A working paper (WP) released by International Monetary Fund (IMF) has given an insight into the tax revenue generation potential of 113 countries including India as compared to their actual tax receipts.

The Paper might thus prove handy for fiscal pundits in certain countries to rework their tax system. It has estimated tax capacity - the maximum level of tax revenue that a country can achieve - and tax effort - the ratio between actual revenue and tax capacity for 113 countries from which data were available .

Released on 16 th December, the Paper captioned “Understanding Countries' Tax Effort” suggests that the initial step that a country should follow before implementing new taxes or increasing the rate of the existing ones is to analyze its tax effort , to determine how far its actual revenue is from its tax capacity. If a country is near its tax capacity, then changes in the tax system should be oriented to improve its quality or only slightly increase tax rates.

It has concluded that most European countries, with a high level of per capita GDP and education, open economies (particularly since the creation of the customs union), low levels of inflation and corruption, and strong policies of income distribution, are near their tax capacity. This is particularly the case for Austria, Belgium, Denmark, Finland, France, Italy, and Sweden (with tax efforts higher than 90 percent) where, probably, the demand for public expenditure is a crucial determinant of the higher level of tax revenue.

As put by the paper, “Taking into account how near these countries are to their tax capacity, they appear to be very efficient in collecting taxes (with low levels of evasion).”

It says Singapore, Korea and Japan are exceptions, with very high level of per capita GDP but lying far from their tax capacities. This is also explained, in part, by a matter of public choice. VAT rates in these countries are among the lowest in the world: between 3 percent (1994) and 7 percent (2011) in Singapore; 5 percent in Japan in 2011; and 10 percent in Korea in 2011. These three countries and Indonesia contribute to the fact that the Asia and Pacific region has the lowest level of tax effort.

The study shows that high levels of exemptions and low tax rates explain, in part, why some developing countries have a low level of tax effort. Therefore, in the case of these countries, public choice explains at least a share of the distance between the actual revenue and the maximum level of revenue that these countries could achieve.

The Paper has used the stochastic frontier tax analysis to determine the tax effort and tax capacity of 113 countries. It says: “This is a relative method with predictions of tax effort using a comparative analysis of data on these countries. That is to say, the method determines if a country's tax effort is high or low in comparison to that of other countries, taking into account some economic and institutional characteristics. While in production frontier analysis, the difference between current production and the frontier represents the level of inefficiency, in tax frontier analysis, the difference between actual revenue and tax capacity includes the existence of technical inefficiencies as well as public choice or policy issues (differences in tax legislation, for instance, in the level of tax rates)-things that countries can modify.”