Revenue Administration Reform in Middle Eastern Countries, 1994-2004

Contributor Notes

Author(s) E-Mail Address: williamcrandall@canoemail.com and jbodin@imf.org

The paper provides an overview of revenue administration reforms implemented in Middle Eastern and North African countries over the past decade with IMF assistance. Although reforming tax and customs administration is neither quick nor simple, several countries in the region have embarked on comprehensive programs of reforms to modernize their revenue administration, and encouraging progress has been achieved. Experience shows that there are many challenges to be faced and that critical requirements need to be met, including political commitment, strong leadership, willingness to abandon ineffective practices; and establishment of reform projects with clear mandates, agreed objectives, and realistic timeframes.

Abstract

The paper provides an overview of revenue administration reforms implemented in Middle Eastern and North African countries over the past decade with IMF assistance. Although reforming tax and customs administration is neither quick nor simple, several countries in the region have embarked on comprehensive programs of reforms to modernize their revenue administration, and encouraging progress has been achieved. Experience shows that there are many challenges to be faced and that critical requirements need to be met, including political commitment, strong leadership, willingness to abandon ineffective practices; and establishment of reform projects with clear mandates, agreed objectives, and realistic timeframes.

Introduction

The purpose of this paper is to review revenue administration reforms implemented over the past ten years in selected Middle Eastern and North African countries, including Afghanistan, Algeria, Egypt, the Islamic Republic of Iran, Jordan, Lebanon, Mauritania, Morocco, Pakistan, Saudi Arabia, Sudan, Tunisia, and Yemen. These countries have been selected from among those where IMF Fiscal Affairs Department (FAD) technical assistance (TA) in tax and customs administration has been requested in the past ten years. It is important to mention that, in recent months, other countries, including Libya and Syria, have also requested FAD TA to support implementation of their revenue administration reforms.

In the Middle Eastern and North African countries,2 an important goal is to improve the structure and administration of the tax and customs systems to enhance efficiency and (non-oil) revenue mobilization. The provision of TA in these areas is the responsibility of the FAD Revenue Administration (R1) and Tax Policy (TP) divisions.3

This paper provides a discussion of: (1) key background features and revenue performance in the Middle Eastern region; (2) revenue administration reform and policy issues; (3) revenue administration reform and progress in the region over the past ten years; and (4) an assessment of the reforms that have been implemented.4

I. Background on the Middle Eastern Region

Revenue structure and interregional comparisons

Despite inherent difficulties in regional comparisons,5 it is useful to examine Middle Eastern countries’ tax revenues in the light of performance in other regions. Table 1 presents a regional comparison for the period 1997–2001. It is clear from the data presented that tax revenues for the Middle East over this period are low by worldwide standards, reflecting a variety of factors but certainly contributing to a desire on the part of many governments to make revenue administration reform a priority.

Table 1.

Non-Oil Revenue Structure (Central Government)—Regional Average, 1997–20016

(In percent of GDP)

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Source: IMF.

In terms of particular countries in the region, Table 2 examines revenues for selected Middle Eastern countries over a ten-year period, comparing 1990 with 2000. Focusing on tax revenues, there are improvements in Lebanon and Tunisia, and to some extent in Jordan and Morocco. However, in other countries, tax revenues as a percentage of GDP have declined (including in Algeria, Egypt, Mauritania, and Yemen). Interpretation of these variations would need to take into consideration a variety of factors ranging from changes in the tax system (including in the level of tax rates and customs tariffs, and the scope of exemptions) to modifications in the political, social, and economic circumstances. Moreover, in the five years since 2000, there have been many further changes, particularly for those countries that introduced the value-added tax (VAT) after 2000.

Table 2.

Revenues as a Percentage of GDP in Selected Countries, 1990 vs. 20007

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Source: IMF staff compilations.

As a further general comment, while trade taxes (excluding VAT on imports) have generally decreased, they still remain relatively high in the Middle East compared with the rest of the world (see Table 3 on trade taxes as a share of total tax revenue). Only Africa is higher.

Table 3.

Trade Taxes as a Share of Total Tax Revenue, 1980–98

(Unweighted averages, in percent of total)

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Source: Michael J. Keen, ed., Changing Customs (Washington: IMF, 2003).

Combined with the spread of the VAT (see below), this has implications for customs administration reform because the revenue collection role of customs in the Middle East will continue to be critical for the foreseeable future.

Petroleum issues

Many countries in the Middle East have revenues available from mineral resources (especially hydrocarbon). For some countries, this has meant a reduced interest in (non-oil) tax revenues, and consequently little incentive to develop effective revenue administration. Historically, in some countries, little priority was given to the revenue administration and collection procedures for taxes and levies, which were often based on antiquated, ineffective systems (usually involving extensive negotiations between taxpayers and tax officials).

More recently, given the realization that oil and gas revenues are in fact exhaustible, volatile, and uncertain, the complex issues of sustainability and intergenerational resource allocation have led several countries to rethink the importance of tax revenues. Some Middle Eastern countries have now embarked on fiscal reforms intended to reduce their dependence on hydrocarbon revenue, and others will follow. As is the case for revenue reform instituted for any reason, this will entail establishing the proper tax policies and administrative structures for a modern and effective tax system based on voluntary compliance.

