Is it fair that 80-85% of personal income tax collections is formed through those earning less than AMD 120 thousand income per month?

Transcription

1 Is it fair that 80-85% of personal income tax collections is formed through those earning less than AMD 120 thousand income per month? Interview with Ms. Gohar Gyulumyan, Senior Economist of the World Bank Yerevan Office on the Tax Code, which recently passed its first reading at the National Assembly - Ms. Gyulumyan, while the draft Tax Code (TC) has passed its first reading, some of its provisions were severely criticized by MPs from both opposition and ruling fractions. What is the World Bank s assessment of the TC version in its first reading? - First, I would like to mention that we worked with the respective government counterparts starting from the early stage of analysis through the last stage of finalization of the draft Tax Code. We provided technical assistance, which helped to simulate various scenarios in terms of the adaptation of international experience, its implications, the design and rates of various tax types. It was a purely technical, analytical work aimed to help the authorities decision-making. Some of our recommendations were accepted, others - not. Nevertheless, the version of the TC, which was sent to the National Assembly had received the positive opinion of the WB experts. And we say positive or negative not in their abstract sense but based on certain principles: to what extent the TC with the proposed tax policy and administration principles is commensurate to the challenges that Armenia is facing today, to what extent it will (a) contribute to addressing these challenges, (b) the transparency and effectiveness of the system will increase, (c) the fundamental principles of taxation - horizontal and vertical equity will improve, and (d) broader opportunities for tax revenue mobilization will be ensured without compromising the equity principle? All of the provisions were reviewed from these stand points. And I can assure that in our judgements we relied on both official statistics and survey data. - State Revenue Committee (SRC) Deputy Chairman Vakhtang Mirumyan mentioned in the Parliament that the positive effect of the TC on the State budget revenues was estimated to account for 1.8% of GDP. This means that it will lead to an increased tax burden. To what extent it will contribute to the development of the economy? You are referring to its positive effects but will the positive effect be equivalent to losses they talk about? - Yes, the overall fiscal effect of the TC is assessed to be equal to 1.8% of the 2015 GDP. It is a fixed figure: around AMD 90 billion. But I would like to stress that this effect will take place during the period of , because the changes will come into force gradually and not all at once. - So, the increase of the tax burden by AMD 90 billion will not happen during the first year? - No. For example, from January 1, 2017, only the provision on tobacco and alcohol excise tax will become effective. From January 1, 2018 other changes will come into effect. The new threshold for SME taxation will become effective from January 1, There are also other changes which are minor and they will come into effect in 2020 and later. - Let s clarify. In the National Assembly the raised question was: what would have been the increase of actual tax collections for 2015 if the TC became effective in January 1, 2015? The answer was: the positive effect on budget revenues is 1.8% of GDP. It appears that the answer was not complete because during the first year of implementing the TC the tax burden increase will be less, won t it? - The SRC Vice Chairman, in my opinion, meant the hypothetic situation when all of the provisions would become effective on the same date. But this cannot be the case. One should take into account of the economy s ability to digest. A tax legislation, suggesting a change equivalent to 1.8% of GDP, cannot be

