Fighting the Shadow Economy as an Alternative to Raising Business Taxes

19/ 09/ 2024

Recently, the Verkhovna Rada supported the draft law on raising taxes No. 11416-d in the first reading. This version includes, among other things, an increase in the military tax to 5% and additional taxation of bank profits at a rate of up to 50%. The European Business Association has been actively involved in the dialogue between business, the government, and the Verkhovna Rada and has already commented on most of the proposed measures to fill the state budget through additional tax burdens on businesses. The ЕВАs experts believe that any additional taxation of compliant businesses, including the increase in military tax, could distort the competitive environment, as it would become economically disadvantageous to operate “in the white.” Companies that remain in the shadow economy gain economic advantages compared to those that pay taxes. Accordingly, it can be assumed that this might push some compliant businesses into the shadow sector to survive during the war. Therefore, in the view of businesses, effective combatting of the shadow economy is capable of providing a sustainable source of budget revenue and improving the economy. According to estimates by the Institute of Socio-Economic Transformation, the state budget loses about UAH 400 billion from the shadow sector. This amount corresponds to the additional funds currently lacking in the state budget. Additionally, businesses suggest that accumulating funds through economic reserving could be an alternative to raising the military tax. The ЕВА has also proposed several ideas for alternative budget revenue sources, such as additional taxation of gambling and the used car market, and reducing certain state expenditures. Businesses support the governments idea of removing the VAT exemption limit for goods up to EUR 150 sent in international express and postal shipments and taxing VAT on all imported goods, except for personal items in accompanied and unaccompanied baggage. From the perspective of the IT industry, the proposal to increase taxes contradicts the idea of creating the Diia City legal regime, which established 25 years of unchanged tax conditions. Changes to the conditions in Diia City could lead to increased service costs and loss of competitiveness in the global market, potential exits of companies from the Diia City legal regime, and even investment relocations to other jurisdictions. Experts estimate that if the tax changes are implemented, it could lead to a 30% decline in the IT sector by 2025, reduction in job numbers, decreased foreign currency earnings, and tax revenues. In the context of the proposed increase in the profit tax rate for banks, the ЕВАs experts believe that the fiscal effect of such a decision will be short-lived and will significantly reduce dividend income from state banks already in the next year. This decision will have significant negative consequences for public finances. Moreover, the introduction of such a retrospective obligation is a troubling signal for all sectors of the economy, highlighting the risks of the regulatory environment and reducing the desire to invest in Ukraine. A sharp change in fiscal policy could negatively impact the capitalization of banks and create a need for recapitalization. In the case of state banks, the need for recapitalization will entail additional expenditures from the state budget. Thus, the fiscal effect of this decision could be offset by many long-term negative consequences. Therefore, the ЕВА would like to once again emphasize the fiscal potential of the shadow sector. Among the managers of member companies surveyed by the ЕВА, 35% identify tax and customs reforms as key priorities. Recently, important legislative changes have been adopted to launch the reform of the Economic Security Bureau and the State Customs Service. At the same time, it is crucial that these reforms are not just “on paper” but are fully implemented. We hope that the business perspective will be taken into account!

The European Business Association has been actively involved in the dialogue between business, the government, and the Verkhovna Rada and has already commented on most of the proposed measures to fill the state budget through additional tax burdens on businesses.

The ЕВА’s experts believe that any additional taxation of compliant businesses, including the increase in military tax, could distort the competitive environment, as it would become economically disadvantageous to operate “in the white.” Companies that remain in the shadow economy gain economic advantages compared to those that pay taxes. Accordingly, it can be assumed that this might push some compliant businesses into the shadow sector to survive during the war.

Therefore, in the view of businesses, effective combatting of the shadow economy is capable of providing a sustainable source of budget revenue and improving the economy. According to estimates by the Institute of Socio-Economic Transformation, the state budget loses about UAH 400 billion from the shadow sector. This amount corresponds to the additional funds currently lacking in the state budget. Additionally, businesses suggest that accumulating funds through economic reserving could be an alternative to raising the military tax.

The ЕВА has also proposed several ideas for alternative budget revenue sources, such as additional taxation of gambling and the used car market, and reducing certain state expenditures. Businesses support the government’s idea of removing the VAT exemption limit for goods up to EUR 150 sent in international express and postal shipments and taxing VAT on all imported goods, except for personal items in accompanied and unaccompanied baggage.

From the perspective of the IT industry, the proposal to increase taxes contradicts the idea of creating the Diia City legal regime, which established 25 years of unchanged tax conditions. Changes to the conditions in Diia City could lead to increased service costs and loss of competitiveness in the global market, potential exits of companies from the Diia City legal regime, and even investment relocations to other jurisdictions. Experts estimate that if the tax changes are implemented, it could lead to a 30% decline in the IT sector by 2025, reduction in job numbers, decreased foreign currency earnings, and tax revenues.

In the context of the proposed increase in the profit tax rate for banks, the ЕВА’s experts believe that the fiscal effect of such a decision will be short-lived and will significantly reduce dividend income from state banks already in the next year. This decision will have significant negative consequences for public finances. Moreover, the introduction of such a retrospective obligation is a troubling signal for all sectors of the economy, highlighting the risks of the regulatory environment and reducing the desire to invest in Ukraine.

A sharp change in fiscal policy could negatively impact the capitalization of banks and create a need for recapitalization. In the case of state banks, the need for recapitalization will entail additional expenditures from the state budget. Thus, the fiscal effect of this decision could be offset by many long-term negative consequences.

Therefore, the ЕВА would like to once again emphasize the fiscal potential of the shadow sector. Among the managers of member companies surveyed by the ЕВА, 35% identify tax and customs reforms as key priorities. Recently, important legislative changes have been adopted to launch the reform of the Economic Security Bureau and the State Customs Service. At the same time, it is crucial that these reforms are not just “on paper” but are fully implemented. We hope that the business perspective will be taken into account!