Historical influences

In many countries of the region, revenue administrations have also been influenced by the French and British revenue administration traditions. This has led to fragmented tax administrations, including: (1) the split of tax administration functions (e.g., in Morocco and Mauritania), with the collection function being assigned to the treasury (Comptabilité Publique), rather than the tax administration; and (2) the split of direct and indirect tax operations (e.g., in Egypt and Jordan until recently), with the responsibility for domestic tax operations (VAT and income tax) fragmented between two separate administrations. In the context of best international practice today, these fragmentation characteristics are considered ineffective and inefficient. Many countries in the region have realized that reforming these outdated organizational structures can lead to significant benefits, including more effective and efficient tax administration and improved taxpayer compliance.

The case of the VAT

One of the most significant tax reforms in the Middle East over the past decade or so has been the introduction of the VAT. This is part of a worldwide phenomenon. In 1969, only 8 countries had a VAT; by 2004, this number had grown to 126. Prior to 1990, among the 13 Middle Eastern countries reviewed, only two had a VAT (Morocco and Tunisia). Today, seven more have been added (Algeria, Egypt, Jordan, Lebanon, Mauritania, Pakistan, and Sudan), and legislation has been drafted in three others (the Islamic Republic of Iran, Saudi Arabia, and Yemen). The revenue-raising potential of the VAT has been an obvious reason for its spread throughout the region. Indeed, worldwide experience shows that a well-designed VAT, with a broad base, limited exemptions, a single rate, and a high threshold, can be an efficient revenue-raising instrument8 and a powerful vehicle to modernize the tax administration.

An IMF November 2000 study9 has shown that VAT performance has been a major component in the growth of tax revenue in a number of developed and developing countries and that it constitutes a significant share of total revenues—on average, about 25 percent of total tax revenue and more than 5 percent of GDP. Box 1 below summarizes the key design features that are conducive to good VAT performance.

Key Design Features that Are Conducive to Value-Added Tax Revenue Performance

Base. Standard advice is for a broad-based VAT with exemptions limited to basic health, education, and financial services. The consequences of exemptions, including those on retailers and service providers, are adverse. Experience shows that implementation of a consumption tax at the import and manufacturing stages creates definitional problems (what exactly is “manufacturing,” and how should one treat a manufacturer with retail outlets?). Restricting the consumption tax to certain categories of goods and services limits the tax base (a large part of the economy escapes the tax net) and distorts commercial decisions.

Rate. Adoption of more than one positive rate and use of a zero rate for domestic transactions have a significant negative impact on tax administration. It also significantly increases taxpayers’ compliance costs. Experience shows that the redistribution that can be achieved through indirect taxes is intrinsically limited. The key point here is that even if the poor spend a large proportion of their income on particular items such as food, the rich will typically spend a larger absolute amount, so a reduction in the rate actually transfers more money to the rich than it does to the poor. This is why the majority of “modern” VATs implemented in recent years have a single positive rate and a zero rate limited to exports.

Registration threshold. The level of the threshold at which registration for the VAT becomes compulsory is critical for its successful implementation. This is the case especially in countries with weak administrative capacity where it is obvious that the capacity of small businesses to issue invoices and maintain proper books and records is problematic. In these countries, absent a sufficiently high (turnover) registration threshold, implementation of an account-based, self-assessed VAT is unrealistic.

Table 4 reflects some of the wide diversity of experience in VAT (from November 2000), reflecting that, for example, the standard rate varied from 3 percent in Singapore to 25 percent in Denmark and Sweden. There is considerable variation in the yield of the VAT—several countries garner less than 1 percent of GDP in VAT revenue, while at least five raise over 10 percent of GDP.

Table 4.

Value-Added Tax Features by Region, November 2000

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Source: IMF staff calculations.

As evidenced in Table 5, in the Middle East today there is also wide diversity in the characteristics and results of the VAT:

Table 5.

Characteristics of the Value-Added Tax in Middle Eastern Countries, 2004

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Source: IMF staff calculations.

The standard VAT rate (unsurprisingly) has a significant impact on revenue.

Despite this diversity, and while both inter- and intraregional comparisons can be affected by many factors, two conclusions emerge: the VAT has an important impact on tax revenues in Middle Eastern countries, and VAT performance in these countries compares well with developing countries and transition economies.

Other important issues associated with the VAT (including design, organizational structures, and impacts of the VAT on the reform of tax administration) are discussed below.

II. Revenue Administration Reform and Policy Issues

Role of revenue administration, and the need for reform

The role of revenue administration (tax and customs) is to collect taxes as specified in the law.11 However, how the administration goes about this responsibility is critically important to the effectiveness of the tax laws themselves. Until the early 1990s, it was thought by many that strong enforcement was the key to successful revenue administration. In today’s context, it is considered that an effective and efficient revenue administration is one that will ensure compliance through a balance of reliable services and education, and targeted audit and enforcement activities.

When this objective is achieved, a modernized revenue administration will be characterized by a function-based structure with a strong headquarters, fully automated business processes, risk-based compliance programs, and skilled and professional staff acting with fairness, honesty and transparency. The revenue administration will maximize the collection of taxes according to the law, at the lowest acceptable cost to the government (administrative cost) and to the taxpayer (compliance cost), and will be adequately resourced, effectively managed, and independent from political processes.

