On Tax Administration

The current tax reform is designed, first and foremost, to increase tax revenue through better tax administration. Overall, the changes aim to shrink the shadow economy and broaden the tax base.

In today's post I write about tax administration and what it should depend on.

Our country's current tax system is accusatory and reactive, which means it is administered through tax audits and penalties. The levers available to the tax authorities generally allow them to make subjective decisions, because our court system is far from perfect and tax disputes are usually resolved in favor of the state. This makes taxpayers dependent on the tax authorities. That is a separate topic that calls for more detailed analysis, but broadly speaking it is a normal instrument; without it, far fewer taxes would be paid.

Nevertheless, tax administration does not depend on audits alone. It includes other aspects that deserve attention:

Simplicity and structure of taxes. The simpler and clearer a tax is, the harder it is to evade and the easier it is to administer and collect. For example, the transport tax is very simple; it is now often calculated automatically, and its collection rate is very high. VAT is also a tax that is fairly hard to avoid, unless there are tax exemptions, as is the case with us at present. CIT and MET are complex taxes, as each requires intricate calculations and supporting documentation.

Tax awareness and education. It is very important to begin teaching the basics of taxation at school, and to hold various educational events aimed at fostering an understanding of why people must meet their tax obligations: explaining why taxes matter, what they are for, what depends on them, what the consequences of non-compliance may be, and so on. Proactive education greatly reduces, in the long run, the number of people who will try to avoid paying taxes. It is also very important to make transparent where taxes go, all the more so when they are earmarked, such as social contributions, pension payments, contributions to the Social Health Insurance Fund, and so on.

Reducing tax arbitrage between different categories of taxpayers. We have a great many tax exemptions granted to particular industries, companies and territories. Such exemptions create incentives to devise tax optimization schemes. We already have a great many such arbitrage opportunities, and the new Tax Code adds even more. Let me give a few examples based on the innovations proposed in the new Code.

Take a chain of fitness clubs registered as a single legal entity, which falls under the general tax regime and pays all taxes. Next door, another chain opens, with each club registered as a separate legal entity and each placed under a special tax regime with all its benefits. The first company will pay 12% VAT (and the fitness industry has virtually no input VAT to offset, so the full amount is paid on turnover), 20% CIT and all payroll taxes. The second company pays a 4% retail tax, all its employees are registered as individual entrepreneurs, and each of them also pays minimal taxes. As a result, the first company has an incentive to split up as well, since otherwise it will simply lose the competition and go bankrupt: the tax burdens are too different.

Another example is a banking holding company in which the bank pays 25% on net profit, the marketplace 20%, and the leasing company 10%. It is logical that the holding will maximize profit in leasing and the marketplace and reduce the bank's profit, with the bank bearing all the costs while the subsidiaries, with no expenses or investment, generate the profit. Such cases are very hard to investigate and prove: they open the door to corruption and subjective judgment, and proving deliberate tax evasion becomes extremely difficult.

Automation of tax processes. It is important to build systems in this area and, to give credit where it is due, our country has come a very long way. For example, the electronic invoicing system (ESF) is one of the best in the world, and when we move to an advance-based system, it will give a major boost to exporting companies in particular. Our risk management system is also advanced: it reduces the number of audits. Still, there is room for improvement in automation, especially in big data analysis. Tax data is not only a source of information for collecting taxes; it is also a very valuable resource for assessing creditworthiness and analyzing economic activity, and a predictor of the country's economic indicators. Filing tax returns is very complicated, tax forms require extensive knowledge, and many fields could be pulled from databases and pre-filled, so there is clearly room to grow here.

Therefore, under the new Tax Code, tax collection should be secured not only by stronger tax control and automation, but also by introducing tax education and awareness, tax partnership and, most importantly, by eliminating tax discrimination by industry, territory and taxpayer. Industries develop not thanks to tax exemptions but thanks to a level competitive playing field. The more competition there is, the greater the incentive for companies to grow and make better, more competitive products. Unfortunately, there is no escaping the basic laws of economics, even if one manages the economy by hand.