Kyrgyz Republic: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
07 Mar 2003
eISBN:
9781451821413
Language:
English
Keywords:
ISCR; CR; Kyrgyzstan; export; VAT; cost; functioning VAT system; processors value; General government VAT collection; claims of exporter; value of trade; VAT exemptions; Agricultural production
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This Selected Issues paper examines figures related to the key policy areas for the Kyrgyz Republic. Specifically, the paper studies the sources of growth, the cost competitiveness of export, and trade restrictions in the region, which are all linked to the achievement of the growth and poverty reduction targets of the National Poverty Reduction Strategy. It addresses the issues of agricultural taxation and fiscal aspects of the environment. The paper also focuses on a specific structural problem in taxation, and analyzes the fiscal aspects of environmental protection.

Abstract

This Selected Issues paper examines figures related to the key policy areas for the Kyrgyz Republic. Specifically, the paper studies the sources of growth, the cost competitiveness of export, and trade restrictions in the region, which are all linked to the achievement of the growth and poverty reduction targets of the National Poverty Reduction Strategy. It addresses the issues of agricultural taxation and fiscal aspects of the environment. The paper also focuses on a specific structural problem in taxation, and analyzes the fiscal aspects of environmental protection.

V. VAT on Agriculture: The Case of the Kyrgyz Republic17

A. Introduction

67. Weak revenue performance has been a major fiscal challenge for the Kyrgyz Republic and several reforms have aimed at improving taxation. In 1996, a new tax code was introduced that simplified tax legislation and procedures. In particular, import duties and excises were included in the value added tax (VAT) base, a Large Taxpayer’s Unit was established, customs administration was strengthened, greater authority was provided to the State Tax Inspectorate (STI), and the excise tax base was broadened. However, the country’s general government tax ratio at 15.8 percent in 2001 remained one of the lowest among the CIS countries where the average tax ratio was 22.5 percent (Table V-1).

Table V-1.

General Government Tax Revenue in BRO Countries, 1999-2001

(In percent of GDP)

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Sources: IMF Country Staff Reports and desk economists.

68. One of the main areas where further progress could be made is the VAT—the most significant source of tax revenue. In 2001, the VAT constituted a third of total government revenues and almost half of tax revenues. The main weaknesses of the present VAT is its limited coverage: exemptions are granted in several sectors, most notably in agriculture which accounts for 35 percent of GDP. Moreover, agricultural processors buying inputs from exempt agricultural producers are entitled to credit on those purchases at a rate of 3 percent.18 Therefore, one of the main recommendations of the two previous Fund tax policy technical assistance missions (March 1999 and January 2002) was the removal of the VAT exemption on sales of large agricultural producers, along with the associated VAT credit for food processors.

B. Tax Structure in BRO Countries

69. After the dissolution of the U.S.S.R., new independent states established their own tax systems. Initially, the new tax laws in most states resembled the laws of the former Soviet Union, but gradually tax systems diverged. While the tax rates, threshold levels, and the number and complexity of exemptions differed, reforms in the late 1990s started to move towards reducing the tax rates (especially in profit, personal income taxes, and payroll taxation) and introducing more exemptions.19 The introduction of numerous exemptions also complicated tax procedures providing more scope for corruption. Recognizing these shortcomings, the countries took renewed steps to broaden the tax base and reform tax administration to improve compliance rates. In many countries, tax ratios improved, but on average, the share of tax revenues in GDP was lower in 2001 than in 1999.

70. The main sources of revenue in most BRO countries are the VAT, corporate income taxes, personal income taxes, and excise taxes. The VAT was generally introduced in 1992 at a single rate of 28 percent (Table V-2).20 At that time, only Latvia and Ukraine adopted preferential rates. Since then, VAT rates have been reduced to about 20 percent and few other countries introduced preferential rates (Belarus, Estonia, Lithuania, Moldova, and Russia) while others shifted back to a single rate (Kazakhstan and Latvia).

Table V-2.

VAT Rates in BRO Countries

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Sources: OECD, AMECO; IFS; LMIDB; ARBERD; and staff estimates.

