Argentina - Tax Administration Technical Assistance Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-4959-AR MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$6.5 MILLION TO THE REPUBLIC OF ARGENTINA FOR A TAX ADMINISTRATION TECHNICAL ASSISTANCE PROJECT DECEMBER 21, 1988 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY AND EQUIVALENT UNITS Argentine Austral (A) = 100 Centavos As of December 1, 1988: US$ 1.00 12.8 Austral (commercial official rate) US$ 1.00 = 15.6 Austral (free market rate) Austral 1.00 = 7.8 US cents (commercial official rate) Austral 1.00 = 6.4 US cents (free market rate) ARGENTINE FISCAL YEAR January 1 - December 31 ABBREVIATIONS DGI Directorate of Tax Administration (Direcci6n General Impositiva) PPF Project Preparation Facility TAPSM Technical Assistance for Public Sector Management  FOR OFFIMCLL USE ONLY ARGENTINA TAX ADMINISTRATION TECHNICAL ASSISTANCE PROJECT LOAN AND PROJECT SUMMARY Borrower: Republic of Argentina Beneficiary: Directorate of Tax Administration, Treasury Secretariat, Ministry of Economy Amount: US$6.5 million equivalent Termzu Fifteen years, including a five-year grace period, at the Bank's standard variable interest rate. Financing Plan: Government US$ 4.2 million IBRD US$ 6.5 million _______________ Total US$10.7 million Economic Rate of Return: Not applicable Staff Appraisal Report: Not Applicable map: IBRD 20450 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without Wotird Bonk authorizatson.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF ARGENTINA FOR A TAX ADMINISTRATION TECHNICAL ASSISTANCE PROJECT IN AN AMOUNT EQUIVALENT TO US$6.5 MILLION 1. The following memorandum and recommendation on a proposed loan to the Republic of Argentina fo, the equivalent of US$6.5 million to strength- en the collection activities of the Directorate of Tax Administration (DGI), Treasury Secretariat, Ministry of Economy, is submitted for approval. The loan would have a term of 15 years, including 5 years of grace, at the Bank's standard variable interest rate. 2. Background. The significant deterioration of Argentina's public sector revenues is at the root of much of the recent instability in the fiscal accounts which, in turn, has contributed to the worsening of macro- economic performance. Current tax revenues fell from a peak of more than 23 percent of GDP in 1980 to a projected 21 percent in 1988. This disap- pointing trend is the result of several factors, ranging from the effects of the combination of high rates of inflation and the lags in tax collec- tions (the so-called Tanzi-Olivera effect), to industrial promotion incen- tives that undermine the tax base and noncompliance with tax laws. 3. An important factor contributing to noncompliance--a traditional problem in Argentina--has been the inability of the DGI to develop into a modern tax agency. Its task has been made more difficult by changes in tax legislation that increased substantially the number of taxpayers; and the inflationary environment, which has hindered effective tax assessments. Simultaneously, the development of computerized techniques of accounting by large corporate taxpayers has vastly outstripped the DGI's auditing abili- ties. Failure to introduce modern methods of computing and information control has led to progressively more inefficient operation of the tax agency; and its inability to enforce tax legislation, in turn, has fueled increased noncompliance. 4. The macroeconomic program underlying the Letter of Development Policy addressed by the Argentine authorities to the Bank on September 22, 1988, envisages a substantial reduction in the deficit of the nonfinancial public sector in 1989. Accomplishment of this goal is a necessary precon- dition for a restoration of more orerly macroeconomic conditions and for an eventual resumption of adequate ustained growth. The deficit target for the nonfinancial public sector of 1 percent of GDP not only anticipates considerable improvements on the expenditure side, but is also predicated on a substantial reversal of past revenue performance. The Government has presented to Congress a program of tax reform that is expected to increase revenues and limit tax elusion through the improper use of industrial promotion benefits. In addition, it has recognized the need to accelerate DGI reforms to increase tax collection efficiency, encourage voluntary compliance with legislation, and repress fraud and evasion. To this end, the Government has produced a plan of short-term measures that will serve as a bridge to the longer-term DGI restructuring program.  5. Rationale for Bank Involvement. Under the Public Sector Manage- ment Technical Assistance Loan, 2712-AR (TAPSM), approved in September 1986, the Bank providing initial support for restructuring DGI, with a small program of US$2.2 million encompassing change in the organizational structure, modernization of operations, and the development of advanced techniques of tax control and auditing. The medium-term restructuring program has also benefitted on several occasions from technical assistance provided by the IMF. The implementation of the program has produced some important advances, including: a review and rationalization of the list of registered taxpayers; the development and implementation of a uniform taxpayer identification code--a measure that has the potential of substantially reducing administrative complexities; a revision of tax forms for the main taxes, which has reduced paperwork and promoted a more efficient information gathering; the completion of two of the large systems of information processing and cross-check, which are now providing support to direct tax auditing; and upgrading the computer mainframe. But more difficulties than expected were encountered in some critical areas, particularly in the development of the taxpayers' current account system. Furthermore, some important organizational ana systemic issues--such as the amount and effective use of DGI's resources, internal control procedures, adequacy of tax auditing techniques--had not been adequately addressed until recently. The proposed loan would thus provide the necessary financing for the execution of a program intended to bridge the gap between full realization of the benefits of basic DGI structural reform and the need to counter the recent fall in tax revenues. Given the tight budgetary constraints faced by the Argentine Government, it would be virtually impossible for DGI to carry out the restructuring program on its own within the necessary timeframe. At the same time, while the program aims at a substantial increase of efficiency in the short term, its implementation would contribute to lasting improvements. The Bank would finance approximately 60 percent of the project costs, a higher proportion than similar technical assistance loans. Its justification rests in the importance of the project to Argentina's overall macroeconomic program; moreover, it is similar to the type of assistance given in the recently- approved Social Sector Technical Assistance Loan (2984-AR). 