Income and social tax. The high tax burden of the personal income tax (PIT) and the social security tax provides a strong incentive to evade the payment of these taxes. Although the personal income tax has reasonably progressive rates (from 12 percent to a maximum of 20 percent), the marginal cost of taxes for both employees and employers creates strong incentives not to formalize the labor contract: employees prefer current to future consumption, while employers seek to reduce costs and increase competitiveness. Overall, the taxation rate of the PIT and the social security tax over the net wage is 68 percent. This implies that for each additional GEL paid to worker in net wage, there is 0.68 GEL to be paid in taxes if the contract is formalized. Financing of the pension system continues to suffer from low compliance in the area of social taxes. (for more details see Social Protection Chapter).
Corporate and income tax exemptions. The Tax Code currently includes a number of exemptions from corporate and personal income tax, which narrow the tax base, increase the discretion of tax inspectors and the potential for corruption. The IMF has recommended to review and abolish many of these exemptions. The Ministry of Finance has started preparing an amendment to the Code eliminating most of the current exemptions from personal and corporate income tax. This includes in particular the exemptions from CIT for enterprises in mountainous regions, the exemption of profit generated by energy renewable sources, consumer appliances and energy saving equipment. However, this proposal to amend the Code will still have to be finally presented to the Parliament, after it was withdrawn in September 2001.
Administrative provisions for tax enforcement. An essential feature of a good tax code is a clear definition of tax administration procedures and rights and obligations of taxpayers and tax officials. A reasonable balance needs to be defined between the interests of the taxpayer to simplify taxation procedures and reduce administrative burden and the interest of the tax administration to effectively enforce taxation. In Georgia, the possibility to enforce tax collection has been unduly restricted by reducing the powers given to the tax administration in chapter 42 of the tax code to seize and sell delinquent taxpayer property. As a consequence the only remaining enforcement measure, which does not require a court ruling, is the freezing of a taxpayer’s bank account. Considering the absence of specialized tax courts and the weakness of the court system in Georgia, this does not provide the tax administration with sufficient means to improve its compliance management. Enforcement powers of the tax administration should be harmonized with current practice in Organization for Economic Co-operation and Development (OECD) countries.
Abolishing nuisance taxes. Earlier the World Bank and IMF reports have recommended the elimination of nuisance taxes because they typically have extremely low revenue yield and are a burden for small businesses. The tax package prepared Ministry of Finance included the elimination of some of these nuisance taxes, (e.g., the tax on economic activities, the resort tax, the hotel tax, the advertisement tax, and the tax on the use of local symbols), but no progress has been made partly because these taxes are assigned to local governments. However, due to their very limited revenue potential, they contribute less than 10 percent of total local revenues. Considering the administrative and compliance costs of these taxes the actual revenue gains might even be negative, efforts to eliminate these taxes will need to continue.
General. The public perception of the quality and fairness of tax and customs administration in Georgia is generally very negative.[7] Substantial and visible improvements on the ground will be needed to begin dispelling this perception. This also requires a political commitment to abolish practices which protect and support special interests of taxpayer groups by introducing special exemptions in the tax legislation, thus eroding the tax base, or/and executing pressure on the revenue authorities to grant favourable treatment to specific taxpayers. It will also be necessary to reduce the incentives for revenue officials to participate in corrupt practices and to develop the necessary control mechanisms to detect and punish such behaviour.
Efforts to reduce capture and corruption are to be complemented by long-term strategies to improve the tax policy design and build revenue administration capacity. Tax policy reforms should focus on overall policy design issues instead of exclusively discussing the level of tax rates. Eventual tax rate reductions will only be feasible if accompanied by broadening of the tax base and administrative improvements. Key to improving administration is the effective implementation of self-assessment and the fair and equitable treatment of all taxpayers. Two areas that require special attention are (a) customs administration, and (b) enforcement of personal income tax and social security contributions.
Short-term Reform Priorities. While substantial capacity building in tax and customs requires long-term strategies, there are a number of essential short-term reform initiatives, which should be launched immediately, to improve revenue performance and reduce tax-related distortions.
