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Exit Capital Tax 2019 — leave them, kids, alone

author: Alexander Shemiatkin

source: "Ekonomicheskaya pravda"

19 November, 2018 Press

A resource exceeding the IMF assistance by a huge ratio belongs to the government, but they do nothing to take it in their hands.

Corruptive tax

Is corruptive tax an evil? Let’s suppose that a tax is levied under the pyramid principle, and its payment is a guarantee of security and calm business conditions.

Such a tax exists for all. Can such a tax then facilitate development of the country?

I think that examples confirming the positive effect of the corruptive tax may be found among the Asian countries.

Cognitive distortions (for example, lack of self-control) explored by Richard Thaler, are a rational explanation for this.

A human remains a human regardless of the seating place. And if it is common for people to protect their personal interests, they will always do it, no matter what position they hold. Private interest prevails in the behavior of any economic agent. The question is, what opportunities does the decision maker have?

If a private interest of an official is paid with a corruptive tax in a system with efficient mechanism for collecting such a tax, the government system does not interfere economic growth. Monopolies and other deviations in terms of democracy arise in such systems, but that is not the point now.

Western countries use an economic model without a corruptive tax. In such countries, the powers of officials are limited; the authorities operate within the austerity budgets. Accountability and transparency are stipulated.

However, such mechanisms do not provide a guarantee against corruption scandals.

Therefore, the powers of officials should be minimized, and the state monopoly reduced even in such traditional institutions as the police. In such countries the economy is always stronger than in countries with a corruptive tax.

Economic schizophrenia

Ukraine is the poorest country in Europe. This is a direct consequence of double standards.
We are officially fighting the corruptive tax creating a bunch of expensive institutions for this purpose, but the corruptive tax is the basis of public administration. This is not even “running on the spot.” This is an economic schizophrenia.

Psychiatrists while describing communication with schizophrenics note that the head starts to hurt over time, and a feeling of depression arises. People with healthy mind find it difficult to withstand such communication, they avoid it.

Investors avoid the schizophrenic model of the Ukrainian economy in the same way. Those who have already “put foot in it” with their property cannot stand a headache, they escape with regret about the lost time and money.

In order to develop the economy and increase GDP per capita, the corruptive tax must be either “legalized” or eliminated. Its “legalization” is impossible due to the European integration path chosen by Ukraine.

Its elimination is possible only through the elimination of its environment – discretion (the ability to act at own judgment – ET) and decrease in the number of officials. Therefore, the recipe for treatment of Ukrainian economic schizophrenia is obvious – a total reduction of officials and their powers.

What’s better? An area not controlled by the state or an area controlled by the state with a systematic violation of the law? The best reform of the SFS is its liquidation. The best reform of the environmental inspection is its liquidation. The best institutional reform is to leave us alone.

The Exit Capital Tax successfully solves the issue of liquidation of the SFS. After the introduction of the ECT, 100 tax officers will be able to administer the tax, 80 of whom will be engaged in transfer pricing. VAT is already automated, and the minimum quantity of people is required to deal with it.

In fact, we are talking about the departments within the Ministry of Finance. The customs is a separate body, the tax police already need to be filed as a history. Local tax departments may be transferred to local authorities to control local taxes.

Surely, these are thoughts aloud, but these thoughts show the logic put behind the ECT.

ECT as a failed investment project of the state

The Exit Capital Tax could have become an investment project of the state. Funds retained by the business in the form of profit tax would be considered as an investment.

Simplification of administration (compared with profit tax) would allow to reduce tax staff and create background for institutional reform.

The Ministry of Finance and the Ministry of Economic Development and Trade have carried out calculations of the ECT model for two years. The Cabinet of Ministers has approved the “Forecast for Ukraine’s Economic and Social Development for 2019-2021” by the Resolution No. 546 of July 11, 2018.

According to the forecast prepared by the Ministry of Economic Development and Trade, GDP gains additional 1.3% growth in the first year of implementation of the ECT. The chart below shows the modeling results of three scenarios: 1 – basic; 2 – with the ECT; 3 – a negative version of the basic scenario.

It is hard to find another bill on amendments to the Tax Code, the consequences of implementation whereof were calculated and recalculated in such a way.

In April this year, the Ministry of Finance and the Ministry of Economic Development and Trade presented to the Presidential Administration a calculation of the amount that needs to be compensated for the non-deficient implementation of the ECT. This amount was equal to UAH 26 billion in the first year of implementation.

