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




Kyrgyzstan Review, 10 years ago




RECOMMENDATIONS

On the basis of objectives of the Comprehensive Development Framework of the Kyrgyz Republic till 2010, the National Strategy of Poverty Reduction and the Fiscal Reform Strategy in the Kyrgyz Republic till 2005 as well as taking into account the analysis performed in this report, one may recommend the following changes to be made in the system of government revenue collection[1].
 
 
REFORM OF THE LEGISLATION, BUDGET AND ADMINISTRATIVE SYSTEMS
 
1. The Tax Code must become the only legislative document regulating taxation. All taxes, which are now regulated by other legislative acts (deductions to the ESLF, road tax, deductions for development and reproduction of mineral and raw materials base as well as taxation of FEZ subjects) must be either integrated in the Tax Code, or revoked.
Expected annual budget impact,
% of GDP[2]
Benefits
The effort will remove confusion and contradictions in the legislative acts relating to taxation.
Risks
No risks in the case of integration of the mentioned taxes in the Tax Code.
Year 1
Year 5
Protection from risks
*
*
 
2. To establish the following procedure of the Tax Code interpretation and establishing the practice of compulsory application of laws: 1) Jogorku Kenesh shall adopt the Commentary to the Tax Code, 2) decisions on specific disputable situations in the sphere of taxation shall be taken by courts, 3) the exclusive right to adopt tax-related instructions and speak on behalf of the Government on the issues of taxation shall be transferred to the Ministry of Finance.
Expected annual budget impact,
% of GDP
Benefits
The effort will remove the current practice, when interpretations and instructions of the Ministry of Finance, the STI and the NBKR[3] may contradict each other.
Risks
The existing potential of the Tax Policy Department of the Ministry of Finance may appear to be insufficient for implementation of the new broadened scope of the tasks.
Year 1
Year 5
Protection from risks
To begin strengthening the Tax Policy Department of the MF several months before introduction of changes with attraction of foreign technical aid.
*
*
 
3. To allocate grants from the Republican budget to the local budgets on the basis of the formula, which would take into account effectiveness of the local powers activity on collection of taxes, besides other indicators.
Expected annual budget impact,
% of GDP
Benefits
Increase of transparency in intergovernmental finance. Encouragement of the local authorities to increase tax collections.
Risks
No risk for budget revenues. Incentives for improvement of tax collections may be undermined, if the increased tax revenues are centralized.
Year 1
Year 5
Protection from risks
For the purpose of protecting from centralization of additional revenues, a connection between the amounts of the grant and efforts in tax collection must be formulated in the legislative procedure.
0.1%
0.5%
 
 
4. Increase of official salaries of the tax service officers and introduction of appropriate incentives and sanctions to encourage higher effectiveness of tax collection to the budget with simultaneous decrease of the number of officers.
Expected annual budget impact,
% of GDP
Benefits
An essential constituent of the tax collections reform is support provided by the officers responsible for collection of taxes, to the changes in the tax system, as well as of their collecting receipts to the budget rather than being involved in illegal extortions and bribery.
Risks
Increased expenses caused by these changes, must be covered by a short-term donor aid and revenues from the budget; the importance of latter must grow in long-term perspective. However, increase of budget revenues will take place, only if these changes are accompanied by other reforms including changes in tax rates, public information campaign, retraining of tax officers and raising prestige of the organization engaged in collection of taxes. The Law On Civil Service, which requires a united approach to establishing salaries to all civil servants, is another obstacle.
Year 1
Year 5
Protection from risks
Authorities and society must recognize and proceed in practice from the following: the task of the tax service is collection of taxes to the treasury based on the Law, rather than satisfying somebodys personal interests. The increased expenses can initially be compensated by means of aid provided by international donor organizations for the comprehensive program of tax collection system reforming. To prepare draft amendments to the Law On Civil Service for implementation of the gradual growth of the level of salaries paid to civil servants. This will allow a more even distribution of the burden on the budget.
-0.1%
0.7%
 

REFORM OF VAT
 
5. To provide for refund of VAT and excise taxes paid for material resources and their full refund from the budget to exporters or enterprises making capital investments.
Expected annual budget impact,
% of GDP
Benefits
A standard and necessary element of administration of VAT and excise taxes. Unless this reform is implemented, businessmen shall not consider VAT as a fair tax.
Risks
There is a risk of budget revenue losses due to increased VAT and excise tax refunds.
Year 1
Year 5
Protection from risks
These losses will be compensated for by the increased number of the law-abiding taxpayers, improvement of conditions for economic growth and expansion of the tax base.
*
*
 
6. To impose VAT on supplies of agricultural production. The duty to transfer tax to the budget should be placed on purchasers, i. e., processing and trading enterprises.
Expected annual budget impact,
% of GDP
Benefits
Decrease of the tax burden on the processing enterprises. Additional incentives for exports of agricultural products (a zero rate for exports). Investing into export-oriented agricultural enterprises will become more attractive (VAT refund and zero rate for exports). Peasants will obtain the possibility to get VAT credits on purchased inputs. This, in its turn, will increase demand for purchases of these resources from officially operating producers and decrease demand for products originating from the shadow economy (including smuggling).
Risks
Unfavorable influence on small farmers, if a threshold value for registration is not chosen correctly.
Year 1
Year 5
Protection from risks
A registration threshold should be established at the level, which will make small/poor farmers exempt from taxation.
0.36%
0.58%
 
