amortization funds, and wage levels. Enterprises were also subject to turnover taxes, again established on an individual enterprise basis, levied on a tax base as a percentage of retail prices that represented the difference between planned levels of producers’ costs and retail prices. Because retail prices were fixed while costs varied, this produced multiple effective tax rates but insignificant cascading and avoidance of tax charged. One factor increasing the price of labor as a production input was payroll taxes (including social security contributions) levied at a proportional rate on the gross wage bill. By contrast, workers paid a withholding wages tax at a proportional rate as a final tax on their earnings adjusted for family size. Taxes on foreign trade, together with quantitative restrictions, were designed to capture foreign exchange earnings and to insulate the domestic economy from foreign influences. Finally, although interest on deposits with state banks was not taxable, the state collected specific service fees and charges.
One important distinguishing characteristic of transitional economies was the very marginal function performed by tax administration, reflecting the implications of dominant state ownership and control of economic activities. Thus, the tax administration was not engaged in the traditional functions of assessment, collection and enforcement of taxes. Assessment was essentially plan-determined, with no scope for appeal. Collection took place through transfers between accounts held with the state banking sector. Enforcement through general or selective audits, fines, and penalties was virtually nonexistent because most tax revenue was obtained through a few taxes only, paid compulsorily in one form or another by a relatively small number of state enterprises. As a result, the role of the tax administration was limited to merely verifying the arithmetical correctness of tax-based transfers between bank accounts.
Prospects for Tax Reform in Transitional Economies
All transitional economies have accepted the need for a fundamental restructuring of their tax systems as they evolve from being controlled economies to becoming market economies. This restructuring is necessary to take account of the microeconomic efficiency effects of taxation applied to newly independent economic agents. Also, in the short run, macroeconomic considerations call for maintaining fiscal stability in the face of contracting tax bases and rising demands for significant social welfare and public infrastructural outlays. Moreover, the opening of the economy to the out-side world brings in its wake an increased domestic susceptibility to external economic developments.
While tax reform in transitional economies to be effective cannot be long delayed, it also cannot precede underlying structural change. The central dilemmas for policymakers are how to balance longer-term concerns of equity and allocative efficiency with the shorter-term concern with declining revenue, and whether to go for a “big bang” comprehensive approach in adopting a Western-type tax structure or to proceed more gradually. In practice, they have adopted mixeds of both approaches, in the process saddling themselves with complex distortionary features.6 Experience in East Germany in bringing its tax system more in line with that of West Germany, and of reforming tax systems in other East European economies has shown that significant adjustments become much more difficult to implement in the second round as opposition to them builds up. Moreover, the economies in Eastern Europe are recognizing after more than a decade that reformed tax systems are difficult to legislate, and once legislated, even more difficult to implement unless complemented by institutional, administrative (including legal), and attitudinal changes within the tax administration and taxpayers. The Baltic countries (Estonia, Latvia, and Lithuania) have formally introduced West-ern-based tax systems by decree in 1991/92, but their implementation is proceeding very slowly.
The overall record in transition economies is, at best, mixed. Their VAT systems remain complicated to operate because of the retention in the CIS countries of the origin principle and a cash rather than accruals basis of assessment; multiple rates; excessive exemptions; and mixes of invoice- and accounts-based methods of establishing tax liabilities. Similar multiple rates and excessive exemptions, especially for agriculture, characterize the schedular personal income tax and profits taxes. Land taxes remain primitive, in part reflecting the uncertain situation regarding land titles and thus land values.
Clearly, the normally difficult and drawn out process of tax reform is likely to prove even more so in transition economies. While legislation can often be put in place by fiat, for a modern tax system to take root requires a structural sea change of institutions, laws, procedures and, not least, in the thinking of tax authorities and taxpayers.
Summary of IMF Tax Policy Advice
What are standard IMF recommendations on tax policy?
What mixeds are common to all countries and what mixeds are unique to specific countries?
