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26.06.24 18:33 22 0

Taxes will inevitably rise. Why, how much and where will money go?

The government is preparing tax increases that will affect businesses and citizens. When will it happen?

One of the founding fathers of the United States, Benjamin Franklin, said that only two things are inevitable: death and taxes. In the Ukrainian reality, these two things are closely intertwined, as Ukraine maintains the Defence Forces at its own expense, on which our lives directly depend. Not a penny of international aid can go to the army. Therefore, almost all of the funds raised by the state are directed to the security and defence sector.

Out of the total state budget revenues for 2024 of UAH 1.76 trillion, UAH 1.69 trillion is earmarked for defence. According to the Ministry of Finance, UAH 732.8 billion has already been spent in January-May.

As previously reported by Deputy Defence Minister Yurii Dzhyhyr, more than 70% of the Ministry of Defence's budget will be spent this year on military salaries, payments to the dead, payments for injuries, and another 20% on the purchase of weapons.

However, there is not enough money. At the beginning of the year, Roksolana Pidlasa, the head of the Verkhovna Rada Budget Committee, said that the mobilization of 400,000 to 500,000 people liable for military service and additional needs for the purchase and modernization of military equipment could require an increase in state budget expenditures in 2024 by about UAH 700 billion.

According to Finance Minister Serhii Marchenko, there is currently a gap of $5bn (over UAH 200bn at the current exchange rate) in the budget for weapons purchases.

That is why the authorities are considering raising taxes to fill the budget deficit. At the same time, Prime Minister Denys Shmyhal emphasizes that the government is not discussing this issue. However, the Cabinet of Ministers will appeal to the Verkhovna Rada to increase funds for the defence and security sector.

According to Danylo Hetmantsev, chairman of the Verkhovna Rada Committee on Finance, Taxation and Customs Policy, the government is calculating the needs and the amount required, but it is not less than UAH 300 billion by the end of the year. And it is impossible to fill the budget without the main taxes.

"The changes will affect budget-forming direct and indirect taxes, including VAT, military duty and excise taxes. We need to increase both the expenditure and revenue side of the budget to finance the army," he said.

The government will start working more productively on the idea of tax increases and budgetary changes after June 28. Until then, the Cabinet will be busy settling various issues with the IMF, says People's Deputy Yaroslav Zhelezniak.

BusinessCensor analyzed how domestic tax rates may change and whether there are alternatives to tax increases.

What taxes will increase and when

The main proposals concern an increase in VAT and military tax. The latter is to be introduced for individual entrepreneurs on the simplified taxation system.

Thus, the military tax is planned to be increased from 1.5% to 5%. This increase, according to Forbes, could bring in an additional UAH 90-100 billion to the budget, not including individual entrepreneurs.

Discussions are ongoing about increasing the VAT rate, which is currently 20%. Most likely, the tax will increase by 2-3%, and each percentage point brings about UAH 40 billion in additional annual budget revenues. In other words, such a change could bring in up to UAH 120 billion.

The relevant draft law is expected to be submitted to the Verkhovna Rada in early July. However, even if it is adopted promptly, the new tax rates will not come into effect until September. At the same time, according to Yaroslav Zhelezniak, no one can say which taxes will be raised, when and by how much.

"The final parameters will be known after June. Why? First, the IMF Board of Directors must approve a decision on the fourth review of the Extended Fund Facility programme at its meeting in June, which will allow Ukraine to receive a tranche of $2.2 billion. After that, the parameters of budget and tax changes will be formed. Before that, no one will give an answer about tax increases, because they do not exist," he said in a commentary to Ukrainska Pravda.

What will be the consequences of a tax increase

"As for the consequences, I think the Cabinet of Ministers will calculate them. But the consequences for the economy, if the army is unfunded, could be much worse, fatal," Hetmantsev said.

In fact, the authorities began to change the system of taxes and fees at the end of 2023, when $60 billion in US aid, including military aid, was stalled in Congress. The key decision then was a law to increase the corporate income tax on banks. Last year, banks paid a record UAH 73.5 billion in this tax, which is twice as much as in the previous 15 years.

This decision was welcomed by economic experts, who consider it a reasonable step by the government.

Thus, tax revenues in May 2024 in Ukraine increased by 40% (year-on-year). The main driver of these figures was the income tax, in particular its increase to 25% for banks this year.

At the same time, May's revenues from consumption taxes (VAT, excise duties, and customs duties) decreased by 5% compared to April. However, they were up 42% year-on-year. This was preceded by a vote in the first reading to increase excise taxes on fuel and tobacco. A similar decision is also being prepared for alcohol - the government has already approved the relevant draft law.

Although experts generally consider the increase in excise taxes to be a positive development, there is a dark side to this decision: higher fuel prices will inevitably lead to higher costs for Ukrainian companies, which will ultimately be put on to the end consumer`s shoulders through higher product prices. This, in turn, will accelerate inflation. Thus, the NBU's current forecast is for inflation to accelerate to 8.2% in 2024.

An increase in the VAT rate will lead to higher prices for goods. The National Bank says that VAT is the tax that has the fastest effect on price increases. However, experts agree that this will have a moderately negative impact on the economy.

At the same time, experts do not agree with the introduction of a military tax for individual entrepreneurs in the form currently being discussed - 5% of income. This will immediately double the tax burden on entrepreneurs of Group III. The people's deputies are waiting for the Ministry of Finance to justify the proposal, but the Rada's tax committee does not support this particular configuration of tax increases. However, Hetmantsev warned that given the situation, the proposals could be radical.

