US embassy cable - 04ANKARA796

UNCLAS SECTION 01 OF 03 ANKARA 000796 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR EB/IFD, EUR/SE, AND E 
TREASURY FOR OASIA - JLEICHTER AND MMILLS 
NSC FOR MBRYZA AND TMCKIBBEN 
 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, PGOV, TU 
SUBJECT: MEETINGS WITH BUDGET AND TAX OFFICIALS 
 
 
REF: ANKARA 
 
 
1. (Sbu) Summary: Deputy General Manager for Budget Ahmet 
Kesik described to econoffs the state of play on the 2004 
budget, saying there is a TL 7 Quadrillion gap, of which TL 
3.7 Quad stems from recent populist measures and 3.3 Quad 
from lower-than-expected revenues in 2003.  Kesik echoed 
senior GOT officials' claims that the 10 percent 
across-the-board cut in discretionary spending--proposed in a 
supplementary budget sent to the Prime Minister--could be 
implemented without seriously hurting government programs. 
Kesik admitted, however, that the GOT may have to look to the 
revenue side as well to close the gap.  In separate meetings, 
the Director General of Revenues and his Deputy described the 
new strategic plan they are elaborating to achieve more 
effective tax collection.  Both the Revenue and Budget 
officials claimed that the GOT-proposed reduction in VAT 
rates--from 18 to 8 percent--on the textile sector would have 
the (counterintuitive) effect of helping the fiscal situation 
because textile sector export rebates on VAT exceed 
collections.  End Summary. 
 
 
Budget Official on Fiscal State of Play: 
--------------------------------------- 
 
 
2. (Sbu) In a meeting with econoffs January 28, Ahmet Kesik, 
Deputy Director General for Budget in the Ministry of 
Finance, shed some light on the state of play between the GOT 
and the IMF on the 2004 fiscal situation.  According to 
Kesik, for 2004 there is a TL 7 Quadrillion gap (USD 5.2 
Billion) between the primary surplus projected in the IMF 
program and current estimates.  Kesik said that the IMF 
believes the gap may be higher, but Kesik stood by the GOT's 
figures.  He said that TL 3.7 Quadrillion of the gap arises 
from the GOT's pension payment and minimum wage increases, 
according to IMF calculations.  (Kesik noted but that GOT 
officials calculate the cost of these measures at TL 3.4 
Quadrillion but he used the Fund's numbers.) The remaining TL 
3.3 Quadrillion of the gap comes from the "base effect" of 
lower-than-expected revenues in 2003.  Of the TL 3.3 
Quadrillion, Kesik said TL 800 Trillion stemmed from a 
shortfall in VAT collections on petroleum products, because 
petroleum prices had not been increased in the second half of 
2003, whereas the 2003 budget projected price increases in 
line with CPI inflation. Likewise, Kesik said the absence of 
increases in electricity and natural gas prices had 
contributed to the shortfall. 
 
 
3. (Sbu) To begin bridging the gap, GOT officials have 
prepared and proposed to the Prime Minister a package of 
measures worth between TL 3.1 and 3.4 Quadrillion to be 
included in a supplementary budget.  With GOT officials keen 
to avoid revenue-side measures, the central element of this 
proposal is an across-the board cut of 10 percent nominal in 
"discretionary" spending, excluding personnel costs.  Kesik 
claimed that these cuts could be implemented without hurting 
the substance of government programs.  According to Kesik, 
these expenditure items had been slated to increase roughly 
25 percent, i.e. substantially more than projected inflation, 
such that a 10 percent cut should not be too damaging.  Kesik 
said that the cutbacks include military spending, although a 
substantial share of military spending is off-budget in the 
Defense Industry Support Fund. (Under the reform program, 
however, this Fund will be phased out and all military 
spending brought on budget by 2007.)  So far, the military 
seems to be accepting the need for the 2004 spending cuts. 
More broadly, the GOT still needs to work out the total 
package of compensatory fiscal measures with the IMF to close 
the remaining gap. Subsequent to the meeting, the press has 
reported that the GOT will announce an additional TL 3.0 
Quadrillion of measures, consisting of TL 1.5 Quadrillion 
from increased Special Consumption Taxes on fuels and TL 1.0 
Quadrillion from a reduction in VAT rates from 18 to 8 
percent (See below). 
 
 
Revenue Issues: 
-------------- 
 
 
4. (Sbu) In subsequent meetings, Director General for 
Revenues Osman Arioglu and his Deputy, Bulent Tas, echoed 
Kesik's contention that the GOT would increase revenue if it 
decreased repeat decreased the VAT rate on textiles from 18 
to 8 percent.  Note: As reported reftel, IMF officials had 
expressed skepticism about this proposal. End Note.  Kesik 
said this change would yield between TL 600 and 700 trillion. 
 