Tax policy. The main challenge is to stabilize the tax policy framework, and avoid ad-hoc short-term policy measures. In general, the revenue impact of tax exemptions should be properly analyzed, and no further exemptions/tax reductions should be introduced without such analysis is explicitly presented in Parliament. Any tax policy changes should be taken in the context of the annual budget. It also recommended that the 2001 tax package prepared by MoF be re-submitted to Parliament, including key elements such as: reducing the scope of exemptions, raising the VAT threshold to GEL 100,000 (or US$50,000) and introducing complementary simplified tax.
Tax administration. A number of actions could be take to support long-term reform efforts:
Discontinue the practice of soliciting advanced payments to meet revenue targets and Design a new performance measurement system with appropriate indicators, supplemented by special incentives to improve revenue administration practices;
Centralize revenue accounts in the Treasury and make payments on “a first come first served basis”;
Begin implementation of special program to control imports through the railway system, especially of petroleum products;
Increase coverage of LTI and focus on improving LTI performance.
A Longer-term Agenda. A more comprehensive reform program for the medium and long-term reform of the Georgian revenue system will then need to consider the following issues:
Broadening the base and lowering tax rates. While some taxes may be relatively high and may promote non-compliance – especially the general VAT rate of 20 percent and the combined tax burden on labor – taxes from excisable products are not fully exploited. A longer term tax policy reform objective for a poor economy like Georgia should be to reduce the tax burden on consumption and labor. However, this can only be achieved by (a) broadening the tax base of VAT and profit/income taxes; (b) increasing collection by improving the efficiency and effectiveness of tax and customs administration.
Past experience with tax policy reform in Georgia has shown that mere tax rate reductions without corresponding improvements in enforcement and compliance management will not contribute to increasing tax compliance. Rate reductions therefore do seem not feasible as long as revenue losses from the rate reduction cannot be compensated by a broader tax base and a better enforcement. Tax policy reform in Georgia therefore will need to mirror experience with tax reform in OECD countries in the last two decades, where rate reductions (mainly in the area of direct taxation) were achieved through base broadening and improving tax administration.
VAT Reform. The VAT should not be replaced by a sales tax. Rather, the VAT as the mainstay of the revenue system in Georgia should be strengthened. The VAT design appears buoyant, albeit if its base has been eroded by exemptions, privileges, and fraudulent practices involving both tax inspectors and tax payers. Increasing the threshold and reducing the number of taxpayers will help improve its administration and implement the true spirit of the VAT. Corresponding decreases in revenues can be compensated by introducing a simplified tax, as proposed by Government, and reducing exemptions to broaden the tax base. The implementation of a true VAT necessarily has to ensure refunds for exporters and zero rated goods. On the administrative side, it is important to advance existing initiatives to improve cross-checking, monitor registration, and regulate invoices.
Tax Simplification. The elimination of nuisance taxes will facilitate administration and reduce the administrative burden on small businesses. In Georgia, nuisance taxes are local taxes generating little revenue. The best would be to eliminate these taxes and find alternative (more solid) own revenue sources for local governments, such as the land and property tax, which are not currently collected centrally (see Chapter IV on Inter-governmental Fiscal Relations). In some cases, these are complemented by a small turnover tax, as is already the case in Georgia.
Addressing corruption. The creation of an Inspector General Office (IGO) within the MoR has been a step in the right direction. The work of the IGO should be provided with the appropriate legal and technical instruments to carry out its function. Technically, it is important to develop accurate assessments of where the opportunities for corruption arise, through an analysis of the business process and the use of indirect statistical methods. Legally, the IGO must have the powers to access relevant information from tax-offices and taxpayers. It should also be clear to the agencies and to the public how the recommendations of the IGO would be implemented. The role of the Chamber of Control in evaluating tax performance will no doubt be helped as the IGO builds up strength. The government needs to consider if the current profile of corruption requires development of legal instruments, other than those dealing with corrupt practices in the public sector, to address corruption in the revenue agencies.
Making effective a functional organization. The centrepiece of a modern approach to tax administration is self-assessment. To properly implement self-assessment requires changing the culture, both in government and society, of how taxes are calculated and collected. The direct contact between officials and taxpayers should be reduced, with emphasis shifted to taxpayer services, quick attention to arrears enforcement and selective but effective auditing. Internal control and anti-corruption services should help keep taxpayers and officials honest. Appeals mechanisms should serve to protect taxpayers rights. The extensive advise provided by donors has already acquainted the authorities with the principles of self-assessment. However, the reform agenda continues to be broad and will take time to implement. Te following issues would seem to require special attention:
Registration. It is necessary to review the current registry with emphasis on taxpayers that are not active and looking for quality taxpayers that may be hiding as small or not even registered.
