VAT increase to 21%: How realistic is it and why government decided to raise tax
To support businesses by compensating for losses caused by Russian shelling, the government decided to establish an insurance fund of up to $4 billion. One billion of this amount is planned to be secured by raising the VAT rate by 1 percentage point to 21% starting in 2027.
The decision to change the tax must be adopted by the Verkhovna Rada. Although the probability of MPs supporting the VAT increase is extremely low, the government has already included UAH 58.7 billion in next year's budget from this measure for a new program to support businesses.
The Ministry of Economy admits that the VAT increase may not happen, so they are preparing an alternative – an increase in import duties. However, the Rada is not ready to support this option either.
Overall, the government's idea to raise VAT to 21% starting next year emerged three weeks ago due to the need to support businesses that began to suffer colossal losses as a result of intensified Russian shelling.
Enterprises across various sectors of the economy have been suffering serious damage and destruction since July. Metallurgy, pharmaceutical companies, logistics, and retail are affected. As of August, about 500,000 square meters of logistics space have been put out of operation, which accounts for 30% of high-class warehouse facilities, most of which were located in the Kyiv region.
The most affected were the facilities of Nova Poshta, Rozetka, Epicentr, and the supermarket chains ATB, Silpo (Fozzy Group), Varus, and Aurora. As a result, there were delays in parcel delivery and a decrease in the assortment of goods in retail chains.
In September, gas stations came under heavy shelling – primarily those of the state-owned company Ukrnafta, which directly supplies fuel to the Ukrainian military. Large shopping centers, particularly in the capital, are under threat.
Business and budget losses amount to billions
According to preliminary estimates by the Ministry of Economy, total business losses from shelling could reach up to $10 billion by the end of the year. However, it is not only businesses that are losing, but also the budget. Against the backdrop of an existing defense deficit of $27 billion, revenues to the treasury could shrink by tens of billions of hryvnias more.
"About UAH 70 billion in tax revenues may not reach the budget due to Russian attacks on businesses. This is an estimate as of early September. Strikes continue daily, and this figure may increase," Prime Minister Serhii Koretskyi said in an interview with The Economist.
The existing business support mechanisms amid intensified attacks are no longer yielding the necessary results. Recently, the government improved Resolution No. 1541 on partial compensation for losses. In particular, Kyiv and the region were included in the list of high-risk territories. This allows businesses in the capital region to insure against war risks and receive compensation for part of the insurance premium. The maximum compensation amount for an enterprise was increased from UAH 3 million to UAH 5 million per year. However, this is not enough, a source in the government told Business Censor.
The Ministry of Economy believes that the main focus should now be on war risk insurance. Currently, given the threats of intensified shelling, the insurance schemes used previously are practically non-functional.
Until recently, the commercial reinsurance market was operating. That is, it was possible to get insurance from Ukrainian companies that reinsured risks in London on the Lloyd's insurance market. "It was expensive, but it worked to some extent. The volumes of such insurance were very limited, but after the intensification of shelling by Russia, this volume almost disappeared," noted Minister of Economy Oleksandr Kravchenko during an expert discussion on business support.
New insurance fund of up to $4 billion
That is why the Ministry of Economy decided to create a special insurance fund. The volume of such a fund is currently planned at $3-4 billion. Of this amount, up to $1 billion will be provided by the state specifically through the additional 1% of VAT, $2-3 billion will come from donor support, and the third component will be contributions from the businesses themselves, which must pay 2% of the amount for which they wish to insure their assets.
Currently, the loss coverage amount for an enterprise is limited to $10 million per year. However, it can be increased if the volume of donor assistance grows. In fact, such support will be more useful precisely for medium and small enterprises.
For now, there is only a general concept for creating a business insurance fund. There are no project details yet. According to Business Censor, the Ministry of Economy's idea is for the fund to operate throughout Ukraine without any geographical restrictions and cover the widest possible range of business activities.
"We hope to create a sufficiently diversified portfolio both by industry and by region, which will eventually give reinsurance companies much more comfort in taking risks onto their balance sheets with more adequate premiums," Kravchenko noted.
According to him, there is already potential readiness from Ukrainian companies to cooperate with the fund from the insurance market, and from foreign ones from the reinsurance market.
Sources of Business Censor in the government say that the IMF and the World Bank do not oppose raising VAT to 21% to fill the insurance fund. It is worth recalling here that in 2024, the issue of raising VAT to 22% was discussed with the IMF in the context of increasing the state budget's revenues. However, such a step was considered a measure of last resort and lacked the support of the majority of MPs.
MPs are not ready to raise VAT and duties
The decision to change the VAT rate is made exclusively by the Verkhovna Rada. Currently, MPs are not ready to support the proposal to raise it from 20% to 21%. "I think a positive vote in the Rada for the VAT increase is highly unlikely," Roksolana Pidlasa, head of the budget committee, told Biznes Tsenzor in a comment.
This is an unpopular step that will effectively lead to the end consumer having to, so to speak, support businesses "out of their own pocket," while businesses are already raising prices to compensate for losses from shelling.
The Ministry of Economy believes that raising VAT would be the optimal option for filling the insurance fund, but admits that passing this issue through the Rada will be problematic. Therefore, they are preparing an alternative option to fund it with state money.
"This is the most realistic option (raising VAT - ed.) that will provide resources. Therefore, I am not saying it will succeed, but we have few options. Raising import duties is also possible, but it puts significantly greater pressure on inflation," Kravchenko noted in a comment to Business Censor.
The National Bank has calculated that the inflationary pressure resulting from the VAT increase to 21% will be quite moderate.
"Depending on how the retail segment absorbs this potential VAT increase, the effect may range from 0.4 to 0.7 percentage points, but this concerns a one-time price correction," NBU Deputy Governor Volodymyr Lepushynskyi noted, answering the outlet's question.
The Ministry of Economy estimates the impact of the VAT increase on inflation at 0.8%.
The NBU has yet to calculate the impact of raising import duties on inflation, as it is unknown on which specific imports and to what level the rate hikes might be proposed.
The Ministry of Economy has not yet detailed this alternative step. However, the Rada has already stated that it is useless to hope for its support. "I do not believe in either option. This can be passed in only one case – if businesses demand it," an influential representative of the mono-majority noted in a comment to Business Censor.
Businesses, in turn, have not yet officially expressed their position. The idea of supporting enterprises affected by shelling is perceived positively, but the option proposed by the government is viewed ambiguously. To finally evaluate it, there is a lack of details regarding how the proposed mechanism will work.
Oleksandr Parashchii, Head of the Analytical Department at the Concorde Capital investment company, believes that the idea of funding it with state money should be abandoned altogether.
"It is better to attract international funds. This is better even in terms of informing about our war losses and continuing talks on further compensation at Russia's expense," he noted in a comment to the outlet.
According to his logic, if foreign partners spend more on helping Ukraine in any form, it will subsequently strengthen their desire to extract compensation from Russia.
The Ministry of Economy has slightly different logic. They believe that to attract more investors, the state must also demonstrate its participation in supporting businesses. Later, if the insurance fund operates successfully, the need for state funding will decrease.
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How the government will act in case the tax initiatives fail in the Rada is still unknown. For now, they still hope for success and are considering the possibility of increasing VAT or import duties. Perhaps not from January, but a little later. However, if this fails, they will have to either reduce the size of the insurance fund or increase its funding volume at the expense of investors.