This overall objective is valid for all countries, including those in the Middle East. However, for many economies in the region and elsewhere significant effort is needed to achieve it. For this reason, most countries have embarked on programs of revenue administration reform, beginning in the 1980s for many developed countries, and in the 1990s for others. Most Middle Eastern countries began serious efforts at reform in the 1990s.

Based on experience, many benefits can result from revenue administration reform:

For revenue administration reform to be successful, critical requirements have to be met, including: a strong political commitment to reform, with clear decisions and the provision of necessary resources; professional and stable leadership; a willingness to abandon old, ineffective practices; and the establishment of a formal reform project with a clear achievable mandate, agreed objectives, and realistic timeframes. The absence of these requirements has impeded the progress of reform in several countries, including some in the Middle East.

Reforming revenue administration is neither quick nor simple. There are a great many challenges to be faced, and these tend to mirror the preconditions for success. Some of the major ones confronting most Middle Eastern countries include the following.

Low levels of compliance with the tax laws. A common challenge all countries face is the need to reduce noncompliance with tax laws. However, while noncompliance exists everywhere in a variety of forms, the lack of systems to identify critical compliance risks and the lack of capacity to develop and implement effective compliance strategies are significant matters of concern in most transition economies and developing countries.

A number of factors have an impact on compliance levels. For instance, public attitudes and respect for government institutions affect compliance, especially in countries where the payment of taxes has not been historically important or disciplined. The nature of the tax system—simplicity and stability of the laws and the tax rates—is also a major determinant in compliance. Other factors, ranging from the public perception that the government provides inadequate quality services to the degree of development of the banking systems and the effectiveness and efficiency of the revenue administration, are also important.

Insufficient political commitment. The lack of commitment to, and understanding of, reform efforts on the part of political leaders is another challenge faced by revenue administrators. Many features of revenue administration reform—such as streamlining the tax office networks, transferring collection responsibilities to the tax department, merging direct and indirect tax administrations within a single agency, and moving to postrelease audits to properly manage risk—have been opposed in several countries. Political leaders have also failed to take action to sustain reform, and sometimes have denied support to revenue administrations in using enforcement powers provided by the law.

A lack of capacity, expertise, and resources. There are examples of countries that have embarked on major reforms in the 1990s, often with considerable TA from donors, but their success has been impeded by restricted capacity in management and an insufficient level of expertise. The result has been an inability to sustain the initiatives that have been launched. Reform initiatives also require time, effort, and human and financial resources. Too often, the true costs of reform initiatives are not considered at the outset, with the result that initiatives lose momentum and incur extensive delays.

The role of customs. Customs administration in this paper deals with the revenue-related aspects of the work of customs in the Middle Eastern countries. While the customs role in relation to direct taxes is limited (consisting mainly of information exchanges with tax administrations and, in a few countries, collection of withholding income tax on imports), it has a crucial role with respect to indirect taxes. Since these taxes are generally levied on a destination basis, it falls on customs to play a key role in ensuring that commodities entering and leaving a country are subject to the appropriate tax regime. In this aspect, the role of customs has increased because of the spread of the VAT in several Middle Eastern countries.

Reform of customs administration has been every bit as much a worldwide phenomenon as tax administration reform, and the Middle East has been no exception. One key purpose of customs reform and modernization is to remove impediments to trade; in other words, to minimize administrative costs incurred by the government and compliance costs incurred by traders in a manner consistent with legislative and policy objectives. In the past, the whole process of assessing and collecting trade taxes was built around extensive physical inspection of shipments at points of entry. This process was often complicated by outmoded legislation and trade tax policies that involved extensive rate differentiation and pervasive exemptions. Prior to reform initiatives, customs administration was characterized by poorly designed procedures, an inability to exchange information with other branches of the revenue administration, widespread corruption, and poor relationships with the private sector.

Customs modernization and reform involve fundamental changes in the overall customs environment and in the way in which customs administrations discharge their mandates. Based on best international practice,12 changes are normally required in four key areas.

Customs administrations around the world, including many in the Middle East have concluded that reform of this nature requires both political commitment and comprehensive strategic planning.

Policy issues

Tax policy is a critical responsibility for all ministries of finance. For some time now it has been recognized that effective tax policy can never be a reality without an effective tax administration, and that administrative capacity to implement tax laws is a prime determinant of the results those laws will produce.13

Experience with tax reform initiatives undertaken by countries in the past decade shows that tax policy changes can only provide the expected results when sufficient attention has been paid to implementing appropriate administrative support. The experience of Commonwealth of Independent States (CIS) countries in which a VAT law was hastily introduced in the early 1990s illustrates this kind of problem. In some cases, tax authorities are still struggling to administer the VAT properly, and it has not yet been possible to establish the conditions for an account-based, self-assessed VAT. Similarly, many of the African and Middle Eastern countries that were advised by tax policy experts to introduce a global income tax in the early-1990s have not yet been able to establish the systems needed to ensure the effective control of a taxpayer’s global income.

