Abstract
This paper examines a few selected aspects of adjustment and restructuring in the Czech enterprise sector. It examines financial performance of the Czech enterprise sector, drawing on data reported by nonfinancial enterprises to the Czech Statistical Office (CSO) in 1993. The findings reveal that significant progress has been made in the nonfinancial aspects of adjustment, but a large part of the enterprise sector has been slow to adopt measures to achieve sustainable financial viability.
II. The Efficiency of VAT Implementation: A Comparative Study of Central and East European Countries in Transition 1/
1. Introduction
Many countries in central and eastern Europe have undertaken significant tax reforms since 1989 as part of the move from centrally planned to market-based economies. Major components of the reforms have included the introduction of new taxes such as personal income taxes, corporate profits taxes, and broad-based consumption taxes. As a result, the form of public revenue mobilization has become more transparent and less distortionary. Long-term benefits from such reforms are undisputed: over time, these should provide sufficient resources for necessary government operations while exerting minimal disincentives on the operation of a market economy. However, individual economic agents and government administrators have to adapt to the new institutional environment, and transitional adjustment costs may impede speedy convergence to an efficiently functioning new system.
Of particular interest in this regard is the efficiency with which economies in transition collect value-added tax (VAT) revenues. This tax has been advocated by some commentators as an economically efficient revenue source which, if properly designed, imposes few distortions on the decisions of private economic agents. 2/ On the other hand, administrative costs of calculating, collecting (including refunding), auditing, and enforcing the tax may be high. For example, as a tax on each stage of production, the number of registered taxpayers is large compared with a sales tax levied on retail sales only. 3/
This note examines the efficiency of VAT collections in five central and eastern European countries in 1994, viz., the Czech Republic, Hungary, Poland, Romania, and the Slovak Republic. With the exception of Hungary, which has had a VAT since 1988, VAT systems in these countries have been newly established in the last two years. The general method of measuring efficiency is to compare the actual tax collections with those that would have resulted if the statutory VAT rates had been applied without any “revenue leakage.” This approach, while conceptually simple and appealing, is in practice, subject to a number of constraints. Since the VAT is levied at each stage of production, calculating the amount of tax that should be collected based on the statutory tax rates requires detailed knowledge of the production process (for example, in terms of an input-output table). 1/
However, because of the lack of such information, an alternative method using final consumption data is employed in this study. This method makes use of the fact that the economic incidence of the VAT is on final consumption, and involves the comparison of the average statutory tax rate and the average effective tax rate, using household consumption data. One problem is that differences between VAT systems in terms of exemptions, etc. are difficult to incorporate accurately. However, this is not believed to alter the general findings of the analysis.
The main result is that the five countries fall into two broad groups: three countries (the Czech Republic, Poland and the Slovak Republic) are of roughly equal and relatively high efficiency, while the other two (Hungary and Romania) are of roughly equal but relatively low efficiency. These findings remain, however, somewhat tentative because of the difficulties involved in estimating the underlying average statutory and effective tax rates. First, survey data on consumption are typically reported for categories which do not match identically those to which VAT rates apply, thus hampering the precise calculation of average statutory VAT rates. Second, the effective tax rate is difficult to calculate due to problems associated with measuring domestic consumption. Whether this is best approximated by consumption as measured in the national accounts, retail sales, or some other number, is debatable.
Given these measurement problems, the results should be interpreted with caution. However, for comparative purposes, the relevant issue is whether the relative ranking of countries is robust to the measurement problems. For the broad groupings of high and low efficiency mentioned above, the results are probably fairly robust.
