Pavlo Sebastianovich: Medium and Small Businesses Displaced From the Legal Field of High Tax Rates

27 August 2015

The government is obliged to enter into a social contract with the Ukrainians. If the vast majority of people not agree with the Ministry of Finance tax innovations – the government will has not the moral rights to apply sanctions to those who do not agree with the rules. In this way tax reform fall into the trash can, as well as the reform of the previous government, and the Ukraine will lose a year of its economy growth history.

Pavel Kuhta has done a very good and thorough analysis. It becomes clear, how Finance Ministry and Tax Service officials do think. Those officials, which by a strange coincidence should make tax reform.

At a time when the tax reform activists are aimed at rapid economic growth for our country, the officials talk about the preservation of revenue. They see Ukraine as a good working vehicle in which it is necessary to pump up the tire a little, wipe the glass and this car will rush to catch up with European gangers.

Activists are sounding the alarm – the economy has fallen by 17% in the first quarter and by 14 % in the second. Income per capita is falling, crossed the mark of $ 1,000. And the government still believes that we need to clean the brake and rear lights, instead of using a modern transport system. Fortunately, part of the former Soviet republics did this already and the recipe is clear.

Experts from the public believe that the main thing that we need to change in our society – a relationship. The relationship between government and citizens. The ratio of people to the wealth. The ratio of people to the state. Instead of thinking about how to live on the money that is possible to collect, the government decides how to collect as much as it sees fit.

Current taxes allow big business to work legally, while medium and small businesses displaced from the legal field of high tax rates. The small business employer can not waste two times more per employee, than the amount for which the employee is ready to work. This is something that concerns mathematics.

As concern to psychological part. Officials financial disclosure statements are full of big multi-valued numbers, and people can not understand how they can earn such money? Deputy Attorney General – the multimillionaire, Ministry of Internal Affairs – a multimillionaire, a judges of the Supreme Court – the millionaires, the relatives of senior officials – the millionaires… All citizens are assured that the taxes they pay are not directed to the benefit of the citizens but to the welfare of officials.

The Government believes that it is unfair that big business pays all taxes, that officials honestly declared their millions, but a small business does not want to pay taxes. Government officials honestly can not understand what is this a kind of business so they could not buy a cash register, could not to pay extra tax on the 5 years car, could not to pay extra property tax, could not to pay white wages? Government officials do not hesitate to say that this business should be closed and the owners of such business, dissatisfied with high taxes, it is better to leave the territory of Ukraine.

Those who write reforms today, pursue only one goal – to fill the budget at any cost. We do not hear of any initiatives to improve the conditions of doing business. All the efforts of the representatives of the Ministry of Finance aimed at strengthening the responsibility of entrepreneurs, to increase the number of taxes, and even restrict access to justice. Threats, threats, threats… The Ukrainian people have heard so many threats from the previous government, but have never heard of economic incentives.

The approach “from the filling of the budget” must be firmly rejected. Today, the country has one goal – rapid sustainable economic growth. And reformers have to have only one goal – to attract foreign and domestic investments. Public experts – economists, businessmen, auditors, financiers – combined their efforts to convey to the government their consensus how to make our country attractive for investments.

The First – to make the lowest in Europe payroll tax. It does not matter – whether payroll taxes all combined into one, or they will remain different – the main thing that their sum does not exceed 20%. The number of 20% do not arise out of thin air, it is estimated how much an entrepreneur spends on one employee using legal methods of minimization.  New tax rates should be set such that the entrepreneur shall pay the same amount in the budget and wouldn’t think how to minimize.

The Second – to remove the most discretionary tax – income tax. Experts believe that in a situation of shortage of turnover capital, unavailability of cheap credit, reinvestment should not be taxed. Dividends are to be taxed, but not income. In addition, Estonia has experience, that the tax on distributed profits is able to have a significant impact on attracting investment. Estonia has set a tax on distributed profits and is ahead of Lithuania and Latvia 4 times on the volume of investments per capita.

