How Can the Republic of Moldova Reduce the Tax Gap and Strengthen Voluntary Tax Compliance?

 

In an interview dedicated to the challenges and prospects of tax administration, international expert Damian Migueles Chazarreta shares his experience and European best practices in reducing the tax gap and improving tax compliance.

 

In this interview, you will learn:

• What are the main causes of the tax gap and how they differ from one country to another;

• How to strike a balance between supporting taxpayers, encouraging voluntary tax compliance, and implementing tax control measures;

• What are the current strengths and challenges of tax administration in the Republic of Moldova.

We invite you to explore an international expert’s perspective on opportunities to modernize tax administration in the Republic of Moldova.

Read the full interview!

 

1. From the perspective of your international experience, how would you define the main components of the tax gap, and what are generally the key factors contributing to it? Are there significant differences between countries in terms of the underlying causes of the tax gap?

 

Put simply, the tax gap is the tax that should have been paid but wasn’t. Countries measure it in slightly different ways. In Sweden, we compare the tax that would be due if everyone reported correctly with the tax we actually assess after our controls. Unpaid tax, for example after a bankruptcy, we count separately. We also leave out the revenue a country gives up on purpose through lower rates or exemptions, the so-called policy gap. That’s a political choice, not a compliance problem.

 

One distinction I find useful is between what an audit can find and what it can’t. If a company inflates its costs, there’s a paper trail, and a good auditor will spot it. But if a plumber is paid in cash and never writes a receipt, no audit in the world will find it. The two problems need different tools.

 

And this is where countries can differ substantially. Sweden and Denmark have extensive withholding and third-party reporting. As Danish evidence shows, evasion is extremely low for third-party reported income but much higher for self-reported income. The remaining tax gap therefore tends to be concentrated in areas where the administration has less independent information.

 

Elsewhere, the picture looks different. Romania has the largest VAT gap in the EU, and Italy has a large VAT gap as well as a significant undeclared economy.

 

The nature of the problem is different again in highly internationalized economies such as Luxembourg and, at least historically, the Netherlands, where cross-border corporate structures, transfer pricing and profit-shifting risks receive much greater attention.

 

So, I would not expect the same tax-gap strategy to work everywhere. The composition of the economy, the tax system, and especially the information available to the tax administration determine both where the tax gap arises and which tools are likely to be effective.

 

This is also why I would be cautious when comparing headline tax-gap estimates internationally: differences may reflect not only different levels of compliance, but also different definitions, data availability and measurement methods.

 

2. The State Tax Service is placing increased emphasis on taxpayers’ voluntary compliance. Based on your experience, what tools and approaches can a tax administration use to strike the right balance between preventing non-compliance, supporting taxpayers, and applying audit and enforcement measures?

 

Voluntary compliance and enforcement are not opposites. In my experience, the trick is to match the tool to the reason people don’t comply. Someone who made an honest mistake needs a different response from someone who is deliberately hiding income.

 

I would think about it in four steps:

First, make compliance easy and low-cost and evasion difficult and expensive. Third-party reporting, pre-filled returns, good digital services and clear information can prevent errors and remove opportunities for evasion. Evidence is striking here: compliance is extremely high when income is independently reported to the tax authority.

 

Second, you need to understand why the taxpayer is getting it wrong. Sometimes it is deliberate evasion, but sometimes it is complexity, lack of information or simply a mistake. Swedish evidence on securities reporting is a good example: about 30% of taxpayers with errors made them to their own disadvantage. Auditing harder is probably not the best solution to that problem. Better information, simplification or pre-filling may be much more effective.

 

Third, maintain credible enforcement. Randomized Swedish audits show that controls can affect taxpayers’ behaviour for several years afterwards. Enforcement therefore matters not only because it corrects today’s return, but because it changes expectations about detection tomorrow. Moreover, perceived probability of detection is perhaps the most important tool tax agencies have control over. But audits should be targeted where they are likely to have an effect, rather than simply maximized.

