Academic Expounds on Taxation Loopholes

EghtesadOnline: Why does tax-to-GDP ratio in France or Denmark stand at 46% while it’s below 10% in Iran? How come the Swedes give half their incomes to the government but in Iran many leave no stone unturned to evade taxes? Have the westerners managed to build the culture of tax morale and tax compliance of their citizens but we’ve failed in doing so?

News ID: ۷۸۵۰۷۰

27 November 2019

In an interview with the Persian-language weekly, Tejarat-e Farda, Ali Marvi, professor of economics at Allameh Tabataba'i University, answers these questions and some more. According to Financial Tribune, excerpts follow:

Reducing people’s economic reasoning to lack of culture does not allow us to analyze issues carefully. The fact of the matter is that people make many of their decisions by comparing economic costs and benefits, so unwillingness to pay taxes is not a behavior solely observed in Iran.

To ensure funding for public goods, including security, health and basic education, is one of the main reasons governments charge taxes. Some of these public goods, such as security, are non-excludable, which means it is available to all and cannot be withheld, even from people who do not contribute to its public funding. That characteristic, in turn, leads to what is called the free-rider problem with public goods.

Since you need not contribute to the provision of a public good to benefit from it, some people will inevitably choose to use the same and yet shirk the public responsibility of paying for it. Someone who refuses to pay their taxes, for example, is essentially taking a “free ride” on revenues provided by those who do pay them.

People’s lack of tax compliance might also be blamed on the fact that they really don’t know how and where the government spends these resources. Will these resources get lost and squandered in the labyrinth of bureaucratic functioning or spent on corruption?

These two perspectives might be behind people’s non-compliance tax behavior. However, there might be other reasons why people fail to pay taxes in Iran as well as in other countries.

The free-rider problem with public goods also comes from the general belief that Iran is connected to oceans of oil revenues and the government can pay all costs of running the country from oil money. This is an instinctive reaction.

People of other countries would also take the same course of action, i.e. dodging the taxman, if they know they will get away scot-free and that the system can’t catch tax cheats.

The taxation system needs to be designed to reduce the chances of willful tax evasion to zero and ensure compliance with the tax law. To do so, the government must be doubly efficient in devising clear, accurate tax code and identifying potential taxpayers.

On top of that, tax collection should not hurt the business environment or act as a brake on economic activities. It must give enterprises breathing room and also minimize any friction between the taxman and taxpayer.

Our taxation system is rife with major flaws. There are more than 10 types of taxes in the world but in Iran there are only three types of taxes, namely corporate income tax (tax on the profits of corporations and companies), also known as performance tax; value-added tax (a consumption tax placed on a product whenever value is added at each stage of the supply chain, from production to the point of sale) and personal income tax levied on the wages, salaries, dividends and other income earned by a person.

In Iran, CIT and VAT account for the greater share of tax revenues whereas PIT earnings are usually not that significant. In fact, Iran does not have a comprehensive PIT law whereas in other countries, tax on individual income is the chief type of tax. Income tax constitutes more than 40% of overall tax revenues in developed countries.

In addition, PIT plugs tax loopholes by arresting those who have managed to somehow escape paying corporate income tax and value added tax. The taxation systems in other countries have been designed so that the tax office collects people’s data from various data pools of other governmental agencies. This makes people more than willing to provide tax office with their detailed information for fear of penalty or extra tax.

In developed countries, capital gains tax on precious metals like gold or foreign currencies or bank deposit accounts is by far higher than tax on manufacturing profits or stock market, which automatically encourages people to opt out of speculative activities to pay less tax and invest in production.

In Iran, however, manufacturing enterprises account for the lion’s share of tax revenues, while activities such as trading gold and foreign currencies are subject to zero tax rate. Our taxation system directs people toward investing in intermediary activities.

All the above problems must be resolved in Iran’s taxation system in order to increase tax compliance and foster favorable attitude toward tax authorities.

Moreover, the government needs to provide transparent reports on where tax money goes and whether such spending is effective and justified. After all, higher legitimacy for governmental actions leads to higher tax morale.

Iran Tax Facts & Figures

According to Director of Iranian National Tax Administration Omid Ali Parsa, 40% of Iran’s economy are exempt from paying taxes.

Besides tax exemption, the government budget in Iran also suffers from widespread tax evasion.

Gholamali Jafarzadeh Imenabadi, a member of Majlis Plan and Budget Commission, puts the size of tax evasion at 400,000 billion rials ($3.29 billion) annually.

“Up to 800,000 billion rials [$6.58 billion] will return to the government coffers [annually] if the current legislation on tax exemption was reformed and reviewed. I believe the value of tax exemption and tax evasion together is more than 1,000 trillion rials [$8.23 billion],” Fars News Agency reported.

According to Eliyas Hazrati, the head of Majlis Economic Commission, 85% of Iran's tax revenues come from only 3% of taxpayers.

Stressing the need to discover new sources of funding the government budget, he said there's a gap between Iran's 1,270-trillion-rial ($10.45 billion) tax revenue and 3,200 trillion rials ($26.33 billion) in current expenditures (per annum).

Mohammad Hosseini, a member of Majlis Plan and Budget Commission, recently told Fars News Agency that tax revenues were estimated to hover around 862.68 trillion rials ($7.1 billion) in the first half of the current fiscal year (March 21-Sept. 22), but they reached 647.01 trillion rials ($5.32 billion).

The budget law estimate of tax revenues for the whole year is at 1,725.36 trillion rials ($14.2 billion).