Budget-2015: Economic development or conservation of negative tendencies?


The draft budget, presented by the Government, is an instrument to conserve negative trends of Ukrainian economy. Instead of economic stabilization, as it is declared, it will only lead to economic and financial exhaustion of the country, loss of achievements in the humanitarian sphere, impoverishment and high possibility of social conflict, which may be out of control.

Such conclusion is logical, considering current economic situation. Today’s financial stabilization has not been achieved, investments have not come, but tax burden on business has increased, which resulted in the shutdown of many enterprises. According to the IMF’s prognosis for 2015, we should expect a real fall of the GDP by 4.3% after its fall in 2014, which is around 7.5%. 

Investments


Reduction of investment flows into the economy over the last two years is the most dangerous phenomenon. In January – September 2014, foreign investors made only $1.9 billion of direct investments (capital stock). Moreover, foreign investors handled only 2.5 billion UAH (about $156 million) of capital investments out of the total amount of 135.5 billion UAH of capital investments. For already six years, the situation with the investment and innovation security in the country is critical.

It should be noted that all unpopular reforms were being conducted and are being conducted now under the slogan of creating good conditions for investors. But real foreign investors practically do not come to Ukraine because of high level of corruption and low level of propriety rights protection. Unfortunately, in spite of numerous formal decisions on these problems, any of them is solved. Domestic investors do not invest because of high taxes and absence of access to the credit resources at acceptable rates, which would correspond to the level of profitability in the economy. However, if there is no investments, the economy will be in further recession and the country – in technological decline.          

Budget indicators

The State budget of Ukraine for 2015 is based on the following macro-indices:  

  • real GDP fall – 4.3%,
  • nominal GDP volume –1720.8 billion UAH,
  • consumer price index (CPI) is expected to be at the rate of 113.1% (from December to December in the previous year),
  • producer price index (PPI) - 115.2% (from December to December in the previous year).


The payroll is expected to be at the rate of 467 billion UAH, an average wages will be equal to 3 882 UAH, but, in reality, it will decrease by 4.4%.

Income of enterprises is expected to be 272.1 billion UAH. The export volume of goods and services will decrease by 8.9% and will be $59.1 billion, and the import volume will decrease by 12.8% and will be $60.7 billion.

These macro indicators are quite real within the framework of current legislation. But the assumptions, on which the forecast of economic and social development of Ukraine for 2015 is grounded, do not include relevant changes, which are provided in the accompanying bills submitted along with the draft budget for 2015.

Revenues

The state budget for 2015 assumes the revenue at the rate of 475.24 billion UAH that is 97.42 billion UAH or 20.5% more than in 2014. Such revenue increase is caused by three factors: 

- changing the way of revenue distribution between the state and regional budgets;

- taking into consideration additional revenue, provided by amendments to the legislation which are not adopted yet; 

- inflation increase.


VAT is still the main source on filling the State budget in 2015. The prediction of incomes from this tax in 2015 is at the rate of 156,108 million UAH. Personal income tax funds are expected to be around 42,325.5 million UAH, while corporate income tax funds –33,573 million UAH.    

The state income from personal income tax (PIT) is expected to increase the most, almost three times as much as in 2014 (in 2014, 14 191.7 million UAH). In 2015, VAT funds are predicted to be higher than in 2014 by 6,150 million UAH or by 4.1%. On the contrary, corporate income tax funds are forecasted to decrease from 37,952.8 million UAH in 2014 to 33,573 million UAH in 2015.     

Progressive taxation model

The explanatory note to the Bill “On the State Budget of Ukraine for 2015” states that this raise will be caused by introduction of the progressive model of personal income taxation, by increase of the personal income tax rate from 15% to 20% as well as by the pensions taxation line decrease.    

We believe that the introduction of the progressive model of personal income taxation would have been expedient in other conditions, as such system operates like an automated fiscal stabilizer which also enhances social justice (the more you earn, the more you pay). 

