Expert predicts change in Ukraine's tax laws (05/24/98)

Expert predicts change in Ukraine's tax laws

CAMBRIDGE, Mass. - As certain as taxes are, in Ukraine, they are also certain to change. This is the good news.

Yuri Sokol, an authority on Ukrainian tax policy, spoke on April 6 at a seminar titled "The Establishment of Tax Administration and the Development of Tax Legislation in Ukraine" sponsored by the Ukrainian Research Institute at Harvard University and The Harvard Ukrainian Business Initiative. "Although a rational tax code currently does not exist, the tax system is evolving in that direction as the market economy develops," stated Mr. Sokol. He commented that he believes that the new Parliament elections of March 29, will actually speed up reforms, instead of being an obstacle.

Ukraine accepted advice from the U.S. in 1991 and re-organized its system to reflect Western standards. This task is complicated considering the fact that the Soviet accounting system, which in large part is still in use today, does not account for profit and loss, but only for the transfer of goods. Moreover, people were not accustomed to paying taxes of any sizable amount, Mr. Sokol explained.

Ukraine's transformation into a free market economy involves a total transformation of government, society and business. Simply selling off state-owned enterprises will not create a free market. Rewriting the tax code is one example of the change that is needed, as is a public education program aimed at altering people's understanding and willingness to comply with the tax code.

What has been created is a powerful ministry that employs about 65,000 people, of which 10,999 are tax police. Individual income, practically speaking is not taxed; instead the employer is taxed at a rate of 48 percent on salaries paid out. This practice is considered one of the key explanations of why nearly half of Ukraine's businesses operate in the so-called shadow economy.

Despite its name, the shadow economy is not evidence of corrupt business, but is proof of an unofficial, and thriving, system of exchange designed to avoid government taxation and regulation. Another means of avoiding tax on salaries is to compensate employees with benefits other than money, such as free housing, said Mr. Sokol. As a result of low compliance with taxes on salaries, the state has needed to rely upon other forms of taxation, the chief ones being the Value Added Tax (VAT) and excise taxes (such as those on tobacco and liquor). While the VAT is expedient to collect, in the long term it taxes production - a disincentive that works against increasing production.

The government realizes that a new tax code must be drafted, and has mandated that this be done by the end of 1998. In addition, businesses will be required to adopt standard accounting procedures during this time. Combined with other changes - the creation of more businesses, growing foreign investment, development of a stock market, increased insistence by the International Monetary Fund and other international institutions for economic reforms - there is more pressure to develop a rational tax code. "Lacking a free market and standard accounting system meant that a tax code based on that logic would not have operated correctly, but as the different components in the free market system evolve, so too will the tax code," stated Mr. Sokol.

This seminar is part of the Harvard Ukrainian Business Initiative's program to promote the development of business in Ukraine and spur economic and institutional reforms needed to support the country's development into a market economy.