6. ProJect ObJectives. The main objective of the program, apart from the envisaged contribution to improved Government finances, is the increased efficiency of DGI. The present program also would address some problems not envisaged in the longer-term program (e.g., the re-evaluation and development of internal and external auditing techniques, and restructuring of DGI's training unit) but whose solution is vital to address the future needs of the DGI. As a byproduct, the proposed project would generate valuable data critical to budgetary and economic management. 7. Project Description. The project is composed of six components. The first consists of the development of a computerized system of "surveil- lance" of the 2,000 largest taxpayers (US$85,000 of project cost). This will permit a closer follow-up of this significant group's compliance with VAT, income, and property taxes. The second component aims at a substan- tial improvement in the tax inspection ability of DGI, to be achieved through an increase in the number of tax inspectors of DGI (up to 50 percent, or 600 inspectors), as well as the recruitment of a number of computer analysts and programmers (US$365,000). A third component will provide the necessary training for the newly hired inspectors and computer  - 3 - specialists, and will review the structure of the training unit within DGI (US$2 million). Under the fourth component, the procedures and systems for internal auditing and control will be reviewed and, on the basis of a preliminary evaluation, an in-depth auditing of DGI operations will be conducted (US$1.2 million). The fifth component will, in turn, involve a revision of current techniques for the inspection of taxp-yers, with parti- cular attention devoted to the analysis of accounting systems supported by mainframe computers (US$2.3 million). Finally, personal and multiuser computer equipment will be provided, with particular emphasis on the needs of a more decentralized operation of the DGI, and of the system of monitor- ing the 2.000 largest taxpayers (US$3.2 million). In addition, the project preparation facility advance of US$732,000 will be repaid out of the Loan. Up to US$300,000 of retroactive financing for expenditures after November 1, 1988, would help avoid interruption of start-up activities if unforeseen delays prevented a timely signing of the Loan. This is consi- dered essential since most components of the project are to be completed before the end of the third quarter of 1989. A breakdown of costs and the financing plan are shown in Schedule A. Amounts and methods of procurement and disbursement, as well as the disbursement schedule are shown in Schedule B. A detailed description of these components is provided in Annex I. Annex 2 presents a matrix detailing objectives, components, expected outputs and impacts, and timing of the project. 8. To enhance the project's institution-building effects, DGI's organization structure for carrying out these activities will emphasize the Darticipation of the Bureau's career staff, to the extent possible, in contrast with the Tax Bureau's normally heavy reliance on outside consult- ants. The latter will only be utilized to provide specialized expertise not available within the DGI, or for directing those components whose objective is a "once-and-for-all' action (such as the database for the 2,000 largest taxpayers and the computing equipment). 9. Agreed Actions. The Government has completed a number of prepara- tory actions, supported by a project preparation facility (PPF) advance, and has taken a number of other steps. The actions already taken include (i) the appointment of a commission within DGI responsible for carrying out the project; (ii) the issuance of a decree authorizing an exception to the general public sector hiring freeze and for the recruitment of the new inspectors and analysts; (iii) the identification of the 2,000 largest taxpayers to be monitored through the database of large contributors; (iv) the appointment of an executive director in the project, as well as the directors of the components; and (v) the contracting with the firm charged with hiring the new inspectors and the analysts/programmers. The Govern- ment has also agreed to proceed to contract with consultants and the consulting firms necessary for the implementation of the preliminary diagnostic for internal aditing, as well as to signing the Management Service Contract for equipment purchase before loan effectiveness; to agree with the Bank on a satisfactory list of indicators of DGI efficiency that will be used to monitor the targetted improvements in its future perform- ance, and on the course of action to be taken following the completion of the preliminary studies in the third and fourth components.  10. Benefits. The project is expected to bring about major improve- ments in the efficiency of tax collection, to reduce tax evasion, and discourage fraudulent practices. While, by its own nature, the extent of the tax revenue enhancement that might result from these actions is difficult to estimate precisely, the authorities expect that the efficiency gains might lead to an improvement in collection of VAT, income and capital taxes perhaps as high as a half of one percent of GDP in the course of 1989. Only slightly over one third of this amount would contribute to a reduction in the budget deficit, as the remainder is distributed to the Provirces under the provisions of the revenue-sharing law. However, a program that contributes to the perception of a stronger enforcement if tax laws would also be helpful to counter the traditional increase in tax evasion during an election year, when expectations of a tax amnestrf become stronger. Besides the direct revenue effects, other benefits are expected to accrue from the increased capacity to handle the reform envisaged for the VAT, as well as from the reduction of fraudulent tax expenditures by obtaining a better control of firms benefitting from fiscal incentives granted under the industrial promotion law. 11. Risks. The program is designed for maximum short-term impact and, as such, it poses a strong challenge to DGI's management. Furthermore, the presidential elections scheduled for May 1989 might weaken the resolve to carry out the proposed actions. More fundamentally, the possibility of change in the top management of the DGI at the end of the present Adminis- tration's term in November 1989 might disrupt the implementation of the proposed measures. To minimize these risks, great care has been exercised to design project components that would enjoy bipart.san support. Ultima- tely, however, the overriding importance of the project objectives is considered great enough to justify these and other implicit risks. 12. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank, and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments Washington, D.C. December 21, 1988  SchedUle A Paeg 1 of 2 ARGEKIRNA TAX ADMINISTRATION TECHNICAL ASSISTANCE LOAN Summary of Project Costs a/ (US$ mllions) Project Component Local Foreign Total A. Database for 2,000 Largest Taxpayers 0.09 0 0.09 B. Recruitment of New Personnel 0.37 0 0.37 C. Training of New Personnel 1.98 0.02 2.00 D. Improvement of Internal Auditing 1.19 0 1.19 E. Tax Inspection Techniques 2.27 0 2.27 F. Provision of Computer Equipment 1.07 2.16 3.24 Repayment of PPF 0 0.73 0.73 Total 3&*. Costs 6.99 2.91 9.89 Price Contingencies 0.38 0.40 0.78 TOTAL PROJECT COSTS 7.37 3.31 10.67 a/ Cost estimates do not include duties and local taxes, which are negli- gible.  -6- Schedule A Page 2 of 2 ARGENINA TAX ADMINISTRATION TECHNICAL ASSISTANCE LOAN Financing Plan (US$ millions) Local Foreign Total Government 4.18 0 4.17 World Bank 3.18 3.32 6.50 TOTAL FINANCING PLAN 7.36 3.32 10.67 Percent of Total 77.60 22.40 100.00 Disbursements (US$ millions) Fiscal Years 1989 1990 1991 Annual 3.6 2.2 0.7 Cumulative 3.6 5.8 6.5 Percent of Total 55.4 89.2 100.0  -7- Schedule a Page 1 of 2 A2R lVTINA TAX ADMINISTRATION TECHNICAL ASSISTANCE LOAN Procurement Method (USS thoussands) Items ICB Other Total Cost Individual Consultants 45 45 (45) (45) Auditing and Recruiting 1,335 1,335 Services (1,335) (1,335) Training Services and 3,795 3,795 Materials (1,268) (1,268) Hardware (Purchase and 1,342 134 1,476 Leasing) (1,342) (20) (1.362) Purchase of Software 903 71 974 (903) (71) (974) Internal Costs 1,525 1,525 (0) (0) Repayment of PFF Advance 732 732 (732) (732) Price Contingencies 784 784 (784) (784) TOTA1 2,245 8,421 10,666 TOTAL LOAN (2,245) (4,255) (6,500) NOTES: (1) Figures in parentheses are the respective amounts to be financed by IBRD. Cost estimates do not include duties and local taxes, which are negligible. (2) 'Other" methods include local shopping and purchase of services from consulting firms consistent with Bank guidelines.  Schedule B Pop 2 of 2 ARGCNINA TAX ADMINISTRATION TECHNICAL ASSISTANCE LOAN Financing of Project Costs (US$ thousands) IBRD Govern.ment Total Component Amount t Amount t Amount t Tndividual Consultants 45 100.0 0 0 45 0.4 Auditing and Recruiting 1,335 100.0 0 0 1,335 12.5 Services Training 1,268 33.4 2,527 66.6 3,795 35.6 Hardware (Purchase and 1,362 92.3 114 7.7 1,476 13.8 Leasing) Software 974 100.0 0 0 974 9.1 Internal Costs 0 0 1,525 100.0 1,525 14.3 Repayment of PPF Advance 732 100.0 0 0 732 6.9 Price Contingencies 784 100.0 0 0 784 7.3 TOTAL PROJCCT COSTS 6,500 60.9 4,166 39.1 10,666 100.0  -9- Schedule C ARGENTINA TAX ADHINISTRATION TSECNICAL ASSISTANCE LOAN Timetable of Key Project Processing Events (a) Time taken to prepare: Four months (b) Prepared by: Government, with interna- tional agency assistance, including US$0.73 million PPF advance (c) First IBRD mission: July 19(8 (d) Appraisal mission departure: October 1988 (e) Negotiations: November 30 - December 2 1988 (f) Planned date of loan effectiveness: March 1989 (g) List of relevant PCCRs and PPARs: None Special Conditions A. Conditions of effectiveness of this loan would be the contracting of consultants to carry out the preliminary diagnostic of the internal auditing needs under terms of reference satisfactory to the Bank and the signing of the Management Service Contract for the acquisition of computer equipment. B. DGi will also contract consultants and consulting firms, by March 31, 1989, to carry out the training of the new inspectors and computer analysts/programers, and to review existing tax inspection techniques and develop new ones, under terms of reference satisfactory to the Bank. C. DGI will develop a list of indicators of internal performance in consultation with the Bank by April 30, 1989. These indicators will be used in semi-annual reports assessing DGI's efficiency. D. DGI will consult the Bank subsequent to the completion of tht. preliminary studies under components C (internal auditing) and D (develop- ment of tax inspection techniques) before proceeding further in the execu- tion of the programs.  . 10 - Pale 1 of I TAX ADINISIRTION TEOSICAL ASIShTANC LOAN TME STAiPAW OM SW WSRCATIONS STATIEfNT OP 8ANt LOAIS AND IDA OtED1T3 (As of S _pts.hew 80, 16) (U#S olnliems) Amount Lose Loan No. Year Borrower Pupose Cancll atIon* Undisburted Fully disbursed loans (20) 1,184.0J 2081 1961 Baneo Neeional Oil and 0. 67. 6 18.1 do Dooerrol lo Credit 2032 1981 Yaeimientoo Rf Itnory 200.0 2.9 Petroliforos Fiscaloo Conversion 2068 1981 Banco Nacionol Industrial 100.0 23.6 do Ooesrrollo Credit 1I 2298 1968 Argentina Highway 100.0 17.7 2592 196S Yoelmientoa as$ Utilization 180.0 1U6.2 Petrolitoros Fiscal.e and Tech. Assist. 2082-1 198$ Yoeimientoo Re inery 116.0 3.32 Petrol iforoo flscales Converslon 2641 1986 Argentina Water Supply 60.0 57.3 2675 196 Argentina Agricultural 850.0 172.9 Sector Loan 2712 1986 Argentina Public Sector Mgt. 16.5 9.68 2751 198 Argentina Power Engineering 14.0 10.89 2798 1967 Argentina Small and Medium 125.0 116.6 SCSal Ind. Credit 2805 1987 Argentina Port 50.0 60.0 2816 1987 Argenino Trade Polley 600.0 4.0 2864 1967 Serviclos Electricoo Power Distribution 276.0 276.0 ran B.A. 2920 */ 1986 Argentina Municipal 0ev. 120.0 120.0 2928 ! 1968 Argentina Banking Sector 400.0 400.0 2870 a/ 1988 Banco do Is Nacion Agrlc. Credit 106.5 106.6 2984 */ 1988 Argentina Social Sector 28.0 28.0 TOTAL 4,015.6 of which hno been repaid 750.8 8,235.8 Amount Sold 12.8 of which has been repaid 12.8 Total now hold by Bank 8,222.5 Total Undisburosd 1,401.6 */ Not yet signed.  - 11. -- PopeI le S p...1 f 2 TAX ASU1N1IS1RATNU TEOSGICAL ASSISTANCE LOAN THE STATUS OF AM CROtP OPERATIIOS STATlE?3 OF IFC INVESIRTS f (As of Spt. S0, 190) elS* millions) Yoer Obligor Type of Busineoss Total Equity Loans 1960 Acindcr Industria Arg. S.A.* Stool Products 3.7 - 3.7 1980 Papel-rc Rio Parrnc, S.A.* Pulp and Piper 3.0 3.0 1981 Fcdes* S.A. Automotive 1.5 - 1.5 1962 Page* 3.0 - 3.0 1965/72 Colulosc Argentina, S.A. Pulp and Paper 12.6 - 12.6 1969/? Dtatinu. Siderce, S.A.* Stool Products 17.0 - 17.0 1909 Editorial Codex, S.A.* Printing 7.0 2.0 6.0 1971/73 Colera Avellonedc, S.A.* Cement 56. - 5.5 1977/04 Alpargctas S.A.I.C. Textiles A Fibers 50.6 5.0 45.5 1977 Soyox S. A. Soybeen Processing 25.0 - 26.0 1978 Masouh, S.A. Pulp and Paper 29.9 2.4 27.5 19?8 Juan Minetti, S.A. Cement 103.0 - 103.0 1976/79 Ipako-Industriag Chemicals and 20.3 2.0 18.3 62/87 Petroquisicas Arg. Petrochemicalo 1979/83/34 Alpeeca S.A. Fisheries 6.8 1.6 8 .2 1984/86 Petroquimie Cuyo S.A.I.C. Petrochemicals 46.1 4.0 42.1 1936 Inversiones Industriale. Capitcl Market 1.3 1.3 - S.A. and Roberts S.A. 1986 Atanor S.A.M. Chemicals 6.0 1.0 7.0 1986 Banco Roberts S.A. Capital Market 20.0 - 20.0 Hidra Oil Chemicals and 60.0 - 80.0 198J Gcrovcgilo/Zorrequln Food A Food Proe. 13.0 - 13.0 1967 Terminal 0 Port, Storage 5.5 - 6.5 1988 Bunge y Born Food A Food Proe. 40.0 - 40.0 1936 Arcor Food A Food Proc. 12.0 - 12.0 1936 8R U Dev. Finance 30.0 - 30.0 1998 Astra Chemicels 37.4 - 37.4 1980 Chiret Chemicals 5.2 5.2 - 1938 Brida. Chemicals 20.8 - 20.6 1936 Baneo General do Negoclos Finance 10.0 - 10.0 Total Cross Comitm.nts 817.8 24.5 693.3 Less Cancellations, Terminations Repayments and Sales 241.1 3.0 238.1 Total Comitmnts Now Hold by IFC 376.7 21.S 355.2 Total Undisbured (IFC only) 1S2.2 8.7 143.5  - 12 - Annex I ARGENTINA TECHNICAL ANNEX TO THEl MD0RANDUK OF TEE PRESIDENT FOR A TAX ADHINISTRATION TECHNICAL ASSISTANCZ LOAN I. PROJECT BACKGROUND A. Deteriorating Fiscal Deficits and Inadequate Revenue Generation 1. After a sustained increase during the second half of the 1970s, Argentina's overall tax revenues, collected both by the