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H:\AAWBANK\AAACurrent-draft-July2003.doc
International Experiences with Administration of Local Taxes:
A Review of Practices and Issues
John L. Mikesell
Professor of Public Finance and Policy Analysis
School of Public and Environmental Affairs
Indiana University
Bloomington, Indiana
1. Introduction
Many countries, including but not limited to those in the group of developing and transition nations, have concentrated taxing authority and tax administration with the central government. However, there is a spreading sense that local governments throughout the world are growing up (Bahl, 1999), that they no longer require central government guidance and control for them to make a positive contribution to provision and delivery of government services, that they can and should assume more responsibility for finance of those services, and that bringing decisions closer to the people, the voters, will improve government efficiency, effectiveness, and responsiveness. An important element in the case for subnational revenue-raising responsibility is the idea that governments should face at least part of the political consequences of obtaining resources to provide services.
As nations give local and regional governments significant authority to levy taxes and responsibility to finance independently a greater share of the cost of the services they provide, there are two significant lessons from international experience that they should keep in mind. First, international experience clearly demonstrates that taxes need not be administered by the government that levies them. Giving subnational governments meaningful authority to tax gives them power to adjust the size of their budgets and to establish how the tax burden from financing that budget will be distributed. It may be argued that giving localities power to adjust the rate of a tax yielding them revenue provides sufficient fiscal autonomy. However, given the choice, some subnational governments will administer the taxes they levy and some subnational governments will levy taxes that others will administer. Both options can be feasible. The principle of complete localization of decision making does imply that the governments should decide for themselves whether they will administer the taxes that they levy or whether they should have them administered by some other entity, either another government or a private organization operating under contract with the taxing government.[1] Choice of administration can be an element of fiscal autonomy.
Second, international experience makes clear that local and regional administration should not be automatically dismissed as technically impossible or unwarranted. In practical terms, whether local and regional governments in fact administer the taxes that they levy depends on a mix of both technical and political considerations (Veehorn and Ahmad, 1997: 109). The significant substantive issues will be explored in greater depth later, but they may be summarized along the following lines. Local administration provides full scope for decentralization of revenue policy (how a tax is administrated is a practical element of policy itself) and its implementation and exploits familiarity with local business practices and institutions for efficient operation of the revenue structure. Central administration captures the efficiency advantages of scale and technical expertise and permits a more balanced fight in disputes with powerful taxpayers. The actual administrative pattern should balance these advantages within existing national circumstances -- along with the practical issues of comparative administrative capacity across the tiers of government and with the political factors that shape decisions at all levels of government.
Countries that follow the path of revenue localization and assign taxing authority to tiers of government below the central level – regional and local – may choose various intergovernmental administrative assignments for collection of these taxes. However, assignments of tax collecting responsibility may conveniently be arrayed into three groups: (i) a single, central government agency that administers all taxes levied by any level of government in the country; (ii) a central government tax authority plus subnational tax authorities that operate independently of the central authority and of each other; and (iii) a tax authority operated by the central government and independent subnational authorities with considerable shared and cooperative operations of some administrative tasks. Another possibility is to have independent subnational agencies administer taxes levied by the central government. For example, German lander and Swiss canton tax authorities administer major taxes for the central government. This arrangement is, however, rare. Unitary states tend to the first organizational format and federal states often use a mixture of formats.[2] A similar pattern may exist within a region in regard to relationships between the region and its local governments – there may be a single regional administration, a regional administration with independent local administrations, or regional and local administrations that share and cooperate.[3]
Not all taxes levied in a country necessarily follow the same administrative format – administration may be entirely independent for one tax, fully central for another, while there will be considerable cooperation for others. User charges and prices for goods and services sold by governments – electricity, housing, water, solid waste collection, etc. -- follow a different pattern: these systems are virtually always administered by the government providing the service, without regard for the division of administrative authority that would be used for tax collection.
2. Comparing the Alternatives
Local taxes may be collected by the governments that levy them or they may be collected by the tax administrators of another government. The range of national practices is quite wide and provides considerable evidence of the consequences of these administrative choices.
2.1.Centralized Administration.
