Document o f The World Bank

Report No: 25875-UA

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED LOAN

IN THE AMOUNT OF US$40.00 million

TO UKRAINE

FOR THE

FIRST STATE TAX SERVICE MODERNIZATION PROJECT

IN SUPPORT OF THE FIRST PHASE OF THE STATE TAX SERVICE MODERNIZATION PROGRAM

May 7,2003

Poverty Reduction and Economic Management Department Ukraine, Belarus and Moldova Country Unit Europe and Central Asia Region

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APL CAS C M M ConOps CPAR CQ DC EA ECA ECCU2 EMP EO1 ESW EU FIS FMR FMS GDP GOU GPN HQ I A S IBRD IC ICB ICR ICT IDA ID-APL IFAC IFC IMF IOTA IP I S ISA

CURRENCY EQUIVALENTS

(Exchange Rate Effective December 3 1,2002)

Currency Unit = Hryvnya (UAH) 100 UAH = US$18.75

US$lOO = UAH533.24

FISCAL YEAR January 1 -- December 31

ABBREVIATIONS AND ACRONYMS

Adaptable Program Lending Country Assistance Strategy Capability Maturity Model Concept o f Operations Country Procurement Assessment Report Consultant's Qualifications Direct Contracting Environmental Assessment Europe and Central Asia Europe and Central Asia, Ukraine/Belarus/Moldova Country Unit Environmental Management Plan Expression o f Interest Economic and Sector Work European Union Financial Information System Financial Monitoring Report Financial Management System Gross Domestic Product Government o f Ukraine General Procurement Notice Headquarters International Accounting Standards International Bank for Reconstruction and Development Individual Consultants International Competitive Bidding Implementation Completion Report Information and Communication Technologies International Development Association Institutional Development Adaptable Program Lending International Federation o f Accountants International Finance Corporation International Monetary Fund International Organization o f Tax Administrations Internet Protocol International Shopping International Standards o f Auditing

I S 0 IT K P I LAN L C LDP L T O M O E M O F MTR NBF N G O N S P A D PCD PHRD PID PIP P O M PPF

QCBS O & M SBD SEI SIL SME SOE ss STA STS STSMP S&I TA TLISRD TOR SA UAH USAID USD VAT VR

QBS

International Standards Organization (United Nations) Information Technology Key Performance Indicator Local Area Network Least Cost Letter o f Development Program Large Taxpayer Office Ministry o f Economy and Issues o f European Integration Ministry o f Finance Mid-Term Review Non-Bank Financed Non-Governmental Organization National Shopping Project Appraisal Document Project Concept Document Policy and Human Resource Development (Japanese Grant) Public Information Document Project Implementation Plan Project Operations Manual Project Preparation Facility Quality Based Selection Quality and Cost-Based Selection Organization and Management Standard Bidding Document Software Engineering Insti tute Specific Investment Loan Small and Medium Enterprises Statement of Expenditures Single Source State Tax Administration (STS HQ) State Tax Service State Tax Service Modernization Program Supply and Installation Technical Assistance Top Level Integrated System Requirement Document Terms o f Reference Special Account

United States Agency for International Development United States Dollar Value Added Tax Verkhovna Rada

Hryvnya

Vice President: Johannes F. Linn

Sector Director: Cheryl W. Gray Country Director: Luca Barbone

Craig R. Neal Task Team Leader:

UKRAINE FIRST STATE TAX SERVICE MODERNIZATION PROJECT

CONTENTS

A. Program Purpose and Project Development Objective

1. Program purpose and program phasing 2. Project development objective 3. Key performance indicators

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 2. Ma in sector issues and Government strategy 3. Sector issues to be addressed by the project and strategic choices 4. Program description and performance triggers for subsequent loans

C. Program and Project Description Summary

1. Project components 2. Key policy and institutional reforms supported by the project 3. Benefits and target population 4. Institutional and implementation arrangements

D. Project Rationale

1. Project alternatives considered and reasons for rejection 2. Major related projects financed by the Bank and/or other development agencies 3. Lessons learned and reflected in the project design 4. Indications o f borrower commitment and ownership 5. Value added o f Bank support in this project

E. Summary Project Analysis

1. Economic 2. Financial 3. Technical 4. Institutional 5. Environmental 6. Social 7. Safeguard Policies

Page

3 3 4

5 6 8 .

10

15 16 17 18

20 23 23 27 30

31 32 33 34 37 38 41

F. Sustainability and Risks

1. Sustainability 2. Critical risks 3. Possible controversial aspects

G. Ma in Conditions

1. Effectiveness Condition 2. Other Implementation Program and Conditions o f Board Presentation

H. Readiness for Implementation

I. Compliance with Bank Policies

Annexes

Annex 1: Project Design Summary Annex 2: Detailed Project Description Annex 3: Estimated Project Costs Annex 4: Cost Replacement Analysis Annex 5: Financial Summary Annex 6: Procurement and Disbursement Arrangements Annex 7: Project Processing Schedule Annex 8: Documents in the Project File Annex 9: Statement o f Loans and Credits Annex 10: Country at a Glance

41 42 44

44 45

46

47

48 55 66 67 69 70 80 82 84 86

MAP( S)

Ukraine (IBRD 27828R)

UKRAINE First State Tax Service Modernization Project

Project Appraisal Document Europe and Central Asia Region

ECSPE

9PL 1 Loanl

Date: May 7,2003 Sector Manager: Helga W. Muller Country Director: Luca Barbone Project ID: PO57815

US$ m % US$ m US$ m Date Date 40.00 46.8 45.56 85.56 0613012008 Ukraine

Team Leader: Craig R. Neal Sector(s): Central government administration (1 00%) Theme(s): Tax policy and administration (P), Administrative and civ i l service reform (S)

Credit

Loanl Credit

9PL 2

rotal

t Lending Instrument: Adaptable Program Loan (APL)

Borrower

73.74 63.5 42.32 1 16.06 0613 0120 1 3 Ukraine

113.74 87.88 201.62

BORROWER [BRD rotal:

45.16 0.40 45.56 14.42 25.58 40.00 59.59 25.98 85.56

Grace period (years): 5 Commitment fee: 0.75%

Years to maturity: 20 Front end fee (FEF) on Bank loan: 1.00% Payment for FEF: Capitalize from Loan Proceeds

Borrower: UKRAINE Responsible agency: STATE TAX ADMINISTRATION OF UKRAINE (STA) Headquarters o f the State Tax Service o f Ukraine (STS)

Address: State Tax Administration o f Ukraine, 6, 8 Lvivska Square. Kiev, 04655, Ukraine Contact Person: Mr. Olexiy SHYTRIA, First Deputy Head / Modernization Project Manger Tel: (380-44) 247-3309 Fax: (380-44) 212-4597 Email: sta-project@sta.gov.ua

Estimated Disbursements ( Bank FY/US$m):

Project implementation period: 5 years (and approximately two years o f project preparation financed by the PPF,

Expected effectiveness date: 01/01/2004 2002-03).

Expected closing date: 06/30/2008

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A. Program Purpose and Project Development Objective 1. Program purpose and program phasing:

By reforming tax administration in Ukraine, the State Tax Service Modernization Program (STSMP) seeks to lay the foundations for a sustainable tax system. Sustainability has technical, political, and economic dimensions. I t requires a tax administration that is:

Efficient and effective.

0 Even-handed, transparent, and accountable.

0 Commerce-friendly (i.e., predictable in i t s treatment o f taxpayers, minimally burdensome in i t s transactions, and a contributor to macroeconomic stability).

More generally, sustainability requires an administration where a strong assumption of voluntary compliance to the Tax Legislation by taxpayers i s matched with a strong capacity to detect and properly remedy non-compliance.

The STSMP supports a comprehensive, decade long transformation o f the State Tax Service (STS) including i t s national Headquarters, the State Tax Administration (STA). For an orderly process o f institutional development, the STSMP embodies two sequenced phases. Each phase addresses a mix o f organizational and management issues, as well as operational issues. The initiatives add up to a comprehensive reform, while building and demonstrating the STS's implementation capacities.

The STSMP focuses on tax administration. As an investment operation, the STSMP leaves tax policy matters largely for other instruments o f Bank and IMF support (e.g., adjustment operations, policy dialog, etc.). However, the STSMP does seek to strengthen the capacities o f the Ministry o f Finance (MOF), Ministry o f Economy and on Issues o f European Integration o f Ukraine (MOE), the Verkhovna Rada, and the STA in the areas where their responsibilities overlap and important synergies are created. These areas include reviewing, analyzing, revising, and drafting tax legislation and regulations for the purpose of: (a) more efficient and effective tax administration; (b) lower compliance costs for taxpayers and for third-party payers o f taxes (hereafter collectively "taxpayers"); and (c) more predictable revenue collection and more effective pursuit o f other fiscal objectives.

Since the STSMP does not encompass tax policy, i t s impact on total tax revenues, or even revenues as a percentage o f GDP is, strictly speaking, unpredictable. Nevertheless, with an estimated 50-70 percent rate o f compliance to the Tax Legislation, the STSMP i s highly likely to lead to an increase in revenues collected, by expanding the de facto tax base. This wil l provide the Government with opportunities to encourage a virtuous cycle o f (a) lower rates; (b) lower compliance costs; (c) broader sharing o f the tax burden; (d) economic growth; and (e) increased tax revenues. Whereas the STSMP objective i s improved compliance - and not increased tax revenues per se -- revenues from increased compliance should also provide more than adequate additional resources to justify and sustain the STSMP's expenditures. (See Section E for economic and financial analyses o f the STSMP.)

2. Project development objective: (see Annex 1)

The two-phase State Tax Service Modernization Program seeks to establish a sustainable state revenue system. This includes: (a) voluntary compliance with the Tax Legislation by

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taxpayers and third-party payers; (b) competent, honest, and equitable administration by the State Tax Service; and (c) a growing and efficient enterprise sector.

Phase 1 seeks to establish sound organizational and operational foundations for the State Tax Service. These include: (a) modernized business process and organizational designs; (b) a consolidated and function-based structure; (c) a proven prototype o f modernized taxpayer registration, tax accounting, declaration processing, and document management functions; (d) strengthened capacities in priority areas o f human resource management, senior and middle management, legislative and statistical analysis, audit, collection, large taxpayer offices, etc.; and (e) enhanced public accountability mechanisms.

Phase 2 seeks to modernize STS operations on a nationwide basis and to complete the modernization o f the STS's institutional management functions (i.e., executive management and institutional representation, legislative affairs, internal business support, internal control, reporting and analysis, human resources, internal administration, document and records management, institutional computing resources).

A sustainable state revenue system i s one that provides the legally mandated revenue to the state budget -- on the basis o f technically, politically, and economically sustainable arrangements. The STSMP would seek to:

0 Increase voluntary compliance to the Tax Legislation by taxpayers, by: (a) reducing the cost o f compliance; (b) increasing the probability o f discovery o f tax evasion and non-payment; (c) increasing the credibility o f collections and effectiveness o f dispute resolution mechanisms; and (d) increasing taxpayer and third-party understanding o f the Tax Legislation, administrative procedures, available taxpayer services, taxpayer rights, as well as taxpayer and STS obligations.

Achieve competent, honest, and equitable administration o f taxes by the STS, by: (a) improving the STS's capacity to apply the Tax Legislation accurately and uniformly; (b) improving the STS's capacity to monitor and maintain i t s administrative integrity; and (c) strengthening the public's ability to monitor and hold the STS accountable for proper tax administration.

Foster economic growth by: (a) enabling a reduction in tax rates via a broader tax base, as a result o f increased compliance; (b) reducing micro-economic price distortions via more uniform cost structures across f irms, as a result o f greater compliance; (c) reducing operating costs o f productive entities via lower compliance costs and reduced corruption and administrative abuse; and (d) increasing macro-economic stability via greater fiscal stability, as a result o f sustainable revenue performance.

0

0

3. Key performance indicators: (see Annex 1)

The following are performance indicators for the STSMP.

Improvement in an indicator o f voluntary compliance from a 2001 baseline o f 54.54 to 65.0 by the end o f Phase 1 to 80.0 by the end o f Phase 2.

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0 Improvement in an indicator o f the cost o f voluntary compliance from a 2001 baseline o f 56.1 1 to 65 by the end o f Phase 1 to 75 by the end o f Phase 2.

Improvement in an indicator o f likelihood o f detection o f non-compliance from a 200 1 baseline o f 5 1.70 to 60 by the end o f Phase 1 to 75 by the end o f Phase 2.

Improvement in an indicator o f the quality and integrity o f STS administration from a 2001 baseline o f 34.56 to 55 by the end o f Phase 1 to 80 by the end o f Phase 2.

0

0

B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: 20723-UA Date of latest CAS discussion: 8/16/00

The CAS dated August 16,2000 specifies a "two-legged" strategy, with subordinate sub-goals. The two main tracks are: (a) support c iv i l society in i t s demand for better government; and (b) support opportunities to strengthen institutions that foster sustainable development.

The STSMP i s fully consistent with and supportive o f these twin goals:

0 Demand for Better Government. By increasing the accountability o f the State Tax Service, among other mechanisms, a successful State Tax Service Modernization Program would support the sub-goals o f reduced regulatory burden on businesses; improved quality o f public service delivery; and reduced corruption.

Development-Oriented Institutions. As indicated in Annex B 9 to the CAS, a Bank-supported tax administration modernization project would support the sub-goals o f revenue policy reform and improve the capacity o f public institutions. A successful State Tax Service Modernization Program would also further the sub-goals o f consolidating the macro-economic environment and improving the business environment.

0

The CAS for 2004-2007 i s currently under development. Board discussion i s planned for July 24,2003. As o f May 1,2003, the draft mission statement for the new CAS is: To assist Ukraine in building institutions necessary for sustainable and equitable growth and for poverty reduction. To support Ukraine 's aspirations with regard to increasing integration with the EU and with the WTO. To help provide Ukraine's citizenry greater voice and to foster stronger accountability of government. The STSMP remains consistent with and supportive o f these goals.

The two track approach o f the 2000-2003 CAS has also shaped the STSMP preparation and design processes. As part o f the preparation o f the STSMP, a pair o f accountability bodies are being established. First, under the authority o f the Presidential Administration, an independent Oversight Panel w i l l be established for the STS. The Oversight Panel comprises a small number o f high profile, internationally recognized experts in fiscal administration and public management. The Oversight Panel wi l l convene at least twice a year to assess the STS's progress in transforming i t s relationship to the rest o f Ukrainian society. The Panel wi l l makes i t s findings public. To provide the Oversight Panel wi th a point o f reference for i t s assessment, the Cabinet o f Minsters has published a public vision statement for the modernization o f the tax

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system, including the principles for the transformation o f the STS. (See Annex 1.1 o f the Project Implementation Plan in the Project Files for a translation o f the Government's vision statement).

As a complement to the Oversight Panel, and to strengthen the voice o f the many stakeholders in tax administration, the STA has established a Public Collegium (founding meeting June 16,2002). This body comprises representatives o f Ukrainian non-governmental organizations concerned wi th taxes, commerce, and public administration reform. The Public Collegium shall meet at minimum on a semiannual basis and provide the STS with a consultative forum for advice and feedback on matters o f tax administration. In addition to the Statute on the Public Collegium, the STA has published a vision statement for i t s modernization program (of which the STSMP i s a central element). L ike the Cabinet o f Minister's vision statement, the STA's vision statement emphasizes accountability, probity, and service-orientation in tax administration.

The accountability bodies and vision statements wi l l combine to strengthen the channel for Ukrainian society to express i t s demand for better public institutions.

The STSMP w i l l undertake a complete modernization o f the STS, directly supporting the second pillar o f the CAS: creating development-oriented institutions. Over the course o f a decade, the STS's organizational structures, management arrangements, and operations w i l l undergo a complete overhaul. The efficiency and effectiveness gains in tax administration that will emerge through the STSMP will directly contribute to a more commercially supportive environment, at both the micro and macro-economic levels. The STSMP will also lead -- over time -- to a rationalization o f the mechanisms to collect revenues for those sub-national administrative uni ts that gain legal powers to raise their own revenues. This wil l encourage the reform process for intergovernmental finance by allowing local spending authorities to have a corresponding measure o f control o f their revenues -- within a transparent, wel l founded legal and technical framework.

2. M a i n sector issues and Government strategy:

Main Sector Issues.

In Ukraine, the transition from an administered economy to a market-based economy has been drawn out. Despite the decade that has passed since independence, the transition remains unfinished. Among other things, both the productive sector and state agencies s t i l l rely on a variety o f old-style, administrative mechanisms to obtain and redirect revenues. T o a large extent, these mechanisms preempt many o f the financial decisions that independent economic actors would make in a market system. With i t s oversight over tax and non-tax revenues equal to approximately 20 percent o f GDP, the STS i s a key feature o f financial-economic administration in Ukraine. Correspondingly, it must figure prominently in any modernization o f the Ukrainian economy.

Since i t s inception in 1996, the State Tax Service has made substantial progress in organizing itself into a conventional national tax authority (from i t s start as a collection o f decentralized administrations with dual reporting relationships to central and regional authorities). During this period, the STS has also built up various technical capacities, including upgraded physical facilities, staff training, some basic information system tools, and some strengthened procedures (e.g., audit selection). I t has also made some efforts to rationalize and

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streamline i t s organizational structures (e.g., consolidating small local offices, piloting large tax payer offices, and simplifying the structure o f Headquarters). As a result, the STS has succeeded to maintain revenue collections in l ine with the performance o f the national revenue agencies that emerged from the former Soviet Union. (Comparable data series that would support finer judgements regarding the relative revenue performance o f specific national revenue authorities are hard to obtain. The large role that non-tax revenues play in the fiscal affairs o f these countries and the divergent practices among the national tax authorities in handling non-tax revenues, such as social insurance contributions, make comparisons o f aggregates not very meaningful.)

In Ukraine, the basic elements o f tax and related legislation are present. However, they exhibit many deficiencies. These create problems for fiscal stability and administrative effectiveness. The prevailing legal framework i s somewhat o f a patchwork, reflecting i t s disjoint and incremental development. I t contains many ambiguities, contradictions, and special privileges. All o f which create problems for administration and for taxpayer compliance. Efforts by the Governments and the Verkhovna Rada during the past few o f years to pass a comprehensive Tax Legislation have not yet come to fruition, despite the high priorities attached to the new code by the President and the past two Governments.

In the meantime, the STS has struggled -- and to a reasonable degree succeeded -- to keep i t s administrative practices and revenue performance in line with changing legislation. This has been exceedingly difficult and not without setbacks and reversals. For example, VAT collections in 2001 and 2002 have suffered in the wake o f a December 2000 law that provides for forgiveness o f pre-2000 tax arrears, an extended period for paying post-2000 VAT arrears, and a longer intra-year payment period. Slow reforms in key enterprise sectors, including energy, have compounded the lack o f financial discipline and added to the demand for further tax expenditures and forgivenesses. Shrinking de jure and de facto tax bases increased legislative churn, in turn, hampering tax administration and burdening compliant taxpayers. In 2002-3, however, the Ukrainian authorities have had some success in stabilizing the tax base. Revenue performance has correspondingly improved.

Notwithstanding the mixed degree o f success in revenue collection in an exceedingly difficult environment, the administration o f taxes in Ukraine i s marked by inefficiencies, inaccuracies, and unevenness, as well as corrupt practices. These problems f low from a number o f sources: both internal and external. As noted above, the legal context creates problems in administration. Problems also arise from the absence a national culture o f voluntary compliance to the Tax Legislation, widespread dependence on administrative procedures, and substantial tolerance for extra-legal practices within state and private entities.

Weaknesses in the STS's internal capacities are also important sources o f problems in tax administration. Skills, incentive structures, operational and management practices, information system tools, internal controls are all aspects that need significant improvements to raise STS efficiency and effectiveness and lighten compliance costs for taxpayers.

Weaknesses in the management o f the STS are also sources o f difficulties. Although fiscal pressures lessened somewhat in 2000-1 (with the up turn in the economy and the termination o f the practice o f accepting non-cash forms payment for tax obligations at the end o f 1999), a high level o f pressure f rom the expenditure side o f the state budget keeps the STS in a position where i t has to continually focus on meeting detailed and disaggregated revenue targets. Among other things, this perpetuates a reactive, short-term management focus by the STS. These

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pressures impede efforts at long-term administrative reforms, in addition to poisoning taxpayer relations.

(See the Project Files for a more detailed Descriptive and Diagnostic Analyses o f the STS's performance, organizational development, and operational capacities.)

Government Strategy

Many o f the factors affecting tax administration in Ukraine are systemic and outside o f the purview o f the fiscal authorities. These include the overall performance o f the economy, the speed o f reforms o f the role o f the state and o f privatization, and the rate o f progress towards a satisfactory degree o f the ru le o f law (especially economiclcontractual law). The governments which took office in 2000 and in 2001 respectively have publicly committed to make progress on these fronts, often in the context o f closer European Union integration. O f necessity, however, these are long te rm agendas.

As mentioned above, the Government i s pressing forward with improvements in the legal context for tax policy and tax administration. With the frustration o f attempts to create a comprehensive reform though an entirely new Tax Legislation, the Government and the Verkhovna Rada have adopted an incremental reform strategy on a tax-by-tax basis (Le., VAT, personal income tax, enterprise profit tax, excise taxes, etc.). This includes clarifying and tightening the tax base definitions, rationalizing the rate structure, simplifying the procedures, etc. Bank support for this approach comes through the Programmatic Adjustment Loan and through an active policy dialog. (See Ukraine: Tax Policy and Tax Administration -- Draft for Discussion with the Government, September 2002, in the Project Files.) As indicated above, the STSMP supports capacity building in the legislative and statistical analysis areas, but does not target predetermined tax policy changes.

In relation to tax administration, the Government has approached the Bank to assist wi th the formulation and financing o f a long-term and comprehensive modernization program for the STS. This flows from the CAS, as well as the Action Plan o f the Cabinet o f Ministers, dated April 2000, and agreements reached with the Bank in the context o f the Programmatic Adjustment Loan (among other policy statements).

In accordance with a regulation o f Cabinet o f Ministers dated September 19,2000, the STA established a Modernization Department to plan, oversee, and coordinate the various internal and externally-supported reform efforts in tax administration. This formalizes a process o f strategic development for the STA that has been facilitated by PHRD Grant-funded technical assistance (TA). Through this assistance, the STA and the Bank have worked closely in developing the modernization strategy that underpins the STSMP.

3. Sector issues to be addressed b y the project and strategic choices:

The issues in the public financial management sector encompass:

e Expenditures and revenues.

0 Policy and administration.

National and sub-national entities.

e Institutional and fiscal dimensions.

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political judgment i s that public agencies are more capable o f assuaging these concerns. In the STSMP, there will be scope for divesting some o f the functions in an orderly fashion, as the STS builds i t s capacity to operate in the mode o f a modem tax authority.