However, in the current economic conditions, increasing tax rates on citizens’ incomes, in particular, increasing marginal tax rate (from 17% to 20%, in the case when income exceeds the size of 10 minimal wages), will probably lead to “shadowing” a part of the revenue, instead of attracting additional inflows to the budget.   

Tax pressure

Overall, the revenue is expected to increase at the expense of tax pressure on the population. In the conditions of price increase, including the increase due to emission provision of the budget revenues, devaluation of hryvnya, introduction of custom duty and freezing of social standards to the level of 2013, the amendments to the tax legislation will only result in the impoverishment of the population and growth of shadowing profits.    

Raising the tax rate on passive personal income from 15% to 20%, in the condition of increasing distrust in our banking system, will lead to a reduction of deposits’ volumes in banks as well as a reduction of people’s motivation to invest into the economy of Ukraine. In turn, it will lead to a decrease of tax base and, consequently, of budget revenues.

Reducing the threshold of pension tax from 10,000 UAH to three minimum wages (UAH 3654, as of 01.12.2014), with continuing price increase for the vital goods for the pensioners, in particular, for medicine, health care, and utilities, will have a negative impact on their living standards and will also bring not more than 33 million UAH to the budget.     

Besides, there is a number of comments on the novelties in the tax system. For instance, rating electricity as excisable goods is contradicting, because in its essence excise duty is the tax applied to the goods, which damage health and environment, or to the goods classified as luxury. Likewise, the excise duty on retailing spirits, tobacco and fuel is in fact a VAT. Thus, its implementation is expedient only in case of VAT abolishment.     

Summing up, we can note that these amendments to the tax legislation will cause even deeper GDP fall next year; thus, the budget revenues will not be fulfilled.  


Consumer demand


Despite increasing nominal amount of expenditures on consumption compared with the plan for 2014 (by 54.6 billion UAH or by14.2% to 439.5 billion UAH which is 83.4% of the total budget expenditures), there is a danger that households’ expenses will be reduced because of proposed amendments to the tax legislation (particularly, because of the introduction of housing fixed property tax and tripled land tax rate) and also because of further tariff increase on housing and utility services, which may exceed 55% of the total households’ income.

In turn, it will cause significant reduction of the households’ consumer demand – the main component of the GDP, which in 2013 constituted 72% of the GDP’s structure, and this will lead to reduction of revenues from VAT and excise tax.     

Budget expenditures

Contrary to the Government’s statement about the need in cuttings, the expenditures in the draft state budget of Ukraine in 2015 turned to be considerably higher than those in 2014.

The expenditures in the draft amount to 527.2 billion UAH, which is almost 20% more than in the previous year. Besides, expenditures in  the general fund of the State budget of Ukraine amount to 502.9 billion UAH (increased by 30% compared to 2014) and expenditures in the special fund of the State budget of Ukraine –24.3 billion UAH (decreased almost by 60% against 2014). It should be noted that the general payroll expenditures were increased by 25%. The development fund expenditures were increased by 33.5%, and, at the same time, the special development fund expenditures were decreased by 41.2%.

Moreover, the share of expenditures for the development in the total amount of the state budget is 7.5% against 8.3% in 2014. The nominal amount of expenditures for development is 39.5 billion UAH and, in comparison to 2014, it was decreased by 2.8 billion UAH.

Consumption expenditures were increased by 26.3%, compared to 2014, but simultaneously, their amount is equal to 92.2% of the total amount of the state budget expenditures (against 87.2% in the previous year).

Thus, there is a yearly tendency that “the consumption budget” increases at the expense of “the development budget”. Based on that, we may conclude that, in 2015 budget, that there will be still a limiting factor for the economic development.  


Reforming inter-budgetary relations

In regards to the amendments to the Budget Code of Ukraine, a new system of budget levelling provides horizontal levelling of taxable capacity of the territories, depending on the rate of earnings per capita. Besides, according to the authors of changes, it should promote the interest of local authority in drawing additional earnings and expanding an existing tax base.     