Centralized tax administration can provide high quality service at low cost for subnational governments, but may dull transparency and public accountability for tax policy, may delay cash flow to the subnational governments, and will reduce local autonomy. Evidence from the international review of the alternatives for tax administration suggests the following specific conclusions about centralized administration:
(i)To the extent there are economies of scale in tax administration processes, a centralized administration improves the chances that these cost savings will be realized. Smaller independent local administrations may obtain the economies by contracting with larger entities or by combining operations with other administrations, but this is less certain to occur than if the administration is centralized.[4]
(ii)A centralized administration provides a single structure for dealing with all taxpayers throughout the country. With good administrative control in the central system, the same procedures and processes will be followed everywhere in the nation. That permits a single information system for tracking taxpayers and their economic activities and a single taxpayer identification number for all taxes. A single master file with all relevant data would provide a strong tool for enforcement and collection through matching across tax types. A single taxpayer identification number would assist enforcement and a single registration process into the information system would simplify taxpayer compliance.
(iii)A single centralized system improves the chances that taxpayers will receive consistent and unbiased treatment by the tax authority, no matter where in the country the entity or its taxable activities are located. Uniform treatment without regard to where the taxpayer may be located or to whom the taxpayer is can improve the chances that administration will be seen as fair and not playing favorites and that it will not be slanted to provide “deals” to certain taxpayers. Because local administration is closer to the people, there is always the concern that the administration will play favorites and that confidential taxpayer information will be misused when the people handling the returns know the taxpayers. With central administration, no matter where a taxpayer may be in a country, the taxpayer will be subject to exactly the same administrative régime and none will enjoy a competitive advantage because of administrative differences. A perception of balanced administration likely contributes to the probability of compliance with the tax.
(iv)A central organization can facilitate rotation of personnel, a critical component of internal control to reduce the potential for corruption. In a smaller administrative unit, there may simply be too few auditors of adequate skill relative to the number of complex assignments to maintain regular rotation for those assignments.
(v)Central administration reduces the number of points of contact between a taxpayer and the tax authorities and, because there are certain overhead costs that will be associated with collecting any tax, may reduce the cost of administration and compliance for the overall revenue system, central plus subnational. A single administrative authority eliminates the possibility that the taxpayer will be confused about what tax organization is responsible for answering questions, receiving filings, enforcement, etc. Taxpayers will not be confused as to what avenues should be followed to get assistance with tax compliance or as to what authorities are involved in making appeals or with other contacts. A single audit assignment can cover central and subnational taxes; there need not be multiple visits in a single audit cycle. When there are multiple administrative agencies involved, some payments, correspondence, appointments, etc., inevitably get misdirected by some taxpayers. None of this will happen if there is only one authority collecting taxes in the country.
(vi)The large administrative agencies that centralization produces may afford more qualified personnel, may be able to pay higher salaries (and thus reduce the attractiveness of corruption), may allow personnel to specialize to a degree not feasible with smaller administrative units, and may have budgets that permit more sophisticated information technology.[5] It has historically not been economical for small units of government to invest in costly and specialized technology and equipment used in tax administration or for them to hire personnel capable of dealing with more complex compliance issues. Those units also have greater difficulty justifying specialized training programs when the staff numbers are small. In small administrative agencies, staff may be required to handle all routine duties, thus losing both the gains from specialization and the internal control advantage of separation of duties.
(vii)A centralized, national tax administration can be better equipped, legally and in terms of resources, to deal with national and global business entities. Subnational agencies may be completely overwhelmed in efforts to enforce compliance from such large businesses. For instance, Tannenwald (2001, 42) observes that, in the United States, “state and city tax departments are increasingly ‘outgunned’ in attempting to enforce [the corporate income tax].” They simply lack the legal and accounting talent to keep up with avoidance or evasion strategies of large business. This problem certainly must be even more acute in developing and transition countries.
(viii)A large, centralized national tax administration will be better able to deal with taxable activities that cross regional or local jurisdiction boundaries within the nation.