2 implemented all at once. It should be done in the course of several years so that taxpayers and consumers are able to adapt to the new situation. Therefore, the time span of was chosen, i.e., there will be a gradual increase of the burden. And the excise tax will be introduced at an earlier stage, because this process will not be associated with any technical complexities. - As a matter of fact, the proposed change in the tobacco and alcohol excise tax is among the most criticized ones. Why? - I know. I am following the discussions at the National Assembly and other platforms, and the focus is on several issues: the personal income tax, dividend taxation and the reduction of the VAT taxation threshold in the SME sector. As to the change to the excise tax on cigarettes, it has its emphatic opponent with its apparent motivation. - An opponent in the tobacco business? - It's not a secret that Armenia is a tobacco manufacturer /exporter and importer. It should be also noted that there are high and low price segments of tobacco. The local manufacturer operates in the lower price segment. The TC proposes a design change in the excise tax: the current design of the excise tax contains only a fixed component, whereas the one proposed in the draft Code also has a value-linked component. And if the value of cigarette goes up, the tax burden will also increase, and the increase will be more significant for the imported cigarettes, which belong to the higher price segment. The TC stipulates that during the tobacco excise rate will grow by 15% annually. Moreover, changes to the excise tax on tobacco were to be initiated anyway, irrespective of the Tax Code, due to Armenia s accession to the Eurasian Economic Union (EEU). The point is that in Armenia the rate is very low compared to other EEU states, and the issue that, over several years, Armenia should consistently increase the rate was part of the agenda of the Eurasian integration processes. And with the changes stipulated in the TC, in 2021, the tobacco excise tax rate will still be lower than in Russia. However, it is justified because Armenia belongs to a lower income grouping of countries compared to Russia and Kazakhstan. As I mentioned, imported tobacco is in the higher price segment, and the excise tax increase will have an adverse effect for the importer. - Let s talk about the personal income tax (PIT). Here also the criticism is focused on its higher rate and the issue of replenishing the budget at the cost of medium and medium to high wage earners. - The proposed change to the personal income tax will have a neutral effect on budget revenues. Additional budget receipts of only AMD billion will be ensured which, in my opinion, is insignificant. The main change in the PIT rate and design aims to improve the tax progressivity. If we assume that the PIT in Armenia should be progressive, then its design should be so as to ensure such progressivity. The PIT structure, which has been applied since 2013, at first glance seems to have a progressive design with 24.4%, 26% and 36% rates. However, note that 24.4% and 26% represent a very weak progressivity design. The first and second brackets are very close to each other (by 1.6 points), and the third one is very high (by 10 points). It appears that today, according to actual data, high income earners easily split their incomes to comply with the second or even the first thresholds. When we analyze the actual PIT collection data, we come up with actual 25% PIT rate. This is the first deficiency. Now a scale of 23%, 28% and 33% is proposed, i.e., the difference between each of these three thresholds is 5 points. And this transition aims to stress progressivity. The second deficiency of the existing system is rather global by nature. In particular, according to the applicable tax legislation, in Armenia there is no personal income tax as such. In essence, it is a payroll tax. Thus, if we consider the structure of household incomes, the weight of wage is high on low income groups

3 and, on the opposite, it is low for those with overall high income, because they have other incomes, too (dividends, interest earnings, etc.). In other words, in this country the notion of the personal income tax has been equalized to the perception of payroll tax. When we say 'income tax', it should apply to all incomes. All declared incomes should have their fiscal implications that, in reality, is not ensured. It appears that the system of income and property declaration is ineffective. People declare their incomes, and then there is no fiscal implication - no one seems to be interested in this information. - Does the Tax Code address the issue of full taxation of incomes? - The Tax Code proposes solutions for at least certain types of incomes. For example, a 5 percent tax is proposed for dividends received by individuals. First, taxing dividends is an accepted international practice, and second, it is not a heavy burden. - Apart from ensuring tax revenues, what other issues does it address in its current version? - It ensures the principle of horizontal equity of the tax policy. - And does it have a negative effect on investments? - Let s be clear, in general, about the investment attractiveness and potential investments in Armenia. Currently, we observe a situation with reduced investment trends globally. In 2015, Armenia received foreign investments that accounted for only 1.7% of GDP, whereas in the same indicator was 8-9%. Investments have gradually fallen to the present level. - Does this mean that the 5 percent dividend taxation cannot become the main cause for falling investments and there are deeper underlying causes? - Yes, the 5 percent cannot be an impediment. The 5 percent dividend taxation, for instance, has been applied in Georgia for several years now, and despite this, the same Armenian investor can prefer investing in Georgia and go there. Apart from the 5 percent, there is a number of more important factors for making a country attractive for investors, including the competitive environment, rule of law, independence of the judicial system and so forth. There are institutional factors that are more important for investors. And the reaction of capital holders (dividend recipients) is natural: nobody wants to pay more taxes. - Let s talk about the criticism against you (I mean the World Bank and other international financial organizations). There are views that you exert pressure for having the Tax Code passed rapidly, mainly as it reads in its current version. They also refer to its underlying reason: in the near future we are going to face the issue of servicing the loans taken from you, and you seek to increase budget revenues through tax changes so that we are able to repay the debt and its interests. So, is there pressure or no? - I do not share these views at all. These are primitive speculations. To illustrate my point I would say that today Armenia s external debt has grown compared to by reaching 41% of GDP. However, it has not reached an unsustainable level, yet. Yes, there are concerns, but one cannot state based on these concerns that the World Bank is highly worried about the repayment of its loans, and thus, forces to increase the taxes. The issue of development of the Tax Code did not come about last year or this year. As early as in 2013, we started our budget support credit program, and both the Tax Code and changes to the Bankruptcy Law, as well as amendments to the Law on Waste management and other laws have been part of the stated program. Now it would be unreasonable to state that the World Bank posed ultimatums in the mid-year of 2016.