It is equally true that complexities in tax laws can compromise tax administration. In many cases, complex and complicated measures offer only marginal advantages from a tax policy perspective with disproportionately high inefficiencies in administration, and a resulting reduction in overall effectiveness. For Middle Eastern countries, some of the tax policy concerns influencing tax administration are set out below.

Simplification of VAT laws. Notwithstanding the encouraging results achieved with the VAT in some Middle Eastern countries, there is still a significant need to improve the structure of this tax. Common problems include registration thresholds that are too low (and, in some countries, multiple thresholds), an unnecessarily complex rate structure, and too many exemptions. However, there are some encouraging trends in these areas including a move toward broadening VAT bases, including retail and services (e.g., in Jordan, Lebanon, Pakistan, Morocco, and Mauritania); some countries have substantially increased registration thresholds (e.g., in Jordan, Lebanon, and Pakistan); and there has been some movement toward a single rate structure (e.g., in Lebanon, Mauritania, Pakistan, and Sudan).

Elimination of exemptions. The widespread use of tax exemptions in Middle Eastern countries, as in other transition countries, has an obvious negative impact on revenues. In addition to losses of revenue, tax exemptions contribute to the complexity and lack of transparency of tax systems and can lead to harmful tax competition, which may have a global, long-term negative impact on tax bases. The IMF has consistently advised in favor of broadening tax bases, decreasing tax rates, and providing appropriate depreciation and capital allowances to promote an environment conducive to investment, instead of granting concessions. In any case, when these concessions cannot be avoided, exemptions should be strictly limited in terms of coverage and duration to avoid widespread abuse.

Simplification of income tax. In some Middle Eastern countries, the move toward global income tax systems to replace schedular income taxes is still seen as desirable in the medium to long term. However, it is widely recognized that this reform should be adopted only when appropriate capacities to administer a modern income tax system have been developed (e.g., to support implementation of the new income tax law adopted in 2005, Egypt has embarked on a major reform to improve the capacity of the tax administration). In addition, the simplification of income tax systems has been a common trend together with a search for more effective taxation mechanisms, including withholding and presumptive taxation systems, the latter developed for small and hard-to-tax groups of taxpayers. For example, a simplified regime, the “forfait” has traditionally been applied to small taxpayers below a turnover threshold in most Francophone countries, including Algeria, Mauritania, Morocco, and Tunisia. Moreover, in implementing their income tax reforms, countries like Egypt and Lebanon are also developing simplified taxation system for their small taxpayers.

Trade policy. As noted earlier in this paper, there have been many changes in trade policy in the Middle East (e.g., Egypt, Lebanon, and Morocco) and elsewhere over the past 10 to 15 years. A good example is the desire and need to simplify customs tariffs and reduce the large number of rates that exist in many countries. This can have a significant impact in terms of effective administration and reducing the burden of compliance on taxpayers. Not only do customs administrations have to adapt to such changes, but the way in which they modernize their activities will have a direct impact on the effectiveness of trade policy reforms. For example, a fully modernized and effective customs administration will be the prime source of information for all trade-related statistics. Most customs administrations have this responsibility, and their support is crucial for an effective trade policy function. In addition, customs administrations are required to provide important input on the enforceability of trade policy changes being considered. Finally, the effectiveness with which customs administrations carry out their basic functions such as classification, valuation, and origin determination has a major impact on the effectiveness of basic trade and tax policies.

Historically, some customs administrations have been hesitant to embrace modernization. There appear to be two main reasons for such resistance to change. The first, a common problem, is a general resistance to the inevitable organizational disruption that occurs in a modernization initiative. The second relates to the impact that simplified procedures and transparent operations could have on opportunities for corruption and other rent-seeking.

Customs administrations willing to modernize can reap significant benefits in terms of more effective and efficient tax and trade policy administration. Successful reform will require a significant redeployment of resources and energies toward new or revised functions: a strengthening of valuation capabilities; a reduction in physical inspections with the introduction of risk profiling and targeting systems to support post-clearance audits; improved origin determination; and major improvements in monitoring exemptions and suspensive regimes.

III. Reform Effort Over the Past Ten Years in the Middle East

Tax administration

As a means of assessing tax administration performance over the past decade or so, Appendix I identifies certain features of tax administration in the countries reviewed, and summarizes the status of these features in the early 1990s versus today. These features represent areas where FAD has provided tax administration recommendations to Middle Eastern countries over the past decade. By looking at the situation in the early 1990s and comparing it with today, a snapshot emerges of the overall extent of tax administration reform and modernization. This appendix presents a high-level summary, which, by definition, cannot describe all the nuances of each category. It is a “best-fit” exercise only.14 Based on this information, it is possible to form some initial conclusions about progress in the Middle East in each of the tax administration areas.

Reform strategy. Not a single country of those surveyed can be said to have had in place a detailed and comprehensive tax administration reform strategy more than a decade ago. Now, nine have a full reform plan in place, and two others have a strategy considered to be in its early stages. Traditionally, developing and transition economies have a critical weakness in their lack of capacity for strategic planning, and reform efforts will be suboptimal without addressing this concern. This is a major reason why FAD has more recently focused on upstream15 or strategic TA, in coordination with other donors that support implementation of the revenue administration reform programs. Delivering these programs still represents a major hurdle for countries in the Middle East, but the strategic processes and the political commitment have come a long way in several of them.

