On the 2025 Tax Reform

A new Tax Code is due to be adopted in 2025, and I am often asked for my views on the proposed reforms. From the standpoint of an individual or a business owner, any tax increase is naturally perceived negatively, since it affects short-term well-being. But it is important to examine the issue from a macroeconomic perspective.

The problem on the spending side

The budget deficit already stands at KZT 10 trillion, and revenues are growing much more slowly than expenditures. An analysis of the structure of budget spending reveals a key problem: there is virtually no development budget. Most spending goes to social and current needs. This does not mean that spending cuts are unnecessary; on the contrary, they are needed. However, a review of budget requests from all government bodies showed that the initially requested amount was KZT 50 trillion. After optimization and the postponement of lower-priority expenditures, it fell to KZT 32 trillion, and then to KZT 25 trillion through strict prioritization. This shows that simply cutting costs inevitably shifts resources toward other critically important areas. The state needs to improve its budgeting and control system, and this process must be continuous. But it is important to understand that current spending needs far exceed available budget funds, and the scope for increasing them is limited by the budget rule.

A deficit of KZT 10 trillion is an enormous sum, equal to 67% of the country's total revenues. Meanwhile, Kazakhstan still has many unresolved problems: a shortage of schools and hospitals, and outdated, worn-out infrastructure. About 400,000 children are born in the country every year, equivalent to the growth of an entire city. This requires substantial investment in social and educational infrastructure, yet the development budget is practically nonexistent. That is why we see schools operating three shifts, a shortage of places in kindergartens, and overcrowded hospitals. Without investment in development, it is impossible to ensure sustainable economic growth and a better quality of life.

The investment problem

Attracting investment, especially in manufacturing, requires substantial spending on infrastructure, which is currently lacking. In recent years, investment, particularly foreign investment, has fallen significantly. Building large plants and factories requires power grids, water supply, sewerage, roads and railways, housing and other infrastructure. This task falls to the state: if it does not create the basic conditions, business cannot simply show up and build a plant in an open field.

A good example is the Almaty Industrial Zone. When it was launched in 2016, we were the first company in the zone. Today there are no vacant sites left there, because the city provided all the necessary infrastructure, which attracted business. Many more industrial zones like this are needed, but their development is held back by a lack of funds.

This is one example, but the problem is systemic. Limited revenues prevent the state from investing in development at the required level. Without such investment, private capital cannot be attracted, because conditions must first be created in which business can operate efficiently and invest in the country's economy.

The problem on the revenue side

When it introduced a large number of tax breaks and preferences, the state was counting on the Laffer curve, according to which a lower tax burden should have broadened the tax base. In fact, the opposite happened: the share of tax revenue in GDP is steadily falling, while government spending continues to grow.

Budget revenues can grow either by expanding the tax base or by raising the tax burden. Expanding the base takes considerable time, at least 10 years, because it requires economic growth. So while broadening the tax base is necessary, it does not solve the current deficit problem, which means that raising the tax burden remains the only quick solution.

Kazakhstan's economy is a developing one, where a significant share of tax revenue comes from indirect taxes. In developed countries such as Switzerland, VAT is 8%, but income tax can reach 50% thanks to high household incomes. In Kazakhstan, the main sources of revenue remain VAT, CIT and PIT. Raising CIT and other income taxes would reduce the scope for reinvesting profits, and CIT remains difficult to administer, especially given the many loopholes for tax avoidance. PIT in Kazakhstan is paid largely by low-income earners, so a further rate increase would erode their purchasing power. A progressive scale is possible, but its effect on budget revenues would be negligible.

Thus, VAT remains the only tax capable of bringing in an additional KZT 5–7 trillion. The question is what rate it should be raised to. This requires precise calculations based on estimates of revenue from a range of initiatives: a change in the tenge exchange rate, which would increase tax receipts from subsoil users; liberalization of fuel and lubricant prices, which would raise excise and CIT revenues; a review of the taxation of government securities; higher rates for the gambling business; better tax administration; lifting the ban on paying interest on current accounts; and so on.

