The government raises taxes. Why and what will be the consequences?

Some of them have already been approved by parliament, others are still only draft laws. But all of them, at least according to officials, are designed to find more funds to finance Ukraine's defense.

Some, like the increase in excise taxes on fuel, have already caused concern, and plans to tax sweet water are ridicule. But the consequences for people and the economy from other tax changes proposed by the government could be serious.

What taxes can increase and how exactly? What could be the consequences of raising taxes, besides the government-declared increase in budget revenues? And are there any alternatives to high taxes now?

Why does the government want to raise taxes?

In the first weeks and months of the Russian invasion, the Ukrainian authorities took a number of steps towards business: they lowered the rates of some taxes (for example, the VAT on scarce fuel, for which people lined up at gas stations, was reduced to 7%, and excise taxes were abolished altogether), small businesses could take tax holidays, and tax audits were cancelled.

This was done to support businesses and the population in the first months of military uncertainty and prevent economic collapse. And business responded by quickly adapting to work in war conditions and voluntarily paying taxes in advance, and the economy - after contracting by a third in the first year of the war - even began to recover.

“At the beginning of the war, money was not counted at all - it was about saving the country, saving the economy, and the state largely accommodated business,” explains Vladimir Dubrovsky, senior economist at the Center for Socio-Economic Research CASE Ukraine.

According to him, in the country “a certain social contract developed when business, despite everything, paid taxes voluntarily.”

However, in the second year of the war, pre-war tax rates first returned, and then tax audits. In the third year of the war, when financial and military assistance from partners began to flow less rhythmically than in 2023, and the prospects for this support for 2025 remain uncertain, the government and pro-government deputies (as experts had warned) started talking about the need to increase taxes.

Ukraine is forced to defend itself from a state whose military spending is comparable to the size of the entire Ukrainian GDP

According to Finance Minister Sergei Marchenko, every day of the war, which has been going on for three years, costs Ukraine an average of UAH 5.6 billion (that is, more than $1 billion is required every 10 days). At the same time, as the official reminds, Ukraine finances military expenses exclusively from its own funds - financial assistance from Western partners goes only to finance civilian expenses - paying salaries to public sector employees, pensions.

That is, everything that the Ukrainian economy now produces, and that goes to the budget in the form of taxes, goes to finance defense - military salaries, weapons, equipment, medical supplies.

At the same time, Russia’s military budget, which Ukraine is forced to resist, is three times larger than Ukraine’s.

“According to open data, the Russian Federation plans to spend $120 billion in 2024 to finance aggression against Ukraine. At the same time, expenditures on the security and defense sector of Ukraine in the current version of the 2024 state budget amount to $42 billion (at the calculated exchange rate of 40.7 UAH/dollar),” the Minister of Finance notes in a column in LB.ua.

The lack of funds is quite objective, admits Vladimir Dubrovsky, “our enemy has such military expenses as the entire GDP of Ukraine.” And even before the war, Russian GDP was more than 10 times higher than Ukrainian.

“That is, the scale of the economy is absolutely incomparable, but it is necessary to maintain an army that is comparable in size, and the military must receive comparable salaries, not the same as those of the enemy, but decent, and such that they can support their families,” explains the economist.

In addition to this gap in financial capacity that existed between Ukraine and Russia even before the war began, the situation has become more complicated in 2024 with the delay of aid from partners, especially the US aid package due to blockage in Congress.

Therefore, in the first months of this year, Ukraine was forced to increase spending on security and defense by $6 billion. It is this, as well as the increase in payments to the military on the front line, that the head of the budget committee of parliament, Roksolana Pidlasa, in an interview with Ukrayinska Pravda, calls the main reason for the current search for additional funds.

By the end of the year, according to government calculations, another 500 billion UAH are needed (including for additional mobilization). And all this was not provided for in the budget for 2024, during the preparation of which it was believed that the intensity of hostilities would decline in the second half of the year.

"That did not happen. That’s why they are now so panicky looking for additional revenue,” says Dubrovsky.

An economist at the Center for Economic Strategy, Yuri Gaidai, also calls tax increases inevitable. In a note on Facebook, he notes that UAH 500 billion is needed “to finance the very basic needs of the army and maintain at least approximate parity with the Russian Federation.”

