In Ukraine, approximately 23 percent of the employed population work informally, and another 10-30 percent receive partially formal payments. As a result of the grey labor market, a lot of potential state budget revenue is not paid, which leads to insufficient funding of social programs.
The salaries of approximately 6 million Ukrainians are paid in full or partly illegally. Uncollected tax revenues amount to approximately $6 billion, which is approximately 45 percent of actual government revenues from single social contribution and personal income tax, according to a report published by the Centre for Economic Strategy.
Why it matters
Currently, payroll taxes in Ukraine include 22 percent for single social contribution, 18 percent for personal income tax, and 1.5 percent of military duty. Calculated as a nominal rate, that’s 41.5 percent, and as an effective rate, that’s 34 percent. Ukraine is way ahead even of many developed economies in terms of the fiscal payroll burden. For example, in the United States, the effective tax wedge is 28.29 percent; in South Korea – 23.26; in Switzerland – 22.06.
As a developing country, Ukraine is subject to multiple economic pressures, and it should look up to developed economies such as Switzerland as role models. Switzerland’s effective payroll tax rate is almost twice lower than that of Ukraine, which is partly why we are still a third-world country.
In light of the COVID-19 crisis, there has been a tendency towards tax liberalisation. Among the OECD countries, there has been the largest decrease in the average tax wedge since the global financial crisis of 2008-2009.
Reducing labor taxation is paramount in order to boost economic growth and ensure employment expansion. Ukraine should follow the example of Organization for Economic Cooperation and Development countries and consider supporting its business and people in difficult times by reducing the tax burden on wages. Excessive payroll taxation overburdens companies and employees thereby increasing their inclination to not pay taxes at all.
Effective solution
The problem, however, cannot be solved through coercion or procedural changes. We need to uphold a fundamental fiscal reform to reduce the payroll tax burden along with the liberalization of labor legislation. A structural reform aimed at lowering taxes is the silver bullet.
The Office of Simple Solutions & Results is currently developing optimal tax reduction models, working on the impact assessment, and putting together the legal amendments. Our target should be 20-25 percent of the effective payroll tax rate.
A payroll tax cut can be financed in a budget-neutral manner by cutting or better managing public spending. Crucially, compensation shouldn’t imply increases in any taxes on consumers or SMEs. The saved funds can be channelled into investments thereby boosting Ukraine’s economic well-being overall.
Benefits of the proposed reform
The main worry underlying this reform is the envisioned budget losses. However, in Georgia, after such a reform, state revenue went up. As a result of a collision between income tax and single social contribution at a 25 percent rate (down from 60 percent), income has increased. Currently, Ukraine’s population is evading a 41.5 percent rate but there will be less incentive to do that if the tax is 20-25 percent, as proposed.
As a consequence, more people will be keen to formally declare their employment, sign up for credit programs or mortgage. Increased social security will make the Ukrainian population feel protected, and so ensure more predictability and stability. It will also make spending easier.
The much-needed reform will not only increase transparency, but it will also help level the playing field for businesses across the board. Also, by reducing the most harmful of direct taxes, the reform will accelerate economic growth. As we seek to recover from the covid crisis, this reform will be instrumental in helping our economy bounce back and grow.
Fiscal reforms are often the hardest to push forward because of various vested interests. However, Ukraine’s main economic problem and the reason why we are the poorest country in Europe is over-regulation of the economy. The existing payroll taxation is overwhelming, and partly contributes to rising levels of social capital moving abroad. Employees, and not the state, should be deciding on how to use their money. There is not a single developing country in the world with such a high effective payroll tax rate, where these taxes are fully paid. The need to uphold the proposed reform in Ukraine is vital to our economy.
The Office of Simple Solutions & Results is working closely with the respective stakeholders to enforce a simple reform: cut payroll taxes. I encourage members of parliament and the Cabinet of Ministers to join our efforts: the proposed reform is much needed.