The Fiscal Affairs Department (FAD) of the IMF has offered advice on tax policy to many countries. This chapter provides an account of the nature and scope of recent IMF advice given to countries in response to their requests for technical assistance on tax policy. It identifies in this advice both common themes applicable to all countries and special mixeds designed to address issues unique to a specific country or countries.7
Reforming the tax system in any country is a complicated undertaking, with its scope and direction frequently circumscribed by many political and economic factors. One unmistakable common goal of tax reform is the simplification of existing tax systems in recognition that overly complicated tax systems tend to generate inefficiencies, inequities, high compliance costs, and tax evasion. With the fundamental tenets of tax policy as described in this Handbook as a basis, the IMF has also advocated the need to enhance the neutrality of the tax system and to lessen the demands on tax administration. In general, the IMF has recommended achieving these goals through either the simplification of the structure of existing taxes or the introduction of new and simple taxes to replace old and complicated ones.
Many of the countries that seek advice are engaged in IMF structural adjustment programs. One critical component of many of these programs is the alleviation of fiscal imbalances that threaten macroeconomic stability. IMF advice has therefore frequently taken into account the need for additional revenues. It has been guided by the principle of designing tax policy measures that would generate adequate revenue to meet budgetary needs in as economically neutral a manner as possible. Nevertheless, in countries where revenue needs were particularly severe or where existing administrative capacities were seriously inadequate, the IMF has also suggested interim measures that may deviate from the long-term goals of tax reform.
To illustrate patterns and trends in taxation, a data base on tax structure for IMF member countries is presented for 1975–1992 in the Appendix (Tables 1-36). Countries are grouped by geographic region and level of development into six country categories: OECD, African, non-OECD Asian, Middle Eastern, non-OECD Western Hemisphere, and Eastern European and transition economies.
The following section examines in greater detail the scope and nature of IMF advice on tax policy.
Nature and Scope of Recommendations
Overall tax revenue
Most countries rely on tax revenue as the main source of funding for the public sector. The size of the public sector—including social insurance—tends to be positively related to the per capita income of the country. Hence, the share of tax revenue in GDP also tends to increase with per capita income. The share of tax revenue in GDP is largest in OECD countries and is smaller in developing countries.8 In 1986–92, this share averaged 30.4 percent of GDP in the OECD countries, 17.7 percent of GDP in the African countries, 14.1 percent of GDP in the non-OECD Asian countries, 13.6 percent of GDP in the Middle Eastern countries, 16.5 percent of GDP in the non-OECD Western Hemisphere countries, and 27.3 percent of GDP in the transition economies (Tables 1-36 (in percent of GDP)).
Domestic consumption taxes
Domestic consumption taxes are a critical component of most tax systems. They comprised from 19.4 percent to 36.6 percent of tax revenues in the different regions of the world in that same period (Tables 1-36 (in percent of tax revenue)).
In most countries, the largest proportion of consumption tax revenues comes from broad-based sales, turnover, or value-added taxes. The overall objective of domestic consumption taxes is to tax the consumption of a broad base of goods and services at a low rate, so that maximum revenue is obtained and the burden is widely spread. Efficiency is achieved through equal treatment of different sectors and activities.
Although many countries make use of multilevel turnover taxes, this results in cascading. Hence, these taxes are inferior to a VAT. Retail sales taxes avoid the problem of cascading but are more prone to tax evasion than a VAT. As a result, the VAT is a good tax.9 IMF advice in the area of domestic consumption taxes has generally focused on the VAT. The IMF has provided extensive assistance to countries engaged in both the introduction or restructuring of an existing VAT Many countries have introduced a VAT in recent years (most notably in the transition economies). Other countries have reformed and simplified their existing VATs (most notably in the Western Hemisphere). In arriving at their recommendations, the IMF has frequently used the experience of the countries of the European Union (EU) as a guide.
