“Tax exemption is a tool of inexpedient government intervention into market processes. In the midst of oppressed business environment, where fiscal interest of the government prevails over investment considerations and sustainability in the future, granting preferences to one of the parties undermines competition and confidence in the rules of the game in the market.” – Aziz Timurov, an expert in economics from Tajikistan, participant of the CABAR.asia School of Analytics.
Brief overview of the article:
1. Tax exemptions do little to increase the investment attractiveness of Tajikistan, but almost always affect the decline in the budget revenues due to under-received tax payments;
2. There is always a chance that the beneficiaries of tax exemptions will be not the industries and enterprises that need it the most, but those that can acquire such economic preferences;
3. The main function of a small business should be social, not fiscal: it stimulates self-employment among citizens, helps to reduce unemployment rate, and lays the foundation for middle class growth and democratic development in the future.
In the “Law of the Republic of Tajikistan on the State Budget for 2019”, the Government of Tajikistan proposed to provide tax exemptions to certain industries and enterprises. A similar measure of public policy has been applied before. However, the practice of granting tax preferences, including also exemption from customs duties’ payment of a particular industry, to an enterprise, whether private or public seems to be a very doubtful measure in the current situation. Tax exemptions do little to increase the investment attractiveness of Tajikistan, but almost always affect the decline in the budget revenues due to under-received tax payments.
In the midst of growing state budget expenditures, tax base reduction and the general deterioration of business conditions in Tajikistan, whereof local experts and international development institutions have been repeating for years as mantra, the government seems to prefer solving current tasks promptly, without trying to rethink its approach to the essence of problems in the economy.
From general question to specific
According to experts and entrepreneurs, the tax system in Tajikistan is burdensome, repressive, obscure and ambiguous. It should be noted that the changes in the latest edition of the tax code of the Republic of Tajikistan (RT) were precisely of a technical nature, which in no way, however, affected the tax rate – they remained as high as they were. If we look at the dynamics of changes in the total tax burden, then the maximum value of the tax rate reached 84.5 percent of the profits in 2012. (See fig. 1). Currently it is 67.3%, which it is still a high tax rate. Olimjon Boboev, a member of the Tajik parliament and chairman of the Party of Economic Reforms of Tajikistan, the former director of the Institute of Economics and Demography under the Academy of Sciences of the Republic of Tajikistan, adheres to the same opinion that “the tax rate should not exceed 36-40%”.
In all fairness, it should be clarified that 67.3% is a conditional figure. As an example, it is not applied to small business entities, which are the majority in the republic. However, the thesis that taxes in Tajikistan significantly burden business – remains true.
Chart.1 Total tax rate (% of commercial profit). Source: World Bank
Tax administration is becoming more complete, which is a good thing, apparently. However, there are several factors that adversely affect the tax and budget policies.
First, let us discuss the practice of collecting non-tax payments. These are fines, penalties and other fees for violation of specific legislation. In addition, there are fees for public services and other government initiatives that involve revenue to the budget. Although the ratio of non-tax payments to tax revenues is insignificant, about 1 to 10, non-tax payments can act as an insignificant compensating mechanism in case of lost revenues from tax payments. In such situation, for example, in the case of low tax charges, there is a likelihood of an increase in fees from non-tax revenues.
The notorious plan on fines, monetary penalties for violations of the law, as well as some, at times extravagant legislative initiatives of recent years, which are invading the private sphere -are basically of fiscal interest. The revenue part of the budget should be formed at the expense of tax revenues and nothing more. It should also be mentioned about the practice of debts relief, as one of the quasi-fiscal operation forms of the state, which also create a burden on the state budget.
Secondly, budget spending grows by about 20 percent per year. This is not only increased government commitments to citizens, but also a fundamental approach embedded in fiscal policy: always spend, and if possible, spend more. The growth of budget expenditures can be justified by calling it strategically important for the country. This may be energetics, tourism industry or any other field or business entity. Such practice encourages seeking mechanisms to replenish the income section of the budget in order to serve its expenditure side. Usually, when planning expenses, a forecast of future income is taken, from the taxes themselves, by virtue of macroeconomic forecasts, last year’s income, the situation with remittances, the opportunity to receive grants, loans, or other investments that the Ministry of Finance technically perceives as investment income, which is not entirely true.
