Sectoral reforms, human capital and tax policies: what to expect in the next four years

In this article, we look at sectoral reforms that should create prerequisites for sustainable economic development and EU integration. We also discuss planned changes in the taxation system that should increase budget revenues. Overall the proposed measures (if implemented properly) will result in more efficient spending of public funds and will improve the investment attractiveness of Ukraine.

Human capital: improvements in education and care for the vulnerable 

The current IMF program focuses on macroeconomic stability and sustainability of public finance and therefore it only briefly mentions human capital (previous programs usually also included only general references to healthcare or education reforms). Specifically, the IMF program states that the Ukrainian government will refrain from introducing new “special” (privileged) pensions or lowering pension age since the Ukrainian pension system is already strained. EU documents do not mention healthcare reform either, perhaps implying that healthcare reform launched in 2017 should continue (at the same time EU-2023 Review notes that the absence of a national health insurance card does not allow implementation of the European Health Insurance Card in Ukraine). The Ukraine Facility Plan includes investment in healthcare (see Table 2) but no institutional reforms. It pays a lot of attention to education and social security: these spheres are essential to preserve and develop Ukraine’s human capital. 

The government will continue consolidating social payments (recently it adopted a decree on the Single System for Social Sphere that will keep the data of all the recipients of social support). The creation of this single database has been ongoing for over 15 years, and now it is supported by another World Bank loan. The need to change the model of social support has been discussed for years, but recently the government made a few practical steps to replace “the zoo” of social payments with tailored support for households. The aim of this new system is to address specific needs of a household (restore lost documents, find a job, enroll children into a school etc.) so that it becomes sustainable. Social services will be provided not only by state and communal entities but also by private organizations or NGOs.

A comprehensive law on the integration of veterans into civilian life (to be adopted) will address healthcare needs, retraining, employment, and support for veteran businesses. Ukraine plans to develop an electronic system with information on all the people with disabilities that will use the International Classification of Functioning Disability and Health. The system will automatically offer support to these people.

Both EU-2023 Review and Ukraine Facility foresee de-institutionalization of elderly, people with disabilities, and children. The former two groups will get tailored social services and the latter one – foster families.

The major reforms of the housing policy foresee the adoption of legislation to enable leases with an opportunity to buy communal housing, to improve the transparency of the distribution of social housing and opportunities for civil society organizations (CSOs) to monitor social housing projects. The standards for social housing such as accessibility, energy efficiency etc. will be adopted (in fact, they will be introduced for all the housing – see Table 3).

EU-2023 Review notes that Ukraine still has to do some work on eliminating discrimination: to implement the equal rights strategy and gender pay gap strategy, to ratify the ILO convention 190 on reducing violence and harassment. Ukraine also needs to start collecting relevant data, e.g. statistics on court cases on discrimination, to be able to measure progress in this sphere. 

Ukraine’s EU integration includes integration of the labour markets. Thus Ukraine will need to provide for EU citizens and their children the same rights to access employment and education as Ukrainian citizens have. Recently, the legislation for employment of foreigners was simplified (the wage floor was abandoned) but they still need an employment permit. Ukraine recognizes foreign qualifications since 2021 but it still needs to implement the EU law on professional recognition in full and to join the EURES network which supports the EU single labour market. Simplification of employment for foreigners will be beneficial for Ukraine because it currently faces labour shortages in some industries.

Another EU requirement is better protection of the rights of workers: strengthening social dialogue and powers of the respective Council, aligning workplace safety norms with the EU and providing more powers to labour inspections (implementation of ILO Conventions 81 and 129 which Ukraine ratified a long time ago).

Ukraine Facility Plan foresees adoption of the new laws on vocational and pre-school education. Two draft laws on vocational education (4207, 4207-1) that were submitted to the parliament in 2020 were rejected by the parliamentary committee on education in August 2023. In April 2024 the Ministry of Education presented another draft law on this topic (currently under discussion). The ministry plans to intensify cooperation between vocational schools and potential employers and to provide new equipment to vocational schools. The draft law on preschool education was adopted in the first reading more than a year ago. This new legislation on vocational and preschool education should establish fair market rules and a “guaranteed” access to preschool education for all the children of relevant age. 

Speaking of other education levels, the EU-2023 review mentions implementation of the Strategy on higher education adopted at the end of 2022. The strategy foresees mergers of higher education institutions to exploit economies of scale and development of the “money follows a student” principle: provision of educational grants to students instead of “budget-funded places” for the majority of specialties.

Although Ukraine has very little money to invest into science and research, it cooperates with the Horizon Europe program; it also adopted the National Open Science Plan and Strategy for Innovation Sector development. Today this sphere is probably the least reformed. The Ministry of Education and Science plans to introduce performance-based research funding, the first steps to which were made in 2018 when the National Research Fund was created.

Energy market and green transition: more market elements, less government regulation

Measures in this sector (among them market pricing of energy and enhancing competition) aim to raise energy efficiency and thus lower consumption and greenhouse gas (GHG) emissions. They include alignment of Ukrainian legislation with EU directives on electricity and gas markets and on atomic energy; introduction of market-based carbon pricing mechanisms and a different carbon tax model; development of more efficient (decentralized) district heating (table 3). Ukraine should adopt an Energy and Climate plan that would set a more ambitious goal than the current 27% of energy supplied by renewable sources by 2030 (in 2021 this share was about 6%).

These changes will be accompanied by investment in energy infrastructure and energy efficiency (table 4).