New forms and methods of inter-budget regulations suggested in the bill will facilitate partial decentralization of power, definition of clear areas for spending public funds through the introduction of target-oriented transfers (educational and medical subventions) and for growing financial autonomy of local budgets.

However, the reform of inter-budgetary relations does not lead to decentralization, because the funds for current expenditures on education and health care are concentrated in the state budget (as opposed to 2014, when they were in the local budgets) and will be transferred to local budgets as appropriate subventions. Thus, the expenditures on development are separated from the expenditures on administration in the mentioned spheres, which creates an unbalanced system. This reduces the responsibility of local authorities in these spheres and, in general, it threatens stability and possibility to fund education and health care which are the basic needs for living and development.       

Social guarantees

Final provisions of the bill (p. 7) cover a special procedure of determining expenditures for financing social security, particularly, in the order and in the amount established by the Cabinet of Ministers, based on the available financial resources of the state and local budgets as well as the budgets of obligatory state social insurance funds.  

Using such a manual mode conflicts with the fundamentals of the budget process, written in the Constitution of Ukraine (Article 95). In particular, it is the Verkhovna Rada of Ukraine, which should determine any expenditures for social needs, their amount and purpose, by law.    

Given that the fulfilment of the state budget’s revenues is doubtful, because it is based on unreal calculations of income, considering new amendments to the tax legislation and general economic situation in the country, then the possibility to finance social guarantees included in the bill is highly questionable.        

According to the addendum to the law (Annex concerning justification of articles), the volume of the areas mentioned is estimated as additional expenditures of around 180 billion UAH (in the conditions of 2014).

Wages

Established rate of minimum wages and minimum cost of living do not take into consideration depreciation of monetary incomes and savings influenced by high prices’ inflation and national currency devaluation. It becomes visible by the reduction of purchasing power, living standards and social safety. It also creates risks of further impoverishment, especially among most vulnerable segments of the population. In particular, we are talking about those for whom pensions and other kinds of social benefits and assistance are the main and often the only source of income.      

Analysis of the suggestions on cutting expenditures in 2015 shows that this cutting is conducted for the sake of cutting without any prior basic analysis on positive and negative consequences of this step. In order to develop business in the country, products and services must be consumed by the residents. That is why responsible governments seek expanding the number of consumers and their consuming capacity, i.e. income which people are ready to spend on consumption, and improving competitiveness of national products in comparison with imported ones. An irresponsible government reduces incomes of its own consumers, stimulates import and declares that it sees no prospects for domestic production. We believe that a mere cutting of expenditures is not a constructive policy.      

Budget deficit

According to the Bill, the marginal amount of the state budget deficit for 2015 is 63 billion UAH or 3.7% of the GDP, excluding the deficit of Naftogaz of Ukraine. However, according to the explanatory note to the draft budget, the government plans to borrow 279.7 billion UAH and pay off the national debt equal to 158.9 billion UAH. Thus, the difference between borrowing and repayment is 121 billion UAH. That is obviously a real fiscal deficit including the borrowings, which the government was suggested to use for re-capitalization of the banking system, Naftogaz of Ukraine, other state enterprises, and the Deposit Guarantee Fund. Apart from that, in order to finance the deficit, it is planned to spend 17 billion UAH of revenues from the privatization of the state enterprises.        

State debt

By the end of 2015, the state debt will reach 68% of the GDP, which exceeds the maximum limit of 60%, mandated by the legislation for the financial security and solvency of the state. However, already today there is a risk of insolvency, based on the paragraph 10 of the Final provisions of the Law. This provision enacts that the National Bank of Ukraine owns more than 60% of internal debt, issued as public bonds. That is why it is suggested to restructure this debt by changing the bonds issued earlier for the new ones with the circulation period of up to 20 years and the interest rate of 5% per year. In fact, this means that the government makes new borrowings from the National Bank, which, instead of stimulating commercial banks to credit the real sector of economy and create new jobs, uses emission for financing the government, despite the fact that it is actually prohibited by law.  