All countries introduced the VAT in January 1992 except Georgia (March 1992) and Lithuania (January 1994)

Implementation Problems

71. The BRO countries have encountered several problems while implementing the VAT. Notably, compliance rates are low, tax fraud is present, and poor law enforcement and widespread tax exemptions narrow the tax base and complicate procedures. Furthermore, VAT arrears are high and poorly specified exemption laws provide loopholes for tax avoidance. Also, the system is unpredictable because of the introduction of frequent amendments including transitional or ad hoc measures to temporarily increase revenues.21 More generally, there is a clear negative correlation between perceived corruption and overall tax ratios of which the VAT is a significant part.

72. Most of these problems reflect extensive exemptions. This stems from the pervasive use of tax policy as a subsidy mechanism to specific industries and sectors rather than as a non-discretionary means to raise revenues. Such exemptions defeat the purpose of the VAT as a neutral tax on final consumption. A properly functioning VAT system should not distort the prices that consumers and producers face. Moreover, exemptions increase administrative costs, provide more opportunities for tax avoidance or evasion, introduce cascading, and weaken the VAT’s feature of self-policing.22 These, in turn, lead to low compliance and poor revenue collection.23 Indeed, the average VAT collection as a percent of consumption in the CIS countries, while already low before, declined further to 7.4 percent in 1999-2001 from 8.0 percent in 1996-1998 (Table V-3).

Table V-3.

General Government VAT Collections in BRO Countries, 1996-2001

(in percent of nominal consumption)

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Sources: IMF Country Staff Reports and desk economists.

C. Treatment of Agriculture Under the VAT

73. In many countries throughout the world, the agriculture sector benefits from a special VAT treatment. A large number of countries exempt the agriculture sector.24 The common reasons cited for exempting agriculture from the VAT include collection difficulties, distributional concerns, the need to assist the poor, tax competition, and political considerations. However, there are feasible and more effective solutions to these problems aside from VAT exemption. For example, collection difficulties are not a problem only in agriculture, but with all small traders. A common solution is to establish an appropriate threshold level to ensure that collections exceed administrative costs. Meanwhile, distributional concerns and political considerations are better advanced through targeted social expenditures that will directly benefit the poor. Moreover, as demonstrated by experiences in countries that apply the standard VAT rate to agriculture (e.g., Chile, Denmark, New Zealand, Finland, and the United Kingdom), these problems can be overcome.

74. In the CIS and the Baltic countries, agriculture is treated in various ways. These range from either assigning the standard rate to the entire sector, exempting it altogether, or applying a host of more complicated arrangements (Table V-4). For example, Estonia and Georgia apply the standard rate to the entire agriculture sector. Some countries assign a preferential rate to the entire sector (Moldova and Russia) or assign lower flat-rate schemes to small farmers (Lithuania and Latvia). Others zero-rate or exempt specific agricultural products (Belarus and Moldova). In Ukraine, the standard VAT rate applies to the sector, enterprises can keep their collections and, in addition, are entitled to credit for their inputs. Finally, some countries have exempted the agriculture sector altogether (Armenia, Azerbaijan, the Kyrgyz Republic, and Turkmenistan). Although all countries in this group have, above-average shares of the agriculture sector in GDP, the Kyrgyz Republic has by far the largest share at 35 percent (Table V-5).

Table V-4.

CIS and Baltic Countries: VAT Rates

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Prior to January 1999, primary agriculture was exempted from the VAT.

On July 1,2001, the VAT rates of 20 percent (standard rate) and 10 percent (for selected agriculture products) was unified at 16 percent Instead of paying the VAT, farmers and agricultural producers pay a specific single tax calculated based on either the value of their land or on gross sales.

Small exempt farmers are required to obtain a certificate indicating that they are entitled to the flat-rate compensation.

The agriculture sector is entitled to register for the VAT and to charge the full 20 percent cm its outputs, but is permitted to retain the amount collected. The taxpayer is also entitled to claim a credit for VAT on inputs.

Table V-5.

