The tax base in transition : the case of Bulgaria

The transition from socialism characteristically reduces existing tax revenues at the same time that it increases the need for government spending. An increasing need for revenue combined with an eroding tax base creates a transition-related fiscal gap and a challenge for tax policy. The solution, say the authors, is not to lay a heavier tax burden on new private firms. The issue is how to meet revenue needs without inhibiting private sector development. Large-scale tax evasion in the private sector - the de facto outcome in Bulgaria and in many other transitional economies - may be a good incentive for development of private enterprise, but it is illegal and inequitable to wage-earners and salaried workers. The chief means of increasing tax revenue are to: (1) reduce tax rates to decrease the benefit of evasion; (2) improve tax administration (to increase tax coverage and better dectect evasion); and (3) increase penalties for evasion. These three measures effectively decrease the benefits and increase the cost of tax evasion to economic agents. It takes time to improve tax administration, however. Given administrative limitations, what should the tax structure be? The authors contend that an administratively feasible system designed to encourage development of the private sector during the transition should: (i) be simple, not complex or oversophisticated; (ii) be administratively implementable with current resources; (iii) impose a low tax burden on all economic agents; (iv) rely on broad tax bases with minimum exemptions; (v) begin the long-term improvement of tax administration; and (vi) limit the severity of tax penalties in the transition from an authoritarian to a democratic regime. In theory, reducing the cost of compliance and increasing the expected cost of noncompliance should reduce tax evasion and increase tax revenue. In practice, small businesses and self-employed citizens tend to evade taxes, providing an effective zero tax base. The government has little to lose from reducing taxes on the self-employed but, to be equitable, it should reduce taxes for everyone. As a general rule, say the authors, economies in transition should impose lower tax burdens than are imposed in mature western market economies. It may also reduce the perception of"exploitation"by giving the impression of a more modest government consistent with the dynamic private sector led economy.