39623 The World Bank PREMnotes MARCH 2007 NUMBER 112 PUBLIC SECTOR GOVERNANCE Estimating Economic Benefits for Revenue Administration Reform Projects Tuan Minh Le (Senior Economist, PRMPS), Duc Minh Pham (Senior Economist, EASPR), and Luc De Wulf (Consultant, PRMTR) The World Bank relies in part on economic benefit estimates to evaluate the mer- its of investment projects. Recent lending operations for revenue administrations in Vietnam have led to some rethinking of these calculations. This Note shares their findings. Financial and economic analysis, particu- Shortcomings of earlier estimates of larly the cost-benefit-analysis (CBA), is part economic benefits of the standard requirements in the Project Review of the financial and economic Appraisal Document (PAD). The CBA sec- analysis in several of the PADs indicates tion of PAD is a summary of the quantita- two major shortcomings. First, the authors tive assessment of the project's incremental of several project documents have limited net benefit to the society, taking into themselves to stating that the projects account the comparison of "with project would be feasible both financially and eco- and without project" scenarios. Such fore- nomically, but do not attempt to quantify casting, measurable in monetary terms, the statement. This is obviously inadequate. based on calculation of the economic rate of Second, the authors of several other project return or net present value, and including documents make no distinction between sensitivity analysis, is a sophisticated exer- the expected financial and economic bene- cise. Note, whereas social analysis in an inte- fits that are to be factored in the pro forma grated CBA is critically important in identi- cash flow profiles of the projects. fying and quantifying the distributed In the revenue management moderniza- amount of benefits and costs to the "win- tion projects, financial benefits are reflected ners" and "losers" of a reform project, it is in the increase in budget revenue that the beyond the requirements for a PAD and thus project generates. These financial benefits not explored further in this PREM Note. are in fact transfers from the private sector This note provides some pointers that to the public sector, and tend to be cancel may be useful in estimating the economic each other out. In terms of social welfare, benefits of revenue reform projects. The these can be considered beneficial to the guidance can also assist in preparation of the country only to the extent that the budget Technical Annex of the financial and eco- makes better use of these funds than the nomic analysis of individual projects as private sector. However, quantifying these required by Bank guidelines. The building relative benefits is tricky and colored by blocks of the guidance were developed in political views; to date no conclusive state- the context of the preparation of the PADs ment has been made. These projects do, of the up-and-running Vietnam Customs however, benefit society if they reduce Modernization Project (VCMP), and of the administrative and compliance costs, as Vietnam Tax Administration Modernization will be noted in the following section. Project (TAMP), which is in preparation. FROM THE POVERTY REDUCTION AND ECONOMIC MANAGEMENT NETWORK Economic analysis in the PADs requires ing assumptions that fully take into account reliable and pragmatic approach the particular country circumstances and The measurement of economic benefits the project targets. The sensitivity of the and costs is built on information devel- results can be tested using slightly different oped in the financial appraisal, and assumptions. Some pointers are as follows: draws extensively on the economic prin- The reduction in administrative and ciples developed in the field of applied compliance costs will depend on local cir- welfare economics. The CBA exercise ana- cumstances. As a starting point, a reason- lyzes the pro forma cash flow of the proj- able "soft guesstimate," possibly for cost ect, and nets out the impact of debt reductions of 0.1 to 0.5 percent of the cargo financing and the financial transfers value, can be used. between economic agents, as discussed previously. For this reason it retains only Calculating the benefits from lower the real net-cost and welfare-enhancing clearance times relies on the following benefits of the project. For the PAD, data: (i) clearance times and share of where practicality is critical, a simplified imports and exports that enter and leave approach will focus on the main sources the country through ports of entry; (ii) pro- of benefits. This approach is now applied jection of this trade over the project period; successively to projects that aim at mod- and (iii) targeted reduction in clearance ernizing the customs and tax administra- time per port of entry. Economic benefits tions in Vietnam. can be estimated at 0.5 percent (with values ranging from 0.2 to 0.8 percent for exploratory sensitivity estimates) of the Customs Administration value of the cargo per day the clearance Some of the major economic benefits esti- time is lowered. Survey data for Vietnam mated in the CBA in the VCMP include identified the clearance delays that were the fact that the cost of preparing cus- the responsibility of Customs and those toms clearance documentation (including that were the responsibility of