Tax analysis and forecasting of revenues are of critical importance to governments in ensuring stability in tax and expenditure policies. To augment timely and effective analysis of the revenue aspects of the fiscal policy, government has increasingly turned the attention toward in-house tax policy unit rather than relying on tax experts from outside.
To ensure a balanced budget and/or to curtail deficit financing, it is of the utmost importance for the Ministry of Finance to be able to effectively monitor not only the expenditure side but also the collections of tax revenues on a regular basis. Depending upon the level of sophistication of the monitoring system, it is possible to track major sources of revenue collection on a weekly or daily basis.
In order to perform this task, it is necessary to establish an effective information system within the government. A proper measurement of actual revenue collection vis a vis expected revenues is possible only if there is a well-developed database. This database should provide the main input for analysis of tax functions, including behavioral responses to new tax measures, revenue forecasting and tax expenditure analysis.
In the process of policy formulation, tax policy forecast and has to weigh tax policies in terms of the following basic criteria, such as: (a) economic efficiency, (b) economic growth, (c) revenue adequacy and stability, (d) tax simplicity, and (e) low administration and compliance cost.
(a) First of all, any tax on goods and services increases the price of a good by adding a percentage of the price (ad valorem tax) or a fixed amount of money (specific or unit tax) to the original price. This creates a gap between the value that the consumer pays for the good (demand price) and the economic resource cost of production (supply price). If the tax is not designed to offset another market externality, it will create a distortion in the market that will affect the behavior of consumers and/or producers. Such a distortion will have a cost attached to it that the economy has to bear, known as the deadweight loss. If, however, we start with a tax distortion in one market, then adding yet another distortionary tax can be beneficial.
Market distortions of any kind, as a result of a tax, create a loss of economic efficiency (e.g., a loss of consumer and producer surpluses). The size of this loss depends primarily on the price elasticities of demand and supply of the items whose markets are distorted, as well as on the rate of the tax imposed. The higher the price elasticity of demand/supply, the higher the inefficiency introduced into the market by the tax. Also, high tax rates lead to larger economic efficiency costs. A tax is said to be efficient if the deadweight, or efficiency loss, is small. These efficiency losses can be substantial. Some of studies of efficiency loss for the Albania have found it to be in the range of 15 to 50 % of 1 Lek of tax revenue.
Taxes, such as an income tax or a tax on goods and services with an inelastic demand/supply, tend to have a smaller impact on producer or consumer behavior and, therefore, cause less of a distortion in the economy. At present, the economic efficiency of a tax is an important issue, although not the sole consideration, when designing an efficient tax system. Efficiency criteria for any tax system require that the tax be neutral. That is, the tax should create neither major distortions in consumption and production behavior nor change private investment decisions by favoring one set of investments over the others.
(b) Every good tax system should foster economic growth in its country. This can be achieved primarily through the expansion of savings and the direction of investment into high return activities. An efficient tax system should also be a deterrent to the disincentive to work, which occurs in countries where there is a very high payroll tax.
In order to stimulate higher economic growth, well-designed tax systems should encourage competitive growth across various sectors of the economy. Even more importantly, the distortion and/or opportunities created by a tax system should not be the cause for tax planning, but provide direction towards more productive endeavors through lowering the tax rates, eliminating tax on tax and widening the base.
(c) Budget expenditures and revenue estimates are usually done within a specified framework of economic assumptions reflecting the level of the expected GNP growth rate, the rate of inflation, and other macroeconomic variables. Revenue estimates are undertaken with respect to these underlying macro variables. Besides the influence of macro variables, the challenge in making any revenue estimate lies in the ability to anticipate and incorporate the behavioral responses to changes in the tax laws.
Generally, the total tax revenue of the government will invariably depend upon the size of the tax base, the levels of tax rates adopted within the tax system, administrative efficiency, and the compliance rate. The taxes introduced should be appropriate and sufficient to finance the expenditure needs of the government over time. In other words, revenues should rise with national income, and the entire tax system should evolve to enhance the revenue yield over time.
