Advising on Tax Reform in Mongolia

Over the last 15 years, international economics professor Craig MacPhee has been asked to serve as an advisor in several countries of the old Soviet bloc, including Georgia, Poland, Russia, and the former Yugoslavia. In summer 2006 he had the unique experience of working in Ulann Bataar, Mongolia, the world’s least densely populated country and the world’s coldest capital city. The most democratic and peaceful country in central Asia, Mongolia is regarded as strategically important for its significant copper and gold resources and is a site of active exploration for oil. Mongolia is a major transportation corridor between Moscow and Beijing.

Mongolia suffered the same problems that afflicted many other countries making the transition from communism to capitalism. The collapse of the Soviet Union, Mongolia’s main trade partner, meant that agriculture and industry lost both suppliers and customers. Loss of government revenue from publicly owned enterprises led to inflationary monetization of budget deficits, resulting in high inflation, unemployment, and low standards of living.

Ulaan Baatar is a modern metropolis of 900,000 with many new buildings, state of the art communications, and traffic jams. In the rest of the country, there are few paved roads and power lines. Nearly one-half of the population lives in gers, large round tents covered with felt. Most of the people living in gers are nomadic herders who refer to themselves as the five-animal people (camels, goats, horses, sheep, and yaks). This large subsistence agriculture sector and many other small enterprises are not fully recognized in official income statistics and contribute little or nothing to government revenue.

Mongolia has made significant progress in lowering inflation and increasing employment, thanks in large measure to restrained monetary policy, foreign investment and high copper and gold prices. Nevertheless, the International Monetary Fund has expressed concern that the economy and the government budget could be vulnerable to decreases in its terms of trade.

One way of addressing this vulnerability is tax reform, broadening the tax base, simplifying the laws and lowering rates in order to encourage more investment, job creation and less tax evasion. This year the Mongolian parliament considered bills to reform many of its tax regulations. At the request of the Mongolian government, the United States Agency for International Development arranged for Craig MacPhee to analyze three indirect-tax proposals. MacPhee worked with officials of the Mongolian tax and customs departments to develop a computerized database of imports because most VAT and excise revenue comes from imported products. Next he developed computer models for estimating the revenue effects of proposed changes in the tax laws. MacPhee then met with members of relevant parliamentary working groups to discuss the results of the analysis with them and trained officials in the tax department, the finance ministry, and the industry and trade ministry in the use of the computer models. Although the Mongolian government passed an ill-advised windfall-profits tax to increase its immediate return from the high price of metals, other tax bills that the parliament passed were consistent with pro-growth policies.

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Marilyn Hoskins