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chapter 2 Creating a Capitalist Tax Structure after Communism Even in the best of times, extracting resources from a population has eluded leaders who aspire to increase revenue. In the Soviet era, leaders in communist regimes managed to extract revenue by closely controlling all formal economic activity. Collecting taxes was an administrative task within the overarching structure of (near total) state control of the economy. Garnering taxes amounted thus to little more than withdrawing revenue from various enterprise accounts to which the state had full access. That said, communist states still failed to control absolutely all economic activity, as pockets of informal private economic activity occurred beyond the state’s reach. The private activity that had been previously illegal and thus hidden became legal and necessarily encouraged within the new postcommunist capitalist regimes. Nevertheless, the new bureaucracies could not easily tax it. Encouraging and tapping new private economic activity became the new challenge for the emerging capitalist states. After communism, bureaucratic capacity was weak in many sectors, but it was especially weak in the tax bureaucracy given the almost-automated, administrative nature of taxation under the past planned economy. Achieving the authority and capacity to tax economic activity quickly daunted the newly elected postcommunist leaders. Tax laws had to be fundamentally redesigned. The new tax laws would need to reallocate responsibility for tax revenue within the population, establish a new approach to taxing consumption, and identify and evaluate the usefulness of entirely new tax forms that would have made little sense under a communist system, like property taxes or inheritance taxes. Elected of‹cials lacked experience in distributing the revenue burden effectively across different economic actors and activities; bureaucrats lacked the resources and practical experience of collecting taxes; and taxpayers had little if any experience in recognizing and meeting their ‹scal obligations to the state. This lack of experience all around rendered the modern state’s revenue imperative extraordinarily dif‹cult to meet after the collapse of communism. This chapter provides a broad overview of the initial challenges to creating new tax systems in Eastern Europe, focusing on the early transitional reces19 sions, the loss of traditional revenue sources, and the undermonetization of the economy in the early and mid-1990s. This discussion seeks to elucidate the overwhelming task of designing tax structures that would reliably generate revenue, mesh with existing attitudes about inequality and wealth distribution , and ultimately raise revenue suf‹ciently and ef‹ciently under challenging political and economic constraints. This chapter then examines three necessary aspects of the ‹scal transformation. First, the postcommunist governments had to develop a tax system that functioned within a private property, private business environment. Second, these governments had to expand, retrain , and empower the tax bureaucracies to collect the new taxes. Third, the populations had to learn to adapt to and abide by the new capitalist tax regime. After exploring these three areas, the chapter closes with some discussion of the distributional implications of the evolving tax regimes in postcommunist economies. Fiscal Reform under Recessionary Conditions When the East Europeans began to redesign a tax system more appropriate for a private capitalist economy, economic conditions were dire. Fiscal reformers faced four inhospitable and mutually incompatible conditions under which they had to reorient the tax system: falling economic output, rising unemployment , growing demand for social protection, and the political vulnerability of new politicians. In virtually all East European countries, a severe contraction in production and trade followed the collapse of communism. The contraction of the postcommunist economies immediately limited the pool of resources from which revenue could be drawn. While some economic decline was expected with the collapse of Soviet-era trading relations and the closure of inef‹cient state enterprises , the degree of contraction in the early years of transition was severe. For instance, during the ‹rst three years of transition, Hungary’s GDP declined by 17.6 percent, Poland’s GDP by 15.6 percent, and Czechoslovakia’s GDP by 15.4 percent. Economies to the east were hit even harder. The GDP contracted 26.4 percent in Ukraine, 25.6 percent in Bulgaria, and 25.0 percent in Romania.1 In the case of Russia, this contraction was even higher and lasted much longer, approaching 40 percent by 1998 (Appel 2008). These early transitional recessions confounded ‹scal reform because as the tax base shrunk, the generation of revenue became particularly dif‹cult while the need for social protections ballooned. The postcommunist governments faced growing 20 tax politics in eastern europe...

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