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									                                TAX REFORM IN ARMENIA

In a market economy, taxes play an important role—so important that it can be definitively
stated that without an efficient tax system, an effective market economy is not possible. The
effective functioning of the whole economy depends on how correctly the tax system is built.

Taxation is a major tool by which governments direct and influence how resources necessary
for economic and social objectives are allocated. Taxation also plays the role of one of the
most important economic regulators.

Furthermore, the importance of a tax policy is due to the fact that taxes are a major source of
governmental funds, and every government must rely on taxes to finance all or part of its
operation and spending. Thus, one of the most important objectives of taxation is to generate
sufficient revenues.

Meeting this objective has become very important in countries in transition. Many socialist
countries have experienced serious budgetary problems. Tax reform was needed to meet the
revenue needs of government budgets in the transition period and to achieve macroeconomic

Tax reform was needed not only for achieving this stabilization and revenue raising in
transition, but also because tax reform actually facilitated and support many other economic
reforms necessary for economic restructuring.

Implementing tax reform engendered enormous technical and informational, not to mention
political, difficulties in all countries. Transition processes are not simply reforms, but abstruse
changes in systems that affect nearly all spheres of social life—cultural, moral, psychological,
sociological, economic and political. These changes involve painful contradictions between old
and new mechanisms: shocking situations and general instability.

In this paper we will look at tax reform in Armenia, explore the changes that took place in tax
policy from 1992 to the present and underline existing problems, especially in tax
administration, that hamper achieving optimal tax performance. In conclusion, we will try to
assess the degree of overall success of tax reform in Armenia.

Literature Review

Over the past ten years there has been a virtual revolution in applied taxation in the countries of
the former USSR and Eastern Europe. In their attempt to catch up with western economic
systems, there has been an considerable interest in implementing some of the aspects of tax
systems found in market economies, although their economies demanded a system of change
which is much more fundamental (Hussey and Lubick).
The fundamental tax reform required junking old tax systems and replacing them with
completely new tax laws and regulations. It required the creation of a new system of taxation
of both companies and private individuals: that is, physical and juridical persons.
Reformation of tax systems was needed for three reasons.
    • First, because the tax systems that had existed in socialist countries were completely
        incompatible with a market-oriented economy. Indeed, they were not even tax systems
        in the usual sense (Gandhi and Mihaljek 1995);

   •   Second, since the break-up of the Soviet Union in December 1991 deficit financing has
       been one of the most serious problems for financial stabilization. Tax reform was the
       only way to ensure that budget deficits were able to be financed without undermining
       overall macroeconomic stability (V. Gandhi and Mihaljek 1995);
   •   Third, tax reform, being itself a part of the minimum package of simultaneous reforms,
       also facilitates and supports many other economic reforms, such as price reforms,
       financial and external sector liberalization, labour market reforms, etc. (Gandhi and
       Mihaljek 1995).

A major theme of tax reform has been the widespread adoption of VAT. The popularity VAT
is due to its well-known characteristic that, in its ideal form, it is the least distorting type of
broad-based consumption tax. At the same time, has a built-in self-enforcing mechanism (Tait
1995). Furthermore, its record of generating large amounts of revenues quickly, and in
comparatively painless fashion, has given it a reputation of a money machine.

The tax-credit type of VAT has three principal advantages over single-stage retail and non-
retail sales taxes in limiting the scope for evasion. First, VAT is self-policing to some extent
because underpayment of the tax by a seller (except, of course, a retail firm) reduces the tax
credit available to the buying firm. Second, crosschecking of invoices enables the tax
administration to match invoices received by purchasers against those retained by sellers. This
crosscheck ability is a valuable aid in audit activities, though not a substitute for a true,
systematic audit. Third, the fact that a large share of VAT is collected prior to the retail level is
an advantage, particularly because in most transitional countries an abundance of small-scale
retail firms do not keep adequate records (Gillis et al 1992).

The tax system plays also important role in regulating capital flow and attracting investment,
which is crucial for increasing production and—consequently—economic growth. In more
integrated financial markets, the allocation of resources is more sensitive to differences in
national tax rates. Differences in tax systems between countries can result in capital flow
affecting both the location of investments and ownership of capital (Andersson 1995).
In order to stem capital outflow, and also to direct private investment into priority areas,
governments selectively offer substantial tax incentives to investors, such as tax holidays and
tax credits for investments. But by far the most effective tax incentive is lower tax rates for all
firms (Gillis et al 1992).

Reasons for preferring lower tax rates on broader income tax bases are not difficult to find.
   • First, income taxes imposed at high marginal rates are not administrable. With high
      marginal tax rates, the incentive to avoid taxes is very high. Faced with high income tax
      rates, taxpayers everywhere tend to react in three ways: (1) they evade taxes by
      concealing their income, particularly capital income not subject to withholding
      arrangements; (2) they avoid taxes by altering economic behaviour to reduce tax
      liability, whether by supplying fewer labour services, shipping capital to tax havens
      abroad or hiring lawyers to find loopholes in the tax law; and (3) they bribe tax
      assessors to accept false returns;
   • Second, the growing mobility of capital across international boundaries has meant that
      the risk of capital flight from a particular country increases when that country’s top
      rates of income tax exceed those prevailing in industrial nations, where tax rates have
      been falling;
   • Finally, high marginal rates on income tax have not proven to be particularly effective
      in correcting severe inequalities in income distribution (Gillis et al 1992).

