Financial Times

A crisis in tax administration?
By P. Guruge
Until recently the public was generally not aware of any problems in tax administration in Sri Lanka, although it was not a secret to the tax paying public and many others interested in a fair tax administration. Those directly involved in tax administration were trying to present a rosy picture during past several years, but the facts and figures reveal the contrary.

The bottom line of effective tax administration is the collection of required revenue for the government and the creation of a happy taxpayer population willing to comply with tax laws. When the performance of the tax administration for the past years is taken into consideration it is difficult to say that we have achieved any of these two important targets.

As far as the Inland Revenue Department (IRD) is concerned the income tax revenue has come down year after year as illustrated below on a comparison of the years 1992 and 2000. As a result of this drop in income tax collection the shortfall in revenue collection for the government has increased annually.

The other criteria the "happiness of the tax paying public" was also not to be seen. Some one can say that the taxpayers may not be happy under any circumstances. But a large majority of taxpayers are reasonable enough to acknowledge fair treatment by the tax administration, if there is in fact such treatment. In fairness to the Inland Revenue, it must be stated that this dissatisfaction is equally applicable to other tax departments such as Customs and Excise as well. The main problems faced by the tax paying public is non-transparent treatment due to discretionary authority used by tax administrators, non-compliance with rules and regulations, lack of coordination and rent-seeking activities by the tax administrators in general.

Unhealthy vacuum
Due to the unsatisfactory situation in the revenue administration many capable officers at various levels retired from the service pre-maturely leaving a vacuum in the tax administration. This has lead to very quick turnover at the higher levels of tax administration. For example, during the last three decades the Inland Revenue Department has had more than a dozen Commissioners General which gives an average period of service less than two years per individual in many cases, (in some cases not more than a year) which is not a healthy feature from any standard of good administration leave alone tax administration. As a result many top level tax administrators during the past few decades were apparently not so interested in the improvement of tax administration but preferred a trouble free period of (short) service.

When the tax administration was unable to deliver the goods the policy makers in the 70s and 80s rushed to other measures of tax collection (mainly indirect taxes) which has compounded the administrative problems further. When the Turnover Tax was expanded in 1981, it gave very good revenue and the tax administration was very pleased.

They just depended on this easy source of revenue (with very many bad effects) instead of improving the direct taxes. Finally, the time came to change this cascading and inflationary tax to a more reasonable (Value Added Tax) VAT type of a tax. With the introduction of GST in 1998 the period of easy revenue from turnover tax enjoyed by the Inland Revenue came to an end. VAT type of taxes are not so easy to administer. It requires a great deal of modern technology and other systems and procedures. The Inland Revenue was using easy systems and adopting a relaxed style prior to the introduction of GST. Thus it was very difficult for them to comply with the startup requirements and the maintenance of critical levels of administration of the GST/VAT.

The result is that the expected revenue from GST/VAT is also not forthcoming even after five years of the implementation. As a result of all these shortcomings the compliance levels were very discouraging, although it is the prime requirement of a self-assessment system. It is very often said that the number of income taxpayers is inadequate when compared with the economic development which has taken place during the last few years. Not only individuals even corporate taxpayers (companies) do not properly comply with tax requirements. It is said that there are about 40,000 registered companies in Sri Lanka. Even if 30,000 are really operating we must have nearly 30,000 company tax files. But according to the latest statistics of the Commissioner General of Inland Revenue there are only about 18,187 resident companies registered with the Department of Inland Revenue. Out of these only 8,000 file income tax returns and only less than half of that pay any tax at all! What has happened to voluntary compliance?

The simplification of tax laws and procedures may be further expanded in the next few years in order to pave the way for streamlined efficient tax administration.

Tax amnesty
In furtherance of these objectives two other major steps have been taken by the government. One is the introduction of unprecedented exoneration of tax and related offences. The legal background for this has been provided by the Inland Revenue (Special Provisions) Act No. 10 of 2003.

As a result any person can make a declaration to the Commissioner General of Inland Revenue declaring his or its undeclared income or assets up to 31.3.2002.
When such a declaration is made, there will be no investigations, inquiries or the payment of taxes or penalties on such undeclared income or assets, if any. Further any pending disputes will be settled on the basis of declarations regarding the tax due made by the relevant person. This will be applicable to all taxes and levies (other than VAT) administered by the Commissioner General of Inland Revenue (including defunct taxes and levies), taxes administered by the Director General of Customs, Director General of Excise, Commissioner of Excise, Exchange Controller and Import and Export Controller.

All these years tax administrations specially the Inland Revenue was saddled with a huge mountain of tax arrears which increased year by year. Arrears of tax which was only Rs. 8 billion in 1992 increased to around Rs. 54 billion in 2002 after just 10 years. There were no adequate steps taken either to collect these arrears or write them off from the books. Many officers neglected the collection of current taxes on the current year basis. Now officers will have to either collect arrears within five years or face the time-bar. In future tax officials should realize that the only way to reduce the accumulation of arrears of taxes is to collect as much as possible on current year basis without waiting for late collections.

