Reform of the SOE sector is a high priority for the government. The recently published “National Strategy 2020” promises “state property management reform,” and related reforms in areas such as the organization of government agencies, public procurement, competition policy, and corporate regulation. Reform of the SOE sector also features prominently in the government’s 2014 Coalition Agreement. High levels of direct and indirect state support is adding to the significant fiscal risks emanating from SOE sector, a problem that is being exacerbated by the severe economic situation. In addition, weaknesses in the management of the state’s investment portfolio need to be addressed to help to significantly increase the value of the government’s portfolio of state assets. This will only be possible through improved oversight and governance of the SOE sector.
This report has been compiled against a backdrop of political uncertainty and heightened security concerns. Public financial management (PFM) reforms may not be to the forefront of government priorities at present but severe budgetary pressures need to be addressed and measures adopted to help implement sustainable fiscal policy. The report focuses on immediate PFM reforms needs that help alleviate immediate budget pressures, and also identifies medium-term reforms to address long-standing weaknesses in PFM systems.
Social Security Contributions (SSC) in Ukraine need urgent attention. If nothing is done, the budget is poised to lose 4.5 percent of GDP in revenues in 2016 due to a legally mandated SSC rate reduction adopted in March 2015. The Ministry of Finance (MoF) is studying a number of options to find a responsible, revenue neutral, approach to lowering SSC rates, which at 40 percent of payroll are above all countries in the OECD. At the same time, Ukraine hosts a very large informal sector which stands as a difficult obstacle to developing its social and economic potential. However, there is no fiscal space to forgo tax revenues. The shift of the tax burden away from labor (as recommended by previous FAD missions) cannot jeopardize the integrity of public finances; it needs compensation from reliable sources of tax revenues. A closely connected issue is the Single Tax System (STS) originally designed for small entrepreneurs, but which has become very porous to others. The regime allows qualifying taxpayers to pay a very low tax on income and a symbolic SSC fee, and offers ample opportunities for avoidance by employers who contract their workers as independent entrepreneurs. To restore horizontal equity with regular employees, the STS requires fundamental reform, addressing: a (turnover) cap for the STS that is too high, a system that effectively overrides the VAT threshold, unnecessarily admits legal persons and offers important tax and SSC incentives for employees to reclassify as independent entrepreneurs – a practice that is currently very difficult to combat due to poor rules and enforcement practices. However, the revenue potential here should not be exaggerated given the difficulty in taxing this segment of the population.
The SFS was established in 2014 as the successor to the Ministry of Revenue and Duties (MRD), and with three components—tax, customs and tax police. Following the turbulence arising from mid-year leadership changes in the SFS, reform momentum was invigorated and a number of important initiatives are being pursued. Since May 2015, a comprehensive reform plan has been approved; execution of the plan has commenced; many regional and local leaders were replaced; a change director was appointed; integrity programs were expanded; and a set of indicators that provide for a substantial lift in organization performance are being pursued. There are preparations for ambitious changes to organization structure which will merge the field networks across tax and customs.
Immediate revenue measures need to be balanced with some attention to more fairness in tax collection. The mission recommends to cease revenue deferral arising from trivial tax disputes by requiring at least a partial payment of disputed tax before the appeal goes forward; collect tax arrears by promoting installment arrangements that fit the crisis conditions; strengthen routine monitoring of filing and payment obligations to control tax discipline; and make mandatory that largest taxpayers deal with their tax affairs at the large taxpayer inspectorate (LTI) offices instead of local offices. Ineffective internal dispute resolution processes should be replaced with an independent and fairer administrative review.