To stem the outflow of capital and create a favourable for investment conditions, more than tax
rates have to be taken into account. Even more important are the overall macroeconomic
conditions and the stability and transparency of rules and regulations. The tax system can
support this by allowing general, rather than specific, provisions. This ensures that the revenue
base is not eroded, a condition that inevitably leads to destabilizing tax changes in the future.
Also, the tax system should be transparent to the investor, with no scope for a negotiated
settlement of tax liabilities. Once institutions are established and markets are integrated, the tax
system may play an increasing role in the ability of these countries to attract capital and
promote adequate domestic levels of saving and investment (Andersson 1995).

It is important to keep in mind that any tax system ultimately has its performance limited by
the administrative capabilities—legislation, enforcement, collection, human resources and
record keeping—of the country that adopts it. This points to the importance of highlighting the
administrative needs of long-term tax systems, and making adequate preparations for them well
in advance of their actual implementation (Jantscher et al 1995).

It is also important to note that tax administration is a significant option for increasing tax
revenues. Changes in tax administration permit more taxes to be collected form existing tax
sources, even at unchanged tax rates. The potential for increased revenues from such actions is
very large in virtually all countries in transition, although seldom realized. The reasons for this
include shortages of well-trained tax administrators, excessively complex tax laws, corruption
and outdated tax administration techniques. These combine to make tax evasion one of the
most intractable problems of economic policy in countries in transition (Gillis et al 1992).


This study has several purposes: first, to look at the dynamic of tax revenues and budget
deficits from 1992 to the present in order to assess the success of tax reforms; second, to
describe the present tax situation in Armenia; and third, to underline some problems of tax
reform, especially in tax administration, that are hampering the achievement of an optimal tax
performance. Given these purposes, the study involves elements of both explorative and
descriptive research.

In this study we will try to answer to the following research questions:
    • What have been the main directions of tax reform in Armenia?
    • What legal changes occurred that reflect tax reforms?
    • What was the dynamic of tax revenue during the specified period of time?
    • What was the dynamic of budget deficits during the specified period of time?
    • What is the tax performance in Armenia presently?
    • What problems hamper optimal tax performance?

To answer these questions we will analyse existing statistics. The sources of the statistical data
are the following: the draft of CEE/NIS Fiscal Review and Assessment by Barents Group LLC;
Report on Fiscal Sustainability and Fiscal Indicators in Transitional Countries by Barents
Group LLC; Statistical Report; and Armenia. Economic Trends. We will also analyse changes
in the laws, reflecting directions of tax reform. The subject of the analysis in our research is tax
policy, while units of observations are statistical data and laws.

Before describing how we will answer these questions, and what indicators we will use to
measure tax performance, we shall define what we mean by the ‘success’ of the reform and
what it means to achieve optimal tax policy.

Given the role of taxes in transitional economies, we understand the optimal tax policy as one
that maximizes economic growth and minimizes tax evasion. Therefore, to assess the success
of the present tax system we will look at the ability of the system to produce large amounts of
revenue, which ensures the macroeconomic stability necessary for the economic growth. To
assess the success of raising revenues it is useful to look at the budget deficit, because (we
assume) the optimal tax policy will reduce the budget deficit. But since revenues constitute
only one variable in the budget deficit, we will also look at a second variable—expenditures—
to avoid spurious relations. To measure tax performance, the following indicators have been
chosen: those focusing on the level of taxation, those covering tax structure, and those that
exhibit specific characteristics of taxes.

Indicators of tax policy

    •   Ratio of tax revenues to GDP. The tax-GDP ratio is likely to be among the most
        important indicators of tax policy. The overall tax ratio is in many ways the single most
        significant indicator of national fiscal development and revenue performance.
    •   Ratio of budget deficit to GDP. This indicator is needed to see how changes in tax
        revenues affect (if they do) the budget deficit, and thus to assess the success of tax
    •   Ratio of expenditures to GDP. This indicator is important to assure that the relation
        between changes in tax revenues and the budget deficit is not spurious.
    •   Tax buoyancy. This indicator provides us with probably the single meaningful measure
        of overall ‘tax effort’. Tax buoyancy is the change in tax revenues compared to the
        change in GDP over the same period.
    •   Coefficient of variation of annual buoyancy numbers. This provides a useful indication
        of the stability of tax performance.
    •   Ratio of direct taxes to indirect taxes. The ratio of direct/indirect can give us estimates
        of the importance of VAT, since VAT is the most important indirect tax. This
        information can also be assumed to reflect the degree of modernisation of the tax
        system, because the modernity of the tax system may be measured to some extent by
        the importance of VAT, since the old revenue system relied heavily on enterprise taxes.
    •   VAT efficiency ratio. This is a measure of VAT performance: VAT revenues as percent
        of GDP over the standard VAT rate.
    •   Top marginal rates of personal income tax and corporate income tax. Another way of
        assessing the ‘growth-friendliness’ and ‘investor-friendliness’ of a system is to use
        marginal tax rates. Moderate tax rates on broad bases are, as a rule, more conducive to
        both simplicity and efficiency—and thus to growth and investment—than higher rates
        on narrower bases.
    •   Relative size of the basic exemption. This can give us a rough estimate of the ‘depth’ of
        tax coverage, in the sense of how deeply it reaches into income distribution. The
        relative size of the basic exemption is measured by the ratio of exemptions to GDP per

Tax administration is a factor of extreme importance for the optimal tax system. Therefore, we
will look at several indicators of tax administration.

