US embassy cable - 05YEREVAN626

UNCLAS SECTION 01 OF 02 YEREVAN 000626 
 
SIPDIS 
 
SENSITIVE 
 
EUR FOR CACEN, EUR/ACE FOR LONGI 
 
E.O. 12958: N/A 
TAGS: EAID, ECON, EFIN, AM 
SUBJECT: ARMENIA FINALLY TAXING THE RICH? 
 
REFS: A) YEREVAN 52  B) 04 YEREVAN 1899 
 
SENSITIVE BUT UNCLASSIFIED. PLEASE PROTECT ACCORDINGLY. 
 
------- 
SUMMARY 
------- 
 
1. (SBU) Four months after President Kocharian called for 
reform of the state tax and customs services, the 
International Monetary Fund (IMF) and the World Bank have 
applauded improvements in Armenia's tax collection.  The 
government has increased overall tax collections by 19.3 
percent over last year and, most importantly, there has been 
a 35 percent increase in social payments that has been 
matched by an increase in pension transfers.  IMF Resident 
Representative Jimmy McHugh told us that his data indicate 
that much of the rise in VAT and profit tax collections is 
from large taxpayers, although the burden has increased on 
small businesses, too.  McHugh said that progress on tax and 
social payment collections makes the lack of progress in 
Customs reform stand out even more.  He said that the 
Customs Service is trying to squeeze increased revenue from 
small importers and still favoring large oligarch 
businesses, a view corroborated by one such large importer. 
The IMF reports that it is ready to enter into a new three- 
year arrangement with the GOAM that will concentrate on 
reforms in the tax and customs services.  End Summary. 
 
--------------------------------------------- --- 
PRESIDENT:  "HIGHER REVENUES, FAIRER COLLECTION" 
--------------------------------------------- --- 
 
2. (SBU) In January, the President called for a reform 
agenda to increase tax revenues in a way that did not chill 
new investment and growth (ref A).  He stressed the need to 
scotch nepotism and corruption in the system that led to 
illicit tax privileges for Armenia's oligopolies and 
harassment and overtaxation of smaller businesses to 
compensate.  In his addresses to the State Tax Service and 
State Customs Committee, President Kocharian spoke candidly 
about reforming the revenue services to meet the 
government's twin goals in the fiscal sphere:  raising tax 
revenues in order to support social spending while making 
the business environment more fair and inviting.  He 
specifically noted that the tax service investigates small 
and medium sized firms far more often than large firms, 
despite the fact that large firms pay an incommensurately 
small share of the tax burden.  At the time, business 
associations and the press welcomed the President's 
initiative to crackdown on Armenia's oligopolistic economy. 
 
--------------------------------------- 
TAX REVENUES AND SOCIAL PAYMENTS ARE UP 
--------------------------------------- 
 
3. (SBU) The IMF Resident Representative and the head of the 
World Bank office in Armenia told us on April 5 that the 
government's renewed efforts to improve tax audit functions 
and the transfer of social security payments to the tax 
service (which can then crosscheck labor and tax data) has 
raised tax collection by 19 percent over last year.  Social 
contributions have risen significantly as the tax 
authorities now are charged to collect social payments from 
employers at the same time they collect other taxes.  Also, 
a drop in simplified tax collection, which was created for 
small businesses but exploited by large ones to evade 
taxation, suggests that the tax service is collecting more 
revenues from larger firms as they are move under the 
appropriate tax regime.  Domestic collection of VAT grew by 
37 percent, which the IMF representative attributed to large 
companies coming off the simplified tax regime into the 
regime of VAT and profit taxes. 
 
