With Rada’s tax reform proposal (Bill 3357) presented ahead of the draft budget process-2016, stakeholders’ assessment of this proposal is sharply divided. Ukrinform asked Mr. Jerome Vacher, the IMF Resident Representative in Ukraine, whether the Fund has had a chance to formulate its vision of Bill 3357 and its ramifications for Ukraine’s budget in 2016 and beyond.
With local elections page soon to be turned over, the tax reform starts occupying front pages. Rada’s Tax and Customs Policy Committee has submitted their proposal, and some politicians claim this reform is far from being supported by the IMF. Can you shed the light on what is the precise attitude of the Fund regarding this proposal?
A key objective of the program is to restore financial stability, so that the economy can start growing again. This can only by achieved if the budget deficits are moderate and sustainable, and are successful in reducing the very high level of Ukraine’s public debt—which at about 90 percent of GDP is one of the highest among emerging market countries. In this regard, our discussions with the government in recent weeks have focused on the 2016 budget; how to preserve the gains of the past months in terms of fiscal stabilization, and how to achieve the targets that we agreed jointly with the authorities for the coming years. Tax policy therefore needs to be carefully considered within this framework and with the aim to achieve these objectives. In this respect, across the board tax cuts that are not compensated by credible other measures, such as spending cuts, will only increase the deficit and debt, and undermine confidence and financial stability. This would be a major risk for Ukraine, something that it cannot afford at this moment and after the sacrifices that the population has made over the last year. Thus, these tax reform proposals are not something that we as Ukraine’s partners can support.
The Tax and Customs Policy Committee’s Chair Nina Yuzhanina assured http://www.rada.gov.ua/news/Novyny/117605.html all estimates underpinning Bill 3357 have been shared with the Fund’s experts and they are expected to verify them this November, either to validate or to reject them. Is the Fund evaluating the cost of the proposals and can you share with us your initial findings?
We have looked at the proposals and have been working closely with the Ministry of Finance on estimates of various options and measures. Our current estimate is that the bill registered with Parliament on Monday will reduce tax revenues by about 9-10 percent of GDP. This is a very large number, and almost unprecedented for a revenue loss within a single year when looking at international experience. It is extremely difficult to see how this could be offset by compensating measures in the 2016 budget, which already faces the loss of temporary revenues and needs to cover important expenditure priorities for next year. It is critical that the government clearly explains the risks of these tax proposals to the Parliament; from our side, while we have shared our views with members of the tax committee, it is not our role to validate proposals or negotiate with Parliament, as the counterparts for our discussions are the government and the central bank.
Can Ukraine afford the 2016 comprehensive liberal tax reform as late as in early November 2015? Will there be time to scrutinize it in Rada, to approve it, and, most importantly, for taxpayers to come to terms with new requirements?
In general, it is always preferable that a country’s parliament has sufficient time to debate tax reforms and for members of parliament be able to come with an informed opinion that has the interests of the country that they represent in mind. However, tax reforms should not be discussed in isolation. In the abstract, one could advocate the merits of very low tax rates. But Ukraine also has pressing spending needs and a need to safeguard financial stability. And before tax rates are discussed, one needs to have a clear view on the spending priorities that should be supported by the country’s tax effort. If spending needs to be reduced, it is important to discuss how and over what period this can achieved, who should bear the burden. All these aspects, both on the revenue and expenditure side, need to be carefully discussed together, so that the deficit target that has been agreed for next year (3.7 percent of GDP) can be achieved. Otherwise, tax cuts will only result in higher deficits and more debt, resulting in a new vicious cycle that will undermine financial stability.
114 co-authors of reform assure the society that it is a self-financing initiative, albeit under the proviso that up to one tenth of state budget expenditures would be axed. Sponsors of the reform believe the de-shadowing would be a key off-setting driver which would fill in the gap. Do you support the claim that tax rates cuts would on their own bolster revenues? And would Rada, in your opinion, be bold enough to cut expenditures, especially, after local elections are behind?
There is no cross-country evidence that lowering tax rates by themselves would increase revenues sufficiently to be self-financed. You mentioned de-shadowization of the economy, which is an objective which we very much support. When you look at emerging economies, there is little correlation between the level of tax rates and the size of the informal economy, even more so when one also considers more advanced economies. There are many determinants - mostly institutional and structural – that affect the size of the informal economy. In systems where tax payers do not feel compelled to pay and know they will not be sanctioned, it is very unlikely that lowering rates will make a significant difference. Sustained efforts over several years will be needed to significantly improve tax administration, as well as tax payers’ attitude in registering their business, declaring their real incomes, and paying their fair share of taxes. It is therefore an illusion to assume that lower tax rates will automatically be offset by the de-shadowisation of the economy. Now, on expenditures it is not up to me to judge the capacity and willingness of members of parliament to approve expenditure cuts. I can make only two points in that context. First, expenditure cuts of the magnitude that will be required in this case, cannot be decided on the spot. These would inevitably affect education, health care, social assistance, and pension benefits, and would require careful consideration of the type of reforms in these areas that will make the cuts fair and sustainable, while improving the quality of the services that the country offers. Second, in this specific context, there is very little evidence of countries that have managed to cut expenditures by 10 percent of GDP in one year. Basically, it is unrealistic to simply call for an across-the-board spending cut of such magnitude. Issues such as who in society would need to bear the burden of such deep adjustments need to be discussed in detail before the tax cuts are considered.
Regardless of the fate of the tax reform – be it approved in the MP Yuzhanina’s version, or MOF’s, or in between – one should acknowledge that Ukraine’s tax burden suffocates the economy, with the social security contribution being the major culprit. The system ought be fixed, and now – don’t you think ?
While the tax burden in Ukraine is not small, what suffocates the economy and in particular the development of small and medium sized businesses, is the level of corruption and the arbitrariness in the application of policies that have created a very weak business environment. In all surveys these come on top of what hinders business in Ukraine. Significant action on this front, together with proper macroeconomic policies, is the only way to improve business and bring back the economy to higher growth, and avoid that Ukraine goes through the regular boom and bust cycles that have been so detrimental to Ukraine’s overall economic progress. Tax cuts, therefore, by themselves are not a substitute to these reforms. That said, we do, of course, see an urgent need to modernize and simplify the tax system. This should go hand in hand with efforts to reform the SFS – something that we support and that is critical-- as well as to eliminate loopholes that make the tax base too small. These together with more efficient spending will create space for lower tax rates in a prudent and affordable manner.
And what if all your fears about revenue performance are proved wrong in 2016? What if Ukrainians, fascinated by a tax liberalization, observe their New Year resolutions, what if they start paying their taxes, demand “white” wages from their employers, flock to tax offices to declare their assets and hidden incomes, demand fiscal checks from restaurants and marshrutkas, reprimand their just elected local councils that they set the real estate tax too low - and, as a result, revenues flow into public coffers? Would IMF acknowledge it has been too harsh on Ukraine’s reformers?
Well, what you describe would seem to many like an economic miracle. I am confident that this could happen over the medium term, but it would only be the result of sustained reforms and efforts as we discussed previously. It will also happen when Ukrainians taxpayers receive a level of public service that is fully commensurate with what they expect from their contribution. But before we get there, in our advice on policies and our support to reform programs, we focus on numbers and evidence. This guides our advice on fiscal policy in particular, and certainly guides what our Board can approve for the IMF to support as a creditor. Revenue projections can be updated, but only if there is sufficient and tangible evidence reflecting trends that can be linked to implemented policies.
Oleksandr Kharchenko, Kyiv