2. Brief overview of VAT systems
In accordance with the European Union (EU) norm, the VAT systems in the five countries are generally of the consumption-based credit-invoice type. 1/ The general characteristics of the VAT systems, including rates and broad exemption rules, are presented in Table 2.1. In addition to the standard and reduced rates, each country zero rates certain goods and services, in particular, exports. There are important differences among countries with respect to exemptions, both for particular categories of productive units in the economy, and for specific goods. 2/ In particular, the Polish and Romanian systems contain relatively many exemptions for specific goods and services, while the base of the Hungarian system is broadest, and the Czech and Slovak systems are intermediate. The exemption thresholds existing in 1994 for each country have been expressed in local currency and in U.S. dollars using average annual market exchange rates. Firms that have annual turnover less than these thresholds are not required to register in the VAT system. If they choose not to register, they neither pay VAT nor collect refunds on VAT paid on inputs. Clearly, the usefulness of the single currency measure is limited, for there might be differences among countries in the structure of production across firms of varying sizes. However, the general pattern is that Hungary and Romania have much lower exemption thresholds than the other three countries.
VAT System Characteristics in 1994
VAT System Characteristics in 1994
| Czech Republic | Hungary | Poland | Romania | Slovak Republic | |||
|---|---|---|---|---|---|---|---|
| Tax rates (In percent) | |||||||
| Standard rate | 22 | 25 | 22 | 18 | 25 | ||
| Reduced rate | 7 | 10 | 7 | -- | 6 | ||
| Exempted goods and services | |||||||
| Health | x | x | x | x | |||
| Science/culture | x | x | |||||
| Finance | x | x | x | x | |||
| Food | x | x | |||||
| Social services | x | x | x | x | x | ||
| Communications | x | x | x | x | x | ||
| Turnover thresholds | |||||||
| Millions of local currency | 2 ¼ | 1 | 12 | 10 | 2 ¼ | ||
| Thousands of U.S. dollars | 80 | 9 | 49 | 6 | 72 | ||
VAT System Characteristics in 1994
| Czech Republic | Hungary | Poland | Romania | Slovak Republic | |||
|---|---|---|---|---|---|---|---|
| Tax rates (In percent) | |||||||
| Standard rate | 22 | 25 | 22 | 18 | 25 | ||
| Reduced rate | 7 | 10 | 7 | -- | 6 | ||
| Exempted goods and services | |||||||
| Health | x | x | x | x | |||
| Science/culture | x | x | |||||
| Finance | x | x | x | x | |||
| Food | x | x | |||||
| Social services | x | x | x | x | x | ||
| Communications | x | x | x | x | x | ||
| Turnover thresholds | |||||||
| Millions of local currency | 2 ¼ | 1 | 12 | 10 | 2 ¼ | ||
| Thousands of U.S. dollars | 80 | 9 | 49 | 6 | 72 | ||
3. Methodology
As mentioned above, the general approach to measuring efficiency of VAT collection is to compare the effective tax rate with the average statutory tax rate. This methodology necessitates: (i) a measure of revenue collections; (ii) an estimate of the consumption base on which the VAT is levied; and (iii) a calculation of the average statutory rate.
a. The effective VAT rate
The effective tax rate (ETR) is measured as total VAT revenues as a proportion of final consumption. The base on which the ETR is defined is not determined by the legal definition of the tax system, but should correspond with the perceived economic incidence of the tax. It is assumed that the tax is passed on to final consumers, so that a natural tax base is final consumption. Three issues that arise in this context are: (i) the data source that should be used to measure consumption; (ii) whether government consumption should be included; and (iii) whether the base should be defined net or gross of tax collections. The answers to these questions depend in part on the analytical use to which the ETR is to be put, in particular, its comparison with the average statutory rate (defined below).
The two main data sources for estimating aggregate consumption are the national income accounts and reports of retail sales. Since VAT payers are required to be registered, the use of retail sales may appear to be prudent. However, this may mask the objective of revealing low levels of compliance from retail establishments that escape registration and inclusion in data surveys. On the other hand, national accounts data include estimates of activities of nonregistered entities, and so any inefficiency due to evasion of this kind (as opposed to that due to administrative laxity for example) may be identified using that source. In addition, certain components of consumption (particularly services) may not be included in retail sales data.
