Read Part I and Part II of Sam Vaknin's The Blessings of the Informal Economy series of articles first

Some countries in transition have been more successful than others in battling the informal economy and confining it to niche activities (such as domestic help, car servicing, or baby sitting). There are characteristics common to the more successful plans to wean the economy off its informal propensities in countries such as Croatia, Bulgaria, Hungary and others. Here is the continuation of CER's survey of the more successful measures implemented by more than 20 countries from Kazakhstan to Macedonia.

Databases and information gathering

• Estimating the magnitude of the informal economy was made a priority objective of every national bureau of statistics. In some countries (such as Croatia, Czech Republic, Hungary, Poland and Bulgaria) they devoted considerable resources to this effort. In doing so, the bureaux of statistics coordinated closely with a wide variety of relevant ministries and committees that oversee various sectors of the economy.
• All registrars were computerized: land, real estate, motor vehicles, share ownership, companies registration, tax filings, import and export related documentation (customs), VAT, permits and licences, records of flights abroad, ownership of mobile phones and so on. The tax authorities and the public revenue offices (PRO) were granted unrestricted access to all the registers of all the registrars. Thus, they were able to find tax evasion easily (by investigating the sources of wealth—how did the taxpayer build this house and buy a new car if he were earning 500 DM monthly according to his tax return?)
• The PROs were given complete access to the computers of the clearing houses and to all computerized and non-computerized financial records.
• The computer system of the tax authorities constantly compared VAT records and records and statements related to other taxes in order to find discrepancies.
• Gradually, submissions of financial statements, tax returns and wealth declarations are being computerized on even a monthly basis (for instance, VAT statements).
• A (frequently controversial) system of informants and informant rewards was established, including anonymous phone lines. Up to ten percent of the intake or seizure value related to the information provided by the informant goes to such informants.

Law enforcement

• In many countries in transition, tax inspectors and customs officials received police powers and their wages were increased and augmented by a percentage of tax revenues. The salaries of all tax inspectors—regardless of their original place of employment—were equalized (of course, taking into consideration tenure, education, rank, etc).
• Judges were trained and educated in matters pertaining to the informal economy. Special courts for taxes, for instance, work well. Judges were trained in tax laws and the state tax authorities provided binding opinions to entrepreneurs, businessmen and investors regarding the tax implications of their decisions and actions. In some countries, these measures served to increase the certainty of the business environment and decrease the venal official arbitrariness so typical of post-Communist countries.
• Tax inspectors were assigned to the public prosecutors' office to work as teams on complex or big cases.
• An independent financial and tax police with representatives from all relevant ministries but under the exclusive jurisdiction of the PRO was established in many of these countries. The remit of this police encompasses all matters financial (including foreign exchange transactions, property and real estate transactions, payroll issues, etc.)
• Hiring and firing procedures in all the branches of the tax administration were simplified. The number of administrative posts was reduced and the number of tax inspectors and field agents increased.
• Tax arrears and especially the interest accruing thereof became the first priority of the clearing houses and tax asuthorities. This is especially evident in Russia—though for political reasons—in the investigsation of the oligarchs for back taxes.
• All manufacturers and sellers of food products (including soft drinks, sweetmeats and candy, meat products, snacks) had to purchase a licence from the state and were subjected to periodic and rigorous inspections.
• All contracts between firms are registered in the courts and stamped to become valid. Contracts thus evidenced are accompanied by the registration documents (registrar extract) of the contracting parties. Many "firms" doing business in Macedonia or the Czech Republic, for instance, are not even legally registered.

Reforms and amnesty

• A special inter-ministerial committee with minister-members and headed by the PM was established in some countries. Its roles: to reduce bureaucracy, to suggest appropriate new legislation and to investigate corruption.
• In all the countries in transition, the bureaucracy has yet to be pared down drastically. The more permits, licences, tolls, fees and documents needed—the more corruption. Less power to state officials means less corruption. The One Stop Shop concept should be implemented everywhere (a single location for the simultaneous issuance of all such paperwork).
• A general amnesty was often declared in many of these countries. Citizens declaring their illegal wealth were pardoned by law and either not taxed or taxed at a low rate once and forever on the hitherto undeclared wealth. But the frequent and rather predictable usage of this otherwise effective instrument blunted it and made it counterproductive. People evaded taxes and waited for the next presidential or government pardon.

The tax code

• By far the most effective measures has been to impose a VAT system. VAT is one of the best instruments against the informal economy because it tracks the production process throughout a chain of value added suppliers and manufacturers. Macedonia—the latest to have done so in April 2000—saw its finances transformed from budgetary deficit to budgetary surplus in a matter of six months.
• That the labyrintine tax codes of countries in transition need to be simplified is common wisdom and in consensus. Emphasis should be placed on VAT, consumption taxes, customs and excise taxes, fees and duties. To restore progressivity, governments should directly compensate the poor for the excess relative burden. But these measures were rarely put to practice.
• After revising the tax code in a major way, few governments declared a moratorium on any further changes for at least four years.
• The self-employed and people whose main employment is directorship in companies were given the choice between paying a fixed percentage of the market value of their assets (including financial assets) or regular income tax.
• In some countries, all property rental contracts are registered with the courts. Lack of registration in the courts and payment of a stamp tax renders the rental contract invalid. The courts are allowed to evidence and stamp a contract only if it carries the stamp of the Public Revenue Office (PRO). The PRO registers the contract and issues an immediate tax assessment. Contracts which are for less than 75 percent of market prices are made subject to tax assessment at market prices. Market prices are often determined as the moving average of the last 100 rental contracts from the same region registered by the PRO.
• Filing of tax returns—including for the self-employed—is only with the PRO and not with any other body. In the former republics of Yugoslavia, tax returns are sometimes filed with the ZPP, the national clearing house.

