Where does the state get money during a war?

The war continues. International leaders announce their support for Ukraine on big stages, but behind closed doors, every vote in favor of funding is fought for.

The volume of support is decreasing, and the risk of its further reduction is becoming more tangible every day.

Approval of the 56th aid package by the US Congress was delayed for months. For Ukraine, a six-month wait was too expensive. Considering this and the size of Ukraine’s state budget deficit, which is more than UAH 400 billion, the government will have to take unpopular steps. Let's take a closer look at some possible sources of financing to cover budget deficits during the war.

Rapid change: three likely sources of filling the state budget

• Issue of monetary units. The option of issuing, or printing, currency units may seem attractive due to its speed and availability. However, this approach will inevitably lead to the devaluation of the national currency and the depreciation of the income of citizens and businesses. Ukraine avoided using this method in 2023, realizing its negative consequences.
• Increase in taxes. Increasing the tax burden may be a temporary solution to provide the budget with additional resources. In the short term, this approach will help ensure the budget is filled. At the same time, it must be remembered that this carries risks of increasing the shadow sector of the economy and also negatively affects the conditions for doing business.
• Domestic government loans. Turning to internal government loans is one of the ways of additional financing. Ukraine is currently using this method at a limited level, approximately 4% of the country's total needs. This indicates potential for expanding this source of funding. It is important to ensure transparency and efficient use of these resources.

What can help in the long run?

In the medium and long term, the state budget deficit should be financed through an increase in revenues (through the creation of new businesses and new jobs) and a reduction in the shadow sector of the economy. The Ministry of Economy of Ukraine has launched various business support programs that help increase entrepreneurial activity. At the same time, the volume of tax evasion and avoidance schemes, according to estimates by the Institute of Socio-Economic Transformations, amounts to about 460-700 billion UAH per year. Realizing this opportunity requires real reform of the revenue administration system, transparent customs work and the fight against corruption.

In addition, income from the frozen assets of the aggressor country and the assets themselves should also be a source of financing the state budget deficit of Ukraine. But in this case we depend on the decisions of international partners.

The Ukrainian government plans to reform the tax system, including increasing excise taxes and the tax burden on certain goods, such as fuel, alcohol and tobacco. The measures are aimed at increasing budget revenues and ensuring financial stability in war conditions. The plan for potential changes is set out in the National Revenue Strategy until 2030, approved by the Cabinet of Ministers on December 27, 2023.

Military training for individual entrepreneurs: to be or not to be?

The possibility of introducing a military tax for individual entrepreneurs cannot be ruled out. Currently the military tax is 1.5%. Individual entrepreneurs do not pay it. At the same time, the government is developing a bill to introduce mandatory payment of military duty by single tax payers. Although such an innovation in relation to private entrepreneurs (PE) contradicts the very concept of a simplified taxation system, which provides for minimal taxes and reporting, under martial law this is a potential scenario for the development of events.

Reforming the simplified taxation system is a sensitive issue. Micro and small businesses are the basis of entrepreneurship and economic sustainability of the country. More than 2 million individual entrepreneurs are registered in Ukraine. In the last 12 months alone - from February 1, 2023 to February 1, 2024, Ukrainians have created a record number of individual entrepreneurs over the last decade - about 315 thousand.

The taxation system for individual entrepreneurs is simple and understandable. Individual entrepreneurs pay a single tax, single tax on their income (during martial law and 12 months after its end, payment of the single tax is voluntary, provided that the length of service for this period will not be accrued in case of non-payment) and VAT if the single tax payer is in on the general taxation system.

At the same time, there is a problem with large businesses using this status for tax optimization. And in this direction, the government has identified steps such as reforming the application of the simplified taxation system by excluding legal entities, introducing safeguards to reduce abuse, increasing the VAT registration threshold and increasing effective tax rates to the level of the general regime.

Solving the budget deficit problem and improving the tax system requires strategic decisions. These options, such as issuing currency units, raising taxes and internal government borrowing, are quick wins, but they have potential disadvantages, including currency devaluation and an increase in the shadow sector of the economy.