Financing Government in the Transition: Bulgaria: The Political Economy of Tax Policies, Tax Bases and Tax Evasion

The transition from socialism is accompanied by a fundamental change in the conception of government. New models of the role and financing of government are required to replace the former socialist structure. A number of alternatives models are available from which to choose in making this change, ranging from the minimalist state that restricts its role to protecting private property rights and ensuring external defense and the rule of law to the more interventionist, paternalistic government of the welfare state.Under socialism, there had been direct and all-encompassing control of economic activity. Whichever model is chosen for the new market economy, if a government seeks access to resources, means of financing are required to withdraw the required resources from alternative market allocation. Although financing can, in principle, be provided by government borrowing and by inflationary means, the first offers limited scope in the early transition, and the second should be a last resort. With opportunities for borrowing restricted and given the social and economic costs of inflationary financing, tax revenues have an essential role in financing adequate functioning of government.The transition also brings special circumstances that affect taxation. The socialist social safety net disappears just when segments of society find themselves disadvantaged and even potentially destitute in the new market economy, and as the government finds itself confronting falling real output and contracting tax bases for its available tax instruments. Successful transition may itself be threatened, if the revenue needs required to contain social unrest cannot be met. Taxation further affects incentives for private sector development, for labor-market participation and for informal-sector activity.There are, therefore, important issues associated with the financing of government in the transition. In this volume, the issues are identified and considered against the background of the Bulgarian early transition experience but the issues are of general interest for transition countries. The contributors to this volume have all spent time, in some cases considerable periods (and, in two cases, have lived their lives) in Bulgaria. They include the World Bank's operational country economists for Bulgaria and other specialist World Bank staff. The authors have been members of World Bank missions to Bulgaria, with the exception of a coauthor of chapter II (she, however, had a role in the introduction of the value-added tax). Information base for this book was collected over the course of a number of World Bank missions between 1992 and 1994. The time frame of the studies covers the first five years of Bulgaria's transition, and ends in December 1994 at which time the Bulgarian Socialist Party (the successor to the former Communist Party) secured an absolute majority in parliamentary elections. Bulgaria thus became one of many former communist countries where voters ultimately chose a socialist party to manage the transition. Where appropriate, the analytical issues that arise in this volume are considered from a political-economy perspective that includes concern with why policies were adopted or were delayed and it looks at the relationship between efficiency and income distribution.