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Tetiana Koshchuk

Growford Institute expert in tax issues 

In the conditions of the war in Ukraine, the search for ways of tax environment improvement for economic activity has provoked a new round of discussion on liberal tax reform.

This time, in a particularly radical variant of reducing the tax burden, which was called the “10-10-10 reform” and subjected to a storm of criticism both from the authorities, who are responsible for the stability of public finances in Ukraine, international organizations, and from many recognized experts in fiscal issues. I agree with them.

However, I would like to add a new angle to the discussion: not only to confirm that there are “many flaws” in this liberal initiative, but also to show how we should recognize when ‘everything is right’ in the tax reform and it has the prospect for successful implementation.

In 2008, I was greatly impressed by Grz. Kolodko’s article “Institutions, Policies and Economic Development”. Its author is twice Minister of Finance of Poland, the main architect of Polish economic reforms, a Professor of Economics who specializes in structural reforms and public finances. Today he is the head of the research institute TIGER.

Over time, the relevance of the mentioned work has only increased, and its conclusions regarding the indicators of successful economic policy can be transferred to a narrower policy direction and with their help to test any economic or tax reform.

So, let us look at Gzh. Kolodko’s conclusions in terms of “markers” of effective tax policy and use them to test the 10-10-10 reform.

  1. To ensure positive results, tax policy must be based on a vision and at the same time be free from illusions. Without a vision, tax policy (and those who implement it) is incomplete,undecided and unconvincing. It is like a journey without a destination. A long-term vision should be simultaneously ambitious and realistic, acting as an signpost to show society the right development path and the way to fulfil its aspirations. The vision should not only stimulate such aspirations, but also keep them within reasonable limits, so that they can be fulfilled in the course of time. If the lack of such vision in practice is covered up by the declarative illusions of“beneficial shocks” or “civilizational leaps” and a hastily painted picture of a cloudless future, the prospects for GDP growth and tax system improvement will not be too promising. 

Now let us analyze the 10-10-10 reform in view of the abovementioned. Its main goal (“final point”) is to ensure dynamic economic growth and tripling of GDP per capita in Ukraine in a short period of time (without specifying it). Hardly anyone will object to the fact that this goal is, although very blurred, but ambitious. But is it realistic?

In my opinion, it is difficult to imagine that in the conditions of a shortage of financial resources in the world, which is exacerbated by the negative impact of the war in Ukraine on the advanced economies, foreign investors will be in line to invest in a war-torn country with unresolved corruption even in case of a two-fold reduction in taxes.

And high rates of GDP growth are impossible without a massive foreign investments inflow! As much as we would like it, tax reform is not a “magic wand” that can quickly overcome structural crises and create economic miracles on its own.

A separate topic is the realism of fiscal compensators of the proposed tax liberalization model. A barrage of criticism has already been expressed about this.

I will show only the most illustrative example – budget losses from the reduction of the VAT rate from 20 to 10%.

In 2021, VAT revenues amounted to UAH 536.48 billion, which accounted for 36.9% (more than a third) of Consolidated budget revenues. This means that the state, which, as mentioned above, cannot expect an economic miracle, risks losing about 1/6 of tax revenues only due to a twofold reduction in the VAT rate.

If we take into account the fact that since the beginning of the war there has been a significant decrease in consumption in Ukraine due to the mass migration of our citizens abroad, but at the same time prices of goods and services (VAT tax base) have gone up, the loss of VAT revenues in monetary terms will be at least UAH 200 billion.

For comparison: in pre-war 2021, the budget received UAH 180.3 billion of excise tax… And the 10-10-10 reform provides for the reduction of the personal income tax rate from 18 to 10%, the abolition of the single social contribution (SSC) (rate of which is 22%) … How to cover all these losses? By rejecting the reduced VAT rate of 7%? By indiscriminately cancelling tax benefits for the total amount of UAH 180 billion?

Or maybe international donors will pay for our liberal “tax feast”? If this were true, Ukraine would not have to finance the record budget deficit through large-scale emission or new borrowings, confidently heading towards the threshold of the share of public debt in GDP.

And it is difficult to predict how long the war will continue… In fact, it will be even more difficult for the foreign governments to convince their citizens of the need to provide assistance to Ukraine, not only to finance military operations, but also to “partially support” our businesses.