 
 
--------------------------------------------- ------- 
BUSINESS ASSOCIATIONS CITE TAX REFORM'S MIXED RECORD 
--------------------------------------------- ------- 
 
4. (SBU) Members of the American Chamber of Commerce (who 
are largely representatives of American-owned small and 
medium sized firms) told us that they have seen no 
difference in the tax collections, inspections or in their 
liabilities, adding that they have consistently been the 
favorite subjects of tax audits anyway.  For its part, the 
Armenian Merchants Union and Union of Manufacturers and 
Entrepreneurs (which consists of Armenian-owned firms, some 
of which are large) told us that since the President ordered 
reform of the tax administration in early January, their 
members have complained that the tax service has more 
frequently inspected, refused to accept valid tax reports, 
and pressured companies to inflate their tax liabilities in 
order to deter future inspections. 
--------------------------- 
CUSTOMS LESS KEEN ON REFORM 
--------------------------- 
5. (SBU) The IMF Resident Representative said that he "felt" 
that the increase in Customs Revenues was less due to reform 
and largely due to squeezing small importers.  A large 
importer of foodstuffs (not American) who admits to 
regularly bribing customs in exchange for preferential 
treatment confirmed this, saying he is receiving the same 
deal as always.  (Note:  The deal--Customs will value his 
import at USD 500 rather than the USD 900 that they have set 
for a ton of his product (regardless of the invoice price), 
and then he and the customs officials split the 32 percent 
VAT and tariff that he would have paid on the remaining USD 
400.  That is, he pays Customs USD 64 under the table for 
each ton of imports of this product.  He added that for tax 
purposes his firm then under-invoices the onward sale of the 
product to account for the undocumented expense of the bribe 
to customs.  End Note.) 
 
6. (SBU) Besides creating personal revenue for customs 
officials, the way that imports are priced and taxed allows 
Armenia's well-connected oligarchs to maintain monopolies on 
trade in basic food and consumption items (ref B).  Reform 
of the Customs Service would have a strong impact on the 
Armenian economy far beyond raising government revenues, but 
the opposition of well-placed oligarchs who benefit from 
preferential import arrangements will make reform of the 
Customs Service difficult to realize. 
 
---------------------------- 
IMF PROPOSES NEW ARRANGEMENT 
---------------------------- 
 
7.  (SBU) The IMF plans to agree on a new three-year 
arrangement with the GOAM that will focus on reforms of the 
tax and customs services and the financial sector.  The new 
IMF program will require the GOAM to strengthen the audit 
function in the tax service and improve the large taxpayers 
unit.  The IMF Resident Representative James McHugh told us 
that a precondition for the first payment from the IMF is 
that the GOAM publish the top 300 corporate taxpayers, so 
that everyone can see who is paying and who is not.  When 
the State Tax Service publishes its list of large taxpayers 
in April 2005, it is important that it include the 
oligarchs, lest the tax crackdown reinforce public distrust 
of the tax administration and the cat-and-mouse culture of 
tax collection and evasion.  McHugh pointed to the success 
of publishing the top 100 corporate lossmakers, which he 
said cut the claimed losses by two thirds.  The IMF will 
also require that the GOAM demonstrate that the Customs 
Service is using invoices to determine import tariff and VAT 
liabilities at the border, removing the Customs Service's 
primary tool of corruption. 
 
--------------------------------- 
COMMENT:  EQUAL TREATMENT MATTERS 
--------------------------------- 
 
8.  (SBU) We were skeptical of President Kocharian's 
commitment to improving tax collection, despite his strong 
rhetoric.  We concur with the IFI's that results are 
impressive, at least for now.  There is enough slack in 
enforcement of Armenia's tax law that the government can 
significantly increase revenues just by bringing more of the 
untaxed economy into the tax system without raising the tax 
liabilities of those who actually pay taxes now.  The World 
Bank estimates Armenia's shadow economy as 43-53 percent of 
Armenia's GDP in 2004.  Capturing this shadow economy in the 
tax system is sure to draw complaints from large and small 
businesses alike; not only oligarchs evade taxation. 
Nevertheless, it is good news that the State Tax Service 
appears willing to take on large taxpayers who have long 
evaded taxation, rather than selectively enforcing a tax 
crackdown against small businesses only.  Reform of the 
Customs Service will be harder, because the oligarchs depend 
on special treatment to keep would-be competitors' products 
uncompetitive.  Besides discouraging new investment, the 
failure to maintain an equal tax environment creates an anti- 
competitive economy that perpetuates Armenia's oligopolies, 
which in turn put off potential market entrants and would-be 
taxpayers. 
EVANS