Indicators of tax administration

    •   The degree of computerisation of the tax administration. The degree of computerization
        is an indicator of the modernity of the tax administration. This is important, as one of
        the challenges of transition is the shift from a reliance on manual to computerized
    •   The ratio of registered taxpayers to total population. This ratio may give a rough idea
        of the efficiency of the tax administration.
    •   The size of the tax gap. The bottom line with respect to tax administration in many
        ways is the size of the ‘tax gap’, the difference between the potential tax revenue if all
        taxes were fully enforced and the actual taxes collected
    •   The corruption index. This indicator helps in assessing the size of the tax gap.
    •   The size of the hidden economy as a percent of GDP. This is another helpful indicator
        to assess the size of the tax gap.

Since no ‘ideal’ or optimal level of taxation can really be calculated, it may be useful for some
purposes to compare measurements of tax performance in Armenia with relevant data from
other, formerly centrally-planned countries. For this comparison we will use data provided by
the Barents group LLC. In the data provided by Barents group LLC, the countries are grouped
in two groups. In our comparisons we will follow the same grouping.
The first group, will be referred to as the NIS group. It includes the countries of the former
Soviet Union except the Baltic states. The countries of this group are: Armenia, Azerbaijan,
Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan,
Ukraine and Uzbekistan.
The second group, referred to as the CEE/NIS group, includes countries of the first group plus
countries of Central Eastern Europe and the Baltic states. The countries of this group are:
Albania, Armenia, Azerbaijan, Belarus, Bosnia, Bulgaria, Croatia, the Czech Republic,
Estonia, Georgia, Hungary, Kazakhstan, Kyrgyzstan, Latvia, Lithuania, Macedonia, Moldova,
Poland, Romania, Russia, Slovak Rep., Slovenia, Tajikistan, Turkmenistan, Ukraine and


Armenia has been implementing an independent tax policy since 1992, when new principles
were set forth. In fact, the whole sphere of taxation was renewed, with new laws pertaining to
VAT, revenue tax, and income tax adopted. While speaking about tax reform we should first of
all consider the creation of a new tax system. The old, centrally planned tax system, as was
mentioned above, was not tax system in the usual sense. Essentially it did not tax individuals
(or households) as such, but instead financed state expenditure by, in effect, diverting some
enterprise profits to the government budget as they flowed though the banking system.

The diversion of enterprise profits was organized through a system of norms (obligatory
contributions) set for the enterprises, which in practice were not only extremely differentiated,
but also very often subjective. Instead of being integral, the requirements were adjusted to the
capacities of each company. Moreover the size of the norms depended greatly on the relations
with bureaucracy officials, rather than on objective conditions and requirements. This meant
that the tax system of a command economy had no clearly defined, transparent, commonly
recognized legal tax base or commonly applied tax rate structure.

Thus creation of a new tax system replacing system of norms was a necessary step in removing
subjectivity and voluntarism from the relations between the state and companies, since no
business activity can develop effectively where relations with the state and budget are not
strictly defined, but depend on somebody’s will and change from case to case.

So with creation of a tax system there was a shift from what may be broadly called ‘enterprise’
to ‘personal’ taxes: that is, taxes paid by households explicitly (e.g., through a personal income
tax) or implicitly (through VAT).

The tax policy aimed at reducing the pressure of direct taxation in order to create supportive
conditions for the development of the private sector and to promote savings. These objectives,
as well as the fact that sectors such as agriculture and small-scale private sector enterprises are
difficult to tax directly, contributed to the shift from direct to indirect taxes. This increased the
importance of enhancing the yield from indirect taxes, which became the main contributions to
the state budget (see Graph 1).

                                                      G ra p h 1
                         D y n a m ic s o f D ir e c t a n d In d ir e c t T a x R e v e n u e s
                                        (a s a % o f to ta l r e v e n u e s )




                            1991       1992       1993       1994       1995      1996       1997     1998
             In d ire c t      0       3 9 .5     2 4 .4       2 0 .7   2 0 .6      33       4 2 .1   4 4 .9
             D ire c t       2 6 .5    4 3 .8     2 4 .7        45      3 2 .7     2 5 .9    2 3 .6   1 5 .6

Source: Peculiarities and Stages of Economic Reform in Armenia. 1991-1998. Statistical
Manual. (For details of the dynamics of the Structure of Tax Revenues see Table 1.)