national Government and by the provinces, have shown a disturbing downward trend during the 1980s, despite the adoption of several revenue-enhancing measures after 1985. In 1987, national tax revenues stood at slightly less than 18 percent of GDP, and provincial revenues yielded about 4 percent. Thus, total collections stood some two percentage points lower than the 1980 peak of 23.5 percent of GDP; moreover, they are expected to decline even further during 1988. Lack of revenue buoyancy has been a major reason for the consistently unsatisfactory fiscal performance, which has required repeated efforts to contain expenditures that have caused, among other things, historically low levels of public investment. The resulting fiscal and quasi-fiscal deficits have been major determinants of Argentina's unsatis- factory macroeconomic performance, since the financing requirements of the public sector have strained domestic-currency financial markets and led to very high real interest rates and high and variable inflation rates. Recent stabilization attempts have registered some success in slowing the rate of growth of expenditures, and even in reducing them in real terms; even so, the revenue performance has remained disappointing. Reversing the downward trend in revenues is one of the most important priorities for regaining effective control of the macroeconomic environment and promoting growth. 2. There are multiple explanations for this unsatisfactory revenue performance. When the rate of inflation increases, the real value of tax revenues tends to be reduced, as there is a lag between the formation of tax obligation and the actual collection by the tax agency. This is the so-called Tanzi-Olivera effect. This factor cannot be underestimated, given the high rates of inflation registered in Argentina. However, its importance has been somewhat reduced since the authorities have recently taken several measures to reduce collection lags. It is estimated that the average collection lag in 1974 was between three and four months, whereas in 1988 it is probably less than one month. 3. A second important explanation for insufficient growth of revenues is the industrial promotion law. By granting incentives in the form of exemption from the VAT, as well as from income and capital taxes to firms willing to locate in selected areas of the country or belonging to "priority* sectors, this law has caused a steady and difficult-to-reverse  - 13 - erosion of the main sources of national tax revenue. Furthermore, insuffi- cient control mechanisms have encouraged fraudulent practices, without setting clear limits on tax expenditures. Estimates of fiscal costs of the industrial promotion regime run as high as 3.5 percent of GDP. While the recently approved revision to the industrial promotion law represents an improvement--it limits the maximum amount of subsidies and, through the establishment of tax credit bonds, does not undermine the base of indivi- dual taxes--the impact on revenues of the previously granted subsidies will be felt for many years to come, as the Argentine law makes it difficult to r erse 'acquired rights.' Very recently, the Government submitted to Congress legislation that will limit the open-endedness of industrial promotion benefits; this is expected to contribute to increasing fiscal revenues. 4. Moreover, a high and increasintg rate of noncompliance with the existing tax legislation has gone hand-in-glove with what is widely perceived as loss of effectiveness of the National Tax Agency (DGI). While tax evasion is, by its nature, difficult to estimate, many observers of the Argentine system agree that for taxes that rely on a certain degree of voluntary compliance by the taxpayers, actual collections may be only a fraction of potential revenues. Furthermore, tax amnesties have been granted repeatedly in the past to boost revenues. This has contributed to the expectation of future amnesties, and strengthened the perceived inabi- lity of the DGI to prosecute effectively and enforce the law. The combina- tion of these factors provides a further incentive to evasion, in a vicious cycle that is detrimental to government revenue generation and to Argentina's economic development. B. The Tax System: Revenues and Administration 5. General Constraints on Revenue Generation. Revenue collection problems result from the interaction of the structure of the tax system, the weaknesses of its administration and legal constraints. In the first instance, the structure of national taxes is somewhat atypical compared to countries with similar levels of economic development. The tax system is greatly fragmented, with over 20 nationally administered taxes, the majority of which yield little revenue. The two most important revenue sources in recent years have been indirect taxes: the excise tax cn oil products, and the VAT, each yielding approximately 3 percent of GDP (before refunds to exporters). It is notable that the tax on oil products and the VAT on imported goods require very little collection effort, as they do not hinge on the taxpayers' voluntary compliance. Even though a tax reform in 1985-86 was designed to give direct taxes a greater role in overall taxation, the income tax still does not yield more than about 1.5 percent of GDP, or less than 10 percent of overall revenues. By comparison, the average income tax to GDP ratio for middle-income developing countries was around 8 percent of GDP during the early 1980s. At the same time, social security contributions, at about 5 peLcent of GDP, are at levels similar to that of OECD countries. The constitutional structure of Argentina also limits the possibility of reducing the public sector deficit through increased national taxation. Following a recent reform in the revenue sharing law (the so-called coparticipation law), provinces are entitled to receive roughly 60 percent of eligible national taxes--i.e., taxes that do not have a specific earmarking by law.  - 14 - 6. Institutional Constraints. Several agencies administer and collect national taxes: the DGI, the Social Security Administration, the Customs Service, and other minor bodies. The DGI is, by far, the most important of the agencies, both with regard to the amount of revenue collected and its auditing and prosecuting powers. Operating over the entire national territory, its main functions are the assessment of tax liabilities and the collection of revenues. It collects approximately 60 percent of total national revenues, corresponding in recent years to rough- ly 10 percent of GDP. It administers the income and capital taxes, the VAT on domestic products, the national excise taxes, and other minor taxes. Tax revenues are distributed to the national treasury, the provinces, several special funds and, more recently, to the social security system. 