Another important strategic choice in public administration i s centralized versus decentralized provision o f services. In the area o f tax administration, international practice i s generally a mixture o f both, with the scope o f operations aligned with the geographic character o f the object o f taxation (e.g., corporate income at the national level and real estate at the local level, with sales taxes often in between). The STSMP will focus on the taxes administered on a national basis. But i t w i l l also provide for an orderly devolution o f responsibilities for local revenues, as capacity, cost-effectiveness, and administrative integrity factors warrant.

4. Program description and performance triggers for subsequent loans:

The STSMP seeks to support a long-term and comprehensive modernization o f tax administration in Ukraine. The Adaptable Program Lending (APL) instrument was selected to support this broad-based approach. The APL provides an instrument to lay out a feasible, demonstrable, and disciplined path to the long term goal.

The logic for the comprehensive approach in the STSMP rests on the fact that the economic and development goals associated with tax administration are voluntary compliance by tax payers, l ow compliance costs, and the transparent and proper administration o f taxes. These goals cannot be met solely by improvements in policies, organizational structures, management practices, procedures, information technology, staff training, or public educatiodoutreach. The goals require a coherent package o f a l l o f these elements. Moreover, these goals are hard to achieve by exclusively focusing on specific taxes, specific classes o f taxpayers, specific regions, or specific functional areas. Narrowly focused interventions leave unreformed elements o f a tax administration operating side-by-side with reformed elements. These typically leave too many necessary factors for the success o f the reformed part exposed to problems arising in the unreformed parts. For example, a focus on the VAT might leave important organizational and incentives problems untouched. A focus on one region would leave an enterprise's transactions in other regions outside o f the integrated taxpayer account and hamper revenue-risk based audit selection. A focus on internal auditing and controls would leave the day-to-day operational systems and procedures unreformed and without adequate monitoring mechanisms to support the internal controls.

Whereas the objectives o f the STSMP require a comprehensive, multifaceted reform program, the need to ensure manageability o f the program and to control r isks necessitate a program constructed from a properly sequenced set o f coherent and internally consistent activities. Proper sequencing and phasing are also required because institutional development i s inescapably an exploratory processes. As a result, the STSMP must accommodate iterations o f planning, implementation activities, testing and stock-taking, as wel l as revision and replanning.

PROGRAM STRUCTURE & TIMING (see Annex 2 for more detail)

The modernization o f the STS i s an important element in the modernization o f the overall tax system in Ukraine, as articulated in the Cabinet o f Minister's October 23,2001, Public Vision Statement, as well as a number o f other important initiatives -- most notably the Government's tax legislation reform program.

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MODERNIZATION STRATEGY

ACCOUNTABILITY FRAMEWORK

INSTITUTIONAL RE-DESIGN

ORGANIZATIONAL MODERNIZATION

MANAGEMENT MODERNIZATION

"Priori&-Tactical" Initiatives

Capacity Building

Institutional Management Systems

OPERATIONAL MODERNIZATION "Priority-Tactical" Initiatives

Core Tax Operations Prototype

Core Tax Operations National Roll-out

Oneoine STS Institutional Develooment I >>

Kev:

1

I >>

* * *

t - *

I >> I >> >> -

I 2

>> I >>I >> 1 >> I >> I >>

primary activities tactical and preliminary initiatives *

continuation activities >>

As a comprehensive modernization program, the STSMP forms a central element o f the STS's continuing program o f institutional development. However, the STSMP should not be mistaken for the entire STS modernization effort. Many STSMP activities extend STS modernization initiatives that have been ongoing for a number o f years. Moreover, the STSMP

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w i l l run in parallel and complement other STS modernization initiatives during the program period. Most notably, the STSMP wil l generate a stream o f organizational and business process innovations that the STA main departments will selectively exploit, without waiting for the entire package o f modernized processes and systems to emerge. In general, these innovations w i l l be the ones that do not require legislative and regulatory change or major information systems development efforts (which depend on the strategic modernization initiatives under the STSMP). In short, there i s more to the STS's modernization than the STSMP and (as noted below) more to the STSMP than can be presented here.

As summarized in the diagram above, the STSMP comprises two phases (2003-07 and 2008-12). Each phase contains organizational and management modernizations as well as operational modernizations. As noted above, these activities are linked to other STA modernization initiatives. They are also closely interlinked within each phase, as well as linked across the phases.

The most salient activities under the STSMP are:

The elaboration o f a Modernization Strategy for the Ukrainian tax system. This includes the Cabinet o f Ministers' Public Vision Statement o f October 23, 2001, The Head o f the STA's Public Vision Statement o f November 14,2001, and the STA's Strategic Plan o f June 2001 (an annually updated, three year roll ing plan).

The creation o f an Accountability Framework. This comprise two bodies: one consultative assembly o f representatives o f stakeholder associations in Ukraine; and one independent high-level panel to assess STS's progress in transforming i t s relationship to the rest o f Ukrainian society on the basis o f voluntary compliance to the Tax Legislation and a credible capacity to detect and properly resolve noncompliance. The consultative assembly -- the Public Collegium -- had i t s founding meeting on June 16,2002. The high level "assessor" body -- the Oversight Panel -- w i l l be established as soon as loan funds become available (target: by March 3 1, 2004). These bodies wi l l convene periodically each year during the program period.

The Institutional Re-design o f the STS. In accordance with the strategic vision for a voluntary compliance based tax system, the institutional re-design includes the re-design o f the STS's organizational structure and i t s nineteen main business process segments. The organizational re-design specifies a function-based structure and consolidates the STS's overly-extended presence across Ukraine. The business process re-design addresses both the STS's management and operational business functions. These institutional re-design activities are concentrated in 2002-04. They lead (in 2003-04) to an independent review o f the integrated, re-designed business processes and the package o f proposed legislative and regulatory changes which are necessary to implement the modernized business processes. Based on the outcome o f the independent review o f the business processes and the approved legislative and regulatory changes, the organizational and business process re-designs will shape the Phase 1 organizational consolidation, the management capacity building, and the development o f a prototype o f modernized core tax operations (during 2005-07).

The Organizational Modernization o f the STS. Based on the re-designed organizational structure, the Phase 1 organizational modernization implements the function-based organizational model and consolidates the STS's administrative structure to 6-10 "super regional" units, and 120-130 "inter-district" un i ts (from the current 27

0

0

0

0

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oblast-level units and the approximately 450 "rayon-level" units, plus branch offices). Phase 1 also includes the expansion o f the large taxpayer office network to reach a coverage o f approximately 70 percent o f revenues. The Phase 1 organizational consolidation, together with the Phase 2 national roll-out o f the modernized core tax operations, will set the stage for a streamlining o f the STS in Phase 2.

The Modernization o f Management o f the STS. The modernization o f management includes capacity building among senior, middle, and line management, as well as the modernization o f the STS's institutional management functions (e.g., human resources, internal controls, administratiodlogistics, etc.). These wil l be carried out throughout the course o f the STSMP. In Phase 1, there wi l l be a number o f "priority-tactical" initiatives in selected management capacity building and institutional management areas. These include support for the human resource management in the context o f the organizational consolidation and support for improved information exchange among the key public entities involved in revenue policy and revenue administration. In Phase 2, a number o f key institutional management systems w i l l be implemented. These systems will extend the various Phase 1 management capacity building activities (including the priority-tactical initiatives) and exploit l i n k s embedded in the modernized operational systems.

The Modernization of Operations o f the STS. In Phase 1, the modernization o f operations includes the development o f a prototype o f a modernized core o f tax administration operations (Le., taxpayer registration, tax accounting, declaration processing, and document management, with support for customer service, audit, collections, and other critical functions o f tax administration operations). There w i l l also be a number o f "priority-tactical'' initiatives in Phase 1 for selected operational areas (e.g., strengthening audit, collections, and large taxpayer offices). Based on lessons learned in the prototype development and on emerging requirements, Phase 2 w i l l roll-out o f the modernized core o f tax administration operations on a national basis and extend the systems support for, customer services, audit, collections, appeals, investigation, and legal operations.

The Ongoing STS Institutional Development. This encapsulates al l the parallel activities o f the STS that fa l l "outside" o f the STSMP (Le., excluded from i t s cost, financing, and activity descriptions), yet upon which the success and impact o f the STSMP depend.

The above diagram presents a highly simplified, schematic view o f the STSMP activities

e

e

e

over the ten year period o f program. O f necessity, i t subsumes, in one or more o f the broad headings, a multitude o f essential activities (e.g., anti-corruption, stakeholder relations, registration simplification, etc.). Whereas, the component structure presented in the next section and in Annex 2 provide more detail, they too subsume many details o f the program design and present only one o f many possible "views" o f the program. Greater program detail i s captured in the extensive -- and s t i l l evolving -- program design documentation. Some elements o f these can be found in the Project Implementation Plan. (See the Project Files for the latest version.)

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TRIGGERS

The following shall trigger the transition from PHASE 1 to PHASE 2

1. Formally adopted key modernization design documents (based on I S 0 15504)

Strategic Plan: Stating the STS's mission, the vision o f the STS Leadership, and the goals and measurable objectives o f modernization.

The STS Functional Organization Document: Defining the organization required to implement the goals expressed in the Strategic Plan. Mapping tax administration operations across the levels o f the organization. Specifying office functions and summarizing tasks at each level.

Concepts of Operation Document (ConOps): Defining a sound business process for each task in the Functional Organization Document. Identifying steps in each task to be accomplished by personnel using manual procedures and those that are candidates for automation.

Top Level Integrated Systems Requirements Document (TLISRD): Defining sub-projects to create a legal, sound, standardized, and efficient tax administration organization -- based on the ConOps. Defining the manual and automated procedures by which functionally-organized offices operate. Specifying the automated systems to be developed by the STS, contractors, and/or systems suppliers.

Integrated Systems Architecture Document: Defining the automated systems blueprint --based on the TLISRD. Specifying the sites to establish, support, and utilize the technologies and other information systems tools.

0

0

0

0

2. Successful implementation of the structural consolidation of the STS.

0 A reduction in the number o f administrative u n i t s o f the "middle" tier from the current 27 oblast-level un i t s to 6-10 super-regional un i ts (with subordinate large taxpayer offices and inter-district offices).

A reduction in the number o f administrative uni ts o f "lower" t ier f rom the current 450 rayon-level local offices (with subordinate branch offices) to approximately 130 inter-district offices (with subordinate branch offices).

The consolidation o f transactions processing functions f rom the local branch office level towards higher level offices and/or regional processing centers (to the extent that improvements in telecommunications and transport infrastructure allow), setting the stage for organizational streamlining -- especially o f the branch

0

- 14-

office level -- in Phase 2.

3. Successful design, development and piloting of a prototype modernized core of tax administration functions (registration, accounting, declaration processing, and document management) using formal management procedures (based on UN I S 0 12207).

4. A Phase 1 STSMP assessment report (including lessons learned), demonstrating, to the satisfaction of the Bank, the success of Phase 1, including the readiness of the operational prototype for national roll-out and satisfactory progress towards the K P I targets.

5. A Phase 2 Project Implementation Plan (PIP) satisfactory to the Bank.

6. A renewal of the Letter of Development Program, satisfactory to the Bank.

C. Program and Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown) :

APL - Component A (Phase 1: 2003-2007)

A l . Organization & Management Modernization A1 .l. Strategic project management capacity building

A l , 1.1 design, planning, & testing Al.1.2 project management & administration Organizational consolidation & functionalization Human resource management capacity building*

Legislative and statistical analysis capacity building*

Al.6.1 inter-agency Al.6.2 internal Al.6.3 community at large

A 1.2 Al.3. Al.4. Management capacity building* Al.5 Al.6 Stakeholder relations capacity building

A2. Operations Modernization A2.1.

A2.2. Customer Service Call Center A2.3. Compliance strengthening* A2.4. Large taxpayer office strengthening*

Prototype o f modernized core tax administration operations (registration, accounting, declaration processing, and document management)

APL -- Component B (Phase 2: 2008-2012)

Bl . Organization & Management Modernization B 1.1. Strategic project management capacity building

- 1 5 -

B 1.2. Organizational streamlining B 1.3. Institutional management capacity building

B2. Operations Modernization B2.1. National roll-out o f core modernized operational (registration,

accounting, declaration processing, and document management)

B3. Continuation of Phase 1 Incremental Recurrent Costs

Note: "*" indicates priority-tactical initiatives -- as contrasted with long-term strategic initiatives.

The inputs required to achieve the outputs associated with the various componentshub-components include: technical assistance, training, study tours, minor c iv i l works, office and related equipment, vehicles, information technologies, information systems, technical services (such as communications services, period taxpayer surveys, office site engineering surveys) and incremental recurrent operational cost items (such as information and communications technologies licences and maintenance, communications charges, office and related supplies, vehicle operations and maintenance).

Compon

A. STS Modernization - PHASE 1

A1 . Organization and Management Modernization Component

A2. Operations Modernization Component Total Project Costs

0.0

59.50

25.66 85.16

Bank- Financing (US$M)

22.41

17.19 39.60

% of Bank-

financing 0.0

56.0

43.0 99.0

1 .o 100.0

2. K e y policy and institutional reforms supported by the project:

Tax administration in Ukraine currently retains a high degree o f administrative discretion. The institutional culture also embodies a very strong assumption by the tax administrator o f evasive/criminal behavior by taxpayers. In large measure, these are legacies o f the Soviet system and artifacts o f the incomplete transformation o f the Ukrainian economy. The strong enforcement-orientation o f the STS also reflects Ukrainian law that sets a very low threshold for the deliberate concealment o f income to be a criminal offense.

The STSMP seeks to move the administrative framework and the institutional culture o f the STS to a modem, voluntary compliance-based model. A decade o f continuous progress on many fronts w i l l be required for this transformation. The STSMP supports this behavioral transformation through improvements in organizational arrangements, management practices, operational capabilities, and strengthened client services. Among other things, the STSMP will

- 1 6 -

strengthen the STS's capacity to be a credible and impartial agent in the detection and resolution o f tax evasion and non-payment. This i s a necessary ingredient for encouraging voluntary compliance among taxpayers. I t i s also an important ingredient in the transformation o f institutional culture and practices o f the STS. It wi l l provide the STS with the ability to rely on selective and procedurally-correct methods and to move away from i t s current reliance on broad-based enforcement o f tax collection. This wil l help lighten the burden on law abiding taxpayers and improve the general business climate in Ukraine.

In particular, the STSMP supports:

Strengthened institutional accountability mechanisms, increased administrative integrity, and anti-corruption initiatives -- as part o f a process to transform the STS's relationship to the rest o f the Ukrainian society to one o f open, accountable and impartial relations.

Implementation o f true self-assessment o f obligations by taxpayers -- as way o f reducing compliance costs, reducing opportunities for STS staff to abuse their office, and increase administrative efficiency.

Strengthened taxpayer service, including the inculcation o f an institutional culture o f client-orientation -- as a way to increase voluntary compliance.

Improved audit selectivity and audit execution procedures -- as a way to lighten the burden o f compliance on law-abiding economic entities and increase the probability o f discovery and resolution o f significant non-compliance.

Improved appeals and dispute resolution mechanisms -- as a way o f protecting taxpayer rights, while allowing the STS to achieve efficient and effective revenue performance within the confines o f the Tax Legislation and within the accepted norms o f obligations and duties o f taxpayers and STS staff alike.

3. Benefits and target population:

Benefits 0 More efficient and effective revenue administration, contributing to more stable

fiscal management and macro-economic stability.

0 Reduced compliance costs.

0

0 Reduced misadministration and corruption.

More predictable, even handed, and uniform application o f the Tax Legislation.

Target population 0 The general public benefits f rom fiscal and macro-economic stability, including the

resultant economic growth and the anti-poverty effects o f l ow inflation.

The taxpayers benefit from reduced compliance costs and reduced misadministration and corruption.

Honest taxpayers benefit from greater client orientation and from a reduction in the tax burden o f meeting the fiscal shortfall created by non-compliance.

Honest tax officers benefit f rom an improvement in the internal integrity o f the STS

0

0

- 17-

and more effective tools to conduct tax administration.

4. Institutional and implementation arrangements:

The STS wil l implement the program under the management o f the STA. The STA Modernization Department will coordinate and administer the STSMP, as well as other internal and externally-supported modernization initiatives. The Head o f the Modernization Department has personal responsibility for the STSMP and reports to the Head o f the STA as well as to the First Deputy Head o f the STA (the formal Modernization Project Manager).

The Modernization Department has a substantial staff (up to 198 in accordance with the Cabinet o f Minister's September 19,2000, regulation that established the Modernization Department). Nevertheless, the technical and substantive aspects o f the STSMP will be carried out by teams made up o f staff f rom Headquarters (STA), STS regional offices, and the Modernization Department (with the facilitation o f international advisors). The management o f the STSMP i s tightly integrated into management o f the STS as a whole. Key decisions in relation to the STSMP are taken by the STS executive team (the Head o f the STA, the First Deputy Head, and the other seven Deputy Heads). At this juncture a separate project board i s not envisioned, since the business o f reforming the STS will not be truly distinct f rom the business o f running the STS. The procurement and financial management aspects o f the STSMP are also integrated into corresponding arrangements within the STA. An important element o f the preparation for the STSMP has been discovering the proper balance between STSMP-specific procedures and management arrangements and corresponding mainstream arrangements within the STA. (See the Project Implementation Plan in the Project Files for greater detail on these procedures and other program management arrangements.)

An expressed goal o f the STSMP i s to strengthen the STS's capacity to plan and execute strategic investment projects -- as a permanent institutional function. Accordingly, investments to govern, manage, analyze, administer, monitor, and evaluate the STSMP will be integrated into a Strategic Project Management Sub-component within the Organization and Management Component (in both phases). (See Section C sub-section 1 for an outline o f the STSMP component structure.) This approach contrasts to the more typical arrangement o f a "stand-alone" project management component or sub-component aimed more narrowly at the Bank-financed project.

As an important element o f building the STA's permanent capacity to manage strategic projects, the STA has adopted (and adapted) a number o f international standards, formal methods for project management and business systems analysis methods to apply to the STSMP (including I S 0 12207 and 15504). These, and other formal methods, w i l l help keep the complexity o f the Modernization Program from overwhelming the STS. These methods w i l l also be instrumental in managing the program, in the face o f inevitable changes in the legal, technical, and political environments (as wel l as personnel changes). These formal methods, and the disciplined documentation they require, provide the STA and the Bank with a r ich set o f dated deliverables with which to closely supervise program progress.

Among other things, the formal methods include quality assurance and configuration (change) management. These are controlling and auditing functions. They are the responsibilities o f specific sub-units o f the Modernization Department. (See Figure 1 .) For integrity purposes, these u n i t s also maintain independent reporting relationships directly to the Project Manager (the First Deputy Head o f the STA). Project monitoring and evaluation are also

- 18-

closely allied functions to be performed by the Modernization Department. Among other things, these include tracking o f the agreed-upon Key Performance Indicators and other progress indicators (including periodic taxpayer and staff surveys). Monitoring and evaluation also include the maintenance o f the financial management system, including the production o f the periodic financial management reports (FMR), the annual reports, the mid-term review (MTR) and the implementation completion report (ICR).

I I

Personnel

Figure 1 : Organization o f Modernization Department

STA Head

- Activity Control

-- Quality Control 1

1 STA First Deputy Head

~ Modernization Department Head

I-

I DeputyHead I Organizational Desigo &

Human Resource Mgt.

Information System -- Development

, Information Security

First Deputy Head

~

I Deputy Head

Program Development,, Plannmg, Monitoring, Risk Management, & External

Affairs

Tax Adnutustratlon Enhancement Urut

Tax Audit Enhancement Utut

I General Utut 1 i Curbing Tax Infhngements 1

Project Financial Management and Accounting

Procurement o f Bank-financed activities shall be undertaken in accordance with standard Bank procedures and the corresponding Guidelines.

Financial Management (see Annex 6B for Financial Management Assessment Report)

a Implementing agency: Implementation o f the Project would be undertaken by the STA Modernization Department and the STA. Modernization Department was created as a separate unit under the authority o f State Tax Administration to provide and to be responsible for implementation o f modernization procedures. The STA Modernization Department i s to be responsible for the management o f a l l project activities, including

- 1 9 -

procurement, disbursement operations preparation, and financial reporting preparation. I t would maintain books o f accounts for the project, prepare and disseminate financial statements and financial management reports, and ensure timely audit o f the financial statements. STA financial and accounting departments will organize supervision and control functions over the operations o f the STA Modernization Department and will provide authorization for the operations. Representatives o f the State Tax Administration Management w i l l s i g n financial documents o f the project.

All the documents supporting the operations under the project w i l l be submitted to the financial department o f STA for their control, safeguard and reporting. Copies o f the document wi l l be placed with the STA Modernization Department.

Fundsflow: The Project funds f low i s designed to manage funds provided by the World Bank and Government. The World Bank funds w i l l be deposited at the loan account and will be used for direct payments and transfers to the Special account; funds from the Special Account opened in the commercial bank acceptable to World Bank will be used for local payments and foreign contract payments; the third part o f funds i s STA co-financing, which i s the subject to budget procedures regulations that require State Treasury involvement, and stipulates that this amount wi l l be charged under the normal regulations stated in STA Modernization Department for other budget spending. Budget funds wil l also be used for the payments o f duties and taxes.

The disbursement process will conform to the Bank disbursement procedures.

Reporting and monitoring: The new financial department unit o f the Modernization department will submit quarterly reports on commitments, disbursements under the project to the Bank. This report i s to be supervised by the Kyiv-based FMS. The financial department wi l l prepare quarterly financial monitoring reports (FMRs) for the Project. The FMRs wil l include the following areas: (a) Financial Reports (b) Project Progress Reports and (c) Procurement Management Reports. These financial reports w i l l be submitted to the Bank within 45 days o f the end o f each quarter. The f i r s t quarterly FMRs wil l be submitted not later than 45 days after the end o f the f i rs t quarter after the Effective Date. The form o f FMR has been agreed and found acceptable to the Bank. FMRs forms are attached to the Report.

Disbursements: Disbursements from the World Bank Loan w i l l be made based on traditional disbursement methods (Le., f rom the Special Account with reimbursements made based on Statements o f Expenditures (SOEs) and full documentation, and direct payments from the Loan Account). The proceeds o f the World Bank loan w i l l be allocated in accordance with Table C (disbursement), Annex 6. To facilitate timely project implementation, the Government wi l l establish, maintain and operate, under terms and conditions acceptable to the Bank, one separate Special Account denominated in USD. The State Tax Administration Modernization Department w i l l also open a local account for local expenditures in the State Treasury.