The other is the proposed "Revenue Authority". This has generated a great deal of heat among various levels of tax administrators not only in the Inland Revenue but in the Customs and Excise as well. As far as the government is concerned this is a step in the right direction in order to safeguard the overall revenue base of the country and to streamline the respective administrative machineries. As a result those who are genuinely engaged in tax administration will be benefited immensely. It is very strange that certain sectors have started protest campaigns against the establishment of a Revenue Authority.

However, this type of structural change, which is fundamental, should be handled carefully. We should clearly understand the pros and cons and go through the process accordingly and not merely because some organization proposed it or funded the process. First of all a firm political commitment is very necessary. If the political will is not available the success rate will be very low. Then the proposed structure should be what we require exactly to deal with our problems. In many cases such restructuring has been a failure due to the negligence of local conditions. Mere establishment of a super structure will not be sufficient. In many countries revenue authorities have failed due to the following reasons.

Non-integration of different tax departments.
No change in compliance and education programmes
No autonomy over staffing
No independent stable budget
No adequate political commitment

Many problems in tax administration are due to the excessive discretionary powers enjoyed by tax administrators not only in relation to taxpayers but in relation to their own staff. Very often procedures are not followed in granting scholarships, promotions, transfers etc. which will frustrate the staff. Very often tax officials wouldn't give a fair hearing to taxpayers unless they are "known" to them someway or the other.

The future
What will happen to our tax administrations in future? There is no easy way out. Sri Lanka's structure of tax administration has reached the point of collapse. One basic reason is the inaction of authorities in tackling corruption. There were instances where clear evidence was available against corrupt officials but no action was taken against them. If one looks at the Administration Reports of Commissioners General of Inland Revenue, it will be very difficult to see any problems in the administration. Everything seems to be working fine. No disciplinary action, no interdictions or suspension from services, etc. except for a few petty offences in some years. No problems at all. But is that the correct position?

That is the problem we face now, not only in tax administrations but in other areas of public administration as well. Sometimes action against corrupt officials is not taken due to sympathy. This "sympathy syndrome" has damaged our public service to a large extent. Another reason is non-recognition of the ill-effects of these corrupt practices. The corruption in administration especially in tax administrations will have a direct impact on revenue collection. It will become an illegal appropriation of government revenue by tax officials.

That's why in many countries they apply special codes of conduct for tax officials. In Sri Lanka also this may be appropriate since the normal regulations in "AR and FR" seem to be inadequate and time consuming.

Managers in tax administration should be made adequately competent to deal with inefficiency and corrupt practices. Under the existing system this does not happen. They are just kicked upstairs on the basis of seniority. The recruitment system may have created a lot of problems in tax administration. Sometimes many tax administrations in Sri Lanka are over staffed. It is very important to identify the tasks to be performed and the required quantity of human resources. The selection criteria has to be reconsidered. Dependence on educational qualifications (like graduates with classes, etc.) alone may not be appropriate.

There are enough qualified people in that category. But what is required today is honest and efficient officers. How can you find them by looking at their educational and other qualifications? It requires time. Therefore, all appointments should be made on contract basis and any inefficient and corrupt officials should be dismissed.

This point leads to another important aspect with regard to human resources in tax administrations. It is very important to offer a very attractive remuneration package to revenue officials selected on contract basis. Otherwise, they may again fall into the vicious circle of low remuneration and corruption.

Just touching the symptoms will not be sufficient. You will have to go to the root cause. The entire system has to be changed. One cannot blame tax officials alone. The category of tax practitioners and other professionals such as lawyers are also responsible for this situation greatly. They sometimes work as go-betweens among tax officials and taxpayers and breed corruption. They sometimes work in collusion with top level tax managers. Along with a good code of conduct for tax officials there should be an equally good code of conduct (enforceable in law) for tax practitioners and others helping taxpayers.

Another area is "outsourcing" the activities of tax administration as much as possible. This will make matters easy for tax administration. Many have not understood that we have already done this in many areas. In Sri Lanka specially in income taxation we started the first out-sourcing by introducing PAYE tax about three decades back. Now it is working fairly well. Also consider the number of other withholding tax systems in operation. All these are out-sourced activities. In fact we collect more income tax revenue from these activities.

Therefore, we must look for other areas for out-sourcing for the benefit of the country. We cannot run tax administrations only for the benefit of tax officials! Many activities done by the revenue administration are not up to the mark. Collection of default taxes, taxpayer education, human resource development, etc. are some of these areas which may be handled by others competently if out-sourced by reducing the burden on tax administration. With regard to Customs also there may be some areas (if not all the areas like in some other countries) which can be given to outsiders. Especially in excise administration one has to reconsider their Police functions. If Police functions are handed over to the Police their revenue functions may be performed much better and in an orderly manner.

However, a word of caution is appropriate. The private sector anywhere in the world has no magic. They are committed to a goal. Generally, they work for the maximisation of profits. All their resources are geared to that. Sometimes people call this "exploitation" in relation to human labour. But they are adequately remunerated and properly administered. That is the basic difference between the government or public service and the private sector.

In the public sector very often we have no goal nor adequate commitment. Unless we remedy this situation we will not be successful. Even the private sector can go wrong. (The author, formerly of the Inland Revenue Department, is now advisor, Fiscal Policy in the Finance Ministry)

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