Government purchases are generally subject to VAT. 1/ The ETR is then ideally calculated as the ratio of total VAT revenues to total final consumption (both private and public). However, the average statutory tax rate is estimated using surveys of private consumption patterns only. Since collection efficiency is measured by comparing the ETR with the average statutory rate, the definitions must be consistent. Therefore, the ETR used here relates only to direct final consumption by individuals, and is the ratio of VAT paid on nongovernment purchases to final private consumption. 2/
Because statutory VAT rates are defined on a net basis, the ETR is calculated in a similar fashion. 3/ That is, the consumption base used to measure the ETR is net of VAT paid. Because VAT is usually levied on a good’s price inclusive of other excise taxes (such as specific taxes on alcohol, tobacco, and fuel), the base is not reduced by revenues from such taxes in the calculation.
b. Average statutory tax rate
Because detailed production data such as input-output tables are not available for the countries considered in this study, it is not possible to calculate an average statutory VAT rate on the legally defined base. However, under the reasonable assumption that the VAT is passed forward to consumers, it can be assumed that the economic base is final consumption. Under a credit-invoice VAT with refundable credits 1/ and no exemptions (e.g., for small businesses, etc.), the structure of taxation at each stage of production is irrelevant to the determination of the ultimate incidence. Any taxes paid on intermediate products would be credited against taxes paid at later stages, and the final tax liability for a particular consumption good would just be given by the statutory rate on that good. Thus, for such a tax system, it is not necessary to have information about production processes, and household consumption patterns are sufficient to estimate the average statutory VAT rate.
When exemptions exist and credits are not always refundable, the average statutory rate is more difficult to calculate from consumption data alone. For example, if some sellers of a good are exempt from filing VAT returns, then the implicit tax paid on purchases from such firms is the unrefunded portion of any input taxes paid at earlier stages of production. The tax paid on purchases of the same good from VAT-registered sellers is the statutory rate, which may be higher or lower than the implicit tax paid on purchases from exempt sellers. 2/ In this case, applying the statutory rate to total purchases of the particular good will give an inaccurate measure of the actual average VAT rate on that item, which is a weighted average of the explicit tax on purchases from registered sellers and the passed-forward input tax on purchases from exempt sellers. However, with little information on the share of consumption of particular goods that is purchased from exempt and nonexempt firms, it is difficult to adjust for this factor.
It should be noted, however, that this drawback is a result of the exemption of certain productive units in the economy (e.g., small retailers) and is not caused by the exemption of particular goods and/or services from the tax base. In theory, any pattern of tax rates (including zero rating) on goods and services can be accommodated within the current framework, since private consumption patterns are used to calculate average statutory rates. It is only when a particular good or service faces more than one rate, due to either the exemption of sales from certain producers or exemption of purchases by a particular group of individuals (e.g., pensioners), that this method is problematic.
The approximation methodology employed here is to assume that the effective statutory tax rate on goods that are not exempt is equal to their actual statutory rates under law. This is not exactly correct as some nonexempt goods are sold by exempt businesses. On the other hand, it is assumed that the effective statutory tax rate on exempt goods is zero, which is inaccurate to the extent that inputs in the production of such goods have been taxed. To address the quantitative impact of these approximations, the appendix to this note examines the effect of exemptions of certain goods and productive units on the estimation of the average statutory tax rate. In general, the higher the threshold for exemption, the larger the share of total value added that is exempt, and the higher the unadjusted estimate of the average statutory rate. This, in turn, means that the efficiency estimate described below will be underestimated. On the other hand, the larger the number of goods for which all sales are exempt, the lower the unadjusted average statutory rate estimate. In this case, the measured average statutory tax rate will be too low, and the measured efficiency level will be overestimated. The implications for the interpretation of the results are discussed in section 4.
The average net statutory VAT rate is defined as
where ti is the VAT rate on good i, and σi is the share of gross expenditures on good i in total household spending. 1/ Information on consumption shares is drawn from household surveys and other official statistical sources.
c. Collection efficiency
To measure the efficiency with which VAT laws are implemented, the effective VAT rate, τe, is compared with the average statutory rate, τs. Specifically, efficiency is defined as
In a comparative study, an important issue is the extent to which possible errors in measurements of efficiency are common to all countries. If the efficiency measures are equally biased in all countries, then comparative ratings are unaffected, and the information derived is useful. However, if the measures are biased independently, not much confidence can be placed in either the comparative or absolute results, unless these biases are small. Based on the information available, it is difficult to know the extent to which the biases are correlated.
