Tax systems in the reforming socialist economies of Europe

As socialist countries move toward market systems, fiscal policy is an important part of their reform agenda. First, they need to reorient public spending to focus more on the provision of"public"goods. Second, they need to adopt more selective, predictable, and nondiscretionary means to finance such spending. The goal of this paper is to lay out some of the broad trends and issues now emerging as socialist economies attempt to reform their systems of taxation. The primary focus is on Eastern Europe, although many of the same trends and issues arise in the reforming socialized countries of Asia and Africa. Particular attention is paid to Hungary and Poland, which are most advanced in the tax reform process. The experiences they have had and the problems they are facing provide valuable lessons for those countries just starting on the reform process.Public Sector Economics&Finance,Environmental Economics&Policies,Economic Theory&Research,Banks&Banking Reform,Municipal Financial Management

The legal framework for private sector activity in the Czech and Slovak Federal Republic

Since its velvet revolution in late 1989, the Czech and Slovak Federal Republic (CSFR) has moved steadily to create the conditions for developing a private market economy. Not only has the CSFR freed up the conditions for entry of new private firms, but it has also taken far-reaching steps to return property to former owners and to privatize large parts of its state-owned industry. For this emerging private sector to thrive, there must be a clear legal framework to provide decentralized rules of the game. The author describes the evolving legal framework in the CSFR in several key areas: property, contract, company law, foreign investment, bankruptcy, and antimonopoly law. Essentially the same legal framework exists in the Czech and Slovak republics, although the legal frameworks of the two could diverge considerably in the coming months and years if the country separates, as is expected. The CSFR differs somewhat from its Central and Eastern European neighbors, especially Poland and Hungary, in that its pre-war legal system was more thoroughly abrogated during the socialist period. So, fewer people are familiar with market-oriented legal principles and practices. On the other hand, in 1989 the CSFR had the advantage of starting with a relatively clean slate on which to craft modern laws. In some areas of law - such as company, contract, and antimonopoly law - legal reform in the CSFR is relatively well-advanced and could to some degree serve as a model for other reforming socialist economies. In others - including constitutional and real property law - legal reform is embroiled in political controversy and is lagging behind developments in some neighboring countries. The interests of former property owners are clashing with those of current tenants, creating a surge of new disputes entering the courts. The surge in cases is likely to be exacerbated as the current moratorium on bankruptcy claims against state enterprises expires in 1993, and as cases under the new intellectual property laws and commercial code come onstream. The CSFR's judicial system, suffering from recent purges of judges compromised by the former regime as well as generally low pay and prestige, appears to be relatively ill-prepared to cope with the skyrocketing demands expected in the newly reformed system. All in all, it is a time of great progress, great confusion, and great challenge.Legal Products,National Governance,Environmental Economics&Policies,Legal Institutions of the Market Economy,Judicial System Reform

In search of owners : lessons of experience with privatization and corporate governance in transition economies

The author reviews the goals of privatization and evaluates various methods used to achieve them in different transition settings. The task is not only to change ownership but to create corporate governance and to further the development of legal norms and supporting institutions needed in full-fledged market economies. Initial results of privatization programs are only part of the picture. How they foster further evolution of ownership is equally important. Experiments in privatization abound, from extensive efforts at sales to strategic owners (as in Estonia and Hungary), to programs based primarily on insider buyouts (as in Russia and Slovenia), to innovative mass privatization programs involving the creation of large and powerful new financial intermediaries (as in the Czech and Slovak Republics and Poland). Each approach has inherent strengths and risks. But if the objectives are to severe the links between the state and the enterprise, to school the population in market basics, and to foster further ownership change, the initial weight of evidence seems to favor significant reliance on voucher privatization, especially given the difficulty most countries have finding willing cash investors. Formal programs of enterprise privatization are often only a small part of the picture, although they get the most attention. Even where formal privatization has been slow (as in Bulgaria and the Ukraine), a process of asset"recombination"is occurring, often behind the scenes - whether a recombination from state to private firms or from some private firms to others. In the Czech Republic, for example, the ownership of enterprise shares by funds or fund shares by individuals will change through formal and informal trading, but the ownership of enterprise assets may also shift to some extent as owners or managers sell or spin-off assets into new companies. In Russia, this shifting of assets to new, more closely held firms may be quite widespread, as managers with small minority ownership stakes in newly privatized firms try to gain greater control over assets. As one Hungarian observer noted, this is the period of"primitive capital accumulation"in the post-socialist world. Formal programs may lay important ground rules but uncertainties of every type overwhelm most formal efforts at privatization. The final outcome is far from predictable.Banks&Banking Reform,Financial Crisis Management&Restructuring,International Terrorism&Counterterrorism,Economic Theory&Research,Municipal Financial Management,Economic Systems,Economic Theory&Research,Banks&Banking Reform,Municipal Financial Management,Financial Crisis Management&Restructuring

