SEPTEMBER 2017 GOVERNANCE NOTES No:2 CUSTOMS REFORM AND PERFORMANCE CONTRACTS: EARLY RESULTS FROM MADAGASCAR Prepared by GAEL RABALLAND (GGO19), CYRIL CHALENDARD (DECTI), ANA FERNANDES (DECTI), AADITYA MATTOO (DECTI), AND BOB RIJKERS (DECTI). Malagasy customs introduced performance-based pay revenue losses equal to 30 percent of non-oil revenues for customs inspectors in Madagascar’s main port of (Chalendard, Raballand, and Rakotoarisoa 2016). Toamasina, incentivizing them to curb tax evasion and illicit financial flows, and expedite customs clearance.1 Malagasy customs, under the leadership of a new While performance pay has been associated with positive director general, initiated reforms from 2015 to address outcomes in education, health, and tax collection when customs performance, including deep collaboration with objectives are clearly defined (Hasnain, Manning, and the World Bank. The reform did not involve investment Pierskall 2014; Prentice, Burgess, and Propper 2007), in information technology or equipment. Moreover, the little is known about its usefulness in motivating World Bank only provided training and analytic and customs agents to achieve multiple objectives, including advisory support, including on-site visits to countries with facilitating trade while maximizing revenue collected and similar systems. minimizing fraud.2 World Bank support included a study of tariff evasion Initial evidence suggests that individual inspector channels using mirror trade statistics (Ibid 2016). Based performance contracts improves customs performance on this study, the Malagasy authorities identified two and service delivery by reducing clearance times. The priorities: reforming the accelerated clearance program reform’s success to date reflects effective management and improving human resource management by in customs, strong support from the Minister of Finance introducing performance contracts. and Budget, extensive stakeholder consultation, application of data mining techniques, more intensive Inspector performance contracts reward good monitoring, and deep collaboration between Malagasy performance with (i) bonuses,3 (ii) training opportunities at customs and the World Bank. If the early results prove home and abroad, and (iii) accelerated career progression. robust, public servant performance contracts could They sanction poor performance by reassigning be a cost-effective approach to improving revenue inspectors to less desirable positions.4 The contracts administration and service delivery in other contexts, were written after consultations with inspectors and including fragile countries. the private sector over several months (from May to September 2016), and contain seven objective indicators USING HUMAN RESOURCE MANAGEMENT TO covering the speed with which goods are cleared, the IMPROVE PERFORMANCE AND SERVICE DELIVERY efficiency of customs controls, and targets for revenues and fraud detection. Madagascar, a fragile and fifth poorest country in the world (2015 GDP per capita of $402), is a valuable context PRELIMINARY LESSONS for examining the impact of performance pay on customs operations. With a tax to GDP ratio of 10 percent, the Implementing the performance contracts required country’s revenue mobilization is among the lowest in both a focus on human resource management, and the world. Customs revenues account for 44 percent of consensus building through stakeholder dialogue. A overall tax revenues, despite estimated tariff evasion project implementation unit was established, which was 1 The reform effort is part of Madagascar’s Public Sector Performance Project (P150116). 2 Political and internal motivations for Cameroon customs inspectors are described by Cantens, Ireland, and Raballand (2012). 3 In addition to merit awards, each quarter the best performer receives a bonus ($1,000) representing 2.5 times Madagascar’s GDP per capita. 4 Working in the Toamasina Port is the most attractive position in Madagascar customs as the result of higher opportunities for bonuses from fraud recording. Inspectors get a share of the amount of the recorded fraud. 1 GOVERNANCE NOTES SEPTEMBER 2017 No:2 pivotal to the success of the program. It uses detailed 1 a. Assessed Taxes data on import declarations collected from the Automated 300 System for Customs Data (ASYCUDA) to monitor each Assessed taxes (Ariary billions) inspector’s performance. Inspectors in Toamasina play a key role in mobilizing domestic revenues. The average 200 customs officer usually collects 1.5 percent of total annual tax revenues each year (about $1.4 million per inspector per month), but revenues fluctuate as imports vary seasonally. 