While speaking about the shift from direct to indirect taxes it is important to mention the
introduction of VAT (as well as further adjustments facilitating its efficiency), as VAT has
became the most significant tax contributor, at 6.9% of the GDP in 1999. (Source: Armenia.
Economic Trends). VAT was introduced in Armenia in 1992 with a standard rate at
introduction of 28%, later reduced to 20%. Furthermore, the VAT threshold was introduced in
July 1997 to encourage small and medium business. Prior to this there was no threshold for
legal entities and the only threshold applied to physical entities. Physical entities were not
required to charge and collect VAT on their taxable sales if their turnover was no more than 75
times the minimum wage (Davis et al 1995).

At its introduction the threshold was equal to AMD 1 million. This meant that businesses were
not considered to be VAT taxpayers if their revenue from taxable transactions during the year
preceding each quarter did not exceed AMD 1 million. This policy was continued—in the next
year, 1998, the threshold was increased to AMD 2 million. In 1999 the threshold was further
increased by 1 million, and has remained at AMD 3 million. (Overview of the tax system of
Armenia 1999).

A positive development in facilitating the efficiency of VAT was the adoption of the Law on
Value Added and Excise Tax, which came into effect on July 1st, 1997. This law helped
simplify the treatment of imports and exports by shifting totally to the destination principle.
Previously, Armenia had a dual VAT system, which treated NIS-traded items according to the
origin principle and non-NIS trade according to the destination principle. That is, for NIS
countries imports were zero-based and exports were taxed. In the case of non-NIS countries,
imports were taxed and exports were zero-rated. According to the new law, VAT is assessed
according to the destination principle on internationally traded goods and services; i.e. imports
are taxed while exports are zero-rated.

As a consequence of reducing direct taxes and introducing indirect taxes, the portion of direct
taxes as a percent of total taxes decreased by half from 1993 to 1997, from 60% to 29%.
(Source: Fiscal Sustainability and Fiscal Indicators in Transitional Countries. Barents Group
LLC) This trend continued, and in 1999 the share of direct taxes in total tax revenues remained
relatively small (24%), while VAT and excises together accounted for 56% of total tax
revenue. (Source: Armenia Economic Trends)

The change in the ratio of direct to indirect taxes and shift from direct to indirect changes
indicates the growing importance of VAT and the modernization of the tax system. But
although the VAT has become the major contributor to the GDP, the VAT efficiency (the share
of GDP collected for each percentage point of the standard VAT rate) in Armenia remained
low. It is at 0.2, while the average countries of the NIS group have a rate of 0.3 and the
CEE/NIS countries have an average of 0.46 (see Table 2). This can be explained by the fact
that, although all countries that had formally and centrally planned economies have
approximately the same rate of VAT (20%), the coverage of VAT varies widely from country
to country.

The main reason for the difference in coverage is the proliferation of exemptions. The
proliferation of exemptions in law not only narrows the base, but also makes proper
enforcement more difficult. Withholding and verification also creates problems where the tax
base is ill defined and there are many exemptions and deductions.

Here we should note that beginning from June 1997 the power of the government to give
exemptions was ended. Now exemptions are given only by law and not by governmental
decree. This seems to be a positive development, since the proliferation of exemption outside
the tax law was of special concern.

In Armenia, a number of steps were taken to reduce the number of exemptions: in November
of 1994 exemptions from VAT were removed. This includes gas, electricity, communications
and telecommunications, transportation (all but tram, trolley bus and metro), as well as the
provision of food to workers and students and cultural, educational and leisure activities. VAT
on the turnover of gaming machines and racetrack winnings has been replaced by a 50 percent
special tax. The government removed exemptions for sugar, edible oil, and butter as of July 1,
1995, and for water and sewage as of September 30, 1995 (Davis et al 1995).

Despite these changes, a significant number of VAT exemptions still remain (24), including the
following: transportation services by urban passenger electric transport; education payments
for secondary, professional, and high schools; scientific research work; agricultural produce in
Armenia; products and services imported to Armenia for humanitarian and charitable purposes
(Overview of the tax system of Armenia 1999).

The situation is approximately the same with personal income tax and the enterprise profit tax.
In order to broaden the tax base, a number of exemptions were also eliminated from personal
income tax and the enterprise profit tax. Nevertheless, the ratio of PIT Exemption/GDP per
capita is higher in Armenia (0.37) than in countries of the NIS group (0.3) and the CEE/NIS
group (0.27) (Fiscal Sustainability and Fiscal Indicators in Transitional Countries. Barents
Group LLC).

To broaden the tax base, not only have exemptions been removed, but also the tax rates on
profit and income tax have been cut. This was done not only to ease the tax burden on the
general population, but also to create favourable conditions for investment. In general,
countries that attempt to impose substantially heavier taxes on capital income often experience
outflows of capital to countries with lower tax rates on capital. In this respect, Armenian
legislation is milder than that of other CIS countries; the top margin rates of personal income
tax (PIT) and corporate income tax in Armenia are lower than the average of the other
countries. According to 1998data, top margin personal income tax in Armenia is 30% (the NIS
group average is 34%, the CEE/NIS group average 35%). Armenian corporate income tax is
25% (the NIS group average is 30%, the CEE/NIS group average also 30%) (Fiscal
Sustainability and Fiscal Indicators in Transitional Countries. Barents Group LLC).

