The COVID-19 crisis has devastated lives and livelihoods around the globe. Just as businesses have had to transform operations and individuals have had to rethink every aspect of daily life as they respond to the crisis, governments also have had to reinvent how they operate. This is especially true for tax authorities, which face new challenges as they seek to support unprecedented levels of government spending1 as well as a recovery from the deepest global recession since the end of World War II.2
Tax authorities are figuring out how to operate with remote workforces and rebuild audit strategies that are sensitive to current economic conditions. They are deploying new tools to support collections efforts as large-scale debt moratoriums, filing postponements, payment extensions, and widespread bankruptcies introduce noise into the traditional analytics used to segment taxpayers. Tax authorities are learning to do all of this while facing enormous pressure to collect tax revenue while also being considerate of the taxpayers trying to recover from the crisis.
Many tax authorities were facing challenges even before the COVID-19 crisis. For example, in 2017, the European Union’s value-added-tax (VAT) gap alone was approximately €137 billion. For context, that’s equivalent to nearly 20 percent of the European Union’s historic Next Generation EU fund that was recently agreed to as a way to help countries recover from the pandemic-related recession.
Tax authorities are figuring out how to operate with remote workforces and rebuild audit strategies that are sensitive to current economic conditions.
And the COVID-19 crisis has exacerbated these challenges. For example, for the fiscal year through July 15, 2020, the South African Revenue Service reported an underrecovery of $4.8 billion—more than the combined amount that South Africa borrowed from the International Monetary Fund and the African Development Bank to combat the crisis-related effects.3 Brazil’s federal tax collection in June 2020 fell to a 16-year low for the month.4 In Texas, state tax collections have decreased by approximately $5.7 billion from March through June 2020, compared with the same period in 2019.5
Tax authorities are well aware of the immediate headwinds they face from the COVID-19 crisis, and many are already mobilizing to respond. As they begin this transformation journey, it’s helpful to reflect on how the changes they lock in today could help not only to mitigate the risks of the COVID-19 crisis but also—if done correctly—to better prepare themselves for the future. Failure to consider this could cause tax authorities to face even larger future tax gaps than they are currently experiencing.
Reimagining what the future could look like
How can tax authorities position themselves for success over the next several decades, even as they are working tirelessly to address today’s challenges? It starts by having a vision for what the future could look like and how tax authorities could thrive within it.
In one provocative vision for the future, for example, the tax authority becomes entirely invisible. This is one possible scenario that could evolve from today’s landscape of cashless payments, cash registers and digital-invoicing tools that are connected directly to accounting software, and digital tax registries—that is firmly established and maturing in many countries. To understand what this would mean, let us follow the journey of an imaginary taxpayer—a baker we will call Maria.
Today, when Maria shops for raw materials for her business, she pays a VAT in most OECD countries.6 When she sells a loaf of bread, she collects a VAT from the customer. Maria must keep meticulous records of every transaction, and—during each VAT filing period—calculate thousands of these transactions in order to reconcile her net VAT obligation. This is in addition to tracking business expenses and other corporate income tax deductions, employee payroll withholding, and other tax records to ensure that she is fully tax compliant. Under this system, tax compliance is time consuming and costly. And in many cases, it reduces cash flow to small businesses, which must wait to receive VAT and income-tax refunds.
An invisible tax authority could change all of this.7 In such a system, when Maria buys her raw materials, she doesn’t pay any tax. Instead, the cashier terminal simply sends real-time information to the tax authority, creating a digital record of the purchase. When Maria sells a loaf of bread, her customer pays a tax that reflects the value added throughout the entire value chain (think of this as a “virtual VAT” or an “auditable retail sales tax” system), and again, real-time information is sent to the tax authority. This system creates an auditable trail through the real-time digital records of transactions—not through counterparties reporting pairs of input VAT and output VAT—enabling the tax authority to levy a net tax at only the end of the value chain because it already has visibility into every previous transaction.
The data sent to the tax authority are used to calculate Maria’s corporate income tax obligation generated from each transaction in real time, and estimates of her business revenue and costs and other deductions are made (and refined over time with machine learning). VAT collected by Maria and her per-transaction corporate income tax obligation are immediately deposited with the tax authority as part of each transaction.8 Once a quarter, Maria receives a digital tax statement showing her total liability and what’s already been paid automatically. Her remaining net tax obligation or refund, if any, is automatically processed, according to the preferences Maria has set on her account.