Arrears enforcement. The current stock of arrears plus fines and penalties is large but a large portion of it might not be collectable. It is necessary to make a realistic assessment of what can be collected from the stock and develop timely methods to prevent new arrears from aging, setting clear priorities.
Auditing. There should be a sustained effort to build the quality of auditing. Special attention initially could be placed on critical aspects of the VAT such as VAT refunds, cross-checking of credits and fake invoices. Important to good auditing is the development of risks profiles to guide selection and improve effectiveness. Greater information management capacities available now have to be used to develop such profiles.
LTI. The LTI in not a centre of excellence. Efforts to update the roaster of large taxpayers and to reach coverage of at least 50 percent of the revenues collected by the tax agency are worthwhile, but they have to be sustained. The LTI has to take a more proactive attitude to performance and reform and it is good place to begin developing new incentive mechanisms away from simple revenue targeting.
IDA Support to the Private Sector in Georgia
IDA's Policy. To support private sector development and attract needed foreign investment, the World Bank (namely IDA) has developed the Country Assistance Strategy (CAS), which focuses on removing key policy and institutional (including governance) constraints, as well as financial, energy and infrastructure bottlenecks. On the basis of the FY03 Integrated Trade Development Strategy IDA will provide reform support and progress monitoring through the ongoing Enterprise Rehabilitation Project, an FY06 Private Sector Development Project, and the ongoing Business Environment Surveys and Studies. IDA will also provide support (in conjunction with USAID) for improving access to affordable finance through further financial sector reform, and will help reduce trade, transit and marketing costs through the FY05 Trade and Transport Facilitation Project, building on the FY03 South Caucasus Trade and Transport Facilitation Study. IFC will complement these activities through investments in small and medium-sized businesses and, in coordination with USAID, through technical assistance for business development. Support for alleviating energy bottlenecks will be provided by IDA’s ongoing energy portfolio and dialogue.
Support to SMEs. The Small and Medium Scale Enterprise (SME) sector is a crucial area for potential private sector growth, and IDA has been supporting the sector through its ongoing Enterprise Rehabilitation Project. IDA plans, through the FY06 Private Sector Development Project to provide expanded support for management training, creation of export-oriented clusters of SMEs, advice to business associations and government, and monitoring of the business environment. Additionally, IFC will conduct a targeted study of the SME sector in Georgia to identify key obstacles to its development, and then recommend specific improvements in the regulatory and administrative environment.
IFC Financial Support to the Private Sector in Georgia
IFC's Policy. IFC’s lending and investments in Georgia have been tailored to the country’s special circumstances: limited foreign investments, the non-existence of large local companies, limited access to financing for a nascent SME sector, and the lack of advice for private companies on business related issues such as corporate governance and leasing. IFC would also provide support directly to the private sector through the Georgia Business Development Project, a five-year technical assistance program implemented by the Private Enterprise Partnership with the support of the Canadian International Development Agency (CIDA). The main components of the project, as already stated in the above, include development of the leasing sector and improvement of corporate governance practices. The corporate governance initiative is helping Georgian businesses improve their practices to build investor confidence and increase their access to financing. This component of the program also includes advice to the Government on improving corporate governance policies and regulations.
Assistance to SME Sector. To reach small and medium enterprises, IFC provided equity and long-term credit lines to TBC Bank and helped establish Georgia Microfinance Bank – the ProCredit Bank - the country’s first bank specializing in lending to micro and small enterprises. In June 2000, IFC purchased a 10 percent stake in TBC Bank. IFC’s support helped TBC to grow from a “pocket” bank into the largest and one of the best performing commercial banking institutions in Georgia. In 1999, IFC helped establish the ProCredit Bank - the first bank dedicated to lending to micro and small enterprises in the country, and now the fastest growing banking institution in Georgia. IFC has also supported other Local Companies, for example, GG&MW, a mineral water production company, where IFC’s loans supported the company’s acquisition of key strategic assets and strengthened control over its key brand, Borjomi mineral water. IFC’s equity investment helped the company rehabilitate two mineral water bottling facilities, diversify its product mix and develop the distribution network. IFC sold its stake in the company in 2002.