The Challenges in Implementing Tax Reforms - Example

The Challenges in Implementing Tax Reforms By student’s name Course code+ name Professor’s name University name City, state Date of submission Introduction Tax reform is the process that involves changing the manner in which taxes are collected or managed by the government. The process may involve the introduction of Value Added Tax or its expansion where it already exists, the broadening or simplification of corporate or personal income taxes or the elimination of stamp and other duties (Moyi and Ronge 2006, 3). Tax reform may also involve revising the tax code and other tax laws to provide comprehensive provisions on the administration of tax and the criminal liabilities that arise due to tax evasion. Tax reforms involve a complex process that is characterized by broad issues of economic policy and issues relating to tax structure and administration. Due to these factors, the implementation of tax reforms is often a challenging task. As stated above, tax reforms involve complex issues of economic policy. This means that there must be the political will and support for tax reforms to take place. Such political support is not always forthcoming due to the fact that tax reforms always creates winners and losers hence it may be less favorable among the political elite who may have other personal interests (Sentance 2014, 1). This is more so in developing countries. This essay focuses on the various challenges in implementing tax reform, especially in emerging markets. The essay draws upon examples of the challenges experienced in implementing tax reforms in Uganda and also borrows from other emerging countries such as India. Why Tax Reform? Tax reform, as stated above, is meant to introduce changes in the way a government collects or administers taxes. Tax reform introduces a new tax policy or system in a country that is meant to induce economic growth. A tax policy is concerned with issues of how much revenue the government collects, its use and whether the method used to collect the tax is the right one. The process of tax reform is meant to identify the purpose of the available tax instruments and how well these tax instruments achieve their purposes. One of the purposes of tax reform is to ensure that the tax system that is in place supports the objectives that the government has set out (OECD 2016, 2). A sound tax system is pegged on an appropriate tax system that is developed to meet the specific economic needs of a country. A sound tax policy is dependent on three factors namely the architecture, engineering and management factors (Rao 2015, 2). The architecture component of a tax policy relates to the design of the policy which should be consistent with the goals or objectives of the policy. This means that if the tax policy’s objective is to create a business-friendly environment suitable for multinational companies, the architecture of the design of the policy should reflect this objective. The engineering aspect relates to the mechanics put in place to apply the design or the architecture. The engineering aspect is usually influenced by the systems that have been set up to collect tax. The management aspect, on the other hand, relates to the strategies for the implementation of the policy. The management aspect may be determined by many factors such as the competence level of the administration, the information system involved and political support (Rao 2015, 2). The importance of tax reform is founded on the purpose of taxation for a country. There are different benefits that are attributed to taxation. However, in developing countries and emerging markets, the purpose of taxation is to stimulate economic growth, promote external and internal stability and to ensure that income is distributed in an appropriate manner (Kayaga 2007, 7). The tax collected by governments is used to fund different programs meant to grow the economy. Further, governments also use tax incentives to lure multinational companies to invest in their countries to provide job opportunities for their population hence promoting economic growth. Tax reforms are introduced by the government in line with the goals and objectives the government has set for a country. This means that tax reforms are seen as the instrument upon which the goals can be achieved. It is a way of streamlining the tax system in a country to ensure that it is in line with the strategies that are currently in place. Taxation is also important for stability because an increase in tax yields reduces the need for deficit financing hence promoting economic stabilization (Kayaga 2007, 8). Since tax reforms are meant to promote the economic growth of a country, it follows that these reforms are also important in the stability of a country. The stability of a country arises from its ability to provide for its people which can be achieved through economic growth. Based on the different uses of tax, tax reforms become an important aspect of a country and a driver of economic growth. Governments, therefore, need to change the tax policy or the tax system in a country to fit their objectives or to achieve their growth needs. As the economy of a country grows, the government may need to change the tax policy to ensure that it is aligned in accordance with the fiscal objectives in place at the moment. Global pressures may also influence tax reforms especially in the event of a financial crisis. Recent Tax Reforms Countries have adopted different tax reforms in an effort to stimulate development and achieve economic stability. Many countries all over the world, including developing countries and emerging markets, have introduced value-added taxes as part of their tax reform. Some countries introduced uniform VAT rates while others have multiple rates depending on the commodities. The introduction of VAT has several benefits such as allowing the tax system to be more broad-based (Azizul 2015, 7). In many countries, VAT applies to almost all commodities hence promoting a broad application. This is beneficial to a country because the broad-based application increases the revenue collected. Another benefit of VAT is its neutrality due to the fact that it applies equally to different products. This is more so in countries with uniform VAT rates. In a country such as Kenya, for example, the VAT rate stands at 16% on all products. Trade taxes have also been introduced as part of tax reforms. This is where governments impose high tax rates on international trade. However, due to