(ix)Central administration may permit adoption of more sophisticated structures of some taxes. For instances, it is easier for a local government to administer an income tax based on “earned income” or payrolls than a broad tax on income from any source on the Haig – Simons concept; the former requires enforcement against employers in the jurisdiction, a far easier task than the broader reporting from entities outside the jurisdiction that the latter would almost certainly require.[6]
(x)Central administration may facilitate transfers of revenues to mitigate horizontal fiscal disparity across subnational units of government. Revenue from taxes administered by subnational governments almost always stays with the government collecting the revenue, leaving great disparity between regions with high endowment of the tax base, e. g., natural resources, heavy industry, etc., and those lacking such an endowment.
2.2.Independent Subnational Administration.
An important standard of modern public finance is the principle of subsidiarity, the idea that governmental actions should be taken at the lowest level of government, the level closest to the people, at which the desired objectives can be achieved. The principle, when applied to tax administration, suggests that independent regional and local tax administration ought not be dismissed, but should be considered as another alternative in the efficient, effective, and responsive implementation of overall national tax policy. Casanegra de Jantscher (1990, 179) maintains that “tax administration is tax policy” in developing countries. The same certainly holds true in transition nations and, given variations in enforcement terms and conditions across a country, also applies to an important degree for tax policy in any nation. Therefore, if it is reasonable for regional and local governments to develop tax policy as an element of a program for localization of government financing, then it is similarly reasonable to consider the degree to which independent regional and local administration may be economically and technically feasible. It certainly would be politically feasible and possibly politically desirable in a program of increased fiscal responsiveness. This is particularly critical because the taxpayer’s contact with the tax law – the representation of what tax policy is – is through its administrative apparatus. Hence, as far as the taxpayer is concerned, the representation of tax policy will be the tax administrators.
Regional and local governments, even within a single country, vary widely in terms of size, professionalism, and economic development. This makes precise conclusions about independent tax administration difficult. However, general experience with independent regional and local tax administration suggests the following:
(i)Familiarity with local conditions and easy adaptability to those local conditions can facilitate registration of taxpayers, collection, and enforcement of many taxes. Indeed, when local governments have designed their own tax base and structures, local administration can be designed specifically for the tax in that application and policy and administration can be fully merged. Administration need not be a central one stretched to apply to the local structural peculiarities, administrative decisions can be made without dragging them through a centralized bureaucracy and, should enforcement be directed toward large taxpayers as an administrative strategy (Baer et al, 2002), the selection will be based on large taxpayers within the local or regional tax system, not those large in national terms. Decisions get made locally, not in some distant central headquarters.
(ii)Local administration can apply taxes on economic activities that fall below the threshold of central government interest because local administrators have familiarity with the local business environment from information generated through local licensing and regulatory processes and can generate revenue by bringing small enterprises into the tax system at relatively low cost. Bringing them into the subnational tax system may also assist central government revenue mobilization if there is information exchange between central and subnational administrations.
(iii)When administration of local taxes is separate, it is much easier for taxpayers to see which government is levying what taxes -- and to hold the appropriate governments accountable. Transparency can be lost when a central authority administers the tax levied by a lower level of government. Taxpayers receiving a consolidated regional / local property tax bill or preparing a consolidated regional / local income tax return often cannot easily discern what government is levying which portion of the total tax bill. That reduces the degree to which fiscal autonomy improves accountability for budget choices that have been made. Independent administration usually exposes responsibility for the tax being levied.
(iv)Independent regional and local tax authorities can act as “insulated chambers of experimentation” for tax administration. They can innovate new approaches and techniques, exploiting the nimbleness that often characterizes smaller organizations. For example, state revenue departments in the United States have been leaders in the application of new information technology, bar-coding, and imaging to tax administration, the State Revenue Department of Western Australia markets its revenue collection information system widely, and Gujarat state in India has developed a computerized system for checking commercial vehicles to enforce the road tax at interstate check posts that reduces clearance time from thirty to two minutes. Some subnational governments have greater flexibility and control over resources than others, some have more creative administrators than others, and some have better environments for experimentation than others. That allows something like natural experiments in tax administration, a result that cannot easily happen within the confines of a single, centralized administration. Furthermore, the impact of confusion and mistakes if the experiment fails is localized and limited.