Although tax rates play important role in creating favourable conditions for investment, their
proper, objective and consistent enforcement is even more important. Here it is worth
mentioning that the main concern of foreign investors has been not the tax burden, but the
general instability of the tax system and its frequent amendments. In addition, there has been
fear that there will be unpredictable changes in the tax system in the future, because within the
existing framework, companies are very often not sure whether they will have problems with
state inspection bodies. The reason for this is the fact that tax legislation in Armenia, from the
moment of its formation, was subject to frequent changes. This can be explained, first of all, by
the general political and macroeconomic instability, which produced a constant need for
revising legislation and adjusting it to existing conditions. Secondly, legislation could not be
satisfactory in the long run, as it had been made in the style of the Supreme Council of the
Soviet Union with the acquisition of some normative documents on the basis of

recommendations from international organizations. Furthermore, over the short term—that is,
for a society that taking its first steps in creating property—the legislation was too ponderous.
In addition, it very often included many laws that were artificial and regulations that
contradicted each other. This by itself made the relatively undeveloped tax administration even
more difficult to carry out.

Apart from ambiguous tax laws and amendments, the tax administration in Armenia has faced
a large number of problems:
    • The lack of professionals. Here particular attention should be paid to changes in the
        roles of tax inspectors. From simple verification of transfers, they have shifted to more
        challenging compliance activities—auditing—that demand entirely new skills and
        abilities from the tax officials and a totally different operational strategy from the tax
        administration. The lack of professionals has contributed to a weak, underdeveloped
        level of auditing, where the goal of new tax audits has become to detect underreporting
        of taxes.
    • The lack of computerization. Though the information is collected on computers in the
        districts, there is little systematized analysis of the data. Each district maintains its own
        computerized list of taxpayers, but there is no central master file of all taxpayers in the
        republic. This exposes the individual districts to risks like possible destruction of their
        files due to power failures. The file of registered taxpayers is not updated to clearly
        distinguish those enterprises that are currently active from those that are temporarily
        inactive or those that are permanently out of business (Davis et al 1995).
    • A low level of accountancy. The accounting standards adopted in the Soviet system
        were incompatible for a market economy, and the introduction of new accounting
        standards has been slow and prolonged.
    • The shadow economy. The size of the shadow economy in Armenia is larger than in the
        NIS or CEE/NIS group, according to 1996 data. If reckoned as a percentage of GDP,
        Armenia has a rate of 52%, the NIS group has 39% and the CEE/NIS group 28% (see
        Table 3).

These problems, together with weak enforcement and low wages for the tax inspectors create
an environment conducive to corruption1, where small volume quick cash turnovers make it
possible to avoid taxes. This necessarily leads to a decrease in the overall efficiency of the tax
administration. A rough indicator of this is a low ratio of registered taxpayers to the total
population (in Armenia 0.04, whereas the average for the NIS and CEE/NIS groups is 0.16).
Another factor is a decrease in tax collection, an indicator of which is the size of the ‘tax gap’,
the difference between the potential tax revenue if all taxes were fully enforced and the actual
taxes collected. Data from 1998 indicates that this level in high in Armenia, at more than 35%
(see Table 3).

Here we should also mention accumulating tax commitments. At present Armenia is
experiencing significant shortfalls in direct tax revenues due to non-compliance. Enterprises
often premeditatedly hide the real volume of their production in their reports, which lead to tax
derelicts and tax avoidance. The more important the hidden economy is, the harder it is to
enforce taxes properly and the larger the ‘tax gap’ is likely to be.

  According to the Wall Street Journal, in the entire Post-Soviet territories the level of corruption in Armenia’s
state apparatus is second only to that in Tajikistan.

The volume of tax commitments has impacted directly on the level of GDP and the budget
deficit. In the first half of 1999, the net flow of arrears accounted for 3.2% of GDP, while one
year ago this ratio was 1.9%. According to data from the Tax Inspection of RA, tax
commitments comprised 86.7 billion drams as of January 1, 1999. The pace of accumulating
arrears is alarming. The tax arrears were 35.6 billion drams, an increase of 89.2%, in
comparison with 1997. In the total amount of arrears, VAT has the greatest share (49%)
(Peculiarities and Stages of Economies Reforms in Armenia).

When we turn to the dynamic of total revenues we will see that in 1991 revenues constituted
29% of GDP. With the introduction of the new tax system in 1992, this sharply declined to
20.3% of GDP. This happened because old sources of revenues came under stress, while the
new sources of revenues took time to develop. Furthermore, measures to decrease tax evasion
also do not promise quick fixes to the revenue problem. Over the next few years, revenues
continued to fluctuate until 1996, when they began stabilizing and slowly increasing, though
not reaching the level of 1991 (see Graph.2).