If the tax revenues are insufficient to meet expenditure needs, the government must resort to borrowing, printing money, selling assets or slowing down the implementation of development programs. All these actions generally hurt the economy, especially the poorer segment of society. For example, borrowing from the Central Bank or printing money could be inflationary, effectively devaluing the cash holdings of the poor at a disproportionately higher level than those of the rich. Therefore, the tax system should be buoyant; that is, tax revenues should increase at a rate equal to or greater than the growth of the GDP. To ensure this, the government should adopt tax policies that include growing sectors of the economy in the tax base.
Just as revenue adequacy is important to finance government needs, the stability of tax revenues over time is equally important in order to maintain the continuity of the fiscal policies of the government. If the tax revenue tends to fluctuate over time, it creates an air of uncertainty that adversely affects government programs. When revenues fall, expenditures must be curtailed. In the process of streamlining expenditures the first which go tend to be the development expenditures, as claims of recurrent expenditures precede development expenditures. The slowdown of development expenditures leads not only to lower economic growth rate over the medium and long term, but, over the short run, new development programs are poorly implemented, resulting in delays, escalation of costs, and, ultimately, in total abandonment of projects.
When the tax system is structurally unstable, it becomes a source of risk and imposes another element of economic inefficiency on the country.
(d) Simplicity must apply to the administration of the law as well as its legal structure. Complexity in tax administration and opaqueness in tax laws helps to induce corrupt behavior on the part of both taxpayers and tax officials. In such an environment, much of the efforts of the taxpayers and tax officials, which otherwise could have been used constructively for economic development, is channeled into circumventing the system.
(e) The simpler and the more transparent a tax system, the lower its administration and compliance costs. As tax revenue is collected mainly to finance government needs, a high cost of tax collection reduces the net tax revenue available to the government. By the same token, a high compliance cost by taxpayers should reduce the resources available to the private sector for productive activities. Therefore, one of the criteria of a good tax system is low administration and compliance costs. If these costs constitute a major portion of the tax revenue, the tax system needs to be restructured.
While undertaking a tax proposal, tax policy unit which make the forecasting of revenues employ various analytical tools to evaluate the system in terms of efficiency and distributional impacts, as well as potential revenue generation.
There are several factors involved in the preparation of revenue forecasts of a tax system.
First, it is the evaluation of Tax Elasticity. Evaluation of the correlation between revenue and national income reaction gives the tax forecasting a valuable insight into the overall tax system. This understanding assists the tax policy in planning for necessary tax changes confidently and in seeking the inclusion of the more buoyant sectors of the economy into the tax base.
Second, it is evaluation of Changes in Economic Conditions. Changes in economic conditions are expected to modify forecasting assumptions in various ways. For instance, changes in the foreign trade sector as a share of the total production in the economy affect the taxable capacity of a country. This is especially true in the case of a developing country, in which trade taxes constitute a significant proportion of tax revenues. Similarly, the deregulation of certain sectors of the economy should automatically change the structure of the relevant markets for goods and services, and such changes will consequently affect the size of the tax bases. Devaluation of the domestic currency will also affect the quantities of imports and exports, which in turn will affect the trade tax revenues from import duties. Changes in the economic conditions of major trading partners will also have a significant impact on the domestic economy and on tax revenues.
Third, it is the evaluation of the Effect of Inflation and Price Changes. Movements in price levels have different effects on the tax structure and real revenue collection by the government. For instance, inflation has an ambiguous effect on business income tax revenues, by affecting differently the components of taxable income, such as depreciation allowances, accounts receivable and payable, and costs of goods sold. Furthermore, the impact of inflation on indirect tax revenues will ultimately depend on whether the tax is imposed on a unit tax or ad valorem tax.
Forth, are several macro and micro conditions that influence the economy and market of the Albania, such as: macroeconomic environment, changes in different tax bases, trade flows, business income, domestic transactions of goods and services and change of demand for excisable goods
Financial forecasting is not easy, but a structured approach can help forecasters ask the right questions, given the environment and audience; use the most appropriate techniques; and apply the lessons from one round of forecasting to future rounds.