Unstable tax policy framework. The history of tax policy changes in Georgia since adoption of the tax code demonstrates a lack of long-term policy planning and a focus on short-term policy measures, disregarding the general consistency of the Code. Such approach has led to constant changes to Article 273 (on transitional provisions). Even fundamental policy changes are not introduced as permanent features of the tax system, but as temporary ones. A typical example is the cigarette taxation, which has been modified six times (!) since the Code entered into force. New taxation schemes are often introduced late in the year, for short periods of time and without clarification as to their duration. The current taxation scheme for tobacco products was introduced for the year 2001 only on December 2000 and was extended for another year through another amendment to the Code on December 2001. An even worse case is the excise tax on the importation of pyrolysis liquid products which was set at a rate of 400 GEL per ton on December 2000 and reduced to 50 GEL per ton less then four month later. There are numerous similar examples of short-term tax policy measures and frequent changes of tax legislation Such an approach neither allows the business community to calculate its tax burden over a longer period of time, nor does it permit the revenue authorities to design appropriate taxation strategies and develop a long-term planning of resource mobilization. The strong influence of lobbies in Parliament and the obvious tendency of parliamentarians to further narrow the tax base by granting sector and specific exemptions and rate reductions also contributes significantly to the low quality of tax policy making in Georgia.
VAT Threshold. Currently, VAT registration is mandatory for businesses with an annual taxable turnover of 24,000 GEL or more (and voluntary for a businesses below this threshold). As a result of the low registration threshold, the tax administration has to deal with a large number of small businesses as VAT taxpayers who contribute little to total VAT revenues. For example, an increase of the threshold from 24,000 to 100,000 GEL would reduce the number of mandatory taxpayers from around 13,000 to 3,200. It would at the same time reduce the total VAT collection by around 23 percent. A reduction in the number of taxpayers could substantially facilitate the administration of the tax and help combat VAT evasion by permitting a more comprehensive cross-checking of VAT invoices and making it more difficult to establish shell companies for evasion purposes. However, this result can only be achieved if the scope for voluntary registration is reduced. The Ministry of Finance therefore should consider to limit voluntary registration, e.g. by excluding businesses with a turnover below 50,000 GEL.
VAT Distortions. There is increasing frustration with the performance of VAT and the distortions its creates because the tax net is narrow and businesses are often unable to deduct VAT payments on their inputs. First, despite the low threshold, the number of 17, 000 businesses registered is quite low by international standards. Second, a true VAT, which is supposed to avoid tax cascading and economic distortions, requires a prompt and full refund of the part of the tax on inputs which exceeds the tax due on outputs. This is especially important for exporters. In Georgia the amount of unpaid VAT refunds is large (about 29 million GEL at the end of 2001). Tax inspectors should eliminate the practice of treating VAT as advanced payments against future tax liabilities in order to meet their monthly revenue targets (see section on tax administration below). Third, while many countries have introduced limited exemptions or reduced rates in their VAT laws to reduce regressive elements of the tax, the scope of tax privileges in the Georgian VAT continues to increase, and the country has embarked on the dangerous path to use tax privileges as a way to compensate for administrative or legal deficiencies.
Frustration with the distortion effects of the VAT has caused some policy makers to consider whether to replace the VAT with a sales tax. The objective would be to reduce compliance risks by applying the tax to one stage of the business cycle only. There are serious concerns regarding this idea. VAT despite its relatively low efficiency has become the main revenue source, contributing 45 percent to total gross tax revenues in 2001. Experience in other countries shows that sales taxes have a far lower revenue potential than the VAT, because it does not capture the total value added in the production and distribution phases and their rates normally are not higher than 5 percent--because of administrative difficulties. In addition, compliance risks and compliance management challenges would not be reduced because collection would have to rely on the retail sector which is more difficult to administer. Rather than replacing the VAT with a sales tax, the focus should be to improve VAT administration and actually implement the key principles of the tax, such as an effective refund system for exporters. A performance of the tax improves; consideration could then be given later to lowering the standard VAT rate.
Proposed simplified tax. To compensate for the revenue loss caused by increasing the VAT threshold, MoF plans to introduce a simplified tax for taxpayers who are not registered for VAT, and to modify the current presumptive tax for individual enterprises, which raises relatively little revenues (in 2000 actual presumptive tax collection was only 5 million GEL or 0.7 percent of total tax revenues), by changing it to a fixed tax with a broader tax base. The MoF proposal is to levy the simplified tax rate of 7 percent on gross income, which will require some basic accounting. The fixed tax will, similar to the current presumptive tax, be based on the nature of the business activity, the size of the business and the business location; it will include more types of small businesses than the presumptive tax. Although some (Foreign Investor Advisory Service (FIAS) December 2001 report) consider a fixed tax to be extremely complicated, it need not be so. The fixed tax, if well designed, can be transparent and easy to administer tax. It offers no scope for negotiation to taxpayers, does not require detailed bookkeeping, and could reduce the opportunity for corruption and the compliance costs for taxpayers. There are some issues regarding this presumptive taxation scheme:
The combined fixed tax and simplified tax is supposed to compensate for the increase of the VAT threshold. However, estimated revenues from the fixed and the simplified tax are 27 million GEL, which is far less than the expected decrease in VAT revenues. While the increase of the VAT threshold and the introduction of the fixed tax are laudable reforms, the revenue impact of the reform will need to be studied further.
Parliament has rejected the proposed simplified tax because it considers the rate (7 percent) too high and the coverage too narrow. According to some parliamentarians, the scope of the tax should extend to some larger businesses, which clearly reflects the interest of certain business sectors to simplify and reduce taxation. Presumptive taxation based on gross figures should be limited to Small & Medium-Sized Enterprises (SMEs) with no sufficient bookkeeping, while all larger businesses are required to keep books and records and are taxed on a net basis. There is no good reason to extend the scope of the simplified tax to larger tax payers.
Excise Taxation. Due to its open borders and weak administrative capacity Georgia faces major problems collecting excise taxes. Reduction in excise tax rates has been the preferred method to improve compliance, but with no positive results so far. Despite this experience the trend to reduce excises continues, which is worrisome. Georgian excise taxes are actually very low by international standards already, and the focus should more be on efficiently enforcing the excise tax regime. Compared to the CIS country average, excise tax revenues in Georgia are low; in 2000 excises in Georgia contributed 1.5 percent to GDP, while the CIS average was 2.1 percent. Looking at neighbouring countries, excise revenue performance is much higher in Armenia with 2.5 percent of GDP and somewhat higher in Russia with 1.9 percent of GDP; it is much lower, however, in Azerbaijan with only 0.5 percent of GDP (which is together with Tajikistan the lowest figure in the CIS region). The fact that Georgia has managed to accumulate a surprisingly high level of tax arrears in an area where arrears normally should not build up – according to IMF data the amount of tax arrears on excises was equivalent to 2.7 percent of GDP by beginning of 2000 – shows, however, that excise revenue increases will also depend on the ability and support of the tax administration to collect revenues from major businesses in the oil and cigarette industry.
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.
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