other agen- reducing the facilitation money that may cies at the border. Thus, the analysis could be involved in the process) would fall, estimate the benefits from improved cus- that cargo will clear faster, and that inter- toms operations as well as the additional national trade will expand as a result of benefits that would accrue if these other increased competitiveness of the econo- agencies were to reduce their clearance my. Little research has been done on the delays as a side benefit of the Customs cost of preparing clearance documenta- modernization project. tion. But an OECD (2003) study mentions Reducing the variability of clearance survey data from the EU and Japan, sug- times as measured by the standard devia- gesting that these costs could range from tion would permit the trader to operate 3.5 to 15 percent of the value of the with less inventory. The authors know of import cargo. The benefit from faster cus- such data only in the case of the toms clearance and a reduction in the Philippines. Halving this standard devia- variability thereof relate to reduced loss tion is estimated to provide benefits equal of business opportunities, lower invento- to an additional benefit of 0.2 percent of ry costs, and lower depreciation of the cargo value. (Reduced benefits should be goods held up in transport. Hummel assumed where the variability is lower.) (2001) estimates that each day saved in The main point would be to draw attention shipping time is worth 0.8 percent of the to this policy objective. value of the shipment of manufactured goods. Improving external competitive- Better customs clearance procedures and ness will also expand trade, as has been lower trader costs would provide dynamic abundantly illustrated in the macroeco- benefits through enhanced external com- nomic literature. petitiveness that will result in faster export growth. For illustration, one could add one The quantification of economic benefits percentage point to the projected export requires only basic data on trade and cus- growth during the project period. toms clearance delays, and adopts simplify- 2 PREMNOTE MARCH 2007 Tax Administration dynamic sense they adversely affect eco- Some quantifiable economic benefits nomic behavior; their reduction would ben- expected from tax administration reform efit the economy. The design and targets of projects are as follows: the revenue enhancing project will have an impact on the benefits generated. Based on Macroeconomic benefits good knowledge of local circumstances, Trade liberalization will result in lower rev- basic assumptions can be reflected in the enues from trade taxes. If this trend were estimates. Results are likely to increase the not accompanied by an increase in domes- awareness of taxpayers and tax authorities tic tax revenue or lower expenditures, of the burden of compliance costs. A few deficits would ensue. The negative social pointers: and economic effect of these options could · Compliance costs for domestic taxes be avoided if increases in domestic tax rev- have been estimated at 2 percent to 10 enues were to make up for the loss in trade percent of the revenue of these taxes, up tax revenue. This represents economic ben- to 2.5 percent of GDP (Evans 2003). efits for a project that increases domestic revenue mobilization. Their quantification · Some taxes yield cash flow benefits (time depends on (i) the benefits derived from lapse between the occurrence of tax lia- retaining the expenditures that would be bility and tax payment), and can substan- scaled down if no additional taxes were tially reduce the net compliance cost. raised, and (ii) avoiding the economic costs of deficit financing. These benefits need · Compliance costs tend to be higher for not necessarily be quantified, yet they are small and medium-sized enterprises certainly positive, suggesting that the cal- than for large enterprises that are better culated benefits represent a lower bound equipped to deal with tax authorities. estimate. · Projects that aim at simplifying the tax system--making it more predictable, Reduction in administrative costs of collecting enhancing the accountability of tax offi- the taxes cials, improving tax payer services, The modernization of tax administration speeding up appeals and audits, and should lead to lower costs per amount of introducing automation--are likely to revenue raised as (i) the tax administration reduce compliance costs more than proj- is streamlined, (ii) tax officials are better ects that include none of these elements. trained, and (iii) taxpayers become more compliant as a result of enhanced tax payer · Compliance costs relate to wage costs for education, and the establishment of taxpay- in-house and outside advisors, and for er support centers, process simplification, this reason are expected to be lower in and improved automation. If the project low-wage countries than in high-wage results in a simpler tax policy, that would countries. Yet, studies on compliance also add to the benefits. costs done for India do not corroborate this reasoning. Reduction in compliance cost for the taxpayer These costs, which tend to be higher than Support trade liberalization the cost of administering the tax itself, Trade taxes distort consumption choices include the cost individuals and enterprises and resource allocation. In fact, this is often incur in