4 - The main criticism is against the International Monetary Fund. - I would not like to answer instead of the IMF, but again, it is not true. Armenia's two-digit economic growth in the 2000s' - of which we took so much pride was thanks to three main channels of financing. The first one was the remittances which grew at 2-digit rates and were directed to finance consumption and the construction sector. The second one was the foreign direct investments which, as I mentioned, accounted for 8-9% of GDP and lastly, the lending (to both the public and private sectors). Now all these three sources of financing have dried up. Thus, there are no grounds for optimism about their rapid recovery. For example, last year remittances dropped by 35% and, ideally, this year the mentioned inflow can only be stabilized. The same is true about foreign investments. In relation to lending, as I already mentioned, the external debt that stands at 41% of GDP is not an indicator of debt unsustainability yet, but these days external financial resources cannot be attracted at the same rate as during the last 5 years. In other words, in order for the government to be able to maintain the current level of budget spending, internal resources should be mobilized. In 2015 the State budget deficit was 4.8% of GDP, which was financed primarily from external sources. It is not a stable level of deficit, and Armenia cannot maintain such a level for another 3-5 years. The deficit should be reduced, meaning that budget revenues should increase. So the issue of increased revenues should be addressed for it not to affect adversely the redistribution mechanisms, meanwhile putting the burden on groups of the society managing higher incomes. - I understood from what you said that international organizations say to Armenia: 'We have been giving money until now but we won't do so any longer. Do not rely on us and collect more taxes by yourself'. - Over the last 3 years, Armenia has attracted large volumes of funds from the international market (in 2013 Eurobonds at the amount of US$ 700 mln and in 2015 at another US$ 500 mln were issued). This figure is significantly high compared to the financial support provided by the World Bank. Yes, US$ 200 mln from the second issuance was used for the partial buyback of the first issuance but the remaining US$ 1 billion must be repaid by Moreover, loans from these markets are rather cumbersome and short-term, while the World Bank loans have a maturity of years. The issue is not that the WB loans will no longer be available. US$ 50 million provided by the WB is not a major source of financing from the budget deficit perspective: we use it as a means to maintain our effective dialogue around the economic policy and structural reforms. In this case the government addresses the liquidity issue by financing the budget deficit from funds leveraged from the international market with a sovereign rating. Due to global and other developments, in Armenia the tax to GDP ratio is still 22%, and this level of state revenues is insufficient for addressing fundamental social or infrastructure issues Addressing these issues, maintaining the macroeconomic equilibrium is our most important concern. And when they claim that the Tax Code does not lead to development, I want to ask: what salient development prospects are ensured by the existing tax framework or the economic policy? Especially when such arguments are generic and invalid. - What would you say about reducing the VAT threshold for SMEs? - Yes, the Tax Code envisions a reduction of the threshold from the current AMD 115 million to AMD 40 million. Here also it is more a matter of speculations than concerns. It was decided to set an AMD 115 million threshold in 2013: before it was AMD 57 million. At the time when this change was made, ¾ of the SME sector comprised micro enterprises with 0-10 employees. About 20% accounted for small enterprises and only 5% were medium ones. In fact, we have such a structure of the SME sector where micro enterprises needing to survive and grow in the market prevail. And increasing the threshold in such an