0

0

0

D. Project Rationale 1. Project alternatives considered and reasons for rejection:

As discussed earlier in Section B-3, the alternative o f private provision o f tax administration services i s largely a matter for the orderly divestiture or outsourcing o f selected services, but essentially at the margin (e.g., window operations and declaration preparation). Tax administration i s a central part o f the state function and the state tax administration i s properly a

- 20 -

focus o f Bank support in areas o f fiscal management and public administration. Tax administration plays a critical role in maintaining fiscal and macro-economic balance and in determining the tone o f the business environment. Given the request o f support by the Government as part o f a CAS, nonintervention in tax administration would require serious political andor institutional problems that would prevent the Bank making a positive contribution.

Given the serious deficiencies in tax administration in Ukraine, the serious efforts undertaken by the STA to develop a modernization program, and the broad recognition -- among senior public officials, legislators, and the taxpayer community -- o f the need to address the problems o f the STS, the main program alternatives relate to the type, scope, and timing o f Bank assistance.

Tax administration i s fundamentally a matter o f institutional capacity-building (albeit within the framework o f a rational, internally consistent, and efficient Tax Legislation). As a result, Bank support in the form o f an investment operation i s the most appropriate instrument to address the issues o f tax administration, as contrasted with an adjustment operation or economic and sector work (ESW) and policy dialog. An institutional capacity-building investment operation i s particularly appropriate in the presence o f the IMF's ongoing fiscal dialog and the Bank's Programmatic Adjustment Loan.

The relative weight attached to organization and management reforms -- versus operational capacity-building -- i s a key program design question. The program can lean one way or the other in terms o f what i s included under the program. Alternatively, the program may support one area or the other more heavily at different points in project l i fe .

At the beginning o f the project dialog in 1998, the STA focused primarily on building operational capacities through investments in information technologies. This project alternative was rejected, due to the fact that the automation o f unreformed business processes, institutional structures, and management practices do not obtain the development impact sought: namely increased voluntary compliance, lower compliance costs, and high administrative integrity.

During 1999-2002, the STA has developed a modernization program that recognized and addressed the organizational and management dimensions o f institutional development, reforms o f business processes, and the sustainable management o f information and information technology assets. This strategy i s in line with international best practices. The STA has also become increasingly aware o f the magnitude o f the task o f institutional development. I t has conceived and adopted a phased approach to institutional development (including information system modernization). The Bank project team endorses this general approach. The specific m ix and timing o f these efforts i s largely a matter o f technical design choices, and less one o f project alternatives.

Within the context o f an investment operation to finance the institutional development o f a core public agency, the basic project alternatives include: (a) narrowly-focused versus comprehensive reform initiatives; (b) short-term versus long horizon efforts; and (c) combinations o f breath o f focus and time horizons as well as intermediate cases.

The Project Concept Document (PCD) contains an extended discussion o f the alternative lending instruments (Le., a short SIL, large SIL, dual SILs, and an APL) and decision criteria. (See the Project Files.) Basically, the conclusion was the A P L i s the most effective instrument in

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setting the stage for and controlling a long-term process o f institutional reform o f tax administration in Ukraine. The design o f the STSMP, including the triggers employed, w i l l provide the Bank with a substantial degree o f risk management.

The STSMP design i s fundamentally a long-term transformational strategy. However, the STS has a variety o f shorter term focussed modernization activities on-going or planned. These include those undertaken on the STS's own initiative as well as those undertaken with the assistance o f other external assistance providers (Le., US Treasury, USAID, the IMF, the Dutch Tax Service). An important program design consideration i s how tightly to integrate these initiatives into the STSMP. A related question i s how much to focus on short-term initiatives within the STSMP. Despite the additional design and management challenges, it was decided that the STSMP would explicitly integrate the efforts o f the other external assistance providers (in keeping with the broad mandate o f the Modernization Department). Also, the STSMP w i l l encompass a stream o f "priority-tactical" initiatives to address pressing problems and to follow-up the activities o f the other external assistance providers. These are in addition to the "main" stream o f strategic initiatives aimed at the long-term transformation o f the STS.

Leaving the other modernization initiatives outside o f the framework o f the STSMP and focussing solely on long-term initiatives was rejected due to the likelihood o f running at cross-purposes, redundancy o f effort, and preemption o f reforms by short-term "fixes". Also, any long-term reform effort needs "early wins" to establish credibility and maintain reform momentum. Nevertheless, the program management challenge wil l be to balance the urgency o f short-term problems with the needs to insulate the strategic effort from them. For example, the STSMP needs to address the current pressing problem o f arrears with investments in new procedures, sk i l l s , and information system tools. However, these investments need to be configured so that the loses are minimized when the modernized procedures and information systems are put in place relatively soon thereafter.

An interesting lesson in the preparation o f an institutional development program emerged in the course o f managing the tensions between the long-term and short te rm dimension o f the STSMP design. Specifically, in a "old-style", highly centralized (public) administration -- such as the STS -- the trade-off between short- and long-term initiatives are actually most acute through their competition for the attentions o f the very small number o f decision-takers (as contrasted with competition for financial or technical resources). This phenomenon also underlies the previously-mentioned problem o f the STS being caught in the crisis-management treadmill. Accordingly, the program design must combine and strike a delicate (and dynamic) balance between short- and long-term initiatives. This i s necessary to release enough o f the short-term pressures to allow the executive management o f the STS to initiate the longer te rm institutional reforms. These, in turn, are necessary to admit modem, delegative management practices.

- 22 -

2. Ma jor related projects financed by the Bank and/or other development agencies (completed, ongoing and planned).

Sector Issue Project

Bank-financed * Public financial management capacity building

* Public expenditure management capacity building

Public sector management adjustment

Other development agencies Tax Legislation and policy modernization and administrative capacity building

Tax Legislation and policy modernization and administrative capacity building

Tax Legislation and policy modernization and administrative capacity-building

?/DO Ratings: HS (Highly Satisfactory), S

Institutional Building Loan (1993-99)

Treasury System Project (1999 - ongoing)

Programmatic Adjustment Loan I(2001- 2002) Programmatic Adjustment Loan I1 (under preparation)

IMF: Technical Assistance Program in Tax Policy & Administration (1 993 - ongoing) USAIDJUS Treasury: Technical Assistance Program in Tax Policy & Administratioi (1 997 - ongoing)

Government o f the Netherlands: Technical Assistance for Large Taxpayer Office Pilots (October 2000 - ongoing)

(Satisfactory), U (Unsatisfactory), HI

Latest Supervision (PSR) Ratings

1Bank-financed projects only) implementation

Progress (IP)

S

S

S

Highly UnsatisfE

Development Objective (DO)

S

S

H S

3. Lessons learned and reflected in the project design:

The IMF has participated in many tax administration reform efforts. Silvani and Baer (1997) summarize the lessons learned in "Designing a Tax Administration Reform Strategy: Experiences and Guidelines", IMF Working Paper WP/97/30. They state the following principles.

0

0

Political commitment to and the sustainability o f the reforms are crucial.

Simplify the tax system to facilitate administration and reduce compliance costs.

- 2 3 -

Encourage voluntary compliance.

Formulate a clear strategy.

Identify the tax and accounting laws that require change.

Take an integrated approach to the tax collection process.

Differentiate the treatment o f taxpayers by size.

Ensure effective management o f the reform process.

Set priorities and establish a timetable.

Begin fundamental reforms with pilot projects.

Identify bottlenecks.

These principles have also guided the STSMP design.

The World Bank has also undertaken a large number o f projects that touch on tax policy and tax administration. Eighty-three o f these are surveyed in Barbone, Das-Gupta, D e Wulf, and Hansson 1999. "Reforming Tax Systems: The World Bank Record in the 1990s". Policy Research Working Paper 2237, World Bank, Washington, DC. The findings are also recapitulated in PREM note number 37 (April 2000). Distilling the lessons learned from investment operations:

Diagnosis and project design should embrace a strategic vision o f the tax administration, including institutional issues, such as accountability, client services, cost-effectiveness, anti-corruption, and good governance, in addition to the traditional concerns o f tax administrators for strengthening operational capacities.

The project design, including pace and phasing, should carefully match the implementation capacity o f the agency and the country context.

Performance indicators need to be devised, benchmarked, tracked, and compared against best practices. Among other sources, the indicators should draw upon taxpayer surveys.

0

Among the numerous lessons learned and incorporated in the STSMP, one o f the most challenging i s to ensure sustained political commitment to the reform program. The STSMP preparation has proceeded in a carefully gauged fashion and moved forward only when there are clear signs from the leadership o f the STS (and other quarters) that i t i s serious about reforms. The preparation work has also included efforts to lock-in as much as possible the support for the STSMP. In particular, the STSMP preparation process has been based on the commitment to the Bank by the Head o f the STA to establish an independent Oversight Panel for STS activities and to establish an independent advisory body comprising key stakeholders in tax administration in Ukraine -- the STS's Public Collegium. The Public Collegium had i t s founding meeting on June 16, 2002, and i t s f i r s t working meeting on July 9,2002. The Oversight Panel i s pending funding arrangements. Corresponding reform visions statements have been promulgated by the Cabinet o f Ministers and the Head o f the STA. These serve as public declarations o f the principles o f the reforms and standards against which the accountability bodies can measure the progress o f the reform o f the tax system and the transformation o f the STS's relationship with the rest o f Ukrainian society.

- 24 -

These accountability mechanisms will help establish both a constituency and a feedback mechanism for the reform process, ensuring that i t i s not simply dependent on the intentions and commitment o f the officers o f the STS or specific government figures. O f course, this i s not an iron-clad mechanism. Another mechanism to help foster political commitment to the STSMP i s a technical design that seeks as many "early wins" as possible without stalling the long-term reforms. The division o f the STSMP into a stream o f strategic initiatives as wel l as priority-tactical initiatives is, in part, designed to achieve some early wins. The division should also help cement the political support derived from the involvement o f the other bilateral and multilateral external assistance providers, since many o f the priority-tactical initiatives under STSMP are extensions andor support to the initiatives launched by the other external assistance providers. The bottom line, however, i s that in a fluid and delicate political environment like Ukraine, there i s a real limit to the effectiveness o f external mechanisms to lock-in political commitment -- both technical or governance mechanisms. Nevertheless, the STSMP has sought to exploit a l l those available.

In short: Automation i s not enough. Operational procedures also need to be redesigned, streamlined, and otherwise strengthened. Moreover, operational capacity building i s not enough. The broader institutional setting needs to be addressed. This includes the organizational structure, management roles, responsibilities, and practices. Similarly, staff roles, responsibilities, practices, and general institutional culture are critical elements in a modernization program. Institutional functions such as strategic project management, human resources and information systems planning and management, internal auditing and other integrity controls, general administration, etc., are also key determinants o f success. The modernization o f the tax agency's organization, management and operations are also insufficient. Projects need to address elements that l i e outside the agency boundaries, such as public and professional relations, client education and outreach, dispute resolution mechanisms, etc.

A counterpoint to the above lessons, however, i s that there are many challenges and pitfalls in complex projects. Institutional development projects are, by their nature, complex (as i s information systems development). Moreover, they are always exploratory processes. They depend greatly on specific local conditions and on the capacity o f the implementing agency to manage their complex and fluid natures. Because o f their high degree o f interdependence and multi-year gestation periods, such projects are exposed to r isks associated with:

0 Changes o f government.

0

0

0

Changes in the agency and project management.

Rapid and continuous changes in tax legislation.

The inability o f traditional organizations to relinquish the discretion afforded by paper-based systems in favor o f the precision and impartiality o f modem, integrated revenue administration systems.

The inability to attract and retain qualified informatics and other highly specialized financial professionals in the face o f large public sector -- private sector wage differentials for those skil ls.

0

These risks are above and beyond the technical and technological challenges o f tax administration modernization. (See for example, the ICRs for the Hungary Tax Administration Modernization Project and the Philippines Tax Computerization Project.)

- 25 -

Broadly speaking, the STSMP reflects the lessons learned and recorded in the IMF and Bank documents. I t encompasses organizational and management features, as well as operational features. I t focuses on the STS but not to the exclusion o f initiatives aimed at actors outside o f the agency (e.g., the MOF, MOE, and the Verkhovna Rada). To manage the r isks associated with such an institutional development/information systems project, the program i s phased. A sequence o f coherent and consistent initiatives build towards a long-term goal o f the transformation o f the STS, without making the entire program hostage to any negative development that may occur during the long program period. (The Philippines tax project ICR underscores this point.)

The extraordinary rate o f change in information technologies and related methodologies presents well known and frequently cited challenges, as do the need to package technologies and related services into coherent and manageable contracts. A greater challenge, however, i s the collection o f issues grouped together as "Change Management". This includes fostering acceptance o f changing organizations, roles, business processes, technologies, and service standards by agency staff, managers, clients and other agencies where there i s a close interaction at the operational level (e.g., the Customs Administration, and/or the State Statistics Committee). Change management also encompasses the technical/managerial problems o f running old and new processes in parallel during extended transition periods. Among other things, this can easily overwhelm the small handful o f key staff that understand the administration's business processes and the inner workings o f the agency's older and typically patchwork information systems.

The role o f key senior staff from the core o f the various tax administration functions i s also critical in the design phase for the new systems to support new administration processes. All too often the technological aspects o f such systems modernization initiatives wind up dominating the design work. I t i s critical for success that the business professionals lead the effort. Only they have the necessary s k i l l s and experience to take the required design decisions and establish priorities among competing design considerations. (The Hungary project ICR underscores this point.) The transformation o f the project concept, f rom i t s early days as a proposal for a tax automation project (in 1998-99) to a sweeping reform o f the STS's organization, management, and operational arrangements reflects the efforts to incorporate these lessons. The steady transformation o f the planning and implementation management arrangements for the STSMP also reflect these lessons. At the outset, the Bank's technical counterparts were a relatively small group, with a high proportion o f outsiders. At this stage, the counterparts are a large group including the senior technical and executive management o f the STS. The use o f formal international standards for business process analysis and program management (based on I S 0 15504 and 12207) also helps ensure that the business needs are maintained in the forefront, while capitalizing on the rigor and discipline o f methods developed in the context on contemporary information systems projects.

Regarding Bank project preparation and supervision, a few points are commonly cited. Both the Hungary and Philippine ICRs point out the importance o f continuity o f the project team. They both highlight the benefits o f having qualified informatics professionals on the team (among other things, to smooth procurement actions for the large systems contracts). The Philippine ICR indicated that, in retrospect, the Bank team should have included a tax administrator and that relying solely on the IMF to cover this area was not an adequate approach. The Hungarian ICR echoed this concern. Both the Hungary and Philippine ICRs suggest that the project's implementation suffered from haste. The Hungary ICR indicated that fast-track preparations l e f t substantial investments undefined. The Philippine I C R indicated that the implementation phase should have been broken into sequential sub-projects and implemented

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over an eight to ten year period (instead o f the planned five year period). In both cases, supervision requirements were high. The Philippine ICR noted that the actual supervision input was two and hal f times the forecast input in the Staff Appraisal Report. The Hungarian ICR noted that having the Bank task manager stationed in Hungary greatly enhanced the Bank's role to help manage activities on essentially a day-to-day basis.

In short, such institutional developmenthnformation systems projects are supervision intensive and dependent on high quality preparation. T o every extent possible, the preparation standards for the STSMP have been maintained at a high level. During implementation, the already strong project team representation in the Kyiv resident mission wil l be strengthened.

4. Indications o f borrower commitment and ownership:

As discussed above in sub-section 3 on lessons learned, there i s a real limit to the effectiveness o f external mechanisms to lock-in political commitment especially over the long term, and especially in a fluid and delicate political environment l i ke Ukraine. These include both technical or governance mechanisms. Nevertheless, the STSMP has sought to exploit a l l those available. During program preparation, the Bank has set progress milestones that build on the G O U and the STS's indications o f commitment. In particular, program preparation milestones has been conditional on: (a) the formal endorsement and dissemination o f the vision statements by the G O U and the STA; and (b) the establishment o f the Public Collegium and Oversight Panel. These independent bodies are tasked, among other things, wi th holding STS accountable for progress towards the modernization vision. These accountability mechanisms should help energize and sustain the commitment o f the G O U and the STS to the STSMP.

There are a number o f other important indicators o f the G O U and the STS's commitment

The progress made in the last few years in the area o f institutional development and reform o f the STS.

The creation -- on the basis o f the Cabinet o f Minister's regulation o f September 19, 2000 -- o f a substantial STA Modernization Department, and significant progress in staffing the Department.

Significant analytic and planning effort in the form o f the PIP and the large volume o f design documents created under the guidance o f the US Treasury resident advisors. (See the Project Fi les for the latest draft o f the PIP.)

The development o f a vision statement for the reform o f the tax system that i s clear-minded, candid, sober, and in line with contemporary best practices.

The commitment to the establishment o f independent, credible and effective accountability mechanisms.

and ownership. Among them are

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The vision statement for the reform o f tax administration as promulgated by the Cabinet o f Ministers on October 23,2001, i s based on two basic goals. (See Annex 1.1 o f the Project Implementation Plan in the Project Files for a translation o f the full text o f the Cabinet o f Ministers vision statement, including the more detailed subsidiary goals in tax policy and tax administration.)

1. T o foster economic growth that i s sustainable and beneficial to the broad

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population o f Ukraine.

To transform the STS into a leading institution in the evolution to accountable and democratic public administration.

2.

On November 14,2001, the Head o f STA also published a vision statement for i t s modernization program (of which the STSMP forms an integral part). (See Annex 1.2 o f the PIP in the Project Fi les for a translation o f the full text o f the STA's vision statement, including the more detailed subsidiary goals in organizational, management, operational, and client services.) The vision statement also l i n k s to a new Strategic Plan for the STS developed during June and formally approved on October 19,2001. (See Annex 1.3 o f the PIP for a translation.) As part o f a permanent strategy formulation process, the STS Strategic Plan underwent an annual update in late 2002.

Over the last few years the STS has managed to undertake a number o f institutional development and reform activities. Although most activities are works in progress and, o f necessity, are incomplete or not fully effective, they do represent a genuine reform effort. These activities include:

Issuance of taxpayer identijkation numbers. Between 1996-1 999, the STS completed the assignment o f identification numbers to a l l legal and physical persons.

Transfer of tax policy to the Ministry of Finance from the STS (1 997).

Streamlining of local offices. Since 1996, the number o f local offices has been reduced from 796 to 548 as o f January 1,200 1, and to approximately 450 by the middle o f 2002. (In large measure, this has come through the subordination o f local offices to other local offices in the form o f branch offices with reduced operational roles. A number o f outright office closures have already taken place.)

Pay and bonus reform. During 199617, STS developed, and the Government approved, a special remuneration structure to facilitate the retention o f quality personnel in the STS. Today the STS has a special status within the c iv i l service (although the differential has shrunk over time).

Establishment of large taxpayer offices. Since 1999, with the assistance o f the IMF and the Dutch Tax Administration, the STS has set up seven offices in the major cities to handle large taxpayers. An additional office covering Westem Ukraine i s planned for 2003. The seven offices cover between 30-40 percent o f total tax revenues. By expanding the coverage o f the seven and adding the eighth office, the STA targets about 70 percent o f total tax revenues to be covered by these specialized offices (by 2005).

Simplification of auditingprocess. Initially, the Tax Legislation dictated the audit o f firm at least every two years, and several audits could take place during the same year. As o f September 25, 1997, an enterprise cannot be audited more than once a year. Also, with the support o f the IMF, STS personnel have been trained to prepare an annual audit strategy, that i s coordinated with al l the other revenue agencies (customs, social insurance funds). As a result o f a more rational audit strategy, about 10 percentage o f enterprises were included in the national audit plan for 2001, whereas in 1997 roughly ha l f o f all enterprises were subject to audit. In addition to the selection o f specific enterprises for auditing, the plan assigns audit responsibilities for small, medium and large enterprises to the appropriate

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administrative levels o f the STS. This i s part o f the integrity building process o f breaking the links between the auditor and enterprises.

Upgraded information on collections and arrears. Since 1996, the STS has gradually upgraded i t s information on collections and arrears. This has helped STS maintain revenue performance, despite the difficult economic and institutional environments, especially those prior to the upturn in 2000. (These systems remain limited in their effectiveness, however, in large measure due to the difficulty o f moving information f rom the local offices where they are processed to higher levels where the problem arrears are managed.)

Strengthened enforced collection procedures. Since 1998, the STS has worked with the IMF on improving enforced collection practices to prepare the agency for a weakening o f i t s legal powers to use the banking system to collect back taxes. This includes organizational arrangements at each o f the three levels o f the STS. Following a pilot in 2000, the STS has begun to ro l l this out nationally. (Although the net f low o f new arrears i s declining, arrears continue to accumulate. To a significant degree this i s not a administrative issue, but instead a matter o f weak fiscal discipline in favored sectors, also weaknesses in the court mechanisms to resolve and enforce collections referred to the courts.)

Establishment of an Appeals Department. In 1997, the STS set up an appeals department within the agency to address complaints by taxpayers regarding tax policy interpretation by the STS officials. The number o f administrative appeals grew from 1997 to 1998 and steadily declined between 1998 and 2001 (from 9,63 1 to 4,669).

Improved internal controls. Between 1996 and 1999, the number o f internal investigations steadily increased from about 160 to 200 per year. In parallel, the number o f disciplinary actions grew from 200 to 1200 suggesting a leveling o f f o f both investigations and disciplinary measures. Nevertheless, the STS, and especially the staff involved, have shown a genuine commitment to take seriously the need for institutional integrity.

Increased stakeholder consultations. The STS has taken steps to strengthen the consultation process with i t s relevant stakeholders. Currently, the STS executives meet periodically with the Ukrainian League o f Entrepreneurs and Industrialists and the Ukrainian Association o f Trade Unions. Also, on the STA's prompting, the Association o f Taxpayers o f Ukraine was established, with i t s founding congress held on November 27,1998.

Stronger taxpayer information dissemination. Beginning in 1997, the STS has made major efforts to improve the availability o f information to taxpayers. I t publishes periodically information regarding new tax laws and regulations, as well as complementary information regarding the interpretation or analysis o f existing legislation and procedures.

Electronic Fi l ing. In 200 1, the STS introduced electronic filing over the Internet for enterprises. In 2002, this was extended to declarations fi led by physical persons.

Modernization Designs. In July 2001, the STS executive team developed a Strategic Plan for 2002-2005. Following upon the Strategic Plan, in M a y 2002, the STA executive team approved a preliminary organizational map for a consolidated and function-based organization as a design target for the STSMP. During 2002 and

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early 2003, the STA has developed high-level business process redesigns (including the sub-processes) for Registration, Declaration Processing, Audit, Human Resource Management, Tax Accounting, Document Management, Taxpayer Services, Collections, Institutional Computing Resource Management, Institutional Management and Representation, Line Management Support, Investigation, Large Taxpayer Office Operations, Internal Controls, Reporting and Analysis, Internal Administration, Legislative Affairs, Legal Operations and Appeals. The entire set o f designs are being "integrated" to ensure internal consistency.

