USE OF THE RESULTS OF TAX GAP MEASUREMENT FOR THE ROLE OF THE TAX ADMINISTRATIONS IN THE GLOBAL CRISIS USE OF THE RESULTS OF TAX GAP MEASUREMENT FOR STRUCTURING THE RISK MAP AND DESIGNING CONTROL PLANS by Stefano Pisani Montevideo, Uruguay April 12 –15, 2010 Italian Revenue Agency

Italian Revenue Agency Background Agreement between Italian Revenue Agency (IRA) and the Ministry of Economy to establish the goals and the results. To plan activities, to face the potential risks and to foresee criticalities it is necessary to develop a methodology to estimate potential collection. “… potential collection is that which could be collected if no taxpayers would voluntary breach the law and involuntary errors would amount to zero” (Das-Gupta, Mookherieee, 2000). The objective of the paper is to present the sources and methods adopted by IRA to estimate tax gap as the missing portion of tax potential. Italian Revenue Agency

The comparison is based on the taxable amount (tax base): General framework Top-down approach based on comparing tax data to National Accounts (NA) aggregates (estimated by Italian National Statistical Institute – ISTAT). Three main indicators: GDP (and its components), VAT and Regional Tax on Productive Activities (IRAP). The comparison is based on the taxable amount (tax base): It comprises the transactions recorded on the business profit and loss account and exclude the figures from the capital account; NA provide exhaustive figures of the potential revenue and not the subsequent tax; It excludes the gap deriving from an incorrect tax statement with a tax base that is filed correctly (e.g. application of an incorrect VAT rate). Italian Revenue Agency

Statistical framework SNA 1993: The national account shall also include the underground economy (legal productive activities that are not registered mainly due to statistical deficiency and to economic reasons). ISTAT isolated the economic underground that escapes direct observation because of its connection to tax evasion. Estimation procedure based on the labor input method: Calculation of the total labor input considering the regular and the irregular workers (benchmark universe); Adjustment of the per-capita value declared by enterprise to correct the underreporting of the revenue; Comparison between the supply side and the demand side estimates in an Input-Output model. Italian Revenue Agency

Italian Revenue Agency Breakdown of the GDP based on the economic underground and its components (2006) Gross domestic product (100%) Economic Underground (16,9%) Other component (83,1%) Irregular labor (38,0%) Other (62,0%) Italian Revenue Agency

Italian Revenue Agency Breakdown of the economic underground by sector of economic activity (2006) Agriculture; 3,42% Industry; 16,81% Services; 79,77% Italian Revenue Agency

Evasion of taxable amount ISTAT estimations provide the general benchmark framework of the potential taxable amount. IRA uses the regional GDP as an indicator to assign the monetary recovery objectives to each regional office. IRA conducts its own tax evasion estimations based on VAT using a method that is widely spread internationally (Reckon 2008). Two definitions of evasion: Not remitted – without complicity (lower bound) Not collected – with complicity (upper bound) Italian Revenue Agency

Italian Revenue Agency Flow chart of the methodology used to estimate the potential VAT base and the Tax Italian Revenue Agency

The features of this tax are: Italian Revenue Agency Territorial analysis IRAP is used to perform analysis on a territorial base and to provide a breakdown by economic activity. The features of this tax are: A large taxpayer universe including the operators comprised in the assessment of the GDP almost in full; A tax base that is very similar to the value added at factor cost estimated in the national accounts; Regional articulation performed on the basis of the production carried out in the location. On the basis of IRAP, we may distinguish between the evasion component generated by informal labor and the one stemming from other types of fraud. We perform estimates for 102 provinces and six economic activity sectors. Italian Revenue Agency

Conclusions VAT estimates are mainly used for time series analyses (1980-) at national level to investigate the determinants of tax evasion. IRAP estimates allows IRA to identify the areas with highest criticalities as well as the sectors with highest exposure to tax evasion risk. This is not the end but rather a starting point for future actions: integrate the top-down approach with bottom-up techniques based on the results of tax audit; analyse the determinants of evasion and isolate the role of the Tax Administration in reducing the tax gap, and therefore, increasing voluntary compliance. The latter variable is the most important objective in fulfilling the Administration's mission. Italian Revenue Agency