In contrast to oil-producing Arab nations, non-oil-producing Arab countries rely on tax revenues to cover government spending. However, they have encountered significant difficulties when it comes to acquiring sufficient tax revenues. This has pushed them to either cut down on investment spending, ask for foreign aid, or borrow from internal and external sources.
These mechanisms help offset the immediate government budget deficit. However, it is risky to continue adopting this approach as its economic and social costs may be too high. Widespread tax evasion by both individuals and businesses is a main reason behind low government revenues in many Arab countries. Tax revenues do not exceed 15% of GDP in Egypt and Jordan, and 20% in Tunisia, compared with 35% in the Organization for Economic Cooperation and Development (OECD) countries.
Although tax revenues in Morocco represent 25% of the GDP, official data indicates that 85% of corporate taxes are paid by only 2% of companies, while one out of two companies declares incurring permanent and structural losses in order to avoid tax payment. Policy-makers in non-oil-producing Arab countries are seeking ways to increase tax compliance in order to generate more revenue and keep growing government budget deficits in check.
Tax evasion includes various illegal measures to which both natural and legal persons resort to with the objective of evading tax obligations according to the law. The loss of tax revenues resulting from tax evasion consists of two components. The first is local. It includes undisclosed profits in the informal sector, as well as inaccurate disclosure of regular activities to reduce taxation. The second is international. It includes multinational corporations’ manipulation of their accounts in order to shift taxation from one country to another. It is also relevant to individuals who deposit their financial assets in offshore banks illegally to hide a portion of their taxable revenues.
To address the issue of tax evasion, it is necessary to understand it in all its aspects and the reasons behind it, which can be summarized in the following five factors:
First, one of the main reasons behind the spread of tax evasion is weak political and administrative institutions. Excessive bureaucracy in governmental departments, proliferation of corruption, and weak legal environment are closely linked to the spread of an informal economy and the increase of tax evasion.
Second, the high tax burden is an important reason behind tax evasion. High tax rates encourage corporations and individuals to develop tax evasion methods. Liberal economy experts use this argument to convince governments that decreased tax rates can lead to an increase in tax revenues, due to improved tax compliance. Nevertheless, international experiences prove that tax evasion can be low at high tax rates, and vice versa. Political governance, which is manifested in how legitimate the government is in the eyes of the taxpayers and how it spends tax revenues, is fundamental to the way this puzzling question is interpreted.
Third, reduced tax evasion depends on the powers of the national taxation departments and their effectiveness. Computers and specialized software can greatly assist in a better auditing of taxpayer accounts. Increased sanctions also can contribute to tax evasion deterrence. In addition, international experiences proved that cross-checking with “third party” data that document transactions and resulting cash flows was important for a better estimate of due taxes.
Fourth, in addition to tax evasion, excessive and inefficient use of tax exemptions is a reason behind low government revenues. The size of tax exemptions is considerable in Arab countries, as is the case in Tunisia and Morocco, where data are available regarding the issue. Tax exemptions usually lack transparency. They are sometimes affected by pressure exerted by private interest groups, and are sometimes subject to fraudulent practices cases.
Fifth, amendment of laws and legislation to make them tougher is not enough to spur greater tax compliance, especially since there is a common belief that Arab governments are not politically ready to control tax evaders. Periodically, countries resort to tax exemptions to give evaders an opportunity to pay their taxes without penalties. While tax exemption has an immediate positive impact on government revenues, it is frustrating for honest taxpayers, and weakens tax compliance in the future, because people may believe the tax exemption will be repeated.
Non-oil-producing Arab countries need to build taxpayers’ trust in the integrity of their tax systems. Tax fairness, transparency and simple legislative and regulatory procedures and requirements are key factors that should determine the form of tax reform designed to reduce tax evasion. Tax fairness requires that taxpayers pay similar taxes in similar circumstances. It also requires that the tax burden be equally distributed by expanding the tax base and progressively abolishing tax evasion and inefficient tax exemptions, from which only specific groups benefit.
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