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: / Analytics / The Tax System of the Kyrgyz Republic (2003)




Kyrgyzstan Review, 10 years ago




1. ROLE OF THE TAX SYSTEM IN THE ECONOMY OF KYRGYZSTAN

Traditionally the tax system has several basic functions in the economy. Collection of the funds necessary for implementation of the public expenditure programs and economic regulation are among them. Specific features of implementation of these tax system functions in the contemporary economy of Kyrgyzstan are considered below.
 
The main task of the countrys tax system is to insure sufficient government budget revenues. For the recent years the government had to considerably reduce its expenditures, including those for strategically important spheres of education and health care. A direct reason for this was the debt crisis, which caused sharp reduction of external borrowings of the government and increase of expenditures for the servicing of external debt. Obviously, further borrowings will never achieve the former scale, so, the only sustainable long-term strategy of the public services provision may be mobilization of the necessary resources in the form of taxes. The question of what public expenditure programs and in what scope are necessary for the country, is worth of separate discussion, so it was not given consideration in this report. One may only note that effectiveness and transparency of the public expenditure programs are of a decisive importance for the tax systems functioning. Citizens will pay taxes in a law-abiding manner, if they see and understand that their money is actually spent for socially useful purposes.
 
From macroeconomic point of view increase of tax receipts is an essential task. This is supposed to decrease the government budget deficit and insure stability of the government external debt. The PRGF program coordinated with the IMF contains the requirement of insuring the level of tax receipts in 2005 at the level of 15% of GDP (12.4% of GDP in 2001). Without fulfilling this requirement it is hardly possible to hope that the subsequent restructuring of the public external debt of Kyrgyzstan will ever take place.
 
Other macroeconomic problems, whose resolution also greatly depends on the tax system, may include attraction of external and domestic investments to the economy of the country as well as increase in exports of goods and services. Many taxes used in the international practice, first and foremost VAT, were specially designed in such a way, as to stimulate investments and exports. Unfortunately, these stimulating peculiarities of taxes have been insufficiently activated in Kyrgyzstan.
 
One of important tasks of the countrys economic development is diversification of the sectoral structure of the economy and decrease of its dependence on successes/failures in just several branches. To achieve this, the country requires a tax regime, which would be uniformly favorable for all economic agents and would not create artificial preferences for certain branches at the expense of other ones (as is currently taking place, with some preferences being granted to agriculture by shifting the tax burden off to the processing industry).
 
One of the main problems of the countrys economy, which account for considerably low share of tax receipts in GDP according to the international standards, is availability of a vast shadow economy sector. According to the estimates of the National Statistics Committee, the share of the shadow economy in GDP is about 25%. The existence of such a big shadow sector is in many respects connected with the shortcomings of the tax system and, first and foremost, with uneven taxation of different branches or types of enterprises. This resulted in a forced retreat of many enterprises and individuals into the shadow they would not be able to survive in conditions of official economy paying all taxes.
 
Decrease of tax rates is a popular idea of bringing the economy out of the shadow. This must stimulate expansion of the tax base, thus compensating for the budget revenue losses caused by reduction of rates. It is clear that effect of the tax rate decrease depends on the benefits, which would be received by enterprises coming out of the shadow. For many businessmen the legal status, as it is, is not a sufficient compensation for expenses connected with payment of taxes (though not so big as the current rates). Getting access to relatively cheap credit resources, cease of unofficial payments to corrupted representatives of power bodies, effective legal protection of the interests of businessmen in court, etc., might be the incentives. Without these circumstances (many of which do not take place in Kyrgyzstan) one may hardy expect a significant extension of the taxable base through reduction of rates. Besides, even if expansion of the tax base takes place, it may be protracted, as many potential taxpayers will be assessing the situation and studying the experience of those, who will be the first to come out of the shadow. All this implies, that decrease of rates is justified, if there are grounds to believe that this will not lead to decrease of the budget revenues[1], or if there are impressive reasons for giving up a part of the budget revenues (which will have to be compensated for at the expense of other sources). Removal of tax obstacles impeding development of small and medium-size businesses may be considered as one of these impressive reasons. This part of economy is now completely or partially in the shadow, but it can remain there only while the volumes of production are relatively small. The existing tax burden, which is heavy enough (high rates of income tax and deductions to the Social Fund, difficulties connected with VAT credit) for large enterprises paying an enormous share of taxes, considerably hampers growth of new enterprises, which must become the motive power of the economy in the future.
 
The tax system is frequently considered as a means of economic and social regulation through redistribution of resources between economic agents. In conditions of Kyrgyzstan such regulation is considered to be extremely ineffective and leading to various undesirable effects. Availability of numerous preferences and exceptions in payment of taxes is one of the most important reasons inducing those, who may not use these preferences, to retreat into the shadow. Consequently, providing for neutrality of the tax system is an urgent task.


[1] An example of such decrease is reduction of the highest personal income tax rate from 33% to 20%, which has not caused any negative consequences for tax collections. Evidently, there hardly were taxpayers paying personal income tax at the rate of 33%.