Toward the New Tax Code

Correcting the mistakes of past years is often very difficult, and sometimes even politically costly. When the state introduces benefits or concessions, or creates inequality among entrepreneurs, it does so less for the country's economic benefit than to win political support, and that support has a very short-lived effect. Such decisions are hard to reverse later. Individual economic actors, who do not grasp the broader economic processes, receive certain benefits, but the damage to the country's development is severe: someone appears to gain from these privileges and to save money, yet the system as a whole fails to develop and stalls. Cheap gasoline and cheap utilities, for example, are seen by everyone as a gift from the state. In practice they lead to worn-out infrastructure, an inability to expand production and falling revenues, and eventually to a sharp rise in tariffs, needed to repair breakdowns and simply to keep companies alive. Many countries have been through this.

Artificial barriers in the form of tax breaks for small businesses do not foster the growth of SMEs. They lead to the fragmentation of businesses and hold back the institutional growth of small firms into medium-sized and large ones. That lowers labor productivity across the economy and therefore slows economic growth and the growth of household incomes. This is why the view from the macro level will always differ from the view from the micro level when a decision is made.

Over the past 20 years, our tax system has made every possible mistake under the pressure of populist decisions, which has thrown our financial system badly out of balance. Reversing all the benefits that are harmful at the macro level will now take years of determined decision-making. The adoption of the new Tax Code can be called part of a victory for common sense, but only part: not everything has been fixed. I expect that later amendments will bring more common sense to various parts of the Code. Below are brief comments on the main changes; I agree with some and disagree with others.

The increase in the VAT rate to 16% is more of a compromise. Without oil revenues, the state budget is so badly unbalanced that it is simply impossible to solve the problem without raising the rate of the main tax. My own calculations showed that the rate should have been around 20%. But everyone understands that this would be painful: it would have a large one-off effect on inflation, and we also have a huge number of VAT exemptions. States with high social spending, and we are one of them, usually have very high tax rates. Most European countries, for example, are welfare states, and their rates are extremely high, because tax is a mechanism for redistributing income. When Kazakhstan cut the VAT rate to 12% some years ago, it led to cuts in social and infrastructure spending and to complete dependence on oil prices.

The retail tax now applies only to retail. It was the introduction of reduced rates for small business that led to the wholesale fragmentation of businesses and to the creation of huge tax-avoidance schemes. The point of the retail tax was never to lower the tax burden but to simplify tax calculations for SMEs. Under lobbying pressure, however, medium-sized businesses operating in the B2B segment began to split up and reduce their tax payments. This not only cut tax revenues but also created barriers to medium-sized businesses growing into large ones. The retail tax also produced unfair competition: large businesses could not fragment in the same way and so paid more than other players, which was a strong disincentive. Now the retail tax will apply only to retail, with a high threshold of KZT 2.4 billion. This should create more or less equal conditions for entrepreneurs and remove their ability to optimize taxes through the B2B segment.

The VAT threshold of KZT 40 million. I was trained as a tax specialist and understand how VAT works. For businesses in the B2B segment, VAT should be added on top and then deducted further down the chain, so that the net effect is zero. Those in retail are covered by the retail tax, with its KZT 2.4 billion threshold, and pay no VAT. But because of the large number of exemptions and preferences, the very paradigm of VAT has changed considerably: VAT did not reach the retail stage, chains were broken, and huge schemes for optimizing VAT payments emerged, including for cashing out. So the KZT 40 million threshold is also more of a compromise than a solution to the problem. I think that once a retail tax with a high threshold is in place, and with a low threshold for the general regime, even KZT 40 million will become a much less significant problem. In the early stages, though, businesses will keep fragmenting in any case.

The introduction of VAT prepayment. I have looked into this subject in considerable detail. The Ministry of Finance is trying to solve not only the problem of replenishing the budget but also that of setting up a VAT refund process for exporters, which is one of the most important tasks for stimulating the economy. At present the process is very complicated and corrupt, and it takes enormous effort to administer. VAT prepayment should eliminate entirely the building of "pyramids" to obtain VAT refunds, and anyone who has ever claimed a VAT refund knows what that means. The budget works on the principle that the state refunds only VAT that has actually been paid into it. Previously, invoices were issued against which VAT was offset, but someone in the chain might not pay, for various reasons: no money, a fly-by-night company, bankruptcy and so on. Tax officials built pyramids to trace this, and if non-payers turned up in the pyramid, the exporter was not refunded that amount. Technically it is not the exporter's problem, since he cannot influence a subcontractor, but the state is also right in a sense not to refund what was never paid. The new system works so that a company with no VAT balance in its personal account cannot issue an invoice, which fully solves the problem of pyramids and VAT non-payment. To protect honest entrepreneurs, so that they do not have to tie up their money in prepayments, I think the system needs further refinement: through risk management systems (SURs), honest taxpayers should be granted tax credits; prepayments should be replaceable by bank guarantees; and VAT should be paid monthly.

The higher CIT for second-tier banks. I have written about this many times and will not repeat myself. I will only say that creating unequal conditions for business entities leads to tax optimization, and the banks will actively use it. The root of the excess profits lies in regulation and was created by the state itself. Instead of correcting the regulatory distortions, the state is fighting distortions by creating new ones. Everyone knows that the ban on paying interest on current accounts and the caps on interest on foreign-currency deposits bring the large second-tier banks trillions in profits. A higher CIT rate will lead to further concentration in the banking sector, because large banks will be under less pressure than small ones.

The inclusion of residential property in the VAT base. On the one hand, everyone understands that the construction industry generated the most VAT schemes and VAT optimization. On the other hand, one must understand that the primary housing market competes not only within itself but also with the secondary market, where no VAT is paid. This will undoubtedly put pressure on the primary market, and it will raise the risks of a shadow market in which apartments are sold at double prices. For nationwide labor productivity to grow, we need urbanization and incentives for people to move from villages to cities, which requires big cities to grow. That in turn requires a steady rise in housing completions, and VAT on housing will act as a brake. I am not sure how justified that is.

The progressive PIT system is the right measure, and most developed countries use progressive taxation. One "but" is needed, however: a progressive system must work together with tax deductions that encourage people to spend money inside the country, such as deductions for mortgage interest, for the cost of a first home, and for medical treatment and education. We have not yet introduced these, and all of it still requires detailed study and consideration.

The new Tax Code contains many other new initiatives; I have noted the most significant ones, which will affect the country's economy. Overall, one must understand that the new Tax Code is a big step forward, though largely a forced one, and there is still a great deal of work to be done to refine it, remove inaccuracies, clarify business processes and find errors.