Tax Legislation. The Government has put forward to the Verkhovna Rada a new draft o f the Tax Legislation that includes important simplifications and a partial decriminalization o f income concealment (below 85,000 UAH -- subject to voluntary payment o f due taxes). If enacted, these changes should help set the stage for improved STS-taxpayer relations.

Improved SME environment. USAID and IFC implemented surveys during 1997-2001 indicate improvements in tax administration practices have translated into an improved small and medium enterprise (SME) environment.

5. Value added of B a n k support in this project:

Bank involvement brings to the STSMP international experience and technical knowledge, external and internal coordination, activity integration, and project implementation discipline.

As indicated above, the Bank has extensive experience in tax policy and tax administration projects throughout the world. The Europe and Central Asia (ECA) region also possesses particularly strong resources in the areas o f institutional development and information systems projects in general. Consequently, the Bank can mobilize a fair amount o f expertise and experience in these areas.

When it i s most effective, the Bank plays an important role in coordinating and catalyzing the efforts o f the multiple external assistance providers that are typically working on taxes in a country such as Ukraine. Moreover, tax administration sits at the juncture o f a number o f development issues, such as fiscal policy, treasury management, customs administration, enterprise and financial sector development, anti-cormption, etc. An involvement in tax administration can effectively complement other Bank initiatives in a country. Similarly, within a specific country the various state agencies that are directly involved in, or influence, tax administration often are not particularly cooperative partners, especially during a period o f substantial change. The Bank can help facilitate the changes, by being a technically competent, but relatively neutral, party to the dialogue. The Bank can also use i t s access to the higher levels o f government to resolve inter-agency disputes that threaten to stall an important national project.

In countries with low compliance rates and a large tax gap, the IMF's and other external assistance providers' prescriptions are for far-reaching and integrated reforms. For an outside assistance provider to be truly effective, i t must have a long-term relationship with the tax authorities and help bring sufficient resources and sustained attention to bear on the problem. Otherwise the prospects for systemic change are low. The Bank, among the host o f external assistance providers, i s particularly wel l suited to provide this long-term, resource-intensive support.

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E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8)

1. Economic (see Annex 4): 0 Cost benefit 0 Cost effectiveness 0 Other (specify)

NPV=USS million; ERR = % (see Annex 4)

Taxes are inter-sectoral transfers. Thus, changes in tax levels or the incidence o f taxes are not amenable to straightforward economic cost-benefit analysis -- except to the extent that the distributional implications are known and there are acceptable distributional weights. In practice, the real incidence o f taxation i s poorly understood -- even in the most advanced and well studied economies. There are rarely, if ever, any generally accepted distributional weights.

Improvements in tax administration do have economic implications. These include: (a) efficiency gains in tax administration by the tax agency; (b) efficiency gains by taxpayers associated with lower compliance costs -- inclusive o f bribes, side payments, and waiting costs; and (c) effectiveness gains in tax administration that make the de facto tax rates more closely match the intended de jure tax rates.

The economic impact o f improved effectiveness o f tax administration comes through a number o f channels. This includes the reduction in the "noise" contained in after-tax price signals. This can arise through micro-economic channels, wi th differences in cost structures less influenced by tax evasion and avoidance. Improved tax administration can reduce inflation tax financing o f fiscal deficits and reduce the noise in price signals via macro-economic channels. The economic impact o f the effectiveness o f tax administration may also f low through improvements in income distribution, as a result o f reductions in tax evasion and nonpayment.

Compliance costs and compliance rates are notoriously hard to measure accurately. Similarly, the economic efficiency gains associated with sharpened prices signals and distributional gains associated with increased compliance rates are also hard to measure. In the long term, however, these effects are likely to dominate the economic impact o f lower administrative costs per unit o f tax revenue collected. Moreover, the administrative efficiency measurements require careful interpretation, since the objective o f tax policy i s not simply revenue collection. The objective also includes the setting o f post-tax price incentives and distributional results. Effectiveness in these aspects o f tax policy may, in fact, require a greater administrative effort than simply maximizing revenues per unit o f administrative expenditure.

Annex 4 presents a fairly simple cost-replacement, financial analysis. By comparing a stream o f STSMP-related costs to a stream o f projected incremental tax revenues, the analysis shows that required increase in the compliance rate to cover the cost o f the STSMP i s so low as to be virtually assured (and, as a by-product, the investments shown to be financially sustainable). In particular, i t only requires a 0.0053 percent increase in revenues each year between 2005-12, with the resultant 0.45 percent increase maintained during 20 13-33, to cover the full cost o f the STSMP (including a depreciation and asset replenishment program). A 0.25 percent increase in revenue each year between 2005-12, with the resultant 2 percent increase maintained during 2013-33, yields US$835 mi l l ion in net present value. This 2 percent increase in revenues, however, translates into only a 1.3 percent increase in the compliance rate (assuming

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a 65 percent compliance rate). By increasing the compliance rate f rom an assumed level o f 65 percent to 75 percent (in 2012-33), the model yields a net present value o f US$8,264 million. (The above calculations use a 10 percent discount rate.)

In short, any reasonable improvement in compliance as a result o f the STSMP will yield very substantial revenue benefits that can be applied to improving the fiscal balances in Ukraine as wel l as to reducing tax rates. Such benefits would be in addition to the distributional and economic efficiency benefits indicated above.

2. Financial (see Annex 4 and Annex 5): NPV=US$ million; FRR = % (see Annex 4)

A far-reaching institutional development program in tax administration, such as the STSMP, somewhat complicates the usual project financial analysis. The dividing l ine between the program and the "rest" o f the agency i s very blurry. Also, in tax administration the main focus i s on tax revenues (which may represent a twenty percent o f GDP or more), whereas administrative costs o f the agency typically represent only a percent or two o f the revenues managed.

Consequently, the financial analysis presented will focus on the investment and incremental operating costs associated with the project investments. These are analyzed in Annex 4 and summarized above, in connection with the economic analysis discussion.

The analysis presented in Annex 4 does not, however, incorporate operational savings. Potential operational savings induced by the STSMP arise through an eventual reduction in the necessary staffing level and a reduction in the number and size o f the premises used by the STS. To a large extent, these reductions will take place in Phase 2, once the new consolidated organizational structure i s put into place in Phase 1 and the modernized operational systems are rolled out on a national scale in the f i rs t part o f Phase 2 (Le., 2008-10). Whereas a substantial part o f the staff streamlining wil l come through the STS's 8-10 percent annual staff turnover, there may wel l remain a few thousand staff that become redundant once the new systems are in place.

At this juncture, it i s too hard to project the net savings associated with staffing. The level and timing o f any surplus labor that will emerge i s too uncertain, as i s cost associated with any redundancies (in accordance with the then prevailing c iv i l service laws). Similarly, it i s too early to predict the future wage structure required to retain a substantially upgraded s k i l l s mix needed to run a modemization tax administration. The net savings associated with the reconfigured inventory o f STS premises i s also uncertain at this stage. The absence o f well-functioning real estate markets and substantial uncertainty regarding the terms under which the STS would release surplus premises to the State Property Fund, makes the net savings o f reconfiguration and streamlining the STS premises unpredictable. Consequently, the net savings associated with the streamlining o f the STS in Phase 2 i s forecast as zero. At the time o f appraisal for Phase 2, however, these net savings will be far more predictable.

Notwithstanding the difficulties o f predicting the timing and value o f the operational savings associated with the STSMP, in economic terms, gains in the administrative efficiency o f the tax agency are only second order, as compared to those economic efficiency and

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distributional gains to the wider economy.

Fiscal Impact:

As a tax administration modernization program, the STSMP's expected fiscal impact i s dominated by the forecasts made for the improvements in tax revenue performance. Given the low compliance rates in Ukraine, the revenue impact o f the STSMP i s l ikely to be positive and very large. Unfortunately, the level and pattern o f the revenue effects are exceedingly hard to predict. The table below presents data for the program period for two scenarios f rom the model in Annex 4. The first represents an end-of-program increase in the compliance rate f rom an assumed 65 percent to 66.3 percent -- an improbably l ow increase (yet one that s t i l l yields US$835 mi l l ion in net present value over the course o f 2003-33). The second row represents an end-of-program increase in the compliance rate to 75 percent -- a much more reasonable increase (with a US$8,264 net present value). Both scenarios show large positive fiscal impacts during the program period and beyond.

Fiscal Impact Analysis (2003-2012) in US$ million

Annual increased

in revenue 2005-2012

3. Technical:

K e y determinants o f the efficiency and effectiveness o f tax administration are the clarity, consistency, and practicality o f the Tax Legislation and other relevant laws and regulations. A critical technical task for the STSMP wil l be to build a permanent capacity to

0 identify and resolve the features o f the legal context that make it diff icult to administer or comply with the Tax Legislation. This includes contradictions and ambiguities. I t also includes features o f the law and regulations that may make sense in terms o f the intent o f tax policy and the principles o f the legal system, but are problematic to implement. The STSMP envisions a sub-component to build capacity in the STA, the MOF, the MOE, and the Verkhonva Rada to analyze and refine tax policy, including activities to support the "legal re-engineering" o f tax administration (i.e., strengthening the feedback loop from tax administration to tax policy). In addition, the sub-component w i l l strengthen the f low o f statistical data f rom the lower levels o f the STS (where most o f the transactions take place), to the STA (Headquarters), and then on to the MOF, the MOE, and the Verkhonva Rada for the purpose o f tax policy formulation and revenue forecasting. The goal, in addition to building the technical capacities, i s to improve the interactions among these key entities in the tax system and improve the effectiveness o f economic management in general.

There are a myriad o f technological/methodological issues facing a major institutional development program, especially one with substantial information systems modernizations. These include the need to undertake a proper and effective organizational and business process analysis and redesign. These provide the base to establish a new and more appropriate

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organizational structure, as wel l as to base application development and the processing and network architectures. The systems analysis must also be sustained and maintained up-to-date, to reflect evolving business requirements and technological possibilities. In other words, systems analysis and application management must be developed as a permanent, in-house capacity.

The STA has adopted formal analysis and project management methods based on UN-IS0 standards 15504 and 12207. These w i l l be implemented under Software Engineering Institute's (SEI) Capability Maturity Model (CMM). The methods and related design and planning outputs are built into the STSMP, especially in Phase 1. A Project Preparation Facility (PPF) Advance o f US$2.0 mi l l ion has been mobilized. A majority o f these resources w i l l be used to obtain the training and technologies required to undertake these formal analyses and undertake project management. Approximately one year after the commencement o f the training and development o f the analysis and design products, the STA wil l seek Level I1 C M M Integration certification f rom an SEI accredited certification agency. In addition to providing quality assurance during the design, implementation, and operations phases o f the STSMP, the C M M I certification wi l l help make the STS an attractive employer for information systems professionals and help offset the public-private remuneration differential for such high-demand ski l ls .

Data cleaning and data migration (including from paper records) are major undertakings with large time and resource requirements. The STS w i l l try to minimize the amount o f historical data transferred from i t s legacy information systems (including paper records) to i t s modernized system. Among other things, this will require some changes in procedures, so that historical data have a lessened role in contemporary transactions. I t wi l l also require the preservation o f some o f the older information systems, to ensure the historical data are available if required.

4. Institutional:

The management o f change i s probably the most challenging o f the institutional issues arising out o f the STSMP. As mentioned above, this includes fostering acceptance o f changing organizations, roles, business processes, technologies, service standards, etc. by agency staff, managers, clients and even other related agencies (e.g., the Ministries o f Interior and Justice, Custom Administration, and/or the State Statistics Committee). This i s an extremely challenging undertaking.

Individuals and agencies tend to resist change, simply because it i s change. Also, there are losers in the process o f tax administration reform, especially as opportunities for corruption are squeezed out. These include staff as wel l as taxpayers, who, as a result, may resist the reforms. Clear and decisive leadership by the STA executives in the direction o f reform has already been indicated. This will need to be sustained and broaden to ensure the forward momentum o f the reforms. Also, tapping the substantial reservoir o f professionalism in the rank and f i l e o f STS staff and managers will be critical to buffer the reforms from resistance in response to losses o f personal power and/or the opportunities to personally profit f rom positions as tax administrators.

Rooting out corruption and other forms o f abuse o f office i s challenging in a political economy where abuses are common in both the state and private entities. Eliminating abuses

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require action on many fronts. Technical innovations, such as less discretionary business processes, organizational structures that distribute authority across units, and automated systems that enforce business rules and enhance internal audit are al l important instruments in shrinking the opportunity for abuse o f office. Persuasive and informational instruments are also needed to help create an institutional culture that isolates staff that abuse their office and make it easier for those inclined toward professionalism to follow these inclinations. An additional ingredient i s the need to properly apply systems o f rewards and sanctions for performance and misperformance. Whereas the Ukrainian civ i l service and criminal codes provide the legal basis for strong sanctions, and STS's personnel policies allow for substantial performance based rewards (in terms o f compensation, roughly equal to base salary), a critical element in the reform process wil l be the STS management's uniform and even-handed application o f the sanction and reward system. In part, this turns on the development o f the tools to monitor performance and detect abuses. In part, it requires a management culture that sees institutional integrity as a cornerstone o f building a voluntary compliance based tax administration. The STS has made a genuine effort at building and staffing i t s internal control units and punishing staff that violate the trust o f their office. More work i s required on these fronts, however. Of necessity, this will also be multifaceted. Modernization o f human resource management Gob descriptions, qualification, compensation policy, disciplinary policy, rotation and career planning) i s important. Strengthening STS's public accountability through the Oversight Panel and the Public Collegium are also import tools to shape the staff and management culture o f the STS.

4.1 Executing agencies:

The STS i s the implementing agency for the STSMP. In the last six years, the STS has established itself as a credible revenue authority on a national level. I t has done so despite an incomplete transformation from i t s beginnings as a rather decentralized and disjointed administration. At this juncture, there s t i l l remains a fair degree o f sub-national influence over the corresponding local units o f the STS. This influence i s part o f the political economy o f directed state resources (including through extensive exemptions and tax forgiveness). By creating a nationally integrated tax administration, the STSMP should curtail the interference by local authorities in tax administration. Nevertheless, to be successful, the STSMP will have to acknowledge the political forces at the sub-national level. I t w i l l also have to ensure that STS's modemization program meets the legitimate needs o f local authorities with the administration o f local levies.

Under the present system in Ukraine, most revenues that f low to local authorities come either as transfers f rom the central budget or as specified shares o f national taxes that are levied within the jurisdiction. In the context o f the Government's broader administrative decentralization strategy, there i s a policy o f gradual devolution o f revenue raising powers to localities. The specifics o f the decentralization o f revenue mobilization, however, are likely to take a few years to crystalize. The development o f the technical capacity o f localities i s likely to take even longer. For efficiency as well as administrative integrity reasons, the STSMP supports a withdrawal o f the STS's physical presence at the local level (mainly in Phase 2). The consolidation and streamlining o f the STS may entail the transfer o f surplus capacity from the STS to the localities. Given the current uncertainties over the decentralization process, at this stage it i s impossible to determine any specifics on how this transfer o f surplus capacity w i l l take place. More detail with respect to the decentralization process and with respect to the STS's consolidation processes w i l l be available for the preparation o f Phases 2 o f the STSMP. The

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role, if any, o f local authorities as executing agencies andor STSMP beneficiaries wi l l be clarified at that stage.

4.2 Project management:

The STSMP i s an ambitious program. I t will take al l o f the project management resources and a l l o f the management's attention that STS can muster to contain the variety o f implementation risks. The STA Modernization Department, with i t s authorized staffing level o f up to 198 staff i s a clear indication that the STA understands the magnitude o f the task before it. The STSMP i s specifically designed to strengthen the project management capacities o f the STS in the areas o f (a) project governance; (b) formal management methods; (c) analysis, planning and presentation support; (d) administrative capacities, i.e., procurement, finance, record keeping, personnel, etc.; (e) change management techniques; and (fl monitoring, evaluation, and quality assurance. The capacity building efforts are aimed more broadly than jus t the STSMP-financed activities. They are specifically designed to strengthen the capacity for the STA to manage strategic investment projects as a permanent, institutional management function.

4.3 Procurement issues:

Information systems procurements are among the most challenging among al l Bank-financed procurement. Substantial attention has been paid to proper contractual packaging o f the elements that comprise the specific information systems to be procured under the STSMP. Also, the project team i s providing technical assistance and training in this area.

4.4 Financial management issues:

The Financial Management arrangements for the STSMP, as administered by the STA Modernization Department, satisfies the Bank's minimum financial management requirements.

The STA Modernization Department has successfully designed and i s implementing a financial management system for the STSMP, including formalized business process and document flows and the corresponding responsibilities. The Financial Monitoring Reports formats have been developed and are acceptable to the Bank. An integrated Financial Information System (FIS) has been designed and i s in the final stages o f final documenting o f the system. The STA Modernization Department i s capable o f satisfactory record-keeping for all transactions and balances, the preparation o f regular and reliable financial statements, safeguarding the program assets by the application o f Ukrainian accounting ru les and regulations, and the preparation o f financial statements for the Government authorities.

Audit arrangements

The STA Modernization Department wi l l ensure that the STSMP financial statements, Special Account, and Statement o f Expenditures (SOEs) are audited by an independent auditor acceptable to the World Bank, in accordance with standards on auditing that are acceptable to the Bank. The auditor shall be a member o f a professional body that i s a member o f the

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International Federation o f Accountants (IFAC). The annual project audit wi l l be carried out in accordance with the Guidelines for Financial Reporting and Auditing of Projects Financed by the World Bank (March 1982). The audit report shall be in a format in accordance with the International Standards on Auditing promulgated by the International Federation o f Accountants (IFAC). The audited financial statements o f the STSMP will be sent to the Bank within six (6) months o f the end o f the Government’s fiscal year (December 31).

Financial Risks

The STSMP exhibits substantial risk from the financial management perspective. Risk factors include: (a) the significant financial resources involved in the STSMP; (b) the complexity o f the STSMP and related financial operations; (c) the strong central authority by STA management, which may hinder the timeliness o f activities and the independence o f the technical decisions; (d) the general weaknesses in financial management in the Ukrainian public sector; and (e) the Supreme Audit Institute controls over the STS have yet to be implemented.

5. Environmental: 5.1 Summarize the steps undertaken for environmental assessment and E M P preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis.

Environmental Category: C (Not Required)

The project i s not l ikely to involve any new construction or expansion, or demolition o f entire buildings. The civ i l works wi l l deal mainly wi th refurbishment and remodeling inside existing buildings.

Minor disturbances may be caused by noise, dust, disruptions associated with movement o f men, materials and equipment. Reconstruction wastes will have to be properly disposed of.

The TOR for the engineering consultants wi l l include the obligation to incorporate into the bidding documents appropriate environmental clauses and ensure that the construction activities are carried out in accordance with adequate safety and environmental protection measures. Special attention should be given to the proper handling and disposal o f asbestos materials, mercury containing bulbs, and any other hazardous substances. Building wastes containing asbestos wi l l not be recycled and reused in construction activities financed by the project.

5.2 What are the main features o f the E M P and are they adequate?

Not applicable.

5.3 For Category A and B projects, timeline and status o f EA: Date o f receipt o f final draft: No t applicable.

5.4 How have stakeholders been consulted at the stage o f (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms o f consultation that were used and which groups were consulted?

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Not applicable.

5.5 What mechanisms have been established to monitor and evaluate the impact o f the project on the environment? D o the indicators reflect the objectives and results o f the EMP?

No t applicable.

6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes.

The fairness and efficiency with which the state obtains resources from the society to fund public services i s an important element o f the social contract. By fostering a tax system based on high levels o f voluntary compliance to the Tax Legislation, the STSMP seeks to help improve the legitimacy o f the tax system. This, in turn, i s an important ingredient in the social legitimacy o f the broader fiscal and political systems.

There are n o specific negative social consequences expected from the STSMP design except, possibly, a gradual labor force reduction. The social effects o f the shedding o f surplus labor in the STS should be rather muted. The process i s l ikely to extend over three to four years during Phase 2 o f the STSMP. With annual staff turnover running between 8 and 10 percent, a substantial share o f labor shedding wil l be voluntary and driven by individual decisions to pursue other employment opportunities. Re-skilling and reassignment o f c iv i l servants to other public agencies (including municipal administrations) can be expected to create an orderly distribution o f much o f the balance o f the surplus staff. O f the remaining displaced personnel, they would not be concentrated geographically (such as surplus labor in industrial and extractive sectors). Moreover, the redundant labor would be literate and numerate individuals and among the most re-employable o f a l l redundant workers. At that point in time when the scale o f anticipated redundancies becomes clear, the financing o f separation costs wi l l need to be more closely assessed. At this juncture, the potential operational savings from a streamlined STS, including a release o f surplus premises, are expected to provide the STS with a workable budgetary envelope to finance the separation costs (i.e., loan finance i s not envisioned). The separation costs and the separation procedures wil l be governed by the then prevailing c iv i l service legislation.

The program's impact on poverty i s also difficult to pin point. Nevertheless, tax evasion i s regressive. Those with the resources to avoid taxes benefit the most. Whereas higher compliance rates, including a broader tax base, may bring more middle class individuals and smaller f i rms into the tax net, this should be o f f set by lower tax rates and the advantages o f bringing gray and black market activities into the formal economy (e.g.: access to credit, licenseslpermits, and writen contracts with the formal sector; the ability to openly advertise and to scale-up business operations; as well as reduced exposure to bribes, penalites and sanctions associated with illegal operations and the lack o f permits and licenses).

As indicated in the recommendation o f the December 2000 Poverty Paper: Ukraine -- Social Safety Nets and Poverty, "Anti-poverty measures also include a strengthening o f institutions and stable fiscal and monetary policies.'' In other words, macro-economic instability, including inflation driven by monetized revenue shortfalls, exacerbates poverty. (See also Dollar and Kraay, "Growth i s Good for the Poor", 2000.) A more effective tax administration reduces the r isks o f inflation and macro-economic instability and is, thus, an anti-poverty policy.

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6.2 Participatory Approach: How are key stakeholders participating in the project?

In the context o f the preparation o f the STSMP, and in i t s implementation, a number o f important accountability/feedback mechanisms are being established.

First, on the basis o f an appropriate executive decision o f the Presidential Administration, an independent Oversight Panel for the STS wil l be established under the STSMP. The Oversight Panel will comprise independent and internationally recognized experts in public administration and revenue administration in particular. The Panel wi l l be formally tasked with holding STS accountable for progress towards a Cabinet o f Ministers published vision statement for the transformation o f the tax system in Ukraine. (See Annex 5.1 o f the P P in the Project Fi les for a translation o f the decree. See Annex 1.1 o f the PIP in Project Files for a translation o f the Cabinet o f Ministers vision statement.)