7. The external environment in which DGI operates is generally unfavorable--which is a major reason why DGI has not been able to increase collection substantially despite the numerous revenue enhancement measures approved over the years. The tax system itself, besides its excessive fragmentation, has been confounded by great variability in legislation, confusing or contradictory application of tax laws and regulations, and frequent disregard for the administrative viability of proposed tax changes. Tax amnesties, granted repeatedly in the attempt to raise revenues, have inhibited DGI's pursuit of evaders, and created expectations of further immunity from prosecution. An additional constraint is the way in which DGI must interact with other public bodies in its operations. The tax tribunal and the accounts tribunal deal with DGI's institutional products, the former acting on taxpayers' appeals on DGI decisions, and the latter verifying DGI's performance and behavior. However, the legal powers of DGI vis-&-vis taxpayers are limited, and extremely lengthy procedures can follow an unfavorable audit before a final injunction is issued. This also has contributed to the impression of DGI's reluctance to combat tax evasion. 8. The effects of this unfavorable external environment were compounded by increasing strains on DGI's resources and the absence of forward-looking planning. During the 1970s, the number of registered tax- payers increased dramatically as a result of the introduction and generali- zation of the VAT and of other legislative modifications, as have the complex features of incentive schemes such as the industrial promotion law, that would require increased auditing ability. Resources available for these purposes, however, have failed to match the increasing demands posed by the evolution of the tax system and the increase in the number of taxpayers. DGI's staff has remained relatively stable at less than 11.000 for the past several years (about 6,000 personnel assigned to operations in Buenos Aires, and the rest distributed among the provinces). Of the total, only 1,300 are tax inspectors, handling 1.6 million registered taxpayers. The ability of the agency to retain and motivate qualified personnel is also hampered by many problems. The DGI is organized as an autarkic agency, i.e., with a certain degree of independence from general public sector rules. This allows the agency to offer somewhat more attractive working conditions than other government bodies. However, the managerial scope in these matters is severely limited by union contracts that mandate an extremely flat compensation curve and extensive union participation in management decisions, e.g., hiring and other personnel matters. As a result, private-sector auditing firms have routinely used DGI's staff as a resource pool for recruiting qualified manpower.  - 15 - 9. The internal ability of the agency to process and utilize informa- tion has also been hampered by the long-range planning and the failure to introduce more modern information gathering and processing systems. DGI entered the 19809 without a clearly defined strategy to cope with increa- sing demands on its resources, and with obsolete internal operating and processing systems. Compounding these problems was a long-standing tradi- tion of politicization of key managerial positions, and a very high turn- over in the Director-General position: the current administration appoint- ed four directors in the first two years in office, although by the end of his term, the current Director will have the longest tenure on record, three-and-a-half years. 10. Bottlenecks to Current Restructuring Efforts. In 1986, a medium- term restructuring plan was developed to address these problems and ineffi- ciencies, with the help of IMF and Bank's technical assistance, under the Technical Assistance for Public Sector Management Project, Loan 2712-AR (TAPSM). The legal powers of the DGI were increased, by granting the agency access to banking and financial data previously covered by secrecy or anonymity rules. Draft legislation was submitted to the Argentine Congress to change the powers of the DGI and to speed up the judicial process when tax evasion is ascertained (the project has not yet completed the legislative process). Internally, the organization was restructured, along the recommendations of an IMF technical assistance report, with measurable efficiency gains. An ambitious program of computerization of the processing of information was also implemented, with the multiple objective of allowing cross-checks between financial and sales data of enterprises and individual taxpayers, and setting up a current account system, with the ability to handle the information requirements of large numbers of taxpayers. 11. The restructuring plan has yielded some important advances. Thanks to the internal reorganization, it was possible to review and purge the list of registered taxpayers. A uniform taxpayer identification code has been developed and implemented, consolidating several previous codes. This measure has the potential of substantially reducing administrative complexities. A revision of tax forms for main taxes has reduced paperwork and produced a more efficient gathering of relevant information. Two large systems of information processing and cross-checking have been completed and already are providing support to direct tax auditing, and the existing computing equipment has been upgraded. However, more difficulties than expected were encountered in some critical areas. The design and implemen- tation of the various systems has proven a more complex exercise than envisaged, particularly in the development of the taxpayers' current account system; moreover, bureaucratic difficulties have also slowed the pace of transformation. Additionally, the initial plan did not fully address some organizational and systemic issues--such as the amount and effective use of DGI's resources, the internal control procedures, the adequacy of tax auditing techniques--and the slow pace of implementation of the new system increased the difficulties caused by the progressive discon- tinuation of the old, manual procedures.  - 16 - C. The Project 12. General Objectives. In formulating its macroeconomic program for the second half of 1988 and for 1989 (reviewed and supported by the Bank). the Government realized that slippage in the performance of DGI should be reversed and given high priority, and that it would not be wise to wait for the completion of the medium-term restructuring plan. Consequently, with Bank assistance, it elaborated a short-term program designed to boost the efficiency of the DGI, and to serve as a bridge towards the time of full effectiveness of the already-initiated process of reform. The project addresses critical areas of DGI operations: (i) the control of tax compliance of large taxpayers, (ii) the availability of additional human resources to carry out tax inspections; (iii) the internal training function; (iv) the adequacy of internal control; (v) the adequacy of tax auditing techniques; and (vi) the lack of microcomputing equipment. The proposed loan would help provide the necessary financing for the execution of the program. The Bank would finance approximately 60 percent of the project costs, a higher proportion than similar technical assistance loans, but one that is justified in view of the importance of the project for Argentina's macroeconomic program. It is also similar to the approach adopted in the recently-approved Social Sector Technical Assistance Loan (2984-AR). The Government has committed itself to provide local counter- part funds. 