Hardly had legislators reduced VAT for farmers to 14% before they immediately began to doubt their own decision. We also doubt it, because we believe that the reduction of the VAT rate is necessary not only for farmers, but for honest business, economy, and most importantly – for ordinary citizens!
Taxes should provide a sufficient amount of state budget revenues to fund public needs and services. All those who deal with public finances in this country remember it very well. However, they seem to forget, at least some of them, that the “necessary evil” – taxes – should do the least harm to the economy and minimize its distorting influence on economic agents’ decisions for the latter to have incentives to work and invest.
It should be admitted that finding a balance is really difficult, as the requirements for the tax system are mutually exclusive. In real life, this balance is constantly shifted towards higher taxation, arguing it by the need to build a “welfare state”. Endless political cycles are rich in populist promises of participants in the election campaign. As you know, fiscal policy in Ukraine is very sensitive to such cycles. For thirty years, accumulated and unfulfilled election promises, together with the distorted structure of the domestic tax system and inefficient methods of tax administration have resulted in imbalances in the state budget, significant shadow economy, including its offshore sector, taxpayer opportunism, low quality of public services. Pensions, medicine, education, science, defence, transport infrastructure and many other socially significant issues, for which, in fact, taxes are paid, leave much to be desired. That is why the taxpayers’ opposition to the decisions and actions of the authorities in the tax sphere is mostly caused by a striking discrepancy between, on the one hand, the taxes paid, and on the other, the quality of public services received. Of course, this is not an excuse for either the payers or the state, so there is no way to do without mutual concessions. Moreover, the first such step of the state towards payers can be the following.
Everything or almost everything in the public sphere comes down to taxes and the number of those willing to pay is not increasing, and, to top it all, even the economy is in a state of permanent lockdown. In previous material there are already arguments as to why taxes cannot be raised further. So let us try to understand what to do next in such, admittedly, not very favorable circumstances?
It is necessary to start, of course, with VAT, because it is the most harmful for our economy and creates the largest tax gaps of all existing taxes.
Let us remember that almost a year has passed since the fight against VAT “twists” began. Much has been done along the way. A temporary commission of inquiry has been set up in the Verkhovna Rada, and the joint efforts of the specialists from the Security Service of Ukraine and the State Tax Service have eliminated errors in the work of the system of electronic administration of this tax. As a result, last year ended with a truly impressive, compared to previous years, indicators of filling the state budget with relevant tax revenues. However, for objective reasons, last year also saw a significant drop in real GDP, capital investment at the lowest level in twenty years, negative expectations of business activity. In addition, inflation began to accelerate earlier this year.
That is why, in our opinion, the reduction of tax pressure on the economy cannot be postponed. Moreover, we need to start with the largest, in the fiscal terms, tax, reducing its regulatory rate to 15%. This is the minimum basic tax rate sanctioned by the European VAT Directive and is a trade-off in many respects. In short, the main advantages of its implementation, in addition to the actual reduction of the degree of tax pressure on the economy, are as follows.
First, and this is extremely important, such a value of the VAT rate, if does not completely exclude, then at least extremely complicates further existence of the shameful practice of “twists” and illegal reimbursement of tax amounts from the state budget. After all, despite the year of combating this phenomenon, we constantly hear from the tax service and other regulatory authorities about the identification of the next minimization schemes. Victorious reports are, of course, great, but there is no bottom to it. Moreover, instead of making this activity impossible, the government plans to continue to fight it. Such a struggle for the sake of struggle? At least, paragraphs 6 and 7 of the recently approved Government Action Plan to prevent tax evasion by business entities and money laundering in offshore areas provide for the implementation of tax control measures for unjustified VAT tax credit on a permanent basis until the end of 2022 and further.
Second, which is a direct consequence of the first, the reduction in the rate eliminates the sources of funding for corruption, in particular political one, the fight against which is no less intense, but, as we know, not very successful.
Third, there must be an increase in the fiscal efficiency of the tax. For example, on average in the economy, the indicators of the tax efficiency of VAT published by the State Tax Service have increased over the last year, but the disagreement by individual industries remains quite high. As of January 2021, traditionally the lowest indicator of tax efficiency was recorded in the field of wholesale and retail trade (1.5%), and in the field of “public administration and defense” it was 17.2%.
Fourth, such initiative is fully in line with the logic of the policy of supporting the population, effective demand in a pandemic, which is spelled out in all the recommendations of well-known experts and world institutions over the past year. The purchasing power of the population increases by the amount of funds not received by the budget, so they will still be returned to the budget as paid taxes (VAT and excise tax).
Fifth, a reduction in the VAT rate will have a positive psychological effect on ordinary taxpayers, which should increase the level of voluntariness of payment. For the last decade and a half, this is in fact the only such initiative when the state reduces the burden on the income and expenditure of citizens, so we should expect a positive behavioral effect in general, the consequences of which are difficult to overestimate.
If there are advantages everywhere, then what are the disadvantages of such step? The main risk for the domestic public finance system because of the reduction in the tax rate is certainly associated with a natural decrease in tax revenues from VAT. It is a known fact that 1% of VAT costs the budget UAH 20-25 billion, so in proportion to the rate reduction, the amount of losses of the state budget should be expected. However, the good news is that these losses will be offset very quickly. According to our estimates, the state budget of Ukraine for the year may receive by UAH 30-40 billion of tax revenues from VAT less than planned. In the short run, these shortfalls can be fully offset by acceleration in GDP growth of 2-2.5% in addition to the expected growth rate, as final consumer spending has always been and remains a significant factor in economic growth. The coefficient of elasticity of GDP growth by the final consumer expenditures of the population is 0.95 (see Fig. 1).
Figure 1. – Dependence of GDP on final consumer expenditures of the population
Source: Author’s calculations
The public welfare, the country of which we have been striving to build for all the years of independence (but, unfortunately, unsuccessfully), must be paid for by taxes, not public debts, which, ironically, are still taxes only for future generations. It should be recalled that over the past ten years, public debt service expenditures in state budget current expenditures have increased fivefold. This may be a coincidence, but according to official statistics, the birth rate in Ukraine in 2019 was at its lowest level (1,228) for 15 years, and experts predict its further decline. People feel something wrong in the “Ukrainian kingdom”, albeit intuitively, but the protective reaction is obvious.
Therefore, today the conceptual choice facing Ukraine in the field of taxation is small. More precisely, we can choose only between two mutually exclusive alternatives: either we begin the process of reducing the extremely high tax burden and, as a result, promote the development of the domestic economy, or, as before, “tighten the screws” while squeezing the already small official economy that will continue to flow into the shadow or offshore sectors. For taxes to be paid by all, in full and in accordance with current legislation, two conditions are required. The first is a functioning economy, the second is an adequate taxation system. Thus, the rational choice is obvious: it is better to have less, but later more than more, but later… as always!
Doctor of Economics, expert of the Growford Institute Kostiantyn Shvabii for Dzerkalo tyzhnia.