The IMF has typically recommended that the VAT have a single rate within the range of 10 percent to 20 percent, depending on revenue needs (with a zero rate for exports) and that exemptions be kept to a minimum. In countries where a single-rate VAT seemed politically infeasible, the IMF has proposed a dual-rate structure (a normal rate coupled with a reduced rate on a limited number of items). FAD has argued strongly against the adoption of a VAT with more than three rates. FAD has also urged against taxing certain goods, principally necessities, at low rates or exempting them. It has favored redistributing income on the spending side rather than on the tax side.
As regards the base of the VAT, the IMF has focused on limiting the scope of exempted items to a few standard ones that are difficult to administer under a VAT, such as rental incomes from housing, financial services, and the agricultural sector, and on taxing all other goods and services, including construction materials, professional and personal services, sales of new buildings, and purchases by government, other public, and nonprofit entities. In selected transition economies, the IMF has departed from typical practice and recommended that the VAT be applied to farmers, because, compared to many countries, the farms are large and few in number.
In a few countries, the IMF has expressed a preference for taxing essential items at a reduced rate over exempting them, but if they were to remain untaxed, it recommended exemption rather than zero-rating. To promote capital formation, the IMF has uniformly recommended the adoption of a consumption-type VAT, although this narrows the base of the VAT relative to a gross- or net-income-type VAT. To maintain international competitiveness, the IMF has also recommended the adoption of a destination-based VAT. For interstate trade among the countries of the Commonwealth of Independent States (CIS), the IMF did not object to the adoption of an origin-based VAT, because of the absence of border controls and other administrative reasons.
The IMF has recommended that the VAT cover the manufacturing stage. In some countries with stronger administrative capacities, it has recommended that the VAT cover the retailing stage as well, with this as the ultimate goal in most countries since this results in the broadest and most efficient VAT. The IMF has been a firm advocate of using the invoice-credit method of accounting. It has frequently recommended that the VAT have a threshold level based on turnover for exempting small traders. This threshold eases the administrative burden with little loss of revenue. In some cases, this recommendation has been coupled with a provision for allowing small traders to opt into the VAT if they wish to credit VAT on their purchases.
The introduction of a VAT requires considerable effort in educating taxpayers and training tax administrators. For this reason, the IMF has sometimes recommended that countries first reform and improve the structure of turnover or sales taxes before introducing the VAT. The recommendations for reform of these taxes are similar to those for the VAT in that they have emphasized broadening the base and simplifying the rate structure.
The IMF has also offered considerable advice on re-form of excise taxes, which most countries already have. Excises have many uses in a system of taxes, including revenue generation with little excess burden, correcting for negative externalities, and enhancing vertical equity. It has generally recommended a five-pronged strategy for excise tax reform: first, to limit the list of excisable goods to a few traditional ones, such as tobacco products, alcoholic and nonalcoholic beverages, and petroleum products (and perhaps vehicles and some luxury goods); second, to replace specific with ad valorem rates to prevent the erosion of revenue by inflation; third, to choose excise tax rates that are internationally comparable; fourth, to tax imports as well as domestic production so as not to disadvantage domestic production; and fifth, to levy VAT on the price inclusive of excises. The IMF has also at times recommended that countries maintain a combination of specific and ad valorem rates if tax administrative capacities are too weak to ensure that goods are valued accurately and if the excises are intended to be externality-correcting.
International trade taxes
International trade taxes are generally a more important part of the tax system in developing countries than in industrialized countries. The lowest-income countries tend to rely most heavily on international trade taxes, primarily import taxes or duties. Trade taxes comprised only 2.5 percent of tax revenues in OECD countries and 93 percent of tax revenues in transition economies in 1986—92 while these taxes ranged from 24.9 percent to 36.6 percent of tax revenues in other regions during that period. Among developing economies, the transition economy countries were an exception, with a relatively low reliance on international trade taxes, reflecting their relative isolation until the past few years and the lack of customs administration.
