Proposals on VAT and Progressive Personal Income Tax

Note: This is a 2015 position, written when the budget was in surplus; the author later came to advocate abolishing VAT exemptions.

Every market economy has a set of instruments for managing macroeconomic processes. One of them is the state's fiscal policy. By adjusting the tax burden, the government pursues several objectives that sometimes do not correlate with one another in the short term.

Forming the national budget.

The state finances its expenditures mainly through taxes. Tax revenue is therefore driven by two factors: the tax burden and the tax base. In a crisis the tax base shrinks, and the state does not receive its full tax revenue. At such times the government usually tries either to broaden the tax base or to raise the tax burden. Broadening the base is a difficult task, so here the authorities chose the path of least resistance and set about raising the tax burden.

Regulating the country's macroeconomic indicators.

Through fiscal policy, the state influences business activity. When the tax burden falls, it benefits companies and stimulates economic growth. When growth is very strong, the state should, as a rule, raise the tax burden to rein it in, thereby withdrawing part of the profit for the future and then using it during a downturn or stagnation.

Zharas Akhmetov and I have now decided to collect our scattered work on the country's economy into a single document. We will see what comes of it.

On taxes, for example, I have several proposals that Zharas and I will discuss.

Here are some of them, which in my view are more rational than the innovations proposed by the government's economic bloc.

Value-added tax (VAT).

VAT is an indirect tax, and in essence it is paid by the end consumer and only within the country. If goods are exported, the VAT paid on purchases of goods and services must be refunded from the budget, since exported goods should not be subject to VAT. The state is reluctant to refund VAT, because the refund process is open to many schemes for illegally reclaiming VAT that suppliers never paid. Although such cases account for a small share, the state uses them as a pretext not to refund VAT, or to delay refunds as long as possible, relying on reconstructions of the supplier chain (the so-called pyramids) and the conjectures of tax inspectors. In a country that wants to build an export-oriented economy, VAT refunds should be an important and well-functioning mechanism, because bureaucracy in this area makes life considerably harder for exporters.

There are several problems here. The first is control over VAT payment along the chain by all suppliers of goods, works and services to an exporting company. The second is that during the investment phase companies accumulate substantial VAT, which they recover very slowly, whereas exporters claim a refund as soon as the conditions for it are met. In 2014, it is true, amendments were made allowing VAT on the construction of production buildings and structures to be recovered over 5 years.

To solve the first problem, the question of control over VAT payment must be resolved. This is a very complex issue that requires detailed study.

But it seems to us that the logical step would be to require every VAT payer to hold a separate VAT bank account, into which the counterparty pays the VAT amount. In other words, when a company sells goods or services to another company, the principal amount goes to one account and the VAT to a separate one. From that account the VAT payer can pay VAT to another counterparty or remit it to the state. This is a very complicated mechanism, but it fully resolves the problem of VAT cash-out schemes and gives complete control over these funds. In retail sales, VAT is paid by the company, and the tax authorities would only need to establish control over retail sales. This procedure would also make VAT refunds much easier.

As for investment VAT, it should be allocated in proportion to the depreciation of the fixed assets concerned, so that it is recovered only over the depreciation period. This seems more correct than claiming the full amount for refund immediately.

The taxation of loan interest is a pressing issue. Under the current Tax Code, when companies lend to one another they must pay VAT on the interest, and if a company grants an interest-free loan, a notional income is imputed and VAT is also charged on it. This rule completely stifles intra-group development and the financing of subsoil users, for whom it is very difficult to simply increase capital. With second-tier banks restricting lending and the stock market dead, businesses have to devise various schemes, such as borrowing from a second-tier bank against a cash deposit or using assorted investment agreements. All this holds back investment activity in the country and prevents companies from investing normally. We believe that interest income on loans should be exempt from VAT, at least between related parties, and that the question of simplifying bond issuance on the stock market should be worked out.

Agriculture should be one of the drivers of the country's economic development. The problem is that large producers compete with markets and traders who buy most of their produce from the public without VAT and resell it at markets, while large producers must sell with VAT. Moreover, in order to compete, many agricultural enterprises operate in the shadows, understating their actual harvest to save on taxes. It is difficult to track the real harvest, and therefore difficult to monitor retail sales of agricultural products. The best option would be to cut the VAT rate to at least 6% for the agro-industrial sector and food production. This would stimulate the sector and help curb the shadow economy.

Reforming the taxation of personal income.

Currently in Kazakhstan personal income is taxed at a flat rate of 10%. That is a fairly low level of taxation, but there are also mandatory pension contributions and the social tax. In the near future, pension contributions will be raised by 5 percentage points and mandatory medical insurance will be added. In total, roughly 40% of each employee's net income will go to these charges. That is already quite high and noticeable, and it will encourage the shadow economy.

At the same time, individuals have practically no deductions to reduce their taxable income.

Why do Western countries use a progressive tax scale?

There are many reasons, but one of them is that above a certain level of income, individuals save the money rather than spend it. So by lowering the burden on low earners and raising it on high earners, we get roughly the same budget revenue while stimulating consumption among lower-income groups.

It is also much easier to monitor high earners, since there are far fewer of them than low earners.

So, strange as it may sound, I would recommend creating a progressive tax system with more deductions that can reduce the taxable base for personal income tax (PIT). This would stimulate consumption and raise the incomes of lower-income groups.

Deductions should definitely be introduced for the purchase of real estate, mortgage interest, vehicles and education, and the tax-exempt income threshold should be raised.

The progressive scale must be cumulative, with the higher rate applied only to the incremental portion of income.

All this fits well with the introduction of universal income declaration.