Turkey: Challenges in tax reform in an international perspective

Presentation by Teresa Ter-Minassian at the MoF-UNDP seminar on “Tax Policy Options for Turkey in the wake of EU

accession”Ankara, Jan. 12-13, 2009

The views expressed are those of the author and not necessarily of the IMF

Overview of presentation Revenue trends and

composition in Turkey in an international perspective

Recent reforms

Main remaining challenges for tax policy and administration

Overall revenue trends

Turkey increased its overall tax revenue to GDP ratio significantly between 1995 and 2001, by more than the OECD average and most emerging markets (EM) countries, but progress has stalled in recent years

The revenue ratio remains significantly below the OECD and EU averages, albeit slightly above the EM average

In a medium-term perspective, a gradual further rise in the revenue ratio may be needed, together with expenditure reforms, to create sustainable fiscal space for new priority spending.

Revenue trends in the OECD

Changes in tax to GDP ratio (percentage points), 1995-2006

-8.00 -6.00 -4.00 -2.00 0.00 2.00 4.00 6.00 8.00 10.00

OECD - Europe

OECD - Total

Slovak Republic

Hungary

Poland

Finland

Canada

Netherlands

Germany

Luxembourg

Czech Republic

Ireland

United States

Denmark

Austria

Belgium

Japan

France

Sweden

Switzerland

Italy

Greece

United Kingdom

Norway

Mexico

Portugal

Spain

Korea

Turkey

Revenue trends in TurkeyGeneral government tax revenue in selected OECD

countries, 1998-2006

1 5 .0

2 0 .0

2 5 .0

3 0 .0

3 5 .0

4 0 .0

1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7

Pe

rc

en

t o

f G

DP

T urk e y K o re a M e xic o O E C D a ve ra ge

Tax ratios in the OECDTax revenue to GDP ratio in OECD countries, 2006

0.0 10.0 20.0 30.0 40.0 50.0 60.0

OECD - EuropeOECD - Total

DenmarkSwedenBelgium

FranceNorwayFinland

ItalyAustria

NetherlandsUnited

HungaryCzech Republic

SpainLuxembourg

PortugalGermany

PolandCanadaIrelandGreece

Slovak RepublicSwitzerland

United StatesJapanKorea

TurkeyMexico

Revenue composition

The share of taxes on goods and services in general government revenues, albeit declining in the more recent years, is significantly higher in Turkey than in the rest of the OECD

The share of excises (Special Consumption Tax, SCT) is especially high (about 20%, compared with less than 8% on average in the OECD), reflecting:

Very high rates (as much as 275%) on some products; and The relative ease of collection of these taxes

The revenue productivity of the VAT remains relatively low (around 30%, compared to the 40% more typical in better-performing VATs). This reflects broader than average range of exemptions and coverage of reduced rates, as well as weaknesses in the administration of the tax

Revenue composition

Since the PIT and CIT rates are not substantially lower than OECD averages, the relatively low share of income taxes in total revenues (21.5% vs over 36% on average in the OECD) reflects:

Leakages from the base (significant exemptions and other preferential treatments); and

Weak compliance and enforcement.

Despite relatively high rates, revenue from social security contributions is also below the OECD average, reflecting the high degree of labor market informality and enforcement weaknesses

The small weight of property taxes (less than 1% of GDP) mainly reflects inadequacies in property valuation

Revenue composition in Turkey and the OECD

OECD: General government tax revenue, 2006

Excises, 7.8%

VAT, 19.0%

Social security,

26.3%

Income taxes, 36.3%

Others, 10.6%

Turkey: General government tax revenue, 2006

Others, 14.0%Excises,

19.9%

VAT, 22.2% Social security,

22.4%

Income taxes, 21.6%

Recent tax reforms in Turkey

Main steps taken in recent years to rationalize the tax system

Move towards a modern dual PIT: Some simplification of the PIT structure A more uniform taxation of financial income

A design of the CIT (including a rate cut, and rules on transfer pricing and thin capitalization) more in line with the growing internationalization of the Turkish economy

Tax administration reforms Establishment of a semi-autonomous, functionally organized

Revenue Administration (RA) and a large taxpayer office (LTO) Strengthened IT infrastructure for the RA

But, also some retrogression: Introduction of new special treatments and tax incentives Repeated tax amnesties, weakening compliance morale

Agenda for further reforms

Additional efforts to mobilize revenue over the medium term should be consistent with efficiency and equity objectives, and take into account Turkey’s growing trade and financial integration into the global economy, and in particular Europe

These considerations argue for focusing further tax reform efforts on:

