This Selected Issues paper describes labor market trends in Belarus and the role of labor market institutions in the outcome. The paper examines the current status of the tax system in Belarus and assesses recent efforts to reform it. It argues that the current tax system in Belarus is distortionary, and that it weakens the competitiveness of the economy. The paper also provides preliminary estimates of the pass-through from the nominal exchange rate (for the U.S. dollar and the ruble) to inflation in Belarus.

Abstract

This Selected Issues paper describes labor market trends in Belarus and the role of labor market institutions in the outcome. The paper examines the current status of the tax system in Belarus and assesses recent efforts to reform it. It argues that the current tax system in Belarus is distortionary, and that it weakens the competitiveness of the economy. The paper also provides preliminary estimates of the pass-through from the nominal exchange rate (for the U.S. dollar and the ruble) to inflation in Belarus.

II. Tax Reform In Belarus11

1. The comparatively large size of government in Belarus may not be compatible with the authorities’ objective of securing rapid economic growth. This chapter examines the current status of the tax system in Belarus and assesses recent efforts to reform it. The chapter argues that the current tax system in Belarus is distortionary, and that it weakens the competitiveness of the economy. The tax system could be improved by abolishing some inefficient taxes, simplifying others, eliminating exemptions and privileges, and in some cases lowering rates. However, broader fiscal reform is needed to support the tax reform. Section A discusses the current status of the tax system in Belarus; section B suggests ways to improve the design of the tax system in the context of the broader reform agenda; and section C concludes.

A. Overview of the Tax System in Belarus

Revenue performance

2. Since independence, Belarus has maintained revenue collection at levels close to those of Soviet times, avoiding in the process the sharp revenue decline characteristic of most countries in the initial transition period. However, it also reflected the pattern of general economic transition and delay in reforms of a predominantly state-owned economy. Relatively high levels of tax collection also removed the need to reform public expenditures.

3. The ratio of general government revenue to GDP in Belarus is the highest among the CIS countries. At around 45 percent of GDP on average in 1999–2003 (Table 1), it is also very high when compared with most other transition economies with a similar level of income. Tax revenue—including the taxes of the social protection fund and several other earmarked budget funds—averages almost 43 percent of GDP. Some off-budget funds, such as innovation funds, are not included in general government revenue, but are estimated at about 2 percent of GDP.

4. Changes in the structure of taxes in recent years have reflected the worsening financial situation of the enterprise sector. In particular, weak performance of enterprise profit taxes has been compensated by stronger performance of both taxes on labor and of indirect taxes. The favorable performance of taxes on labor has reflected repeated administrative increases in wages, as well as social protection fund contributions (also a tax on labor), while weak profit taxes resulted from the worsening enterprise finances. (The number of loss making firms has fluctuated between one third and one half of industry for several years.)

Belarus: General Government Revenue, 1999-2003

(in percent of GDP, unless otherwise indicated)

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Including budget earmarked funds and not including innovation funds.

Source: Ministry of Finance, SPF, and IMF staff estimates.

Current status of the tax system

5. Belarus has undertaken several important tax reforms in the past decade. These include introducing the credit-method VAT, improving the excise tax law, simplifying the corporate income tax, and strengthening tax administration. Current tax legislation is comprised of laws, presidential edicts and decrees, government resolutions, and instructions related to different types of taxes and their application.12 Unlike many countries in the region, tax compliance is satisfactory in Belarus; tax administration and enforcement are adequate.13

6. To modernize the tax system, the authorities have been introducing a comprehensive tax code. They are doing so in stages, beginning with the adoption of the general part of the tax code effective January 1, 2004. It unifies the concepts and definitions used across different pieces of legislation. It also creates the framework for the introduction of the special part of the tax code that will stipulate changes to laws governing individual taxes. While a draft of the special part was presented to the Council of Ministers in January 2004, its adoption is not expected soon. Moreover, some provisions of the general part are currently suspended as they contradict existing tax laws and regulations. It is expected that they will be enforced together with the special part of the tax code.