VAT. The statistics on the VAT were discussed earlier in this study and have been included in Table 6 in Appendix I to provide as complete a picture as possible. In countries with an integrated, function-based tax organization, it is important to note the impact that introduction of the VAT has had on other aspects of tax administration, from introduction of self-assessment and reorganization of the tax administration to taxpayers services and enforcement programs, and development of information technology (IT) strategies. Many of these are referenced in the sections below.

Self-assessment. Self-assessment refers to a system of voluntary compliance whereby taxpayers comply with their basic tax obligations without intervention from a tax official, based on information they receive about their tax obligations. The taxpayer completes a tax return to accurately identify all tax liabilities and submits it voluntarily with the payment. When this does not occur, the tax administration takes the appropriate enforcement action. The principle of voluntary compliance is grounded in two key ideas: tax administrations have limited resources, and taxpayers have the best information about their tax liabilities. There are many advantages of self-assessment: reduction in the cost of tax administration; opportunity to use staff more effectively; fewer taxpayer disputes; speedier collection of revenue, combined with proper risk-based audit, more effective deterrence and detection of evasion; and potential increases in overall revenue. Tax system design should therefore reflect this reality.

In the Middle East a decade ago, only four countries could be said to have a basic self-assessment system—Algeria, Mauritania, Morocco, and Tunisia. Now, Jordan and Pakistan can be added to the list of those with a self-assessment system, with a further four countries having introduced self-assessment in connection with the VAT (Egypt,16 Lebanon, Sudan, and Tunisia), and some self-assessment efforts having been started or planned in the Islamic Republic of Iran, Saudi Arabia, and Yemen. Despite a history of resistance to self-assessment17 in developing countries, the Middle Eastern countries have made realistic progress in introducing self-assessment, although this progress is almost entirely an offshoot of the VAT.

Function-based organization. In many countries, the administration of domestic (both direct and indirect) taxes has been structured along a functional basis. This involves consolidating activities and resources based on business processes and commonality of function, such as audit, collection enforcement, and taxpayer services. Strong functional units are established in headquarters with a capacity for strategic and operational planning, technical advice, performance measurement, and monitoring and evaluation. This produces improved management and control, effective specialization, economies of scale, better use of infrastructure and facilities, and simpler and more consistent treatment of taxpayers.

In the Middle Eastern countries a decade ago, only some of the French legacy countries (e.g., Algeria and Morocco) had function-based organizations. By 2004, both Jordan and Pakistan moved forward to introduce functional organizations for tax administration; Egypt, Sudan, and Lebanon had done so in respect of VAT. Afghanistan is planning a functional approach. A total of 11 of the 13 countries reviewed either have moved or are now moving toward function-based organizations.

Integrated direct and indirect tax administration. A key strategic recommendation of FAD over the past ten years has been the integration of direct and indirect tax administration, or more specifically the integration of VAT and income tax administration. There are demonstrable advantages to this type of organization, which: (1) facilitates implementation of function-based operations; (2) reduces the costs and compliance burden for taxpayers, and permits more efficient operations for the tax administration; (3) increases the effectiveness of tax administration with common registration, collection, and audit functions; and, (4) facilitates synergies when modern practices for VAT can be levered to the entire tax organization. Of 126 countries that currently have a VAT:

The issue of integration is particularly relevant where a country has introduced a VAT. As noted earlier, in the Middle East, nine countries have a VAT (Algeria, Egypt, Jordan, Lebanon, Mauritania, Morocco, Pakistan, Sudan, and Tunisia), and legislation has been drafted in three others (the Islamic Republic of Iran, Saudi Arabia, and Yemen). Of the 13 countries reviewed, 5 already have an integrated tax administration (Algeria, Jordan, Morocco, Tunisia, and Mauritania), and 5 others have developed elements of integration or are planning to integrate their organizations (Egypt, the Islamic Republic of Iran, Lebanon, Pakistan, and Yemen).

Large taxpayer offices (LTOs). A special office for large taxpayers, within the tax department, has long been advocated for the domestic tax administration. Such an office reduces noncompliance among large taxpayers and ensures better services to them, serves as a pilot to introduce administrative changes (e.g., a function-based organization and self-assessment), reflects critical differences between large taxpayers and others, and provides an appropriate focus on the majority of a country’s tax revenues. FAD recommends full-service LTOs as the means of achieving these desired objectives. In the early 1990s, none of the countries surveyed had a separate office for large taxpayers. Today, 10 countries (Egypt, the Islamic Republic of Iran, Jordan, Lebanon, Mauritania, Morocco, Pakistan, Saudi Arabia, Sudan, and Yemen) have a LTO and 2 (Afghanistan and Algeria) are planning to establish one.

Other segmentation—medium-size and small taxpayers. It is now widely recognized that a function-based organization is more effective than a tax-type organization. Additionally, a recent trend in several countries is to also orient the tax administration organization around key segments of the taxpayers. These countries have established special offices and/or programs to deal with specific segments of taxpayers, such as large taxpayers, medium-size businesses, and small enterprises and individuals.19 In these countries, the tax administration organization uses a combination of segment-type and function-type criteria, which allows the tax administration to improve the allocation of the available resources and its programs by tailoring them to the compliance pattern of different segments of taxpayers (Box 2).