100 Setting explicit performance targets required overcoming resistance through consultations and 0 negotiations with inspectors. The implementation unit’s 2014q1 2015q1 2016q1 2017q1 approach of structured dialogue, backed by strong support from the director general and the minister of finance and Reform port Nonreform port budget, proved successful. Despite initial anxiety, the vast majority of inspectors when surveyed said they preferred performance contracting after being trained on using the 1 b. Assessed Taxes per Declaration Assessed taxes per declaration (Ariary billions) new monitoring system. Performance contracts have also enabled better information flow from the ground to the 60 director general and the implementation unit. 50 Discussions to define the contract between the implementation unit and the inspectors began in 40 May 2016, coinciding with the restructuring of the accelerated clearance program. Performance contracts were eventually signed in September 2016 and entered 30 into force in October 2016.The reform is ongoing and will be evaluated in depth; however, preliminary findings have 20 emerged from ASYCUDA. 2014q1 2015q1 2016q1 2017q1 PRELIMINARY RESULTS Reform port Nonreform port Tax revenues grew since the start of the training period. Figure 1a plots the evolution of assessed taxes over time for Toamasina (the reform port) and other seaports 2. Evolution of Average Delays (nonreform ports). Vertical lines represent the appointment Average delays: Date of assessment - Date of submission of the new director general in the first quarter of 2015, the 5 start of the training phase in the first quarter of 2016, and the effective start of the performance contracts in the first Average delays (Days) quarter of 2017. Tax revenue growth was driven by trade 4 with an increase in the number of import declarations, and greater tax revenue per declaration (see Figure 1b).5 3 Nonreform ports also collected more taxes, both in 2 total and per declaration (Figures 1a and 1b), Since revenue improvement occurred in both reform and 1 nonreform ports, the change does not appear associated 2014q1 2015q1 2016q1 2017q1 with introduction of performance contracts in Toamasina. Reform port Nonreform port In Toamasina, customs clearance times dropped substantially, but increased in other ports (see Figure 2). 5 To reduce confounding factors during the study period, imports handled by any firm eligible for the accelerated clearance program, are excluded from the sample. 2 GOVERNANCE NOTES SEPTEMBER 2017 No:2 The reduction in clearance times was remarkable and 3. Evolution of Physical Inspections in the Reform Port Declarations routed to red channel (Percent) driven both by fewer physical inspections (see Figure Physical inspections (Red channel) 3) as well as expedited inspections and documentary 70 controls. From a trade facilitation perspective, the performance contract reform appears to be successful. 60 50 The rate of physical inspections in Toamasina decreased but not in other ports in 2016. The observed 40 sharp decrease in the final allocation to the red channel 30 is due to a change in inspector behavior.6 Inspectors utilized the new opportunities offered by the performance 20 contract by (i) “upgrading” fewer declarations from the 2014q1 2015q1 2016q1 2017q1 yellow channel for documentary inspection to the red Time channel and (ii) by downgrading to the yellow channel Red (initial) at reform port Red (final) at reform port more declarations assigned to the red channel. Red (initial) at nonreform ports Red (final) at nonreform ports The reduction in physical inspections coincided with better inspection targeting and more declared fraud. 4. Evolution of Fraud Record Declarations routed to yellow or red channel (Percent) Figures 4a and 4b plot the evolution of the proportion of a. Yellow channel and red channel declarations reported to be fraudulent in the yellow or red channel, or the red channel, respectively. The introduction 20 of performance contracts—which incentivize fraud recording—was associated with a marked increase in fraud recording in Toamasina, but not in the other ports. 