Second, the STA has established an independent consultative body -- the Public Collegium -- comprising a number o f key representative o f stakeholder organizations in the area o f public and tax administration. Among the founding NGO stakeholder organizations are: Ukrainian Union o f Industrialists and Entrepreneurs (including regional representatives); All Ukrainian Association "Public Control"; Academy o f Sciences o f Ukraine-economic Department; Union o f Economists o f Ukraine; All Ukrainian Association o f International Law; All Ukrainian Association "Ukrainian Market"; Association o f Taxpayers o f Ukraine; Association "New Epoch"; and "Tonis Center" (Kharkiv TV company). As the Public Collegium begins i t s operations, other stakeholder associations w i l l be encouraged to join.

In contrast to the Oversight Panel (which serves as a neutral assessor o f progress in the reform o f the tax system), the Public Collegium i s a forum in which the representatives are expected to represent the interests o f their respective stakeholder groups. Together they are also expected to provide a broad based counterpart for the STS to engage with on matters o f tax administration. The Public Collegium, which had i t s founding meeting June 16,2002, has been established on the basis o f a decree by the Head o f the STA. The Head o f the STA published on November 14, 2001, a public vision statement. Analogous to the Council o f Ministers visions statement, this wil l provide a point o f reference for the Public Collegium to assess the progress o f the STS in i t s modernization. (See Annex 5.2 o f the PIP in the Project Files for a translation o f the decree. See the Annex 1.2 o f the PIP in the Project Files for a translation o f the STA's vision statement.)

Third, the program design and implementation processes address another important stakeholder constituency: the STS staff. Notwithstanding the assistance provided by the international advisors from the US Treasury, USAID, and the Dutch Tax Service, the formal process o f redesigning the STS's operational and management business processes and organizational structures i s fundamentally being carried out by the STS itself. Starting with a set o f teams in the Modernization Department and steadily expanding to include an increasing number o f staff f rom the main departments at Headquarters and representatives f rom oblast and inter-district offices, the designs draw on an expanding circle o f STS staff input. As the business process and organizational redesigns become more concrete, the design and planning documents wi l l provide the basis for an increasingly elaborated in-reach informational program (such as the modernization flyer initiated in July 2002). T o facilitate the planning and implementation processes, the Head o f the STA has formally identified three thousand staff as modernization

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representatives for their respective business units. These individuals include the deputy heads o f all u n i t s throughout the STS. The modernization representatives are tasked with: (a) being informed o f the modernization program and communicating this to their colleagues; (b) being a conduit for prompted and unprompted feedback from colleagues; and (c) being responsible for coordinating implementation activities as these activities reach their business uni ts .

Fourth, as the redesigns become more concrete, the external stakeholders (both state and private entities) wi l l be brought into the design process. The formal design methods adopted for the STSMP entail the identification o f the external stakeholders that interact with the STS on the operational level (e.g., Customs, State Statistics Committee, Ministry o f Justice, etc.). The formal methods require key officers o f these agencies to be a part o f the design, review, and clearance processes (enforced by the program quality assurance unit). These interactions engage a widening set o f external interlocutors, as the design documents capture greater and greater detail.

To facilitate the interaction with the non-state, external stakeholders, the STS has begun presentations and discussions with the membership o f the Public Collegium. As the modernized organizational structures and business process move towards implementation, the informational outreach program w i l l ramp up. The outreach program will be multifaceted and will address both the objectives o f the reforms, as well as the transactional implications for taxpayers o f the modernized business processes. Among other things, the development o f the prototype o f the core operational functions in Phase 1 w i l l entail direct assessments o f taxpayer responses. Annual taxpayer surveys wil l provide another instrument to obtain taxpayer feedback.

Fifth, the parliamentarians are another key stakeholder constituency. In addition to keeping key Verkhovna Rada members apprised o f the goals and progress o f the Modernization Program, the STSMP provides for the legislative support for the package o f legislative and regulatory changes that will be required to implement the redesigned business processes. The Verkhovna Rada, in turn, wil l determine what elements o f the proposed package wil l be enacted into law. Based on the enacted changes, the STS w i l l revises i t s business process and organizational designs to meet the legal prescription o f the Verkhovna Rada.

6.3 H o w does the project involve consultations or collaboration with NGOs or other c iv i l society organizations?

NGOs and civ i l society organizations will be involved through the various panels, as discussed above.

6.4 What institutional arrangements have been provided to ensure the project achieves i t s social development outcomes?

The program does not have specifically targeted social development goals. Nevertheless the program does entail institutional changes in the capacities and culture o f the STS that target improvements in service standards, integrity, and effectiveness. These should help reverse the regressive nature o f tax evasion.

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6.5 How w i l l the project monitor performance in terms o f social development outcomes?

The program does not have specifically targeted social development goals. Nevertheless, the program does entail periodic taxpayer surveys to assess the extent to which the STS i s improving i t s services, integrity, and effectiveness. These will shed some light on the progress made in reducing tax evasion and i t s regressive impact on real incomes. These should also provide some evidence o f the impact o f the STSMP on the sense o f legitimacy o f the tax system (although taxpayers typically find it hard to distinguish between tax policy and tax administration in direct assessments o f the tax system.)

7. Safeguard Policies:

7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies.

See Sub-section E-5.5 above.

F. Sustainability and Risks 1. Sustainability:

Tax administration i s a core state function. Thus, the STS i s l ikely to remain active and i t s role stable. This should translate into a sustained need for the functions and capacities built under the STSMP. As the cost-recovery analysis shows, the investments cover their costs even with a very l ow increase in compliance rates. This should ensure financial sustainability at the level o f the consolidated government budget.

Nevertheless, there are always uncertainties whether the Government would return sufficient funds to STS out o f the improved tax revenues. These are essential to cover the recurrent and depreciation costs associated with information technologies.

In relation to sustained government support for the STS and the STSMP investments, i t i s important to note that increased voluntary compliance to the Tax Legislation, which i s a central objective o f the STSMP, i s also a measure o f the popular legitimacy o f the tax regime and the tax administrator. Thus, the success o f the STSMP in transforming the relationship between the STS and the rest o f Ukrainian society to one based on openness, accountability, and service orientation, should translate into an increase in the legitimacy o f the STS and i t s role. This, in

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turn, should translate into the political support required to maintain the STS's resource allocation at a sufficient level to sustain the STSMP investments. O f course, the failure o f the STSMP to affect the transformation o f the STS would leave the STSMP investments vulnerable to inadequate financial resources to sustain them.

M

M

The "losers" in the process o f increasing the integrity o f tax administration may present r isks o f politically-driven, budget cuts for the STS, and/or threats to undermine the STS's roles and powers. Both may negatively affect the sustainability o f the STSMP investments.

Public awareness and information campaigns wil l seek to encourage compliance by, among other things, casting noncompliers as burdens on compliers and by linking tax revenues with public service quality. In addition, enhanced public awareness o f the STS's increased ability to detect and resolve evasion wil l help tip the cost-benefit calculation o f taxpayers toward compliance and away from noncompliance. Service needs assessments wi l l help ensure congruence between taxpayers' needs and STS services.

Successful implementation o f modern organizational structures, management practices, operational procedures, and information systems wil l provide the STS with

Below the level o f political risks, the single most critical technical risk factor in the sustainability o f the investments i s the ability o f the STS to retain informatics and other specialized staff in the face o f large wage differentials between the public and private sectors for these ski l ls . The STS currently enjoys some advantaged remuneration scheme, v i s - h i s the rest o f the civ i l service. This should help the STS attract and retain a reasonable level o f quality in i t s general operations and administrative functions. However, there are specialized positions, such as informatics specialists, senior auditors, and tax lawyers, for which the wage differential to the private sector i s quite large. As private sector employment becomes less r i sky , the difficulty o f attracting and retaining these specialists will become even more acute. Such problems are endemic in the public sector around the world and tend only to diminish as the focus o f the state shr inks to the essential core activities and the state can afford to compensate staff competitively. Outsourcing and other contractual arrangements for high demand specialists can help address the problem. However, these contracting arrangements also create their own challenges, by raising the level o f required in-house expertise necessary to specify, select, monitor, and manage sophisticated, outsourced technical services. They also can be divisive. The STSMP will seek to address these issues as part o f the set initiatives in the human resource areas, as well as those initiatives in focused in specialized areas such as strengthening the STS's information systems planning and management capacities.

2. Critical R i s k s (reflecting the failure o f critical assumptions found in the fourth column o f Annex 1):

Risk :ram Outputs to Objective Taxpayers do not respond to the STS's ncreased service orientation and ncreased capacity to discover and esolve tax evasion and under-reporting vith greater voluntary compliance with he Tax Legislation.

STS staff and managers do not respond 3 the new arrangements with increased lrofessionalism, service orientation, and ntegrity.

Risk Ratina I Risk Mitiaation Measure

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Other related public agencies anc nstitutions (including sub-national mthorities) do not respond to the STS's mproved business processes and mproved capabilities with cooperation md support.

The Government's and Parliament's :ommitment to the modernization o f tax idministration flags.

?om Components to Outputs ,Losers" in modernization effort disrupt vork.

Key staff andor managers are diverted o non-STSMP tasks or distracted by rises.

Political turnover results in flagging upport for the STSMP.

herall Risk Rating

S

M

S

M

S

S

the latitude to credibly ins is t on professionalism as the basis for continued employment. A lower staffing level would also allow greater staff remuneration and thus raise the opportunity cost o f j ob loss.

The STS's role as the primary source for state revenues should provide i t with continued political influence among state agencies. As appropriate, the Bank can influence these inter-agency "negotiations" by raising coordination issues at the senior-most levels o f the Government.

"Early wins'' in the STSMP design can help sustain Government and Verkhovna Rada support. In particular, the Unified Legislative and Statistical Capacity Building Sub-component aimed at the MOF, MOE, VR, STA among other key actors in revenue policy and administration should help convey the STSMP as a "positive sum" investment program. The Bank's country dialogue can help continue focus attention o f the GOU and the Verkhovna Rada on the importance o f tax system reform. Similarly, the Public Collegium and Oversight Panels represent public channels to ensure adequate government attention to tax modernization.

The use o f public oversight and formal feedback mechanisms, both external and internal to the STS, should allow the broad collection o f "winners" in the modernization effort to ral ly against attempted disruptions by the "losers" in the modernization process.

The structure, mandate, and authorized staffing levels o f the Modernization Department should help minimize the risks o f the diversion o f key staff and managers to non-STSMP activities.

Early successes in the STSMP design and the civil society feedback mechanism should strengthen the constituencies for continuation o f timely STSMP implementation.

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Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligib1e or Low Risk)

3. Possible Controversial Aspects:

The STSMP entail no genuinely controversial aspects. Tax administration i s a recognized core state function, and the STS performs a conventional set o f tax administration activities. The modernization approach embodied in the STSMP i s ambitious but not heterodox. Even the accountability framework established for the STS has a fair number o f international precedents -- albeit few in Ukraine.

There is, however, reputational risk associated with an agency that has a history o f heavy-handed administrative practices. The STSMP addresses these risks in a number o f ways. Most prominently, the Bank has consistently maintained establishment o f the accountability bodies as a condition o f preparation and continued involvement. The technical design o f the STSMP centers on the transition to a tax system based on voluntary compliance and integrity o f administration (e.g., the implementation o f true self-assessment). These w i l l lead to a much less contentious stance towards the typical taxpayer. The STSMP embodies many technical features that wi l l facilitate close monitoring by the Bank o f the STS's progress towards high-integrity, even-handed administration.

G. Main Loan Conditions 1. Effectiveness Condition

Provision o f a satisfactory legal opinion on the validity and binding force o f the Loan Agreement.

2. Other [classify according to covenant types used in the Legal Agreements.]

Implementation Program:

The Develoument and Modernization Department

The Development and Modernization Department shall be responsible for administering and coordinating adequate arrangements for the overall implementation o f the Project and the Program among the STS's redesigned organizational structure, including aspects related to the carrying out o f procurement o f goods and the selection and employment o f consultants' services, preparation o f disbursement applications o f Loan proceeds, management and maintenance o f Project accounts, and the preparation and submission o f the progress reports. To that end, the Borrower, through the STA, shall maintain the Development and Modernization Department throughout Project implementation under terms o f reference satisfactory to the Bank and with sufficient and suitable human, financial and technical resources.

Oversight Panel

The Borrower shall establish, not later than March 3 1,2004, and thereafter maintain throughout the Program, an Oversight Panel under terms o f reference and with resources and a composition satisfactory to the Bank. The said Panel shall consist o f an independent high-level panel vested with responsibility for assessing the STS's progress in transforming i t s relationship to the rest o f

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Borrower’s society to one based on voluntary compliance with the tax legislation coupled with a credible capacity to detect and properly resolve noncompliance, and shall comprise a small number o f high profile, internationally recognized experts in fiscal administration and public management. The Panel shall meet at least twice every Fiscal Year to carry out such assessment, making i t s findings public.

Public Collegium

The Borrower shall maintain to the satisfaction o f the Bank, throughout the Program, the Public Collegium as a consultative assembly o f representatives o f stakeholder associations in the Borrower’s territory, consisting o f representatives o f Ukrainian non-governmental organizations concerned with taxes, commerce, and public administration reform. The said Collegium shall meet at least on a semiannual basis and shall provide the STS with a consultative forum for advice and feedback on matters o f tax administration.

Annual Work Promam

The Borrower, through the STA, shall: (i) prepare and submit for the Bank’s comments and approval, not later than September 30 o f each Fiscal Year, a draft annual work program for the following Fiscal Year including, inter alia, a detailed description o f planned activities for procurement o f goods and technical services and selection and employment o f consultants’ services and sources and uses o f funds; and (ii) adopt and carry out the annual work program in the form and substance approved by the Bank.

Operations Manual

The Borrower, through the STA, shall take a l l action required to ensure that the Operations Manual i s applied and followed at a l l times in the implementation, monitoring and evaluation o f the Project, and, except as the Bank shall otherwise agree, the Borrower shall ensure that the STA do not assign, amend, abrogate or waive the Operations Manual or any provision thereof.

Training under the Study Tours

For the purposes o f the training to be provided by the study tours, the Borrower shall:

(a) fumish to the Bank for i t s approval, the content o f each such training, including an explanation on how such training i s consistent and conducive to the objectives o f the Project and whether it offers the best price/quality ratio, as wel l as the schedule for i t s implementation;

select the trainees in accordance with a transparent process and criteria satisfactory to the Bank;

not later than December 1 o f each year, exchange views with the Bank on the training to be carried out during the following calendar year; and

furnish to the Bank a report o f such scope and detail as the Bank shall reasonably request, o n the results o f each training and the benefits to be derived therefrom.

(b)

(c)

(d)

Promess Reports

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Without limitation upon the provisions o f Section 9.07 o f the General Conditions, the Borrower, through the STA, shall, commencing on April 30, 2004 and thereafter, not later than January 3 1, April 30, July 3 1 and October 3 1 in each calendar year and until Project completion, prepare and furnish to the Bank a progress report, o f such scope and in such detail as the Bank shall reasonably request, describing, in accordance with the Monitoring and Evaluation Indicators, the progress achieved in the implementation o f the Project during the preceding quarter o f the calendar year.

Mid-Term Review

The Borrower shall:

(a) maintain policies and procedures adequate to enable it to monitor and evaluate on an ongoing basis, in accordance with the Monitoring and Evaluation Indicators, the carrying out o f the Project and the Program and the achievement o f the objectives thereof;

prepare, under terms o f reference satisfactory to the Bank, and furnish to the Bank, on or about September 30,2005, a report integrating the results o f the monitoring and evaluation activities performed on the progress achieved in the carrying out o f the Project and the Program during the period preceding the date o f said report and setting out the measures recommended to ensure the efficient carrying out o f the Project and the Program and the achievement o f the objectives thereof during the period following such date; and

review with the Bank, by December 3 1,2005, or such later date as the Bank shall request, the report and, thereafter, take a l l measures required to ensure the efficient completion o f the Project and the Program and the achievement o f the objectives thereof, based on the conclusions and recommendations o f the said report and the Bank's views on the matter.

(b)

(c)

Conditions of Board Presentation:

There are no project-specific conditions o f Board Presentation. The standard conditions have been met. The Statutory Committee Report was fi led with Board Operations on April 14,2003. The Deputy Prime Minister communicated the Cabinet o f Minister's formal approval o f the negotiated documents to the Bank in a letter dated April 30,2003. DECDG indicated that Ukraine provide i t s extemal debt reports for 2002 on April 11, 2003 and i s thus current with i t s extemal debt reporting requirements.

H. Readiness for Implementation 1. a) The engineering design documents for the f i r s t year's activities are complete and ready for the

start o f project implementation. 0 1. b) No t applicable.

2. The procurement documents for the f i rs t year's activities are complete and ready for the start o f project implementation.

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3. The Project Implementation Plan has been appraised and found to be realistic and o f satisfactory

i? 4. The following items are lacking and are discussed under loan conditions (Section G): quality.

1. Compliance with Bank Policies 1. This project complies with al l applicable Bank policies. 2. The following exceptions to Bank policies are recommended for approval. T h e project complies

with al l other applicable Bank policies.

Helga W. Muller Luca Barbone Team Leader Sector Manager Country Director

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Annex 1: Project Design Summary UKRAINE: First State Tax Service Modernization Project

Hierarchy of Objectives Sector-related CAS Goal: B) Supporting Supply of Ievelopment-Oriented nstitutions.

3) Revenue Policy Reform.

6) Public Institutions.

Jrogram Purpose: i sustainable state revenue ystem founded on (i) roluntary compliance with the 'ax Legislation by taxpayers nd third parties; (ii) ompetent, honest, and quitable administration by the ITS; and (iii) a growing and s c i e n t enterprise sector.

Sector Indicators:

Simplified and transparent tax system in place which will broaden the tax base and lower the tax burden.

Close coordination o f revenue administration by Customs and STS.

Improved STS performance as shown by taxpayer surveys.

End-of-Program Indicators:

Improvement in an indicator o f voluntary compliance from a 2001 baseline o f 54.54 to 80 by the end o f Phase 2.

Improvement in an indicator o f the cost o f voluntary compliance from a 2001 baseline o f 56.11 to 75 by the end o f Phase 2.

Improvement in an indicator o f likelihood o f detection o f noncompliance from a 2001 baseline o f 5 1.70 to 75 by the end o f Phase 2.

Improvements in an indicator o f the quality and integrity o f STS administration from a 2001 baseline o f 33.56 to 80 by the end o f Phase 2.

Sector/ country reports:

:AS monitoring activities and 3conomic and Sector work

Vogram reports: ;TS operational data and inalytic work.

'roject-financed surveys and inalytic work

from Goal to Bank Mission)

From Purpose to Goal) :ontinued political support for nodernization o f the revenue ollection system.

konomic stability and regress in the general conomy (including stable )ositive developments in the ntemational determinants).

jeneralized progress toward he rule o f law in Ukraine.

Hierarchy of Objectives 'roject Development 3bjective: 4 sustainable state revenue iystem founded on (i) roluntary compliance with the Tax Legislation by taxpayers md third parties; (ii) :ompetent, honest, and :quitable administration by the $TS; and (iii) economic lynamism by the enterprise iector.

Outcome I impact Indicators:

Improvement in an indicator o f voluntary compliance from a 2001 baseline o f 54.54 to 65 by the end o f Phase 1.

Improvement in an indicator o f the cost o f voluntary compliance from a 2001 baseline o f 56.11 to 65 by the end o f Phase 1.

Improvement in an indicator o f l ikelihood o f detection o f noncompliance f rom a 2001 baseline o f 5 1.70 to 60 by the end o f Phase 1.

Improvements in an indicator o f the quality and integrity o f STS administration from a 2001 baseline o f 33.56 to 55 by the end o f Phase 1.

>reject reports:

STS operational data and inalytic work.

'roject-financed surveys and inalytic work

sum S

from Objective to Purpose)

2ontinued political support for nodemization o f the revenue .ollection system.

!conomic stability and irogress in the general conomy (including stable iositive developments in the ntemational determinants).

jeneralized progress toward he rule o f law in Ukraine.

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Hierarchy of Objectives 3utput from each Zomponent: I. Efficient, effective, and iccountable organization ;tructures and management :apabilities (that are properly ;ynchronized with tax policies ind aligned with the GOU's irogram).

Output Indicators:

Al. 1.1 A complete set o f detailed modernization plans developed and formally adopted by the Head o f STA (including Strategic Plan, Functional Organization Plan, Concept o f Operations Document, TLISRD, Information Systems Architecture, and Action Plan for Development and Management), by Q1 2004

Al. 1.2 Up-to-date, accurate, and transparent project monitoring and control maintained throughout project period.

A1.2 A strengthened H Q and a consolidated organizational structure (e.g., 10 super-regional and 120 inter-district offices + branches), e.0.y. 2007.

A l .3 . A contemporary human resource management concept developed and under implementation, via re-organized and properly staff and properly trained HR Department, by e.0.y. 2007.

A1.4. Approximately 350 executive and 2400 middle managers trained in and operating according to contemporary management practices, by e.0.y. 2007.

A1.5 Tax pol icy and legislation prepared in a well-informed and coordinated fashion among the MOF, MOE, Verkhovna Rada, the STA, and other key fiscal

'reject reports:

balyt ical, planning and mplementation documents Irepared by project teams, :onsultants, etc. and BRDAMF supervision nissions.

2uarterly project progress 'eports & supervision nissions.

halytical, planning and mplementation documents )repared by project teams, :onsultants, etc. and BRDAMF supervision nissions.

Critical Assumptions from Outputs to Objective)

raxpayers respond to the ;TS's increased service rientation and increased :apacity to discover and esolve tax evasion and mder-reporting with greater roluntary compliance with the Tax Legislation.

STS staff and managers espond to the new irrangements with increased )rofessionalism, service )rientation, and integrity.

3ther related public agencies md institutions (including iub-national authorities) ,espond to the STS's improved winess processes and mproved capabilities with :ooperation and support

The Government and 'arliament continue the :ommitment to the nodemization o f tax tdministration.

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!. Efficient, effective and ransparent tax administration iperations.

PHASE 2

. Efficient, effective, and ccountable organization tructures and management apabilities (that are properly ynchronized with tax policies nd aligned with the GOU's rogram).

actors, by e.0.y. 2007.

A1.6 Well targeted and well informed communications between the STS and key public and private stakeholders in Ukraine, by e.0.y. 2007.

A2.1. A proven prototype o f modemized core tax administration operations (i.e., registration, accounting, declaration processing, and document management, plus support for customer service, audit, collections, appeals), by e.0.y. 2007.

A2.2 Modem Call-center operational servicing tax payers and tax officials on a nationwide basis, by e.0.y. 2007.

A2.3. Strengthened compliance function (including audit and collections functions) by e.0.y. 2007.

,424. Eight fully equipped and operational large tax payer offices, by e.0.y. 2007.

PHASE 2

B 1.1.1 Up-to-date suite o f formal business process, xganization, and systems lesign and sub-project ?laming documents :hroughout project period.

B 1.1.2 Up-to-date, accurate, md transparent project nonitoring and control naintained throughout project ieriod.