The stipulated inflow to the budget revenues amounted in 65 billion UAH, received from the excess of profit over the NBU expenditure, affirms these doings. However, the NBU is not a commercial bank and it is established not for filling up the budget revenues. Creating such revenues is a consequence of overstating the value of resources which the NBU gives to the economy. Instead of reducing the rates of refinancing and correspondingly interest rates of the commercial banks, the NBU creates financial resources for financing public expenditures. That not only worsens the conditions of economic development in the country, but also becomes an execution of functions which are not peculiar to the NBU that, in turn, creates risks for the NBU work.

In general, the policy of state debt and fiscal deficit in 2015 looks precarious. It leads to the state debt increase, deeper involvement of the NBU to solve fiscal problems, and involvement of the budget to solve the problems of the banking system.     

CONCLUSIONS AND RECOMMENDATIONS

Implementation of this version of the draft budget actually deprives the national economy in 2015 of almost all potential resources of support for economic development (especially consumption and investment development). That, in turn, creates a foundation for strengthening negative tendencies in the economic system and for dramatic deepening of financial and economic problems in the next years, it will also create unprecedented ground for social indignation, which only will stir up recession processes that recently exist in the country.       

Calculations of the draft State budget of Ukraine for 2015 are based both on norms of the current legislation and norms which are included into the bills submitted to the Verkhovna Rada. Thereby, we should note that not adopting or adopting these bills in other wording would only lead to the budget misbalance. Considering this, we think that the submitted bill can be reviewed only after the Verkhovna Rada takes decisions on the bills, which constitute the base for calculations of the draft State budget for 2015. Besides, it is necessary to foresee the period starting from bill’s enactment until its entry into force, considering the necessity of its development and passing numerous corresponding regulations of the Cabinet of Minister of Ukraine which regulate new reordering implementation of the legislation. The Bill on the State Budget of Ukraine does not provide this time lag.        

That is why, in our opinion, it would be expedient to develop and adopt the State budget for 2015 using current legislation. After the proposed amendments are introduced, it is reasonable to make corresponding changes in revenues and expenditures of the State budget for the corresponding year. In order to reduce a burden on the state budget it would be essential to introduce reforms gradually.        

Decentralization

To our mind, the government should intensify its work not only by introducing the budget reform but also by introducing a complex reform on interrelation of central and regional authorities. We should remind that in the developed countries the main phases of decentralization included elimination of ineffective regional authorities and enlargement of communities (as a result, there was a quantitative reduction of local authorities as well as expenses for their maintenance). It is also necessary to create grounds for systemic reforms in the part on defining an optimum balance between the tax burden and private expenses for the main branches of the budget sphere.    

Hereby, the process of decentralization requires not only re-distribution of revenue sources and expenditure powers between the state and local budgets, but also implementation of the complex reform on territorial organization of local government. 

Intensification of investment activity

The task #1 for 2015 is to increase the investments into the country modernization while using new mechanisms of their attraction. This task should be completed in the following way:

Establishing the development bank and filling it up with capital stock by issuing governmental bonds and monetizing them by the National Bank of Ukraine;

Extending the network of industrial parks and creating free economic zones for the development of new high-tech production. There should be income tax and VAT exemptions for enterprises, which operate in these parks and zones, as well as import duty and VAT exemption for imported equipment, in case if there is a programme of creating new production or modernizing the existing one.       

Providing small and middle size business with an access to crediting by both the Development Bank and special funds which are created and administrated together with the international institutions of development, such as the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB), etc.

The Government should set specific measurable objectives for the Ministry of Economic Development and Trade and the Ministry of Finance of Ukraine, for example, on attracting not less than $8 billion of foreign investments to the economy of the country in 2015, specifically to invest into the real sector of economy. Besides, there should be a defined list of new enterprises of all types of ownership, which will be enacted in 2015-2019, with a determined quantity of jobs and investment resources.     

