The predominant source of corruption in customs collection in the developing world is no great mystery. Developing countries, as a group, tend to have higher marginal tax rates on imports and collect a greater percentage of overall tax revenue through customs. High rates lead to large rent-seeking opportunities for both Customs Agents and Importers.<sup>1</sup> Since lowering tax rates is often politically infeasible or fiscally imprudent (in the absence of other sources of government revenue), it is necessary, at least in the short-run, to find ways of overcoming corruption given the existing tax system. In lieu of overhauling tax-rates, PSI is often suggested as a low-cost second-best solution.

A PSI contract entails the hiring of a private company to inspect goods destined to be imported at their point of embarkation. Originally, PSI was primarily limited to the detection of over-invoicing so as to reduce capital flight . At present, however, PSI is mostly used to detect revenue fraud by verifying the price of goods to be imported, their classification, and to detect outright deceit on customs declarations. There are several seemingly good reasons to advocate its use for these purposes. Normally, given their geographical separation, there is little contact between customs authorities and PSI agents, thereby making collusion between them extremely costly. Also, in a competitive environment, the PSI company is highly dependent upon maintaining a good reputation and, therefore, has strong incentives to avoid corrupt activities (such as colluding with the importer or government officials).<sup>2</sup> Typically, a PSI contract works as follows: The Importer is required to notify the local PSI office in the country of origin that he wishes to bring in a shipment. PSI employees then inspect the shipment with the goal of either verifying its contents against the Importer’s invoice, or, in the case of discrepancies, of “up-lifting” the taxable value of the goods on the Invoice. Once the PSI company is satisfied with any changes made to the Invoice, they seal the shipment and a “Clean Report of Findings” (CRF) is sent to the country of destination ahead of the shipment. The CRF specifies the value and categorization of the goods as determined by the PSI employees. It is typically sent to the Customs Service at the point of destination and, sometimes, to the destination country Ministry of Finance as well.

The Customs Service is required to collect revenues on imported goods.<sup>3</sup> The data coming from PSI is meant to reduce the costs of deterrence of corruption and evasion

> 1 Burgess and Stern estimate that customs revenues compose approximately 2.74% of tax revenues in industrial countries, but, 28.39% in Africa and 30.9% in Asia.  They also note that these numbers may underestimate the amount of revenues collected by customs officials since oftentimes excise taxes are also collected on the border.  See Robin Burgess and Nicholas Stern, “Taxation and Development,” Journal of <u>Economic Literature, Vol. XXXI, (June, 1993).</u>

2 The largest PSI company in operation today is the Swiss Société Générale de Surveillance, however, there are several other competitive PSI companies in operation around the world (see Table 1 below).

3 However, there is one example of the actual collection duties of customs being taken over for a time by a PSI company in the Philippines (See Section 3).

2