7. In the meantime, the authorities have implemented a number of changes to the existing tax system aimed at reducing the overall tax burden. The key change is a reduction in the standard VAT rate, meant to harmonize the rate with that applied in Russia (Box 1). According to the authorities, VAT revenue is expected to decline by about 1.3 percent of GDP in 2004.

Tax Policy Changes in 2004

Effective January 1, 2004, the authorities introduced the following major changes to the existing tax legislation:

1. The maximum VAT rate was decreased from 20 percent to 18 percent. Zero rating for transit services (important for gas transit) was eliminated, increasing the rate to 18 percent. However, the preferential 10 percent VAT rate was not abolished, and its coverage (mainly in agriculture and in goods consumed by children) did not change.

2. The turnover tax burden was reduced from 4.5 percent to 4.15 percent. These turnover taxes are earmarked in the following way:

  • 0.4 percent for special local housing-investment funds (down from 0.5 percent in 2003);

  • 0.75 percent for the housing maintenance fund (down from 1 percent in 2003);

  • two percent for the republican agriculture support fund (instead of one percent to the republican agriculture support fund and one percent to local agriculture support funds in 2003); and

  • one percent for the road fund (unchanged).

3. The preferential profit tax rate of 15 percent for SMEs was abolished in favor of the standard rate of 24 percent. Exemptions granted to housing construction were also abolished.

4. Some preferences on the real estate tax were removed for scientific activities that are not financed by the budget.

5. A new tax on sales of gasoline and diesel fuel was introduced, not exceeding 10 percent.

8. The treatment of some components of the tax base in Belarus differs from that in most countries, and adds to the complexity of the system. Some provisions in the tax legislation in Belarus contribute to higher tax collections. For instance, business expenses face particularly restrictive treatment under the profit tax, as do capital expenditures under the VAT. At the same time, other provisions, such as tax holidays for some categories of taxpayer and a number of individual concessions, offset these gains.

Taxes and growth

9. There is evidence to suggest that the structure of a country’s tax system can have a significant influence on growth.14 Although the tax structure varies among countries depending on their level of income, tax policy can affect long-term growth performance by promoting neutrality, eliminating distortions, and contributing to physical and human capital accumulation. For example, emphasizing taxation of consumption relative to labor and capital could be supportive of growth, insofar as it shifts the tax incidence away from investment and employment.

10. The economic structure of taxes in Belarus has been relatively stable in 1999–2003, with taxes on labor continuously playing a significant role. The hike in the incidence of taxes on labor during 2001 and 2002 reflects high administrative increases in wages at that time. The increase in the share of capital-related taxes in 2003 is mainly due to the relatively strong performance of the property tax.

Belarus: Tax Structure in 1999-2003

(in percent of total)

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Source: Ministry of Finance, SPF, and staff estimates.

Turnover taxes are levied on consumption or capital, depending on the taxpayer’s nature of business.

11. The Belarusian tax system is characterized by several types of taxes that have generally been abolished in neighboring transition countries. In addition to turnover taxes, these include the emergency payroll tax and a number of extrabudgetary innovation funds (with rates from 0.25 percent to 20 percent of production costs). These levies add to the overall tax burden, undermining enterprise finances and discouraging investment.

12. Many Belarusian tax policies and their application are highly distortionary. The rates for some taxes, including in particular the profit tax, are differentiated among different sectors or enterprises depending on their profitability or social importance. As a result, the better performers pay higher tax rates than poor performers, distorting incentives for improving efficiency and, hence, the allocation of capital. Turnover taxes are very problematic as well.15 Another-highly distortionary element is tolerance by the state of different types of tax arrears and non–payment. Tax exemptions, deferrals, rescheduling, and forgiveness applied to individual enterprises or whole sectors (for example, agricultural production) are widespread.16 As of end–2003, tax exemptions and deferrals reportedly amounted to Blr 588 billion (1.6 percent of GDP), including Blr 226 billion (0.6 percent of GDP) in deferred taxes. In addition, at end-2003, tax arrears equaled Blr 456 billion (1.3 percent of GDP), including Blr 206 billion (0.6 percent of GDP) in arrears to the Social Protection Fund.