Unfortunately, the introduction of market energy tariffs is delayed until martial law is lifted. This will impede capital investment in the sector and will likely worsen the financial situation of Naftogas. Recent Russian attacks on energy generation mean that Ukraine has to urgently rebuild power generation capacities. Since the end of the war is not insight, it is better to aim at distributed power generation – small power stations that use gas, oil products or bio materials that are easy to protect. Construction of large generation capacities, such as nuclear reactors, should be postponed. 

Environmental protection: improving quality of land and water, protecting biodiversity and forests

In this sphere, like in all the others, Ukraine should work on aligning its legislation with the EU acquis, specifically, introduce the EU air and water quality standards and relevant measurement system; adopt and implement the draft law on emerald network (a number of nature preservation sites). Automated pollution control systems should be installed at all the facilities, not only the new plants, because the largest pollutants are the old Soviet legacy plants. Ukraine will need to amend its legislation to align with the UNECE Convention on the Transboundary Effects of Industrial Accidents which Ukraine ratified in 2022. Specifically, Ukraine will need to establish closer cooperation between the State Emergency Service and State Ecological Inspection to develop prevention measures to mitigate environmental risks resulting from industrial accidents. 

Agricultural sector: more transparency of state support and demining

The main expected changes in the agricultural sector are (1) introduction of land monitoring systems and (2) supporting only farmers who are registered in the State Agrarian Registry. Ukraine Facility foresees provision to Ukrainian farmers of EUR 75 million in 2024-2025 and the same amount in 2026-2027 for demining.

Transport: reforms of the border crossing points, railroads, and water transport

In this sector, a lot of changes are planned for all the modes of transport. On the railways, the European model will be introduced (the discussion of different models of railroad restructuring can be found at VoxUkraine: article 1, article 2). Western border crossing points will be developed, and regulation of maritime and river transport will be considerably changed in line with the EU rules. Ukraine Facility foresees investment of EUR 350 million in 2026-2027 into reconstruction of transport infrastructure.

Critical materials

Ukraine has many materials that will be useful for years to come, e.g. lithium, rare earth metals, and non-metal materials. The Ukrainian government plans to attract investors into extraction of these materials via product sharing agreements or PPPs.

Tax system: closing loopholes and raising tax revenues

In this last section we consider the planned changes to the taxation system that would enable the government to collect more taxes to finance defense and other needs. These changes are described by the government’s Revenue Strategy, to which both Ukraine Facility Plan and the IMF program refer.

The IMF program is mainly focused on reduction of tax evasion and leveling the playing field. Within this program the government promised to refrain from tax amnesties or introduction of new tax exemptions during the program duration (some tax exemptions on critical imports are possible but should be limited in time and tightly overseen, and by 2026 the system of privileges on customs payments should be harmonized with the EU rules). Both the IMF program and the EU-2023 Review mention the need to implement the EU Anti-Tax Avoidance Directive. Ukraine will develop a unified approach to provision of tax privileges and introduce constant monitoring of the sum of these privileges and their effectiveness.

One of the most important loopholes in the taxation system is the simplified tax regime that allows large companies to “optimize” tax payments by hiring their staff as private entrepreneurs. This way an employee pays only 5% of income tax plus social contribution equal to 22% of minimum salary, which is much lower than 18% of income tax + 1.5% of military surcharge + social contribution equal to 22% of the actual salary. The Revenue Strategy assumes that when deductibles are similar, people will demand official employment because in this case they will not need to administer their taxes. Those who stay on the simplified system will have to use cash registers and will have to pay VAT after they reach a certain revenue threshold. The Revenue Strategy does not specify planned tax rates for entrepreneurs working on the simplified system. It only states that these rates will be differentiated by types of activities and by the sum of revenues.

Progressive scale will be introduced (again) for a “regular” personal income tax. Historically, Ukraine had both flat and progressive scales and it is hard to tell which one was more efficient. The minimum non-taxable income will be replaced by subsidies to the poorest.

All these changes will happen a year after the tax inspection introduces a proper personal data protection system and gains access to bank accounts of people, i.e. the earliest in 2027. The government may need to collect more taxes already in 2024-2025 because of insufficient external economic support. The government may raise the VAT rate or speed up aligning of excise rates with the EU.

Legal entities that use simplified taxation systems will pay the rate equal to the regular profit tax rate – 18% compared to current 6% of turnover + VAT or 10% without VAT. Profit tax privileges and exemptions will be limited so that effective tax rate does not fall below 15%. However, to encourage investment, the government plans to implement instant amortization (i.e. spending on some productive assets will be deductible from the profit tax base in the same year when it is made). 

Until 2027 the government will implement the rules that discourage companies from searching for low-tax jurisdictions (BEPS and OECD two-pillar solution). By 2025 it plans to align the Ukrainian taxation system with international rules and by 2030 – to review all the agreements on avoiding dual taxation and if needed adjust Ukrainian legislation to international norms. 

As we noted in the first article, local governments will receive more powers and opportunities to collect property tax. This tax should become the major revenue source for local budgets, in line with the experience of other countries. 

By the end of 2025, Ukraine will introduce taxation of virtual assets and a new carbon tax model (see table 3).

Conclusion

In some areas (energy sector, education and science, taxation or social support) Ukraine will need major institutional reforms. In some sectors (e.g. agriculture or transport) no major changes are planned but a lot of investment is needed (demining, reconstruction of transport infrastructure etc).

Implementation of the planned reforms will show Ukraine’s commitment to join the EU and will also benefit Ukrainian businesses and public finance. The Ukraine Facility Plan will provide some “seed” investment, e.g. into reconstruction of schools, hospitals or energy efficiency. If institutional reforms are properly implemented, this investment will attract some private players or international organizations. However, this will happen only if Ukraine receives enough military support to be able to defeat Russia.