Purpose of Presentation

• Present comparison of four Draft Tax Codes.
• Highlight major policy features proposed in the four Tax Codes.

 Why to have a Tax Code?

• Gather all tax laws in one document
• Simplify the legal content of Tax Legislation by harmonizing structure, concept, definition and terminology:
  • Eliminate repetitive provisions
  • Avoid inconsistencies that create administrative and compliance difficulties
  • Rationalize common provisions - develop general rules
• Opportunity to improve tax policy- promote equity, neutrality, compliance and administrative simplicity.

 Benchmark for the assessment of tax policy improvements:

• Revenue Adequacy
• Neutrality and Efficiency
• Simplicity
• Equity
• Stability

 Goal of Comparison

• Provide background information for analysis of different tax policy approaches contained in various proposals
• Make comparison by tax base - EPT, VAT, PIT, Excise, Turnover Tax, State Duties, Local Taxes and Property Tax
• Focus on main structural elements - tax base, rates, exemptions, period of filing and advanced payments, rules of sharing between state and local budget

 Overview of four Draft Codes

• Major taxes are retained in three out of four proposals
• All propose major policy changes
• All are incomplete - some important provisions are missing, although the Government proposal is more comprehensive

 EPT - Main Broad Policy Differences

Note: Tymoshenko proposal replaces EPT with the Turnover Tax

 EPT - Tax Privileges

• All Draft Codes repeal some privileges that is a positive approach. However, each of them maintains a number of existing privileges or introduces new ones
• Some incentives would distort investment decisions and neutrality between investment and labor:
  • purchase of new capital (Hubsky’s thorough immediate expensing)
  • accelerate growth of wages and salaries (Sergienko’s Draft)
• All Draft Codes tolerate free economic zones and promote simplified systems
• All Draft Codes fail to unify different simplified regimes and provide rules for graduation to the regular EPT system
• Proposed reduction in tax rates for small businesses (Government’s and Sergienko’s Draft Codes) is questionable in the presence of simplified system

 EPT - filing period and advanced payments

• All three Draft Codes fail to switch to annual filing. Therefore, no substantial reduction in the burden of filing
• The Government’s proposal retains requirement to make advanced payments on the basis of actual income received. The requirement to use actual results proved to be difficult to comply with
• Opposite approach - Hybskiy’s and Sergienko’s proposals seem to eliminate monthly advanced payments. That would create major cash flow problem to the Government during a year

 EPT - summary

• All the three Draft Codes fail to:
  • ease the burden of filing
  • provide uniform treatment (simplified regimes and free economic zones are retained)
  • broaden tax base (new privileges eliminate the positive effect of repealing existing privileges)
• Reduction of the tax rate (Hubskiy) with the same or narrower base would result in immediate fall in EPT revenue.
• Switch to cash method of accounting would make collection of revenue more difficult
• None of the three Draft Codes introduces an appropriate system of advanced payments

 PIT - Main Broad Policy Differences


 PIT - Rate Structure


 PIT - Entrepreneurship Related Expenses
No Draft Code fully recognizes entrepreneur’s expenditures:

• depreciation is denied by all Draft Codes
• only Hubskiy’s Draft allow deductions for interest on loans
• Government’s, Tymoshenko’s and Sergineko’s Drafts allow business expense to be deducted

 PIT - Summary
Positive measures:

• broadening of the tax base through repeal of major exemptions (Government, Hubskiy, Tymoshenko, Sergienko)
• uniform top marginal rate for business entities with both legal status and without legal status (Government, Hubskiy) - fewer distortions
• rate for secondary income match the top marginal rate

Issues:

• use of non-taxable minimum for defining the tax threshold is very controversial
• no basic deductions and credits (Tymoshenko, Sergienko) - penalizes low-income taxpayers
• allowing deduction for production expenditures to entrepreneurs while disallowing them to legal entities (Tymoshenko) - creates distortion in choices of legal form

 VAT - Main Broad Policy Differences

Note: Tymoshenko’s proposal replaces VAT with the Turnover Tax.