Legal process and economic development : a case study of Indonesia

Westeners often complain that laws are not enforced in developing countries."Good"laws are on the books, but in reality individuals and firms evade them with impunity. For example taxes are uncollected, bankruptcy laws unenforced, environmental controls ignored and trade restrictions evaded. Furthermore, corruption often flourishes in government despite repeated condemnation by public leaders. This paper tries to unravel the nature of legal processes in developing countries and explain how and why they may differ from legal processes in more advanced nations. It identifies three broad functions of a legal system and introduces the central theme of the paper - how risk and information costs affect many of the characteristics of the legal process. Next, it proposes two opposing models, the formal and informal, to illustrate different means by which legal functions can be handled. While these models are presented as contrasting alternatives for purposes of exposition, neither pure prototype exists in practice. Real life is always some mixture of the two, with the balance shifting from country to country. The paper then describes formal and informal legal processes in Indonesia, using the Indonesian tax system as a case study.National Governance,Environmental Economics&Policies,Legal Products,Health Economics&Finance,Insurance&Risk Mitigation

Issues in income tax reform in developing countries

Of all taxes, income taxes are the most difficult to implement. Developing countries are usually able to generate large amounts of income tax revenue only from large corporations or foreign investments. They are rarely effective in taxing wealthy individuals or small or medium-size businesses. Using recent tax reforms in Jamaica, Indonesia, and elsewhere as examples, the paper discusses the pros and cons of specific tax reform elements. It summarizes the major issues typically faced in reforming income taxes in developing countries. More revenue, increased efficiency, and a better distribution of the tax burden are usually the underlying goals. Improving enforcement and compliance by simplifying the tax structure and increasing the legitimacy of the tax process is usually the major challenge.Environmental Economics&Policies,Economic Theory&Research,Public Sector Economics&Finance,International Terrorism&Counterterrorism,Tax Law

Bulgaria's evolving legal framework for private sector development

Bulgaria is in the midst of a historic transformation from a planned to a market economy. The Bulgarian government is working steadily to create a legal framework in which the private sector can develop. The authors describe the current legal framework in Bulgaria in the areas of constitutional, real property, intellectual property, company, foreign investment, bankruptcy, contract, and antimology law. These areas of law define property rights, the means for exchanging property rights, and the rules for competitive market behavior - the bedrock of a legal system for a market economy. But the administrative and judicial machinery for implementing these laws is slower to develop. Laws by themselves are only paper; the legal framework comes to life only when legal and administrative institutions can enforce the laws and readily resolve the disputes they inevitably spur, and only when the public accepts that the laws are binding. Moreover, the laws by necessity provide only a general framework. Their content must be filled by more detailed regualtions and practice in individual cases, a process that takes time. The challenge of legal development is as immense as that of economic reform, and the two are inexorably intertwined.Municipal Housing and Land,Municipal Financial Management,National Governance,Environmental Economics&Policies,Banks&Banking Reform

Bank-led restructuring in Poland : bankruptcy and its alternatives

Poland's Enterprise and Bank Restructuring Program, adopted by Parliament in 1993, provided for the resolution of problem loans through workouts, liquidation, or loan sales. In this report, the authors examine how formal"exit"processes (the movement of labor and assets out of one organization into another or into unemployment) work in Poland. They examine three exit processes - court conciliation, bankruptcy, and the liquidation of state enterprises - and touch briefly on the alternatives of debt repayment and the sale of debt. They also examine how Polish firms slated for downsizing or closure differ from those selected for survival. The most problematic of the three exit processes is the liquidation of state enterprises, which is almost entirely controlled by debtors. It is much slower than bankruptcy and should be strictly limited to solvent firms or eliminated altogether, because it invites abuse. Poland has neglected such traditional processes as bankruptcy and workout, partly because of its emphasis on bank conciliation. Now that bank conciliation has expired as an option, Poland should shift its energies to improving traditional, broadly applicable exit and workout processes rather than add new ones for selected types of firms. Special alternatives for selected firms tend to lead those firms to expect lenient treatment and thereby create a moral hazard that could stall further restructuring.International Terrorism&Counterterrorism,Banks&Banking Reform,Strategic Debt Management,Payment Systems&Infrastructure,Economic Theory&Research,Banks&Banking Reform,Strategic Debt Management,Financial Intermediation,Economic Theory&Research,Municipal Financial Management

Developing commercial law in transition economies : examples from Hungary and Russia

