In
2011, parliament adopted the ‘Liberty Act’ which obliged the government to submit
to a referendum any introduction of new national taxes (except excise) or any
increase of the existing tax rates (except when a new tax replaces an existing
national tax without increasing the tax burden). This meant that any permanent
tax increase could materialize only in truly extraordinary circumstances.
Why
did it succeed?
The tax policy liberalization – endorsed by the Ministry of
Finance of Georgia as part of a broad political consensus – benefitted from the
virtuous circle. As much as it helped to broaden the tax base and to increase
revenues, the positive tax revenue response was, importantly, shaped by other indispensable
factors and reforms which unfolded from the beginning of 2004, in the run-up to
the mentioned tax policy liberalization measures:
1.
Transformative and decisive leadership which manifested itself through
zero tolerance of crime, corruption and embezzlement (replacing old staff,
change in staff incentives etc.), front-loaded overhaul of the system of law
enforcement and of administration of justice and the existence of a critical
mass of people willing to go beyond a generalist reformist discourse by taking
personal risks to get things done fast.
2.
Comprehensive institutional transformation of the tax and
customs administration which enabled, early on, to close loopholes and tax
avoidance schemes, to cut middlemen and to change personnel; to progressively streamline
business processes, consolidate databases, mainstream risk-based audits, enact
e-solutions, enhance service orientation, customize outreach to businesses
through provision of on-demand services, modernize infrastructure and
eventually rebrand the Revenue Service to emphasize openness and accessibility.
3.
Increase of Georgia’s potential growth rate through wide-ranging
business climate improvement measures: liberalization of trade and
transportation, deep deregulation and modernization of agencies delivering
public services, simplification of the labor legislation, massive privatization
of enterprises and of the state property together with corporatization of a
small number of remaining state owned enterprises, pro-active engagement with
international investors.
4.
Macroeconomic stability: exchange rate stability in the context
of unrestricted capital mobility, absence of balance of payments gaps, healthy
banking sector, conservative fiscal planning (government’s recurrent revenues
were constantly higher than current expenditures; recurrent spending, including
government consumption and subsidies, was tightly controlled to prevent
emergence of a “premature welfare state”), etc.
How
did it succeed?
The ratio of total annual tax and customs revenues to gross
domestic product increased from 14 percent in 2003 to close to 26 percent in
2007 and stabilized at the level of approximately 25 percent of GDP thereafter.
General government expenditure as a percentage of GDP increased from
approximately 16.5 percent in 2003 to close to 30 percent in 2007 and
thereafter, with capital spending representing around one quarter of such
expenditure. Average monthly salaries in the public sector increased from $50 in
2003 to $400 in 2012, and in the non-public sector from $80 in 2003 to $450 in
2012. Old age pensions increased from $6.50 in 2003 to $90 in 2013, which was
slightly higher than the subsistence minimum for an average consumer.
The takeaway for Ukraine
Drastic tax rates cut alone – without both prior and concurrent law enforcement
and structural reforms to close loopholes and tax avoidance schemes and to
increase potential economic growth – represents significant leap into the
unknown. It can undermine Ukraine’s fiscal stability and confidence.
