Commercial Legal And Institutional Reform (CLIR) - Economic Growth

COMMERCIAL LEGAL AND INSTITUTIONAL REFORM
Diagnostic Assessment Report for the Republic of Bulgaria March 2002
Addressing this tax avoidance problem in a legal reform program focused on collateral
law is complicated, and its resolution requires a larger reform agenda. The problem
implies a number of other issues, including the tax rate. While assessments of the fiscal
system were beyond the scope of this task, the level of tax avoidance and the relatively
large informal economy suggest that the tax rate is too high for current economic
conditions. Analysis of the cost of tax avoidance is required to determine whether
lowering taxes will lead to increased compliance and higher overall revenues. 8
Another business issue affecting bank lending is that a great percentage of those seeking
loans are startups and new companies with no established credit history to support
lending without high levels of collateral and guarantees. Coupled with the fact that
pledges are difficult to enforce and thus do not necessarily provide adequate security,
many banks are not interested in extending loans.
This problem is further compounded by the lack of proper loan evaluation skills in the
banking community and the lack of credit-seeking expertise among potential borrowers.
Bankers interviewed from all banks noted that few loan officers are capable of properly
reviewing loan applications (including business plans, balance sheets, tax statements, and
other documentation of financial viability) and making a sound, market-based
determination of creditworthiness. Little credit information is available, unless provided
by the borrower, so the risk of fraud is perceived as high. 9 Risk evaluators are in short
supply. Moreover, the inexperienced private sector lacks expertise in preparing loan
applications and demonstrating cash flow, profitability, or other indices of potential
success. These factors combine to depress new lending, especially when banks have the
option of safe investments in government bonds and foreign money markets.
Despite these negatives, there are strong positives. First, trade associations other than the
Bankers Association are actively pursuing reform. The Bulgarian Investors Association
is assisting members in obtaining financing by supplying historical financial and
corporate information on its members through an Internet Web site, including balance
sheets for at least five years on the older companies. It also provides letters of
recommendation for its qualified members to banks, and negotiates with banks to offer
better rates to members. The association regularly publishes information on banking and
financing and even posts current deposit and loan interest rates on its Web site for public
comparison. It has the capacity to assist in or lead the development of computerized
8 During the 1980s, Brazil faced similar problems. High taxes, plus poor enforcement mechanisms, led to
high rates of avoidance. Companies that complied with the law were at a severe competitive disadvantage
to the majority of their noncompliant competitors. Brazil lowered the rates from 30 percent to 50 percent
down to 10 percent, which was approximately the cost of multiple bookkeeping and other noncompliance
mechanisms, so that there was no longer an economic advantage to avoidance, especially when factoring in
the risk of audit. The result was the largest collection of revenues in Brazilian history, despite a 60 percent
to 80 percent reduction in the tax rate.
9 One interviewee opined that the lack of credit information available is in part a deliberate policy of the
older banks. The theory (unconfirmed) is that banks have actually opposed publicly available credit
information because they preferred to use the lack of information to pawn off their bad customers on other
banks, evidently by letting them obtain loans elsewhere to pay off existing bad debts without competitors
finding out about the credit risks.
Booz Allen Hamilton
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