In addition, we should consider introducing an inheritance and gift tax on amounts above USD 1 million and including it in PIT, which is standard practice in developed countries, since assets received are in essence income. We should also revisit the taxation of subsoil users and apply international experience with royalty systems, which would bring low-profitability deposits into production. We should also consider the American approach to taxing criminal income, including corruption proceeds.

All these measures could bring in an additional KZT 2–3 trillion, after which the optimal VAT rate needed for a balanced budget can be determined. By my estimates, the rate will fall within a range of 16–18%.

On the tax reform, PART 2

The current tax system does not fully meet the principles of fair taxation. If different tax regimes, with elements of discrimination, are allowed within a single sector, this is not only unfair but also seriously holds back economic development.

The state's main task is to encourage the growth of medium-sized and large enterprises. Small businesses should have an incentive to grow to medium size, and medium-sized ones to aim for the large category. But the current tax system creates the opposite incentives: medium-sized and large companies prefer to split up, because small businesses receive significant tax preferences.

This trend is especially visible in the statistics: the number of small enterprises is growing rapidly, while medium-sized and large businesses are stagnating. Until 1 January 2021, the number of small and medium-sized enterprises (SMEs) remained at 1.3 million. But after COVID-era benefits were introduced for SMEs, sharp growth began: by the end of 2022 their number had reached 1.8 million, and today 2.3 million are registered. The growth has come specifically from small enterprises, while the number of medium-sized businesses has hardly increased.

The root of the problem is unequal competitive conditions, which put medium-sized businesses at a disadvantage relative to small ones. Unless these imbalances are eliminated, it will remain hard for companies to move up to the next level.

For example, suppose you own a large restaurant that falls into the medium-sized category and you pay all your taxes in full, and three cafés operating under a special tax regime open next door. Your business becomes uncompetitive. The difference in tax burden forces large enterprises to split up, dividing a restaurant into formally independent business units (bar, kitchen, VIP area, etc.) to qualify for preferential tax treatment. That is why it is critically important for the tax system to ensure horizontal equalization of the burden within a single sector. Moreover, when large and medium-sized businesses break up into small ones, it greatly hinders the creation of institutionally strong large companies and their growth: administering a large number of enterprises becomes complicated, and effort goes not into raising competitiveness and efficiency but into finding ways to optimize and reduce tax payments.

From the standpoint of economic expediency, the costs of tax administration should be optimal for both the state and taxpayers. Small businesses do need simplified regimes, but the point of these regimes should be not to lower the tax burden but to make administration easier and cut accounting costs. Ideally, the tax burden should be uniform across the whole sector, and micro and small businesses should be given the right to choose a simplified system based on turnover or imputed income (a patent).

Unfortunately, in Kazakhstan tax breaks have become not a tool for simplifying administration but, in effect, a mechanism for reducing the tax burden. Yet their introduction has not increased gross value added (GVA) or solved the problem of entrepreneurship development.

Another serious problem is grey imports, which obstruct the development of local producers and formal retail chains. The cause lies not so much in customs duties, since these go into the common EAEU budget and are then redistributed among member states (Kazakhstan's share is about 7%), as in the fact that grey imports are not subject to VAT on entry and are then sold within the country through various schemes.

The problem is especially acute because of the uncontrolled flow of goods through Kyrgyzstan. Since there are no customs posts within the EAEU, imports go through the countries where customs clearance is easiest and cheapest. Russia suffers most from this, but Kazakhstan is also affected: once goods enter the country, they "dissolve" and go on to the bazaars.

To remove this imbalance, VAT must be paid at every stage. Even if goods are brought in through grey schemes, the seller must pay VAT when selling them. This would eliminate arbitrage schemes and close the loopholes that allow tax avoidance.

Abolishing tax breaks and raising tax rates is a difficult and painful process, and it meets resistance. Most entrepreneurs evaluate the system in terms of current profitability and profit, not from the standpoint of macroeconomics and long-term sustainability. But without a systematic approach to reforming tax policy, it is impossible to create the conditions for balanced economic growth.