3 1.2. Substantial reduction in :he number o f branch offices

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!. Efficient, effective and ransparent tax administration )perations

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and overall staffing levels, by e.0.y. 2012.

B 1.3 Wel l organized, staffed, trained, equipped offices responsible for selected institutional management functions (e.g., personnel, planning and budgeting, internal controls, management information, etc.), by e.0.y. 2012.

B2.1. Efficient, integrated, and automated core tax functions implemented nationwide, by e.0.y. 2012.

Hierarchy of Objectives Project Components I Sub-components: Al . Organization & Management Component

2uarterly management reports md supervision missions

A1 .I. Strategic project management capacity building.

Outputs) "Losers" in modernization effort do not disrupt work.

K e y staff andor managers are not diverted to non-STSMP tasks or distracted by crises.

Continued political support for

Al .2 Organizational consolidation.

A I .3. Human resource management capacity building.

41.4. Management capacity milding.

41.5 Legislative and $tatistical analysis capacity iuilding.

41.6 Stakeholder relations :apacity building.

42. Operations Component

42.1. Prototype o f nodernized core tax idministration operations :taxpayer registration, tax iccounting, declaration xocessing, document nanagement, plus support for :ustomer service, audit, :ollections, etc.).

nputs: (budget for each :omponent) 11. US$59.5 mil l ion (total :ost).

~ 2 . US$25.7 mi l l ion (total ost).

Voject reports: I (from components to

the STSMP

The Government provides counterpart funding for the STSMP on timely and continuous basis.

The Verkhovna Rada passes a sufficiently large proportion of the package o f legislative changes required to implement the modernized business processes.

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A2.2. Call-center operations.

A2.3 Compliance strengthening.

A2.4. Large taxpayer office strengthening.

PHASE 2

B1. Organization & Management Component

B 1.1. Strategic project management capacity building.

B 1.2. Organizational streamlining.

B1.3. Institutional management functions strengthening (e.g., personnel, planning and budgeting, internal controls, management information, etc.).

I

B2. Operations Component

B2.1. National roll-out of modemized core tax administration operations.

B3. Phase 1 Incremental Recurrent Costs in Phase 2 (e.g., information & communications technologies maintenance, telecommunications services, office & other supplies, vehicle operations & maintenance)

PHASE 2

31. US$55.6 mil l ion (total ost).

32. US57.0 mil l ion (total :ost).

33. US$2.7 mil l ion (total :ost).

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Annex 2: Detailed Project Description UKRAINE: First State Tax Service Modernization Project

-- INTRODUCTION AND OVERVIEW OF PROGRAM --

The STSMP i s an ambitious decade long, two-phased program to modernize the State Tax Service (STS), including i t s national Headquarters, the State Tax Administration (STA). The STSMP will thoroughly revamp the STS, including i ts:

0

0 Accountability framework.

0 Organization and management structures.

0

Overall strategic approach and stance v i s - h i s taxpayers and rest o f Ukrainian society.

Operational capacities (i.e., business processes, skills, operational systems, and other tools).

The STSMP seeks to establish a tax system in Ukraine on the basis o f voluntary compliance to the Tax Legislation by taxpayers and related third-party payers o f taxes (hereafter “taxpayers”). The move to voluntary compliance depends upon, among other things, the development o f a system o f true self-assessment. I t also depends on the STS’s capacity to administer the Tax Legislation in an efficient, effective, transparent, and even-handed fashion. These, in turn, depend on a complex mix o f capacity building and behavioral changes (within STS and among i t s clients and partners in tax administration).

The STSMP concentrates on the administrative aspects o f the revenue equation. Tax policy matters (Le., tax rates and tax base definitions) are more amenable to other Bank instruments as well as other multilateral and bilateral assistance. The STSMP, as a result, i s fundamentally an institutional development program. As such, the STSMP spans a substantial time period, i s technically complex, and i s shaped by socialhehavioral dynamics. As discussed in Section D-1 o f the main PAD, these factors informed the choice o f the APL instrument, i t s timing, and program triggers. Section B-4 presents the APL triggers. I t also presents a time-based, schematic overview o f the key themes o f the STSMP. Section C-1 summarizes the high-level structure o f the STSMP components:

(Note: The following cost data do not include the Front End Fees for the two phases.)

By Component:

Project Component I - US$85.16 million -- STSMP PHASE 1 --

(Al) Organization and Management (O&M) Modernization Component (US$59.5 million).

(Al.1) Strategic Project Management (estimated US$13.3 mi l l ion total cost). The f i rs t sub-component o f the O&M Component builds the STA’s capacity to implement major strategic projects. The sub-component incorporates most o f the analysis, planning, substantive

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management, and administration for the STSMP i tsel f . These build on the activities initiated under the PPF. The sub-component comprises two parts.

(Al. 1.1) Design, Planning and Testing. The f i rs t part o f the Strategic Project Management Sub-component supports the integrated agenda of: analysis, detailed design, and testing activities for the STSMP. The initiatives under Design, Planning, and Testing in large measure correspond to the formal analytical methods adopted by the STA for the STSMP. These initiatives include the development and maintenance o f the STA’s:

Al.l. l . l A l . 1.1.2 A1 .l. 1.3 A1 . 1 . 1.4 A1 .l. 1.5 Al.1.1.6 A1.1.1.7 A1.1.1.8 A1.1.1.9

A1.l. l.10

Strategic Plan. High Level Action Plan. Functional Organization Document. Data Models. Concept o f Operations Document (ConOps). Top-Level Integrated Requirements Document (TLIRD). Integrated Systems Architecture Document. Detailed Action Plan. Legislation and Regulatory Change Plan (Le., the identification o f the required legal and regulatory changes and support to affect the changes). Development and Testing Laboratory (for procedures and software).

Without going into a detailed description o f each o f the analyses and corresponding documents, a few comments are warranted in regard to these initiatives. First, the Strategic Plan represents the apex o f the formal hierarchy. I t establishes the basic principle, key goals, and measurable objectives o f the STS and i t s modernization program. The Strategic Plan feeds the subordinate analyses and documents. In particular, it informs the Functional Organization Document and the Concept o f Operations (ConOps). The ConOps reflect the STS’s three-level organizational structure (i.e., HQ, regional, and local) and captures the re-designed management and operational business processes necessary to meet the objectives o f the Strategic Plan. The STS’s main business segments are:

Organization and Management o Institutional Management and Representation o Legislative Affairs o Internal Business Support o o Reporting and Analysis o Human Resources o Internal Administration o Document and Records Management o

Internal Control (inspection, internal audit, anti-corruption)

Institutional Computing Resource Management and Central Operations

Operational o Customer Services o o Tax Accounting o Document Processing

Taxpayer Registration and Registration Audit

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o Enforced Collection and Liquidation o o Appeals o Legal Operations o Large Taxpayer Office Operations o Investigations

Audit Selection, Planning, and Execution

The ConOps record the "products" o f each business process segment as wel l as the exchange o f products between business segments and the exchanges with external entities (e.g., taxpayers, the courts, the MOF, Customs Administration, etc.). Once each o f the ConOps are prepared, they are "integrated" to ensure internal consistency. The ConOps also determine the package o f necessary legislative and regulatory changes to realize the reformed business processes. The sub-component provides resources for an outside review o f the ConOps, as well as for assistance in presenting the legislative and regulatory change package.

The ConOps form the basis for determining the STS's human resource requirements, as wel l as the electronic and manual systems necessary to conduct the reformed business processes o f the STS. These, in turn, determine the array o f sub-projects needed to implement the reforms, which are captured (at the highest level) in the Top Level Integrated Requirements Document (TLIRD).

I t i s important to note that, although the higher level plans should stabilize fairly quickly, these analytic and validation processes are repeated for increasing levels o f detail. Accordingly, the sub-component establishes a development lab for formulating and testing the new business processes, the procedures, forms, skil ls, and software tools needed to implement each new business process.

The necessity for learning-by-doing in institutional development and continuous change in the STS's environment makes these design and validation processes iterative as wel l as permanent institutional functions. Accordingly, the processes and the corresponding "living" documentation require formalized management.

(Al.1.2) Project Management. The second part o f the Strategic Project Management Sub-component supports the STA's capacity to manage the STSMP itself. This includes the technicahbstantive aspects o f the STSMP, as wel l as the more procedural aspects that constitute project administration. This sub-component provides technical assistance, training, tools and other resources to build capacity in the formal methods for project management. These cover the following repeatable project management process (based on I S 0 12207).

Program Management (including standards promulgation, long te rm and transition planning, and overall coordination).

Configuration Management (including, program status monitoring and change control).

Quality Assurance (including monitoring and control o f the application o f the formal methods).

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Acquisition (including procurement, disbursement, and financial management).

Integration (including coordination between ongoing and planned sub-projects, as well as existing legacy sub-systems).

Testing and Evaluation (including independent test formulation, execution, and reporting at five levels: unit, sub-systems, enterprise, pilot, and overall production acceptance).

Implementation (including coordination, awareness-building, installation o f hardware, software, data set, training, etc.).

Data Administration (including specification o f data model, database structures, at the conceptual, logical, and physical levels, as well as data migration).

Security Planning (including access control and disaster recovery and business continuity).

Maintenance (including planning, development, and implementation o f system updates and extensions).

Note: the notion o f "system" used in this context i s a coherent set o f procedures, processes, practices, skil ls, information assets, and information technologies (electronic and otherwise).

Project Management also supports annual project audits, mid-term and respective reviews, as wel l as the monitoring and evaluation o f the key performance indicators (UI)

(41.2) Organizational Consolidation (US$39.4 million). The second sub-component o f the O&M Component addresses the consolidation o f the STS's organizational structure. At i t s inception as an independent agency in 1996, the STS included 27 oblast or major city administrative uni ts. I t also had over 800 u n i t s at the local, rayon level. In the interim, the STS has closed a number o f the smallest offices and consolidated rayon-level administrations to less than 500 uni ts. Many former rayon-level offices were scaled back andor turned into branch offices o f inter-district offices. Under Phase 1 o f the STSMP, the STS wil l implement an ambitious initiative to:

0 Further consolidate i t s administrative structure into approximately 6-10 super-regional units and 120-130 inter-district un i ts .

Scale back operations at the local level to the extent practical.

Set the stage for extensive streamlining o f operations at the lowest levels during Phase 2.

0

0

The process o f organizational consolidation flows from the organizational and business process designs developed under the Strategic Project Management Sub-component. It also incorporates a transition to an organizational model based on common tax administration functions - in contrast with the STS's current configuration based primarily on tax types. In addition to efficiency gains, the function-based organizational structure offers important benefits in

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administrative integrity. These come by spreading the interactions with specific taxpayers across a number o f units and avoiding the control o f key processes and documents by single persons or units. The consolidation o f the STS operations also provides important integrity benefits, by removing document processing operations from local units where the formal and informal interaction with taxpayers i s most intimate and subject to abuse. The consolidation and function-based models are also essential to the transition to tax administration that i s based on “true” self-assessment and the realization o f compliance cost reductions associated with self-assessment.

The constituent parts o f the Organizational Consolidation Sub-component are:

Al.2.1 Consolidation planning and management. Al.2.2 Consolidation implementation support. Al.2.3 Management consolidation. Al.2.4 Staff consolidation. Al.2.5 Premises restructuring. Al.2.6 Local Taxes Administration Plan.

The planning, management, and support sub-components support: (a) access to international experiences in major organizational restructurings; (b) piloting the package o f organizational, procedural, and resource changes; and (c) managing the consolidation on a day-to-day basis. Given the scope o f the undertaking and the need to keep current tax operations running during the transition, the day-to-day management o f the consolidation wi l l need to be spread throughout the organization. It starts with the STS’s executive team (STA Head and Deputy Heads). It also includes al l levels o f management right down to the smallest local office. Accordingly, the STA has identified 3,000 managers and staff (including al l deputy heads o f departments and offices) as being responsible for the modernization process. These responsibilities include being informed o f the modernization activities, being involved in decision-taking and feedback, and being a source o f information and coordination within their respective units.

The management and staff consolidation sub-components address the need to restructure management‘and staffing profiles as well as sk i l l s sets (managerial and technical) so that they correspond to the new organizational structure and the modemized business processes. The sub-sub-component provides retraining, moving expenses (STS-financed), and re-skilling for managers and staff that would leave the STS for positions elsewhere in the public or private sectors. As discussed in Section E-6 o f the main PAD, the optimal staffing level for STS w i l l fa l l substantially over the course o f the decade long program. In Phase 1, however, this reduction i s likely to be relatively modest, due to constraints in the Ukrainian telecommunications and transport infrastructure, and the need to synchronize the modernized and older business processes during the extended transition. With annual staff turnover rates o f 8-10 percent, redundant staffing levels wi l l likely emerge only in Phase 2 (and be relatively modest). Nevertheless, Phase 1 sets the stage for the streamlining o f the STS in Phase 2, by providing re-skilling for separation candidates, as wel l as human resource staff planning and HR capacity building (see below). Any separations would be STS-financed and be governed under the then-prevailing Civ i l Service Code and related regulations.

The premises restructuring sub-component provides for selectively expanding and reconfiguring offices at the middle tier o f the organization, while closing and shrinking offices at the lower levels (STS-financed). In the process, the new premises will need to be physically configured with taxpayer halls, open floor plans, and other features that insulate records and processing

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activities f rom clients.

The local tax administration sub-component supports an analysis o f the prospects for future administration o f local taxes. Currently, most local revenues are earmarked shares o f national taxes that are administered by the STS. In the context o f a proposed national program o f fiscal decentralization, local authorities may be given the powers to raise local revenues through taxes and other levies. At this juncture, the movement towards such decentralization o f revenue mobilization i s currently constrained politically by the large disparities in the income and wealth distributions among the administrative subdivisions o f Ukraine. Nevertheless, the decentralization o f revenue administration i s a prospect that the STS w i l l need to plan for. In particular, as the STS consolidates and streamlines i t s operations, it wi l l need to ensure an orderly divestiture o f administrative responsibilities for any local taxes and levies. I t may also outplace staff and managers into local fiscal administrations.

(A1.3) Human Resource Management* (US$0.3 million). The third sub-component o f the O&M Component focuses on priority-tactical needs in the area o f human resource management. The work under this sub-component i s a prelude to strategic investments in human resource management. I t primarily responds to some clear and pressing needs that the STA has identified. This includes support for the human resource planning dimensions o f the Organizational Consolidation (i.e., staff profiles, job descriptions, selection criteria, etc.). I t also includes some technical assistance for strengthening o f the HQ Human Resource Management Department and line level human resource management functions. In large measure, these activities build on the technical assistance provided by USAID and the US Treasury.

(21.4) Management Capacity Building* (US$1.4 million). The fourth sub-component o f the O & M Component addresses priority-tactical needs in the area o f executive and middle management. In addition to preparing the STS’s executive and middle management teams for the sweeping changes ahead under the strategic stream o f the STSMP, there i s an urgent need to more formally train the management team on contemporary management practices. T o a very large degree, the STS’s brief history has been marked by reactive, crisis management. It has not had the luxury o f a deliberate program o f management reform and capacity building. The sub-component addresses the most pressing areas o f management capacity building. It builds on assistance provided to the STS by USAID and UST advisors. I t also follows up on the init ial training on human resource, functional organization, and formal planning and management methods financed under the PPF.

(A1.5) Legislative and statistical analysis (US$1.4 million). The fifth sub-component o f the O&M Component addresses priority-tactical needs in the area o f legislative and statistical analysis. The sub-component supports capacity building in: legislative analysis, regulatory drafting, revenue forecasting, tax modeling, statistical analyses, and information interchange. These areas represent the intersection o f tax policy and tax administration, and are critical to the management o f the revenue system as a whole. Accordingly, the roles and responsibilities are distributed among the STA, the MOF, the MOE, State Statistics Committee, the Customs Administration, and the Verkhovna Rada committees. The STSMP does not attempt to address al l the issues in these areas. However, the sub-component does provide resources to the key actors to implement a jointly-developed, unified capacity building plan (e.g., technical assistance, training, modeling and information interchange tools, etc.). The sub-component also supports the strengthening o f the STS’s ability to move data f rom the lower levels o f the organization (where the transactions take place and the data are generated) upwards through the organization in form o f aggregated statistical data. These data support the management o f the STS, as well as,

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inform the wider task o f managing the tax system.

(A1.6) Stakeholder Relations (US$3.8 million). The sixth sub-component o f the O&M Component addresses a combination o f priority-tactical and strategic needs in the management o f the STS’s relations wi th i t s external and internal stakeholders. The STS i s a central actor in the Ukraine economy. I t s own effectiveness depends on the efficacy o f i t s interactions with many key counterparts (e.g., taxpayers, opinion and policy-makers, other administrations such as Customs, the judiciary, the Treasury, banks, service providers, etc.). Accordingly, the STA has institutionalized a number o f functions that facilitate these interactions. These include an active public relations program that, among other things, explains tax procedures, STS operations, taxpayer and STS obligations, and seeks to promote a culture o f voluntary compliance to the Tax Legislation. The STA also maintains offices charged with monitoring public, press, and Verkhonva Rada discussions on topics relevant to tax administration and to cany-out the dialogue with such parties. The sub-component provides support to strengthen and extend these functions, including a more formal analysis and organization o f the procedures employed. Since the STSMP i tse l f drives sweeping changes within the STS, STS managers and staff are also key stakeholders in modernization process. Accordingly, the sub-component provides resources to develop and distribute informational materials (both internally and externally). In large measure, these focus on explaining the changes which the modernization program wil l bring. The sub-component also provides resources to support the Oversight Panel and Public Collegium.

(A2) Operations Modernization Component (US$25.7 million).

(A2.1) Prototype Core Tax Administration Operations (US$24.0 million). The prototype covers taxpayer registration, tax accounting, declaration processing, document management, plus support for client services, audit, collections, etc. The sub-component includes two parts:

(A2.1 .l) Prototme Suuport. Prototype Support provides the additional planning and management resources needed for the prototype o f the modernized core tax administration functions. This includes site selection, specialized procurement support, and logistics to oversee the implementation, troubleshooting and evaluation o f the prototype.

(A2.1.2) Prototme Implementation. Based on the organizational and business process designs, the STSMP wil l provide the resources to develop a prototype o f modernized business processes in the “core” areas o f tax administration (Le., taxpayer registration, tax accounting, declaration processing, document management, plus support for client services, audit, collections, etc.). The prototype w i l l be developed in a selected region, and will constitute a complete package o f procedures, organizational arrangements, staffing arrangements, skil ls, forms, documents, as wel l as automated and manual system tools to perform the core functions in a modernized fashion. The unification and simplification o f taxpayer registration i s an important “early win” and demonstration o f the STA’s commitment to lower compliance costs and facilitate private enterprise. The unification o f the registration process, as well as o f the taxpayer accounting and declaration processing, wi l l provide the STS with new opportunities to detect evasion and fraud. The integrated system wil l also provide far better operational statistics for STS management as well as for the M O F and other key actors in fiscal management.

From an implementation perspective, the prototype wil l be developed and implemented

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through a small number o f major contracts, where each contractor i s responsible for bringing critical expertise in the subject area, as wel l as providing the technologies, materials, and training. The three major contracts are:

A2.1.2.1 The Tax Block Contract. A2.1.2.2 Document Management Contract. A2.1.2.3 Information and Communications Technology Infrastructure Contract.

The Tax Block Contract covers registration, accounting, declaration processing, and selected support for the other operational areas. Registration includes, among other things: (a) the establishment and maintenance o f unique identifiers for physical and legal persons; (b) the establishment and maintenance o f relevant characteristics o f taxpayers (e.g., taxable objects, such as natural resources, or payment transactions information, cash registers, etc.); (c) the use o f taxpayer registers in conjunction with stop-filer information; (d) the transfer o f taxpayers between STS administrative units; (e) the registration o f payment mechanisms; (0 the audit o f registration information; and (g) de-registration. Accounting includes, among other things; (a) the establishment and configuration o f taxpayer accounts; (b) the accounting o f tax payments and overpayments; (c) the calculation and accounting o f sanctions and fines; and (d) the consolidation o f taxpayer accounts, include net tax debts. Declaration processing includes, among other things: (a) the electronic receipt and manual data entry o f registration, tax declarations, and payment information; (b) the correction o f errors; (c) the analysis o f errors; and (d) routine and ad hoc reporting, including, for example, the provision o f income information for means tested social assistance. Each o f these major functional systems provide an information base and l i n k s to the other operational areas, including audit, collections, appeals, etc. (although the completion o f the modernization o f these areas will be undertaken in Phase 2).

The Document Management Contract covers the capture, storage, retrieval and distribution o f incoming documents (e.g., declarations, payment information, and correspondence). I t also includes the management o f outgoing documents (e.g., correspondence, notices, payment documents) and the production and management o f standard forms, STS regulations, operational manuals, internal memorandum, as well as public communications, such as bulletins, periodicals, and other informational materials.

The I C T Infrastructure Contract covers the processing and networking technologies upon which the tax application software will run. The technologies required for the platform to run the applications are standard microprocessor-based technologies, including: workstations; medium-range servers; LANs; printers; scanners; and telephone equipment. The prototype region wil l be selected to, among other things, not present overly challenging problems in wide area networking (i.e., be served with reliable data communications o f sufficient bandwidth). Nevertheless, the design will take into account the constraints o f the Ukrainian infrastructure. It will use methods that limit the required volume o f data transmissions. Data and application code will be centrally managed and buffered, to admit continuity o f business operations in the advent o f communications disruptions.

Prototype Implementation provides small vans to transport documents to and from the prototype bulk processing center (and double as staff transport in the course o f the

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re-alignment o f the offices).

Prototype Implementation also includes STS-financed premises configurations to support bulk processing (including document and mail handling). The most appropriate configuration o f document processing, including possible regional processing centers, i s something to be assessed through the prototype experience.

(A2.2) Customer Service Call Center (US$l. 1 million). The Customer Service Call Center Sub-component w i l l provide a centrally managed and operated referral and information source for taxpayers. I t will be implemented in tandem with the STS's internal Help Desk call facilities that will support STS staff on operational and technological matters. Both facilities w i l l utilize voice over IP (via the STS wide area network). Among other things, this wil l allow the STS to establish local telephone access points for taxpayers to the central help facility and knowledge base.

(A2.3) Compliance Strengthening* (US0.4 million). The Compliance Strengthening Sub-component supports priority-tactical initiatives in the area o f audit and collection. Planning and implementation w i l l be driven from the respective STA main departments (generally out o f own budget resources). The sub-component provides for technical assistance to help the main departments formulate and strengthen their plans in these areas. Additional resources for implementation, if necessary and appropriate, may come from the physical contingencies calculated for the STSMP.

