Dimitri Gvindadze
What was it?
The number of taxes in Georgia – 21 in 2004 – was
reduced to 6 by 2008. Taxation became flat. Value-added tax decreased from 20
percent in 2004 to 18 percent in 2006. Social tax (33 percent in 2004) was
reduced to 20 percent in 2005 and then abolished by 2008. Personal income tax
(12-20 percent in 2004) became a flat 20 percent from 2009. Corporate income
tax was reduced from 20 percent in 2004 to 15 percent in 2008. Dividend and
interest income tax was reduced from 10 percent in 2004 to 5 percent in 2009. Georgia
emerged with no fiscally insignificant and “special” taxes, no payroll or
social insurance tax, no capital gains tax, no wealth tax, no inheritance tax
or stamp duty, no property transfer tax, and no tax on foreign-source income of
individuals.
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.
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