Concept of Effective Tax Administration in the Digital Era

Digital Transformation of the Tax Administration

Development of the national economy requires innovation-driven methods of tax administration that would help stabilize and increase the collection of the tax revenues for the governments. Scaling up tax revenue collection contributes to the current needs of the state and provides new opportunities for advancing the infrastructure and economy.

The taxation system is the primary source of government revenue and one of the major drivers of economic growth or restraint. That makes optimization and modernization of the tax administration one of the key priorities for the government.

Digital transformation plays a critical role in improving the efficiency of the tax administration processes. It helps implement innovative digital technologies to minimize tax gaps, increase tax and excise collection, and reduce the share of the shadow economy. The primary goal of the digital transformation of the tax authorities is the transition to digital tax administration through the development of the applicable concept.

The following concept highlights our approach to the digital transformation of the tax administration and translates principles we have implemented in several countries around the world. Most of them have already proven their efficiency or we evaluate them in the ongoing projects.

General Principles of Fair and Just Taxation

Taxation is the imposition of compulsory levies on individuals or entities by governments in most countries in the world. States levy taxes primarily to raise revenue for government expenditures, although they serve other purposes as well[1].

The social contract between the state and its citizens is the basis of sustainable taxation. The amount paid as a tax must meet the state’s budgeting needs and be reasonable to the taxpayer.

Tax fairness is a concept that requires a government tax system should be fair to the citizens. General principles of fair and just tax administration are:

• Acceptable tax rates. The charges should be affordable to taxpayers and preferably flat—so that the income growth would not lead to an excessive tax rate.
• Reasonable amounts to pay. Alongside the relative tax rate, the absolute amount of a charge must be acceptable to taxpayers. For illustration, a lengthier tax period may lead to a substantial amount of accrued taxes. This may be burdensome for a taxpayer because of possible cash deficiency caused by modest budget management. If the taxpayer does not have the required sum in the bank, they need to borrow money incurring excessive capital costs.
• Minimizing or cutting unjustified benefits. Many governments offer tax benefits. This may indicate the tendentious treatment of specific categories of taxpayers. Another disadvantage of benefits is the need for arbitrary that requires additional resources from the tax authorities and resulting in the growing costs of tax administration.
• Absence of advance payments. A taxpayer should pay taxes afterward he conducts taxable activities, receives taxable income, and/or uses taxable assets.
• Sharing the business risks with the state. For example, if the tax regime is based on the fact of shipment and requires an advance payment, the taxpayer—not the state, bears the risk premium. Tax payment in advance is a burden for the taxpayers who have shipped the goods, but have not yet received payments from the customers, because it creates a negative cash flow and increases accounts receivables.
• Transparency. A taxpayer needs to understand how the government spends the taxes he pays and appreciates straightforward evidence that no one stole them, and the authorities use them fairly and efficiently. For example, when tax revenues are helping to develop the taxpayer’s home territory with the visible progress and improvements in real-time.

For the state who owns powerful enforcement tools, it would be challenging to walk in the taxpayer’s shoes and understand their pain. But government authorities should treat every taxpayer fair, just, and in an unbiased manner to ensure their trust and sustain the social agreement.

For the state, the relative size of the tax rates is not such important as efficient revenue collection to support a profitable budget, economy growth, infrastructure development, and ensure social security and defense.

If the state experiences insufficient revenue collection, then it usually tries to raise the tax rates for the loyal and responsible taxpayers. This results in a more severe violation of the taxation equality that further encourages tax evasion and puts in place a solid foundation for the growth of the shadow economy.

Simple and Convenient Taxation for Taxpayers

Besides taxation fairness and equality in carrying the tax duties, it is essential to adopt the principle of simple and convenient tax compliance. This requires adherence to two cornerstone principles.

Simplified Registration of Taxpayers

Tax administration should create an effortless process that will help every citizen become a taxpayer and get a taxpayer identification number (TIN), automatically and with no taxpayer’s actions.

Registering enterprises, self-employed persons, and entrepreneurs with tax authorities, as well as selecting the tax regime and registering the taxable assets, should be simple and convenient for all taxpayers. This requires the integration of tax systems with taxable property registers (including land, real estate, and vehicles) and automated communication with taxpayers.

Simplified Tax Compliance

The traditional tax compliance process includes such steps as:

• Completing and filing a tax return by a taxpayer.
• Tax audit of submitted data.
• Payment of the applicable taxes by a taxpayer.

