Shvabii K., professor, expert of the Growford Institute
If you want Pax, pay Tax
If you want peace, pay taxes. It was this principle that allowed the Roman Empire to exist for a thousand years. Unlike the Roman taxpayers, who did pay taxes in exchange for peace, we, as always, go our “own” way, trying to overcome the existential threat to our existence in the first thirty years of the modern history of Ukraine. Another tax amendment has shaken Ukrainian society and the experts. This amendment proposes to reduce the rates of key taxes (personal income tax, profit tax and VAT) to 10% instead of the existing, really unsuccessful and controversial taxation system. This initiative will already be history with its own name “everything for 10%”.
The idea might have been attractive, but certainly under different circumstances of the place and time, and surely not in time when the active phase of full-scale war has continued for the sixth month in a row along the entire front line of more than a thousand kilometers. Unfortunately, in the modern conditions of war, there is no need to talk about any significant tax breaks. The predicted drop in GDP this year by 30% or more, a significant state budget deficit, a decline of the incomes of the major part of the population, and most importantly, an unknown scenario for the further military operations, will largely transfer the confrontation between Ukraine and Russia from the battlefield to the economic front. which is no less important than all the others.
The timing for “everything for 10” is definitely not the best, since the Ukrainian economy is at least at the stage of stagflation, and liberalizing the tax system, taking into account budgetary needs and a generally balanced approach to such steps, is needed during the phase of economic growth.
What should be done at present, if you try to find a difficult compromise between the need for additional positive impulses to restore economic growth and the financing of necessary expenses, without which the state will not be able to exist.
There is no doubt that, to put it mildly, the imperfect tax system needs to be changed, but under the current circumstances it should be done by redistributing the tax burden with minimal losses for the state budget.
I am absolutely convinced that Ukraine as before can afford to reduce the standard VAT rate to 15%, since the projected inflation in the current year at the level of 30% makes it possible to compensate for the loss of budget revenues, if not in real terms, then at least in nominal terms. It should be noted that last year, with annual inflation rate at 10%, the cumulative increase in VAT revenues amounted to 23.2% for goods and services of domestic production and 38.9% for imports. Total revenues reached a record level of UAH 536.5 billion. Therefore, a reduction in the VAT rate can be relatively painless for the budget, as it can be fully offset by an increase in prices. In fact, July of the current year indicates exactly this trend, in which, according to the Ministry of Finance, for the first time in the current year, it was possible to significantly reduce the budget deficit due mainly to the devaluation of the hryvnia against the dollar by 25%.
Without new statistical data on the current effectiveness of VAT administration, it is difficult to make any conclusions, but the available data suggest that during the last two years, 2020-2021, the volume of budget reimbursement significantly decreased in relative terms (Figure 1). If from 2014 to 2019 the average reimbursement rate was 64%, then during 2020-2021 it was only 52%.
Figure 1. Budget reimbursement of VAT in Ukraine, as % of domestic VAT
On the one hand, this could be evidence of closed loopholes and increased efficiency of the administration of this tax. On the other hand, it may be indicative of, as it was before, the manual mode of managing the process of returning credit to payers. Anyway, the overexecution of VAT revenue plan during two pre-war years makes us think about the significant reserves of increasing of the fiscal efficiency of the administration, and therefore the VAT rate can be reduced without relatively large losses for the state budget. I think this step would be absolutely appropriate from the state, givena significant drop in the population’s income and savings.
In this same context, it would be fair to introduce such an element of the personal income tax as a tax discount for the repair of war-damaged housing, which was discussed in a separate article.
Returning to the historical experience of tax policy during the war and in the interwar period, we can see that in the period between the two world wars in the 20th century, not a single country in the world that participated in them did not reduce the tax burden, but on the contrary, they increased the certain taxes rates and actively used debt instruments.
It can seem strange but the First World War facilitated the emergence of the modern personal income tax prototype. Until 1914 the personal income tax did not perform the important fiscal function as it plays now in the tax systems of most countries of the world. If to be more precisely, there was this tax, but its rates were very low at 2-4%. More precisely, the tax existed, but the rates remained very low at 2-4%.
To be more convincing in the arguments, we can turn to Thomas Piketty’s book “Capital in the Twenty-First Century”, who notes that the difficulties of the financial situation in the post-war years in France led to the fact that the marginal tax rate increased to 50% in 1920, to 60 % in 1924 and even up to 72% in 1925. This complete reversal of the right-wing position on progressive taxation in France was of course due to the disastrous financial situation created by the war. “During the conflict the government had run up considerable debts, and despite the ritual speeches in which politician after politician declared that “Germany will pay,” everyone knew that new fiscal resources would have to be found”. Doesn’t it remind you of anything?
In defeated Germany already in 1919-1920, the marginal rate of this tax increased from 4% to 40%. In the post-war period, the USA went even further by setting the highest tax rate at an unprecedented level of 77%. Our “dream” Roosevelt first came to power in Great Britain in 1933, when the Great Depression was already three years old, which did not prevent him from raising the marginal tax rate to 63% in the same year, then to 79% in 1937. The Victory Tax Act raised the top rate to 88%, in 1944 it went up again to 94%, due to various surtaxes. The top rate then stabilized at around 90% until the mid-1960s. Of course, all this did not apply to ordinary citizens, but primarily the financial elite, which had to pay just this price for the opportunity to live in a free world. I would like to know how many taxes and where the domestic “Battalion of Monaco” paid, which seems to be doing well on the French Riviera!?
Another tax instrument with high marginal rates, which was actively used by the above-mentioned countries, according to Piketty, during almost the entire 20th century, including the cold war, was the inheritance tax. In the USA the tax rate was 70% or more for half a century, in Great Britain it was 80% and more for two decades. France and Germany were not so radical, but in certain periods the rates reached significant levels (30-40%). In this context, I just want to note that this tool can be quite significant, first of all, from the fiscal point of view, because an end the era of offshores, disclosure of banking secrets and automatic exchange of tax information are predicted. And here a lot depends on the state, which should activate and accelerate the implementation procedures of the automatic exchange of information standard (AEOI). As of today, 102 jurisdictions have already carried out at least the first exchange of information, and Ukraine plans to do this for the first time only in September 2024. Of course, this is much more difficult and responsible work than inventing new taxes and reinventing the wheel every time. But to do this political will, not sick fantasy, is needed.
Finally, I would also like to conclude with a quote from Piketty’s book, which seems to be relevant to the current situation in Ukraine with both taxes and debt. “There are two main ways for a government to finance its expenses: taxes and debt. In general, taxation is by far preferable to debt in terms of justice and efficiency. The problem with debt (read government issued bonds – author) is that it usually has to be repaid, so that debt financing is in the interest of those who have the means to lend to the government (sic! – author). From the standpoint of the general interest, it is normally preferable to tax the wealthy rather than borrow from them.”