In such a future, an invisible tax authority increases a business owner’s compliance while reducing the associated burden and cost. This is only one possible future. Rapidly transforming economies and new sources of data, digital tools, and advanced analytics will offer tax authorities many additional ways to improve the citizen experience while increasing compliance and operational efficiency. Consider some other scenarios that tax authorities could face in the future:
- The economy goes cashless. In an economy in which virtually all transactions are conducted with noncash payments, the volume of digital-payment data available would increase, and new transactional patterns would emerge. Advanced analytics and machine-learning capabilities would become much more critical to compliance activities.
- Businesses—especially small and medium-size enterprises—replace accountants with cloud-based accounting software. As the global cloud-accounting software market grows (and becomes cheaper and more reliable), small and medium-size enterprises may increasingly file their taxes through software-as-a-service accounting providers, which would transform how this critical group of taxpayers interacts with the tax authority.
- Gig-economy income becomes a major share of tax liabilities. As the gig economy grows, tax obligations from the income earned in such platforms could become an increasingly large share of what’s owed to tax authorities. This could create a challenge: tax authorities would be facing large aggregate volumes of individuals (each with small-value individual tax obligations) from a sector of the economy that traditionally has faced problems with lack of information reporting and nonfiling.
- Governments enact multiple new types of taxes. As public and political sentiments shift—especially across the OECD countries—governments may enact new taxes, such as technology taxes, data taxes, carbon taxes, and net-worth taxes.9 Each new tax would require tax authorities to integrate new data streams and analytics to assess value, ensure compliance, and administer it effectively.
In many countries, the future is closer than tax authorities think—and the COVID-19 crisis has accelerated it
The possible futures we’ve described aren’t far-off visions. They are scenarios that could play out in the very near term, driven by key global trends that are shaping how businesses operate, how people live, and how technology is integrated into the economy. These trends have been maturing for a long time, and the COVID-19 crisis has accelerated them.
Long before the global health pandemic, the rates of data creation and technology adoption were rapidly accelerating. The global public cloud services market grew 15 percent annually over the past ten years, and as of 2019, 89 percent of small and medium-size businesses around the world were using a cloud service.10
At the same time, economies have been rapidly digitizing. The rise of fintech has increased the sophistication of the payment industry and consumer acceptance of real-time account-to-account payments and digital transactions (even eliminating the manual payment step completely in some cases, such as in Amazon Go stores). And economies have been heading toward a virtually cashless future. In 2016, the Bank of Korea announced plans to move to a cashless society by 2020, and Denmark, the Netherlands, and the United Kingdom have been on track to see fewer than five cash transactions per person per month by 2030.11
In addition, the nature of work itself has been shifting. As of 2016, there were more than 162 million independent workers in the EU-15 and the United States, and global revenues from the gig economy are expected to double between 2018 and 2023.12
Recent data show that the response to the COVID-19 crisis has only accelerated these trends; consumer and business digital adoption vaulted five years forward in just one period of about eight weeks.13 With more than 1.5 billion people around the world confined to their homes at the peak of the COVID-19 pandemic, businesses from grocery stores to healthcare-delivery companies to educational institutes expanded to digital platforms, joining other services (such as meal-delivery, e-commerce, transportation, and financial services) that were already on them.14
In response to the crisis, many countries have explicitly encouraged the use of mobile money—and many mobile-money platforms have decreased or eliminated transaction fees. In India, ATM usage fell by 47 percent in April 2020, and spending via Unified Payments Interface—the nation’s local real-time payment system—increased by roughly 70 percent over the first seven months of 2020. The United Kingdom experienced a 46 percent decline in ATM usage per month on average from March to July 2020, and the average daily value of transactions processed by the United Kingdom’s Faster Payments service rose by more than 10 percent from the fourth quarter of 2019 to the end of March 2020. By the end of 2020, we expect a shift of four to five percentage points in the share of global payment transactions executed via cash—equivalent to four to five times the annual decrease in cash usage observed over the past few years.