How they want to raise taxes

On July 18, the Verkhovna Rada adopted changes to the Tax Code, which provide for a gradual increase in excise taxes on fuel from September this year until 2028. Despite the fact that the name of the law speaks of the harmonization of Ukrainian legislation with European legislation, in practice it will be about increasing budget revenues to increase military expenses.

This was directly stated by the head of the parliament’s financial committee, Daniil Getmantsev, responding to criticism from those who believe that raising excise taxes on fuel at a time when “the whole country lives on generators” is not the time.

“People who criticize the increase in excise taxes know very well that the alternative is not to increase excise taxes or not to increase them. There is an alternative - either pay salaries to the military, or not pay them,” the deputy explained, estimating the September increase at 1.5-2 UAH per liter.

In addition, the government submitted two more bills to parliament for consideration, providing for changes to the budget for 2024 and changes to the Tax Code.

Excise taxes on fuel will begin to increase when the whole of Ukraine lives on diesel generators

The lion's share of these changes concerns the increase in military duty, both for individuals and individual entrepreneurs, as well as its introduction for legal entities, as well as for certain operations.

In particular, the government proposes the following:

• increase the military tax rate on personal income to 5%;
• introduce the payment of military duty by legal entities in the amount of 1% of income from any activity for payers of corporate income tax and payers of single tax of groups III and IV;
• 5% military tax in the calculation of two minimum wages per month for individual entrepreneurs who pay a single tax of groups I, II and IV;
• 1% military tax from the income of individual entrepreneurs of group III;
• 5% military tax on the cost of transactions with banking metals (for the purchase and sale of gold, silver);
• 30% military tax on jewelry sales;
• 15% military tax on the sale of new passenger cars;
• 5% military tax on income from the sale of real estate by individuals who have already sold one piece of real estate during one tax year;
• 5% military tax on the cost of mobile communication services provided, paid by end users of such services;
• introduce a monthly advance payment of corporate income tax in the retail trade of fuel in the amount of 0.5 of the minimum wage established by law on January 1 of each year, based on 1 cubic meter of storage tanks for gasoline and diesel fuel and liquefied gas at a specific gas station.

What does raising taxes do?

According to government calculations, the first stage of bringing excise taxes closer to European standards according to already adopted laws should begin on September 1 and bring an additional UAH 16.9 billion to the budget.

The increase in military duties, according to government calculations, should bring almost another 122 billion UAH to the budget, and in general, tax changes should add up to 140 billion UAH to the budget.

This will be part of a plan to find funds to increase defense spending by UAH 500 billion, provided for in the government's second bill introducing changes to this year's budget. Of this, more than half - UAH 256 billion - should go to the purchase of weapons, almost 78 billion - to military salaries, and more than UAH 40 billion - to fortifications.

To finance all this, in the draft law the government plans to reduce expenses by more than UAH 65 billion, additionally borrow more than UAH 220 billion through government bonds, and also attract more than UAH 75 billion from exceeding the tax plan in the first half of the year (mainly due to additional taxation of banks and income of the NBU, which it transfers to the budget). Another UAH 60 billion will be saved through restructuring and deferment of payments of previous debts.

According to the Minister of Finance, whose signature is on both bills, the government has proposed “the most lenient option for financing additional military needs among all possible ones.”

As the deputy chairman of the parliamentary tax committee, Yaroslav Zheleznyak, predicts, “this will not be quick... and it will be very painful,” because no one likes voting for tax increases.

In a note in Telegram, the deputy predicts that, given the work schedule of the Verkhovna Rada, consideration of bills in the first reading may begin on the 20th of August, and the second reading is possible in September (provided that during this time there is no change of government, which requires and withdrawal of bills submitted by him).

In general, as Zheleznyak suggests, there will be many pitfalls when considering tax increases.

And the head of the budget committee, Roksolana Pidlasa, suggests that deputies will not agree to all the government’s proposals. But, according to her, changes to the budget and the tax increases necessary for this must be approved before the end of August - early September, otherwise the Ukrainian military may find themselves without salaries at the end of September.

What will be the consequences of raising taxes and are there any alternatives?

Raising taxes will not only help cope with the challenges of the current year, but will also lay the foundation for ensuring stability in 2025, the government believes.

This is extremely important “given the changing political context around the world and the prospects for international assistance to Ukraine,” says Finance Minister Serhiy Marchenko. And we're not just talking about the US presidential elections.