Share of Agriculture to GDP in BRO Countries

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Sources: IMF Country Staff Reports

D. The Kyrgyz Case

75. The Kyrgyz Republic has a standard VAT rate of 20 percent levied on domestic supplies of registered businesses with turnovers of over soms 300,000 ($6,522) per year. Exports, agriculture produce, transportation, services, gas and electricity, and supplies to the diplomatic community are taxed at a zero rate,25 Items exempted from the VAT are shown in Table V-6. Among the exempted items, the largest is the agriculture produce. Article 139(3) of the Tax Code exempts from the VAT the supply of agricultural produce grown by agricultural producers. Article 139(4) extends this exemption to farmers that process their own produce. In addition, Article 121(8) states that purchasers of agricultural produce are entitled to a VAT credit equivalent to 3 percent. In other words, small farmers’ sales and large farmers’ direct sales are VAT-exempt. Processors of agricultural produce and retail shops are not VAT-exempt, and they are allowed to deduct 3 percent of the amount of purchases as VAT credit.

Table V-6.

Kyrgyz Republic: Items Exempted from VAT

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Source: Kyrgyz authorities.

76. The agriculture sector pays three types of taxes: the land tax, the road tax (only state and collective farms) and farmers’ Social Fund contributions equivalent to the land tax rate (which may be payable in kind).26 In 2001, total land tax collected from the agriculture sector amounted to som 201 million, or 0.3 percent of GDP (2.2 percent of state tax revenue). Indirectly, the VAT covers part of agricultural produce because agricultural processors and retail shops selling agriculture products are subject to VAT. The Ministry of Finance estimates this indirect VAT collection at som 160 million, or 0.2 percent of GDP. This implies that taxes collected from agricultural produce are only 3.9 percent of total state tax revenue.

77. There are three important weaknesses in the present VAT system. The first is the foregone tax revenue from the exemption of agriculture. Since the Kyrgyz Republic is mainly an agriculture economy and agriculture is the least-taxed sector, an effective way to raise revenue is the elimination of the exemption on agriculture. The second weakness is that the current practice penalizes agricultural exports. Since the sector is exempted from the VAT, producers are not entitled to VAT credits on inputs. Imposing VAT on agriculture would provide an incentive to export as exports are zero-rated while sales to the domestic market would carry VAT. Third, there is a need to address the problem of fraudulent invoices in the VAT system.

Revenue Impact of Eliminating the VAT Exemption on Agriculture

78. What would have been the potential revenue impact of the elimination of the VAT exemption on agriculture in 2001? Three factors were taken into account: (i) the removal of the 3 percent VAT credit to agricultural processors; (ii) the increase in revenue from improving the 20 percent standard VAT rate to large agriculture producers and ‘processors’, and domestic direct sales; and (iii) zero-rating of agricultural exports. Data from the 2000 input-output table and from the National Statistics Committee (NSC) were used in the calculations. The details of the calculation are presented in Table V-7.

Table V-7.

Calculation of the Revenue Impact of Elimination of VAT Exemption in Agriculture: 2001

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Sources: Ministry of Finance, National Statistics Office, and staff estimates.

79. To estimate first the expected revenue gain from the elimination of the 3 percent agricultural credit, it was assumed that 10 percent of total agriculture produce is sold to agricultural processors.27 Assuming that 80 percent of agricultural processors use the VAT credit, the amount received by agriculture processors amounted to som 113 million in 2001. The loss of revenue of removing the 3 percent credit would thus amount to 0.2 percent of GDP.28

80. The elimination of the VAT exemption on agricultural production would increase VAT collection from direct sales in the domestic market. According to the input-output table, 9 percent of the total value of production in agriculture is exported. This amounts to 19 percent of total exports of goods. Deducting this and sales to processors from the total value of production, final direct sales of agricultural produce in the domestic market amounts to som 38 billion. Based on the input-output table, 54 percent of the value of agricultural production represents value-added. Thus, the value-added sold directly in the domestic market amounts to som 21 billion, or 28 percent of GDP in 2001. According to the NSC, about 45 percent of agricultural production comes from very small producers or household plots, and 55 percent is produced in “medium-size” and “large” farms. Assuming that only 35 percent of the “medium and large” farms’ production is above the som 300,000 VAT threshold, the taxable value-added would amount to som 4 billion. This implies that the market share of these farms is 19 percent of total direct domestic sales. The potential revenue gain from the removal of the exemption would have been som 794 million, or 1.1 percent of GDP in 2001.

