Independent States (CIS) and South Caucasus countries comprising Armenia, Belarus, Georgia, Kyrgyz Republic, Moldova, Tajikistan and Ukraine; and the oil producing countries of comprising Azerbaijan, Kazakhstan, and the Russian Federation. Broad trends in tax ratios across these groups are discussed in Section 4.

This study analyzes the relationship between actual revenue collection, the economic and legal revenue potentials, and the tax space, tax gap and tax effort of countries. In addition, countries in the dataset are grouped with respect to their actual tax collections (low, medium, high) and their tax effort (low, medium, high) and comparisons are drawn across them. The size of the shadow economy also effects tax revenue collections, and hence, the effect of the on the tax gap, tax space and tax effort is also analyzed.

# **_4. Tax structure in different regions_**

Tax revenues in the formally centrally planned economies were mainly from enterprise profits, turnover and payroll taxes levied on state-owned enterprises. Individual income tax was relatively unimportant. The current tax system in the transition countries has a greater reliance on direct taxes including the personal income tax (PIT), corporate income tax (CIT), and the payroll and social security taxes; and indirect taxes including VAT, excises and customs tariff.

Personal income tax is still not well developed in the Commonwealth of Independent States (CIS). Many CIS countries still do not have global aggregation of incomes from all sources into ‘total income’ and universal filing of tax declarations by individuals is not widely practiced. Typically, the employer files the detailed list of withholding tax for all its employees in one consolidated return. Most countries in ECA have personal income tax structure with a flat rate. Although this increases the regressiveness of the tax system, the main argument used for introducing flat rates in PIT is to introduce simplicity, broaden the tax base, reduce administrative costs, and improve tax compliance. The flat rate applied to PIT and CIT vary significantly across countries. In 2010, the lowest rate for PIT was 4 percent for Kosovo and the highest for Slovenia at 41 percent and Croatia at 40 percent. For the same year, Ukraine and Tajikistan had the highest CIT rate at 25 percent, while Montenegro had the lowest at 9 percent. However, flat taxes have often been criticized on equity grounds and its effect on tax compliance has been mixed<sup>2</sup> .

The burden of labor taxes (includes PIT, social security contributions by employees, and payroll taxes or social security contributions by employers) are disproportionately high in ECA countries. Labor taxes accounts for about 40 percent of total labor cost on average<sup>3</sup> . In 2010, the tax wedge was highest in Hungary and Latvia at 33 percent and lowest in Belarus at 6 percent. On average, social security contributions contribute to about 77 percent of the tax wedge. Reflecting the historical legacy of the tax structure, the social security contributions are largely paid by the employers. The very high rates of labor taxes contribute to lower employment levels in the formal sector and larger shadow employment in the ECA region.

For most ECA countries, the VAT replaced the complex turnover taxes, and is the single most important source of revenue. Currently all CIS countries have a VAT single rate structure of 20 percent, except for a reduced rate in Russia, Belarus and Uzbekistan for food and medicines. The non-CIS Eastern European countries adopted a European credit-invoice VAT structure with multiple rates.

> 2 World Bank. 2007. In the Slovak Republic, self-employed tax returns increased by 14.6 percent in the first year of the flat tax reform in 2004(p265). In Ukraine, however, the high consolidated rates of payroll taxes discourage PIT reporting, and consequently PIT too, as both share the same base. Employers and employees enter into a collusion to set the “take-home pay” for the employee, which is partly what is recorded in the books and partly in unrecorded cash (p269).

> 3 World Bank. 2007.In the middle-income ECA countries (Poland, Romania, and the Slovak Republic), social security contributions make up for 45 to 49 percent of gross wage, compared to Chile and the Republic of Korea where it is 13 and 16 percent respectively (p282-283).

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