preparing their tax declaration, and the purpose of these taxes as they intend to dealing with tax audits (Evans 2003). Some protect domestic producers at the expense of these costs are in-house costs, whereas of higher cost to the consumer. Trade liber- others result from fees paid to tax preparers alization policies will result in the reduction and outside advisors, as well as the bribes of trade-related taxes over time, a process paid to convince tax officials to reduce their that could be undermined if the revenue tax liability, speed up the tax audits, and authorities were unable to make up for this influence the results of these audits. In a trend by raising more domestic tax rev- static sense these bribes are merely trans- enue. Benefits from trade liberalization fers from taxpayers to tax officials and thus would be slower in coming. These benefits not an economic cost to the economy. In a have been estimated for 1997­2015 at $500 MARCH 2007 PREMNOTE 3 billion (1997 dollars), three-quarters of them. The project may intentionally pro- which would result from the dismantling vide for capacity building to capture such trade barriers in low- and middle- income benefits. Table 1.1 summarizes the potential countries (World Bank 2002). When account benefits of customs and tax administration is taken of endogenous productivity gain, reform. the benefits increase to two thirds. The rev- Conclusion enue generation of the project under con- Financial and economic analysis of rev- sideration would better ensure that the enue administration reform projects is country shares in these benefits. important and feasible. Its findings can Quantification of this would need to be strengthen the resolve of revenue authori- based on country-specific estimates. ties to overcome inevitable resistance to reform. Yet, the methodology used should The project might lead to a reduction in distor- be sound. It should avoid adding finan- tions of the present tax regime cial benefits of the project to economic Many domestic tax regimes contain distor- benefits, use realistic parameters, and tions that could be eased when the project provide a sensitivity analysis. Although assists in strengthening the capacity of the not all economic benefits are readily tax administration to identify and rectify Table 1.1 Potential Economic Benefits in Customs and Tax Administration Reform Projects Customs Issues Estimate range Lower Better administration is cheap- 0.1-0.5% of cargo value administrative costs er for Customs and trader Shorter clearance Trader cost falls 0.5-0.8% of cargo value time Lower variability of Lower inventory costs for Halving the standard clearance time trader deviation provided 0.2% of cargo value Enhanced Faster export growth Export growth increased by competitiveness 1 percentage point Domestic taxation Macroexternality Improved fiscal Not estimated benefits management Lower administrative Simpler system easier to Cost fall by 30% over project costs administer period Lower compliance Taxpayer spends less time and Costs fall by 2% of tax rev- costs money on enue over project period compliance Support trade Avoids delays in trade liberal- Up to 0.8% of GDP over liberalization ization by assuring budget project period revenue Reduces distortions Tax policy improves Not estimated Source: Hummel (2001); Evans (2003); and authors' projections. 4 PREMNOTE MARCH 2007 amenable to quantification, the major References ones should be estimated and the others Evans, Chris. 2003. "Studying the Studies: clearly discussed or "guesstimated," sug- An Overview of Recent Research into gesting that quantification is likely to be a Taxation Operating Cost." eJournal of Tax lower bound estimate. Research 1 (1): 64­92. Atax, University of Peer reviewers: Moustafa Baher El- New South Wales. Hefnawy (Senior Transport Economist, Hummel, David. 2001. "Time as a Trade EASTR), Eduardo Ley (Lead Economist, Barrier." Purdue University. PRMED), and Seth E. Terkper (Senior Economist, FAD, IMF). OECD. 2003. "Quantitative Assessment of the Benefits of Trade Facilitation." If you are interested in similar topics, TD/TC/wp/2003031/Final. Paris, France. consider joining the Tax Policy and Administration Sub-Theme (Public Finance World Bank. 2002. "Global Economic Thematic Group, PRMPS). Contact Tuan Prospects and the Developing Countries." Minh Le at 38485, or click on Thematic World Bank, Washington, DC. Groups on PREMnet. Cost-Benefit Analysis Acronyms, Abbreviations, and Initialisms CBA Cost-benefit-analysis EU European Union GDP Gross Domestic Product OECD Organisation for Economic Co-Operation and Development PAD Project Appraisal Document PREM Poverty Reduction and Economic Management TAMP Tax Administration Modernization Project VCMP Vietnam Customs Modernization Project This note series is intended to summarize good practices and key policy findings on PREM-related topics. The views expressed in the notes are those of the authors and do not necessarily reflect those of the World Bank. PREMnotes are widely distributed to Bank staff and are also available on the PREM Web site (http://prem). If you are interested in writing a PREMnote, email your idea to Madjiguene Seck. For additional copies of this PREMnote please contact PREM Advisory Service at x87736. This PREMnote was edited and laid out by Grammarians, Inc. Prepared for World Bank Staff