Mind the gap: laying the foundations for revenue reform

Understanding how much revenue a government could collect compared to what it does, helps show how best to reform revenue policy and administration.

How much revenue do countries collect? How much should they be collecting?

These might seem like straightforward questions for governments, but in reality the answer is often elusive. In this article we use the example of Ethiopia to show how tax gap analysis is paving the way for extensive revenue reforms there.

A country’s tax gap is defined as the difference between revenue potential (the theoretical amount of revenue that could be collected under the existing legal framework) and the amount of revenue that is actually collected.

Tax gap analysis is a powerful tool that highlights where governments can improve their revenue systems, particularly by:

• Identifying any loopholes that exist in current legislation
• Offering policy choices to governments (by expanding the tax base, introducing new taxes, or altering the rate or coverage of particular taxes)
• Highlighting areas for administrative reform (in the collection and accounting of revenues)

Undertaking a tax gap analysis at the start of a revenue reform programme enables beneficiary governments to focus their finite resources on the most important reform areas, and gives donors and other stakeholders a clear way to chart progress during the reform effort.

In Ethiopia we have undertaken a detailed study of the country’s tax gap and revenue potential at both federal and state level, for all income streams, on behalf of the Ethiopian Revenues and Customs Authority (ERCA). This has involved extensive data collection, interpretation and analysis. The study provides the foundation with which to finance the government’s ambitious development goals, as set out in its current Growth and Transformation Plan (GTP), which aims to promote sustainable economic growth and reduce poverty.

When undertaking tax gap analyses it is important to identify all revenue streams and how these revenues are collected. A country’s revenue agency (either separate customs and taxation departments or a combined revenue authority) should be collecting the majority of revenues, but there are other government departments which also collect revenue. These are considered non-tax revenues, eg licenses, permits and royalties.

The accuracy of data recording, and how that information is shared, is of critical importance when identifying the revenue base and revenue potential of a country.

A tax gap analysis is not just about examining revenue coming in, but how it is collected, who collects it and what happens to it once it is collected. In Ethiopia, the federal system adds an additional layer of complexity when trying to identify the tax gap and revenue potential. Not only are revenues collected at the national level, but each of the nine States and two City Administrations also have the power to raise taxes and collect revenue. Our study found examples of inconsistent revenue reporting between state and federal levels.

All countries have a tax gap. No government ever collects all revenues due because the administration costs of producing 100% compliance would outweigh the revenue gains available. As an example, the tax gap in the UK is estimated at £35bn, which represents 7% of total revenue potential. The tax gap across developing countries ranges from 20-60% of total revenue potential, and our estimate of Ethiopia’s tax gap is within this range.

Our study, the first of its kind in Ethiopia, has provided detailed baseline and revenue potential figures for all revenue streams at federal and state level, and forecasts of all revenue streams for the next decade. The study has highlighted where the biggest gaps exist, thereby demonstrating to the government of Ethiopia where it should focus its resources to increase revenue collection most.

Our recommendations on how to close the gap, while detailed, are aligned with ERCA’s broader strategic goals, and include:

• Increasing staff capacity within ERCA through human resource management and development
• Implementing modern information systems to assist with the accounting and reporting of revenues; focusing on customer education and communication to improve voluntary compliance and encourage investment
• Improving customer support services by streamlining processes and improving operational efficiency
• Simplifying and harmonising tax and customs laws; and
• Establishing modern revenue collection systems

Our tax gap work in Ethiopia has enabled the government to focus its resources on the right reforms, and has paved the way for donors to provide their support in the knowledge that reform efforts are evidence based, and well-targeted.

Source: theguardian.com

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