Ukraine tax reform carries significant costs and risks to 2016 budget, IMF says

By bne IntelliNews October 3, 2016

Ukraine’s 2016 tax reform carries significant costs and risks to the 2016 budget, especially for social security funds, given also the still weak revenue administration, the International Monetary Fund (IMF) said in its staff report published on October 3.

“The deep cut of the social security contributions (SSC) rate implies a significant revenue loss for the social security funds (about 4% of GDP), which required a doubling of the state budget transfers to about 7% of GDP,” the report reads.

In 2016, the Ukrainian government replaced 67 different rates of SSC, which had an effective rate of about 41%, with a single rate of 22% payable only by the employer.

Simultaneously, authorities in Kyiv replaced two rates of personal income tax of 15% and 20% with a single, flat rate of 18%, making the system less progressive. Marginal taxation also increased under a simplified regime for small taxpayers, which covers about 40% of all taxpayers.

“The authorities take the view that the reduction of the SSC rates will lower the high level of informality in the labor market, create new employment and support growth,” the IMF says. “However, international experience on the link between the SSC rates and informality is mixed. Also, so far social security contributions have lagged the authorities’ expectations.”

According to the Fund, successfully reducing informality depends critically on strengthening revenue administration as well as addressing corruption, areas where there is still ample space for improvement.

“In the 2016 budget, the revenue loss is expected to be largely compensated by higher consumption taxes, which are considered to be less distortive. The reform also puts the onus on the State Fiscal Service to administer the VAT collection from the agricultural sector, which has not paid taxes in the past, and to limit the increased risk of smuggling due to higher excises,” the report reads.

In 2016, the government in Kyiv made the agricultural sector subject to the standard VAT rate of 20% from 2017 onward with a transitional arrangement in 2016, eliminating an implicit subsidy to the sector. It also raised excise rates on tobacco, fuel, beer and spirits, reducing the still large gap compared with rates in the European Union, while limiting the increase relative to other post-Soviet neighbours (because of risks of smuggling).

The Ukrainian government also increased property taxes on residential real estate and vehicles, particularly for wealthier individuals, which is expected to raise revenue from property taxes above some countries in Central and Eastern Europe (CEE).

Kyiv also reduced royalty rates on natural gas extraction to support investments and growth in the oil and gas sector.

Overall tax revenue in Ukraine is expected to decline to 34% of GDP in 2016, bringing it broadly in line with the average in the CEE.

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