Summary of WP/94/104: “Eastern Europe—Factors Underlying the Weakening Performance of Tax Revenues”

Authors of Working Papers are normally staff members of the Fund or consultants, although on occasion outside authors may collaborate with a staff member in writing a paper. The views expressed in the Working Papers or their summaries are, however, those of the authors and should not necessarily be interpreted as representing the views of the Fund. Copies of individual Working Papers and information on subscriptions to the annual series of Working Papers may be obtained from IMF Publication Services, International Monetary Fund, 700 19th Street, Washington, D.C. 20431. Telephone: (202) 623-7430 Telefax: (202) 623-7201 This compilation of summaries of Working Papers released during July-December 1994 is being issued as a part of the Working Paper series. It is designed to provide the reader with an overview of the research work performed by the staff during the period.

Abstract

Authors of Working Papers are normally staff members of the Fund or consultants, although on occasion outside authors may collaborate with a staff member in writing a paper. The views expressed in the Working Papers or their summaries are, however, those of the authors and should not necessarily be interpreted as representing the views of the Fund. Copies of individual Working Papers and information on subscriptions to the annual series of Working Papers may be obtained from IMF Publication Services, International Monetary Fund, 700 19th Street, Washington, D.C. 20431. Telephone: (202) 623-7430 Telefax: (202) 623-7201 This compilation of summaries of Working Papers released during July-December 1994 is being issued as a part of the Working Paper series. It is designed to provide the reader with an overview of the research work performed by the staff during the period.

After some initial success in narrowing budget deficits, fiscal pressures have emerged in most countries of central and eastern Europe. Underlying these developments has been a rapid erosion of revenues. This paper analyzes the factors responsible for the decline of tax revenue/GDP ratios.

In several cases, the longer-term trend decline of revenue/GDP ratios was masked initially by a revenue bonanza from profit taxes: price jumps following price liberalization sharply increased profit tax liabilities due to the use of noninflation-adjusted valuation of inventories and depreciation allowances. Large valuation gains were also made in some cases on holdings of foreign currency deposits of enterprises. As inflation abated, the mitigation or disappearance of this boost to tax revenues brought out starkly in subsequent years the underlying weakness of profit taxes. On a cumulative basis, revenue losses from the taxation of enterprise incomes were the largest source of overall revenue losses, reflecting both a collapse of underlying profits and weak tax administration.

Although discretionary reform policies aimed at reducing the intermediation role of the budget contributed partly to the overall decline of revenues, the main factors responsible for declining revenue/GDP ratios were endogenous. Widening deficits required the adoption in later years of revenue-enhancing measures that offset, for the period as a whole, the impact of early measures to lower taxes.

For taxes other than the profit tax, the main source of dwindling revenue/GDP ratios was a decline of effective tax rates, typically particularly large in the second or third year of adjustment programs, with a continued erosion in subsequent years. This was especially evident for payroll/social security taxes and domestic indirect taxes, and likely reflected weak tax administration, as well as changed patterns of employment and consumption.

Looking forward, the paper concludes that a further large contraction of revenue/GDP ratios is unlikely, except perhaps in cases where inflation remains high and tax revenues may still include taxation of significant valuation gains. The likelihood of an uptrend in output and taxable profits, and of more effective tapping of the private sector tax base, suggest an improved profit tax performance. Moreover, economies commencing economic recovery have displayed more buoyant revenues from other taxes in the past year. However, with several factors still likely to affect revenue performance negatively in coming years, the paper does not expect a strong recovery of revenue/GDP ratios. It says much of the weight of continuing fiscal adjustment will thus have to be borne by keeping real increases in spending well below the recovery of growth.

Working Paper Summaries (WP/94/77 - WP/94/147)
Author: International Monetary Fund