(A2.4) Large Taxpayer Ofice Operations Support* (US0.2 million). The LTO Support Sub-component i s a priority-tactical initiative that builds on the STS's ongoing program to establish and equip offices to administer large taxpayers. (Currently, there are seven offices with a target o f eight by e.0.y. 2003). Large taxpayers represent the largest share o f tax revenues, as well as the most complex and sophisticated cases. Concentrating attentions and specialized ski l ls in LTOs i s a widely practiced method to lower compliance costs and increase compliance rates for taxpayers that represent the highest risk o f revenue loss. Planning and implementation o f the LTO support wi l l be driven from the STA main department responsible for LTOs (generally out o f own budget resources). The sub-component provides for technical assistance to help the main department formulate and strengthen i t s plans in these areas. Additional resources for implementation, if necessary and appropriate, may come from the physical contingencies calculated for the STSMP.

Project Component 2 - US$115.32 million -- STSMP PHASE 2 --

(Bl) Organization and Management (O&M) Modernization Component (US55.6 million).

(Bl. 1) Strategic Project Management (US$lO. 1 million). The Sub-component continues the support for:

(B 1.1.1) Strategic Planning and Review. Strategic Planning and Review provides for the continuation o f senior residential advisor(s) to the STS executive team on modernization issues and strategic management o f tax administration. I t also supports

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continued development and updating o f the key design documents for the STSMP (Strategic Plan, Functional Organization Document, ConOps, Information Systems Architecture, and the Detailed Action Plan).

(B 1.1.2) Project Management and Administration. Project Management and Administration captures the program management overhead o f the Modernization Department (plus substantial interpretation and translation costs). It also provides for annual project audits and monitoring and evaluation activities (KPI tracking, mid-term and retrospective review o f Phase 2).

(B1.2) Organizational Streamlining (estimated zero total costs). The Organizational Streamlining Sub-component supports the reduction in the scope and scale o f the STS, as enabled by: (a) the organizational consolidation in Phase 1; (b) the national roll-out o f the modernized core o f tax administration operations in Phase 2; (c) continuous improvements in Ukrainian telecommunications and transport infrastructure; (d) gradual strengthening o f private sector provision o f tax-related services; and (e) prospective simplifications in the Tax Legislation (e.g., in relation to l ow income and the agricultural sector). It encompasses the costs associated with the release o f redundant facilities and, to the extent they emerge, surplus staff. Correspondingly, it encompasses operational savings and asset sales. At this juncture, it i s extremely difficult to forecast the cost o f the streamlining and the savings. The optimal staffing level cannot be determined with any real precision, nor can the timetable and staff surplus be forecast, nor can the terms for separation in the future be confidently projected. (Any separations would be STS-financed and be governed under the then-prevailing Civ i l Service Code and related regulations.) Similarly, the necessary configuration o f premises cannot be determined at this stage, nor can the revenues associated with the sale or release to the state property agency be forecast. In general, the "savings" are likely to exceed the costs. However, based on international experience, few such downsizings yield substantial savings, since they are usually applied to other needs, such as higher remuneration for a more highly skilled staff cadre. Consequently, the cost for this sub-component i s estimated (conservatively) at zero total costs on a net basis.

(B1.3) Institutional Management Functions Modernization (estimated US45.6 mi l l ion total cost). This sub-component provides the resources to modernize the STS's institutional management functions (i.e., the business process segments listed under the Organization and Management business process segments in connection wi th the design work carried out under sub-sub-component Al. 1.1). These modernizations build on the priority-tactical initiatives carried out in Phase 1. They also build on the redesign organizational structure and on the modernized operational systems.

From an implementation perspective, the institutional management function modernizations wi l l be carried out through a small number o f major contracts, where each contractor i s responsible for bringing critical expertise in the subject area, as well as providing the technologies, materials, and training. The five major contracts are:

B 1.3.1 Human Resource Management Contract. B 1.3.2 AdministratiodLogistics Contract. B 1.3.3 Internal Inspections Contract. B 1.3.4 Management Information and Decision Support Contract. B1.3.5 Document Workf low Contract.

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(B2) Operations Modernization Component (estimated US$57.0 million).

(B2.1) Core Tax Administration Operations National Roll-out. The sub-component provides for the national roll-out o f the core tax administration prototype developed in Phase 1 (covering taxpayer registration, tax accounting, declaration processing, and document management), plus extensions to fully support the other key areas o f tax administration operations (e.g., customer service, audit, collections, appeals, investigation, and legal operations).

From an implementation perspective, the national roll-out o f these operational functions will be carried out through a small number o f major contracts, where each contractor i s responsible for bringing critical expertise in the subject area, as wel l as providing the technologies, materials, and training. The seven major contracts are:

B2.1.1 Customer Service Contract. B2.1.2 Audit Contract. B2.1.3 Collections Contract. B2.1.4 Appeals Contract. B2.1.5 Investigation Contract. B2.1.6 Legal Operations Contract. B2.1.7 Information and Communications Infrastructure Contract.

In addition, the sub-component wi l l provide for audit and collections vehicles. The STS wil l also finance premise refurbishments to accommodate document processing centers (regional or decentralized, depending on the design emerging from the Phase 1 prototype experience).

(B3) Phase 1 Incremental Recurrent Costs in Phase 2 (US$2.7 million).

To properly cost and evaluate the STSMP and to provide the STS with the data for i t s cash requirements forecasts to be submitted the MOF, the incremental recurrent costs in Phase 2 associated with the Phase 1 investments needs to be captured. These include:

0

0 Telecommunications Charges.

0 Office and Other Supplies.

0 Vehicle operations and maintenance).

Information and Communications Technologies Maintenance).

Note: The telecommunications charges are incremental over the cost o f the STS ongoing wide area network installation, which are not considered within the STSMP, since it i s an ongoing investment program designed to support current operations.

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Annex 3: Estimated Project Costs UKRAINE: First State Tax Service Modernization Project

Price Contingencies

Total Proiect Cost:

A1 . Organization and Management Modernization Component A2. Operational Modernization Component Total Baseline Cost Physical Contingencies

2.99 1.02 4.01 59.59 25.58 85.17

45.25 7.19

52.44 4.16

Price Contingencies

7.22 15.14 22.36

2.20

2.99 I 1.02 I 4.01

52.47 22.33 74.80

6.36

I Total Project Costs

Front-end fee Total Financing Required

59.59 25.58 85.17 0.40 0.40

59.59 25.98 85.57

0.40 0.40 I Front-end fee I I Total Financing Rewired I 59.59 I 25.98 I 85.57

Works Goods and Supply & Install Technical Services Consultancies & Training Study Tours Misc. - Modernization Department Misc. - Staff Re-alignment Costs Recurrent Costs Physical Contingencies

19.36 5.22 2.00

15.00 0.00 5.67 4.75

, 0.44 4.16

0.00 16.46 0.00 5.18 0.46 0.00 0.00 0.26 2.20

19.36 21.68 2.00

20.18 0.46 5.67 4.75 0.70 6.36

Note: The Supply & Installation contracts for the niajor information system implemented under the STSMP a l l include substantial technical assistance and training as part o f the smgle-responsibility approach to systems implementation. This technical assistance and training cover managerial, operational. and technological areas. Accordingly. the Consultancies & Training Category significantly understates the knowledge transfer under the STSMP.

I

57.27% o f total project cost net o f taxes. Identifiable taxes and duties are 15.72 (US$m) and the total project cost, net o f taxes, is 69.85 (US$m), Therefore, the project cost sharing ratio i s

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Annex 4 UKRAINE: First State Tax Service Modernization Project

As mentioned in Section E-1, tax administration projects are not easily amenable to benefit-cost and other economic analyses. Taxes are inter-sectoral transfers for which the economic benefits are hard to establish. Also, the economic impact o f improved tax administration tends to be defused through the economy through the effects o f improved price signals and improved distributional impacts (as a result o f increased compliance and less reliance on the inflation tax).

The analysis present here i s rather limited in i t s focus. I t seeks to demonstrate that the necessary improvement in revenue performance to cover the cost o f the investment program (both phases) i s extremely low, even under very conservative assumptions. Reciprocally, a relatively modest assumption o f the improvement in compliance rate, as a result o f the investment program, yields substantial incremental revenues that can be used to strengthen fiscal balances and lower tax rates.

The model used in this analysis compares a STSMP-related cost stream versus a projected incremental revenue stream. The present value o f the two streams can then be compared under different scenarios o f revenue performance improvements.

The cost calculation includes: (a) the investment costs estimated for the STSMP; (b) the incremental recurrent cost estimated for the STSMP, which are held at the 2012 level, plus inflation, for the years 2013-2033; and (c) a 5-year depreciation and asset replenishment program for 2004-2033 (inflation adjusted).

Using a 10 percent discount rate, the present value o f the total cost stream i s US$226 million.

The incremental revenue calculation makes a rather simple assumption that revenue performance improves by a fixed percentage each year between 2005 and 2012 (the end o f the program) and then stays at the improved level for the years 20 13-33. The percentage improvement each year in not compounded, but simply an increment over a baseline stream o f revenues (based o n the assumption o f no STSMP). Since the STSMP cost data are in nominal US dollars (inflated at 1.8 percent per year), the baseline revenues are also stated in US$ and inflated at the same rate. (This baseline implicit ly assumes a PPP, no-growth scenario. All things considered, this i s extremely conservative.)

A 0.25 percentage point increase in revenues each year during 2005-2012 leaves a 2 percentage point improvement over the "no-STSMP" baseline for each year during 2012-33. Using this 0.25 percent improvement and a 10 percent discount rate, the present value o f the resultant incremental revenues i s US$1,061 million. This represents a net present value o f US$835 million.

There are no reliable estimates o f the overall rate o f compliance in Ukraine, with numbers as wide as 50 - 70 percent mentioned. If one assumes a 65 percent compliance rate, the two percent improvement in revenues modeled above translates into a 66.3 percent compliance rate (Le., an improvement o f 1.3 percentage point in the compliance rate). Clearly this i s exceedingly low relative to what can be expected from the STSMP. If one assumes that the STSMP will raise the compliance rate from 65 percent to 75 percent, which may s t i l l be a modest goal, then the model would need to see a 2 percent improvement in revenues during 2005-2012 and sustained thereafter at 16 percent higher revenues. This scenario would provide a US$8,264 mi l l ion net present value for the STSMP.

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The following table presents the sensitivity analysis for the model. The total cost present value can be read from the zero incremental revenue column and the 10 percent discount row. The "break-even" incremental revenue improvement i s 0.053 percent, with a 10 percent discount rate. The US$835 mi l l ion net present value can be read from the 0.25 percent improvement column and the 10 percent discount row. The 75 percent compliance rate net present value estimate o f US$8,264 mi l l ion can be read from the 2 percent improvement column and the 10 percent discount row.

Present Value of Net Revenue Stream (2003-33) in US$ millions -- sensitivity analysis --

annual increment in revenue during each vear 2005-2012 and sustained during 2013-33 Y

discount rate

Note: The full model can be found in the Project Fi les in an excel table STSMP-net-revenue-analysis.xls.

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Annex 5: Financial Summary UKRAINE: First State Tax Service Modernization Project

(Phase 1 and Phase 2)

(US$ thousands, Calendar Year) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Total ----------- I- I

Total Investment Costs 2,978 9,564 24,746 28,492 18,647 31,150 22,940 20,622 17,955 10,881 187,976 Total Recurrent Costs 0 82 186 209 259 837 482 1,579 4,377 4,491 12,502

2,978 9,646 24,933 28,700 18,906 31,987 23,422 22,201 22,332 15,373 200,478

Front-End Fee 400 737 TOTAL FINANCING REQUIRED 2,978 10,046 24,933 28,700 18,906 32,725 23,422 22,201 22,332 15,373 201,616

Financing IBRD 1,062 3,896 7,792 10,119 11,346 17,704 19,222 15,119 13,554 13,926 113,740 Borrower 1,916 6,150 17,141 18,581 7,560 15,021 4,200 7,082 8,779 1,447 87,876

TOTAL FINANCING 2,978 10,046 24,933 28,700 18,906 32,725 23,422 22,201 22,332 15,373 201,616

Note: 2003 data reflect the Advance from the Project Preparation Facility.

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Annex 6: Procurement and Disbursement Arrangements UKRAINE: First State Tax Service Modernization Project

Procurement

Procurement Arrangements and Procedures

For any contract to be eligible for financing under the proposed loan (for Phase 1 o f the Program), the procurement shall be undertaken in accordance with the procedures set out in the Loan Agreement. These procedures include those specified for goods and technical services contracts in the Guidelines: Procurement under IBRD Loans and IDA Credits (January 1995, revised January 1996, August 1996, September 1997, and January 1999); and those specified for consulting services and training contracts in Guidelines: Selection and Employment of Consultants by World Bank Borrowers (January 1997, revised September 1997, January 1999 and May 2002). For contracts not financed from the proposed loan, the STS shall apply the public procurement procedures specified by Ukrainian legislation and regulations.

Table A summarizes the proposed procurement arrangements for Phase 1 o f the STSMP. Table A1 elaborates the selection methods used for consulting services and training. Table B presents the thresholds for procurement methods and prior review.

Works contracts under the project shall encompass minor c iv i l works to reconfigure and upgrade approximately 420 existing STS premises to accommodate the needs o f a consolidated, function-based, modem tax administration (i.e., taxpayer service windows, secure information technology and fi le rooms, and open floor plans). All works contacts shall be financed by the STS and procured in accordance with Ukrainian procedures.

Goods (including Supply & Installation) contracts under the project shall provide for: (a) the delivery and set up o f office equipment, furnishings, vehicles, and information technologies; and (b) the supply and installation o f information systems, Le., single-responsibility packages o f custom and standard software, hardware, communications technologies, documentation, together with design, development, implementation, testing, training, and technical support services.

Technical Services contracts under the project shall provide for: (c) the reproduction o f informational materials and provision o f pre-distribution packaging services; and (d) the provision o f media communications services (electronic and print media).

For Bank-financed contracts for goods over US$lOO,OOO equivalent and technical services, International Competitive Bidding (ICB) procedures will be used. For items (a) and (c) above, the latest edition o f the Bank's Standard Bidding Documents (SBD) for Goods wil l be used. For item (b) above, the latest edition o f the Bank's SBD for the Supply and Installation o f Information Systems shall be used (single and two-stage processes, as appropriate). Item (d) above, media services, will be financed by the STS and procured using Ukrainian procedures.

For Bank-financed contracts for goods less than US$ 100,000 equivalent (up to an aggregate amount o f US$300,000 equivalent), International Shopping (IS) procedures will be used. For Bank-financed contracts for goods o f less than US$50,000 equivalent (up to an aggregate amount o f US$150,000 equivalent), National Shopping (NS) procedures wil l be used. Shopping procedures wil l be based on sample request for quotation documents developed by the ECA Region. The shopping procedure will be utilized to address small, time-sensitive requirements that will inevitably emerge out o f the larger information systems and specialized equipment contracts envisioned in the procurement plan. Also, direct contracting methods may be employed in accordance with the Guidelines to acquire, for example, proprietary information

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technologies needed to integrate systems. As noted in Table B, al l direct contracting w i l l require the Bank's prior review.

Domestic Preference may be applied to goods procurements, but shall not be applied to technical service contracts.

Services contracts under the project shall provide for consulting services and training for a wide variety o f advisory, design, implementation assistance, and training inputs to the STSMP. These consultancy and training service contracts will provide the core o f the knowledge transfer and technical assistance that i s the heart o f an institutional development program, such as the STSMP. A wide variety o f international and domestic f i r m s and individual consultants w i l l provide these services, each matched with the most appropriate source o f s k i l l s and knowledge, as well as the most economical and effective vehicle for their delivery and management.

Quality and Cost Based Selection (QCBS) shall be used for the large value contracts. For contracts up to US$800,000 each, Least Cost (LC) wi l l be used for auditing, premises surveying, and periodic taxpayer surveys. Consultant Qualifications (CQ) wi l l be used for small value technical assistance and training contracts (typically less than US$lOO,OOO equivalent). A number o f technical assistance and advisory services contracts wi l l be made with Individual Consultants (IC) that possess specialized s k i l l s and experience. Up to an aggregate o f US$400,000 for f i rms, Single Source (SS) selection may be employed if conditions arises for such methods, as specified in the Guidelines. For example, technology-specific requirements may emerge out o f some o f the larger consulting or training service contracts envisioned in the procurement plan for which only one firm i s qualified. As indicated in Table B, al l single source contracts wi l l require the Bank's prior review. The Bank's standard Request for Proposal documents will be used to procure Bank-financed consulting and training services.

Study Tours. Bank-financed study tours w i l l be reimbursed on the basis o f certified Statement o f Expenses (SOE). Small groups o f 5-10 STS staff wi l l undertake study tours to appropriate sites to learn o f international best practices and experiences in a number o f thematic areas indicated in the Procurement Plan. The Bank w i l l periodically review and clear the l i s t o f proposed study tour candidates, the nature o f the study tour(s), the place and period o f the study tour(s), estimated costs, etc., in accordance with the Implementation Schedule in the Loan Agreement.

Miscellaneous contracts (Modernization Department costs and Staff restructuring costs) will be financed by the STS and procured in accordance with Ukrainian procedures.

Recurrent Costs (including software licenses, maintenance contracts, telecommunications services, vehicular operations and maintenance) will be financed by the STS and procured in accordance with Ukrainian public procurement procedures.

Advertising

The General Procurement Notice (GPN) for the STSMP w i l l be published in Development Business in June 2003 and renewed annually. A GPN for the PPF procurements was published in Development Business in June 2001 and has been renewed subsequently. Specific Procurement Notices for all I C B contracts will also be published in the Development Business in addition to international and domestic periodicals o f the appropriate circulation. Requests o f Expression o f Interest (EOI) for a l l consulting service contracts w i l l also be published in DeveZopment Business and other international and domestic periodicals as appropriate.

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Review o f Procurement Decisions and Supervision

As indicated in Table B, al l goods, supply & install, and technical service contracts procured through ICB, the f i rs t two contracts under International Shopping and National Shopping, and all contracts procured through direct contracting wi l l be subject to Bank prior review as set forth in paragraphs 2 and 3 o f Appendix 1 to the Guidelines: Procurement under IBRL3 Loans and IDA Credits.

All consulting services and training contracts for f i r m s in excess o f US$lOO,OOO, for individuals over US$50,000, and all contracts for individuals selected on a sole source basis will be subject to Bank prior review as set forth in paragraph 2 o f Appendix 1 to the Guidelines: Selection and Employment of Consultants by World Bank Borrowers.

One in four contracts not subject to prior review shall be subject to post-review in accordance with the respective Guidelines.

In addition to continuous monitoring by the procurement staff o f the Bank's Kyiv Resident Mission, supervision missions including a procurement specialist shall be undertaken every six months. In addition, the quarterly project management reports wi l l provide a regular monitoring mechanism for procurement and financial management issues, in addition to other progress indicators.

Rehabilitation & Maintenance 22.48 22.48

Procurement methods (Table A)

,B. Goods, Supply & Install, and Technlcal Service Contracts

C. Consultant's & Training Services including auditing

D. Study Tours

(US$ million equivalent)

25.47 0.06 1.63 27.16 (19.37) (0.04) (1 9.41 1

23.15 0.00 23.15 (19.66) (19.66:

0.65 0.65 (0.52) (0.52:

F. Mlscellaneous MD Staff input 5.93 5.93

Office staffing realignment costs

G. Recurrent Cost

H. Front end Fee

Note: Figures in parenthesis are the respective amounts financed by IBRD

5.05 5.05

i 0.74 0.74

0.40 0.40 (0.40) (0.40)

25.47 0.00 24.26 35.83 85.56 (19.37) 0.00 (20.63) 0.00 (40.00)

~

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Table A I : Consultant Selection Arrangements (optional) (US$ million equivalent)

Works

I\ Including contingencies

/not Bank financed

Note: QCBS = Quality- and Cost-Based Selection QBS = Quality-based Selection SFB = Selection under a Fixed Budget LCS = Least-Cost Selection CQ = Selection Based on Consultants' Qualifications Other = Selection of individual consultants (per Section V of Consultants Guidelines), Commercial Practices, etc. N.B.F. = Not Bank-financed Figures in parentheses are the amounts to be financed by the Bank Loan.

Prior review thresholds (Table B) Expenditure Contract Threshold Contract Subject to Prior

Category (thousand US$) Procurement Method Review

Goods, Supply & Install, and Technical Services

Above US$100,000 ICB Prior review o f all contracts

Contracts 1 BelowUS$100,000 I I S /prior review o f first two contracts (ai

1 BelowUS$50,000 1 N S /Prior review o f first two contracts (ai

direct contract 1 Prior review o f all contracts

Eonsultants & Training 1 Above US$lOO,OOO Firms 1 Prior review o f all contracts

I AboveUS$50,000 I Individual 1 Prior review o f all contracts 1 Prior review o f all contracts single source

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Disbursement

Goods (including Supply & Install) and Technical Service Contracts

Consultancies & Training -- local f i r m s Consultancies & Training -- local individuals Consultancies & Training -- international f i r m s & individuals Studv tours

Allocation of loan proceeds (Table C) (Phase 1 o f the Program)

17.65 100% o f foreign expenditures and 100% o f local expenditures (ex factory cost) and 80% o f other local expenditures

12.00 87% 0.56 92%

5.32 100%

0.48 100%

Table C: Allocation of Loan Proceeds

PPF Repayment Unallocated

Expenditure Category I Amount in US$million 1 Financing Percentage

2.00 1.59

Total Project Costs Front-end fee

Total

39.60 0.40

40.00

Annex 6B: Financial Management Assessment Summary (a full FM assessment report i s contained in the Project Files)

Country Financial Management Issues

The STS i s a major actor in the mobilization o f state budget revenue, through i t s administration o f a large share o f national taxes and other levies. (Note: The revenues f low from taxpayers to the State Treasury. The role o f the administration i s to confirm and ensure the obligations were paid in accordance with the tax legislation.) The STS was not subject to external audit by the Accounting Chamber, as long noted in the CFAA for Ukraine. The lack o f external control over the State Tax Service operations l i m i t s the oversight o f public finance generation. I t also l i m i t s the available information on revenue administration by the STS to external auditors and public. The use o f budget money by the STS, as a budgetary expenditure unit, i s controlled by Control and Revision Department and State Treasure. The nature o f such control i s based mostly on financial compliance revision, but performance audit i s not yet used in such revisions. Taking in account that STSMP requires not only financial control but also performance control for i t s successful implementation, i t i s necessary to develop a mechanism o f interim performance monitoring on the STSMP.

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Strengths and weaknesses of the STSMP

During the process o f assessment o f the project the following strengths and weaknesses o f the STSMP have been identified:

Strengths: Special implementing management unit (the STA Modernization Department) was created to manage the STS's various modernization efforts, including the STSMP. This assumes full involvement o f the STA Modernization Department staff in project procedures. The internal organization structure i s quite clear and strongly regulated. The Modernization Department, as part o f the State tax Administration, i s the subject for control provided by the State internal auditors. The STSMP i t s e l f w i l l be the subject o f control by the STA internal controllers. Segregation o f functions and double, even triple, control over the transactions are implemented. The accountants and controllers have strong qualifications.