 
5. (Sbu) Kesik and revenue officials argued that, because of 
massive false invoicing, the GOT currently  pays out more in 
textile sector VAT tax rebates than it takes in via textile 
sector VAT payments.  According to the Revenue Directorate's 
calculations, the textile sector accounts for 43 percent of 
VAT export rebates, such that the proposed rate reduction 
would reduce rebates paid out by TL 1.393 Quadrillion. On the 
collection side, the Directorate attributes only 7 percent of 
VAT collections to the textile sector, such that the proposed 
rate reduction would reduce collections by only TL 691 
trillion.  The net saving of about TL 700 trillion 
corresponds to the high end of Kesik's range.  The Director 
General went so far as to ask for the USG's help with the IMF 
on this issue.  Comment: While we have no reason to doubt the 
GDR's estimates, we cannot help wondering why, instead of 
reducing the VAT rate, the GDR does not crack down on 
questionable export rebate payments--and underreporting of 
VAT collections--through enhanced auditing of exporters' 
rebates and collections.  Subsequent to the meetings there 
have been press reports, anonymously quoting GOT officials, 
saying they have come up with a package to close the gap, 
including the VAT rate reduction.  Since the IMF has not yet 
agreed to these measures, GOT officials seem to be 
deliberately leaking its package as a way to pressure the 
Fund.  End Comment. 
 
 
Improving Collections and the Unregistered Economy: 
--------------------------------------------- ----- 
 
 
6. (Sbu) The two General Directorate of Revenues (GDR) 
officials explained that a major priority was to improve tax 
collections, via a campaign to bring the unregistered economy 
into the formal sector.  The GDR officials echoed earlier IMF 
staff comments that, in Turkey, even large companies conduct 
some of their operations outside the formal economy.  Tas 
emphasized the key to improving collections is to have a more 
efficient tax administration.  The tax administration 
reorganization moves (see below) under consideration are 
designed with improved collections in mind.  In addition, 
some of the specific actions the GDR is considering to 
improve collections in the short run include a more automatic 
system for VAT collection at gas stations, a reduction in the 
threshold above which transactions are required to go through 
banks, and working with local chambers of commerce to improve 
compliance.  Tas acknowledged that Turkey's history of tax 
amnesties has not helped collections.  In his meeting with 
econoffs, Kesik noted wryly that, with 70 percent of revenues 
deriving from indirect taxes, and 92.5 percent of direct 
taxes deriving from withholding taxes on wages, the GDR 
really should be able to concentrate on the relatively small 
remaining tax base to improve tax collections. 
 
 
Reorganization moves: 
-------------------- 
 
 
7.  (Sbu) Both Tas and Arioglu expressed their appreciation 
for the work of the U.S. Treasury tax advisors, who had 
recently completed their second strategic planning workshop 
with the GDR.  The strategic plan that emerged from the 
workshop was mentioned by Finance Minister Unakitan in a 
recent press conference, and the tax advisors told econoff 
the GDR, and even the Minister seem enthusiastic about it. 
As part of the plan, the GOT would reorganize tax collection 
in several key respects.  At the local level, tax collection 
is currently the responsibiltiy of the "Deftedars," i.e. 
local offices that represent the broad spectrum of Ministry 
of Finance issues.  The reorganization would put tax 
collection in the hands of local offices responsible only for 
tax collection and reporting to the GDR.  The GDR would also 
gain more autonomy from the rest of the ministry, being 
transformed into a tax administration agency.  A large 
taxpayer unit would also be established.  The GDR's ideas are 
receving GOT support so far; however, Tas noted that the 
private sector tax advisory body, the "Tax Council" was doing 
a separate study on the tax administration system. 
 
 
8. (Sbu) Tas explained that the legislative vehicle for the 
GDR's prosposed changes would be the much broader public 
administration reform bill, currently being spearheaded from 
the office of the Prime Minister.  The new legislation is 
expected to be submitted to parliament in late spring or 
summer.  Tas explained that part of the reform would be to 
reduce the number of bodies doing tax audit work, thereby 
improving coordination.  Currently there are four, of which 
two are in the Ministry of Finance: the Financial Inspection 
Board, the Tax Audit Board. The GDR officials noted with 
pleasure that the U.S. Treasury-facilitated plan basically 
implements the kind of measures the IMF tax experts desired, 
such that the IMF recommendations dovetailed with what GDR 
was already doing. 
 
 
Overreliance on Indirect Taxes: 
------------------------------ 
 
 
9. (Sbu)  Both Kesik and the GDR offiicals lamented the 
Turkish state's overreliance on indirect taxation. Kesik 
noted that the IMF would like to see a shift to more direct 
taxation, as a means of broadening the tax base without 
increasing tax rates.  Tas remarked that the trend has been 
for the GOT to raise indirect taxes when revenue was needed 
because it is easier to do so: the GOT has the authority to 
increase indirect taxes but has to get parliamentary approval 
to raise direct taxes. 
EDELMAN