According to Nina Yuzhanina, a member of the Committee on Finance, Taxation and Customs Policy, the concept of the military tax for individual entrepreneurs was to introduce a military tax of 1.5% of the minimum wage. Moreover, the rate for individual entrepreneurs of group III would have been 0.1% of income.

In addition, according to the government's National Revenue Strategy until 2030, a differentiated tax rate scale is to be introduced for the STS (simplified tax system) taxpayers, ranging from 3% for trade to 17% for a number of services, to encourage voluntary transition to the general taxation system.

"The introduction of differentiated rates for certain types of activities will involve a gradual increase over three years with preliminary discussion and definition in amendments to the Tax Code of Ukraine," the document says.

However, the tax increase could further shadow the economy and encourage businesses to look for new tax evasion schemes.

An increase in the military tax to 5% is equivalent to an increase in personal income tax to 23%. The current personal income tax rate, the main tax paid by Ukrainians on salaries and other income, is 18%. But in addition to personal income tax, income is also subject to a 1.5% military tax.

In this case, the same hryvnia deposits will finally lose their attractiveness. Due to the National Bank's systematic reduction of the key policy rate, commercial banks are also reviewing deposit rates for households. Although there is a segment of customers in Ukraine who will keep their money on deposit under any circumstances, the only effective hryvnia instrument will remain domestic government bonds, which are tax-free.

Perhaps this is what they are counting on, as the population is now seen as one of the main potential sources of resources for non-issue financing of defence spending.

By the way, in 2023, Ukrainians paid UAH 175.7 billion in personal income tax and military tax.

Is it possible to do without raising taxes?

The authorities believe that tax increases are unavoidable.

"We have virtually no good solutions left. And we must be aware of this," Danylo Hetmantsev said at the Banking Forum organised by Ekonomichna Pravda.

Some experts share a similar position. For example, this was discussed by Olena Bilan, Director of Dragon Capital's Analytical Department, and Vitalii Vavryshchuk, Head of Macroeconomic Research at ICU Group, during the Money to Win conference by Forbes. Deputy Governor of the National Bank of Ukraine Serhii Nikolaichuk agrees with them.

"Even if a peace treaty is signed in the near future, Ukraine will not be able to dramatically reduce military spending. It will have to keep a large army on the border," explains Vavryshchuk.

According to him, Ukraine should move to a system where everyone pays for victory, whether through tax increases, reservation fees, or service in the Defence Forces.

"In fact, we have a catastrophic situation with security and defence spending. We have a huge hole in the budget, and it's probably not tens of millions, it's hundreds of millions. It's hundreds of billions that we need to raise," Hetmantsev emphasises.

However, there are alternative opinions. For example, Oleh Hetman, coordinator of expert groups at the Economic Expert Platform and associate expert at CASE Ukraine, points out that the budget loses between UAH 250-300 billion a year from shadow schemes. The losses can be minimised through the reform of the State Tax and Customs Services, as well as by rebooting the Bureau of Economic Security.

"The shadow market for excisable goods, fraud, smuggling and other illegal tax evasion schemes is worth UAH 250 billion. Reserves for a quarter of a trillion are lying on the surface," says Mykhailo Nepran, First Vice President of the Ukrainian Chamber of Commerce and Industry.

Illia Neskhodovskyi, an expert on economics, finance and taxation at ANTS, believes that the budget can be raised by increasing import duties. In addition to budgetary benefits, this will also have a positive impact on domestic producers.

According to Andrii Dlihach, PhD in Economics, Chairman of Advanter Group, an alternative solution could be excise taxes, taxes on assets and land. However, this requires putting the cadastre in order so that there is no room for evasion.

At the same time, Danylo Hetmantsev says that the underfunding of military spending amounts to billions of hryvnias:

"Very large sums of money that cannot be accumulated by point solutions or, so to speak, via de-shadowing, as the resource from de-shadowing is already being used."

According to him, we are talking about UAH 60 billion, which used to be "in the pockets of fraudsters". And although this is not as much as needed for the army, it is still a lot of money.

Another possible option for filling the budget is to launch a "printing press".

"We are determined to avoid issuing bonds as much as possible. We see it as a measure of last resort, which we will use when other options for filling the budget are exhausted," emphasises Serhii Nikolaichuk.

The fact that hryvnia printing is an undesirable measure is perhaps the only point on which both government officials and various experts are unanimous.

This is not surprising, as we have experience: in 2022, the NBU purchased UAH 400 billion worth of domestic government bonds. This, in turn, accelerated inflation to 26.6% at the end of the year and also contributed to the devaluation of the hryvnia.

At the beginning of the full-scale war, the NBU fixed the exchange rate at UAH 29.2549 per dollar; from the end of July 2022 to October 2023, it kept it at UAH 36.5686 per dollar. Given the current exchange rate realities (40.65 UAH/$), another round of issuance could have catastrophic consequences.

"In 2025, the budget situation will deteriorate even further. Not only because of the growth in military spending, which we have to cover on our own, but also because of uncertainty about international assistance. The need for international financing for Ukraine in 2025 is estimated at $32 billion, of which we do not yet understand how to cover $15 billion," Danylo Hetmantsev said on the eve of the G7 summit.

The situation should be improved by a $50 billion loan, which the G7 agreed on in view of the profits from frozen Russian assets. However, the idea of raising taxes has not been baulked. Obviously, they will inevitably increase. And most likely in the near future.