Thirdly, the expansion of the tax base at a high rate by means of reducing the types of individual entrepreneurial activities that are operating on a patent (license) basis. Individual entrepreneurs should not be considered by the government as a source of income to the state budget.
Their main function is social: they stimulate self-employment among citizens, help reduce unemployment rate, and in the future lay the foundation for the development of the middle class and democratic development. Citizens who have got a lot to lose will always demand, resist, and protect their interests and property.
Citizens who are economically dependent on the state, public sector workers, retirees will never be agents of development or change. Most of them will always be dominated by dependent moods: they will expect an increase in the level of remuneration, be it wages or pensions. As a rule, this category of citizens does not think about the sources from which their benefits should be formed.
The big business should be of fiscal interest for the government, which provide the bulk of tax revenues, and which most often receives economic preferences. The “money here and now” approach dominates here. Technically, the economic unit of the government is doing its job well: it ensures the collection of taxes. Although, judging by the latest reports from the heads of the tax administration and the state committee on investment, officials admit that tax collection rate has decreased and the overall taxable base is declining. At the same time, they draw conclusions that are not entirely correct, and they see a way out by toughening tax collection measures, identifying cases of tax evasion and by applying other administrative measures.
Such political measure deprives households and businesses of incentives to accumulate and invest. This is one of the reasons for hiding their incomes, leaving the business in the shadow, fueling corruption, and even a complete cessation of business activity.
In view of the above mentioned problems, the policy of stimulating certain “strategically important” industries or enterprises by granting tax preferences seems to be ineffective and sometimes counterproductive measure. I will explain in it the thesis form:
- Frequent use of tax exemption, as a tool to stimulate the development of priority areas in the economy, may indirectly indicate a generally unfavorable business environment, when only special conditions can contribute to the normal activities of an economic entity or the entire industry;
- The policy of attracting investments through partial or full exemption from tax payments for a certain period of time, as a measure specified in 2012 in the “Concept of the state policy of attracting and protecting investments of the Republic of Tajikistan” does not intend to be effective. A private foreign investor will probably look at the general investment climate and business environment in the country rather than be tempted by personal preferential terms;
- High probability of creating a precedent in which a business entity can gain a competitive advantage using an administrative resource. This is one of the weaknesses of the policy of granting tax preferences. It is not clear how and based on which criteria a certain business entity or a whole industry could be seen prioritized or strategic. The government’s decree is not enough. It is not clear why, in addition to the tax code, tax exemptions can be provided by the budget law, by a strong-willed decision, or through a government decree. It is not known how effective would be the enterprises and industries that are partially or fully exempted from tax payments, and whether they will remain effective after a favorable regime ends for them;
- Tax exemptions, also referred to as tax expenses – is a shortfall in the revenue side of the budget. Based on the data of the Tax Committee under the Government of the Republic of Tajikistan, we can observe an increase in the number of tax exemptions provided to various sectors of the economy. So, for example, the total amount of tax exemptions in 2015 was 2.1 billion somoni, in 2016 it increased by 100 million somoni, reaching 2.3 billion, and by 2017 this figure rose to 2.7 billion somoni. It is not difficult to calculate that the tax revenues to the state budget decreased during the same period by the same amount. Diagram 2 shows how much the value added tax fees have decreased due to exemption from VAT.
Let us recall that the expenditure side of the budget is not adjusted downwards, on the contrary, expenditures, as well as the budget development process itself are considered as key principles. Expenditures are considered as prime, whereas income must be adjusted for expenditures, but not vice versa. All further actions of the fiscal authorities emanate from this principle. The policy of program budgeting, experts and international development institutions say, should replace such an inefficient and vicious economic practice;
Tax exemption is a tool of inexpedient intervention into market processes by the government. In the midst of oppressed business environment, where fiscal interest of the government prevails over investment considerations and sustainability in the future, granting preferences to one of the parties undermines competition and confidence in the rules of the game in the market.