10 A concern with the current performance contract framework is whether incentives customs officers to extort, act opportunistically, or abuse their increased discretion over which shipments to inspect. While 0 these effects are difficult to assess, consultations with the private sector do not suggest inspectors were 2015q1 2015q3 2016q1 2016q3 2017q1 overzealous in issuing fines. Some preliminary evidence Reform port Nonreform port shows inspectors downgrade (i.e., decide not to inspect) relatively risky declarations. In addition, some observers b. Red channel expressed concerns about collusion between customs brokers and inspectors. Malagasy customs discovered 30 evidence suggesting some inspectors issued fines smaller Declarations routed to red channel (Percent) than the recommended amount (which is a common practice in Sub-Saharan Africa), nominally complying with the performance contract but benefitting non- 20 compliant importers. This finding warrants adjustments in the performance indicators during a second phase of contracts. Certain inspectors are being investigated, and four out of fifteen opted not to sign new contracts 10 in May 2017 despite having met performance targets. One inspector failed to meet targets. In total, five out of fifteen inspectors were replaced. Sustaining the early successes will require continued 0 surveillance of inspectors and strong management. 2015q1 2015q3 2016q1 2016q3 2017q1 Some inspectors, importers, and brokers may find Reform port Nonreform port 6 As a result, the number of inspections strongly declined in Toamasina. A reduction of 60 percent is seen between the third quarter of 2016 and the first quarter of 2017. 3 GOVERNANCE NOTES SEPTEMBER 2017 No:2 ways to manipulate performance indicators. At the same It facilitates trade by expediting customs clearance, time, publicizing performance metrics and rewarding improves fraud detection, and enhances the efficiency of good performance contribute to a culture of meritocracy controls. In addition, despite fewer physical inspections, and transparency. This is important since only one out of both the number and the frequency of fraud recording every ten inspectors in Madagascar believe promotions has grown. are fair, according to a survey conducted during contract implementation. To be more transparent, a With committed government counterparts, the vacancy announcement to replace the five inspectors in success of this type of contract can be replicated in Toamasina was published internally to all of the country’s other settings, including fragile countries, at limited inspectors (more than 120), and a panel will select the cost. It shows that, despite a fragile country context, best five candidates. This type of recruitment is the first revenue mobilization may be improved and frontline of its kind to fill positions in Toamasina. For the fight officers’ behaviors may change if the World Bank builds against fraud, team-based performance contracts have trust with customs management and tries to tackle been defined and signed with the headquarters unit. concrete customs administration problems. More generally, the reform serves as a stepping stone toward modernizing customs and revenue administration. For example, the director general of tax administration has expressed interest in experimenting with a similar pay-for-performance scheme for tax inspectors. CONCLUSION Malagasy customs piloted the introduction of performance contracts for inspectors to improve revenues, expedite trade, and reduce fraud. While assessing the impact of the reform on customs performance requires more extensive analysis (which the Development Economics Research Group, Trade, and International Integration team and the Governance Global Practice are undertaking), the documented trends suggest the reform has been successful so far. REFERENCES Cantens, T., R. Ireland, and G. Raballand, eds. 2012. Reform by Numbers: Measurement Applied to Customs and Tax Administrations in Developing Countries. Washington, DC: World Bank. Chalendard, C. R., G. Raballand, and A. Rakotoarisoa. 2016. “The Use of Detailed Statistical Data in Customs Reform: The Case of Madagascar.” World Bank Policy Research Working Paper 7625, World Bank, Washington, DC. Hasnain, Z., N. Manning, and J.H. Pierskalla. 2014. “The Promise of Performance Pay? Reasons for Caution in Policy Prescriptions in the Core Civil Service.” World Bank Research Observer 29 (2): 235–264. Prentice, G., S. Burgess, and C. Propper. 2007. Performance Pay in the Public Sector: A Review of the Issues and Evidence. London: Office of Manpower Economics. GOVERNANCE GLOBAL PRACTICE Guiding Results through Public Institutions Governance Notes captures knowledge derived from World Bank engagements and technical and financial assistance requests. The views expressed are those of the authors and do not necessarily reflect the views of the World Bank. For more information, contact: askgov@worldbank.org. 4