Tax reforms in Ukraine: Analysis of the draft law №11416-d

Author: Oleksandr Fedoryshyn, managing partner at F&P

Taxes, as a crucial element of economic policy, are a subject of ongoing debate in many countries, and Ukraine is no exception. The draft law №11416-d, which has already passed its first reading, proposes a number of changes aimed at increasing tax rates. This includes raising the military levy, increasing taxes for individual entrepreneurs (FOPs), as well as for banks and financial institutions. It is expected that these changes will result in a significant increase in state budget revenues in the short term, but certain provisions raise serious concerns regarding their impact on the economy in the long term.

Key provisions of the draft law

According to the text of the draft law, the following proposals are included:

1. Increase of the military levy from 1.5% to 5%.
2. Establishment of a 1% military levy on income for single tax payers of Group III.
3. Increase of taxes for FOPs of the first and second groups.
4. Advance payments for fuel stations (AZS).
5. Increase in the profit tax rate for banks to 50% for 2024.
6. Profit tax rate for non-bank financial institutions (excluding insurers) set at 25%.

It is anticipated that these changes will bring 58 billion UAH to the state budget in 2024 and 137 billion UAH in 2025. Considering the budget deficit, this tax increase seems necessary, but it is important to bear in mind the risks that may arise from potential negative economic consequences.

Analysis of the draft law and negative economic consequences

1. Increase in the military levy: One of the most controversial aspects is the increase in the military levy. A 3.5% increase could have a destructive impact on the economy, particularly on the wage fund. According to OECD estimates, such taxes are among the most harmful for economic growth, as they encourage businesses to move to the shadow sector. In Ukraine, there are already about 3 million people working unofficially, and another 2 million receive part of their salary “in envelopes.” The increase in the military levy could exacerbate these trends.
2. Increase in taxes for small and medium-sized businesses: Such steps may increase the tax burden on the already vulnerable small business sector, which is extremely sensitive in the context of the crisis and war. As a result, this could reduce demand and the incentive for the development of new businesses, potentially slowing down economic growth.
3. Increase in taxes for banks: The proposal to raise the profit tax rate for banks to 50% has its justification in the need to cover the budget deficit but may lead to capital problems in state-owned banks. This will require additional expenditures for recapitalization, which may eventually neutralize the additional revenues from the increased taxes.
4. Need for de-shadowing the economy: One of the key points is the lack of proper de-shadowing of the economy before increasing taxes. The absence of real control over the shadow sector makes such changes ineffective in the long term.

Alternatives and possible solutions

1. Increase in VAT as an alternative to raising the military levy: One possible option for securing additional revenues is to increase the VAT rate. A 1% increase in VAT could bring 45.6 billion UAH to the budget, which is significantly more than the expected revenue from the increase in the military levy. This approach allows for a more even distribution of the tax burden among all taxpayers, which would be less harmful to the economy than increasing the levy on the wage fund.
2. Taxation of crypto-assets: Another alternative is the development of the cryptocurrency market, which is gaining popularity in Ukraine. According to data, 12.7% of the population owns cryptocurrency, which is a significant number. Given this fact, legislative changes aimed at taxing cryptocurrencies could become an additional source of income for the budget.
3. Launching small business support programs: In addition to tax changes, it would be advisable to introduce programs to support small and medium-sized businesses to offset the increased tax burden. This could include tax reductions or providing favorable conditions for entrepreneurs in critical sectors.

Recommendations

Before the second reading of the draft law, a compromise should be reached between the state and businesses, taking into account the opinions of international partners and experts. Special attention should be paid to issues of de-shadowing the economy and mechanisms for controlling compliance with tax legislation to avoid undesirable consequences for the economy in the long term.

Instead of increasing the military levy and adding pressure on businesses, alternative mechanisms for filling the budget should be considered, which will not lead to significant economic losses and will contribute to the development of the national economy.