Reports of successes in politics, with a hint of populism, of course, by the new leadership of the neighboring state in the economy, enlivened the discussion among the Tajik expert community and business about the possibility of borrowing some successful practices. It is about Uzbekistan and the measures of the Uzbek government to improve the investment and business climate. One of the latest achievements of Uzbekistan is considered to be the increased number of taxpayers due to lowered tax rates of certain types. The process of changes in economic policy towards openness has just begun.
However, any populist measure, if applied, always costs money and it is often a large amount. Someone will have to pay more: business, citizens, or some particular group. We do not know whether these transformations will have the expected results. As a rule, we get something average. Now, most of the citizens of Tajikistan are looking at the transformation in the economy, hitherto, being closed, although richer in the resources neighboring country, with admiration and envy. Moreover, they wonder if such transformation is possible in our country.
Under almost any scenario, changes will occur in our country too: this is an objective law of social development. In our case, this may happen when adhering to the previous status quo becomes very burdensome. Moreover, when external and internal factors, external economic or political conditions will put direct or indirect pressure, and when using only the instrument of coercion will not be enough to solve problems.
Can the success of Uzbekistan and other countries in the liberalization and de-bureaucratization of the business environment have a positive impact on us? Give impetus to our reforms? Yes and no. The presence of more successful reforms in the immediate circle of countries, liberal, economically developed, of course, has a positive effect on less successful neighbors through trade, integration processes, infrastructure projects, and exchange of ideas and values. Although the presence of external impulses is important, changes within each country take place, when the old systems, methods and political practices no longer adequately respond to the challenges. In this case, technical and cosmetic measures will not be sufficient.
Conclusions on the tax exemption policy
Due to the urgency of the topic, it was decided to choose and develop one of the budget policy aspects, namely the connection between the budget revenues, coming mainly in the form of tax payments and tax exemptions, also called tax expenses. In the light of a decline in domestic economic conditions, repressive business policies, a strong dependence on external players and unresolved problems in the economy, the situation with tax revenues to the state budget in Tajikistan began to deteriorate. The tax base is reduced due to the withdrawal of entrepreneurs from the legal field of the economy, or even complete phase-out of business.
In this connection, it is assumed that one of the measures to resolve or mitigate the situation is to improve tax administration. Measures to reduce government spending where possible, were timidly but still voiced.
Tax exemption or expenses are the shortfall in budget revenues. This practice has been applied to industries or individual enterprises, whether they are owned by the state or an individual, which are considered important by the state on the basis of a certain criterion.
There are several controversial points here. How to determine which company or industry should be supported, thus losing tax revenues to the budget? How to define a “strategic” industry or enterprise? The practice of granting preferences creates a competitive advantage to the detriment of other economic agents, violating the principle of equity.
The recommendations proposed here by me are identical to the recommendations from the article of the deceased economist Konstantin Bondarenko, “Pitfalls of budgetary policy in Tajikistan”, 2015. In essence, this is a repetition of previous recommendations, because since then no significant changes have been observed:
- Exclude binding the forecast of the revenue to the planned budget expenditures;
- Implement Performance-based budgeting, not process-based (program budgeting);
- Ensure that the Tax Code becomes the only legislative instrument for granting tax exemption;
- Make a quantitative assessment of tax exemptions and show the results to public;
- Develop inventories of paid and free public services and eliminate incentives to raise additional charges, primarily through the provision of imposed services, the issuance of additional approvals or the imposition of fines.
The practice of granting tax exemptions does not necessarily carry negative consequences, since it is just a tool. However, the approach in which it is used in Tajikistan, in conjunction with policies, when expenditures take precedence over income, the situation with the tax base reduction and the business outflow is very alarming, and the measures proposed are purely based on forcible measures and administration, – is not the smartest move in our case. As long as the stimulus in the government will be fiscal interest towards economy and business rather than the investment interest, the current status quo will be maintained.
This article was prepared as part of the Giving Voice, Driving Change – from the Borderland to the Steppes Project implemented with the financial support of the Foreign Ministry of Norway. The opinions expressed in the article do not reflect the position of the editorial or donor.