globalization which has opened national borders and increased the market for trade, governments, especially in developing countries, are eliminating or reducing taxes such as export duties. This is meant to create an incentive for business people to conduct more trade and increase revenue collection in business taxes and VAT among other taxes. Income taxes have also been subject to tax reforms. The International Monetary Fund guidelines on tax reforms recommend that countries should reduce income tax (Azizul 2015, 8). One of the advantages of the reduction of income tax is the fact that tax compliance improves and the pressure on tax administration reduces. People do not feel the need to evade taxation because the rates are low. Further, the decrease in the rate of income tax also reduces the rate of corruption more so in developing countries. On the same issue of trade taxes, the IMF has recommended that governments should stop trade tax incentives or reduce such incentives. This is because such incentives undermine the perception of fairness in taxation and also complicates the process of tax administration. The issue of fairness relates to the government introducing equal rules for all people without favoritism regarding taxes. Governments introduce tax incentives for various reasons such as to promote investment and also to promote development in poorer or marginalized areas. However, research shows that tax incentives have little effect on investment. The key factor in stimulating investment in a country is overall state of the economy of a country (Azizul 2015, 10). Governments should, therefore, be more willing to reduce the incentives and concentrate on other taxation methods that promote fairness and build the economy. One of the benefits of this strategy is the fact that where the government strives to ensure fairness, there is stability and acceptance of the tax policy in place or being introduced. People are interested with the government providing an equal field for all without any special treatment that may give some people an advantage over others. Challenges in the Implementation of Tax Reforms Tax reforms are important in the economic growth of a country. They are necessary to enable governments to attain the objectives and goals set for the country. Tax reforms enable a country to align its fiscal policies towards achieving the desired goals. Governments will in most cases make changes to the structure of the tax system to make the system more conducive to the growth of the economy and increase in employment opportunities. The economic growth of a country is important to its stability. Growth in the economy means better opportunities for the citizens and improvement in the standards of living. This leads to a sense of security for the people and hence avoids political instability which can result from the failure by the government to address social-economic needs of the people. The great importance accorded to taxation makes it an important factor in the running of a country. Despite the importance of tax reforms, governments have not had an easy time implementing the reforms. Although governments make a lot of plans to restructure the taxation system, it becomes difficult for the governments to implement the changes. This is due to various challenges that stand in the way of implementing tax reforms. The challenges discussed below are those that are common to developing countries or emerging economies. Emerging economies are those countries that are of low-income and experience rapid growth (Hoskisson et al. 2017, 249). The challenges that face developing countries in implementing tax reforms may differ slightly with those of the developed countries due to the level of economic growth. The differences in the challenges may also be as a result of the stability in these countries both politically and economically. Unfairness of Tax Changes One of the challenges experienced in implementing tax reform is the unfairness that results from tax reform. It is normal that a change in the tax system must result in winners and losers. There will always be individuals or organizations that benefit from lower tax rates while others suffer the adverse effects of higher tax rates. Due to the pressure exerted by the losers arising from tax reforms, governments come under pressure to eliminate the adverse effects on the people. According to Rao (2015, 5), the major challenge that governments face in implementing tax reform is ensuring fairness through the changes. Even where the changes introduced by the tax reform are progressive, implementation of the changes may be difficult due to the resistance by the people. This problem can be addressed by ensuring that the overall changes introduced by the tax reform are beneficial to the country and to the people. Tax reforms, as stated above, are important not because of the individual tax benefits or changes that result from the policy but rather their importance arise from the effect of the changes as a whole. Tax reforms change the tax system in a country. This means that the benefits of the changes introduced should be looked at from the perspective of the whole system. This means that while some individual changes may have adverse effects on some people or corporations, the overall benefits outweigh these negative effects. One of the recommendations by the IMF towards ensuring fairness in the making of tax reforms is doing away with or reducing tax incentives. Tax incentives promote unfairness in tax reforms since some people or businesses may be exempted from tax or their rates lowered while it is not the same for others. Political and Economic Pressures Other than the unfairness that results from tax reform there is also the political and economic pressures that make the process of tax reform more complex. It is worth noting that politics plays a big role in the adoption and implementation of fiscal policies in a country (Sentence 2014, 1). Tax policies are subjected to the same process of political approval like other policies. As a result, political pressure may delay or impede the implementation of tax reforms especially where there are adverse effects resulting from the changes to be introduced. The increase in the number of lobby groups and special interest groups has further made the situation more complex. This is because every single group seeks to ensure that the members they represent are not affected in a negative way by the changes in the tax system. This leads to delays in the implementation