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Implementing Tax Reform

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Practice Advice on Public Financial Management

Implementing Tax Reform (OECD)

Summary Advice: The OECD provides several strategies on how to reconcile efficiency, equity and other tax policy objectives when implementing tax reform.

Main Points:

Reform design should be guided by a clear strategic vision and backed up by solid analysis

As a starting point, governments might try to obtain a consensus on broad, long-term tax reform objectives. These might include reducing the country’s debt-to-gross domestic product (GDP) ratio, increasing domestic saving and investment, attracting foreign investment or increasing the labour supply. A broad consensus on tax reform goals will facilitate the discussion and evaluation of different tax reform proposals that attempt to realise these broad objectives. Clear communication regarding long-term objectives might facilitate the creation of a broad social consensus that favours the introduction of the most desirable tax-reform measures. When designing a reform that achieves the broader reform objectives, governments might have to find a balance between such different tax design criteria as efficiency, equity, simplicity, enforceability, revenueraising ability, etc. Clear communication with the public about these trade-offs and the choices that have to be made might help in obtaining support for the reform.

Framing tax-policy debates may be crucial when equity issues arise

The evaluation of tax-policy reform implies addressing the impact of the tax reform on income distribution. However, policy makers should bear in mind – and communicate to the electorate – that distributional goals should not be assessed on a tax-by-tax basis. Alt, Preston and Sibieta (2008) argue that in order to pursue sensible tax policy, it is essential to see the tax system as a system rather than to consider its different elements in isolation. Disconnected tax debates may be particularly counter-productive for the implementation of fundamental tax reform. Broadening the VAT base, for example, might be difficult if the discussion of VAT-reduced rates on particular goods takes place in isolation. The framing of the debate on recurrent taxes on immovable property in isolation will likewise hinder its adoption. Alt, Preston and Sibieta (2008) argue that such framing could result from a lack of public understanding of the actual impact of different taxes and of the interconnectedness of the tax and benefit systems. Discussing tax-policy reforms in isolation could reinforce this lack of understanding by allowing the tax-reform discussion to focus on individual taxes only. Lobby groups might have an incentive to frame particular tax-policy reforms in isolation, but this approach is unlikely to be in the interest of the general public.

Advancing reform may require acceptance of some ex ante constraints

Accepting certain constraints up front might help governments to build support for tax reform. A government could, for example, commit to implementing only reforms that were judged to be redistribution-neutral, reforms that did not lower total tax revenues or reforms that did not change the favourable treatment of, say, mortgage interest deductions. However, explicitly accepting some upfront constraints regarding key tax objectives might imply ruling out some Pareto-improving reforms. Ackerman and Altshuler (2006) argue that it is nearly impossible to design a tax reform that relies on base-broadening measures to finance rate reductions and is nevertheless both revenueand distribution-neutral. They argue that, although imposing up front constraints on the tax-reform process can be beneficial, the trade-off is a greater likelihood that the reform that actually is implemented will not dramatically alter the tax system. Policy makers should therefore be careful in setting strong constraints up front, because they may dictate the outcome of any reform effort.

Ex post evaluation and international dialogue may help strengthen the case for change

Ex post evaluation of tax-policy changes might provide valuable insights and offer an opportunity to learn from tax reforms that have been implemented in the past, thereby increasing the probability of better reforms in the future. Countries might evaluate ex post whether the tax reforms have achieved their objectives and analyse why certain objectives were or were not met. They might also assess the impact of tax reforms in terms of efficiency, equity, compliance, evasion and revenues. This will offer an opportunity to improve tax reforms that already have been implemented and might yield valuable insights for future tax reforms. Ex post evaluation might lead to a set of countryspecific best tax-policy practices and clarify the need for specific tax policy evaluation tools and models that have to be developed. Policy makers might commit to an ex post tax reform review by a specific date in order to help legislation pass, as was done in the Netherlands in 2001. bThis commitment will also provide a motivation for evaluation. Another related mechanism is the use of “sunset clauses”, which implies that tax rules have to be confirmed. This might then provide an incentive for ex post tax policy reform evaluation as well.

The proper timing of reform is crucial

Good reform proposals that are put forward at the wrong moment may be blocked. For instance, politicians will have to decide when to bring the reform proposals to the attention of the broader public, when to explain the impact of the reform and when to implement it. New governments that have campaigned for election on a platform of tax reform can use their electoral mandates to make rapid progress. Other issues of reform timing, however, may depend more on the state of public finances than the political conjuncture. Experience shows that it might be easier to implement fundamental tax reform when a country is running budget surpluses that could absorb possible revenue losses or could be used to partly compensate the losers from tax reform. The implementation of counter-cyclical pro-growth tax reform could anticipate possible economic downturns and mitigate their impact by putting the economy on a higher growth path before the downturn hits. In short, governments face incentives to engage in fundamental tax reform when times are good. However, it might not be possible to obtain support for fundamental reform in a cyclical upswing. An economic downturn might then create an opportunity to introduce pro-growth tax reforms and put the economy on a higher long-run growth path. Recessions sometimes expose very clearly the weaknesses of the economy and thus the need for reform. As a result, taxpayers and voters might more easily accept the necessity of reforms that tackle the underlying economic problems. The problem then, however, is that the deterioration in public finances brought about by the downturn may reduce the fiscal space available for financing reforms that might involve upfront costs.