The last two decades have witnessed many instances of successful growth strategies in developing countries. All of them involved the implementation of outward-oriented trade strategies—lowering trade barriers, removing disincentives to exports, and implementing currency convertibility. Among developing countries, those that have adopted strongly outwardoriented trade policies seem to have shown better economic performance than those whose policies were inward-oriented or only moderately outward-oriented.10
As a consequence, the IMF has generally advised against reliance on import and export taxes. With regard to import taxes, the IMF has acknowledged that there may be some role for temporary import taxes, primarily to provide protection to domestic infant or restructuring industries, and secondarily, to provide revenue. The IMF’s recommendations have typically involved simplifying and rationalizing the structure of import taxes, eliminating ad hoc exemptions, setting a uniform minimum tax on all imports (often well below the existing rate), adopting ad valorem rates, and valuing imports on the basis of market-related exchange rates.
The IMF has strongly opposed reliance on export taxes since they are almost always shifted back to producers. It has viewed export taxes as having a limited role in generating revenue; proxying for an income tax on sectors, such as agriculture, that are difficult to tax; and capturing windfall gains, usually on oil or extractive minerals. Often, export taxes are present in the form of implicit taxes. The IMF has strongly advocated the elimination of implicit taxation on trade through nonmarket-related or multiple exchange rates, marketing boards that set below market prices, or surrender requirements on hard currencies. The IMF has also discouraged export subsidies.
Income taxes are a critical component of tax revenues in all regions of the world, ranging from 23.0 percent to 36.5 percent of tax revenues, in 1986–92 (see Appendix tables). Most countries levy both personal and corporate income taxes, although the breakdown between them varies across countries.
Personal income taxes are the mainstay of tax revenues in industrialized countries, while they are considerably less important in developing countries. Personal income taxes are a valuable component of a balanced tax system; nevertheless, they require greater tax administrative capacity than is found in many developing countries.
The IMF’s recommendations with regard to the re-form of personal income taxes have generally been in line with recent international trends in personal income tax reform. These reforms have emphasized reducing the graduation of the marginal rate schedule and broadening the base by limiting deductions, exemptions, and other tax preferences. The IMF has typically recommended a structure with no more than three brackets, with a top marginal tax rate of no more than 40 percent. Along with changes in the rate structure, the IMF has in many instances advocated raising the threshold for incurring a tax liability (i.e., standard deduction) to remove lower-income taxpayers from the tax roles, to enhance the progressivity of the tax with little loss in tax revenue and simplified administration. In other instances, it has advocated lowering the threshold, especially in Western Hemisphere countries, to expand the base. It has also recommended limiting deductible items, such as the number of dependents, mortgage interest and other consumer interest payments, insurance and pension contributions, savings, and charitable contributions. It has also advocated limiting income exempted from the tax, such as certain income transfers and interest earned on government debt. The IMF has also in many cases recommended reforms to make the tax system neutral to inflation, by indexing brackets, credits, standard deductions, and other nominal amounts to inflation.
The IMF has typically favored the adoption of a global income tax to achieve equity goals; nevertheless, it has at times favored the retention of schedular income taxation in economies in which tax administration is weak and taxpayers tend to earn income from only one source. In countries with a schedular income taxation, the IMF has advocated unifying the schedules that apply to different kinds of income so as not to distort incentives and generate inequities. Although the choice of filing unit is an important issue, the IMF has tended not to recommend changes in prevailing practices.
Corporate taxes are a mainstay of the tax system in many countries, though they typically constitute a larger share of tax revenue in developing countries than in industrialized countries. Nevertheless, their complexity in industrialized countries has made them an important focus of tax reform efforts, even though their revenue yield is modest.