But the government's calculations may not come true. Although, as Vladimir Dubrovsky, senior economist at CASE Ukraine, admits, he does not have any special alternatives.

Resuming money printing - as in the first months of the war - would be the worst option, because “this would mean a new surge in inflation.” In fact, says the economist, inflation is also a tax, but it is very unfair and destructive to the economy. In addition, inflation has already been accelerating in recent months.

“Emissions are obviously the worst tool, the step of last resort,” says CES economist Yuri Gaidai.

The government has also already provided for a reduction in non-military spending and new borrowings.

The problem could not be solved, but significantly mitigated, if a law on economic reservations were adopted.

“This means that enterprises will be more sustainable, and the budget will receive money,” says Dubrovsky, but notes that as an economist he supports reservations, but he also fully understands the moral arguments that opponents of this idea make.

Therefore, it is unlikely that it will be possible to avoid raising taxes (and the associated problems in the form of rising prices, deteriorating business sentiment, and therefore a decrease in income).

But this could also be done differently. For example, a temporary military surcharge on VAT could be set at 5%.

“This would mainly solve the problem in terms of money, and would not carry an additional administrative burden,” explains Vladimir Dubrovsky. Of course, this will lead to a certain increase in prices (but less than 5%), as well as to an “increase in schematosis,” but since VAT in Ukraine is administered quite well, this would be “the least evil of all possible.”

But, the economist notes, although the government says that money is needed urgently, it proposes “a bunch of new fees that are inconsistent with each other and the current system of fees, which will be very difficult to administer, and which will not immediately bring revenue to the budget.”

However, as Roksolana Pidlasa predicts, the idea of ​​increasing VAT may still be returned to.

Salaries and businesses will go into the shadows

It is also alarming that the government plans to receive most of its income from additional military taxes, and this is an additional burden on the wage fund. On the one hand, according to the OECD, these are the most harmful taxes for economic growth. On the other hand, “these are the taxes that are most often and most successfully evaded.”

In a country where, according to the State Statistics Service, about 3 million people work unofficially, and, according to surveys and estimates, there are about 2 million who receive additional payments in envelopes, this will mean an even greater shift of the labor force into the shadows.

“If this tax increases, this means that there will be even greater evasion and that the budget, accordingly, will receive less revenue,” warns Vladimir Dubrovsky.

He is also part of a group of economic experts from 13 think tanks that signed the joint appeal on taxes. It says that the government bill “contains a number of extremely negative provisions that will cause significant damage to the economy.”

Even more concerning is the introduction of a 1% military levy on businesses, which would essentially be a sales tax - “the worst tax that has no right to exist, because it is a tax on market transactions,” explains Dubrovsky.

And Yuri Gaidai from the Center for Economic Cooperation calls those from whom the government wants to get the lion's share of budget revenues from tax increases "cash cows" and warns that "in general, the proposed steps place almost the entire burden on white businesses and employees."

If at the beginning of the war, car showrooms in Ukraine were empty due to Russian shelling, now they are empty due to the government’s plans to increase taxes, including on the sale of new cars.

Increasing the military levy for certain industries will also mean going into the shadows. This is especially true for the jewelry store, where “nobody will pay 30% extra.”

A 15% military tax on new cars can work - and even then is questionable - only in the luxury segment, where “they sell only officially, and buyers are not very poor and can afford to pay 15% more,” says Dubrovsky. But even there, buyers can postpone purchases to wait for this tax to be lifted. And everyone else will simply underestimate the cost of sales, that is, they will go into the shadows.

It is significant that immediately after the submission of bills to increase taxes to parliament, car sales increased in Ukraine. As Oleg Nazarenko, General Director of the All-Ukrainian Association of Automobile Importers and Dealers (VAAID), told the specialized publication AUTO-Consulting, the jump in car sales began on July 19. “Car showrooms are empty,” Nazarenko said.

The real estate market may also return to a long-forgotten shadow - 5% of the military tax will drive it there. In addition, says Dubrovsky, “it turns out that buying from an individual on the secondary market is discriminated against compared to buying on the primary market.”

“I don’t know who lobbied for this – apparently, the developers?” – the economist suggests sarcastically.

Therefore, if the government’s proposed tax changes are approved by parliament, “it will not bring in large revenues, and will create large distortions,” the economist warns:

“When the market goes into the shadows, it is always very difficult to get it out of there.”