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15 April, 2011  ▪  Dmytro Kalynchuk

Fiscal Ghetto

The government is essentially putting over one million fixed-rate taxpayers out of business

Starting from April 1, 2011, legal entities can no longer include the cost of purchasing goods, services, or any assets from fixed-rate taxpayers, except IT specialists, as part of their gross expenditure. This is not a bad joke but a norm contained in Article 139 of the Tax Code. Doing business with fixed-rate taxpayers is now an unaffordable luxury for businesses, because it means higher taxable income. They will rather do business with other legal entities rather than individuals.

THE REASONING OF TAX OFFICIALS

The tax officials who have headed the executive branch and pushed through their Tax Code view the flat-tax system as subject to mass abuse, most frequently in terms of the way companies pay salaries and individual entrepreneurs report trade turnover.

“They are on a fixed-rate taxation system but sell goods worth millions of hryvnias. In one Kyiv store, we seized 195 watches worth UAH 74.6 million and in another one 605 watches worth UAH 74 million,” First Deputy of the State Tax Administration Viktor Sheibut said in an indignant comment last year. Tax officials are not worried by the fact that the common tax system, including the payroll tax, rules out legal profitable business in Ukraine. After taking the premier’s office, Mykola Azarov and his team have focused exclusively on solving problems in the budget.

During the Tax Maidan last year, the government was forced to make concessions to fixed-rate taxpayers. Chapter XIV of the Tax Code, which pertains to them, was sent back for revision by the president. The Cabinet of Ministers was instructed to draft a bill within two months that would reflect not only the interests of officials,but also the wishes of entrepreneurs. Four months later, fixed-rate taxpayers’ business is still up in the air. Some are reluctant to officially register due to government's unclear stance (for more details see UW, Is. 11/2011). The Azarov team seems to be OK with this situation. As over one million fixed-rate taxpayers find themselves in a tax ghetto after April 1, the problem may resolve on its own: with their business with legal entities cut off and payments to the budget set at a much higher level, these entrepreneurs may disappear as a class under administrative pressure from tax officials.

GRIM PROSPECTS

Tax officials have actively argued that fixed-rate taxpayers do not contribute enough to the state, but their claim is highly debatable. According to the State Tax Administration, nearly 1.7 million fixed-rate taxpayers (91.6% of whom are individuals) paid over UAH 4.4 billion to the national budget. In any case, manipulations with the Tax Code show that the government forgets or utterly fails to understand the social functions of the flat-tax system — creating conditions for self-employment, reducing hidden employment and so on. The government would have to have at least some plan to create jobs and raise salaries, but no officials are really concerned with issues like these.

At the same time, it is hard to foresee on the macroeconomic level the social consequences of curtailing the flat-tax system amid constantly rising prices for food, utilities, and gas.

On the microeconomic level, the situation is far easier to see: fixed-rate taxpayers who have been leasing premises to commercial firms, including renting apartments to people on business trips, will not be able to do their business legally and compete with office centers and hotels. Jewelers will now work directly with their clients or will hire themselves out to jewellery store owners. Individual auditors and attorneys will risk losing their clients. Accountants who have got used to selling their services to several companies as entrepreneurs will now have to rely on a salary only. It is also possible that providers of these services will move into the shadow economy. In any case, the only group to openly and indignantly raise its voice against the new tax rules is entrepreneurs moving cargo by road — they cannot hide because the traffic police may stop them on a highway at any moment to check invoices, itinerary sheets, and other paperwork.

DRIVERS IN HOT WATER

Despite President Viktor Yanukovych’s familiarity with the transport sector, the Azarov government is no friend of transporters. For example, the Professional Association of Taxi Drivers, the Kyiv Cargo Carrier Association, and others were deeply concerned over Energy Minister Yuriy Boyko’s intention to impose an additional duty on imported oil products. Afraid that gas prices will rise even more, they wrote an open letter to the premier promising civil disobedience if the additional duty was indeed introduced. The government was forced to backtrack and the plan was scrapped. However, this was just a drop in the ocean.

According to the State Statistics Committee, road transport companies employ 254,600 people in Ukraine, and another 443,600 provide “supplementary transport services and auxiliary operations.” The automotive transport sector moved 158.2 million tons of cargo in Ukraine in 2010. These figures may soon take a nosedive as fixed-rate taxpayers, including many owners who purchased trucks on credit, see their clients — legal entities — leave them after the 1st of April.The common taxation system, which makes it much harder to convert money into cash, will hardly be of any use to them, because they need money for fuel, spare parts, and food on the road. Thus, we may see an army of drivers with trucks and no orders.

The recent Auto Maidan was another reaction to novelties in taxation. Those driving in the protest covered long distances to travel to Kyiv and yet went almost unnoticed by the general public. The Ukrainian mass media, and through them the public, were focused on the criminal case opened against ex-President Leonid Kuchma. Logistics companies and firms that employ the services of private carriers are complaining of a multitude of problems centered on drivers flatly refusing to accept bank transfers and stubbornly demanding payments in cash. Contracts are broken, and logistics experts incur penalties from contractors. The situation is escalating.

THE REASONING OF BUSINESS

The partly justified view of tax officials on the fixed-rate taxation system as a way to optimize taxes is not comprehensive. To many Ukrainian businesses, especially manufacturers, putting their units on this system is a way to avoid corporate corruption and optimize the production process. Producers cannot but care about the quality of goods being manufactured. Quality can be enhanced in two ways: using administrative measures (the carrot-and-stick approach) or by stimulating free competition. Numerous Western manufacturers have chosen the latter. They own only the facilities needed for the final assembly of the end products, while small parts and units are purchased from small workshops which compete among themselves and go a long way to improving the quality and lowering the production costs of their products. The results of this organization are well-known: the car industry of German and Japan being prime examples.

Some Ukrainian companies have taken the same approach, for example getting rid of burdensome units, such as cafeterias, transport services, and so on. They outsourced these services to tens of thousands of fixed-rate taxpayers who are actually doing a better job. These sprouts of efficient management will be nipped in the bud after April 1, 2011.

NO END IN SIGHT

It is hard to say whether government officials have even a vague idea about the consequences their initiatives will have. Evidently, in the conditions of a fiscal ghetto they will be squeezing as much as possible out of small and medium business, while the real simplification will be left to market merchants who purchase goods from wholesalers. The rest of fixed-rate taxpayers will have to switch to the common taxation system or leave the market altogether.

Private entrepreneurs are the most active part of the Ukrainian population. As long as they use the fixed-rate taxation system, they remain virtually uncontrollable and independent in the eyes of the government. Can this be the reason why the system is begin destroyed? If so, we should look at historical precedents and learn their lessons. Polish kings once tried to lock in the Zaporozhian Cossacks into ghetto on the steppe when they built the Kodak fortress near the Dnieper River. The Poles managed to keep the Cossacks in check for while, but eventually this culminated in a very unhappy ending for the Polish-Lithuanian Commonwealth. The laws written by the Azarov team will hardly prove stronger than the walls of a fortress.


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