The monetization of subsidies (which gave UAH 16-20 billion) and the funds confiscated from the previous government were designated as compensators. Based on such calculations, the bill was submitted to the Parliament and became an urgent Presidential bill # 8557.

Instead of quickly adopting the bill, a working group was created in the Ministry of Finance, which took up the next, third in a row, calculation of budget losses due to implementation of the ECT. The result of the Ministry of Finance’s work: zero compensators, a “hole” equivalent to UAH 45 billion, monetization of subsidies was taken away from the ECT and used in the budget calculations for 2019.

After another “Treason” of the ECT, participants of the working group suggested the Ministry of Finance to consider covering the deficit by other compensators. Once again, the following were offered:

  • legalization of the gambling industry (shadow turnover of up to USD 1.5 billion, which could contribute up to UAH 10 billion to the budget);
  • amending the taxation rules of the lottery business (in fact, a return to the rules in force until 2015);
  • introduction of an electronic excise stamp on alcohol (could contribute up to UAH 10 billion to the budget (the shadow alcohol market constitutes 50% of the actual market);
  • a moratorium on indexation of the law enforcement costs in 2019 (its financing over the past four years was increased by 2.5 times, and the efficiency of crime detection was dropped to 25%);
  • using the so-called “inflation tail” (one more tax that every Ukrainian pays).

As a result, we received the answer that that’s all cool, but NO, because – there are the reforms, and they are “at the wrong time” now. As well as, actually, the ECT.

ECT as a business investment project

The ECT, as an investment project of Ukraine, did not take place. Then the idea arose to make the ECT an investment project of business. This idea was announced by Alexander Olshansky, president of Internet Invest Group holding, justifying it by saying that business must pay for the reform (if, quoting the former Minister of Finance, we have an “impotent” government).

This option was proposed to the Ministry of Finance, but they shook their heads with sad faces. As it turned out later, the Ministry of Finance had already conducted negotiations with the IMF on the new loan program without informing members of the working group.

Withinnegotiations with the IMF, the ECT was discussed exclusively in the light of cancellation of the third group of single tax payers and implementation of the “ghost” of the ECT. This option implied the use of ECT only for companies with a turnover of up to UAH 200 million, which would be only 25% of the main corporate profit tax payers, and imposing additional restrictions on “payer – non payer” transactions. At the same time, the offshore schemes for non-taxable withdrawal of capital would remain for those companies which fall under the corporate profit tax rules.

Have the Ministry of Finance understood that such a version of implementation of the ECT would lead to budget losses exceeding UAH 45 billion? If not, the question arises as to the competency of this authority. The mere cancellation of a single tax for legal entities would lead to a loss of budget revenues from a single tax in amount of more than UAH 10 billion.

However, another scenario seems much more likely. The Ministry of Finance understood that business would not support the proposed option. The President would definitely not support the cancellation of the third group of single tax as well. Such actions would be a political suicide in the light of the upcoming election.

As to the IMF, it was told too often that the ECT is a bad idea for Ukraine. It will just suffice to mention a 2017 report of the IMF prepared on the basis of the presentation of the Ministry of Finance with the concept of distributed profit tax.

The concept implied both a connection with economic activity, and control of transactions within Ukraine, and revenues from the distributed profit tax only from dividends. Thus, the report did not analyze the ECT, but for a whole year it distorted the perception of the bill by the IMF.

As a result, the Ministry of Finance created a stalemate: business does not agree with the agreement between the Ministry of Finance and the IMF, and the IMF does not agree to change the text of the draft memorandum, at the very least because the draft has already been agreed.

The IMF believes that implementation of the ECT will lead to loss of revenues of the budget in the first years of implementation, and Ukraine cannot afford it without reducing its expenses. Ukraine has too heavy debts to the IMF and other international lenders.

Advance payment

So what have the business suggested? To ensure the smooth introduction of the ECT, taxpayers are willing to pay an advance payment of 50% of the corporate profit tax in 2018. This amount is determined based on the deficiency calculated by the Ministry of Finance at the level of UAH 45 billion.
The corporate profit tax in 2018 is expected to reach UAH 90 billion. Transitional provisions provide for the possibility of extending the advance payment in 2020. At the same time, in 2020, when paying dividends, it is possible to use the advance payment paid in 2019.

When calculating the advance payment, it is proposed to use another indicator – 0.5% of the book value of fixed assets as of December 31, 2017 (i.e., before revaluation under IFRS). For the purpose of calculation of the advance payment, fixed assets acquired during 2018 will not be taken into account.

