Three-Part Series | Act Now
How governments act today will shape the post-COVID world for years to come.
The global COVID-19 pandemic has accelerated many new digital developments in the world today. Digital advancements occurred in the span of just a few months instead of years, even in societies that were thought not to be ready for such digitalization. On the other hand, severe interruptions in our global economy have led to challenging and uncertain times. Many governments are postponing or halting major projects and staying clear of bolt decision-making and execution. This rings especially true for leaders in the tax domain, where COVID-19 has had a detrimental effect on tax revenue. And this while many tax authorities, specifically in Small Islands Developing States (SIDS) and developing countries, are already lagging behind on technology and digitalization. In this three-part series, we focus on why tax authorities should not back out of much-needed investment in new tax administration systems and digital adoption during these times. With the right vision, knowledge, and decisiveness, they can play a crucial role in getting their countries’ economies back on track.
Part 1 | Technology to Improve Compliance
Generally speaking, tax administration systems in Small Islands Developing States (SIDS) are often very traditional or outdated. In today’s world, where citizens’ expectations of technology have only increased, these non-intelligent systems are not built in accordance with current technological insights as well as best practices of, for example, IMF’s TADAT framework. A lot of these systems are non-future proof and have suffered due to customization, leading to upgrade difficulties.
Yet when it comes to investing in new tax systems, tax administrators are often faced with fear. Even in certain times. The renewal of IT systems is typically a large financial project and a high-stake decision for a Minister of Finance of a small country with a small population. Information Technology is often viewed as daunting. A lack of knowledge of selection committees and management regarding the requirements of systems during the procurement process can sometimes lead to decisions being made based on the wrong information. When misunderstood by management and selection committees, tax authorities get hesitant and over-cautious, while they should be tackling such projects with more leadership, confidence, and decisiveness. COVID-19 has added complexity to the situation; governments are now dealing with having to justify to their population and parliament about spending millions on IT, instead of unemployment benefits. But this is purely psychological and a misplaced sense of guilt. It is important to hold on to the right vision in order to see the whole picture. Because it is actually a no-brainer: you should not hold off on investing in IT systems at this moment. You should even accelerate. Let’s explain why.
Missing out on tax revenue
Governments across the globe are deprived of a substantial part of their tax revenues. According to the State of Tax Justice 2020, countries are losing a total of over $427 billion in tax each year to international corporate tax abuse and private tax evasion . The losses to tax abuse are proportionally larger for lower-income countries. The latter are often already dealing with huge budget deficits. Governments need revenue to invest in better education and social protection. Simultaneously, those same governments have often shifted the tax burden to citizens and businesses through increases in personal taxes. So, it comes as no surprise that tax evasion and particularly avoidance, are under scrutiny and now no longer considered financially sustainable – but more importantly – morally wrong.
International tax avoidance is the very legal use of the differences in tax legislation between countries. This results in base erosion and profit shifting. You erode the tax base and shift profit between countries. So instead of the profit falling in the country where the added value is created, it is shifted to a country with low or no tax structures, or the so-called tax havens. In 2021, this is not only morally and socially unacceptable, but also financially no longer sustainable. More and more, multinational corporations are being accused of ‘poor tax conduct’ for paying relatively low taxes over their considerable global profits, while the average citizen pays between 20% to 30% on income taxes. Globally, the largest portion of tax revenue is generated by income tax (pay as you earn) and sales tax. Again, this is largely shouldered by ordinary citizens of rich and poor countries. How can it be that such a disproportionately large part of tax revenue is collected from a group with a substantially smaller financial capacity? That is why the OECD and international exchange of information for tax purposes between jurisdictions is so important. It is a very laborious process, slowed down by the many interests at play, both from decision-makers in the political and business sphere, as well as the countries that are stakeholders. Yet, it can put an end to shifting profit offshore.
Tax evasion is different from tax avoidance in that it is defined by citizens and entities who are deliberately not paying what they should be paying. There are two ways to look at this. The first being the informal economy, where a lot of economic activity is not on the government’s radar screen. The second being a government that is not levying nor collecting taxes in a timely, accurate, and complete manner. This creates a problem because a part of the economy is unknown and consequently not taxed, the other part is overlooked.
Improving tax compliance
So, we have to look at increasing tax compliance, which is defined by the intent of the taxpayer seeking to pay the right amount of tax in the right place and time. Intelligent tax administration systems help increase voluntary tax compliance. As you can see in the Compliance Pyramid, this applies to about 80% of all citizens and businesses, who can be categorized into three different groups.
The first group consists of people who are generally compliant and need few further encouragements. Offering access to intelligent systems makes it easy for them to comply. The second group, though willing, often fails to comply. This specific group needs an extra helping hand. For instance, governmental organizations need to make sure that they are on top of things and that there is (almost) no backlog in collecting. Because collecting what was due over 5 years ago is an even more difficult process. Plus, it does little to promote the compliance culture. The last group is more often non-compliant than not. These citizens and businesses must be deterred from non-compliance by detection. One way to solve this is to give them a pre-calculated tax return with all available taxpayer’s data already filled out. Let them know what they need to pay or receive based on data that you already have. This lowers the threshold and discourages them from being non-compliant. All in all, it really boils down to intelligent systems, data analytics, and digital support services; this helps governments to solve 80% of the tax compliance. Increase the interaction with these groups and let the data help you connect the dots.
What you are left with is a group of 20% of citizens and businesses who intentionally commit fraud. Tax dodging. This is the group that you really must zoom in on. The use of the full range of criminal and civil powers in investigating fraud and enforcing the law is the only avenue that applies to this fraudulent group.
The benefits of tax modernization outweigh the costs
Modernization of tax administration systems is now more crucial than ever as the key to compliance lies in technology. A modern system will help to facilitate citizens’ voluntary compliance with their tax obligations by providing information and assistance services. A modern system will also be more effective with better control actions to detect and regulate. Implementing a new tax administration system is quite a substantial investment, especially for smaller countries. But not doing so comes at an even greater cost as governments struggle to overcome the economic shock of the COVID pandemic. In the next part of this series, we will further discuss the impact COVID has on the future of tax administration.