The tax return process has a long history in the global tax administration practice. Because of its complexity, it is timely and costly for both the taxpayers and the tax administrations.

The modern alternative is a digital tax administration approach, offering automated tax accrual based on comprehensive information about a taxpayer, his taxable activities, and information about assets. In the ideal situation, there is no need for the tax declaration filing by a taxpayer (no-filing principle) since the tax authorities automatically calculate the tax returns based on the taxpayers’ data. This approach helps dramatically reduce, minimize, and eliminate duplicate or redundant information from the tax forms filed by the taxpayers. The automatic filing also minimizes the number of errors and lowers tax administration costs.

For example, factura (tax invoice) is an equivalent of a bill of lading but also a mandatory tax document for the VAT administration. Although the tax authorities can collect all necessary information to calculate the tax base from taxpayers’ primary documents and financial transactions. In the simple analogy, the tax administration should function as a sensor in the data pipeline, and not as a damper that can break the data flow.

The tax administration should function as a sensor in the data pipeline—not as a not as a damper that can stop the data flow

Principle of Equality

Another important principle of the ideal tax administration is the enforcement of the principle of equality. This means that a bona fide taxpayer who pays taxes in good faith should not experience disadvantages compared to those failing to comply and receiving no penalties or other repercussions. Equality of enforcement is equivalent to the inevitability of punishment. Tax authorities should identify those not paying taxes and enforce them to comply.

Historically, it is local tax administrations who supervise taxpayers registered in the corresponding territory. In some countries, tax authorities created special departments for distinct types of taxpayers, for example, by industry, tax regime, or entity sizes. However, the results of adopting any segmentation model will not avoid the bias of a tax inspector who assesses a taxpayer’s performance. Therefore, the equality of tax enforcement depends on bias-related factors.

With this approach, a growing number of taxpayers results in a higher number of tax officers required to conduct tax control supervision. But it is often difficult for the tax authorities to expand the staff accordingly. This situation may entail more law violations. Subjected to a higher burden, the tax inspectors cannot identify all violations in time and take the enforcement actions. Tax administrations should build a flexible, scalable tax administration system that could ensure control and the inevitability of punishment for unconscientious taxpayers.

Therefore, a perfect tax system relies on unbiased digital data collected from various sources—particularly from a taxpayer—and in real-time. With this data, tax administrations can automatically calculate the tax base, make accruals, invoice taxpayers, and collect payments, identify violations, and communicate with taxpayers electronically, without involving a tax administration personnel.

The Goals of Digital Tax Administration

The digital tax administration must focus on increasing tax collection at all state levels—in particular, by reducing the share of the shadow economy.

Tax Gap Concept and Tax Gap Minimization Methods

To build an efficient digital tax administration system, it is essential to realize where the state loses tax revenue. This is an enormous challenge requiring an in-depth analytical approach. Specifically, tax administrations need to use the concept of the Tax Gap, which is a difference between the potential tax revenue and the actual tax revenue collection or the tax efforts.

Among the factors driving the tax gap growth, there are not only a deliberate tax evasion, but also a legal tax gap created by benefits and incentives established by law.

Tax	Industry	Tax Gap Causes	Solutions for Minimization	Potential Outcomes
Excise	B2B	Understated import costs Understated income Counterfeiting	National track and trace system	Up to 700% excise collection growth in specific product categories
VAT / Sales Tax	B2B	Overstated tax deductions Adjustments	Mandatory submission of all VAT e-invoices to tax authorities	Growth of VAT collection up to 150%
	B2C (retail)	Understated income Adjustments	Online Electronic Cash Registers (OECRs)	Growth of VAT collection up to 150%
	B2C (online retail)	Offshore operation (online platform, service provider) Non-filing of tax returns (e.g., Uber driver)	Digital platform for tax administration of B2C and C2C commerce	Growth of VAT collection up to 150%
Income Tax for Self-employed and Individual Entrepreneurs	B2C, C2C (self-employed and entrepreneurs)	Understated income Non-filing of tax return	Digital Tax Administration for Online Economy and Self-Employed (B2C, C2B & C2C)	Growth of the number of registered TINs (INNs) and the tax collected by/up to 100%
Corporate Income / Profit Tax	B2B	Understated income Overstated costs Overstated import costs	Development of a data system to identify and bridge the tax gap	Tax gap reduction by 10-30%
Personal Income tax / Payroll taxes	B2B	Understated income Non-filing of tax return	Development of a data system to identify and bridge the tax gap	Tax gap reduction by 10-30%
Property Tax	B2B, B2C	Non-filing of tax return	Development of a data system to identify and bridge the tax gap	Tax gap reduction by 10-30%

Analysis of the tax gap should consider all taxes and all relationships between them. Understanding the correct size of the tax gap and its components allows to determine the reserve sources of tax revenues, to build the processes to eliminate the gaps, and better control the work of tax authorities.

