Ukraine’s shadow economy is not hard to find. It greets you at the airport with an unmarked cab and insists you sit up front.
It sets up fruit-laden card tables next to the metro entrance and unmarked garment stalls in outdoor bazaars. For many in post-Communist countries, this is the shadow economy – something quite visible and concrete – an everyday resource for surviving the scarcity of consumer goods during the Communist system or the poverty of the 1990s.
But for Ukraine’s tax officials, bootstrap black market entrepreneurs account for only a fraction of off-the-books income. The collective sum of street peddling startups is outweighed by tax evasion schemes perpetrated by so-called black business, often cooked up by creative accountants and unscrupulous lawyers.
As Ukraine faces down a staggering budget deficit, levying taxes on the shadow economy – which official estimates place anywhere from $31 billion to $64 billion – is a tempting proposition. But the diverse forms of off-the-books business in Ukraine means any single legislative solution is unlikely. Instead, the government has advanced a host of different tax reform measures since March, aiming both high and low to recover state revenue.
Starting at the low end, there are several laws currently before the Verkhovna Rada to coax small business and individuals into paying taxes. These bills attempt to make paying taxes in Ukraine less painful – by reducing fees for new businesses and by simplifying administrative procedures. One such law cuts the baseline of a payroll tax called the one-time Unified Social Contribution fee nearly in half, to 18.1 percent of income.
“High payroll taxes not only encourage participation in the underground economy, but also shift to bogus self-employment and contracting out,” explains Peter Spiro, a University of Toronto fellow. “Regarding the payroll tax, a cut is likely to be beneficial. The previous 34.7 percent rate is unusually high.”
Simplifying administrative procedures for corporate tax could also relieve small businesses of an immense burden.
At the high-end, the government’s most ambitious proposition for recapturing lost tax revenue is a May 21 “compromise” bill that attempts to reclaim funds it lost to tax evasion. Unscrupulous companies have a 90-day period to self-declare income that previously escaped taxation – and in return for 15 percent of their revised revenue, Ukraine’s tax service will offer them amnesty and an official certificate of compliance.
Serhiy Verlanov, a senior attorney at PwC Ukraine, says the compromise in its current form won’t benefit his company’s clients, who are mostly big and clean businesses.
“Companies deeply involved in fraud are the ones that will benefit the most. The situation is not transparent, not available to public scrutiny, and it has the risk of being unfair to tax payers.” Sham companies, according to Verlanov, are a major headache for his clients – but until the government goes public with its list of such violators, above-board companies won’t be able to eliminate the untrustworthy links in their supply chains.
A second problem with the amnesty is an ambiguous time period between the January start of the fiscal year and the late May enactment of the compromise.
“One can assume that either the law will be extended for these six months, or the law will be extended for 2015,” said Verlanov. “This is providing incentives for further tax evasion. There is a high risk that grey and black business will wait for another amnesty.”
At the roots of many sham companies and tax evasion schemes is Ukraine’s value-added tax, often shorthanded as VAT. Igor Bilous, Ukraine’s head of taxation, singled out VAT tax schemes in April as a huge part of the illegal sector’s architecture. Some experts have proposed abolishing the system entirely, but this would be a mistake, according to Oleg Matsekh, a business owner and activist with Reanimation Package of Reforms, a community advocacy group: the European Union sees a VAT system as a non-negotiable requirement for partners.
“The current problem is the administration of the system, which is a very difficult problem,” said Matsekh.