The draft of transitional provisions to bill No. 8557 with an advance payment was submitted to the Ministry of Finance but so far there was no public statement on this matter from the Ministry.

Six associations: UUE (Union of Ukrainian Entrepreneurs), FEU (Federation of Employers of Ukraine), UUEI (Ukrainian Union of Entrepreneurs and Industrialists), UAC (Ukrainian Agri Council), UBC (Ukrainian Business Council) have already submitted official applications to the Ministry of Finance.

The applications state that the ECT can be implemented only for all taxpayers, and business supports implementation of the ECT with an advance payment. Business associations asked the Ministry of Finance to continue negotiations with the IMF on such terms.

Despite the applications submitted by the associations, the Ministry of Finance has not made a public statement of its consent to the ECT for all taxpayers starting from 2019. The unified position of the President, the tax committee of the Verkhovna Rada and the Ministry of Finance would make the position for further negotiation with the IMF stronger.

So why is the Ministry of Finance silent?

Flashmob

After the next scheduled tax committee without a quorum, the deputy who was present at the meeting, said irately: if the amount of ECT supporters under the Verkhovna Rada was equal to the amount of Euro-second-hand-car fans, the bill #8557 would have passed.

Ukrainians are able to unite against something. But it is more difficult to unite FOR something. It is not an easy task to bring people who work for living every day, who are not related to budget funds or schemes, into the streets.

Therefore, Alexander Sokolovsky pitched the idea to hold a flashmob in support of #ECT2019 in order to demonstrate to the authorities that the associations are supported by real business, and business is supported by real job positions and employees. A flashmob was taken up by hundreds of companies, revealing interesting facts.

Business owners began to call their familiar entrepreneurs with a proposal to participate in a flashmob. Some of them asked to come and talk with the financiers of the company in order to make a decision on the support of the ECT.

The result of communication: “Everything is cool, but we withdraw profit through interest to Cyprus at 2%, while under the ECT it would be 20%. The owner is not ready to pay dividends at 13%, as it’s 10% more.”

We presented our arguments that this will lead to increase in GDP and purchasing capacity of the population and, therefore, to increase of the company’s revenues, that this is only 13% and legal income that you can safely dispose later, but heard silence in response.

Other meetings revealed that companies with a high-margin business plainly withdraw profits through related individual entrepreneurs paying single tax. The owners were very upset that transactions with related entrepreneurs are subject to taxation at 20% under the ECT.

A flashmob showed how the “ownership effect” explored by Richard Thaler in the theory of bounded rationality works in practice.

A number of businesspeople, considering the consequences of implementation of the ECT, could not shift their attention beyond their own wallet, replenishment of which would change in the conditions of the ECT. An opportunity to live in a country that you do not need to leave to feel yourself like a European turned out to be too general goal in the shadow of the “wallet”.

On the one hand, I was upset by such poor judgement and unwillingness to pay even 13% of the tax. On the other hand, I realized that the ECT will entail nodeficit even in the first year.

The neutralization of non-taxabale funds outflow in offshore and taxation of related single tax payers – that’s one.

TP control over the 4th group of single tax payers and cancellation of the opportunity to split up the business to UAH 150 million to avoid TP control – that’s two.

Simplification of administration, reduction of discretion of tax authorities and acceptable tax rate (despite cases of cupidity) create conditions for business to exit from the shadows that also produces additional revenues.

All of this means that the story of advance payments for bona fide taxpayers can last no more than one year.

IMF

The IMF refuses to understand how the business is willing to pay taxes in advance. The IMF probably does not know that the business have regularly paid corporate profit tax in advance. When the business was deprived of its losses or obliged to use them with installments.

Or, when the business does not claim to refund the overpaid tax due to “requests” of tax authorities not to show losses in the tax returns.

Or that companies can not get a refund of an overpaid corporate profit tax during the last 5 years.

What is the difference in this case, between the advance payment under the ECT and advance payment under the corporate profit tax? Unlike the corporate profit tax, advance payment under the ECT is a payment for transition into the new system. The IMF probably does not know how much the business is tired of this endless reform of the SFS, and its heads who secretly leave the country.
As of today, the IMF does not consent to the implementation of the ECT, threatening to refuse the next tranche. To be honest, the tranches “corrupt” the government. A resource exceeding the IMF assistance by a huge ratio belongs to the government, but they do nothing to take it in own hands.

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