Implementing decentralized legal frameworks requires reasonable laws, adequate institutions, and market-oriented incentives. All three must exist together. In transition economies, not only must new laws be drafted but they must be accompanied by the growth of supportive institutions. And they must be accompanied by economic reforms - whether privatization or banking reforms - that separate actors from the state and reinforce market-based incentives. The authors of this paper use two case studies - Hungarian bankruptcy law and Russian company law - to illustrate the interaction of these three elements in practice. These cases illustrate their general view that Central Europe is somewhat further along on all three dimensions than Russia. As for incentives, in both countries relevant actors exert weaker demand for proper implementation of thelaws on the books than one would expect in more mature market economies. The cases belie any simplistic notion that the rule of law can be mechanically dictated from above. Top-down reform of bankruptcy law in Hungary appears to have been at least marginally successful in changing expectations and behavior, partly because it stimulated the growth of new supporting institutions. Finally, top-down reform of company law in Russia has had little impact to date on either institutional development or firm behavior.Legal Institutions of the Market Economy,Legal Products,Environmental Economics&Policies,Banks&Banking Reform,Judicial System Reform,Legal Products,Banks&Banking Reform,Environmental Economics&Policies,National Governance,Legal Institutions of the Market Economy

Bank-led restructuring in Poland : an empirical look at the bank conciliation process

Since 1992, Poland has been considered a model of commercial banking reform among transition economies. Its Enterprise and Bank Restructuring Program (EBRP) tried to force state-owned commercial banks to build institutional capacity and to resolve problem loans through workouts, liquidation, loan sales, or pay back. The authors reviewed the process and initial outcomes of the bank-led conciliation process. A companion paper looks at experience with the other resolution paths under the EBRP. The outcome is decidedly mixed. The EBRP forced banks to confront their problems, helped them build institutional capacity, and furthered the task of weeding out and closing unviable firms. Despite these strengths, the data suggest that the bank-led conciliation process has had limited power to promote firm restructuring or privatization. The agreements themselves included few tangible requirements for operational or management change. The first two years of implementation saw a slowdown in the layoffs rate, a decline in average operating profitability, and little real privatization. The main impact of conciliation appears to have been to reduce debt service. Weaker banks tended to be more lenient, swapping more debt for equity, and had greater difficulty forecasting future enterprise performance. The EBRP was a good start, but continued work is needed to build strong banks that can impose effective corporate governance on enterprises that need to restructure.Financial Intermediation,Banks&Banking Reform,Payment Systems&Infrastructure,Financial Crisis Management&Restructuring,Municipal Financial Management,Banks&Banking Reform,Financial Crisis Management&Restructuring,Financial Intermediation,Municipal Financial Management,Strategic Debt Management

Foreign investment law in Central and Eastern Europe

One of the most remarkable developments in Central and Eastern Europe (CEE) has been the region's opening to foreign direct investment. CEE states saw foreign investment climb from minuscule amounts in 1989 to more than $7 billion in 1992. All CEE states have enacted new laws on foreign investment as well as related legislation in areas such as taxation and company and environmental law. The authors describe these efforts at legal reform and assess their impact on foreign investment in light of what is known about investor motivation. They concentrate on the role of foreign investment law, referring occasionally to other aspects of law that apply to domestic and foreign investors. They find that specialized foreign investment laws can play a useful role during the transition to a market economy. Of particular importance is their role in sending a strong signal to foreign entrepreneurs that the host country is serious about economic reform and is willing to work with investors to establish mutually beneficial arrangements. Foreign investment laws are also often used to target special incentives to foreigners and create an island of legal development that may differ from -- and sometimes outpace -- other legal development. In such ways they tend to create investment"enclaves."But to the extent that an enclave separates foreign from domestic investors, it can quickly outlive its usefulness. The incentives it fosters may not only bleed domestic treasuries, but may also lead to bureaucratic structures that complicate the investment environment and elevate information and transaction costs for foreign investors. As quickly as possible, the transforming economies should dismantle the enclave and put domestic and foreign investors on an equal footing. This may well mean that foreign investment laws are no longer needed. The Czech and Slovak Federal Republic was the first CEE country to abolish specific foreign investment legislation in favor of a broad commercial code covering all investors. If an enclave does exist, policymakers should focus on the concerns critical to foreign firms. In the design of investment laws to date, the CEE countries have perhaps paid too much attention to preferential tax schemes, ignoring other costs foreign investors face. Policymakers should focus on reducing uncertainty and transaction costs through clear and simple legislation, contract enforcement, arbitration and other alternative dispute resolution mechanisms, stronger protection of property rights, dissemination of information on laws and on business opportunities, and an end to unnecessary bureaucratic intervention. Complex regulations not only increase investor uncertainty but divert bureaucratic resources that the host country cannot afford to squander.Environmental Economics&Policies,Legal Products,National Governance,International Terrorism&Counterterrorism,Trade and Regional Integration