The new tax legislation of Tajikistan, most likely, will uphold the primacy of taxation over investment, will not be business-oriented, and will not be able to affect the growth of consumption and savings of citizens significantly, believes Aziz Timurov, participant of CABAR.asia School of Analytics.
Key points:
- The dependence of the welfare of the majority of households in Tajikistan on remittances makes the government’s efforts to reduce poverty ineffective;
- The tax policy in Tajikistan affects not only the business and investment environment but also the level of poverty and social inequality of households;
- The scenario that the new Tax Code of the Republic of Tajikistan will significantly alleviate the situation of entrepreneurs and households is unlikely.
The Dynamics of Welfare Growth in Tajikistan
According to the World Bank’s classification, Tajikistan is among the countries with lower-middle-income economies. Although it remains the poorest country among the post-Soviet states, since 2000, the republic demonstrated significant GDP growth (7-8% per year); the poverty reduced by almost half over the ten-year period before the 2008-2009 crisis. Such significant economic growth is due to the low base effect, common for most developing countries that have carried out some successful reforms. Nevertheless, the economic growth has not led to sufficient job creation, nor has it significantly reduced poverty.
In Tajikistan, remittances from labour migrants were a specific factor of economic growth. Cross-border labour migration eased extreme forms of poverty, improved families’ welfare, and boosted economic and consumption growth, but weakened the government’s incentives to continue economic and political reforms, increasing dependence on international relations. The 2009, 2014 crises and the current coronavirus crisis demonstrated the labour export (a source of income) is vulnerable to external shocks.
The economic growth has not led to sufficient job creation, nor has it significantly reduced poverty.
The pandemic demonstrated the weaknesses of the economy and public administration: in healthcare, education, social security policy. Real GDP growth slowed to 4.2% year-on-year in the first nine months of 2020, compared to 7.2% in 2019. According to the World Bank, in 2020 there was a slight increase in the poverty rate from 26.3% to 26.5% in the first year of the pandemic. The number of households that reduced food consumption increased by 10%.[1] This was caused by low demand in the labour market, rising unemployment, short-term loss of income of labour migrants abroad.[2]
In 2014, the volume of labour migrants’ remittances began decreasing. At the same time, the rate of poverty reduction began slowing down by about 1 percentage point per year. The remittances growth is inversely proportional to the poverty growth: the fewer remittances the migrants send, the lower the purchasing power and the worse the quality of life of local households, whose income is formed, among other things, with remittances.
As an external factor of the internal development of the country, labour migration exhausted its potential. The repetition of the prosperous 2013-2014 is not expected; the dependence of the welfare of the majority of households on remittances (factor beyond the government’s control) makes the efforts to reduce poverty ineffective.
Improvement of the business environment, which creates labour demand, is the source for further development. The favourable business environment for creating new products and jobs depends largely on tax administration and tax rates. A balanced tax system can create preconditions for economic growth, help to reduce income inequality, and increase the welfare of the population.[3]
How Are Taxes Connected to Poverty Rate?
The work on the fourth edition of the Tax Code of the Republic of Tajikistan was initiated in 2019, even before the pandemic. It was implied that the new Tax Code would become more structured, consistent, and understandable, with improved tax administration and lower rates. The World Bank, which is funding the work on the new Code, sees the ultimate goal of the reform in simplifying the tax system, improving the quality of taxpayer services, and increasing the level of voluntary compliance.
When we talk about taxes and tax policy, we often think that the main stakeholders are the government and taxpayers (entrepreneurs, property owners, or investors). However, this is not quite true. Taxes affect all people, from children to the elderly, regulating income and expenses of the population directly or indirectly through a system of direct and indirect taxes.
Taxes are financial charges from the income or property of residents or non-residents imposed by the state. Using the system of budget transfers and the redistribution of resources, the government maintains its functions’ efficiency and is liable for its obligations, including social ones. The scholarships, pensions, various benefits, one-time payments to the poor are examples of the practical implementation of some aspects of social policy.
Speaking about the population’s welfare in relation to the tax policy, we should remember that taxes do not create wealth, but only redistribute available resources among the recipients of budget funds. Raise in salaries, pensions, benefits, and other social payments can and will increase the beneficiaries’ consumption, reducing poverty in the short term. However, due to a growth in effective demand, and an increase in the supply of money, the prices will rise, and purchasing power will decline. An increase in prices will not allow households even with relatively high nominal income to have high real income and a corresponding level of consumption, while poverty is a state of long-term limited consumption.
The resources, including revenues from taxes, spent to support a socially oriented policy (to raise salaries, to index benefits and pensions) are considered by taxpayers as lost alternative opportunities. For businesses and households, the tax expenses mean fewer opportunities not only for consumption but also for savings and investments in expanding business and improving technology. Eventually, every entrepreneur’s goal is to make a profit and to have a higher standard of living.
Ultimately, the competitive business activities could lead to lower prices for goods and services and higher affordability for low-income families.
Poverty reduction is possible not only due to an increase in real income but also due to the ability to minimise expenses, as a result of lower prices for goods and services previously unaffordable to poor households.
Indirect taxes play a significant role in the welfare level. These are VAT, excise taxes, sales tax, and customs duties. Indirect taxes are the consumption taxes paid by consumers. The higher the indirect tax rate, the more expensive the product or service will be. The rise in prices due to tax expenses limits the low-income citizens’ ability to pay.
Considering the predominance of trade, services, and import over export and insignificant volume of industrial production in the economy, indirect taxes play an important role in the formation of the budget revenues. They are easier to administer and, unlike direct taxes, businesses can shift the tax burden onto the customer, easing their own tax burden. However, with their influence on prices, consumption taxes affect the ability of households to expand or reduce the range of products and services.
