The Budget and Oil: Myths About Diversification and What to Do

Note: this text was written in 2016. The argument for cutting taxes on SMEs during a crisis reflects the views held at that time; the author later advocates abolishing thresholds and special tax regimes.

On the exchange rate, fiscal policy and more (Part 1)

On the Budget

As promised, I am setting out my view of the current situation with the budget, the exchange rate and taxes.

Let us start with the budget. It is no secret that Kazakhstan's state budget depends entirely on oil prices. In the best years, 2011 to 2014, direct taxes from the oil sector made up about 50 percent of all tax and customs revenue. Add the taxes paid by all contractors and payroll taxes, and the share grows even larger. In other words, today the entire economy outside the oil sector can finance only about 50 percent of the budget.

This dispels several myths at once:

1. Myth 1: oil revenues do not shape the state budget. They do. They do so through earmarked transfers from the National Fund, and other projects are also financed from the National Fund under the guise of purchases of state-company bonds. The difference is that the bonds are recorded as assets, so we do not see them as expenditures. These are ordinary bonds in the National Fund's portfolio.
2. Myth 2: industrialization programs are moving us away from oil dependence. They are not; on the contrary, they are pulling us in deeper. Once oil revenues, even at peak prices, no longer delivered the tax receipts that were needed, an export customs duty was introduced, and it was used to finance the budget. Counting all revenues, the budget deficit in 2015 was about 20 percent. And even the devaluation did not help much.

We need both short-term and long-term programs. There is no point talking about developing human capital when you have nothing to pay salaries with. So what matters now is short-term, operational measures, with the right long-term measures developed in parallel.

We talk about long-term measures constantly and at length, so I will not write about them here: developing education, human capital and so on.

What should be done on the operational level?

The government has clearly chosen the easiest option: a weak tenge, higher tax rates and better tax collection. This option works only in the short term and can never serve as the basis of economic policy.

Inflation will catch up with the falling exchange rate, and the currency will have to be devalued again. This will keep happening, but more on that later. Higher rates will eventually shrink the tax base, and we will gain nothing while the economy is discouraged.

In such situations the only way out is to widen the tax base by stimulating the economy.

Whatever people say, our base is the oil sector, and even with prices falling it is still the only profitable industry. Judge for yourself: with a production cost of around $25–30 per barrel and a price of $50 per barrel, the country earns a margin of 70–100 percent. Show me a single industry in Kazakhstan with such a margin. At $50, investors will come to us, and they will come to subsoil use and only to subsoil use.

There is no need to reinvent the wheel in the current situation. We need to stimulate investment in oil production and increase output. What is happening instead? Exactly: for the past 3–4 years production has been steadily falling, and investment in the industry is falling too, for one mundane reason: there is no proper regulation of this industry. Create normal, workable conditions in subsoil use and investors will come back. Any investment in the oil sector will pull along related industries such as oilfield services and construction.

We need to develop mid-sized fields in particular, so that we do not end up dependent on large companies. Did you know that Tengizchevroil accounts for 20 percent of tax revenue? Show me a single country where 20 percent of the budget depends on one foreign company.

What needs to be done?

1. Build a proper tax system and return to the practice of tax stability. Investors want a sound and fair system. The principle is very simple: determine the maximum return for foreign investors and take everything above it in taxes. This is easy to do. Next, to encourage domestic refining, grant tax incentives specifically for oil refining. To encourage purchasing from local producers, apart from a notional discount, one can offer VAT exemption when Kazakhstani goods, works and services are used. Roughly speaking, the investor does not tie up funds when buying from a Kazakhstani producer.
2. Put subsoil use in order: simplify permitting documents, simplify the provision of collateral (which is critical for investment), and remove the dependence of one ministry on another. The simplest way is to create a separate Ministry of Subsoil Use. Everything is currently heading toward solid minerals being handled on their own and oil and gas on their own. Meanwhile, the Ministry of Investment and Development has a host of other tasks entirely unrelated to subsoil use. Its job is, first of all, industrialization and support for entrepreneurship. The Ministry of Energy also has many tasks, chiefly energy efficiency, fuel supply and environmental protection.
3. Review all existing subsoil use contracts, audit all fields, and put in order the current system for monitoring local content and procurement. Review all work programs.

SMEs. Since big business is barely breathing, the state has decided to increase the pressure on SMEs.

In budget terms SMEs are a pittance, yet the decision was made to scrape the bottom of the barrel.

In any country SMEs mean, first of all, employment and consumption. It is through employment and consumption that tax revenue to the budget grows. SMEs need simple taxes and, most importantly, no bureaucracy, a functioning judicial system and a coherent lending system. In a crisis, taxes on SMEs are lowered, not raised, because the workers being laid off by big business have to find jobs somewhere. What they earn in small business they will spend inside the country, and on that consumption they will pay indirect taxes.

In the following parts I will write about stimulating industrialization, agribusiness and exchange rate formation, so that our readers are not faced with overly long texts.