EKIP– Expert Club for Economics and Politics A Different Opinion
Author: Yaroslav Romanchuk, economist and politician from Belarus, president of the Scientific Research Mises Center.
(The text is Romanchuk's recommendation for tax reform in Ukraine)
The world is rapidly evolving towards the breakthrough technologies of the Fourth Industrial Revolution. Since the end of 2010, communication between people has been radically different from 10, 30, let alone 50 years ago. No one would have thought it foolish to go back to the old phones and wired connections.
At the end of this decade, we move in ways that are radically different from those of 10, 30, or 50 years ago. No one would want to go back to the cars, planes, or trains of the mid-20th century.
At the end of this decade, we are producing products and services in ways that are radically different from those of 10, 30, or 50 years ago. No one would have the crazy idea of giving up robots, 3D printers, or modern composite materials.
There is one critically important sphere, however, which is stuck in the deep past. It can either destroy modern means of information, telecommunications, transport and production or, on the contrary, give them opportunities and an incentive for development. If properly built and set up, it can tame the “devil” in man (envy, greed, the pursuit of easy money), free the motivation of the creative consciousness and inspire the spirit of entrepreneurship. However, with the wrong construction, as well as the presence of vicious mechanisms and tools, this sphere destroys producers, entrepreneurs and all people who support themselves at their own expense.
It is about the tax system. Taxes are either a reasonable, adequate, understandable payment for precisely and strictly defined products and services that we, the citizens, have authorized the people we call “government” to produce, or a trap and tool for enslavement. Today, in Belarus, Ukraine, Uzbekistan and other transitional countries in the region, the tax system resembles an attempt to create a printing press in the world of quantum computers.
"Government", in the broad sense of the word - these are all aspects of power. These are the president and the prime minister, the speaker of parliament and the chief justice of the Supreme Court, national and local authorities. "Government" - this is by no means the country itself, not even the legal "state". Ideally, it is a small group of people whom we have elected/appointed to provide specific services and produce specific products. We, the citizens, in solidarity, understanding the advantages of cooperation and interaction, give our money (taxes) to receive services such as safety, education, health care and public transport. The business plan and budget of this production should not differ in any way from the strategies for producing other products and services. We, the citizens, hire people and call them civil servants and politicians. They are administrators and consumers of our money, time, resources and energy. From them we expect honesty, efficiency, professionalism and adequate results for every dollar/lev/euro/ruble received by us, the taxpayers.
The more clearly defined the closed list of products and services that politicians and officials produce at our expense, the more efficiently and transparently the mechanism of financing this production works, the higher the assessment of the quality of the products and services produced, the faster the growth of well-being, the greater the hopes for a bright future. Of course, this is because in this situation we know what we are paying for. Because if we know that a service costs $100, we would never agree to pay $1000 for it.
This is the ideal option. But people in developing countries and countries in transition have never had the chance to build their country “clean”. They have not met angelic officials and guardians of order – Prometheus. Here we observe a great deficit of creditors – visionaries, entrepreneurs – strategists and investors with an eye towards humanitarian and civil projects. In addition, among the “administrators of foreign affairs” there are too many who believe that government = country, state power = country, even president = country. There are too many people who identify the commercial interests of big business with the national interests of the country. For example – BDZ/Bulgarian Posts/CGM/VMZ etc. = national interests of the country.
Moreover, in transitional and developing countries there is a severe shortage of such citizens and taxpayers who understand the meaning, nature and raison de etre of the state and government. The people themselves have lived in the shadow of Leviathan for so long that they have grown up with it, they have become accustomed to the idea that they are not customers, payers and beneficiaries of the services and products that the “administrators of foreign affairs” produce at their expense, but on the contrary – they, the citizens, must work so that politicians and officials can carry out their plans. The majority of people cannot even imagine life without the whip of the Chief. They continue to believe that in the bowels of Big Government, this president/prime minister/political party has survived and hidden, who would bring together in one image the honest and strong Ilya Muromets, the warm and compassionate Mother Teresa, the investment genius Warren Buffett, the hero-entrepreneur Richard Branson, and also a principled, incorruptible judge.
A full and effective tax reform must begin with a detailed review of the functions, powers, resources and assets of the government/state. Before discussing issues related to fees, taxes, tax bases, etc., we must answer the question "How much money should be raised and for what?"
The first step is to determine the mandatory, non-sequestrable government expenditures that are necessary to fulfill existentially important tasks for the country. In other words, everything that needs to be financed so that citizens receive critical services in the areas of protecting life and personal property, functioning basic infrastructure, education and healthcare, and also to fulfill the debt to those who have paid taxes/contributions to the pension fund all their lives.
For a transitional, developing country, the distribution of expenditures in the state budget should look approximately like this (in % of GDP):
- Army – 2% of GDP (country at war – 5% of GDP);
- Police, Internal Security – 2% of GDP
- Court, prosecutor's office, special services – 1.5% of GDP
- Executive, legislative (national, local level) – 3.5% of GDP
- Education – 4% of GDP
- Healthcare – 4% of GDP
- Pensions and social benefits – 11% of GDP
- Basic infrastructure maintenance – 1% of GDP
ALL – 29% of GDP (+/- 1 – 2%)
This is an example of the structure of expenditures in the first stage of a systemic, comprehensive reform. In the course of reforming the pension system, healthcare and education, this structure will also change, as will government spending. Institutions must change in such a way as to ensure the functioning of the state at the level of 20-25% of GDP.
We see that tax reform is only one part of a larger, three-pronged reform. Its other "two chapters" are budget reform and pension reform. A three-pronged task, the solution to which we must present to the government.