                                           Graph 2
                                 Total revenues as % of GDP

                                        1991 1992 1993 1994 1995 1996 1997 1998
              Total revenues as 29.0 20.3 23.2 14.8 18.1 14.9 16.6 18.6
              % of GDP

Source: Peculiarities and Stages of Economic Reform in Armenia. 1991-1998: Statistical

This dynamic of total revenues is mostly conditioned by the dynamic of tax revenues, but it is
also caused by changes in non-tax revenues From 1993 to 1997, the coefficient of the variation
of annual tax buoyancy was 1.12—that is, the average changes in taxes (20%) and GDP (18%)
were almost the same. The percentage of tax revenues to GDP was rather stable and equalled
on average 12% if payroll taxes are excluded, yet the percentage of total revenues to GDP
declined (Fiscal Sustainability and Fiscal Indicators in Transitional Countries. Barents Group
LLC). This can be explained by changes in the non-tax sectors of revenues, revenues that
rapidly decreased during this period: from 1994 to 1997 revenues from grants decreased
approximately ten times, from 11.8% to 1.7% (Human Development Report. Armenia. 1998).

From 1996 we can observe a gradient increase in revenues as a percent of GDP. State Budget
revenues increased 4.5% in 1996 compared to 1995; by 34.7% in 1997 compared to 1996; and
by 33.6% in 1998 compared to 1997 (Peculiarities and Stages of Economic Reforms in
Armenia). This increase in revenues is mainly caused by the increase in tax revenues, because
non-tax revenues for this period did not fluctuate that drastically (see Graph 3).

                                                     G ra p h 3
                      D y n a m ic s o f B u d g e t R e v e n u e s a s P e rc e n t o f G D P






                                               1995            1996            1997            1998            1999
       T o ta l R e ve n u e s a n d           1 7 .8          1 5 .1          1 6 .5          1 8 .5          2 0 .3
       G ra n ts
       T ax R evenues                          1 0 .7          1 0 .6          1 3 .3          1 4 .3          1 6 .8
       N o n -T a x R e ve n u e s             3 .4              3             1 .4            2 .6              2
       G ra n ts                               3 .6            1 .5            1 .8            1 .7            1 .5

Source: Armenia Economic Trends 2000 (for the details of tax and non-tax revenues see Table

Source: Armenia Economic Trends. April-June 1999
The increase in tax revenues, and thus total revenues, had a positive impact on the development
of the budget deficit. Here we should bear in mind that even 100% tax collection cannot ensure
the absence of a budget deficit, since only one half of the budget deficit depends on revenues,
with another half depending on expenditure. Looking at the dynamics of the budget deficit
from 1995-1999 we can see that for the first two years (1995-1997) reductions are caused by
both a decrease in expenditure and the relative stability of revenues. During the second period

                                               Graph 4
                                        Dynamics of budget deficit


                                        1995            1996            1997            1998            1999
           Revenues                     17.8            15.1            16.4            18.4             23
           Expenditures                 28.8            24.4            21.1            22.2            26.8
           Deficit                       11             9.3             4.7             3.7             3.8

(1997-1999), we should note that although expenditures have increased, the budget deficit
continued to decrease. This should be definitely attributed to the steady increase in revenues,
which could support an increase in expenses and keep down the budget deficit (See graph 4).

The increase in total revenues and the decrease of the budget deficit to a rather significant
extent can be influenced by improvements in tax policy and successes in tax reform. However,
a high ‘tax gap’ and large, accumulating arrears suggest that collection could have been much
higher than it actually was.


As we have seen, the tax policy of Armenia has undergone substantial changes from 1992 to
the present. In actuality, a new tax system was created. The changes included a shift from
‘enterprise’ to ‘personal’ taxes, from direct to indirect taxes, a reduction in exemptions, a
decrease in tax rates and simplifications of procedures.

The main directions of tax reform were aimed at raising more revenue in the short term,
ensuring the tax burden was distributed equally, broadening the tax base to reflect the changing
structure of the economy, easing the tax burden on the general population, creating favourable
conditions for the development of the private sector and furthering the ongoing adaptation of
the tax structure to fit a market economy.

Tax reforms have brought some success. Evidence of it can be seen in increased revenues
during this time period, which contributed to the reduction of the budget deficit. This was
possible because of substantial improvements in tax revenue collections. But we should note
that with the increase of revenues, increases in tax arrears also took place, implying that there
is still much room for improvement.

This is reflected in the ratio of taxes to GDP, which still remains lower than in other formally
planned countries. In 1997, revenue as a percentage of GDP was 17% in Armenia, whereas the
average for the NIS group was 25% and for the CEE/NIS group was 32%. The percentage of
revenues to GDP in Armenia is half that in countries like Estonia, Latvia or Poland (see Table
5). This low ratio can be explained by a number of reasons: many exemptions, which narrow
the tax base; the proliferation of special incentives, which complicate tax administration. One
of the biggest set of reasons comes from problems in tax administration, ranging from such
trivial ones as a lack of equipment to major ones such as the large size of the hidden economy,
a high level of corruption, weak enforcement powers, a lack of professionals, weak audit
functions and a lack of systematized computer systems.2