81. While the removal of the 3 percent VAT credit and elimination of the VAT exemption would increase fiscal revenues, a full VAT deductibility for exporters would reduce VAT receipts. Assuming that 46 percent of the value of agricultural exports consists of production costs and 50 percent of these costs are subject to the VAT, the VAT claims of exporters would amount to som 195 million, or 0.3 percent of GDP.

82. The net impact of the above measures at full compliance would amount to 1 percent of GDP. Assuming a compliance rate of only 50 percent, the revenue increase would be 0.5 percent of GDP. However, if the domestic market share of large agriculture producers (556 farms according to the National Statistical Committee) is 30 percent instead of 19 percent and the compliance rate would be increased to 80 percent, the net revenue impact would be over 1 percent of GDP.

Estimated Revenue Impact of the VAT on Agriculture, 2001

(In percent of GDP)

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References

  • Cnossen, S. “Value-added Taxes in Central and Eastern European Countries: A Comparative Survey and Evaluation,” July 1997 (Paris, OECD).

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  • Ebrill, L., et al. The Modern VAT,, 2001, (Washington, International Monetary Fund).

  • IMF Country Reports: Azerbaijan, Belarus, Estonia, Georgia, Kazakhstan, Kyrgyz Republic, Latvia, Lithuania, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan, 1997-2002 (Washington, International Monetary Fund).

  • King, J., et al. Kyrgyz Republic: “Further Reforms of Tax Policy and Administration,” May 2002 (Washington, International Monetary Fund).

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  • Summers, V. and E. Sunley. “An Analysis of Value-Added Taxes in Russia and Other Countries of the Former Soviet Union,” IMF Working Paper WP/95/1, January 1995 (Washington, International Monetary Fund).

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  • Tait, A. Value-added Tax: International Practice and Problems 1988 (Washington, International Monetary Fund).

17

Prepared by Gilda Fernandez.

18

This VAT credit was reduced from 10-12 percent to 5-7 percent in the beginning of 2002, to the current level of 3 percent starting May 2002.

19

In Georgia, for example, 113 specific code amendments were passed on tax policy for the period 1997 to mid-2001, and frequent adjustments were made to the excise tax rates and the list of VAT exemptions.

20

Lithuania introduced the VAT only in 1994.

21

For instance, in Ukraine, since the implementation of the VAT in its present form in October 1997,2000 amendments have been introduced that has increased the complexity of the law and may have contributed to relatively high levels of noncompliance; in Armenia, ad hoc measures to increase revenue such as negotiated tax payments produced very little additional revenue.

22

One of the desirable features of the VAT is the self-enforcing mechanism which provides an incentive for purchasers to require sellers to correctly report the terms of each taxable transaction since VAT claims of purchasers should be supported by valid tax invoices.

23

Exemptions granted at an intermediate stage of production lead to cascading and result in higher revenues since part of the value-added is taxed more than once.

24

Ebrill, et al, (200 1).

25

In contrast to exemption where the trader has to pay VAT on inputs without claiming credit for the latter, zero-rating allows a trader to be fully compensated for any VAT paid on inputs.

26

In 2002, the land tax rates were: 383.7 soms/hectare for irrigated land, 75.9 soms/hectare for non-irrigated land., 263.6 soms/hectare for land growing perennial plants, 33.9 soms/hectare for hay land, and 14.1 soms/hectare for pastures.

27

Based on the input-output table.

28

This does not take into account the higher VAT credit (5 percent) to the cotton industry.

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Cover IMF Staff Country Reports
Kyrgyz Republic: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Volume/Issue:
Volume 2003: Issue 053
Publisher:
International Monetary Fund
ISBN:
9781451821413
ISSN:
1934-7685
Pages:
98
DOI:
https://doi.org/10.5089/9781451821413.002