Typically, governments ask tax authorities to calculate the tax gap. This is a risky approach because of the potential conflict of interest, as the tax administration should develop a tax gap evaluation method, define the key performance indicators to measure their own performance, and plan their outcomes. Unsurprisingly, revenue authorities could be interested in lowering the goals and increasing the deadlines for completing the tasks set by the Government.

To avoid this situation, we recommend creating a special government analytical team. This team should develop the approach to the tax gap evaluation, define the KPIs, goals, and tasks for tax authorities, and propose governance methods to supervise tax authorities.

Digital Infrastructure for the Digital Tax Administration

To implement digital tax administration, it is necessary to build a digital infrastructure with the following components.

Digital Identification of the Tax Base

Digital tax administration infrastructure should support the “single version of truth” about the tax base, for example, maintained in the single tax data warehouse, and support the following capabilities:

• Identification, registration, and assignment of taxpayer identification numbers (TINs) to all taxpayers of all types: individuals, legal entities, entrepreneurs, self-employed, et cetera.
• Identification of all taxable items and assets to create the tax base: land, real estate property, vehicles, income, profit, dividends. The government information systems should register all taxable items and associate them with TINs.
• Identification of inactive taxpayers to mitigate potential fraud risks.

Identification of the tax base must rely upon the automated information collected from the government and other information systems. It must be comprehensive and allow no exceptions. There should be no situations when the tax administration identifies a taxpayer when their tax liability occurs, and there should be no unidentified taxable items.

Establishing a Single Point of Contact for Communicating with Taxpayers

This may be a state email, tax mobile application, or government services portal. Every taxpayer should realize that this is a single and the only channel for their communication with the tax administration and ignoring it may cause fines and other forms of compliance enforcement. Taxpayers should read informational messages from the tax and/or other governmental authorities and respond to them.

Automatization of Data Collection

The next step is empowering tax authorities to collect information about a tax base items and taxpayers’ activities from the following sources.

• Financial institutions (banks, payment systems, mobile wallets) data on customer transactions, including transactions of individuals.
• State real estate registry and cadaster data. Here, it is critical to ensure there is no possibility of using land or real estate without proper registration in the state information system. The proper tax accrual requires a single system for assessing the value of taxable items.
• Vehicle registry. All data collected from the vehicle registers should undergo thorough verification and validation to prevent the possibility of misrepresentation (e.g., understating the engine’s horsepower) to reduce the tax base.
• Foreign trade information from customs authorities (national and foreign).
• Information received from the automated data exchange with the foreign tax authorities.
• Information from local and international online and e-commerce platforms, marketplaces, and digital service aggregators.

A central data warehouse with the information on taxpayers and taxable items will help with automated data analysis and tax gap evaluation. Taxpayers should receive notifications if there are any violations with the request to remedy them voluntarily. This approach will give citizens a sense of the presence of an all-seeing governmental eye supervising tax compliance. Over time, this will shift the mental model of both citizens and enterprises toward the voluntary and timely payment of taxes.

Digital Handling of the Tax Violations

The processes of detecting and registering tax violations followed by enforcement actions should comply with the administrative code, use the maximum level of digitalization, and not involve a tax officer. A good example is the automated registration of speed violations with the use of road cameras. A camera detects a violation of pre-defined rules based on objective information. People are not engaging in decision-making and communication with the perpetrator who does not need to visit the police for live interrogation.

To improve the performance of the tax control, a tax administration can establish a “public control” function to receive tax violation claims from citizens and enterprises and, if possible, reward these activities after confirmation of violations. That may seem to be an unpopular measure that may grow negative responses from society, but it can be highly effective in scaling tax control without increasing costs.

Simplified Tax Compliance for Taxpayers

Simplifying and digitalizing Tax Administration-to-Taxpayer communication, including handling of violations, is a cornerstone of the tax collection, up-scaling tax control capacity, and combating corruption.