To improve the situation, the first thing to do is to make the existing taxes more transparent
and stable. The tax system should facilitate—rather than complicate—compliance and tax
administration. This is best supported by adopting relatively simple taxes, with low rates, broad
bases and few exemptions. A pyramid with a broad base and a narrow apex represents a tax
administration that has been relatively successful in fostering voluntary compliance as well as
in creating an environment that is conducive to investment. Not only must the tax system be
transparent and free from ad hoc decisions, but it must also remain stable for the foreseeable
future. This will simplify and improve tax compliance and tax administration, and will also

  The computerization of the tax administration will improve effectiveness. It will reduce noncompliance and free
tax staff for more productive uses, particularly in the area of audits. Creating more auditors from the current tax
staff will help to foster the ultimate goal of tax administration: maximizing voluntary compliance. However, the
chances of achieving this goal will be hampered if the tax personnel are mistrustful, do not fully understand the
changes, or feel that their job security is being threatened (Jantscher et al 1995).

facilitate investment, since domestic and foreign investors need to know what their various tax
liabilities will be when they undertake specific investments.

Tax compliance must be created, cultivated, monitored and enforced. To a considerable extent,
tax compliance depends upon the perceived ability of the tax administration to detect and
penalize tax violators. But it is also important to facilitate voluntary compliance. Here people’s
perception about the fairness of the system is very important. For these reasons the tax
authorities need to strengthen enforcement efforts, applying sanctions fairly and with sufficient
publicity, because much depends upon the consistency with which the state penalizes those
who ignore the rules, which in this case means avoiding taxes. But voluntary compliance
cannot succeed where taxpayers find it hard to calculate their obligations correctly, as is the
case when laws change frequently, are not clearly explained and, in all too many cases, are not
administered properly.

This means that in order to raise revenues, Armenia’s tax policy should further expand the tax
base, through eliminating exemptions and decreasing tax rates, as well as increasing the
efficiency of consumption-based taxes, which are more favourable for private savings growth
than are income-based taxes. Policy should also aim for long-term goals, simplify procedures
and legislation, make the system more transparent and facilitate voluntary compliance. To sum
up, the system should become more incentive-enhancing and equity-improving, and promote
further compatibility with market economies.


Andersson, K. (1995). “Efficiency Considerations in Tax Policy.” In V. Tanzi (ed.), Fiscal
Policies in Economies in Transition. International Monetary Fund.

Bakhshian, G. and H. Manassian. (1998). “The Role of the State in Economic Development.”
In Human Development Report. Armenia.

Barents Group LLC. (1999). CEE/NIS Fiscal Review and Assessment. Draft Second Quarterly
Country Profiles.

Bird, Richard M. and S. M. Banta. (1999). Fiscal Sustainability and Fiscal Indicators in
Transitional Countries. Istanbul, Turkey: Barents Group LLC.

Buchs, T. D. (1999). “Financial crisis in the Russian Federation.” In The Economics of
Transition.” Vol. 7, No. 3.

Cornely, J., A. Firestone and K. Stilling. (1995). Armenia: Implementing Revenue Enhancing
Measures in 1995 and Beyond. International Monetary Fund.

Davis, J., J. Stotsky and J. Isaac. (1995). Armenia: Continuing Tax Reform. International
Monetary Fund.

Euro.Com. (2000). Armenia Economic Trends. DGIA, NIS/Tacis Services Quarterly Issue:
July–September “Nations in Transit.” (Armenia section.) URL:

Gandhi, V. and D. Mihaljek. (1995). “Scope for Reform of Socialist Tax Systems.” In V. Tanzi
(ed.), Fiscal Policies in Economies in Transition. International Monetary Fund.

Gillis M., D. Perkins, M. Roemer and R. Snodgross. (1992). Economics of Development. W.
W. Norton & Company, Inc.

Jantscher, M., C. Silvani and C. L. Veborn. (1995). “Modernizing Tax Administration.” In V.
Tanzi (ed.), Fiscal Policies in Economies in Transition. International Monetary Fund.

Hussey, M. W. and D. C. Lubick. (1996). Basic World Tax Code and Commentary.

IRS, Milan. (1999). Armenia Economic Trends. Quarterly Issue: April–June

Ministry of Statistics, State Register and Analysis of the Republic of Armenia, Statistical
manual. (1999). Peculiarities and Stages of Economic Reforms in Armenia. 1991-1998.
Yerevan. “Wealth and Corruption.” URL:

Roberts, B. W. (1999). Armenian Fiscal Developments in the First Half of 1999. USAID Tax
and Fiscal Reform Project.

Tax Inspectorate of Armenia: Educational Methodical Centre. Overview of the Tax System of
Armenia. (1999). Yerevan.

Tait, Alan A. (1995). “Introducing Value-Added Taxes.” In V. Tanzi (ed.), Fiscal Policies in
Economies in Transition. International Monetary Fund.

