beyondbrics

The Baltic states did it. Slovakia did it. Even Russia did it. Now Ukraine is close to adopting a tax code that it claims will cut corruption and red tape – and be recognised as one of the most liberal in Europe.

The proof of the pudding will be in the eating. First the new laws must be adopted. Then they must be implemented. And once implemented they must be enforced. Liberal tax regimes have helped created fair business conditions in the Baltic states and Slovakia. But in Russia, the benefits have, to put it mildly, been less clear.

Borys Kolesnikov, deputy prime minister, told beyondbrics that his government was serious about attracting massive investment and boosting domestic businesses by establishing “one of the most liberal tax codes”.

If the legislation is adopted this autumn as planned, corporate profit tax rates would be cut from a current 25 per cent to 16 per cent by 2014. Small businesses would get a five-year exemption, with 10 years for light industry and hotels.

Value added tax would be gradually cut from 20 per cent to 17 per cent by 2014. VAT would no longer be charged upon export-oriented grain transactions, or for legal and business consulting services. Personal income tax would remain in the 15-17 per cent range.

It all sounds great. But still fresh in the memory is this newish government’s first botched attempt at tax reforms. The original draft tax code pushed earlier this summer was declared “liberal”. But when it was made public, many were shocked to find it would have made taxpayers defenceless in disputes with notoriously unruly and corrupt tax inspectors.

Backed by a dominant governing coalition, President Viktor Yanukovich, who took power this year from the pro-west Viktor Yushchenko, says he has the authority and the will to deliver a tax code that will be good for business and for the state budget. His government hopes the tax base will increase, boosting budget revenues instead of deepening a current fiscal deficit, which is expected to hit 5.5 per cent of GDP this year.

If the government succeeds, it could be a huge boost for a nation kept financially afloat thanks to a $15bn IMF standby loan. Finances remain stretched after GDP plummeted 15 per cent during 2009′s global recession, but between 40-50 per cent of business activity hides in the shadow economy. In the recession-battered country, encouraging citizens and companies to pay up is challenging.

Kolesnikov says that with lower taxes, ordinary citizens and oligarchs alike will have to pay their fair share. It will no longer be acceptable to hide profits offshore, adds Kolesnikov, himself a big businessman and confidant of Ukraine’s richest oligarch, Rinat Akhmetov.

But if Ukraine fails to win over the trust of business and citizens, if taxpayers fail to show up, then the country could become even more dependent on IMF aid.

The precedents are tough. Tax reforms succeeded in the Baltic states and central Europe because they were introduced in line with a range of fundamental reforms designed to modernise economies, cement the rule of law and prepare for European Union membership. The improvements are not universal and there is still back-sliding – but in general the reforms have held.

In Russia, tax reform, notably the 13 per cent flat rate, simplified a complex system and stimulated tax payments. But, in the absence of other legal and economic changes, it has not transformed the tax service. Claims of corruption and maladministration abound. It will be a huge challenge for Ukraine’s government to implement tax reform to the level required of future EU members. But can it do better than Russia?