The digital solutions facilitating tax compliance for taxpayers can include:

1. Remote taxpayer identification and registration without visiting tax administration in person
2. Consistent opt-out of tax returns in favor of an automated system for tax accruals and accounting, which significantly reduces the tax administration costs for the taxpayer and tax authorities.
3. Accelerated transition to electronic forms of tax payments and opt-out of paper receipts and cash payments, for example by providing discounts for electronic payments. A system should encourage taxpayers to execute transactions using electronic money to make use of cash economically disadvantageous. For example, implement commission fees on cash transactions. Using digital money also results in lower transaction costs, less crime, and easier collection of taxes.
4. Implementing an automated remote taxpayer control system is functionally equal to tax monitoring of the large taxpayers.
5. Introducing electronic documents into all business (not only tax-related) activities and eliminating duplicated tax forms and reports. Electronic documents should emphasize benefits for the taxpayer’s business and processes, not only for the goals of tax administration and control. Initiatives focused solely on tax control entail extra costs and inconvenience for taxpayers.

Involving Taxpayers in the Tax Administration Process

Involving taxpayers in tax administration processes will upscale the capabilities of tax administrations, reduce transaction costs and contribute to reducing the share of the shadow economy.

A good example is when the tax administration encourages taxpayers to demand fiscal receipts from retailers. Consumers can either scan the paper receipts by mobile application or get e-receipts and validate them in the central tax administration system. Tax administration receives the receipt and, in return, together with their partners, can introduce tax returns, lotteries, cashback, discounts, and other incentives. That should make a fiscal receipt much more valuable to a consumer. Another example involves retail space management companies who may supervise the use of cash registers by their tenants.

A more complex solution is the due circumspection process, where a taxpayer must verify their counterparties and include a tax clause in their agreements—i.e., shifting the tax risks to their suppliers or contractors. Such processes can build a self-cleaning tax environment in which fair taxpayers would expel dishonest taxpayers from business activities.

Labor Taxes

High rates of payroll taxes and contributions, or labor taxes, elicit informal employment and cash payments in many countries. Optimizing labor taxes is a multilayer and challenging task that affects both the taxation and the social (pension, healthcare) systems.

Resolving this challenge requires building an analytical group to study the best global practices and develop a practical local solution. One of the viable options is including the labor taxes in the base tax rate.

Rewarding the Fair Taxpayers and Encouraging the Tax Spending Transparency

To motivate citizens and enterprises to pay taxes, it is necessary to encourage bona fide taxpayers and make information about the collection and spending of taxes fully transparent and publicly available..

In some countries the tax authorities treat taxpayers as voiceless entities obliged to pay on demand. Everything may seem good unless they either grow informal activities or protest. Instead, governments and tax administrations should cultivate gratitude toward taxpayers who contribute heavily to the state’s prosperity and welfare. Public incentives for bona fide taxpayers can include public gratitude, awards (including state rewards), and special marks for the taxpayer’s point of sales and websites.

Another important task involves the development of an open data system for the public disclosing of the tax collection and spending on the government and social needs. Such disclosure can include categories and types of collected taxes, sources of tax revenue, general objectives for the tax spending and allocation towards state budget programs, targeted socially relevant initiatives, and other information with unrestricted access via the web.

It is necessary to understand that many citizens and businesspeople have no habit of being bona fide taxpayers, so the introduction of new fiscal procedures can meet protests among the population and create risks of political instability. Authorities should weigh this factor when developing tax gap minimization strategies—to prioritize steps with the minimum political risks and maximum benefits for the state.

Conclusions

The above concepts follow the mission of creating a centralized digital tax administration system that would help identify and bridge the tax gap and facilitate tax administration for tax authorities and taxpayers.

Digital transformation and optimization of the tax administration can also stimulate private investments and the growth of the national economy.

To ensure efficient tax administration, it is important to realize when and where the state loses potential taxes. In this context, it is essential to use the concept of the tax gap, evaluate tax gaps for the main types of taxes, and develop a tax gap minimization strategy.

To minimize the tax gap revenue, authorities should develop a concept of digital tax administration using objective data about taxpayers and the tax base, as well as digital infrastructure for interaction with taxpayers.

The digital tax administration concept should include a roadmap and implementation plan for key initiatives aimed at minimizing the tax gap and increasing the collection of tax and excise revenues, for example, as shown in the following figure.

Based on this approach, we have implemented over ten digital transformation projects for national tax authorities in Europe, the CIS, the Middle East, and Africa. The following example describes the case of narrowing the VAT gap in B2C and B2B sectors after implementation of our digital solutions.

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[1] Source: Britannica. Taxation. URL: https://www.britannica.com/topic/taxation