4. Results
a. General findings
Table 2.2 below presents the results of the empirical exercise, and shows that the countries fall into two broad groups. One group, consisting of the Czech Republic, Poland, and the Slovak Republic, shows relatively high efficiency levels, while the other, comprising Hungary and Romania, exhibits relatively low efficiency. The two main concerns with the reported statistics relate to the accuracy of measuring the statutory rate, and the proper treatment of VAT paid on government purchases in calculating the ETR. There is some uncertainty about the average statutory tax rate because the categories used in household budget surveys do not match exactly those used for the purposes of defining tax liabilities. Also, information on government-paid VAT is not generally available. As a rough calculation, if the calculated average statutory VAT rate in the Czech Republic was applied to government non-labor and non-transfer expenses, government purchases would account for roughly 30 percent of total VAT revenues. In the absence of more detailed information, it is assumed that the same ratio of total VAT revenues is collected on government purchases in each country.
Statutory and Effective Tax Rates and Implied Efficiency Levels
(In percent)
Statutory and Effective Tax Rates and Implied Efficiency Levels
(In percent)
| Czech Republic | Hungary | Poland | Romania | Slovak Republic | |
|---|---|---|---|---|---|
| Average statutory rate | 12.2 | 12.8 | 8.9 | 9.3 | 15.6 |
| Effective rate | 11.3 | 8.5 | 8.7 | 5.5 | 14.2 |
| Efficiency | 92.6 | 66.4 | 97.8 | 59.1 | 91.0 |
| Relative efficiency vis-à-vis Poland | 94.7 | 67.9 | 100 | 60.4 | 93.0 |
Statutory and Effective Tax Rates and Implied Efficiency Levels
(In percent)
| Czech Republic | Hungary | Poland | Romania | Slovak Republic | |
|---|---|---|---|---|---|
| Average statutory rate | 12.2 | 12.8 | 8.9 | 9.3 | 15.6 |
| Effective rate | 11.3 | 8.5 | 8.7 | 5.5 | 14.2 |
| Efficiency | 92.6 | 66.4 | 97.8 | 59.1 | 91.0 |
| Relative efficiency vis-à-vis Poland | 94.7 | 67.9 | 100 | 60.4 | 93.0 |
As long as the proportion of VAT paid on government purchases is the same in each country, the relative efficiency rankings are unaffected. On the other hand, if the share of government-paid VAT varies across countries, those in which the share is higher (lower) will have lower (higher) efficiency rates than reported in Table 2.2. Despite this caveat, it seems likely that even with more accurate country specific estimates, Hungary and Romania would continue to appear relatively inefficient, while the Czech Republic, Poland, and the Slovak Republic would remain relatively efficient. 1/
b. Impact of exemptions
As discussed in section 3, the efficiency results for countries with high general exemption/threshold levels are probably understated, while those for countries with many explicitly exempt goods and services are likely to be too high. For a thorough investigation of the importance of these approximations, data on the share of value added produced by exempt firms, the share of exempt goods in total value added, and the underlying production processes are necessary. In the absence of such data, the information presented in Table 2.1 is used to qualify the general results above.
First, the rather striking pattern observed is that exemption thresholds are much higher in the group of more efficient countries (as measured above), than in the pair of less efficient countries. To the extent that higher threshold registration rules suggest that the efficiency measures underestimate the true levels of collection efficiency, the preliminary results are strengthened.
Second, the impact of exempt goods and services can also be gauged. We concentrate here only on health care and food, in which the countries’ rules differ most clearly, and which constitute relatively large shares of value added. The evidence suggests that the efficiency estimates for Poland and Romania (which have relatively many exemptions) may be on the high side, particularly if inputs into the production of exempt goods are fully subject to tax. This reinforces the finding that the efficiency of Romania’s VAT system is relatively low, but tempers somewhat the conclusion that Poland’s system is relatively efficient. The efficiency of the Hungarian system is overestimated least due to the exemption of specific goods and services, but this fact probably does not change the general conclusion that it is in the group with less efficient systems.
