Foreign investment - on which Portugal so heavily relies - is facing a crisis, whilst on a local level, Portugal has become somewhat like a mini-Russia. Tax evasion is seems to be the name of the game, although unlike Russia, it is Portugal's companies and corporations who keep revenues trickling into the government's coffers. Tax reform has become a priority, but it's not easy - particularly raising taxes - when Portugal is trying to promote itself as a hub for foreign investment and dearly wants to dangle the carrot of low corporate taxation.

Foreign investment is an essential part of the Portuguese government's overall strategy to modernise the economy. The last decade has seen the government striving to boost international competitiveness through increased foreign investment in transport, telecommunications, energy, agriculture, fisheries, and tourism, plus incentives for investment.

Traditionally, Portugal was seen as having a pretty low corporate tax rate, well by European standards at least. Previously set at 36 per cent, it was then reduced to 34 per cent. The government plans to reduce it further still to around 27.5 per cent in four years. However, Portugal still faces an uphill battle, and its main problem in all of this is Ireland, with its ever-decreasing tax rate, falling yearly until 2003 when it will be an incredibly low 12.5 per cent. Add to that the quality and education of the Irish workforce, and the fact that up-and-coming Eastern European countries have developed the infrastructure and posess the cheap, plentiful labour necessary for tax-efficient business, Portugal must feel like just giving up.

The problems do not end there. It's a surprise that the companies which Portugal is home to haven't upped and gone to greener pastures, given the country's internal fiscal state. The taxation system is in a mess, and an unfair tax burden is placed on large corporations, mainly state-owned ones, and wage earners whose incomes are taxed at source. According to a report in the Financial Times, in 1998 the biggest five companies accounted for 28 per cent of total corporate tax revenue and the top 50 for 45 per cent. The biggest tax evaders are the self-employed and professionals who declare earnings much lower than they actually receive.

The Financial Times quoted Carlos Loureiro, a Lisbon-based tax partner with Arthur Andersen, as saying: 'Everybody agrees that the tax system doesn't work. The weight of taxation falls unfairly: wage earners and a few big companies bear a disproportionate burden. The tax administration is ineffective and the legislation lacks clarity.'

To be fair to Portugal, it has announced a major reform package to try to repair its fragile tax system. In December, a Tax Reform Act was approved by parliament and new tax measures were included in the 2001 Budget. Amongst the measures are lifting bank secrecy laws in some cases so that tax officials can compare bank account figures with tax returns; increasing the remit of taxation to include some capital gains so that it's not just employment income that is taxed; looking at assets such as expensive houses and cars to determine a person's income which can then be taxed accordingly; and simplifying corporation tax for small companies so that they might be more honest when filling in their tax returns. More reforms are set to go through at the end of this year.

Whilst tax evasion is rife, most observers point to the poor state of Portugal's tax administration as the root of the problems. Tax specialist Jose Luis Saldanha Sanches told the Financial Times: 'Commissions of experts, lawyers and legislators can create excellent reforms on paper. But reforms will not work without a well run adminstration to apply them on a day-to-day basis.'

It does seem odd that a country which has Madeira, its very own well-run offshore financial centre, should have such a shambolic tax system itself. It may be because the Madeiran government has a good degree of autonomy from Portugal, but having said that, most legislation is Portuguese, including tax legislation. Perhaps it is simply because Madeira is tiny, focused and is easy to administer, but on the mainland the government has both internal tax turmoil and wider European taxation issues to deal with. Domestic tax reform is relatively simple in the scheme of things; attracting foreign investment, not least through lowering corporate taxes, is much harder. Even if Portugal does achieve its aim of lowering company tax to 27.5 per cent in four years, it's up against stiff competition.