You're reading: Lack of tax reform costs Ukraine billions each year

For a European nation of 42 million people, Ukraine’s economy is remarkably small. According to some estimates, up to a third of it is in the shadows.

Ukraine collected Hr 650 billion, or $26.5 billion, in taxes in 2016. But because of tax evasion and taxation policies, that number is $13 billion too low, according to Finance Ministry estimates.

Making sure people and companies pay tax is the job of the State Fiscal Service, the state agency that oversees all tax and customs operations. But in its current condition — inefficient, corrupt and ill-reputed — the body is in no shape to close the tax gap.

So the Finance Ministry, which oversees the service, plans to reform it through cutting some jobs, filling the remaining positions with staff selected in a transparent competition, and transferring functions online.

If successful, the reformed fiscal service should not only collect taxes more effectively, but also inspire enough trust to make the public and businesses pay their taxes more willingly.

Taking shape

The issue of reforming the State Fiscal Service has been on the table since 2014. Some demands for changing the tax administration have been included in the memorandums signed by Ukraine and the International Monetary Fund.

But unlike other reform areas — such as police, pensions, and agriculture — a full-scale reform of the Fiscal Service was never made a top priority.

But it wasn’t until April that the first major changes came, with the Finance Ministry automatizing refunds of value-added tax, meaning that businesses no longer have to wait for months to have their money returned.

“At any meeting with businesses, this is the first thing they thank us for,” says Yana Bugrimova, an advisor to Finance Minister Oleksandr Danyliuk and the ministry official overseeing the reform of the State Fiscal Service.

The ministry needs to have several more success stories like that, she says, to persuade the IMF and Ukrainian politicians that it is possible to reform the service. Now, there is no faith in it and therefore not much political support.

“They only want to support ideas that have a strong chance of coming to life,” says Bugrimova. “We need several successes like the VAT refund case to get backing for fiscal service reform.”

Meanwhile, plans for the reform of the service are finally taking shape. In August, the Finance Ministry and IMF outlined four areas for overhaul: online and phone services, tax audits, tax debts, and personnel.

Go online

While it is impossible to completely remove the human factor from the tax and customs operations, corruption risks can be reduced, Bugrimova says.

The first step is to transfer more operations online. Today, 90 percent of the public’s visits to tax offices concern 10 types of operations, nine of which could easily be performed online, according to Dmytro Kokhan, a Finance Ministry expert working on tax reforms.

Ideally, Kokhan says, only 20 percent of all the functions performed by the fiscal service should involve face-to-face contacts: the rest should be done online and through the service’s call center. Today, 60 percent of all services are performed via face-to-face meetings with tax officers.

To reduce that number, the State Fiscal Service will move services online and increase the size of the call center: today, due to low capacity, only 50 percent of calls are answered.

Fair audits

To make tax audits corruption-free and more efficient, the Finance Ministry wants to change the way businesses are selected for audit.

At the moment, a centralized algorithm assesses tax risks and determines which businesses should be audited. The names of the businesses are then sent to regional tax offices.

That’s when things start going wrong.

As the number of candidates for audit is far above the capacity of the tax offices, inspectors select which ones to audit themselves, and can solicit bribes from companies to escape a tax inspection.

“We looked at Odesa Oblast,” says Kokhan, showing a recent report. “The tax risk simulator picked out 5,385 companies there for audit. The regional tax office started selecting, and got that number down to 285 companies — that’s how much they can physically audit.”

The plan is to improve the tax risk simulator so that it selects numbers of companies that can realistically be audited, leaving inspectors no opportunities to pick them themselves. A pilot project of the new system will start working in some regions within two months.

Remote audits, where an inspector doesn’t show up at the company but instead analyzes its tax reports, can be partly automatized, say Bugrimova and Kokhan. That would decrease the inspectors’ workload and again reduce the risk of corruption.

Tax debts

Tax debts in Ukraine reached Hr 81.6 billion ($3 billion) in September. Hr 12.5 billion of that is new debt that has accumulated since the beginning of 2017.

The tax office hasn’t been effective in collecting it. On the one hand, the tax inspectors lack freedom to solicit tax debts and need to rely on courts too much.

“The tax office shouldn’t be running to court for every permit,” says Bugrimova.

On the other hand, when it comes to debt soliciting, tax officials have been reluctant to apply even the limited authority they have.

Since the beginning of 2017, the State Fiscal Service was allowed to confiscate declared assets from businesses that owe more than Hr 5 million in taxes without a court ruling. But they were in no rush to do so.

“It hasn’t been going well,” says Bugrimova. “We don’t know why, yet. We’re watching it for now.”

The plan is to prioritize debtors who are still in business and whose debt is new, and to chase them actively. For this, a special unit needs to be organized within the tax office.

Staff shortages are part of the problem. In Ukraine, only 4 percent of tax officials are dedicated to debt soliciting, compared to 13 percent in other developed countries. Optimizing other operations could free up employees needed for the debt soliciting unit.

People are key

New staff will be the cornerstone of the reform. Today, the tax office is so distrusted by the public that it both repulses taxpayers and feeds corruption.

“Today, if a tax inspector demands a bribe from you, would you think of complaining about him to his own tax office? Of course not,” says Bugrimova.

Bugrimova believes that replacing the key employees with new people through transparent competitions will change the culture of the tax office. But it won’t be easy.

“There is resistance to the reform coming from all the political forces,” Bugrimova says. “It could be because some people paid to be appointed to certain positions and don’t want to lose them.”

It doesn’t make it easier that the State Fiscal Service has no real leader now. Its head, Roman Nasirov, was suspended after the National Anti-Corruption Bureau in March opened a case against him. Nasirov is suspected of giving unlawful tax delays to companies.

Following Nasirov’s suspension, his deputy Myroslav Prodan has been the acting head of the State Fiscal Service, representing the service at Finance Ministry meetings when the plan to reform the agency is discussed.

With political elites not particularly fond of fiscal reform, the best hope is for the IMF to finally put it high on their agenda. While the reform has been a structural benchmark for the IMF, it’s never been as high a priority as other issues.

The public needs to push for the reform, too.

“People have little interest in this reform now, because they don’t believe in it or don’t know much about it,” says Bugrimova. “They need to see some progress, some success.”

That taken into account, the reform of the Fiscal Service will take at least three to four years.

“There is enough work here for us and for several governments to come,” says Bugrimova.