13. Program Components. The six components of the program described below are expected to enhance overall revenue performance through several channels. The increased control of large taxpayers and the sharply increased auditing activity that the new personnel and material available to the DGI would permit, are expected to result in a higher number of revenue actions. Internal efficiency would be boosted by the strengthening of internal control mechanisms, thus raising the efficiency of tax collec- tion. But perhaps more importantly, positive externalities are likely to be generated if an image of a more dynamic and aggressive tax administra- tion can be successfully projected. Government officials believe that the increased efficiency could boost revenue collection by as much as one half of one percent of GDP. While the contribution to the reduction of the public sector deficit would be modest--since only a little over one third of DGI revenues accrue to the national treasury--the reversal of the trend would be critical, with far-reaching implications for the future revenue generation. In addition, a strong DGI presence would also contribute to counteracting the tendency for tax evasion to increase during an election year, in the expectation of the granting of a tax amnesty by the new government. 14. Part A: Database for 2,000 Largest Taxpayers. The highly concen- trated structure of tax payments in Argentina (a result of a concentrated industrial sector, and of the low reliance on the personal income tax as a revenue instrument) has necessitated over the years devoting particular attention to the so-called "large taxpayers," that provide the bulk of revenues for VAT, income and capital taxes. The operations of the National Directorate for Large Taxpayers of the DGI, which has existed since 1974, have been hampered by lack of computerization and an outdated and limited roster of large taxpayers, thus reducing the control and analysis of this important group. Under the proposed loan, a computerized database would be developed, to be jointly used by DGI and the Secretary of the Treasury,  - 17 - increasing the size of the group to 2,000 taxable entities from the 800 currently tracked by the National Directorate. Besides facilitating the analysis of information on compliance for the major taxpayers, the database will also permit the retrieval of information relevant for economic and tax management, since it would include data on company purchases and financial transactions. The system is expected significantly to increase the ability to monitor this group of taxpayers. Although development of a computerized taxpayers' current account will eventually replace the need for a separate system for large taxpayers, delays in the implementation of this component of the medium-term restructuring program have been substantial. The expected payoffs from prompt action, as envisaged under this project, justify the component as proposed. The estimated cost to complete the computerized database system is approximately US$85,000. i5. Part B: Recruiting New Personnel. A major reason for the loss of efficiency of the DGI over the years has been the stagnation of auditing ability in the face of a progressively larger number of taxpayers. Under this component, a major effort would be made to increase the number of tax inspections during 1989, through the hiring of new inspectors, and to provide a substantial number of computer analysts and programmers. The target is to hire up to 600 new tax inspectors (which would represent an increase of about 50 percent over the existing workforce), and about 50 analysts/programmers. The increased auditing force will permit the comple- tion of tasks, essential for success of the Government's macroeconomic program. The number of on-site inspections of corporate taxpayers would be increased by almost 30 percent during 1989 (at an annual rate). The addi- tional programmers and systems analysts would help alleviate bottlenecks in the computing center that, in the past, have hampered the timely processing of information. 16. In order to permit the recruitment, on November 2, 1988, the Government issued a decree lifting the existing public sector hiring "freeze" for DGI. In an effort to break away from an entrenched tradition of political influence in the recruitment of new staff by public sector agencies, DGI has decided to rely on external professional support for the search, evaluation, and selection of the new inspectors and analysts to be hired. This departure from past practices should also enhance the public image of DGI and assure an unbiased recruiting process. A recruiting agent (financed through Bank resources) will be solicited among well-established, specialized recruitment agencies. DGI intends to have the staff available before the end of the second quarter of 1989, with the training of new employees completed a month thereafter. Total costs for the completion of the selection and recruitment process would be approximately US$365,000. 17. Part C: Training of New Personnel. Although the new inspectors would have to demonstrate technical expertise during the hiring process, they will also be required to attend specific induction and technical training courses. The contract for the required training to the new work- force will also cover the provision for: (i) course design; (ii) teaching materials; (iii) training for 30 in-house middle managers or instructors; and (iv) the required training facilities and equipment. The training programs would begin by April 15, 1989.  - 18 - 18. The DGI intends to continue to improve its operational capacity in the future. Retraining efforts will, thus, be expanded to cover those present staff members in need of special skills or additional training. The diagnosis and design of these activities would require the expertise of a consultant to be financed under the proposed loan. who would outline a plan for the restructuring and the future activities of the traisiing unit. The Government has agreed to make its best efforts in following up on the recommendation of this study. 19. The expected result of the tasks to be undertaken should substan- tially increase the existing number of professionals, trained in state-of- the-art techniques. In addition, the project would provide an enhanced in- house training capability for future action. The total cost of this component would be about US$2 million. 20. Part D: Improvement of Internal Auditing. The process of intern- al auditing (i.e., the verification of whether the procedures established to perform the functions of the agency are being followed correctly by the ex_cuting agents) is of extreme importance within a tax administration. Incorrect application of existing rules decreases efficiency in the detec- tion and repression of tax evasion; lack of effective control may encourage corruption among tax officials. Within DGI, however, the internal auditing function was not given sufficiently high priority in the past, with a resulting ineffectiveness of the internal auditing unit and a lack of development of satisfactory auditing procedures. Any substantive effort to increase the efficiency of tax collection in the short run must reverse this situation. This component of the project will provide for the development of procedures for internal auditing, a program of training of the established internal auditing force, and the performance of auditing, for 1989, through the use of personnel contracted externally. 