The intentions of development institutions to create favourable conditions for doing business in Tajikistan by reducing the tax burden (by shifting most of the tax burden from income and profits to consumption) in the medium and long term will not have a successful outcome. The increase in indirect taxes will reduce the purchasing power of consumers.
A decrease in the profit share due to tax expenditures limits the ability of entrepreneurs to increase labour demand and create jobs, while high social contributions (25% of the wage fund, 20% – in the new draft Tax Code) give employers little incentive to raise workers’ salaries officially.
The tax legislation has a significant impact on the poverty rate growth. According to the economist and expert in budget policy Uktam Jumaev, the wrong tax policy leads to a reduction in the number of small business entities. The number of people engaged in entrepreneurship also decreases.
This results in a reduction in the total income of individual entrepreneurs, decrease in disposable income, which leads to limitation of consumption and savings. An ineffective tax policy may lead to a decrease in total tax payments due to the closure of small and medium-sized businesses, or the concealment of part of the income. As a result, the budget receives fewer taxes, and social payments from the budget revenues cannot be indexed considering the rise in prices for consumer goods and services.
Conflict of Fiscal and Investment Interests
The new draft Tax Code proposes the abolition of some tax payments and their consequent integration with other taxes. The draft developers propose to reduce the number of taxes from ten to seven. It is planned, in particular, to abolish the tax on sales of primary aluminium, and consider it as payment. It is also proposed to abolish the road user tax and include it in the excise tax. The vehicle tax and property tax are proposed to be combined and classified as local taxes.
Reducing the number of taxes improves tax administration and saves taxpayers’ time, however, it is unknown whether the aggregate tax rates will be low, or the new rates will be the sum of the two previous tax rates. It is also proposed to introduce reduced rates on some types of taxes to the new Code. The VAT rate is proposed to be reduced from 18% to 15%, the social tax rate for employers is expected to be reduced from 25% to 20%. The new draft Tax Code recommends establishing a single tax rate on the gross income of business entities at 18%. Currently, manufacturers of goods pay income tax of 13%, and others – 23%. Such significant measures to reduce the tax burden will lead to a budget revenue shortfall and an increase in the budget deficit in the short term.
Most likely, as the draft Tax Code mentions, the transition will be carried out gradually over several years. The current pandemic and a decrease in budget revenues postponed the adoption of the new Tax Code for an indefinite period. Perhaps, it will be adopted in the fall of 2021 to predict tax revenues better and to plan their collection for 2022. However, it is possible that the adoption of the document will be postponed once again, because the new Code, according to the tax department, implies many exemptions for business, especially for industrial entrepreneurship.
In addition to the fiscal risks of collecting fewer taxes and not fulfilling the obligations during the transition to new tax legislation and the pandemic, there is a problem of conflict of interest between the authorities’ intention to collect more taxes to the state and local budgets, and an attempt to improve the investment and business environment.
One of the main problems of budget policy in Tajikistan is that the forecast of the revenues is linked to the planned expenditures. That is, even if the economic situation deteriorates, this is not the main factor in budget planning. The priority of expenditures forces to search for new sources of income, but not to save. There is an obvious contradiction between the two economic incentives of public policy: on the one hand, collection of more taxes and fees under the approved plan, and on the other hand, encouraging local and foreign businesses to invest and create jobs. Such measures do not lead to an effective result in any policy.
Will the new tax legislation affect the growth of the population’s welfare in Tajikistan? There are more questions than answers. How will the economic agents (the government, businesses, and households) work during the endless pandemic and the transition to new fiscal policy? How will the state fulfil its obligations to the beneficiaries of budget money? What will be the rate of budget deficit? Will the government abandon the practice of adjusting revenues to expenditures, rather than vice versa? Will indirect taxes dominate the overall structure of tax revenues? Will the country take new loans to fill the gap due to the budget revenue shortfall, or increase the emission of money, which will accelerate inflation and affect citizens? External loans, in turn, aggravate another problem – the growth of public debt, which is serviced from the same budget, that is, by citizens.
Findings
- The welfare level of most citizens of Tajikistan is strongly correlated with the volumes of remittances from labour migrants;
- In 2014, the volume of remittances began decreasing, which slowed down the rate of poverty reduction in Tajikistan. The poverty rate increased slightly in 2020;
- Tax payments reduce not only savings and investments of businesses and other taxpayers, but also the system of indirect taxes reduces the purchasing power and consumption of the most vulnerable and low-income households, making them poorer;
- The more taxes and high tax rates – the fewer opportunities for businesses to produce cheap products and services, hire workers, and pay higher salaries;
- The government of the Republic of Tajikistan does not have enough incentive to make the new Tax Code business-oriented. The pandemic, which led to an increase in budget spending in social policy, along with the loss of revenues in 2020-2021, will not allow the government to reduce the number of taxes and their rates. In any case, it will happen not immediately: the transition will be long and gradual, which means that the goals of the government and donors financing the tax reform may not be achieved;
- Most likely, the new Code will not significantly improve the business environment of the Republic of Tajikistan. The loss of budget revenues, hope for an early end to the pandemic and a quick return to pre-crisis indicators and fees, as well as the willingness of development partners to provide soft loans and grants will support the government’s incentives to maintain the current conditions, except for minor changes and additions to tax law.
Recommendations
The new Tax Code must comply with the principle of economic efficiency, business orientation, and social justice through maintaining a balance between direct and indirect taxes;
Tax reform must present a consensus between businesses, households, and the government. There should be no half-measures, long transition, adaptation, or pilot period, introduction of insignificant adjustments, and the primacy of taxation over economic growth and household welfare should be revised.