Tighten Your Belts

2 June 2011, 15:41

Worried by rumours being circulated by international financial organizations about a further escalation of the global crisis, including rising food and energy prices, Prime Minister Mykola Azarov suggested that people should return to “good old Ukrainian traditions”, “stop whining, pick up a spade and feed their families.”  Reasonable as this may sound, the new Tax Code has made it much harder for average Ukrainians to feed their families without evading tax inspectors. According to the Ukrainian Week’s sources, over 56,000 entrepreneurs have closed down their businesses, at least legally, since the beginning of 2011 as a result of growing fiscal pressure. Meanwhile, the number of new businesses started over Q1’11 shrank by one third compared to the same period of 2010. Experts say that this decline is not over yet as tax pressure was not in full swing in January – April this year. The government has not had to resort to maximum tax pressure as the macroeconomic situation has so far turned out favourably for Mr. Azarov’s Cabinet. Future developments, however, could hit taxpayers harder given the IMF’s reluctance to provide Ukraine with another US $1.5bn loan installment. Moreover, the government needs more and more resources to pay back earlier loans and implement “multipurpose development projects” whose costs grew nineteenfold over January-March 2011, year on year. The amount of expenses has not been officially disclosed, though the increase has partly been justified by Euro 2012 preparations.  


The State Tax Administration keeps beating its own records. According to official estimates, budget revenues exceeded UAH 57bn in March 2011, which was 1.5 times more than in March 2010. By the end of April this year tax authorities had also improved their performance: revenues from some categories of taxes had almost doubled since the beginning of 2011, year on year. Vitaliy Zakharchenko, TA Chair, says that this splurge in tax revenues results from the favourable situation in foreign markets for Ukrainian manufacturers. This suggestion is partly true: the National Bank reported that exports reached US $6bn in March 2011 making it the best month since October 2008. Still, this fiscal medal has another side: President Viktor Yanukovych admitted at a meeting of the Economic Reform Committee Board at the end of March, that he had been informed of tax collection in advance and reminded the tax authorities of a long list of those looking forward to a VAT reimbursement. So far though, all officials have to boast of is a VAT reimbursement debt worth UAH 5bn – by optimistic estimates – and promises of automatic VAT reimbursement.   

In any case, the current macroeconomic developments help the government fill in the budget: metallurgy plants exported 50.4% more products over Q1 compared to the previous year, followed by machine building and agriculture with export growth of 45% and 40% respectively. The latter could have exported 20% more, had the grain export quotas been suspended.  

The inflation disaster also contributes to the budget, although official statistics have been underestimating it for the last two years. They have also been playing with the dynamics of the consumer price index which turned out to be at least 10-15% higher than the real number in 2010.  Even with export-oriented products included, production has been growing much slower than money supply. In 2010, nominal GDP was UAH 1,9T or almost 20% higher than in 2009, while real GDP grew a mere 4.2%. Rising prices also help the government fill in the State Budget. Just check your shopping receipt for the VAT rate paid to the state to see how much the government collects in taxes. 

Finally, the sale of over 92% of Ukrtelecom shares for UAH 10.5bn was a significant contribution of the State Property Fund to the government’s financial plan, despite the fact that the company was sold at very close to the starting price to a buyer who was known in advance, i.e. without a proper tender.


Despite all this, the State Budget saw a huge deficit of UAH 799.9mn in January-March 2011, while general expenses exceeded revenues by over UAH 2bn. This statistic does not take into account revenues from the sale of Ukrtelecom, thus it is the most informative as it presents a more realistic picture of public finance which, according to the Finance Ministry, is facing at least three problems.

Firstly, public expenses to serve debts have increased 2.4 times in Q1’11 compared to the same period in 2010, which is much faster than real GDP growth. Debt liabilities cost the government nearly UAH 15.3bn. Mr. Azarov’s Cabinet members explained in a memo that this was the result of “uncontrolled growth of sovereign debt in 2008-2009.” This is true, yet the current government is plunging even deeper into debt. The memo states that the borrowings of January-March 2011 were over UAH 23.5mn, even though the IMF refused to provide Ukraine with the US $1.5 loan installment in March. The likely outcome of this policy is excessive pressure on taxpayers in order to pay its liabilities, including external debt nominated in foreign currencies, the sale of public assets or the country’s default.

Secondly, this yearthe State Budget will not cover the UAH 2.6bn public finance gap caused by the difference in the prices for which NAK Naftohaz buys and sells imported fuel. Balancing out Naftohaz’s financial plan is a whole different story with a long background. But the way the officials admit and disclose the problem to the public might mean that they are not going to streamline cash flows and compensation to top managers, or improve tender transparency within the company, but use all other ways to solve its woes. They may once again increase gas prices for the public as required by the IMF, or sell part of Naftohaz. Bearing in mind the second option could make Ukraine more dependent on the cost of imported fuel and aggravate budget problems. 

Thirdly, the multipurpose development projects look very shaky, especially given the overall situation in public finance. In 2010, Mr. Azarov’s Cabinet passed an unprecedented amendment to the budget law allowing the government to spend more funds borrowed from international financial institutions than planned, while adjusting the amount of sovereign debt respectively. This will not come into effect in 2011, but the development projects exist nevertheless. What is more, their costs grew nineteenfold over Q1’11 compared to the previous year. This raises suspicion that the Budget is being robbed on the eve of Euro 2012.


If the IMF postpones the nest tranche of the agreed loan, the government will have to solve the current financial problems at the expense of taxpayers, as it always has done. Politicians have mentioned this intention many times. One of the instruments they are going to use is to legalise payrolls at small and medium enterprises, even though payrolls are already heavily taxed in Ukraine and paying all social contributions will drive many companies out of business in no time. This situation resembles the Laffer curve where tax evasion is a natural response to overly high taxes and abusive calculation methods.  

Currently, relations between tax inspectors and businesses are taking some interesting new turns. A lawyer of a leading law firm told the Ukrainian Week that entrepreneurs prefer to stay friends through unofficial agreements with tax inspectors who now enjoy vast powers. This recipe is hardly a secret, but mentioned by a lawyer it sounds like a surrender and a sign of the helplessness of businesses before their arbitrary supervisors, as well as a diagnosis to the government, which is irreversibly turning into a commercial instrument. Tycoons are using a simple model: every collected penny adds to their future Brioni suit. Sadly, it is implemented perfectly legitimately and camouflaged as concern for pensioners, among many other “good intentions”. However, the fact is the Pension Fund lacks the cash to pay privileged pensions to one-time civil servants and other categories, not average pensioners.

Another new detail in the life of businesses and the tax authorities is the widely advertised VAT reimbursement launched in the middle of March 2011. Based on April data from the TA, only 35 taxpayers are due to receive it, most of them being involved in heavy industry and quite likely linked to those in power. Vitaliy Zakharchenko announced that 80-90% of applicants for automatic VAT reimbursement did not get on the list because they failed to meet two criteria concerning wages, which must be the equivalent of at least two minimum wages, and tax payments by their counterparts. The latter looks reasonable as the failure to pay VAT by an applicant’s counterpart could be a sign of fraud. The first one, however, shows how cynically the government uses absurd requirements to drag out VAT reimbursement. Sadly, this behaviour of the tax authorities stirs no public protest amongst entrepreneurs as they prefer not to spoil their relations with tax inspectors, especially now, when the new Tax Code is in force.  This is fait accompli. The only question is how long it will take before entrepreneurs lose patience with the appetite of impudent officials, which has not even reached its peak yet.  

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