Tax authorities can evaluate these trends within their own countries to anticipate what their futures will look like and determine what specific steps they can take to adapt in the most advantageous way possible. By developing new tools and new ways of operating in an increasingly digital economy, tax authorities can ensure that they both maintain visibility into the market as new kinds of digital transactions emerge and have the ability to monitor an increasing amount of data for compliance.
The process of reinventing a tax authority can start immediately with three key shifts
As tax authorities reinvent their organizations to respond to the challenges of the COVID-19 pandemic, they also have an opportunity to build a new foundation that will enable them to thrive as economies and citizens cross the digital Rubicon. At a recent conference of around 25 tax authorities hosted by the OECD, tax leaders from around the globe discussed how reimagining three key aspects of their organizations—operating model, workforce, and relationships with citizens—could help tax authorities adapt to global trends while unlocking benefits for their customers and better equipping their organizations to reduce voluntary and involuntary noncompliance in the economy of the future.
As tax authorities respond to the challenges of COVID-19, they also have an opportunity to build a new foundation to thrive as economies and citizens cross the digital Rubicon.
Transforming the operating model to look more like a consumer-facing technology company
Most tax authorities’ traditional organizational structures won’t be able to support the levels of data integration that will be required in the near future. Data-driven decision making will need to be built into every part of tax authorities’ operations, integrating new types of data from new sources.
Technology will no longer be able to be isolated within a silo or used only as a backward-looking analytics tool—say goodbye to analytics departments. Advanced analytics, machine learning, and artificial intelligence will need to be embedded throughout all operations. And as data evolve constantly and rapidly, tax authorities will need to become agile at updating their approaches, deploying new technology faster than ever before.
Placing technology at the core of operations will also present tax authorities with important questions to resolve. They will need to make critical choices about the level of human involvement in decision making: which decisions should be made by advanced analytics with only occasional human intervention and which should be informed by data but still made by humans.
In addition, tax authorities that see a future in which their economies are fully digitized will need to start considering how they integrate themselves into the network of transactions and payments. There are two main approaches they can take. Tax authorities can either be directly integrated into—and central to—the network of transactions and payments, or they can establish connections through third-party private- or public-sector intermediaries. This complex decision will require governments to consider many factors, including the maturity of the local digital-payment and -transaction infrastructure, readiness of the local ecosystem of digital-payment and -tax providers, and level of trust in the government’s handling of personal data.
A tax authority directly integrated into—and central to—the network. A tax authority directly integrated into—and central to—the network of transactions and payments would be a truly invisible tax authority. Every transaction would create a digital record that would be sent to the tax authority in real time. The applicable tax payments (with adjustments where necessary) would be remitted to the tax authority seamlessly and automatically in the background.
This approach would require tax authorities to have vast and ever-expanding amounts of taxpayer data and sophisticated data capabilities. It would require a largely cashless economy and high levels of trust in the government and its ability to handle data safely.
A tax authority connected through third-party private- or public-sector, intermediaries. A tax authority connected to the network of transactions and payments through third-party private- or public-sector intermediaries would enable taxpayers to have more control over their data and interactions with the tax authority. Taxpayers could contract with third-party platforms that would integrate all of their transactional and payment data—including from credit-card and other digital-payment platforms, employer and business accounting software, and bank accounts—and aggregate it for filing with the tax authority. The third-party platforms would have direct connections to the tax authority and could prompt users to approve automatic filings and payments.
In this approach, taxpayers could elect either to have their submissions include all supporting documentation and metadata or to withhold supporting documentation unless it was requested by the tax authority during an audit. This scenario creates the possibility for automatic compliance while leaving taxpayers with a choice of how to integrate into the system.
Attracting and retaining a new type of tax workforce
Tax authorities will need to integrate technologists into each of their departments and teams. In the future, data and analysis experts could make up more than 50 percent of the typical tax-authority workforce. This will require a significant redesign of tax authorities’ talent strategies.
Instead of sourcing talent from accounting companies and tax advisories, tax authorities will have to compete with big-tech companies (such as Google and Facebook) and the fintech start-ups of the world for digital specialists. Instead of relying on the appeal of long-term stability, attractive healthcare benefits, and generous government pensions, tax authorities will have to figure out how to attract a group of people who prioritize workplace culture, meaningful work, and flexibility.