 Tax Exemptions and Zero-Rated Transactions to be repealed under Hubskyi’s Proposals

These changes introduce major improvement to the tax base

 VAT - Summary
Positive measures:

• repeal major exemptions (Hubskiy)
• repeal non-standard zero-rating like energy and sale of meat and milk (Government, Hubskiy and Sergienko)

Issues:

• decrease registration threshold (Hubskiy, assuming the proposal uses the same non-taxable minimum as current legislation) - would increase administrative burden
• cash basis (Sergienko) - would reduce revenue collection
• immediate refund of excessive VAT credit (Hubskiy) - could create evasion in the absence of the appropriate administrative provisions
• multiple rates (Sergienko) - would make VAT administration and compliance very difficult and would create tax planning opportunities
• reduction of the VAT rate (Hubskiy) - substantial losses of revenue from the most stable and efficient source of revenue

 Excise - Summary
Positive measures:

• Three Draft Codes (Government’s, Hubskiy’s and Sergienko’s) provide a significant cut in the number of excisable goods. The goods whose taxation would be terminated are not significant sources of revenue

Issues:

• Expose the list of excisable goods and rates to frequent changes (to be approved by the Parliament according to Tymoshenko’s Draft)
• Decrease rates for gasoline and retain current rates for wine, alcohol and tobaccos (Government’s, Hubskiy’s and Sergienko’s Drafts) - gasoline prices are among lowest in the world
• Use cash method for determining tax liabilities would complicate tax administration and make revenue collection difficult (Hubskiy’s and Sergienko’s Drafts)

 Property Tax - Positive measures

• Additional and important source of revenue for local governments (Government, Hubskiy, Sergienko)
• Eliminate centrally established exemptions for land and give the power to exempt to local governments (Hubskiy)
• Basic exemptions and basic credits - promote equity

 Property Tax - Issues

• Merging the Tax on Owners of Transportation Means with the Immovable Property Tax (land and buildings) is controversial as these taxes are of different nature and methods of assessment
• Extensive list of exemptions that can be further proliferated by local governments (Government, Sergienko and Tymoshenko (Land Tax)) - inequitable treatment
• Some exemptions are poorly defined and targeted - ground for extensive avoidance
  • buildings and structures that are not in exploitation - there is no time limit for exemption, no rules when a part of the construction project should be considered as completed
• Mixing individual and unit valuation of buildings - difficult for practical application
• Multiple rates applicable to numerous categories of land plots - inequitable treatment of land plots of the same value, difficult to comply and administer
  • the standard approach is to differentiate only between agricultural land, land used for industrial purposes and residential. All other characteristics of a particular land plot should be captured in its value

 Do Draft Codes Improve Tax Policy?
Neutrality and Efficiency

• Government’s, Hubskiy’s and Sergienko’s proposals would make little or no improvement because the suggested reduction of the number of existing exemptions and privileges would be offset by new exemptions and privileges
• Compliance of the tax system with the principles of neutrality and efficiency would significantly decline under Tymoshenko’s proposal to substitute EPT and VAT with the turnover tax

Simplicity

• Goverenement’s and Sergienko’s proposals are not transparent and easily understandable
• Although Hubskiy’s and Tymoshenko’s proposals seem to be more understandable and simple, they lack some important definitions and provisions that can hinder the practical application of the Code

Equity

• Government’s and Hubskiy’s proposals would make little improvement of horizontal equity of the system because of retaining a number of simplified systems and free economic zone regimes
• Tymoshenko’s proposal would create major breach to both horizontal and vertical equity
  • tax liability would be determined by the size of the turnover rather than the amount of income earned
  • tax system would rely heavily on the turnover tax that is highly regressive
  • flat rate would eliminate progressivety of the PIT system
• Despite the attempt to improve progressivety of the VAT system, Sergienko’s proposal is not likely to improve overall equity of the system because of modest decline of progressivety of PIT and new inequitable measures proposed for EPT.

Stability

• Government, Hubskiy’s and Sergienko’s proposal are not likely to increase stability of the system because of failure to address existing problems or need to revise newly suggested controversial measures
• Expected rapid failure of the turnover tax system (Tymoshenko) would require major revision of the tax system very soon

 Improving Tax Policy - Summary