Digital tax stamps enable governments to strengthen tax administration and compliance by simplifying the verification, tracking, and monitoring of excisable goods. Firms’ behavioural responses to these stamps determines ex-factory prices, sales revenues, and government excise revenues.
In an effort to minimise underreporting and misclassification by firms manufacturing excisable goods, the Government of Uganda introduced digital tax stamps on some goods that attract excise tax in the financial year 2019-20. The implication was that all manufacturers and importers of the gazetted goods were required to affix digitally traceable tax stamps on their goods. The introduction of the digital tax stamps was one of the recommendations of the Domestic Revenue Mobilisation Strategy as a mechanism to improve tax compliance and revenue collections.
The Domestic Revenue Mobilisation Strategy identifies excise taxes as an area of revenue potential. However, there was no clear track and trace mechanism that the Government would use as a check to ensure firms were correctly reporting their sales revenues. This consequently undermined government’s excise policy reforms since firms could easily underreport their declarations which would minimise their tax liability.
The objectives of introducing digital tax stamps were to protect government revenues, combat trade in counterfeit goods, enhance fair competition in the market, and provide real time statistical data for both tax policy and administration. However, digital tax stamps can only be effective as a means of protecting tax revenues and curbing illegal trade if the technology can be embraced and adopted by firms in a timely manner.
Accordingly, effective administration of tax policy requires tax authorities to adjust and manage the behavioural responses of firms. Given that firms could underreport their taxable sales revenues to minimise their tax liability, a policy response from the tax administration side should be able to implement a track and trace mechanisms to minimise leakages in tax revenues.
Who bears the cost of digital tax stamps?
The introduction of the tax stamps where the cost is met directly by the taxpayer would be equivalent to an increase in excise tax rates and could potentially increase the cost of compliance for compliant taxpayers in the short term. The extra cost imposed on firms by the policy may have forced them to alter their behaviour by declaring relatively lower ex-factory prices.
The behavioural response by firms partly shifts the cost to the Government in the form of lower Government tax revenues since the ex-factory price is the taxing point for most excisable goods. In addition, firms might respond to digital tax stamps by increasing the price of the final products, which may force consumers to substitute to relatively cheaper options – substitution effect of a price change, or stop consuming the goods, because they are relatively poorer – the income effect of a price change.
Any of these behavioural responses would result in relatively lower sales revenue in response to price increases to accommodate the cost of digital tax stamps. Therefore, the track and trace system must be balanced to minimise unnecessary costs to legitimate industry players. Consequently, it is important that the stamped goods remain affordable so as to minimise the consumption of illicit goods.
Negative effects in the first year post-digital tax stamp introduction
The goal of the study was to assess the impact of digital tax stamps on firms’ ex-factory prices, sales revenues and Government excise revenues. The impact on three findings from the IGC study is summarised as below:
- Treated firms’ excisable sales revenues decreased by 24.9% for the period where the Government paid for digital tax stamps (first year post-digital tax stamps); and increased by 30.7% when firms paid for digital tax stamps (second year post-digital tax stamps), relative to the comparison control group.
- Treated firms’ ex-factory prices decreased by 5% when government paid for digital tax stamps, relative to firms in the comparison control group. The effect is more pronounced, with a decrease of 17.4% when firms paid for the stamps (second year post-digital tax stamps). The ex-factory price is the taxing point for most excisable goods, a decrease in the ex-factory price implies lower excise tax revenues. To that effect, a decrease in ex-factory prices signifies that firms respond to digital tax stamps by shifting part of the stamp cost to the Government.
- Excise tax revenues for treated firms decreased by 24.8% for the period that government paid for digital tax stamps (first year post-stamp introduction); and increased by 29.3% when firms paid for digital tax stamps (second year post-stamp introduction), relative to the comparison group.
The findings summarised above suggest that digital tax stamps had negative effects on firm sales revenues and Government excise tax revenues in the first year post-digital tax stamp introduction. This was due to implementation challenges and delays in embracing the new technology. However, in the second year post-implementation, the gains in terms of increased firms’ sales revenues exceeded the firms’ behavioural response of decreasing ex-factory prices. This resulted in an increase of 29.3% in excise tax revenues for treated firms, relative to the comparison control group. These results provide evidence that firms and tax administration may take time to embrace and adopt new technologies, but eventually such policy interventions tend to improve tax revenue mobilisation efforts.
Improving the efficacy of digital tax stamps
Based on the findings of the study, digital tax stamps are effective, and it is recommended that:
- Deliberate efforts are made to ease the adoption the new technology by renegotiating a much lower and uniform price for digital tax stamps. This mitigates the tax avoidance responses by firms and will still ensure that the service provider recoups their investment over a relatively longer period of time.
- Implementation challenges require urgent resolution to maximise the gains from digital tax stamps. Some of the actions required from the tax administration side include: a) Automating the activation process of the tracking features on physical paper stamps, otherwise, the stamps are as good as non-existent; b) Increasing enforcement to mitigate circumventing behaviour by firms. This can be done through increased reconciliations to ensure that produced volumes match declared sales; c) Launching and marketing the KAKASA App to discourage the consumption of goods without digital tax stamps; and d) Modifying the KAKASA Validator to carry out mass validation of tax stamps to decrease on delivery time for businesses
See the related working paper.