ARMENIA FINALLY TAXING THE RICH?

UNCLAS SECTION 01 OF 02 YEREVAN 000626

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TAGS: EAID ECON EFIN AM
SUBJECT: ARMENIA FINALLY TAXING THE RICH?

REFS: A) YEREVAN 52 B) 04 YEREVAN 1899

SENSITIVE BUT UNCLASSIFIED. PLEASE PROTECT ACCORDINGLY.

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SUMMARY
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1. (SBU) Four months after President Kocharian called for
reform of the state tax and customs services, the
International Monetary Fund (IMF) and the World Bank have
applauded improvements in Armenia's tax collection. The
government has increased overall tax collections by 19.3
percent over last year and, most importantly, there has been
a 35 percent increase in social payments that has been
matched by an increase in pension transfers. IMF Resident
Representative Jimmy McHugh told us that his data indicate
that much of the rise in VAT and profit tax collections is
from large taxpayers, although the burden has increased on
small businesses, too. McHugh said that progress on tax and
social payment collections makes the lack of progress in
Customs reform stand out even more. He said that the
Customs Service is trying to squeeze increased revenue from
small importers and still favoring large oligarch
businesses, a view corroborated by one such large importer.
The IMF reports that it is ready to enter into a new three-
year arrangement with the GOAM that will concentrate on
reforms in the tax and customs services. End Summary.

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PRESIDENT: "HIGHER REVENUES, FAIRER COLLECTION"
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2. (SBU) In January, the President called for a reform
agenda to increase tax revenues in a way that did not chill
new investment and growth (ref A). He stressed the need to
scotch nepotism and corruption in the system that led to
illicit tax privileges for Armenia's oligopolies and
harassment and overtaxation of smaller businesses to
compensate. In his addresses to the State Tax Service and
State Customs Committee, President Kocharian spoke candidly
about reforming the revenue services to meet the
government's twin goals in the fiscal sphere: raising tax
revenues in order to support social spending while making
the business environment more fair and inviting. He
specifically noted that the tax service investigates small
and medium sized firms far more often than large firms,
despite the fact that large firms pay an incommensurately
small share of the tax burden. At the time, business
associations and the press welcomed the President's
initiative to crackdown on Armenia's oligopolistic economy.

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TAX REVENUES AND SOCIAL PAYMENTS ARE UP
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3. (SBU) The IMF Resident Representative and the head of the
World Bank office in Armenia told us on April 5 that the
government's renewed efforts to improve tax audit functions
and the transfer of social security payments to the tax
service (which can then crosscheck labor and tax data) has
raised tax collection by 19 percent over last year. Social
contributions have risen significantly as the tax
authorities now are charged to collect social payments from
employers at the same time they collect other taxes. Also,
a drop in simplified tax collection, which was created for
small businesses but exploited by large ones to evade
taxation, suggests that the tax service is collecting more
revenues from larger firms as they are move under the
appropriate tax regime. Domestic collection of VAT grew by
37 percent, which the IMF representative attributed to large
companies coming off the simplified tax regime into the
regime of VAT and profit taxes.



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BUSINESS ASSOCIATIONS CITE TAX REFORM'S MIXED RECORD
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4. (SBU) Members of the American Chamber of Commerce (who
are largely representatives of American-owned small and
medium sized firms) told us that they have seen no
difference in the tax collections, inspections or in their
liabilities, adding that they have consistently been the
favorite subjects of tax audits anyway. For its part, the
Armenian Merchants Union and Union of Manufacturers and
Entrepreneurs (which consists of Armenian-owned firms, some
of which are large) told us that since the President ordered
reform of the tax administration in early January, their
members have complained that the tax service has more
frequently inspected, refused to accept valid tax reports,
and pressured companies to inflate their tax liabilities in
order to deter future inspections.
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CUSTOMS LESS KEEN ON REFORM
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5. (SBU) The IMF Resident Representative said that he "felt"
that the increase in Customs Revenues was less due to reform
and largely due to squeezing small importers. A large
importer of foodstuffs (not American) who admits to
regularly bribing customs in exchange for preferential
treatment confirmed this, saying he is receiving the same
deal as always. (Note: The deal--Customs will value his
import at USD 500 rather than the USD 900 that they have set
for a ton of his product (regardless of the invoice price),
and then he and the customs officials split the 32 percent
VAT and tariff that he would have paid on the remaining USD

400. That is, he pays Customs USD 64 under the table for
each ton of imports of this product. He added that for tax
purposes his firm then under-invoices the onward sale of the
product to account for the undocumented expense of the bribe
to customs. End Note.)


6. (SBU) Besides creating personal revenue for customs
officials, the way that imports are priced and taxed allows
Armenia's well-connected oligarchs to maintain monopolies on
trade in basic food and consumption items (ref B). Reform
of the Customs Service would have a strong impact on the
Armenian economy far beyond raising government revenues, but
the opposition of well-placed oligarchs who benefit from
preferential import arrangements will make reform of the
Customs Service difficult to realize.

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IMF PROPOSES NEW ARRANGEMENT
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7. (SBU) The IMF plans to agree on a new three-year
arrangement with the GOAM that will focus on reforms of the
tax and customs services and the financial sector. The new
IMF program will require the GOAM to strengthen the audit
function in the tax service and improve the large taxpayers
unit. The IMF Resident Representative James McHugh told us
that a precondition for the first payment from the IMF is
that the GOAM publish the top 300 corporate taxpayers, so
that everyone can see who is paying and who is not. When
the State Tax Service publishes its list of large taxpayers
in April 2005, it is important that it include the
oligarchs, lest the tax crackdown reinforce public distrust
of the tax administration and the cat-and-mouse culture of
tax collection and evasion. McHugh pointed to the success
of publishing the top 100 corporate lossmakers, which he
said cut the claimed losses by two thirds. The IMF will
also require that the GOAM demonstrate that the Customs
Service is using invoices to determine import tariff and VAT
liabilities at the border, removing the Customs Service's
primary tool of corruption.

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COMMENT: EQUAL TREATMENT MATTERS
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8. (SBU) We were skeptical of President Kocharian's
commitment to improving tax collection, despite his strong
rhetoric. We concur with the IFI's that results are
impressive, at least for now. There is enough slack in
enforcement of Armenia's tax law that the government can
significantly increase revenues just by bringing more of the
untaxed economy into the tax system without raising the tax
liabilities of those who actually pay taxes now. The World
Bank estimates Armenia's shadow economy as 43-53 percent of
Armenia's GDP in 2004. Capturing this shadow economy in the
tax system is sure to draw complaints from large and small
businesses alike; not only oligarchs evade taxation.
Nevertheless, it is good news that the State Tax Service
appears willing to take on large taxpayers who have long
evaded taxation, rather than selectively enforcing a tax
crackdown against small businesses only. Reform of the
Customs Service will be harder, because the oligarchs depend
on special treatment to keep would-be competitors' products
uncompetitive. Besides discouraging new investment, the
failure to maintain an equal tax environment creates an anti-
competitive economy that perpetuates Armenia's oligopolies,
which in turn put off potential market entrants and would-be
taxpayers.
EVANS