process. In some developing countries, the high level of corruption makes it difficult to get political support in implementing the tax reforms. Government officials may be bribed by business owners and multinational companies where the tax changes do not favor them. Since tax reforms can be put off or delayed, these government officials delay the implementation hence impeding the achievement of the goals and objectives of the tax reforms (Martinez and Santiso 2003, 365). Wilkinson (2017, 2) argues that one of the key characteristics of the largest emerging markets such as China and Turkey is the fact that political stability is achieved when there is economic growth and vice versa. Countries that are characterized by political instability cannot grow economically as the governments may desire. Due to the political instability, it also becomes difficult to establish tax reforms due to the lack of support from the people and from the leaders. Such trends can be seen in certain developing countries faced with internal conflicts such as Somalia and DRC Congo. Due to the political instability witnessed in these countries, economic growth is significantly impeded which makes it hard to effect tax reform. Economic pressures can also arise from factors such as a financial crisis as well as poor economic growth experienced in a country. A mutual relationship exists between economic stability and political stability. This means that political pressures may cause economic pressures which may also affect the implementation of the tax reforms. Economic pressures may be from external sources such as from other countries. Where a country, for example, is seeking to join a trade block it may be forced to introduce a tax reform to ensure uniformity of the trade policies with the other countries in the trading block. In a situation where such a country is already in the process of implementing tax reforms, the influence of the other trading partners may be an impediment to the successful implementation of the tax reforms. Poor Revenue Administration System The implementation of tax reforms requires a proper system to effect the necessary changes. This means that there must be a proper legal framework to provide for the changes. Further, there must also be established institutions tasked with the responsibility of enforcing the new changes and ensuring compliance. This also requires an institution or institutions to collect the tax and administer it in accordance with the tax reforms. Many developing nations, unlike the developed nations, lack such kind of a system to ensure that the tax reforms are implemented and that the changes are adhered to. This explains why in some countries such as the Philippines tax reforms are introduced, but there is not much change that is experienced in terms of increase in revenue collection (Wilkinson 2017, 2). The weak revenue administration system is also coupled with low taxpayer morale that makes it hard to effect the new changes. In situations where there is no proper implementation strategy, the people do not embrace the changes and they end up being less enthusiastic about complying with the changes. A key factor that may further the issue of weak administration systems is the level of corruption in some of the developing countries. Where the level of corruption is high, the implementation strategies are compromised due to the compromises made by the officials tasked with the responsibility of effecting the changes (Cottarelli 2011, 8). Another factor that is also part of the weak administration system is the existence of hard to tax sectors in emerging markets. Small businesses, informal enterprises and state-owned enterprises are some of the institutions that are hard to tax. This means that the revenue targets are not achieved and, as a result, the revenue targets are not attained. Tax Reform Challenges in Uganda as a Case Study The Ugandan government has made significant strides in introducing and implementing tax reforms in the country. There are measures that have been put in place to ensure proper administration of taxes guided by a substantive tax policy (Kayaga 2007, 38). Uganda has experienced an increase in revenues which has enabled the government to invest more in key areas such as education. The increase in revenues led to the introduction of free primary education and the upgrading of key infrastructure such as roads. However, despite the great strides made in tax reform, there are still challenges that affect the implementation of tax reforms in the country. One of these challenges is the HIV/AIDS epidemic that has led to high rates of morbidity and mortality in Uganda. Although the rate of HIV infections in Uganda has reduced significantly, HIV/AIDS has reduced the growth rate of the labor force. This is made worse by the high levels of poverty among the people living in rural areas. Poverty and HIV/AIDS erode the population that is capable of paying taxes hence making it hard for the government to reach their intended revenue targets. For households affected by HIV/AIDS, they are forced to devote much of their spending on health care. In a country where a large section of the population is living below the poverty line, the health costs make it unlikely that the affected individuals will pay tax (Kayaga 2007, 43). The civil war in Northern Uganda presents an example of the challenge of political instability. The civil war led by Joseph Kony and his group, the Lord’s Resistance Army have been fighting the government since 1980s. The militia group has been targeting the civilian population in Northern Uganda where maims, kills, rapes and abducts innocent civilians. Young boys from the areas affected are recruited into the militia while young girls are forced into becoming sex slaves. The activities by the LRA have disrupted the economic activities of the people in Northern Uganda making it hard for them to engage in economically productive activities. The civil war has denied the people living in Northern Uganda the opportunity to take part in nation building (Kayaga 2007, 50). Due to the war, they are unable to pay tax or even take their children to school. Without education, the people living in these areas continue to suffer and live in poverty. The war has also led to the destruction of the infrastructure such as roads, bridges, telecommunication lines, schools and hospitals. These people end up living in deplorable conditions and cannot pay taxes or afford to provide basic needs for their families. Another challenge