In the Middle Eastern countries, there have been some developments in further taxpayer segmentation beyond that for the largest taxpayers. Algeria and Jordan are considering the creation of special offices for medium-size and small taxpayers, and plans are being formulated for a taxpayer segment approach in Afghanistan, Egypt, Morocco, and Pakistan. These efforts represent the very first inroads into additional taxpayer segmentation in the Middle East, which lags behind other regions in this aspect of tax administration reform.

TIN. A unique taxpayer identification number (TIN) controlled by the tax administration and used for all taxes, including those collected at importation, is essential for an effective tax administration. None of the surveyed countries had a proper TIN in the early 1990s, and today eight countries (Afghanistan, Egypt, Jordan, Lebanon, Mauritania, Morocco, Pakistan, and Saudi Arabia) have introduced a TIN that meets the above definition. Sudan and Yemen have made some progress but still have a certain distance to go. It is clear, however, that in the region the full utilization of a unique TIN is proving difficult for many tax administrations.

Taxpayer Segmentation

While a functional and integrated approach to tax administration leads to better utilization and deployment of resources than fragmented and outdated structures, there is also a need to recognize the different risks, requirements, and contribution to overall revenue of the various segments of the taxpayer population. It is vitally important for a tax administration to understand its client base, particularly the different segments that constitute the taxpayer population. The advantages of this approach include: (1) strengthened accountability for organizational outcomes; (2) allocation of resources based on risk to revenue; and, (3) better matching of enforcement, service, and educational programs to specific types of taxpayers.

The large taxpayers are typically distinct legal entities. They are few in number but often with many employees; have high turnover; are often involved in complex international transactions, perhaps through subsidiaries or related companies; may wield influence within government circles; and maintain proper books and records, but with professional accounting and legal assistance to interpret the law to their advantage. The importance of large taxpayers to revenue is clear. If compliance for this group declines, the impact can be substantial. This is why, in recognition of the importance of large taxpayers, many countries have instituted special measures for this segment, usually by establishing a large taxpayer office (LTO).

In contrast, a moderate number of medium-size businesses often have less formal structures, such as sole proprietorships or partnerships; fewer employees; and moderate levels of business activity that are often cash based, but with possibly less diligent bookkeeping resulting in opportunities to underrecord income and evade tax. The demarcation between the large, medium, and small taxpayer segments can sometimes be obscure. However, in many countries the dividing lines are based on turnover and a cutoff is determined for the largest taxpayers. A cutoff point for the medium taxpayer segment is often deemed to be the VAT registration threshold in view of the record-keeping obligations for VAT.

A potentially much larger segment of small businesses poses many difficulties to identify, regulate, and ensure that they contribute something to revenue that is commensurate with their size and capacity to pay. In developing countries, a large share of this group is considered to be in the informal sector. They are almost universally cash based. Often proper record-keeping is nonexistent, and the whereabouts of taxpayers difficult to determine. In some countries, simplified tax provisions apply to small businesses that fall in this segment, in the form of presumptive taxation, often based on the approximate turnover of the business. Ideally this should approximate and substitute for all indirect and direct tax obligations in a single obligation that is easy to comply with and simple to administer.

Taxpayer services. FAD has always recommended that improving services to taxpayers is critical as a support to the self-assessment system, and hence to the effectiveness of tax policies. Services assessed as part of this review include taxpayer registration and the maintenance of related data files, as well as taxpayer education (development of better information programs especially for small taxpayers and new businesses, simplification of forms and procedures including the elimination of requests for unnecessary data, training of tax officials on changes required to develop a more taxpayer-friendly approach, and the establishment of formal taxpayer rulings systems). Historically, the taxpayer service functions have been very weak in developing and transition countries, and their importance has been underestimated.

In the Middle Eastern countries under review, these services are assessed as being poor or basic in the early 1990s. In 2004, some progress is evident, especially because service improvements is one of the most difficult areas in which to change historically entrenched attitudes and organizational cultures. One country (Jordan) has been assessed as improved, and six others (Algeria, the Islamic Republic of Iran, Mauritania, Morocco, Sudan, and Yemen) have implemented minor improvements. In addition, both Egypt and Lebanon have been assessed as improved because of service enhancements introduced in their respective VAT administrations.

Tax operations. The review has focused on the following issues: (1) control and management of arrears, including development of debt control strategies, prompt detection of delinquent taxpayers, classification of arrears by size and by age, and strict monitoring of enforcement actions; (2) VAT refunds, encompassing accelerated refund procedures for exporters and investors, and implementation of risk analysis methods to focus pre-refund audit on highest risk; and (3) audit, including development of better selection methods, development of audit programs based on risk, and strengthening the audit function at headquarters.

Tax operations in almost all Middle Eastern countries have been assessed as basic in the 1990s. In most cases, all the tax operation functions were present but were implemented in outmoded and inefficient ways, with little or no support for self-assessment. By 2004, there is again evidence of good progress. Four countries are assessed as improved (Algeria, Jordan, Egypt, and Lebanon, the last two primarily because of improvements related to VAT), and five as having brought in minor improvements.