Changes in the order of obtaining corporate rights share by the state

In our opinion, it is necessary to introduce a procedure of obtaining corporate rights share by the state in exchange to financial aid, as suggested by the bill on the amendments to the Law of Ukraine “On investment activity”. In the future, it will give opportunities to participate in management of the companies (especially those of strategic importance), receive distributed profits via dividends from the invested capital, at the expense of which to create development budgets.

All mentioned above causes a necessity in systemic and optimizing state influence on creating a new system of management.

Improvement of the state regulation of investments

For this purpose, we suggest the following ways of improving institutional mechanism of the state regulation of investments:

creation of the base for the system of state support of investment. It should be the Plan of the state capital investments, confirmed by the Cabinet of Ministries for three years, which will define the directions of the state support to investment and the amount of financing.

definition of structure, hierarchy, connection with the budget process and interconnection of the documents, according to which the state investment policy objectives are defined along with the procedure of their creation. Such objectives must be conformed to the legislation on the state forecasting and strategic planning with provided terms and procedures of drawing up such documents: Strategy of development of Ukraine (for the period of 5 years); Programme of the Cabinet of Ministries (for 3 years); Plan of the state capital investments (for 3 years); Strategy of regional development (for 5 years); State targeted programmes of sectors’ development (for 3 years); regional targeted programmes of sectors’ development (for 3 years); plans of regional capital investments (for 3 years);

determination of a single procedure of providing state support and using state capital investments for all investment projects, including those based on state-private partnership. Particularly they should contain principles and methods of projects’ identification, project proposals and assessment procedure, creating a relevant single register of projects assessed, which should be an indispensable condition of their inclusion into the Plan of the state capital investments.

development and introduction of necessary orders of assessing the projects which were already implemented, monitoring and evaluating their efficiency, introducing changes to the current orders which regulate the order of selection and registration of investment projects and project proposals.

In this process, the state should become not only an investor’s trustee, but a safe partner, which also profits from the investment and is interested in profit maximization. Efficiency of such a policy depends on the right choice of its directions, methods and on harshness of its implementation.       

Stimulation of export

Task #2 for the Government is the stimulation of export. There should be following conditions for stimulating export: sales markets; harmonization of technical and phytosanitary regulations; export crediting and export insurance; increase of production for export. That is why, in 2015-2016 it is necessary:    

To create an export credit agency (ECA) and fill it up with authorized capital in the amount necessary for supporting the crediting of selected investment projects;

To create trade and economic offices in high-priority countries, focusing their work on helping small and middle-size business;

To create incentives for production and export of high-tech and high processed products, having limited export of raw materials, minerals, goods of a low processing level and having increased export of processed raw materials – finished products.   

Public consumption

The third objective is to ensure public consumption. In the conditions of economic decline, the state must support domestic production in order to retain technological level of the country and to save jobs. That is why the draft State budget of Ukraine for 2015 should include expenditures for the state order of the most important and science intensive products in arms and defense technology sector, space sector, medical equipment and instruments, railway rolling stock, which are produced in Ukraine. Otherwise, production in these sectors will be lost. Volume of such state order must ensure a break-even level of production and renewal of outdated assets. Besides, in the conditions of decreasing demand, the state should promote consumption of domestic goods of machinery construction by introducing credit programmes for purchasing cars, agricultural equipment and power equipment, and by extending leasing mechanisms for using domestic goods.       

Private consumption

Reducing social expenditures can take place only as result of reforms’ programme, which is still absent. In the current circumstances, unreasonable reduction will lead to unpredictable consequences for the country both in a short-term and long-term perspective. Therefore, this reduction cannot happen. 

After freezing wages in 2014, in 2015 wages should increase to the rate of expected inflation. In addition, social payments should be indexed based on the real inflation index and, primarily, that concern the allowances for families with children.     

Hence, we think that the proposals developed will facilitate creation of an effective system of the state administration in Ukraine, based on the principles, which provide efficient investment, aimed at modernizing our economy and ensuring national security.