There are strong arguments for “bundling” reforms into comprehensive packages…

In devising an approach to tax reform, policy makers face a difficult choice between “bundling” and “sequencing” – that is, between attempting to adopt a comprehensive tax reform more or less at once, in what is sometimes referred to as a “big bang” approach and pursuing a more incremental strategy. Both offer advantages and disadvantages, and the question of which is to be preferred depends not only on the institutional and political context, but on the goals of the reform and the obstacles that might be foreseen. In general, however, the literature seems to suggest that comprehensive reform is preferable, at least when it is possible.

…but incremental approaches may nevertheless be preferred in some circumstances

The attractions of comprehensive reform notwithstanding, there are circumstances in which sequencing reforms may be the desirable – or even the only feasible – strategy. In fact, even if a comprehensive approach is followed, governments could still implement the comprehensive reform on a tax-by-tax basis instead of implementing all tax reforms at once. The distinction between the adoption of a grand reform and its implementation should not be overlooked, because the greater the complexity of the changes adopted, the more likely it is that implementation will take time. Yet there are also arguments for taking a more gradual approach to the adoption of reforms.

Whether reforms are comprehensive or incremental, some transitional arrangements may be needed

Governments may sometimes allow for “grandfathering rules” that allow the old tax rules to continue to apply to some existing situations while the new tax rules will apply to all future situations. This strategy might be considered if agents no longer have the opportunity to adjust their behaviour in response to the new tax rules because they are, for example, already retired and therefore no longer have the opportunity to adjust their labour-market behaviour. However, grandfathering rules that are not well targeted will reduce the gains that can be realised by reforming the tax system, particularly if agents are able to take actions that will lock in the old rules. Moreover, grandfathering rules increase the complexity of the tax code, which results in increased compliance and enforcement costs. They can create tax-evasion opportunities where new and old rules co-exist and they may reduce the revenues gains from fundamental tax reform. The old rules might be phased out over time, implying that after a number of years only one set of tax rules will apply. Government would then have to decide upon the proper length of this phase-out period.

Much depends on the quality of the institutions charged with reform design and implementation

Bird (2004) discusses different strategies for “institutionalising” the process of tax reform. The recommendations in this section largely reflect the analysis in Bird (2004) and his review of McIntyre and Oldman (1975). The latter argue that countries that put in place appropriate institutional arrangements for tax reform would both improve the quality of tax reforms proposed and increase the likelihood of their adoption and successful implementation. Appropriate institutional arrangements are necessary in order to ensure the adequate drafting of the tax legislation, the collection and analysis of relevant tax and other data, proper tax-reform planning and effective communication with the broader public. They argue that better planning will increase political support through improved transparency and public understanding. It will be possible to make changes in reform proposals for political (or other) reasons more quickly, while at the same time remaining faithful to the underlying objectives and rationale of the reform. It is easier to resist politically appealing and populist arguments against reform where proposals are backed up by high-quality tax-policy analysis. Moreover, politicians introducing reforms will have more control of the process in terms of timing and presentation.

The transparency of tax reform processes can be a crucial factor

The way that taxation and public spending are perceived by the public or reported by the media may be decisive in winning public support for a particular tax reform. However, voters are typically imperfectly informed and they do not often have the information and/or skills needed to assess the effects of tax policies. Imperfect information may allow politicians to run their own agendas, which may not be in line with the preferences of the median voter.8 At the same time, it may also induce voters and other political actors to block beneficial tax-policy reforms. A proper tax-reform communication strategy and a dialogue with business, unions and other social partners, special interest groups, academics and the broader public may help to overcome the obstacles to the implementation of fundamental tax reform. Clear communication about tax-reform objectives and measures might facilitate the creation of a broad social consensus that favours the introduction of these reforms. A proper communication strategy will also help if the impact of the tax reform turns out to be different than foreseen. It will help to point out why the outcome could not have been foreseen and to explain why the outcome differs from the expected outcome.

Co-ordination of reform across levels of government is important

Sub-central governments in many countries are seeking additional resources for improving the services they provide; channelling these demands into the path of fundamental tax reform is a policy challenge. This strategy could help sharing the burden of tax reforms between the different levels of government, making the implementation of reforms more politically acceptable. Many obstacles to do so could be envisaged, but a justification of tax reform based on the need to be closer to citizens could actually contribute to the success of the tax-reform process.

Successful reform requires strong leadership

The implementation of fundamental tax reforms might require a political champion who can create circumstances that are favourable to their implementation. A political champion will recognise when there is a tax reform momentum and use this opportunity to introduce a tax reform. Bird (2004) states that the essential requirement for successful tax reform is a strong political will exemplified by one or more political champions who are prepared to put their reputations on the line. Their involvement will very likely increase the support for fundamental tax reform. In order to obtain sufficient political support for fundamental tax reforms, politicians may want to identify the winners and losers and the degree to which voters will win or lose as a result of the tax reform. Clear communication about winners and losers might be especially important for the  implementation of fundamental tax reforms if many taxpayers think they will lose while they effectively will not (or not as much as they expect). In fact, the need for providing good quality information becomes more important the higher the costs for taxpayers to collect information.

Source: OECD (2002) "Making Reforms Happen: Lessons From OECD Countries" OECD at (accessed 21 March 2013).]

Page Created By: Matthew Seddon on 21 March 2013. The content presented on this page is drawn directly from the source(s) cited above, and consists of direct quotations or close paraphrases. This material does not necessarily reflect the official view of the publishing organization.

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© University of Toronto 2008
School of Public Policy and Governance