Weekly Hurriyet Column: The Dukes of Moral Hazard

Below is the unedited version of my column for this week. You can read the final version at the Daily News website, but since I have been editing my columns myself on the Daily News media webeditor since March, you won't see much of a difference between the two. As for the title, I have returned to cheesy homages to movies in my titles, and this one is one of the classic American shows of the early 80s. There was a remake in 2005, which turned out to be a complete flop.

Jumping right into more serious matters, as is the norm, I do have an addendum: First of all, I was kind of unfair to the SMEs that I accuse of evading taxes. Part of the problem, which I could not mention in my column due to space constraints, is that if you totally go by the book, taxes are quite high in Turkey for an SME: While the corporate and income taxes do not seem that high by themselves, put in all the indirect taxes and labor taxes, things get piled up quite quickly. Interestingly enough, total taxes appear as only 44.5% of profits in the latest World Bank Doing Business survey, on par with many developed countries, but that seemed a bit optimistic to me. Maybe, they are assuming you can deduct all the indirect taxes? Definitely not in the tourism sector, where I moonlight!...

By the way, I got quite  interesting comments at the Hurriyet page. It seems that the opinion is divided on the use of incentives to nudge people to pay taxes. One reader is suggesting holding a lottery among taxpayers and forgiving the winners' taxes. But another thinks that severe punishment, not incentives, is the key: I do agree that incentives do not do the trick by themselves; as another reader was commenting, no one wants to pay taxes. I would argue that at the extreme, if you beheaded tax evaders and their families and burned their houses down, you would not have many evaders. But not many democratic & civilized governments would want to take that route, so you would need some incentives as well. Yet another reader pointed out to the relation between taxes and democracy: When you pay taxes, you are more likely to be involved and informed in decision-making, according to her. I remember reading papers on this topic both at the inter and intra-country level, but although I promised the reader I would post the links to my blog, I have not been able to find them. So a public apology is in order, but I will keep looking.

But instead let me point at other interesting sources: For example, UK's Institute for Fiscal Studies just published a complete review of the British tax system, led by Nobel laureate Sir James Mirlees. If you don't want to go through the whole thing, Financial Times reports on it (so does the Economist, though I don't have the link for that), and FT's Undercover Economist Tim Harford comments on it. Another interesting read is the recent WB PWC publication on tax effectiveness, also reported by the FT, albeit with an emphasis on the U.K. And this is the same data used in the tax category of the WB Doing Business Survey. Finally, one of the case studies in that section is Turkey's 2007 tax reform.

I am done with the addendum, so on to the column:

The government offered the perfect “bayram present” to the masses last Monday by introducing a complete debt amnesty.

The package includes the restructuring of nearly 300 specific items – not only tax, but also social security, water and electricity debt as well as items that took the media’s attention such as traffic and smoking fines.

While the draft law was introduced as an amnesty, the full amount of the debt is not actually forgiven. Only the late payment fines and interest are to be erased. The principal, on the other hand, is adjusted with inflation and can be paid in installments, with more or less a zero real interest rate. The debt can also be paid with a credit card, a first for Turkey, which would in effect transfer some debt from the government’s receivables account to the banking sector’s.

When you think about it, the move makes perfect sense for the government. Not only is it playing to the public a few months before the general elections, it will also be getting much-needed revenues, creating more room for pork-barreling before the elections. According to this paper, over 1 million individuals and institutions owe the state 6.5 billion Turkish Liras in tax debt in Ankara alone, so the amnesty could indeed create a windfall gain.

But leaving this myopic view aside, the amnesty is not helping with tax collection at all. As Economy Czar Ali Babacan noted during the press conference for the amnesty as well, Turks are not paying their taxes.

Actually, that’s only partly true. People on payroll pay their taxes as long as they are registered. So do large companies, although they make sure they deduct as much as they can – despite the government’s claim that it was merely upholding the law when it went after the Doğan Group. It is the self-employed and the small & medium enterprises who are making up the most of tax evasion in Turkey.

But the government has to make ends meet somehow, and as a result indirect taxes get boosted up. That’s why, in sharp contrast to any developed economy, indirect taxes make up the bulk of tax revenues in Turkey. And that’s also why a Bimmer costs more than twice as much here as in Germany. Economists do not like indirect taxes much because among other things, they distort people’s consumption choices. They are also regressive in the sense that they impose a greater burden relative to income on the poor than the rich.

Part of the solution should be better enforcement. Therefore, Babacan’s announcement that tax inspections would be increased considerably and 1,500 new inspectors would be hired is only commendable. It is said that Americans are afraid of only God and the Internal Revenue Service, or IRS; tax collection would certainly improve by installing some fear in the average Turk’s heart. Speaking of the IRS, a similar independent collection agency would go a long way in convincing people that the government is not using tax collection as a political weapon.

But that is hardly enough. The government needs to create incentives for people to pay taxes as well. Inter-country research on the ethics of tax evasion has revealed that many Turks believe their tax liras are wasted. In this sense, Republican People’s Party, or CHP, leader Kemal Kılıçdaroğlu’s suggestion of printing, on the back of tax returns, where taxes were spent last year is not as silly as it sounds. An independent budget evaluation agency, also a necessity for the now-shelved fiscal rule, would be helpful as well.

But most of all, it is worth noting that tax amnesties create disincentives to pay taxes by making those who are able, and sometimes even willing, to pay wait until the next amnesty. Producing such a moral hazard is exactly what the government needs to be avoiding.

*Emre Deliveli is a freelance consultant and columnist for Hurriyet Daily News & Economic Review and Forbes as well as a contributor to Roubini Global Economics. Read his economics blog at http://emredeliveli.blogspot.com.