The Economic Cost of "Clever" Tax Administration Ideas

In the 1980's it was popular to introduce incentive systems for the promotion of taxpayer compliance. The partial VAT refunds for consumer purchases that are examined in this paper represent one of such schemes. The partial VAT refund system was an idea that was popular amongst professional tax administrators in the 1980s and as a consequence was implemented throughout Central America, Bolivia and Turkey. Such proposals were made with little or no research on the compliance or economic costs that such provisions create. The objective of this study is to measure the compliance costs incurred by the private sector and to measure the administrative costs incurred by the tax authorities in their effort to issue partial VAT refunds for private consumption purchases in Northern Cyprus. Based on the survey of those participating in the scheme, the results indicate that the total compliance and administration costs incurred in North Cyprus in 2003 to run its VAT refund scheme was over US$4.5 million, an amount equal to 1.5 times the total budgetary expenditures made to administer all the domestic taxes in the country, or about 5 percent of the total revenues raised by the VAT in 2003. These results indicate how dangerous it is to introduce indirect tax enforcement measures without first undertaking a careful evaluation of the compliance costs that such measures impose. From an economic perspective, these costs are a complete waste scarce economic resources.