                                                                                    Table 1
                        Table 1: Dynamics of the Structure of Tax Revenues

                 1991       1992      1993     1994     1995      1996       1997   1998
Indirect taxes    0         39.5      24.4     20.7     20.6       33        42.1   44.9
1. VAT                      32.5      19.8     17.7     18.1      21.6       28.3   33.7
2. Excise tax                 7        4.6       3       2.5      11.4       13.8   11.2
Direct taxes     26.5       43.8      24.7      45      32.7      25.9       23.6   15.6
3. Profit tax    11.2       32.4      18.4     36.7     25.4      16.9       12.7     7
4. Income tax    15.3       11.4       6.3      8.3      7.3        9        10.9    8.6

   Source: Peculiarities and Stages of Economic Reform in Armenia. 1991-1998. Statistical

                                                                                                                   Table 2
                                      Table 2: VAT Indicators

                                                                                                    as % of GDP/VAT rate,
                                                                                                     VAT Efficiency (VAT
                                                          Standard VAT rate at
                 Standard VAT rate,

                                                                                 VAT as % of GDP,
                                      Year of VAT





Armenia                  20           1992                      28                    4                 0.20
Azerbijan                20           1992                      28                    4                 0.22
Belarus                  20           1992                      28                   10                 0.48
Georgia                  20           1992                      28                    4                 0.19
Kazakhstan               20           1992                      28                  7(98)               0.36
Kyrgyz                   20           1992                      28                    6                 0.29
Moldova                  20           1992                      28                   10                 0.50
Russia                   20           1992                      28                  4(98)               0.21
Tajikistan               20           1992                      28                    2                 0.08
Turkmenistan             20           1993                      28                    8                 0.42
Ukraine                  20           1992                      28                    8                 0.42
Uzbekistan               18           1992                      30                    8                 0.38
Mean for
                         20                                     28                        6             0.31
NIS group
Croatia                  22           1998                      22                      17              0.78
Czech R.                 22           1993                      23                       7              0.32
Estonia                  18           1992                      10                      10              0.54
Hungary                  25           1988                      25                       8              0.30
Latvia                   18           1992                      14                       9              0.49
Lithuania                18           1994                      18                       9              0.49
Poland                   17           1993                      22                       8              0.37
Slovak R.                23           1993                      23                      8               0.37
Slovenia                 …            1999                      …                       14              0.69
Albania                  20           1996                      13                      14              0.69
Bosnia                   …             …                        …                       …                …
Bulgaria                 20           1994                      18                       6              0.28
Macedonia                …            1999                      …                       …                …
Romania                  18           1993                      18                      5               0.21
Overall mean             20                                     23                        8             0.39

  Source: Fiscal Sustainability and Fiscal Indicators in Transitional Countries. Barents Group

                                                                                    Table 3

                         Table 3: Tax Administration Indicators

                                                 Mean for NIS        Mean for CEE/NIS
                                                    group                  group
Computerization of
Taxpayers Accounts
Number of Registered
                                  0.04                0.16                  0.16
Taxpayers/Total Population
Personnel Appraisal
Tax Gap, 1998                     High
Size of hidden economy
as% of GDP, 1996                  52%                 39%                   28%

Source: Fiscal Sustainability and Fiscal Indicators in Transitional Countries. Barents Group

                                                                              Table 4

                   Table 4: State Budget Revenues by Major Source
          (including the Central Government and Local Authorities accounts)

                                       1995        1996     1997       1998       1999
Tax Revenues                           10.7        10.6     13.3       14.3       16.8
Enterprise Profit Tax                   4.6         2.5      2.1        1.3        2.2
Personal Income Tax                     1.3         1.3      1.8        1.6        1.9
VAT                                     3.3         3.3      4.7        6.2        6.9
Excise Tax                              0.5         1.7      2.3        2.1        2.2
Customs Duties                          0.5         0.9      1.3        1.1        0.8
Other Taxes                             0.6         0.9      1.2        2.0        2.8
o/w Local Government Taxes              0.4         0.5      0.5        0.5        0.5
Non-Tax Revenues                        3.4         3.0      1.4        2.6        2.0
Profits from the Central Bank           2.3         1.7      0.7        0.8        0.6
Local Government Non-Tax Rev.           0.3         0.3      0.2        0.3        0.3
Other Non-Tax Revenues                  0.9         1.0      0.5        1.5        1.1
Grants                                  3.6         1.5      1.8        1.7        1.5
Total Revenues and Grants              17.8        15.1     16.5       18.5       20.3

Source: Armenia Economic Trends 2000

                                                                                    Table 5

                          Table 5: Revenues as % of GDP, 1997

                       Country                                  Percent
     Armenia                                                      17
     Azerbaijan                                                   17
     Belarus                                                      41
     Georgia                                                      10
     Kazakhstan                                                   23
     Kyrgyz                                                       18
     Moldova                                                      34
     Russia                                                       33
     Tajikistan                                                   12
     Turkmenistan                                                 29
     Ukraine                                                      38
     Uzbekistan                                                   30
     Mean for NIS group                                           25
     Croatia                                                      47
     Czech R.                                                     41
     Estonia                                                      39
     Hungary                                                      45
     Latvia                                                       39
     Lithuania                                                    34
     Poland                                                       44
     Slovak R.                                                    42
     Slovenia                                                     45
     Albania                                                      16
     Bosnia                                                 Info not available
     Bulgaria                                                      32
     Macedonia                                                     42
     Romania                                                       27
     Overall mean                                                  32
     Standard deviation                                            11

Source: Fiscal Sustainability and Fiscal Indicators in Transitional Countries. Barents Group


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