5. Further issues
This note has attempted to measure the efficiency with which revenues from value-added taxes are collected in selected transition economies. Clearly, for the purpose of policy making, it is important to have some idea of the sources of any divergence in performance that is observed using the measures derived above. Without providing specific evidence on the nature and strength of these sources, some proximate causes of inefficiency can be suggested. These include: (i) the size of the informal sector and the number of small firms; (ii) the proportion of total consumption satisfied by imports (if it is thought that border taxes are more easily enforced than domestic taxes); (iii) inappropriately set penalty rates; (iv) low staffing levels, or poorly motivated/paid staff in tax collection and/or audit offices; (v) poorly implemented computerization; and (vi) the unfamiliarity of the new system compared with previous practices.
A determination of which of these effects are at work is crucial for designing and implementing a reform of VAT administration. However, a detailed examination of this issue is beyond the scope of this note.
References
Aguirre, Carlos A. and Parthasarathi Shome, “The Mexican Value-Added Tax (VAT): Methodology for Calculating the Base,” National Tax Journal, Vol. XLI, No. 4 (1988).
Atkinson, A.B. and J.E. Stiglitz, Lectures on Public Economics (Maidenhead, U.K.: McGraw-Hill, 1980).
International Bureau of Fiscal Documentation, Taxation and Investment in Central and East European Countries, edited by M. Véghelyi (Amsterdam: IBFD, 1994).
Kay J.A. and M.A. King, The British Tax System (Oxford, U.K.: Oxford University Press, 1986).
Lindholm, R.W., The Economics of VAT: Preserving Efficiency Capitalism and Social Progress (Lexington, Massachusetts: D.C. Heath and Company, 1980).
Data Sources
Czech Republic
Tax revenue: Ministry of Finance.
Aggregate consumption: National income accounts.
Individual consumption patterns: Shares based on 1993 data from “Statistická Ročenka, 1994” Czech Statistical Office.
Hungary
Tax revenue: Ministry of Finance.
Aggregate consumption: National income accounts.
Individual consumption patterns: From household budget survey (Családi Költségvetés), 1991, including data on 12,000 active and inactive households.
Poland
Tax revenue: Ministry of Finance.
Aggregate consumption: National income accounts.
Individual consumption patterns: Statistical Bulletin, December, 1994.
Romania
Tax revenue: Ministry of Finance.
Aggregate consumption: National income accounts.
Individual consumption patterns: From “Anuarul Statistic Al României,” National Commission for Statistics, 1993, pp. 110-11 and 206-7.
Slovak Republic
Tax revenue: Ministry of Finance.
Aggregate consumption: National income accounts.
Individual consumption patterns: From June 1993 CPI weights, in “Štatistické Čísla a Grafy”, Statistical Office of the Slovak Republic.
APPENDIX: Impact of Exemptions
As discussed in section 3, the exemption of certain goods and services or sellers of such items from the tax base has an effect on the average statutory rate, which is difficult to measure without detailed information on the tax rates levied at earlier stages of production, and on the share of consumption purchased from exempt sellers. This appendix presents an example of the adjustments that must be made to the average statutory tax rates calculated in the text, in the presence of exemptions.
Let Xi denote the quantity of good i purchased by an individual at the retail level. This good faces a VAT rate of ti if sold by registered taxpaying retailers, and zero if sold by exempt retailers. The share of purchases of good i made from registered taxpayers is γi, with a share of (1-γi) being purchased from exempt sellers. Assume for simplicity that, apart from labor and capital, all inputs are subject to their statutory VAT rates--that is, no intermediary inputs are exempt. If ϵij is the input of good J used in the production of a unit of good i, then the total tax revenue from sales of good i to final consumers is
where
Total expenditures by the individual on good i amount to
so the average statutory tax rate on good i is
When γi = 0, all purchases of the good are exempt, and the average statutory tax rate is
Exemption of certain retailers--most usually those with small turnovers--is reflected in values of γi between zero and one. For example, the value of γi for services provided mostly by small businesses (e.g., home gardening) will be close to zero, but that for goods which are mainly sold by large establishments will be close to one. As is clear from equation (A.3), as γi → 1, the average statutory tax rate on good i is as included in equation (1) in the main text. Under the assumption that
Prepared by William Jack.