21. The project will involve a first diagnostic phase, during which the existing auditing procedures will be reviewed, as well as the ability of the organizational structure to allow thorough auditing. On the basis of this diagnostic, a program will be defined for each functional area. Subsequently, auditing procedures will be developed through the use of consulting firms, and the existing personnel will be trained in these procedures. A six-month internal auditing program will then be defined, and carried out with the help of external auditors--which will have the responsibility for product quality--in conjunction with established officials. An auditing program for 1990 will also be prepared, to be carried out during that year utilizing internal resources. Finally, the Government has agreed to develop, in consultation with the Bank, a set of indicators of internal efficiency similar to those used by other tax administrations. This would allow both the Bank and DGI's management to monitor the evolution of the agency's internal efficiency during project execution and beyond. through semi-annual reports based on these indicators that would be submitted to the Bank. The estimated cost of this component is US$1.2 million. 22. Part E: Tax Inspection Techniques. This component aims at developing methods of tax inspection that will allow an increased efficien- cy in DGI operations. The project is articulated into two modules. In the first, specialized software will be developed and purchased in order to allow auditing of accounting systems supported by mainframe computers.  - 19 - This is an essential technical requirement for an effective auditing of Large corporate taxpayers, where computerized systems of accounting are by now the norm. Training of DGI officials in the use of the software will also be provided. The second module envisages an assessment and improve- ment, where necessary, of the tax inspection techniques currently used by DGI, in particular for: (i) general tax inspection techniques for industry and commerce; (ii) specialized tax inspection for enterprises in the area of exports, agricultural, refrigeration, banks and finance, oil; and (iii) tax inspection techniques applicable to firms under industrial incentives schemes. DGI personnel will subsequently be trained in the applications of the techniques thus developed. The total cost of this component (including the extraordinary expenses of DGI for carrying out the accelerated inspections of firms in the industrial promotion scheme) is estimated at US$2.3 million. 23. Part F: Provision of Computing Equipment. DGI activities rely intensively on the processing of large volumes of information; however, the level of automation of information gathering and processing is extremely limited. As a consequence of the attempt to centralize the collection of information, as discussed in part B, priority was given in recent years to the development of the central processing system, which has very recently been upgraded. In contrast, the number of personal and mini-computers within DGI has remained low: the entire organization is endowed with only 24 PCs, and the equipment for data processing at a decentralized level is largely outdated. 24. The equipment that would be provided under this component would respond to a series of basic needs of the organization: (i) decentralized gathering and checking of information; (ii) decentralized processing needs; (iii) adoption of standard software for the execution of some basic tasks (word processing, spreadsheets); and (iv) provision of portable equipment for tax inspectors. In addition, the equipment needs for the first component of this project would also be satisfied. In order to address these multiple needs, the project specifies three types of equipment: multiuser, single-user, and portable; the selection of the equipment would be predicated on its being serviced in Argentina if needed. A total number of 200 machines would be provided and distributed throughout the national structure of DGI. The component further envisages a program for training approximately 1,000 DGI personnel in computer applications. The total cost for equipment acquisition and installation would be US$3.2 million. II. PROJECT ADMINISTRATION AND IDPLEMENTATION A. Organization 25. The project will be executed within the Tax Administration; responsibility for its implementation will rest with the director of DGI Directorate. A coordinating commission within the agency has been created, headed by the deputy director of DGI. DGI has appointed an executive director, who will coordinate the administrative aspects of the project and of each component; and directors for the individual components. A major aim of the Argentine authorities is the maximization of the institution- building benefits of the project. Thus, component directors have been chosen from within line personnel, especially detached for the execution of the task. The only exception to this rule will be projects with a once-  - 20 - and-for-all nature (such as the provision of equipment and setting up the database for the 2,000 largest taxpayers). 26. A limited number of consultants will be hired. who must provide full-time services. Government officials, even on leave of absence. would not be employed as consultants. B. Procurement, Disbursement, Accounts, Audit 27. Procurement. Procurement for the proposed project would be in accordance with Bank Procurement Guidelines (May 1985). Goods (which correspond to office and computing equipment) costing US$25,000 equivalent or less would be procured through local shopping involving at least three price quotations. Local shopping would also be used for short-term leasing of computer equipment under procedures satisfactory to the Bank. Procure- ment of the large order of computer equipment would be through Internation- al Competitive Bidding (ICB) in agreement with Bank Guidelines for Procure- ment. All ICB procurement will be submitted for prior review by the Bank. Consultant services (incluaing auditing) with an equivalent cost of US$2.2 million (some 20 percent of total project costs) would be procured in accordance with Bank guidelines. It is expected that the majority of individual consultants would be hired locally. The procurement method would be as follows: Procurement Method (USS thousands) Component ICB Other Total Cost Individual Consultants 45 45 (45) (45) Auditing and Recruiting Services 1,335 1,335 (1,335) (1,335) Training 3,795 3.795 (1,268) (1,268) Hardware (Purchase and Leasing) 1,342 134 1,476 (1,342) (20) (1,362) Software 903 71 974 (903) (71) (974) Internal Costs 1,525 1.525 (0) (0) Repayment of PFF Advance 732 732 (732) (732) Price Contingencies 784 784 (784) (784) TOTAL 2,245 8,421 10,666 TOTAL LOAN (2,245) (4,255) (6,500) NOTES: 1. Figures in parentheses are the respective amounts to be financed by IBRD. 2. 