7. To impose VAT on services of public utilities to the population.
Expected annual budget impact,
% of GDP
Benefits
This will provide for an unified approach to taxation of public utilities and commercial services. This effort is a necessary condition for privatization of the public utilities sector in a long-term perspective.
Risks
Unfavorable influence on the poorest consumers of these services.
Year 1
Year 5
Protection from risks
Low-income groups must be protected with the help of subsidies.
*
*
 
8. To introduce a VAT zero rate on export supplies of gold in respect of production of new natural deposits.
Expected annual budget impact,
% of GDP
Benefits
Attraction of investments to gold mining industry.
Risks
There is no risk, as the zero rate will be applied to new investment projects only.
Year 1
Year 5
Protection from risks
 
*
*
 
9. To ensure implementation of international agreements in VAT taxation of services (in telecommunication sector in particular).
Expected annual budget impact,
% of GDP
Benefits
Creation of better conditions for functioning of the services sector.
Risks
Certain losses of the budget in the short-term, because of increased VAT refunds.
Year 1
Year 5
Protection from risks
These losses must be compensated for from other sources. However, growth of budget revenues is expected to take place in a medium-term perspective due to expansion of the taxable base.
-0.16%
0.20%
 
REFORM OF INCOME TAXES (PERSONAL INCOME TAX AND PROFITS TAX)
 
10. Setting of a flat rate of profits tax at the level of 10%.
Expected annual budget impact,
% of GDP
Benefits
Decrease of tax burden on business and bringing it out of the shadow economy.
Risks
Losses of budget revenues.
Year 1
Year 5
Protection from risks
Expansion of the taxable base and strengthening of taxpayers compliance must compensate for these losses in medium-term perspective. Besides, for offset of negative impact on the budget it would be possible to increase payments of dividends by the state enterprises and to increase license payments for monopolists.
-0.15%
0.1%
 
11. Setting of a flat rate of personal income tax at the level of 10%.
Expected annual budget impact,
% of GDP
Benefits
Bringing a part of taxpayers out of the shadow economy.
Risks
A minimal risk for the budget, as a small number of taxpayers pays tax at the current top rate of 20%.
Year 1
Year 5
Protection form risks
Simultaneous introduction of a regressive scale of deductions to the Social Fund will make it possible to considerably expand a taxable base and even increase personal income tax receipts. Spread of information of the tax reform must expand the tax base, as a greater number of taxpayers will declare their real incomes.
*
0.3%
 
12. Allowing deductions of expenses connected with health care and education services from taxable income.
Expected annual budget impact,
% of GDP
Benefits
Decrease of these services burden for family budgets. This would facilitate fuller declaring of incomes and increase of transparency in provision of services in these sectors, thus leading to increase of receipts to the government budget from these sectors.
Risks
Budget losses are possible in the first year.
Year 1
Year 5
Protection from risks
The analysis confirms that short-term budget losses will be compensated for by an increase of the number of persons declaring their incomes as well as by growth of income receipts from education and health protection sectors.
*
0.6%
 

 
13. A considerable increase in registration fee for purchase of real estate and vehicles, with a partial deduction allowed on these expenses from taxable income.
Expected annual budget impact,
% of GDP
Benefits
Removing taxpayers from the shadow. Redistribution of the tax burden from transparently operating citizens onto those persons, who have gained their income from the shadow activity.
Risks
Risks are connected with improper introduction only.
Year 1
Year 5
Protection form risks
Providing for the existence of the training system and procedures for the agency engaged in collection of fees.
0.15%
0.15%
 
14. Revocation of privileges on personal income tax for the officers of the Ministry of Defense, National Security Service, Ministry of Internal Affairs and Department for Struggle with Organized Crimes.
Expected annual budget impact,
% of GDP
Benefits
Removal of lapses in the tax system. Establishing the rights and duties connected with payment of taxes for all servicemen.
Risks
Resistance of influential law enforcement bodies.
Year 1
Year 5
Protection from risks
Increase of salaries, which would compensate for tax payments. To develop draft amendments to the Law On Civil Service for the purpose of gradual increase of salaries paid to the civil servants, thus allowing a more even distribution of load on the budget.
*
*
 
REFORM OF PATENT PAYMENTS
 
15. Increase of the amount of patent payments in the cases, when analysis shows understatement of taxable incomes.
Expected annual budget impact,
% of GDP
Benefits
Increase of budget revenues. Insuring justice of the tax system.
Risks
Risks are connected with the movement of a part of taxpayers back to the shadow sector. Public dissatisfaction may arise, as a significant part of the population lives on incomes received from small business taxed on the patent basis.
Year 1
Year 5
Protection from risks
Increase must be performed gradually during several years and be accompanied with a proper informational campaign.
0.1%
0.3%
 