At this stage, it is important to determine the necessary minimum of state spending, which corresponds to the quality of state governance, the effectiveness of regulations, and also to the absolute imperative of ensuring rapid (6-9% per year), long-term (minimum 20 years), inclusive (for the benefit of all) economic growth. These are the solutions that will minimize corruption and eliminate the main schemes for "wasting" the budget. These are the solutions thanks to which, within 3 years (provided that systematic market reforms are carried out), more than 80% of the "gray" sectors in the economy will come to light, as long as the government consciously and consistently limits itself and binds itself to financial responsibility and stops its interference in commercial activities (especially in investment ones).
Let's define the given parameters, for example, for Ukraine - GDP for 2017. is ~ $110 billion, for 2018. - ~ $128 billion. This means that in order to guarantee optimal development and growth, the ceiling of state spending should be max. ~ $40 billion. For Bulgaria, with its GDP ~ $57 billion for 2018. the ceiling is ~ $17.1 billion.
The second step in systemic tax reform is defining tax bases. Since taxes are paid by consumers, it is important that tax bases be as broad as possible, universal, non-discriminatory, easy to understand, and difficult to manipulate by auditors and fraudsters.
We can immediately discard some of the most popular bases in today's tax systems. The first is, of course, value added. In its case, the exact definition is a very complex process, very rarely does the taxpayer's interpretation coincide with the opinion of the tax inspector or representative of another control body. Therefore, the value added tax helps to repress producers of services and products. Whatever instructions you write, no matter how many clarifications and explanations you make, the concept of "value added" will be unclear, vague and generating corruption. With the help of VAT, the "administrators of foreign" sell their power and the authority to interpret the concept, as well as the right to exempt (partially or completely) from paying VAT.
VAT is particularly dangerous in countries in transition and developing countries, where the quality of state governance is low, the security, control and law enforcement agencies are on the same page, and nomenclature favorites enjoy tax benefits and preferences.
The second tax base that should be scrapped is the profit of commercial organizations that produce products and services. What is included in profit, what and when is included in production costs, what to do with exchange rate differences – these and other questions arouse many different interpretations, opinions and doubts. Unfortunately, the word, opinion and doubt of the inspector/regulator is more important than the opinion and point of view of the taxpayer. This is where the manipulations come from – the operations of transferring profit to where the tax rate is lower.
The third bad tax base is land and real estate. In transitional and developing countries, there is still no stable and full-fledged market for land and real estate. The concept of "cadastral value of land" is subject to subjective opinions and assessments of officials. Manipulations of the base when calculating these taxes are very common. For producers, there is a real risk of paying high taxes while operating at a loss.
The fourth unsuccessful tax base – gross turnover of the producer of products and services (income). It is calculated very easily – once you have turnover (income), you have to pay tax. This taxation is a punishment for entrepreneurship, especially for small businesses. Gross working capital does not mean that the producer has actually earned.
The following tax bases are optimal for transitional and developing countries:
- Retail trade in products and services. The tax is paid by the merchant. The base is clear – the receipts at the cash register. All entities are placed on equal terms, including domestic and foreign manufacturers, real and virtual, e-stores. The incentives for the development of the shadow economy are minimized, since the sacred rule of taxation is observed – a single, flat rate for all products and services purchased by end consumers. With the help of modern technologies, the administration of this tax would be easy and simple. In Ukraine, for example, the base for this tax would be ~$70 – 75 billion. At a rate of 20%, the budget would receive ~$15 billion. (for Bulgaria?)
- Production of alcohol, cigarettes, energy products, legal drugs. Excise duties on these goods are easily collected (limited number of producers). Products and services in these sectors are highly liquid. With simplified, flat and low rates, producers will have no incentive to enter the shadow economy. Revenues from excise duties in the Ukrainian budget would be ~ $14 - 17 billion.
- Personal income. So everyone knows that they pay taxes and participate in financing the production of products and services by the government. The most important thing here is a flat, uniform rate of 10%. Like the old tithe in the church. The estimated budget receipts over the first three years would amount to ~$4 – 7 billion.
In case of necessity (high state debt, extreme expenses (natural disasters, war), we can consider another broad tax base - the import of goods. Here, the cost of tax administration is minimal. There will be no prerequisites for escaping into the shadow economy if the rate is 3 to 5% of the value of the goods. In the case of Ukraine, with imports of goods in the amount of ~$55 billion, the budget would receive ~$2.5 - 3 billion.
The next task is to determine specific rates for these taxes. This is possible only after the exact volume of government spending is determined. Calculations indicate that the retail tax will be in the range of 15-20%. Excise rates should be set so that the total tax share in the retail price of alcohol, cigarettes and energy products does not exceed 60%. An important indicator in assessing the estimated final retail price is the price of these goods on the “black market”.
In this way, we get an understandable and adequate tax and financial system. To manage it, it will be necessary to create a ministry for financing state expenditures, which will unite the ministry of finance, taxes and fees, as well as customs. This will eliminate the need for businesses to hire armies of accountants and consultants, and the government - regulators and inspectors.
All government revenues should be directed to financing non-sequestrable (those that cannot be cut) expenditures. Producers (especially exporters) would experience a real boom – at the expense of reducing the tax burden and the cost of tax administration, they could sharply increase their price competitiveness both in foreign and domestic markets. As soon as people get used to the idea that this budget/tax policy is serious and not fleeting, many economic activities will leave the gray sector. The volume of retail trade will also increase sharply, which will allow the tax rate to be reduced by a few more percentage points.
These are the general outlines of an innovative fiscal and fiscal reform. If it is supported by monetary and credit reform, deregulation, and the creation of powerful institutions protecting property rights, within a generation the chances of any developing or transitional country in the world to increase its GDP per capita by ~$15-20 thousand are 85-90%.
Translation: Marina Zaharieva
