Five lessons for simplifying tax systems in Commonwealth countries

Taxpayers in low- and middle-income, Commonwealth countries are some of the most burdened taxpayers on the planet. For them, interacting with the tax system is often laborious, time-consuming, and riddled with inconsistencies. Taxpayers in Nigeria report that it takes 908 hours to prepare, file and pay their taxes. In Mauritius, the deductions available riddle the system with complexity. This is still a vast improvement to the state of the tax system 20 or even 10 years ago before digitalisation, even though challenges remain. 

Tax administrators in Commonwealth countries are highly motivated to improve the tax systems in their countries. It was in this spirit that Commonwealth tax administrators from India, the United Kingdom, Barbados, Jamaica, Kenya, Australia, Nigeria, Mauritius, the Maldives, Malaysia and Sri Lanka met to exchange ideas on simplification and digitalisation at Wilton Park in February. 

The focus of the discussion was on the best approaches to simplifying tax systems. Simplification can take various forms, four of which were highlighted in the dialogue: 

1. Simplification of language 

2. Simplification of the tax structure

3. Simplification of processes

4.  Simplification through digitalisation 

In this blog, I highlight five key lessons from this exchange of ideas. 

1. Simplification creates winners and losers

When you simplify a tax system, you create winners and losers. In some cases, no one loses, but different groups win to different degrees. Some of the big winners tend to be taxpayers who get a more efficient process with less time and money spent interacting with the tax system. The Indian tax authority carried out an exercise to unify tax rates and create a tax-free threshold, simplifying the process. They then gave taxpayers the option to stay on the old system or move to the new unified system. The majority of taxpayers voluntarily migrated to the new system. The contrast between the two systems gave taxpayers clarity as they could see which one was better. 

Simplification of tax systems also creates losers. The introduction of a flat rate in India, as discussed above, simplifies the tax structure but also creates losers as lower-income taxpayers have to pay more as a proportion of their income. Evidence from Rwanda also shows that low levels of digital literacy among marginalised taxpayers often result in them paying more to engage with the digital tax system. Sometimes, simplification can erase an entire industry of lawyers and accountants that has evolved to address a quirk or idiosyncrasy of the tax system. For example, in many low-income countries, retired tax officials usually take on the role of tax agents, offering clients the service of navigating a complex tax system. These individuals can lose their source of income if the system is simplified to the point that taxpayers can do it themselves.

2. Technology alone is not the solution

Digitalisation has accelerated the simplification process in many fundamental ways. AI is being used in India to simplify the language in the tax code. AI is also being used to improve risk profiling of non-compliant taxpayers. However, technology is not the be-all and end-all. Digitising and automation may not solve the underlying problems of non-compliance. For example, many countries have rolled out Electronic Fiscal Devices (EFD) technology, which sends real-time information to the tax authority on retail firms’ transactions. There was great hope that this would solve the problem of firms not issuing receipts. The reality is that the problem persists. There are things that technology cannot solve. All simplification and digitalisation processes need to, therefore, be viewed as complements and not substitutes for building tax capacity. The state must continue to build trust. It must continue to build tax-paying norms. It must continue using traditional tools like penalties and threats of enforcement to ensure compliance. As one participant summarised, “you can’t throw technology at a problem.”

3. The simplification process must not rob policymakers and politicians of the privilege of using the tax system to achieve their goals 

Politicians often use the tax system for other policy goals, which can add complexity to tax processes. For example, in 2006, Mauritius introduced a flat rate of 15% for corporate and personal taxes and eliminated exemption provisions. This greatly simplified the process, eliminating the need to apply for exemptions. Over time, this simplification was rolled back due to politicians introducing new objectives that required deductions. This demonstrates that simplification is not once for all: complexity tends to creep back in. One suggestion from the discussion was to ensure that tax authorities adopt a system flexible enough to incorporate changes without needing to overhaul the whole system.

4. Collect taxes by being more accessible

Tax authorities need to move to systems of collecting tax that feel painless for taxpayers. The use of intermediaries or third parties to collect tax through withholding is a great example of this. Another example is giving taxpayers the option to choose to adopt a tax reform rather than mandating that they adopt it. In India, taxpayers were given the option of moving to a new system or staying on the old one. Taxpayers realised the new system was more efficient and voluntarily moved. As another participant put it, ‘Tax authorities should collect tax the way a honeybee collects nectar.’  

5. Tax authorities need to build more trust 

Tax authorities need to listen more to taxpayers and become more accessible. They need to ask themselves: How does the proposed amendment feel for the taxpayer? What are the taxpayer’s pain points? For example, His Majesty’s Revenue and Customs (HMRC )is taking a more custom-centric approach to simplification. One of their initiatives is to ensure that taxpayers pay the right tax at the very beginning. In Australia, they are focusing on making tax just happen. Tax authorities can sometimes speak a different language from ordinary people, often using jargon and difficult terms. This can alienate taxpayers. The objective must be to build trust with taxpayers. Trust is difficult to build but easy to lose.

Learning from each other

 The way we dialogue matters. The Wilton Park model is a great way to leverage an environment and a style of discourse that gets the best out of the participants' insights. Another key learning is that iterative learning has a role to play as the simplification process is rolled out. It’s important to study and learn how and why simplification works. There are opportunities for Commonwealth countries to use digitalisation to leapfrog in ways that high-income countries couldn’t.