Legal issues

• In the last decade, the burden of proof in tax court cases has shifted from the tax authorities to the person or firm assessed.
• Special tax courts were established separately or within the existing courts. They were staffed by specifically trained judges. Their decisions can be appealed to the Supreme Court. These special courts render their decisions within 180 days. All other juridical and appeal instances are cancelled—except for an appeal instance within the PRO. Thus, the process of tax collection is greatly simplified. A tax assessment is issued by the tax authorities, appealed internally (within the PRO), taken to a tax court session (by a plaintiff) and, finally, appealed to the Supreme Court (in very rare cases).
• In many of these countries, the first measure implemented was to amend the laws to allow for greater fines, prison terms and for the speedier and longer closure of delinquent businesses.
• Seizure and sale procedures were specified in all the tax laws and not merely by way of reference to the income tax law. Enforcement provisions were incorporated in all the tax laws.

Customs and duties

• Ideally, this most corrupt of transition institutions, the customs office should be placed under foreign contract managers. But this proved to be politically too sensitive. Instead, the customs personnel became entitled to receive a percentage of customs and duties revenues, on a departmental incentive basis. In any case, some customs and duty offices were subjected to outside inspection by expert inspectors who are rewarded with a percentage of the corruption and lost revenues that they expose.
• In the case of imports or payments abroad, invoices, which include a price of more than five percent above the list price of a product, are rejected in many countries and assessment for the purposes of paying customs duties and other taxes is then issued at the list price.
• In the case of exports or payments from abroad, invoices which include a discount of more than 25 percent on the list price of a product are often rejected and assessment for the purposes of paying customs duties and other taxes is then issued at the list price.
• The numbers of tax inspectors has substantially increased in all countries in transition and their pay was considerably enhanced. A departmental incentive system was often instituted involving a percentage of the intake (monetary fines levied, goods confiscated, etc.)
• The computerized database system (see "Databases and information gathering") is used to compare imports of raw materials for the purposes of re-export and actual exports (using invoices and customs declarations). Where there are disparities and discrepancies, severe and immediate penal actions are taken. Anti-dumping levies and measures, fines and criminal charges are common against exporters colluding with importers in hiding imported goods or reducing their value.
• In many countries, final products are imported and declared to the customs as raw materials (to minimize customs duties paid). Later these "raw materials" are either sold outright in the domestic or international markets or bartered for finished products (for example: paints and lacquers against furniture or sugar against chocolate). This became a major focus of the fight against the informal economy. Two prominent examples (in most agriculturally inclined countries in transition from Romania to Poland) are white sugar and cooking oil (though virtually all raw materials and foods are subject to the aforementioned abuse). White sugar, for instance, is often imported as brown sugar. One way to prevent this is to place sugar on the "import licence required" list, to limit the effective period of each licence issued, to connect each transaction of imported brown sugar to a transaction of export, to apply the world price of sugar to customs duties, to demand payment of customs duties in the first customs terminal, to demand a forwarder's as well as an importer's guarantee and to require a certificate of origin. The same goes for cooking oil (which, when it is imported packaged, is often declared as some other goods).
• In countries where the battle against the informal economy has been more successful, all payments to the customs are made only through the banks or the clearing houses. Customs and tax inspectors inspect these receipts periodically.
• All goods are kept in the customs terminal until full payment of the customs duties, as evidenced by a bank or clearing house receipt, is effected.

Public campaign

• Perhaps the most important fight is over the mind of the public. Many a government embarked on massive public relations and information campaigns, replete with advertsing and top notch foreign agencies. The citizens were made to understand what is a budget, how taxes are collected, how they are used. The main thrust of such campaigns was that people should begin to view tax evaders as criminals. "He who does not pay his taxes—is stealing from you and from your children", "Why should you pay for him?" "If we all did not pay taxes, there would be no roads, bridges, schools, or hospitals" (using video to show disappearing roads, bridges, suffering patients and students without classes), "Our country is a partnership, and the tax-evader is stealing from the till [kasa]" and so on.
• The phrase "Gray Economy" should be replaced by the more accurate phrases "Black Economy" or "Criminal Economy".

The informal economy is here to stay. Efforts should be invested in minimzing its more criminal components and at monitoring its more benign aspects (such as tax evasion). If the countries in transition succeed in reducing its overall size to 15 percent of their official Gross Domestic Product, they will have made it into the club of fiscal rectitude.

Sam Vaknin, 11 December 2000

The author:

The author is General Manager of Capital Markets Institute Ltd, a consultancy firm with operations in Macedonia and Russia. He is an Economic Advisor to the Government of Macedonia.

DISCLAIMER: The views presented in this article represent only the personal opinions and judgements of the author.

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