The Sunday News
Dr Bongani Ngwenya
Preamble
THIS week’s Economic Focus is a continuation and conclusion of the last week’s focus, “Navigating fiscal challenges for sustainable budget deficit management”. The economic downturn presents major challenges for tax revenue administration and collection in Zimbabwe and other developing countries.
With the persistent economic downturn, tax agencies, that is Zimra and those of other developing countries are encountering growing tax compliance risks and greater demands for taxpayer technical support in the face of prospective budget cuts and growing deficits. This week’s Economic Focus examines these challenges and proposes strategies and measures for responding to these challenges.
Economic analysts and empirical research suggest that an economic downturn phenomenon has a tendency of worsening taxpayer compliance with taxation obligations. This drop or fall in compliance has some countercyclical effects on the economy in general. However, tolerating non-compliance may not be an appropriate response to the fiscal challenges because it is distortionary, inequitable, and most critically, it hampers the rebuilding of taxation bases over the medium-term.
For many countries, the revenue decline began in 2008 when general Government revenue dropped by an average of 0,8 percentage point of GDP worldwide. This decline appears to have accelerated in 2009: the annualised tax yield decline averaged four percentage points of GDP across selected emerging and developing economies in the first quarter of 2009, Zimbabwe included.
The emerging challenges to tax collection and the measures for addressing them.
Recurrent budget deficits that are not as a result of a deliberate expansionary fiscus to induce aggregate demand in the economy are a clear indicator of deteriorating tax collection capacity by tax agencies. Since adopting the multi-currency regime as a leverage to turn around the economy from hyperinflation period, Zimbabwe has seen a constant or marginal growing public service or sector expenditure that has not been matched by equally growing revenue bases, later on tax revenue base, evidenced by projected recurrent expenditure for the 2016 National budget at $3,8 billion from a projected total budget of $4 billion.
Informalisation of the economy posses as a serious threat to tax collection ability and capacity of Zimra. As alluded in last week’s article, it is a challenge to tax the informal sector. In addition, economic downturn diminishes the capacity for taxpayers, especially companies and organisations, to comply. Naturally there would be high rate or growth in non-compliance by taxpayers, in the process widening the gap between budget revenues and budget expenditure, hence unsustainable budget deficits. With unabated economic deterioration and informalisation, Zimra faces growing compliance risks involving such issues as tax arrears, loss-reporting businesses, tax withholding, and the cash economy.
There are many different, but interrelated, factors that could have caused revenues to decline in relation to Zimbabwe’s GDP. Three particularly salient factors are (1) the tendency of some tax bases to decline faster than GDP in the face of an economic downturn- closure of companies and deindustrialisation in Zimbabwe (2) a decline in commodity prices and related revenues, and (3) discretionary changes in tax policy — beliefs that informal sector is not easy to tax.
A fourth factor that may significantly affect revenue performance in an economic downturn, however, has received less attention: the possibility of changes in taxpayer compliance, which is the central focus of this article.
In responding to the challenges, this article encourages Zimra to develop a tax compliance strategy that is structured around two major objectives: containing the growth in non-compliance and helping taxpayers to cope with the economic challenges of the downturn. To achieve these objectives, four sets of measures are suggested:
(1) expanding assistance to taxpayers
(2) refocusing enforcement on the highest revenue risks
(3) introducing legislative reforms that facilitate administration, and
(4) improving communication and outreach programmes.
Measures, such as tax amnesties and moratoria on audits may be counterproductive and should be avoided at all costs. In implementing the proposed strategy or measures, Zimra should keep in mind a number of critical issues.
First, early warning of emerging compliance risks or challenges is crucial for their mitigation. Second, a high-level team needs to be established within Zimra to coordinate the development of the economic downturn non-compliance crisis strategy. Third, Government support for tax administration is more important than ever during an economic downturn phase. Finally, Zimra should align their near-term compliance strategies and medium-term modernisations plans.
The impact of an economic downturn on taxpayer compliance
Non-compliance on tax obligations takes different forms, including individuals and companies that
(1) engage in taxable transactions without having registered with Zimra — failure to formalise the informal sector in this country has seen the growth of non-compliance
(2) failure by those registered with Zimra to file their tax returns by the statutory filing deadline
(3) underreporting their tax liabilities, reporting fictitious tax losses or illicitly claim tax refunds, or (4) underpaying the amount of taxes due, i.e. tax arrears.
These forms of noncompliance give rise to a tax gap representing foregone government revenue (opportunity cost); reducing this gap is an integral task for Zimra both in good and bad economic times. When credit is tight or unavailable (liquidity crisis) like what the economy is currently experiencing, credit-constrained taxpayers may be tempted to use tax evasion as an alternative source of finance for their operations. For example, businesses may fail to remit to Zimra the taxes they have withheld from their customers (value-added tax—VAT) or employees (payroll taxes). Taxpayers who face severe economic stress — such as the risk of bankruptcy — may perceive the downside risks of tax evasion (penalties) to be minimal compared with the potential upside gains (avoiding bankruptcy).
Indeed, it can be shown, for instance, that if the bankruptcy costs are large enough, this effect — gambling for resurrection by becoming less tax compliant — can outweigh the progressivity consideration noted above.
If an economic downturn leads to a shift in economic activity, that is, from the formal to the informal sector — what is happening in Zimbabwe, compliance is likely to decline, since it is widely recognised (virtually by definition) that the rate of non-compliance is much higher in the informal sector. These conditions, moreover, may be reinforced by social norms: in a recession, taxpayers may perceive (1) Zimra to be less stringent in enforcing the tax laws or (2) that other people are evading taxes more, making it less risky or more socially acceptable to evade taxes also.
In conclusion, to address the emerging challenges to revenue collection and administration, Zimra should develop a tax compliance strategy for the economic downturn crisis (informalisation). Like all good strategies, this should be based on clear objectives and an appropriate set of measures for achieving them.
Zimra’s fundamental objective this time around (informalisation) should be to contain a rise in noncompliance. If ignored, the rising tide of noncompliance could lead to substantial foregone revenue (opportunity cost) as well as provide an unfair competitive advantage to non-compliant companies and individual tax payers in this country.
Containing non-compliance in an economic downturn requires Zimra to adjust its taxpayer services and enforcement programmes for newly emerging compliance risks (informalisation). Secondly Zimra should be willing to help taxpayers cope with the pressures of the economic downturn.
Naturally, during economic hardships, many viable companies can be expected to experience severe financial distress that could cause them to cease their operations (many companies have so far succumbed) and exit the formal taxation system, resulting in permanent revenue losses to the fiscus.
Measures that could enhance the probability of taxpayers staying in the tax system include adjusting advance payments, accelerating tax refunds, and making greater use of payment extensions. To the extent that these measures provide an element of fiscal stimulus, decisions on their introduction should be made at an appropriate level within the Government and factored into the country’s overall economic program (Zim Asset) for economic growth.
Dr Bongani Ngwenya is a Bulawayo-based economist and senior Lecturer at Solusi University’s Post Graduate School of Business. Feedback: [email protected]/ [email protected]