13. Instability of the legal system in Belarus contributes to the distortionary character of tax policy, as firms’ ability to plan their activity is undermined. Moreover, instability in the tax system results in high compliance costs, as enterprises continually need to keep up with changing and complex tax legislation by hiring accountants, consultants, and lawyers. This burden is particularly important for small and medium-sized enterprises (SMEs).

14. Finally, widespread use of quasi-fiscal activities in Belarus effectively adds to the tax burden on enterprises. Besides the taxes officially levied by the state, many enterprises—both public and private—are required to participate in a variety of activities in the interest of the state. For example, these activities include (but are not limited to) the following:17

  • Enterprises are required to maintain on their balances units that provide social services, including housing, childcare and medical services;

  • Oil refineries have been instructed to provide energy resources to agricultural enterprises for the sowing and harvesting campaigns; and

  • Some ministries and departments assess fees and levies for their services that are not recorded in the budget.

Harmonization with Russia

15. Belarus is seeking to harmonize its tax policy with that of Russia in the context of a broader agreement on creation of a currency union, and possibly a union state. The Belarusian authorities acknowledge the need to reduce the tax burden to improve the competitiveness of the Belarusian economy relative to that of Russia, where significant tax reforms have been introduced, including by lowering nominal rates, broadening tax bases, and simplifying the tax system.

uA02fig01

Revenue structures in Belarus and Russia

(In percent of GDP, 1999-2003 average)

Citation: IMF Staff Country Reports 2004, 139; 10.5089/9781451805086.002.A002

Source: Ministry of Finance of Belarus, Ministry of Finance of the Russian Federation

16. However, to date, tax harmonization has not progressed very far. In August 2000, Russia and Belarus agreed on a process to create a body of unified tax legislation. The action plan adopted at that time envisaged convergence of the list of taxes, unification of tax principles and definitions and introduction of a unified tax code. However, implementation of this plan has been delayed. While favorable oil prices have facilitated the implementation of sweeping tax and fiscal reforms in Russia, lack of structural reform and high expenditure commitments have left Belarus lagging behind in most areas.

17. The Russian tax system relies relatively more on direct taxes, while Belarus depends more on payroll and turnover taxes. Russia has introduced a flat 13 percent rate on personal income tax, while in Belarus, PIT rates range from 9 percent to 30 percent. Excise tax rates differ for some goods, but import and export duties have broadly been harmonized. Turnover taxes and innovation funds do not exist in Russia. Moreover, Russia has moved to the destination principle for assessing VAT liability in trade with all CIS countries except Belarus, though discussions are now underway on shifting to the destination principle (except for energy) between Belarus and Russia as well. To support the competitiveness of Belarusian goods, the authorities have granted tax privileges to Belarusian enterprises and sectors of the economy.

uA02fig02

Tax structures in Belarus and Russia, 1999-2003

(in percent of total tax revenue)

Citation: IMF Staff Country Reports 2004, 139; 10.5089/9781451805086.002.A002

B. Tax Reform Challenges in Belarus

18. The authorities in Belarus hope to promote rapid economic growth and to level the playing field in trade with Russia by introducing a number of tax reforms, mainly in the context of the specific part of the tax code. Currently, the tax burden in Belarus seems excessive by comparison with other transition countries (Box 2). The main priorities are to decrease the tax burden by lowering rates and abolishing some taxes, while expanding the tax base by eliminating ad hoc concessions and exemptions. In particular, tax accounting of expenses, depreciation, and capital spending needs to be brought in line with international practice. Taxes that rely on tax bases largely overlapping with those of internationally accepted taxes (mainly turnover and some payroll taxes), should be abolished. Finally, simplifying the tax system and reducing the number of taxes would reduce compliance costs.

How Large Should the Tax Burden Be for Transition Countries?