Information technology. Many tax administration reforms developed in the past ten years have given a strong focus to computerization. Many have believed that automation alone would be the key to modernizing operations. However, this is not the case. The automation of obsolete and inefficient processes has been particularly disastrous in tax administration. There is widespread acceptance now of the notion that a comprehensive review and redesign if necessary of business processes (usually to eliminate, reduce, and simplify) must take place before automation is undertaken. In fact, such activities are a pre-requisite to the development of IT strategies.

Ten years ago, the IT strategy for all countries in the Middle East could be described as poor, or nonexistent, for all the countries reviewed. There have been a number of improvements since then: Egypt and Lebanon have made significant improvements with the system acquired for the VAT, although it is not yet being used for income tax; Jordan is planning improvements; and some improvements have taken place in Morocco, Pakistan, Saudi Arabia, and Sudan.

Customs administration

Similar to the methodology used for tax administration, Appendix II identifies certain features of customs administration in 10 of the 13 countries reviewed, and summarizes the status of these features in the early 1990s versus today. These features generally represent areas where FAD has made customs administration recommendations in its TA over the past decade. By looking at the situation in the early 1990s and comparing it with today, a picture can be formed of the overall extent of customs administration reform and modernization. As was the case for tax administration, Appendix II presents a high-level summary that, by definition, cannot describe all the nuances of each category. It is a “best-fit” exercise only. On the basis of this information, it is possible to form some initial conclusions about progress in the Middle East in each of the customs administration areas.

Reform strategy. None of the ten countries reviewed had in place a comprehensive customs administration reform strategy more than a decade ago. Now, nine have a full reform plan in place, and the tenth has a strategy considered to be in its early stages. Similar to the situation in tax administration, developing and transition customs administrations have a critical lack of capacity for strategic planning on which the success of reform efforts will often hinge. Establishing a formal reform strategy is always the first step.

Customs law. The legislation governing customs operations and often the organization of the customs function in the government is the customs law or code. As noted in the previous section, clear and simple legislation is critical to an effective customs administration. In the 1990s, eight of the ten countries were considered to have legislation adequate for the customs activities of the day. Today, given the rapidly changing environment, six have revised their customs legislation, and the remainder have reviews under way or planned.

Customs procedures. Customs procedures characterized by repetitive checking, unnecessary complexities, and a lack of transparency constituted one of the prime drivers for customs reform. Ten years ago, five of the ten countries reviewed were considered to have overly complicated and unclear customs procedures, two others met basic requirements only, and three were considered adequate at that time. Now, seven are considered as having shown improvement (Egypt, Jordan, Lebanon, Morocco,20 Pakistan, Sudan, and Yemen), with two others having minor improvements.

Post-release verification. This category remains one of the weakest areas for customs reform for the Middle East. At issue here is the existence of risk-based controls exercised after goods have been cleared for entry, with a deemphasis on non-risk-based physical inspection at points of entry. Ten years ago, none of the countries under review had any effective post-release verification procedures. Today, Morocco has implemented these reforms, and Jordan and Lebanon are listed as much improved. However, while plans exist in some areas, the other countries have made relatively little progress in this area.

Effective organization. This overall category is designed to capture an assessment of the organizational structures and institutional processes that are conducive to integrity and effectiveness in customs administration. In the early 1990s, only one or two of the countries had organizations and processes that were efficient, modern, and structured to ensure integrity. Today, about half the group is considered to have made improvements in these areas, while the other half still has a long way to go.

Information technology. IT investments are as important for customs administration as they are for tax administration. A number of customs application software systems are available, and where they have been effective they have been adapted to reengineered and simplified business processes. The situation ten years ago was that all but one of the countries reviewed had only basic IT systems for their customs operations. Today, all the countries recognize the importance of IT, with five having the most modern systems (ASYCUDA ++ or better), and four others having made a number of improvements.

IV. Assessment and Evaluation

This section will provide observations on progress in tax and customs administration reform, discuss the impact of IMF recommendations on progress made, and draw conclusions about the revenue administration aspects of Middle Eastern countries in general

Main observations

With respect to tax and customs administration reform, specifically over the past ten years, the main comments are as follows.

  • Despite the challenges in the Middle East, several governments have committed to strong programs of reform. While the interest in tax and customs administration reform may have been late in coming to the Middle East compared with other regions, there have clearly been developments over the past ten years that demonstrate a high level of interest. The spread of the VAT, the renewed interest in non-oil revenues, and a general push toward modernization of government institutions have all contributed.

  • The development of reform plans for both tax and customs administration has been a feature in almost every country. Part of the process of committing to reform is the formalization of plans and strategies to implement new initiatives. This formalization is now a feature of all countries in the region, although the degree to which they have been successful varies considerably from country to country.

  • The spread of VAT and its positive influence on the modernization of tax administration has been a major development. To the extent that tax administration reform has taken hold in Middle Eastern countries, it is evident that much of the progress is due to the introduction of the VAT. Administrations have used the occasion of the VAT to develop new businesses processes, including the taxpayer services and audit programs needed for the operations of an account-based, self-assessed tax. However, unless integrated organizations have been established to administer both direct and indirect domestic taxes, these positive developments have not benefited the income tax administration that remains in many countries outdated, inefficient, and extremely ineffective in terms of desired tax policy outcomes.

