Ben Aris in Kyiv -
When Ukraine's newly elected parliament meets for the first time, probably in November, the first thing it will do is vote on a set of sweeping tax reforms that could transform the country and spark a long-awaited economic recovery.
"Once we get a new government in place, the next day I am ready to introduce new laws [on radically changing the tax system]," says Igor Bilous, head of the State Fiscal Service of Ukraine, a newly formed agency under the Ministry of Finance, who has been responsible for drawing up the laws. "The drafts are ready, and have been ready since August, and will reduce corporate income tax, social commitments, [small and medium-sized enterprises] – everything.”
Bilous adds that the companies themselves are "thirsty" for change to a system that has been widely abused in the past. The plan is to reduce and simplify taxes across the board, and hopefully bring more businesses back into the formal economy. "Implementation is not an issue as if you are asked to pay less tax than you were before, then you will pay the next day," Bilous, who heads the service that recently merged the tax and customs services, tells bne on the sidelines of a conference organized by SP Advisors, one of Ukraine's long-standing investment houses.
The cash-strapped Ukrainian government has recently imposed heavy taxes on companies in an effort to fund its military operations in the east against the Russian-backed separatists, as well as plug gaping holes in the 2015 budget. Not only is the economy expected to contract by 9.5% this year, but the government is expecting to end the year with a federal budget deficit of 4.8%, which will have to be financed with donor money as it simply doesn’t have enough cash to meet its bills.
The tax rises have driven more companies into the grey economy. "We need to break this vicious cycle," says Bilous, but adds that the changes in tax code runs deeper than this. "Last three years the government changed tax rates 58 times – that is once every three weeks. With that sort of volatility companies simply cannot survive. Once we have passed these changes, we have to make the rates unalterable for at least three to four years to allow the new rules to work."
Ironically given this year’s events, this is the same strategy that Russian President Vladimir Putin followed when he took office in 2000. Under the previous president Boris Yeltsin, companies could be asked to pay 105% of their profits, so one of the first things Putin did was introduce flat rates for personal income tax (13%) and corporate taxes (24%) that, together with a fortuitous recovery in oil prices, put Russia's budget on a stable footing and underpinned the subsequent decade-long economic boom.
Ukraine suffered similar problems under former president Viktor Yanukovych, whereby the crooked tax authorities would push companies to pay excess profit taxes and skim off the top. Bilous, who has spent the last three months consulting with companies, business associations and investors in order to thrash out a tax code that will promote business, is hoping to see the same results as Russia did. Some 80% of budget revenues come from only four taxes – VAT, personal income tax, corporate income tax and excise duties – so the changes should be fairly easy to impose and the results could be dramatic.
However, perhaps Georgia's reforms are a better parallel than Russia's, as the State Fiscal Service also intends to dramatically simplify the tax code, reducing the number of taxes from 22 to 14, putting the entire system online, and handing more power to collect and spend taxes to local authorities.
Bilous is also hoping to set a precedent for the rest of the government. "I hope the other ministries will be ready too, as I don’t want to be alone," says Bilous.
Into the light
If the new tax amendments are adopted, they will have several consequences. First and foremost tax revenue should rise if tax rates fall. This will also mean that more companies come out of the grey economy and join the formal economy. A result of the fighting and general economic collapse is that the grey economy has been growing in the last year and now accounts for at least a third of GDP by some measures, and up to half of all salaries are paid off the books to avoid taxes.
But more importantly, Bilous points out that the new tax regime should entirely change the government's attitude to how it draws up the budget. "Currently the process starts with the spending lines: here is social spending, here is pension spending, and here are the curves. Then they work out how much needs to be spent and set the taxes to raise that amount. What we are talking about is working out what taxes are appropriate to encourage the development of the economy and decide on spending based on the amount of revenue that produces," says Bilous.
Reforming the tax rates is the first step in a very long shopping list of things to do. Bilous' State Fiscal Service has also taken over the customs service and reforms to that are next on the list. At the same time, the social and pension systems are in urgent need of reform. "Our current pension and social systems are not sustainable – that's it," Bilous states emphatically. "There is a point we have to cut our ties to the past and start a new life. That point is now.”
If the laws are passed in the autumn session, then the new rates will take effect January 1, 2015.
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