Broadening the bases of the major taxes Reducing those rates that are relatively high in an international

perspective Continuing to strengthen the tax administration, facilitating

voluntary tax compliance and making enforcement more effective; and

Seeking to expand own revenue-raising capacity of local governments

Broadening the tax base:Income taxes PIT

Subjecting public pensions to the PIT, with (possibly partial) offsetting adjustment in value of pensions, and reducing generosity of treatment of private ones

Eliminating current exemption of certain types of employment income

Reducing threshold for agricultural incomes Capping all deductions Subjecting all financial income to uniform final

withholding CIT

Significantly reducing existing incentives (with respect of acquired rights), and refraining from introducing new ones

Broadening the tax base:VAT and property taxes VAT:

Reducing the coverage of exemptions Eliminating the 1% rate (not consistent with the EU acquis

communautaire): Exempting wholesale sales of unprocessed agricultural foods Moving other categories to 8% or standard rate

Moving some categories of goods and services (e.g. textiles; entertainment tickets; restaurants; tailoring; and hotel services) to the standard rate, in line with international experience

Limiting scope of free trade zones, especially in view of likelihood of leakages

Property tax Potentially important source of own revenue for local governments Local governments should be given limited authority to set rates of

the tax Ensuring up-to-date valuation of properties through development

of modern national cadaster

Reducing high rates and distortive taxes SCT

Very high rates on some products may promote smuggling and other forms of evasion.

The rate structure for certain products (e.g. alcoholic beverages and tobacco) favors domestic production over imports, and will need to be modified to adjust to EU requirements on accession

To the extent that some of the taxed goods are used as inputs into production, and the SCT cannot be rebated for exports, it reduces competitiveness

The fiscal dividends of base broadening for other taxes, and of improved compliance could be used for selective reductions in the SCT rates

Reducing high-rate and distortive taxes Financial intermediation taxes (BITT and RUSF)

While for the most part acting as substitutes for the VAT on financial services, in some cases (e.g. purchases of foreign exchange and financing of imports) they represent actual turnover taxes, with distortive effects.

Even as substitutes for the VAT, these taxes may be incompatible with the EU Sixth Directive

Social security contributions Relatively high social security contributions rates promote

labor market informality, and reduce employment, as well as competitiveness (since they are not eligible for border tax adjustment). Improved enforcement of their collection (including through avoiding further amnesties) would open space for some reduction in the rates.

Promoting voluntary taxpayer compliance

Effectively promoting voluntary tax compliance requires both facilitating the latter and increasing enforcement deterrence. Possible actions to facilitate compliance include:

Firmly and publicly committing to not introducing new tax amnesties

Streamlining taxation of small businesses Introducing a threshold for VAT payers (aligned with the simplified PIT regime

ceiling) Eliminating the rental ceiling for application of the simplified PIT regime. Developing

and announcing industry-specific standards for input credits and sales for the regime, to guide audit efforts in this area.

Continuing to improve taxpayer services, in particular by developing a national outreach service for new businesses

Implementing a risk-based and timely export refund system, to promote VAT compliance and export competitiveness

Strengthening tax enforcement

Vigorously pursuing implementation of RA-led multi-agency Action Plan to Reduce Informality

Substantially strengthening the audit function Consolidating the audit function under the RA Increasing the number and capacity of RA auditors Developing improved, risk-based audit selection strategies (including with

respect to employers and high net-wealth individuals) Better exploiting data matching and cross checking IT capabilities in audits Allowing indirect determination of tax liability, based on clearly specified

criteria Establishing a specialist investigation unit for criminal tax frauds, and

publicizing results of successful prosecutions

Developing and implementing modern approach to tax arrears management

Focusing on larger, more recent debt Establishing automated debt collection procedures Introducing clear criteria for debt write-offs

Concluding remarks Turkey has already made significant progress in

establishing a modern tax system and tax administration

Although the overall tax burden is not out of line with those of many countries at a comparable level of development, it may well have to rise further over the medium term, as the economy integrates further into the OECD and ultimately the EU

Tax and tax administration reforms to mobilize additional revenue should also pursue other important objectives:

Efficiency (reduction of distortions) and international competitiveness

Reduction of incentives to informality Horizontal and vertical equity Facilitation of voluntary tax compliance; and More effective deterrence of non-compliance

Concluding remarks In my view, the reforms advocated in this

presentation would support these objectives, in as far as:

Effectively broadening the bases of the VAT, PIT and CIT would enhance horizontal equity and reduce distortions

The additional revenue generated by these reforms could be used to reduce certain rates (of e.g. employers’ contributions, certain excises and the financial intermediation taxes), with favorable impact on growth and competitiveness, and to fund additional targeted spending for the poor

A significantly strengthened tax administration would certainly enhance both equity and economic efficiency

I look forward to a lively discussion of these and other possible reforms in the course of the seminar

Thank you!