And international financial organizations, providing funds, every time demand to limit the budget deficit.

2. Tax policy should be based on a theory that accounts for the mechanisms of working of the economy and its growth under the influence of tax instruments. A bad theory can only serve as a foundation of a bad policy. A sound fiscal policy can only be formulated and implemented on the basis of scientifically justified economic doctrine. A successful tax reform requires considerableknowledge. Such knowledge must be based not only on practical experience, but first and foremost on a reliable economic theory, which is, unfortunately, not always available. It is long since Michał Kalecki noted that, contrary to popular belief, policymakers do listen to economists but only to those of the previous generation. Yet even modern economists use only some elements of aneconomic theory, some empirical findings and fragmentary discussions.  

In this regard, we can recall the recent failed liberal tax initiative in Great Britain. The approach, which was very successfully used by Ireland, is now considered out of time, even for the developed British economy.   

Grz. Kolodko also adds that the main problem is that there are many contradictory economic views that can “pave many ways to hell”. Therefore, those who implement tax policy are constantly faced with the dilemma: whom to listen to and whom to ignore? Which ideas to make use of and which to reject? Thus, the risk of errors is enormous and further aggravated by the fact that many politicians and officials lack professional knowledge, and even those who do have some knowledge in economics and taxation often make errors in policy decisions anyway. Moreover, the desire for dialogue and compromises, flexibility and openness, justified though in many cases, often has negative consequences. Average values are useful in statistics, but not in development economics. An effective fiscal policy cannot be the result of “averaging”, with some elements taken from one scientific approach and some from another, and there is a mixture of monetarism and neo-Keynesian approach, new institutional economics and the Swedish school for the sole purpose of satisfying the wishes of possibly broadest spectrum of disputants.  

And what can we see regarding the 10-10-10 reform? A whole mix of contradictions, torn out of the context of “stick” theories and strategies, intuitive “know-how”. In the conditions of the long-term need for significant funding of security and defence, the reconstruction of destroyed infrastructure, expediency of a drastic reduction of the state’s share in GDP is substantiated…  This reform does not give any answers to how to finance pensions and benefits to socially vulnerable categories of the population… The initiative of the SSC abolition itself can cause our EU partners nothing but surprise. In all EU countries, social contributions are paid (mostly even at quite high rates), which are distributed in different proportions (depending on the country) between employers and employees… Ukraine is actively implementing the strategy of the EU integration, where the standard VAT rate cannot be lower than 15%, and the reform proposes to reduce it to 10%… etc.   

3. The variety of approaches hides a great number of interests. The configuration of conflicting interests needs to be watched even more closely than the changes of theory to understand why these or other approaches gain the upper hand. For in fact, it is differing interests, rather than views, that matter. In the end, certain interests prevail, not some positions. In this context, interests are primary, and views are of secondary importance. And often, while some, poorly understanding the problem, are simply mistaken (most of them), others deliberately lie, because they are interested in only one thing – to pay less taxes.        

Comments are redundant here.    

4. Policy in all areas, including the tax one, is the art of compromise. It is always necessary to keep searching for a creative consensus that combines the necessary with the possible, accommodates the contradictory interests of society, resolves conflicts between short- and long-term interests of social groups, between the fiscal needs of the state and the regions, between taxpayers and the recipients of budget funds. Unless potentially conflict situations are not defused by policy tools, reaching a compromise will be more difficult. Moreover, everyone or nearly everyone should be satisfied with the achieved results (redistribution of GDP) to approximately the same degree. Only such compromise can serve as a foundation for the implementation of a successful tax policy of economic growth.     

As already covered in the publications of many tax experts, in particular Y. Haidai and K. Shvabii, the 10-10-10 reform will not resolve the mentioned conflicts, but will only exacerbate them. Therefore, it cannot be successful a priori.    

Therefore, we conclude that we still have to develop the optimal tax policy for Ukraine under current internal and external circumstances, after checking whether it passes the “test” described above. I believe that it will happen. And everything will be as in the quote from the famous Lewis Carroll’s fairy tale: “Don’t be sad, said Alice. – Sooner or later, everything will become clear, everything will fall into place and build a single beautiful circuit as lace. It will become clear why itwas needed, because everything will be right”.