A recent World Bank paper argues that transition economies should target tax revenues at about 22 percent to 31 percent of GDP, depending on the country’s stage of development. For most countries, the paper recommends an increase in the share of direct taxes, especially of personal income taxes, and in most cases a cut in high marginal tax rates, elimination of tax exemptions, and simplification of tax systems. The suggested benchmark structure is based on broad efficiency considerations and consistency with the structure of public expenditure for countries at comparable income levels.

Benchmark Levels and Composition of Tax Revenue for Transition Countries

article image
Source: Mitra and Stern (2002)

Adjusted downward by one percentage point from 7-8 percent for inexperience with this complex tax.

19. Priority steps to improve individual taxes in Belarus include the following:

  • Turnover taxes and taxes for innovation funds should be repealed, albeit phased over a reasonable time period in order to introduce measures to offset the revenue loss;

  • Excise tax rates on a number of commodities (including alcohol, tobacco and fuel) should be increased for revenue and social policy considerations. In most cases, ad valorem rates should replace the existing specific rates;

  • Corporate income tax rates should be unified, with the possible exception of those applying to SMEs. Tax holidays and reduced rates for specific enterprises or sectors should be eliminated, including for the free economic zones. Accounting for tax and balance sheet purposes should be reconciled. Special relief for reinvested profits should be replaced by improved provisions for depreciation. Discretionary disallowances for some business expenditures should be reviewed, taking international practice into consideration. The treatment of losses should be harmonized with international practice by allowing them to be carried forward against future profits;

  • The reduced VAT rate and exemptions for education, medical services, religious activities, banking and financial services, and gambling should be eliminated on grounds of simplicity and transparency. VAT refunds should be paid in full on fixed and intangible assets (rather than spreading refunds over 12 months, as at present). The accrual method of VAT accounting is recommended for both purchases and sales of goods. Special rules that presently govern the prices used for assessing VAT liability should be reviewed; and

  • Personal income tax rates could be reduced from the current five-rate structure to two brackets, since the overwhelming majority of taxpayers (around 99 percent in 2001) pays the basic rate of 9 percent. At the same time, the base rate could be increased modestly to reduce disparities between the corporate and personal income taxes.

20. Measures to offset the revenue loss because of rate cuts and elimination of certain taxes are crucial for the success of the proposed tax reform. These measures could include streamlining public expenditures, abolishing many quasi-fiscal activities, and improving tax administration still further. In the medium term, social security and public administration reforms need to be undertaken to make the overall fiscal stance sustainable.

C. Conclusions

21. The tax burden is relatively high in Belarus, undermining the authorities’ objective of rapid economic growth. In addition, the tax system is overly complex, meaning that compliance costs are high, further undermining competitiveness. Tax reform is needed in the context of broader structural reforms to improve the business environment, reduce pressure on enterprise finances and encourage investment. However, significant expenditure rationalization will be needed in order to finance reduction in the tax burden.

References

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  • World Bank, 2003, “Belarus: Strengthening Public Resource Management,” Report No. 26041-BY.

11

Prepared by Veronica Bacalu

12

Chapter V of IMF Country Report 03/119 describes in detail the status of the tax system. With minor exceptions (noted in Box 1 of this chapter), the tax system is largely unchanged since then.

13

However, there is some evidence to suggest the grey economy in Belarus is rather large (Schneider, 2002), implying that tax administration may have room for improvement

15

In a survey (Rakova 2003), respondents identified turnover taxes as one of the most problematic aspects of the tax system, followed by the profits tax social security contributions and local taxes.

16

For example, the Presidential Decree #138 of March 22, 2004 granted agricultural enterprises debt rescheduling for all debts, including tax arrears, till 2009.

Republic of Belarus: Selected Issues
Author: International Monetary Fund
  • View in gallery

    Revenue structures in Belarus and Russia

    (In percent of GDP, 1999-2003 average)

  • View in gallery

    Tax structures in Belarus and Russia, 1999-2003

    (in percent of total tax revenue)