  • Introduction of self-assessment has been steady due to the influence of the VAT, but in several Middle Eastern countries, income tax regimes are not yet based on self-assessment concepts. The self-assessment nature of the VAT has by definition led to the introduction of modern procedures and systems in countries where this tax was implemented. However, the income tax remains based largely on administrative assessment and antiquated, burdensome procedures in countries with a tradition of separate administration for direct and indirect taxes. Moreover, experience in these countries usually shows that tax regimes that do not use self-assessment are more susceptible to corruption.

  • However, integration of domestic tax administration is moving forward in more than half of the countries surveyed and function-based organizational structures for tax administration are gradually becoming prevalent in the Middle East. The evolution of tax administration structures to modernized organizations based on common functions has taken hold in the Middle Eastern countries. Crucial integration initiatives (unifying all domestic tax operations and functions within an integrated, function-based structure) are less well advanced, but integration will be a fact in the near future for at least 60-70 percent of the countries surveyed.

  • Segmentation efforts have begun in several countries, initially with establishment of LTOs in most of the countries surveyed. In most of the countries surveyed, LTOs have been or are being implemented for the large taxpayers (i.e., those 800–1,000 taxpayers usually responsible for 60–70 percent of tax collections). Implementation is uneven across the region, but the concept has been embraced with only few exceptions.

    Moreover, further segmentation, such as for medium or small taxpayers, is also beginning in some of the more progressive tax administrations. In these countries, a high threshold has been adopted to differentiate small and medium-size taxpayers:

  • The implementation of an adequate TIN has not been particularly successful in several Middle Eastern countries. In many cases there appear to be difficulties with cooperation with other agencies responsible for corporate registration.

  • Only minor improvements have been made in critical taxpayer service areas while improvements in taxpayer operations, especially related to VAT, have generally been launched as part of reform programs. Taxpayer services, as a critical underpinning for self-assessment, generally remain weak with the few success stories usually revolving around VAT implementation. On the other hand, good progress has been made in addressing other operations such as accounting and payment, enforced collection, and in a few cases, audit.

  • The full exploitation of IT for tax and customs administration has not occurred. While all countries are, to some extent, using automated systems in their tax and customs administrations, the concept of business decisions driving IT requirements remains elusive. This is especially true in tax administration where the specific headquarters functions need to emerge as the business process owners to provide requirements to IT specialists.

  • Customs laws and procedures have generally been improved, but risk-based post-release verification programs have not been fully implemented. Many Middle Eastern countries have responded to recommendations to shore up the legislative and procedural inconsistencies in their customs regimes, which is always the first place to start. They have taken advantage of strong examples from other countries to review legislation, and introduce improvements such as the single administrative document approach. However, the movement to risk-based post-release verification lags much further behind.

IMF technical assistance

In all of the countries reviewed, the IMF (FAD) has provided some level of TA over the period of the survey. One issue to consider is the impact of the IMF recommendations in the progress that has been made.

When evaluating the effectiveness of IMF TA in the revenue administration area, it is important to consider the change that was introduced in the mode of delivery of this assistance in recent years. Until 1998–99, long-term advisors were sometimes assigned by the IMF to support revenue administration reforms in a number of countries (e.g., among the countries surveyed, the Islamic Republic of Iran, Saudi Arabia, and Yemen). Since then, most of the IMF’s revenue administration assistance is now provided through missions organized from headquarters, and regional and short-term experts, using an “upstream” approach.21

The objective of this approach is to increase the IMF capacity to provide strategic advice during review-diagnostic missions and support implementation of revenue administration reforms through follow-up missions and visits of senior experts as needed. Experience—particularly in countries covered by the present survey, including Afghanistan, Egypt, Jordan, Lebanon, Morocco, and Pakistan—shows that this approach has allowed a more effective coordination of the TA provided by the IMF, the World Bank, and other donors (e.g., the EU, France, the UK-DFID, and the USAID). Interestingly, this approach has also resulted in additional incentives for governments to take stronger ownership of the IMF-recommended reforms by establishing properly staffed project structure to manage the reform process and by taking appropriate action to secure continuation of the IMF support.22

This approach has proved to be the more cost-effective in countries where implementation of a tax reform strategy is critical for Fund programs. The progress noted for the Middle Eastern countries where the upstream approach was used—including Jordan, Lebanon, Morocco, Pakistan, Sudan, and more recently Egypt—are encouraging. While accountability for success or failure rests, of course, ultimately with the authorities, there are clear signs that the IMF’s revenue administration advice has been instrumental in several countries, including:

However, FAD has not been successful in convincing some countries to implement its advice in the following areas:

V. Conclusions

On the basis of the preceding sections, it is possible to draw some conclusions about the progress of revenue administration reform in the Middle East. These conclusions are based not only on the information provided in the appendices but also on information gained from a review of IMF TA to selected Middle Eastern countries over the past ten years and from interviews with IMF staff.

The following issues are clearly relevant:

In any assessment of progress in tax and customs administration reform, the above factors are paramount. It is obvious that they will have a profound influence on the extent to which government reform initiatives will be successfully implemented in the coming years.