16. Simultaneous collection of patent payments and contributions to the Social Fund.
Expected annual budget impact,
% of GDP
Benefits
Extension of the tax base. Increase of the Social Fund revenues. Providing for a fair tax system.
Risks
Movement of a part of taxpayers paying tax on a patent basis back to the shadow sector.
Year 1
Year 5
Protection from risks
Minimal contributions should be established at a not very high level and subsequently grow gradually.
0.1%
0.4%
 

REFORM OF DEDUCTIONS TO THE SOCIAL FUND
 
17. Fixing a zero rate on contributions to the Social Fund for incomes exceeding 4000 soms a month per one worker.
Expected annual budget impact,
% of GDP
Benefits
Expansion of the taxable base due to coming of a part of the employed out of the shadow sector as employers can get significant savings.
Risks
Decrease of budget expenditures in a short-term perspective. Alternative efforts will be needed for reforming towards a savings-based pension system.
Year 1
Year 5
Protection from risks
Losses of payments to the Social Fund will be compensated for by increase in personal income tax payments. The pension system requires a profound reform and establishing a strong financial sector.
0.1%
0.6%
 
18. To strengthen a relationship between contributions to the Social Fund and the amount of pensions as well as provision of medical services.
Expected annual budget impact,
% of GDP
Benefits
Increase of the number of taxpayers and strengthening of taxpayers perception of the tax system as a fair one.
Risks
Lack of risk for the budget. Nevertheless, the effort may become a reason for social dissatisfaction in case of emergency (for example, refusal to provide medical aid to a patient, who did not pay social contributions).
Year 1
Year 5
Protection from risks
A properly developed informational campaign explaining the importance of the fair tax system.
*
0.5%
 
LAND TAX REFORM
 
19. To introduce an accurate criterion to distinguish land tax payers for eliminating the possibility of income tax avoidance by enterprises and persons, which (who) are not agricultural producers.
Expected annual budget impact,
% of GDP
Benefits
Expansion of taxable base. Strengthening of taxpayers perception of the tax system as a fair one.
Risks
Lack of risks for the budget
Year 1
Year 5
Protection from risks
*
*
 
20. To increase land tax rates.
Expected annual budget impact,
% of GDP
Benefits
Increase of local budgets revenues, which would help them to insure a higher level of services provided at the local level.
Risks
The poorest farmers can find themselves unable to pay at the higher rates. This is a possible risk of social dissatisfaction on the part of land tax payers.
Year 1
Year 5
Protection from risks
Increase of tax rates must be based on a detailed survey of incomes received from land.
0.1%
0.3%
 

REFORM OF LOCAL TAXES
 
21. Revocation of local taxes, which do not bring revenues to the budget, i. e., all of them with the exception of sales tax (till improvement of VAT collections) and tax for vehicle owner (as well as tax on real estate after its imposition).
Expected annual budget impact,
% of GDP
Benefits
Simplification of the tax system and providing for the public support to the system.
Risks
Loss of revenues necessary for provision of important public services for the local power bodies.
Year 1
Year 5
Protection from risks
Due to insignificant revenues received from these taxes, their revocation will be compensated for by the appropriate decrease of expenditures for maintenance of tax administrations performing administration of these taxes.
*
*
 
PUBLIC SUPPORT TO THE REFORMS
 
22. Development of the strategy of interrelations with taxpayers aimed at forming of a positive attitude towards the tax system.
Expected annual budget impact,
% of GDP
Benefits
Well informed taxpayers, who understand why they pay taxes and how these money are spent, will rather agree with compulsory tax payments, than resort to illegal payments for tax avoidance.
Risks
If a tax system is too complicated or considered to be unjust, it will be difficult to inform taxpayers on the objectives and rules of tax collection.
Year 1
Year 5
Protection from risks
To make efforts to provide for simplicity and just character of the tax system.
*
*
 
 
CONCLUDING RECOMMENDATION
 
It is necessary to carry out a reform of the government revenues collection system, which would combine reforming of the administration system and tax rates according to the above mentioned recommendations.
Expected annual budget impact,
% of GDP
Benefits
The reform is necessary for formation of a sustainable economy; it must facilitate coming of businesses out of the shadow sector of economy and moving to the formal one, which provides for the possibilities of economic growth and competitiveness of domestic enterprises in the internal and external markets.
Risks
The main risk is connected with the process of introductions of the changes, which can be complicated with the lack of support on the part of the tax bodies and resistance of the business representatives in respect of transition from illegal payments to the proper payment of taxes.
Year 1
Year 5
Protection from risks
Risks may be decreased by provision of strong public support to the reforms program and through the accurate monitoring of the reforms by international donors.
0.7%
4.73%
 


[1] A more detailed justification of the proposed efforts is given in Chapter 6.
[2] * sign means insignificant positive influence produced on budget revenues (the extent of influence on the budget is within the possible accuracy of calculations). It is expected that the main effect will be produced on economic growth and proper functioning of the state rather than on tax receipts. The given quantitative assessments could be considered as an indication of the order of numbers only.
[3] With respect to the regulation of commercial banks taxation.