 

Finally, build trust. People comply more willingly when they see the tax agency and the tax system as fair. Trust does not replace enforcement, though. The two work best together. A simple and inexpensive way to build trust is a dedicated taxpayer service unit, where businesses and the tax agency can talk, exchange ideas and suggest improvements.

 

3. With regard to the Republic of Moldova, Mr Migueles, based on your experience, you have certainly had the opportunity to analyse the Moldovan tax system. From your perspective, what are the main strengths and challenges of the current tax administration and compliance framework?

 

My knowledge of the Moldovan system is partial, of course. But from my conversations with colleagues at the State Tax Service (STS), I came away with a clear impression: there is real reform momentum. People are open to implementing best practices and improving risk management. For instance, the STS has moved toward a more risk-based way of working and has built up its own analytical capacity, including estimating the VAT gap. Filing discipline in VAT also seems fairly good: the large majority of VAT returns come in on time.

 

There are challenges, of course. A large share of audits is still triggered by refund claims, insolvencies and other mandatory cases rather than by risk. That means a lot of audit effort may go where it does least good.

 

I also see a problem in the fact that the STS publishes a list of firms to be audited. That is likely to trigger behavioural responses, raising compliance among the listed firms but lowering it among firms that are not on the list, due to weaker deterrence.

 

Another challenge is measuring what actually works. If you send a letter, make a phone call, visit a taxpayer or conduct an audit, you want to know what happens afterwards. Did behaviour change? For how long? Without that feedback, it is difficult to know whether resources are being used effectively.

 

Finally, colleagues told me that many employers pay the minimum wage officially and the rest in cash, which erodes both income tax and social contributions. To me, this is a strong candidate for a dedicated gap estimate and a targeted compliance strategy.

 

My honest assessment, though, is that Moldovans are best suited to tackle the challenges. I was impressed by their technical knowledge and their commitment towards a well-functioning tax administration. I believe Moldova can make substantial progress toward EU standards in the coming years.

4. In recent years, the Republic of Moldova has incorporated into its national tax legislation not only relevant EU Directives, but also internationally recognised standards. From your perspective, how important is such alignment for improving tax compliance and reducing the tax gap? Is there also a risk that certain international practices may be adopted too quickly, without sufficient consideration of the national context?

 

Alignment matters, mainly in two ways. First, it gives the tax administration information it would otherwise never see. Take a Moldovan resident with a bank account abroad. Through the automatic exchange of information, the foreign bank’s data now reaches the tax authority at home. That covers a part of the tax gap that ordinary audits can hardly reach. Second, EU VAT rules restrict reduced rates to a defined list of goods and services, which limits how far the VAT base can be narrowed.

 

But yes, the risk exists. EU directives in our field are sound, but it is important to bear in mind that there is no “one size fits all” when tackling the tax gap, and each tax administration needs to identify the tool and methodology that best addresses its compliance problems, legal definitions and tax bases. Given that resources are limited, the STS should—in the same fashion the Swedish Tax Agency has done—carefully evaluate where, and when, each krona or leu does the most good.

 

To me, the right way to approach international standards is: learn from other countries, align where necessary, but adapt implementation to Moldova’s own risks, data and administrative capacity.

 

5. As an international expert, what should be the key priorities and objectives towards which the State Tax Service of the Republic of Moldova should concentrate its efforts in the immediate future?

 

Before you can solve a problem, you need to know what it looks like. So my first priority would be measurement. A random audit program  is optimal to detect the problem’s scope and distribution,  but expensive, I admit. Risk-based operational audit programs can be used as well, including through machine learning, to identify patterns and improve targeting. Both are likely to generate payoffs that last for several years.

 

The second priority is to make compliance easy: prefilled returns and third-party reporting whenever possible make complying easy. There are scale economies in compliance: if the STS takes over part of the work firms do today, total compliance costs can fall while the information reaching the tax authority improves. One example from our own experience: give firms the option to connect their payroll systems directly to the STS. That saves them time, and it makes paying wages off the books much harder.

 

For the next steps, the IMF’s report from this year is a very good place to start.

 

I would not disregard the role of trust either. A friendly and service-minded tax agency is likely to increase compliance as well.