'Other' methods include local shopping and purchase of services from consulting firms consistent with Bank guidelines.  - 21 - 28. Disbursements. The disbursement projections of the US$6.5 million loan would reflect the quick-implementation nature of the project. They would be made for (i) 100 percent of foreign and local expenditures for technical assistance (including consulting services and contract hiring); (ii) 100 percent of foreign and 35 percent of local expenditures for train- ing: (iii) 100 percent of foreign expenditures and 15 percent of local costs for procurement and installation of imported equipment and locally procured equipment, and 100 percent of foreign and local costs for software; and (iv) 100 percent repayment of the PPF advance. Loan funds would be disbursed over a period of about three years. The date for completion of the project would be December 31, 1991, and the Closing Date would be June 30. 1992. Disbursements would be made on the basis of full contractual documentation in the case of studies and technical assistance and for all local currency contracts valued at US$500,000 or more, and for foreign currency expenditures contracts valued at US$50,000 or more. All other disbursements would be made on the basis of certified statements of expendi- ture (SOE). The documentation for the SOE expeAditures would not be sent to the Bank, but would be retained by DGI and made available to the Bank upon request. A Special Account in US dollars would be set up at the Central Bank of Argentina in accordance with procedures acceptable to the Bank. The initial deposit to the Special Account would be for US$2.3 million. This relatively large proportion of the Loan is justified by the short-run nature of the program and by the front-loading of expenditures of many components; it represents an estimated three months of expenditure under the loan. Retroactive financing for up to US$300,000 equivalent would be available so that unexpected delays in signing the Loan do not lead to suspension of ongoing activities. 29. Accounts and Audit. The Borrower would establish and maintain separate project accounts for all expenditures financed under this loan. Accounts and supporting records pertaining to the services and goods financed under the loan, as well as the Special Account, would be audited by independent auditors acceptable to the Bank.  TAX ADMINISTRATION TEOINICAL ASSISTANCE PROJECT Agnx IT Main Government Objectivos Project Component Activities ExP cted Output/Impact Timing Torgets 1. Ineraos Short-Run Control of Tax Collection * Ioprovo monitoring of Devolop databas for 2,000 A microcomputer-supported System to be operstionol by complionce with VAT income largest taxpayers. current account system that July 1989. and capital taxes of largest would allow monitoring of taxpayors. timely payment of sajor taxoes by a subset of taxpayers who contributes about 60 percent of total revenues. The system would be used by DGI and Trensury. It is expected that revenue colloection would significantly improve. 2. Inerease DCI'. Ability to Combat Tax Evasion a Incroese hstwwmn resoureoS Hire 600 new inspectors and 60 The additional manpower would Hiring of inspectors to be for carrying out tax Inspec- analysts/programers through the permit on increase in tax completed by April 16, 1989. tions. use of an independent recruiting inspection of 30 percent at an Hiring of progr ame r to be firm. annual rate. The increased completed by May 1S, 1989. inspection activity would countor the . ndency towards Training and induction of higher tox evasion in an oloec- inspectore to be completed by tion yoer. May 16, 1969. Train new inspectors and The additional analysts/ Training and induction of programers. programners would holp to programmers to be completed by *lleviete bottlonecks in the June 16. 1989. computing center. Continued on next poge ...  Main Government Object,ves Project Component Activities Expected Output/mpact Timing targets A study on th. training needs Study and recomendatiens to be of DGI oill help mansgmnt ready by July 1999. st a scledule for a restruc- turing of the internal train- ing unit. * Increased efficiency of Purchase software for analysis of Ability of DOI to effectively DOI in carrying out tax computerized accounting system audit taxpayers using a modern inspections. and training of the inspectors in accounting system. its use. Asess existing tax inspection Increased ability of DCI to Study on existing tax inspection techniques and develop now one. inspect corporate taxpayers in techniques to be preared by June Train 001's inspoctors in use of fields that have complex 30, 1999; new techniques tochniques. technical roquiroments. operational by September 1, 1989. 3. Improvement of DGI Managment of DOI; Discour- ag"eont of Corruption * Improvement of tho Diagnose priority areas for Identification of areos within Oiagnostic capletd by April Internal auditing functions, suditing. DCI that are in greater need 30, 1989. of internal auditing. Pilot 1999 internal auditing Increasod efficiency of Program to bo carried out betwee program, carried out by om.t.ernal anagement of DCI; identifica- July-Deceber 1989. Sixo and auditors. tion of areas in need of scope of the program subject to greater supervision or Bank ogre--at. different procedures. Dovelopment of internal auditing Effective rovitalization of Troining of internal auditing unit toehniques and training of the training unit (now virtually to be completed by mid-1989. intornal auditing unit. defunct) end modification of rolovant internal auditing criteria. This will be tho necossary step for the 1990 internal auditing program, to be carried out with own reoure s. Continu-d on next pago  Main Government Objectiv-s Proj et Component Act;v;ti Expected Output/loepct Timing Tarete Develop 1990 auditing progra. Will prescribe the 1990 taska Auditing plans to be completed for the Internal suditing by February 1990. unit. Develop indicators of Internal This would allow both Bank and Agrement on indicators by April efficioncy In agreemet with the management to improve monitor- 30, 1909; reports to be prodvced Bank. ing of DGI' efficiency, by *ach following Octobe et *o4 Se i-annual reports, based on April 30. the Indicators, would be produced. 4. Modernization of Compu Acquire computing equipment and Procured equipment would be Dolivery of qu_ipmnt by mid- ting Equipment in Dal train DaI personnel In Its us. used to make the databas4 on 1989; training to begin by date Central and in Rogional largest taxpayers operational; of delivery. Offices it will also be distributed within DOI to modernize data collection end analysis, and to increaso efficiency of tax Inspectors during on-site Inspection.  w t ~~~~B O L I V I Aj' . To r T7 5t. C- SOUTH IVt tt S O U T H i t Ouao0, AgNs }f Focitrso) AMERICA ob, AT MLE R I C A PASIo n . ! 8b l o n , Pi t4A PA,',UA YI |Argentino / N ; . 00 /B(ATA,hIIARCA. J. Co.t.I, 0 terrt / SANT I~~~~~~~~~~~~~A m U t> V.5 \ ~~~t M - Pt ATA~~~~ \ lmw m PMiA to n ,q~ I7- < f < v~~~~~~~~~~~o PrOsOI, SOO .. 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