It’s critical that tax authorities begin rethinking their talent strategies immediately. The public sector is already having a hard time attracting digital talent. For example, only 44 percent of US government employees in 2019 believed that their organizations could recruit people with the right skills.15
And at the same time that tax authorities are making this talent shift—if not before—the private sector and other public-sector organizations will also be making it. Tax authorities will be competing not just with Google and Facebook but also with multinational insurance companies, global manufacturers, and large agricultural processors, among others, in the race for digital talent.
Adopting a relentless focus on building positive relationships with citizens
Tax authorities will need to become more citizen-centric and start building a foundation of transparency, accountability, and trust to enable their digital futures. Today, governments are some of the worst performers in many countries—behind utilities, credit-card companies, and cable companies, among others—when it comes to customer service (Exhibit 1).16 As digital integration becomes the norm in society and consumer expectations for omnichannel experiences continue to increase, tax authorities will need to embrace citizen-centric, digital technologies that can improve taxpayers’ customer experiences and help reduce the gap between consumer expectations and the customer-service levels provided by tax authorities.
Expectations of transparency and data protection are also increasing dramatically among consumers. As technology becomes more integrated into tax authorities, and data—most of them sensitive and personally identifiable—are increasingly driving decision making and being exchanged among tax authorities and third parties, tax authorities will have to think seriously about data protection and cybersecurity and about building trust and confidence with the public.
This presents a challenge for many tax authorities in countries where citizens have traditionally been more wary of allowing the government to hold vast amounts of personal data.
Even as it becomes more common for data to be seamlessly integrated into every aspect of an individual’s life, these attitudes toward governments are likely to persist. A recent survey of consumers in six countries showed that more than half the populations surveyed have limited to no trust in their governments to handle their personal data (Exhibit 2). And it’s still too early to tell how the COVID-19 crisis—and the increased sharing of personal data with the government to support contact tracing and other public-health measures—has affected such sentiments.
In many cases, such mistrust is not tied to a single data breach or abuse but rather linked to overall government mistrust. For this reason, it likely won’t be sufficient for tax authorities to roll out new data-governance protocols and controls as they transform. Instead, they will need to start building trust with their customers today through transparency, accountability, and reliability. This transformation can’t happen overnight, and tax authorities that wait to begin this effort will find that they have greater difficulty in building citizen buy-in down the road, when they begin to transform more fundamentally the ways they operate in a digital economy.
The time to act is now
Leading private-sector companies are focused on anticipating the future and transforming their organizations today to adapt to it. During the COVID-19 crisis, they have accelerated the scope and scale of innovation while using technology and data in new ways, accomplishing difficult tasks and achieving positive results in record time. Faced with increasing tax gaps and rapidly accelerating global trends, tax authorities need to transform just as quickly to keep pace with the changing economy. Yet it isn’t clear that the majority of tax authorities are taking similar steps or moving quickly enough.
Transforming a tax authority’s operations will take time. Large legacy organizations in the private sector typically take at least three to five years to complete a transformation of such magnitude. And when considering this, it is clear that many tax authorities are at risk of moving too slow and thinking too small about the future—especially as the COVID-19 pandemic has amplified focus on short-term strategies to recover from the immediate crisis.
If tax authorities don’t use this moment to prepare for the future, they will likely be forced to undergo two separate once-in-a-generation transformations in rapid succession: rebuilding in response to the COVID-19 crisis and adapting to the digital economy. And more critically, they will risk not being prepared as their economies transform around them.
But if tax authorities fully embrace this moment, improved customer experience, increased compliance, and more efficient operations may only be the beginning of what’s possible. With the help of advanced analytics, tax authorities could create accurate and precise views of microsegmented, noncompliant people and companies, allowing tax authorities to give personalized nudges to self-correctors while deploying auditing teams for high-risk cases—including those at risk of insolvency and those who may be engaging in illegal activity. New technologies could enable tax authorities to reduce tax gaps to zero and completely eliminate no-change audits.17 And transaction-level data could provide real-time economic insights by neighborhood, allowing governments to monitor the health of their economies better and policy makers to target interventions and other policy programs better.
Tax authorities must think big when it comes to what the future could look like. And they must start this process now. They must focus not just on building solutions to the immediate challenges posed by the COVID-19 crisis but also on embracing the future and positioning themselves to reach new levels of success by adapting to it. Creating the tax authority of tomorrow can start today.