The IMF has generally emphasized the importance of adopting a single, proportional rate for the corporate income tax, typically within the range of 30–40 percent (higher in some regions as revenue needs demand) to enhance the efficient allocation of capital. It has frowned upon graduated marginal tax rate schedules for the corporate tax as a means to increase the progressivity of the corporate income tax. Moreover, it has frequently recommended that personal and corporate income taxes have the same top marginal rate to prevent tax avoidance through the choice of corporate or noncorporate form.
The IMF maintains a widely held view that tax incentives of all sorts have proved to be largely ineffective, while causing serious distortions and inequities in corporate taxation. The IMF has recommended broadening the base of the corporate income tax by eliminating sector- or activity-specific tax incentives in the form of tax deferrals or tax exclusions. The IMF has also typically recommended that all domestic enterprises, including state and private ones, receive uniform treatment under the corporate income tax. In most cases, it has advocated uniform treatment of domestic and foreign enterprises. Nevertheless, leveling the playing field has proved to be one of the most intractable corporate income tax problems.
The IMF has recommended the need to base income on an accruals basis. It has also recommended the adoption of clear rules on deductible costs. It has advised that deductible costs be limited to direct business costs, instead of including charitable contributions, payments-in-kind to workers, and other ancillary costs. It has also recommended limiting deductions on borrowed capital to short-term and long-term interest, but not including debt amortization, since this results in a double deduction for capital costs. The IMF has advocated rationalizing the treatment of capital by formulating simple depreciation rules. At times, it has suggested using accelerated depreciation as an alternative to other forms of tax preferences or as an offset to high rates of inflation. It has also recommended ratio-nalizing inventory valuation and loss carryforward rules. In economies beset by high inflation, as in some Western Hemisphere economies during the 1970s and 1980s, and the transition economies, the IMF has advocated indexation of taxable income and revaluation of assets and liabilities. The IMF has also in some countries focused on taxation of the financial and minerals extraction sectors, since there are many special tax issues relevant to them.
The IMF has also advocated the use of a minimum corporate tax in economies where corporate tax revenues have been seriously eroded as a result of various factors, including political forces that have led to excessive issuance of tax preferences, high inflation combined with large nominal interest deductions, and high rates of tax evasion. The most common recommendation is for a minimum tax on assets, defined variously as gross, net, or fixed assets, as in some Western Hemisphere and other countries. An alternative is a minimum tax on turnover or gross receipts, as recommended in several Middle Eastern and African countries.
Capital gains taxation is an issue relevant to both personal and corporate income taxes. The IMF has taken different views on this issue, in some cases recommending that capital gains be taxed as regular income, and in other cases, that they receive preferential treatment. This ambiguity in IMF advice reflects the general uncertainty in the economic profession as to the effect of capital gains taxes on capital formation and economic growth. In a few anglophone African countries, the IMF has favored taxing only the real portion of capital gains.
Payroll taxes are generally much simpler than income taxes. IMF recommendations in this area have generally focused on broadening the base to include all forms of compensation, including in-kind compensation, when this is feasible; maintaining a simple rate schedule; and choosing rates that are internationally comparable.
The IMF has dealt less extensively in the area of wealth-related taxes since these raise relatively little revenue as a proportion of overall tax revenues. Nevertheless, in many countries, taxes on property and land may be important, particularly for financing local public services. The IMF has recommended reforming these taxes by instituting regular revaluation of property or adjustments in the tax rate so as to maintain their yield in inflationary economies.
The IMF has also dealt with a variety of smaller taxes and taxes that are specific to certain countries or regions. In transition economies, one component of the enterprise income tax (i.e., the corporate income tax) is often a tax on excess wages. The IMF has advised against using this form of tax, while acknowledging it may have some role to play in public enterprises in the short run since, in the absence of competitive markets, it may prevent managers from paying workers excessive compensation. The IMF has also recommended the elimination of a variety of small, nuisance taxes that yield little revenue but require substantial resources to administer. In Western Hemisphere countries with serious environmental problems, the IMF has encouraged consideration of environmental taxes, such as a carbon tax on emissions, and a tax on the use of certain natural resources.
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