How Ukraine has lost the policy making capacity

By Anton Shevchenko (Ukraine)

Summary (by the editorial board of VoxUkraine)

Recently, the parliament passed a law that taxes several industries. The law attracted a lot of attention because of its controversy: the prime minister threatened to resign, and media speculated about a conflict within the government. The public perceives the law as a success for the prime minister and, more generally, the government in its fight with the oligarchs.   

This post argues that the law is ill-advised and counterproductive. The law taxes the very industires that have been the engine of the economic growth in Ukraine in the recent years and thus harms the ability of the country to resist the looming economic crisis. Furthermore, the law makes evident the time-inconsistency problem of the Ukrainian government policy, reducing the capacity of the government to influence economy and investors. Finally, it taxes industries not the oligarchs: jobs will be destroyed, investment in the infrastructure discountinued, the tax revenues will dry up, while the oligarchs will move away from developing healthy industries towards rent-seeking activities within the state.  

This law is an example of a myopic and non-systemic approach to reforms in the times of economic and political crisis, which may do more harm than good. 

---------------------------------------------------------------------------------------------------------------
Imagine a country with a projected 6 to 10% GPD decline. Economists play football with arguments (here and here) discussing whether or not the country needs state-funded stimulus. And here the arbiter comes: the government files a bill with a proposal to tax five industries which were the engines of economic growth in last couple years. Yes, you are in Ukraine.

So, the Ukrainian government filed a bill to parliament in the end of July, with an aim to raise short-term tax revenues because economy slowdown and inability to reduce budget expenses were increasing state’s deficit. In the proposal, the government suggested to increase mineral extraction tax for natural gas to 70% (from 28%), to prolong indirect duties on grain export of about 20% (through non-refund of export VAT) for a year and cancel certain subsidies for agriculture (on average 5-7% of revenues) thereafter. Construction industry had to lose the ability to postpone income tax payments until real estate is completed, hotel industry was due to forget about its income tax break until 2020 (granted as stimulus before EURO 2012), green electricity projects were also losing their ten-years income tax break introduced just four years ago. All suggested tax policy changes were due to come into effect either on 1 October 2014 or on 1 January 2015.