Experts say those two economic levers that will allow the Ukrainian economy to start growing.

Returning to the analysis of Paul Kuchta, we have to mention about the shadow economy. The shadow economy, which is so much talk about today – it’s not a problem that must be fought by administrative methods. It is hundreds of thousands of businesses and millions of employee, who did not find a place in the legal economy. Some of them were unable or unwilling to pay the excessive taxes. Others were unable to overcome administrative barriers created by the government in collaboration with big business. Legalization should be carried out very carefully mainly by economic methods.

I do not want to underestimate the importance of economic calculations. And Paul Kuhta has shown himself as a competent expert, putting on the table all the numbers, operated by the reformers. But…

When talking about the man, the numbers can play a cruel joke with us, as it was with the previous government reform. Man – not a calculator, where we get the same result always we click on the same buttons. Calculators are always rational.

Man is both selfish, opportunistic, altruistic or as they say now – limited rational. Watching on TV the deputy prosecutor general, who keeps in office half a million dollars and a box with diamonds, employer, who an hour earlier had decided to formalize all their employees, could avert the legalization. And if this is followed by the complete impunity of the public prosecutor, the majority of businesses will continue to operate in the shadows.

So to climb the ladder of economic success Ukraine should start with:
–  radical payroll tax cuts, corresponding to the level of public service;
–  attractive conditions for investment and reinvestment like made in Estonia;
–  a radical reform of the tax service like made in Georgia;
– digital service like all around the world made;
– (!!!) activation of the Ministry of Economy, which took the silent position in an unprecedented economic decline.

The government is obliged to enter into a social contract with the Ukrainians. If the vast majority of people not agree with the Ministry of Finance tax innovations – the government will has not the moral rights to apply sanctions to those who do not agree with the rules. In this way tax reform fall into the trash can, as well as the reform of the previous government, and the Ukraine will lose a year of its economy growth history.

Tax Reform Week

Tax Reform – What’s On the Table (Pavlo Kukhta, member of the Editorial Board of iMoRe)

Open Letter to the Expert Community and the Ministry of Finance of Ukraine from the VoxUkraine Group of Economists

Vladimir Dubrovskiy: 1-2% of GDP in Additional Revenues as a Result of a Crackdown on Simplified Taxation are Unrealistic Figures (Vladimir Dubrovskiy, RPR expert)

Tetyana Prokopchuk: Business Believes that the Priority is to Simplify the Administration of Taxes (Tetyana Prokopchuk, Vice President of Policy of the American Chamber of Commerce in Ukraine)

Robert Conrad: Tax Reform is not Simply Changing the Law (Robert Conrad, Duke University)

Anna Derevyanko: Cosmetic Changes will not Work for the Society (Anna Derevyanko, Executive Director, European Business Association)

Ukraine Needs a Radical but Sensible Tax Reform (Anders Åslund, Senior fellow at the Atlantic Council in Washington and author of the book “Ukraine: What Went Wrong and How to Fix It”)

Roman Zharko: Core Problem of the Ukrainian Tax System is Practice of Discretionary Use of Fiscal Mechanism to Reach the Established Revenue Targets (Roman Zharko, PhD, Tax Manager, Baker Tilly)

Tax Reform in Ukraine: How to Accomplish the Impossible (Vladimir Dubrovskiy, expert of the RPR group)

Tax Reform in the Light of Macroeconomic Stability: the NBU Perspective (Dmytro Sologub, Deputy Governor at National Bank of Ukraine, and Serhiy Nikolaichuk, Director of monetary policy and economic analysis department at NBU)

Macroeconomic Implications of the Tax Reform (Yuriy Gorodnichenko, UC Berkeley, co-founder of VoxUkraine)

Tax Reform in Georgia: Lessons for Ukraine (Olena Bilan, Chief economist at Dragon Capital, member of the Editorial Board of VoxUkraine)



The author doesn`t work for, consult to, own shares in or receive funding from any company or organization that would benefit from this article, and have no relevant affiliations