which has affected the implementation of tax reforms is the informal sector. Although the extent of the informal sector has not been defined or measured, it forms an important part of the economy. However, due to the fact that these businesses are informal, it becomes difficult to tax them. The people employed in these institutions are also few. This interferes with the number of people who can pay tax. The informal sector creates shadow economies, Despite the fact that tax laws have been enacted requiring taxpayers to pay tax as a way to contribute to government revenues, the actual amount of revenues collected is less due to the inefficiency of the revenue administration in Uganda. There are weaknesses experienced in the collection of tax that has led to inadequate revenues collected (Kayaga 2007, 63). This is due to the presence of inexperienced staff and the lack of enough resources to invest in infrastructure and technology that can help in increasing the revenues collected. The high levels of illiteracy among the taxpayers also contribute to the low revenues collected since they are not aware of their tax obligations. Tax administration is also hampered by the lack of enough resources to facilitate the activities of tax authorities. Tax authorities and institutions need the right infrastructure and personnel to ensure that people pay tax. Such resources are also necessary to ensure that in the event of tax reforms there are qualified people to mobilize support for the changes to ensure the growth of Uganda’s economy. Conclusions and Recommendations Tax reforms are necessary for stimulating the growth a country’s economy. Governments introduce tax reforms as a way of making changes in the tax system or policy of the country to align it with the goals and objectives to be achieved. Tax reforms are meant to promote economic growth by increasing revenue and providing for proper tax administration processes. Despite the great importance of tax reforms, research has shown that implementing these reforms is not always easy. Governments, both in the developed and developing nations, have a hard time implementing changes in the tax policy due to various factors. One of these factors is political pressure that may lead to postponement of the implementation of the reforms. Tax reform may in some cases be unfair to certain groups hence where such groups exert their influence and pressure on leaders, the implementation process is affected. The presence of conflicts and civil wars in a country can also be an impediment to the successful implementation of tax reforms. Political stability is necessary to ensure that the changes are effected. Economic pressures such as in the event of a financial crisis can also contribute to the delay in implementation of tax reform. Another challenge in the implementation of tax reforms is the weak revenue administration systems that make it difficult to enforce the new changes in tax obligations. Governments in developing countries lack adequate resources to collect taxes and also to ensure that every person and business or corporation pays tax as required by law. The lack of proper enforcement mechanism affects the implementation process of tax reforms. Based on the above findings, the essay makes the following recommendations to assist governments in dealing with the challenges in implementing tax reforms. Governments must establish effective revenue administrations capable of promoting voluntary compliance with tax obligations. This means that the governments should establish an effective tax administration infrastructure that can help increase the revenue collected. There is also the need to implement policies to help identify and punish behavior that is inappropriate in revenue administration. The tax authorities must be well equipped to deal with issues with non-compliance with tax obligations (Cottarelli 2011, 10). This ensures that in the event that tax reforms are introduced, every person adopts the changes. From the discussion in this essay, political pressure and economic pressure are also key challenges in the implementation of tax reforms. Governments, especially in developing countries, must move with speed to ensure peace and political stability in every region. Such political stability must be accompanied by strong fiscal policies to help in the growth of a strong economy. This will ensure the economic and political readiness in tax changes (Wilkinson 2017, 3). The unfairness of tax reforms has also been a challenge in the implementation of tax reforms. Governments should levy VAT on a broad base and avoid multiple rates. Uniform VAT rates should be maintained as a way to broaden the revenues collected and also preventing complaints of unfairness from the public. There is also the need to reduce or do away with all tax incentives as a way to ensure that there no major losers or winners in the event of changes in the tax policy. Governments in emerging economies must improve tax administrations and equip tax authorities with the resources needed to effect tax reform. It is also necessary to ensure that the tax reforms are in line with the economic objectives set up by the government. References Azizul, I 2015, Issues in tax reforms, Asia-Pacific Development Journal, 8(1), 1-12. Cottarelli, C 2011, Revenue mobilization in developing countries, International Monetary Fund. Hoskisson, R, Eden, L, Ming Lau, C and Wright, M 2017, Strategy in emerging economies, Academy of Management Journal, 43(3), 249-267. Kayaga, L 2007, Tax policy challenges facing developing countries: A case study of Uganda, Queen’s University Kingston, Ontario, Canada. Martinez, J and Santiso, J 2003, Financial markets and politics: The confidence game in Latin American emerging economies, International Political Science Review, 24(3), 363-395. Moyi, E and Ronge, E 2006, Taxation and tax modernization in Kenya: A diagnosis of performance and options for further reform, Institute of Economic Affairs. OECD 2016, Tax policy reform and economic growth, Available at: https://www.oecd.org/ctp/tax-policy/46605695.pdf [Accessed 28 April 2017] Rao, G 2015, The tyranny of the status quo: The challenge of reforming India’s tax system, National Council of Applied Economic Research. Sentence 2014, The challenges of tax reform, Price house Water Coopers. Wilkinson, B 2017, Political risk in emerging markets, Available at: http://www.oliverwyman.com/content/dam/oliverwyman/global/en/2014/dec/RJ2014%2003_Political%20Risks_Ipad.pdf [Accessed 28 April 2017] Read More