Weaknesses: Strong regulations and excessive control impose long durations o f review, document preparation, authorization and final signature. Implementation and managerial experience o f the Modernization Department i s limited.

Implementing entity

Implementation o f the STSMP would be undertaken by the STA Modernization Department and the STA. The STA Modernization Department was created as a separate unit under the authority o f State Tax Administration to be responsible for implementation o f modernization procedures. The STA Modernization Department i s to be responsible for the management o f a l l STSMP activities, including procurement, disbursement operations preparation, and financial reporting preparation. I t would maintain books o f accounts for the project, prepare and disseminate financial statements and financial management reports, and ensure timely audit o f the financial statements. The STA financial and accounting departments wi l l organize supervision and control functions over the operations o f the STA Modernization Department and wil l provide authorization for i t s operations. Representatives o f the State Tax Administration Management w i l l s i g n financial documents o f the STSMP.

All the documents supporting the operations under the STSMP wil l be submitted to the financial department o f the STA for their control and reporting. Copies o f the document w i l l be placed with the STA Modernization Department.

Funds flow

The STSMP funds f low i s designed to manage funds provided by the World Bank and the Borrower. The World Bank funds wil l be deposited at the loan account and wil l be used for direct payments and transfers to the Special account. Funds from the Special Account, opened in the commercial bank acceptable to World Bank, wi l l be used for local payments and foreign contract payments. The third part o f funds i s STS cofinancing, which i s subject to budget procedure regulations. This requires State Treasury involvement, and stipulates that this amount wi l l be charged under the normal regulations stated in STA Modernization Department for the other budget spending. Budget funds will also be used for the payments o f duties, taxes.

The disbursement process wil l conform to Bank disbursement procedures.

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Staffing

The STSMP implementation w i l l be driven by the STA Modernization Department. The structure o f the Department includes departments responsible for the management and implementation o f various aspects o f the modernization effort. The Modernization Department includes an accounting department, which performs the functions o f internal accounting and controlling, and a financial management department, which includes the staff responsible for the project financial management. The financial management department includes the Head o f the department, Deputy head o f the department, and a number o f Chief specialists. All these employees are regular staff o f the STA Modernization Department. They have accounting and audit experience, as well as some experience with the disbursement procedures and financial management requirements o f the World Bank. Appropriate training has been provided to the relevant financial management department staff, as well as to al l the other financial, accounting, controlling staff o f the STA and the STA Modernization Department, including Heads o f relevant departments. All o f the mentioned employees participated in the preparation o f financial management arrangements for the STSMP. This provides an understanding and practical experience on the requirements. Implementation o f the three PHRD grants was a useful and successful pilot for the STSMP.

Given their very important role for the successful implementation o f the STSMP, i t i s necessary to ensure continuous training for the staff on the FIS system utilization and update on the procedures o f the World Bank.

Accounting Policies and Procedures

The STA Modernization Department was not experienced with Wor ld Bank financed projects. However, jo int ly with STA, i t has implemented three PHRD Grants. As a result, it has already developed an understanding o f the procedures and strategy for accounting used for Wor ld Bank funds. The financial manual, which describes the internal controls (including adequate authorization and segregation o f duties, control checklist, regular reconciliation, etc.) has been completed for the STSMP and was considered as acceptable to the World Bank. According to the design, the STA Modernization Department w i l l be responsible for the financial management o f the STSMP and wil l provide accounting functions. But most o f the operations provided by the STA Modernization Department will be limited to preparation and preliminary supervision. Decision making as to the financial transactions and final control i s with the STA financial and accounting specialists and Deputy Head o f the STA. Accounting o f the STSMP operations wi l l be provided by the STA Modernization Department financial management department in accordance with the accounting and reporting requirements o f the Wor ld Bank. Reports will be based on FMR designed forms and prepared quarterly in U S dollars.

The STA Modernization Department wi l l generate and maintain financial, commercial documents and supporting documentation for all expenditures on a l l activities o f the project.

Internal control procedures designed have anticipated the following levels o f authorization and controls:

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Authorization flow

First level o f authorization i s financial department in the STA Modernization Department, which i s to prepare financial documents for further review and initialization. Documents will be signed by the head o f financial department and Head or (Deputy Head) o f the STA Modernization Department. The First Deputy Head o f the STA Modernization Department wi l l also supervise and s i g n documents.

Second level o f authorization i s the First Deputy Head o f STA or Deputy Head o f STA, who will be authorized to sign documents together with a representative o f the M O F (to be assigned).

Internal audit

Internal audit efficiency o f the STA was not assessed. However project supervision will include the review o f the audits o f the STSMP by the STA internal auditors as well as other controlling authorities.

External audit

The audit would include a project audit. Audit o f the STA Modernization Department i s not anticipated, as i t i s a part o f the State Tax Administration, which should be the object for Supreme Audit Institution control.

The Borrower, through the STA, w i l l ensure that the STSMP financial statements, Special Account, and Statement o f Expenditures (SOEs) are audited by an independent auditor acceptable to the World Bank, in accordance with standards on auditing that are acceptable to the Bank. The auditor shall be a member o f a professional body that i s a member o f the International Federation o f Accountants (IFAC). The annual project audit will be carried out in accordance wi th the Guidelines for Financial Reporting and Auditing of Projects Financed by the World Bank (March 1982). The audit report shall be in a format in accordance with the International Standards on Auditing promulgated by the International Federation o f Accountants (IFAC). The audited financial statements o f the STSMP wil l be sent to the Bank within six (6) months o f the end o f the Borrower’s fiscal year (December 3 1).

Reporting and monitoring

The new financial department unit o f the STA Modernization Department w i l l submit quarterly reports on commitments, disbursements under the STSMP to the Bank. This reports i s to be supervised by the Local FMS. The financial department wi l l prepare quarterly financial monitoring reports (FMRs) for the STSMP. The FMRs will include the following areas: (a) Financial Reports (b) Project Progress Reports; and (c) Procurement Management Reports. These financial reports w i l l be submitted to the Bank within 45 days o f the end o f each quarter. The f i r s t quarterly FMRs will be submitted not later than 45 days after the end o f the f i rs t quarter after the Effective Date. The FMR form has been agreed and found acceptable to the World Bank.

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Information system

The STA Modernization Department computerized accounting system i s completely tailored for the local accounting and reporting needs that encompasses local accounting standards and reporting format. For the purposes o f World Bank financial reporting needs, the STA Modernization Department uses a complex structure consisting o f the local accounting system for the basic accounting information recording, Microsoft project program for the budgeting and cost over performance monitoring, and a Reporting module for the Financial Monitoring Forms preparation.

Costs and Financial Performance

The total estimated cost o f the f i rs t phase o f the STAMP i s US$85.56 million. A major part o f the cost will be incurred by the Borrower and directed to the rehabilitation and maintenance o f existing buildings o f the STA. Taking into account that STSMP includes significant amount o f building works, goods purchases and consulting services, it i s required to provide effective cost control and monitoring over the implementation o f the STSMP and financial performance. Performance indicators have been developed and implemented for the monitoring purposes. The accounting system i s designed to fulfill the requirements o f performance indicators to provide timely and reliable information to the management.

Disbursements

Disbursements from the World Bank Loan will be made based on traditional disbursement methods (Le., from the Special Account with reimbursements made based on Statements o f Expenditures (SOEs) and full documentation, and direct payments from the Loan Account). The proceeds o f the World Bank loan w i l l be allocated in accordance with Table C (disbursement), Annex 6. To facilitate timely project implementation, the Borrower wi l l establish, maintain and operate, under terms and conditions acceptable to the Bank, one separate Special Account denominated in USD. The STA w i l l also open a local account for local expenditures in the State Treasury.

Special Account

To facilitate timely project implementation, the Borrower w i l l establish, maintain and operate, under terms and conditions acceptable to the Bank, one separate overseas Special Account denominated in USD for the STA Modernization Department. The Borrower will be responsible for the appropriate accounting o f the funds provided by the World Bank under the Loan, for reporting on the use o f these funds, and for ensuring that audits o f the financial statements or reports are submitted to the World Bank. For the purposes o f spending in local currency STA Modernization Department wi l l open a transit account in local Ukrainian bank or State Treasury depending on the readiness o f the Treasury to process such transactions.

During the early stage o f the STSMP, the init ial allocation to the Special Account would be limited to US$l,OOO,OOO. Later on, when the aggregate disbursements under the Loan have reached the level o f US$5,000,000, the allocation may be increased up to the

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authorized allocation o f US$2,000,000.

Replenishment applications will be submitted monthly and will be fully documented, including bank statements and reconciliation statements, except for expenditures, which may be claimed on the basis o f Statements o f Expenditure (SOEs). The Special Account would be audited annually by independent auditors acceptable to the Wor ld Bank.

Statement o f Expenditures

Disbursements on the basis o f SOEs will be made for: (i) goods contracts valued at US$lOO,OOO or less; (ii) consulting contracts with f i r m s and training contracts valued at US$lOO,OOO or less; (iii) services provided by individual consultants and training contracts valued at US$50,000 or less; and (iv) training under study tours.

Related documentation in support o f SOE will not be submitted to the Bank but w i l l be retained by the STA Modernization Department for at least one year after receipt by the Bank o f the audit report for the year in which the disbursement i s made. This documentation w i l l be available for review by the auditors and the Bank staff. I f ineligible expenditures, including those not justified by the evidence furnished, or amounts in excess o f agreed disbursement percentages are financed from the Special Account, the Bank w i l l have the right to withhold further deposits f rom the Special Account. The Bank may exercise this right until the Borrower has: (a) refunded the amount involved; or (b) submitted evidence, to the Bank's satisfaction, o f other eligible expenditures that the Bank can use to off-set the ineligible amounts. The STA Modernization Department will be required to maintain al l books and records for post-review by the Bank's supervision missions and for the auditors.

Supervision Plan

The reports o f the progress o f the STSMP implementation wi l l be monitored in detail during supervision missions. FMRs wil l be reviewed on a regular basis by the field-based FMS and the results or issues followed up during the supervision missions. Financial audit reports o f the STSMP w i l l be reviewed and issues identified and followed up. The field based FMS would monitor the agreed action plan to ensure appropriate actions have been implemented by the STA Modernization Department. Preliminary frequency for the supervision missions will be based on the quarter reporting period. The initial supervision o f the project will be provided before effectiveness.

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Annex 7: Project Processing Schedule UKRAINE: First State Tax Service Modernization Project

Negotiations Planned Date of Effectiveness

1 Appraisal mission departure I 07/10/2001 I 10/24/2002 I 11/27/2001 03/25/2003 0710 112002

Prepared by: Craig Neal

Preparation assistance: Ofelia Miranda, Tulia Beltran, Li l ian Canamaso, Valery Ciancio, Anna Musakova, Ilene Photos, and Usha Rani Khanna.

Name Svetlana Budagovskaya Nicholay Chistyakov Dmitro Derkatch Michael Engelschalk Richard Gargrave Valeriy Gladkiy Vitaly Kazakov Craig Neal Claudia Pardinas Ocana Pervaiz Rashid Daniel Ritchie kina Shmeliova Gurcharan Singh Alexi Slenzak Dusan Vujovic Luis Alvaro Sanc.,:z (consL..ant) Pierre Gravelle (consultant) Russ Humphries (consultant) Sraham Holland (IMF) roe Hook (consultant)

SDecialitv Economist Sr. Financial Officer Communications Officer Sr. Public Sector Specialist -- Peer Reviewer Procurement Specialist Research Analyst Financial Management Specialist Sr. Public Sector Specialist -- Task team leader Sr. Counsel Lead Specialist -- Operations Advisor Quality at Entry Review Panel Chairman, Peer Reviewer Program Assistant Sr. Procurement Specialist Operations Officer -- environmental specialist (former) Program Team Leader Fiscal Affairs I Public Administration Specialist Tax Administration Specialist Tax Administration Specialist, Peer Reviewer Quality at Entry Review Panel Member Quality at Entry Review Panel Member

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Notes:

Timing. The STSMP i s an outgrowth o f a single component o f a proposed, multi-sector Institutional Development APL (for which the concept review was October 30, 1998). The ID-APL and much o f the country program experienced a hiatus during 1999 and 2000. In late 2000, the tax administration work associated with the ID-APL was restarted and the ID-APL was transformed into the STSMP. In October 2000, the preparation work re-launched and the project team reconstituted. This led to an Identification Mission for the STSMP in December 2000, with a PCD Review on February, 26 2001. The new PID went to the InfoShop on March 12, 2001. The Planned Schedule indicated above arose out o f the PCD Review.

Cost. The STSMP inherited the ID-APL project code and the accumulated costs. In meeting with the ECA-CAO on June 5,2002, it was agreed that for cost purposes, the STSMP would absorb 25 percent o f the FY99-00 ID-APL costs (US$89.1 thousand). This would account for the cost o f developing an effective interlocutor in the STA. The balance would be considered technical assistance to Ukraine. The STSMP development costs would include US$135.2 thousand o f the Bank-executed PHRD Grant (TF025980).

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Annex 8: Documents in the Project File* UKRAINE: First State Tax Service Modernization Project

A. Project Implementation Plan

PIP 0 0

0 0

0

May 2000 draft o f f i r s t 10 sub-plans, by STA & PHRD TF029546 local consultants. January 2001 commentary on STA's draft PIP, by PHRD TF025908 financed international consultants (Gravelle, Jenkins and Sanchez). June 2001 draft o f the PIP, by STA & PHRD TF025817 local consultants. June 2001 analytic reports by PHRD TF025908 financed international consultants (Gravelle, Humphries, Jenkins and Sanchez). September 2002 draft o f the PIP.

Project Operations Manual (March 21,2003).

B. Bank Staff Assessments

PCD and February 26,2001, PCD Review meeting minutes, with peer reviewer comments.

September 20,2002, Decision to Appraise and Negotiate Meeting minutes.

Mission Documents (TOR, Back-to-office report, Aide-MCmoire, and Follow-up letters). 0 December 2000, Identification mission. 0 January 200 1, preparation mission. 0 May-June 2001, Pre-appraisal mission. 0 July 200 1, preparation mission. 0 December 200 1, preparation mission 0 February 2002, preparation mission 0 June-July 2002, Pre-appraisal update mission

Descriptive and Diagnostic Note (August 2002)

Ukraine: Tax Policy and Tax Administration -- Draft for Discussion with the Government (September 2002)

STSMP Net Revenue Analysis Model.

Procurement Capacity Assessment (May 2001)

Procurement Capacity Assessment update (January 2003)

Financial Management Capacity Assessment (August 2002)

Financial Management Capacity Assessment update (March 2003)

C. Other

PHRD Grant TF026696 (Grant Agreement and related communications with GOU). PPF Advance: Final Draft and related communications with GOU.

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Letter of Development Program (LDP) 0 0

0

September 29,2001, letter from Prime Minister Kinakh. October 23,2001, letter from Country Director, Luca Barbone, in response to P M Kinakh's LDP. November 6,2002, letter from Prime Minister Kinakh.

*Including electronic files

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Annex 9: Statement of Loans and Credits UKRAINE: First State Tax Service Modernization Project

16-Am-2003

Orioinal Amount in US$ Millions Project ID

PO69857 P 0 6 9 8 5 8

P 0 5 4 9 6 6 PO48790 PO35786 PO55739 PO44728 PO44832 PO49174 PO44851

FY Purpose 2003 TB/AIDS CNTRL 2002 SIF 2002 PRlV SEC DEV (APL # I ) 2002 AZOV-BLK SEA CORR BlODlV CONSV (GEF) 2001 LVlV WATERNVW 2000 KIEV PB ENERGY EFFIC 1998 ODs PHASE-OUT (GEF) 1998 KIEV DISTRICT HEAT. 1998 TREASURY SYSTEMS Project 1997 EXPORT DEVELOPMENT

iBRD IDA GEF 60.00 0.00 0.00 50.21 0.00 0.00 30.00 0.00 0.00 0.00 0.00 6.90

24.25 0.00 0.00 18.29 0.00 0.00 0.00 0.00 23.20

200.00 0.00 0.00 16.40 0.00 0.00 70.00 0.00 0.00

Cancel. 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Difference between expected and actual

disbursements' Undisb. Orig Frm Rev'd

60.00 0.00 0.00 48.98 -0.73 0.00 29.70 0.00 0.00

7.64 1.02 0.13 24.01 6.39 0.00 14.26 5.07 0.00 1.60 2.16 -3.56

172.20 144.00 15.68 3.93 3.93 2.23 0.00 2.59 0.00

Total: 469.15 0 00 30 10 000 36230 164.41 1447

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UKRAINE STATEMENT OF IFC's

Held and Disbursed Portfolio

In Mill ions US Dollars J u ~ 30 - 2002

Committed Disbursed IFC IFC

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1996 FUIB 0.00 5.00 0.00 0.00 0.00 5.00 0.00 0.00 1998 HVB Bank Ukraine 0.00 2.28 0.00 0.00 0.00 2.28 0.00 0.00

2000 MBU 3.50 1.70 0.00 0.00 0.00 1.70 0.00 0.00 1994196 Ukraine VC Fund 0.00 1.50 0.00 0.00 0.00 1.15 0.00 0.00

2001 JSC Okean 10.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Total Portfolio: 13.50 10.48 0.00 0.00 0.00 10.13 0.00 0.00

Aoorovals Pendine Commitment

FY Approval Company Loan Equity Quasi Partic 1996 FUIB 10.00 0.00 0.00 0.00 -,_-

1998 HVB Bank Ukraine 5.00 0.00 0.00 0.00

Total Pending Commitment: 15.00 0.00 0.00 0.00

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Annex 10: Country at a Glance UKRAINE: First State Tax Service Modernization Project

Manufacturing .. 42.3 34.3 35.0 Services .. 26.7 46.6 44.4

Private consumption .. 54.1 54.3 55.4 General government consumption .. 17.4 21.5 22.5

POVERTY and SOCIAL

2001 Population, mid-year (millions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual growth, 1995-01

Population (%) Labor force (%I Most recent estimate (latest year available, 1995-01) Poverty (% of population below national poverty line) Urban population (% of total population) Life expectancy at birth (years) infant mortality (per 1,000 live births) Child malnutrition (% of children under 5) Access to an improved water source (% ofpopulation) Illiteracy (% ofpopulation age 15+) Gross primary enrolhen! (% of school-age population)

Male Female

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1981

-20 ~

..4 -40 -

*’ GDI *GDP

GDP (US$ billions) Gross domestic investmentlGDP Exports of goods and services/GDP Gross domestic savingslGDP Gross national savingslGDP

Current account balancelGDP Interest paymentslGDP Total debVGDP Total debt servicelexports Present value of debVGDP Present value of debt/exports

1981-91 1991-01 zooo 2o01 (average annual growth) Agriculture .. -4.2 5.9 10.9

industry Manufacturing .. .. -8.3 -7.7 12.8 10 9 1::: Services .. -1.4 4.6 7.0

Private consumption .. -4 9 5.2 9.1 General government consumption .. -4.4 -1.9 8.6 Gross domestic investment .. -14.6 12.1 8.5 lmwrts of aoods and services .. -0.3 16.6 12.0

1981-91 1991-01 (average annual growth) GDP .. -7.2 GDP Der caDita .. -6.6

Growth of exports and Imports (Oh)

: : k c -15 1 -30

Exports -O’lmports

Ukraine

49.1 71 0 35.0

-0.8 -0.5

23 68 68 13

0 82 83 81

1991

81.4 26.3 26.1 28.5

-3.6

2000

5.8 6.7

Europe 8 Central

Asia

475 1,960

930

0.1 0.6

63 69 20

90 3

102 103 101

2000

31.3 19.2 62.4 24.2 23.9

4.7 1.8

38.9 18.1 35.4 54.6

zoo1

9.1 10.0

Low- income

2,511 430

1,069

1.9 2.3

31 59 76

76 37 96

103 88

2001

37.0 20.4 56.1 22.0 24.1

3.8 2.0

33.7 10.6 30.7 51.5

2001-05

4.5 5.3

1 Development diamond’

1 Life expectancy

1 capita enrollment

-

Access to improved water source

Ukraine 1 ‘*<WIT* I-

i Low-income group

Economic ratios*

Trade

Indebtedness

Ukraine low-income wouI)

xImI*wIII

Note: 2001 data are preliminary estimates. *The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete.

Ukraine PRICES and GOVERNMENT FINANCE

Domestic prices (% change) Consumer prices Implicit GDP deflator

Government finance (% of GDP, includes current grants) Current revenue Current budget balance Overall surplus/deficit

TRADE

(US$ millions) Total exports (fob)

Ferrous and non-precious metals Mineral products Manufactures

Total imports (cif) Food Fuel and energy Capital goods

Export price index (1995=100) Import price index (1995=100) Terms of trade (1995=100)

BALANCE of PAYMENTS

(US$ millions) Exports of goods and services Imports of goods and sewices Resource balance

Net income Net current transfers

Current account balance

Financing items (net) Changes in net reserves

Memo: Reserves including gold (US$ millions) Conversion rate (DEC, local/US$)

EXTERNAL DEBT and RESOURCE FLOWS

(US$ millions) Total debt outstanding and disbursed

IBRD IDA

Total debt service IBRD IDA

Official grants Official creditors Private creditors Foreign direct investment Portfolio equity

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

Composition of net resource flows

1981 1991

.. 163.4

.. 95.6

1981 1991

.. 23,988

.. 21,994

1981 1991

.. 24,671

.. 22,162

.. 2,509

.. -2.928

.. 3.68E-5

1981 I991

2000

25.8 23.2

35.1 -0.1 -1.3

2000

15,722 6,468 1,377 2,584

14,943 908

6,419 2,625

97 115 84

2000

19,522 17,947 1,575

-942 848

1,481

-1,083 -398

1,476 5.4

2000

12,166 1,991

0

3,662 142

0

-a -1,060

332 594

-201

18 113 24 88

118 -29

2001

10.9 8.8

35.6

-1.6 -0.4

2001

17,091 6,720 1,824 3,180

16,839 1,126 6,590 3,379

94 112 84

2001

21,086 20,473

61 3

-667 1,456

1,402

204 -1,606

3,090 5.5

2001

12,481 2,328

0

2,343 21 2

0

3 716

-809 769

-866

353 407 69

338 143 196

96 97 98 99 00 01

I I *--"GDP deflator - 0 ' C P I

I 1 Export and Import levels (US$ mill.)

I

I 95 98 97 96 99 00

0 Exports Imports

Current account balance to GDP (%) I

:omposition of ZOO1 debt (US$ mill.)

G: 447

E: 2,418

4 - IBRD E - Bilate 3 - IDA D - Other multilateral F . Privat 2 - IMF G - Short

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- 88 -