See, for example, Lindholm (1980). Note, however, that this claim is often overstated for two reasons. First, in a static setting, it is unlikely that uniform taxation of all consumption goods is optimal. Second, it is generally not the case that preserving the intertemporal marginal rate of substitution between consumption at different dates at its tax-free rate (by exempting capital income from the tax base) is optimal. (See Atkinson and Stiglitz (1980).) However, the calculation of optimal tax rates is sufficiently complicated and open to argument that uniformity may be an nth-best approach.
Kay and King (1986) report that, when the VAT replaced the turnover tax in the United Kingdom, the number of tax payers rose from 74,000 to 1.4 million, and the number of collectors rose from 2,000 to 12,500.
This is the approach taken by Aguirre and Shome (1988).
VATs are often thought to be by definition consumption taxes. However, income-based VATs are also possible. The main difference is in the treatment of capital investment purchases for purposes of calculating the tax base. Under a pure consumption-based VAT, the total amount of tax paid on any capital purchases is immediately creditable, while under an income-based VAT, the input tax is creditable on an accrual basis over the useful life of the investment. Thus, the income-based VAT retains some of the administrative problems of the income tax system.
A credit-invoice VAT is implemented by basing VAT liabilities on total sales less VAT already paid on creditable inputs. This method accommodates multirate systems more easily than two other alternatives (known as the addition and subtraction methods). Japan, which has a single VAT rate, is the only industrial country with a VAT that does not use the credit-invoice method. It uses the addition method.
The difference between zero rating and exemption is that VAT paid at an earlier stage is creditable on zero-rated sales, but not on exempt sales.
There is, in principle, no net revenue impact of exempting government purchases from tax. However, administration is generally easier, and the scope for fraud narrower, if suppliers must remit tax on all sales independent of the identity of the purchaser.
That is, if Cp is private consumption, Cg government consumption, Tp VAT revenues collected on private purchases, and Tg that collected on government purchases, then the “ideal” measure of the ETR is (Tp+Tg)/(Cp+Cg), and the ETR on private consumption only is Tp/Cp. Another reason for calculating the ETR exclusive of government consumption is that this approach could sharpen the ability of the study to detect inefficiency. In general, one expects a smaller incentive for government purchasers of VATable goods and services to evade the tax; so, including them would reduce the power of any efficiency measure to detect evasion in general.
Taxes on goods and services are nearly always on a net basis--that is, if the tax rate is t and the pretax price is p, then the after-tax price is p(l+t). This is different to the income tax, which is typically levied on a gross basis--that is, if the tax rate is τ and the pretax wage is w, then the after-tax wage is w(1-τ).
A credit is refundable if, when the credit is larger than the gross tax liability, the taxpayer receives a net payment from the Government. If the credit is non-refundable, the taxpayer would pay zero net tax, but would also receive zero net refund, in this situation.
If there is a single VAT rate, the tax on purchases from registered sellers will be higher than the implicit tax on purchases from exempt sellers, as long as there is some value added at the retail stage. However, if there are multiple rates and the rate applied to the final consumption good is less than that applied to some of its inputs, purchases from registered sellers may be subject to a lower tax rate than the implicit rate on purchases from exempt sellers.
In the two-good case, if pretax prices are 1, and if X1 and X2 face tax rates t1 and t2 respectively, then σi = (l+ti)Xi/m, where m is income. The average tax rate is τs = (t1X1+t2X2)/m, which reduces to the expression in the text.
The (simple) average efficiency level of Hungary and Romania is two thirds that of the Czech Republic, Poland and the Slovak Republic, suggesting that the proportion of VAT paid on private consumption in the first pair would have to be 1.5 times that in the second group for the ordering to be reversed. Such a divergence seems unlikely.