5 situation meant that these micro companies would appear in unequal competitive environment together with the new 'medium' ones. I mean companies with annual turnover slightly below AMD 115 million, which need to compete primarily with the larger ones. By combining micro enterprises and these businesses under the same threshold we do not allow the SME sector to develop in Armenia. Now it is proposed to reduce the threshold and create a level playing field for same 'weight category' to compete. It is fairer. - Let's go back to the personal income tax. In 2015, they said that the existing progressive tax rates were high, which, in turn, led to understated incomes, increased poverty and migration. Based on this argument, it was proposed to reduce the rate to a standard level of 20%. Several months later quite the opposite happens: the rate goes up. What has changed during these months? - The provision of a single 20% rate was included in the October version of the draft Tax Code. But from the professional/technical perspective, the idea of a single rate is regressive, and one can say, it is not propoor. The idea of having in place a 20% rate was abandoned for several reasons: first, it did not follow the principle of vertical equity (so that an earner of higher incomes pays a higher tax in terms of its rate), and, second, it created an immediate additional shortage for the budget. As a matter of fact, according to surveys, businesses keep on stating that in Armenia tax rates are high. Once the issue of the PIT coverage is addressed, i.e., the income tax covers both other incomes and all taxpayers and its base broadens, its rate can be revisited. I agree that tax rates have an important role in terms of the country's competitiveness. But one should not expect that tax policy should be the tool for addressing all the challenges: the functions of fiscal redistribution, investment attractiveness, economic development, etc. We pose an unrealistic task for a single document. Ten objectives cannot be achieved through a single policy tool. In economics it is an axiomatic truth that if you have 10 policy problems you should have 10 policy instruments to address them. I would like to reiterate the issue of tax equity. Let's see who pays PIT today? 80-85% of the tax is paid by those who meet the lower threshold with incomes at or below AMD 120 thousand. Is it an equitable structure? Do these people dispose 80 percent of incomes in the country in order to ensure 80% of taxes? The proportion is on its head, and on one hand, it should be fixed through the re-design of tax structure, on the other hand, it should be addressed through the proper administration so to ensure its adequate enforcement. Surprisingly, no one speaks about the reduction of the first threshold rate from 24.4% to 23%. For those with actual incomes up to AMD 120 thousand the burden is reduced by 1.4 percentage points. - Which is only drams. - By following the same logic, I can say that for the middle class the burden increases only by 2 percentage points. - Let s go back to the surprising shift in arguments. Until recently they stated that the applicable rates and the threshold contributed to under-statement of incomes and migration, and today the threshold increases, doesn t it mean that more incomes will be under-stated, the shadow economy will grow and the migration rate will be even higher. - I am disappointed with the I would say the sympathy of some of our public figures towards those who operate in informal economy and hide their incomes. In this context the most discussed area is the IT sector, which is Armenia s potential, its face, its driving force Instead of encouraging proper declaration of incomes by those employed in the sector, they attempt to form a public opinion that the IT sector is the one that will suffer the most, and that the burden will fall on the IT sector, thus, implying that it can move to the informal economy. Moving to the informal economy should be unacceptable. Today being an honest and compliant taxpayer must be the best demonstration of patriotism for all RA citizens. Encouraging and justifying tax avoiders is a duplicity. It means letting our problems in different areas remain unaddressed. It

6 means depriving the poor from access to benefits and the vulnerable from access to free healthcare services. It means that the state of our roads remains poor and so forth. - Citizens move to the shadow economy mainly because of the lack of fairness and trust that their paid taxes will be used for their intended purpose, rather than because of high tax rates. - You know, tax collection is not an end in itself. Taxes are just a part of the fiscal policy. The other part is the budget spending. Maybe the government should work on demonstrating to what extent these funds are used efficiently. We must be concerned with all these matters. When I say that the Tax Code is a good document, I don t mean to say that what is written will be sufficient: the Tax Code must be enforced and implemented the same way as it is written. If today a taxpayer has a tax base and has even declared his tax liabilities, but has allowed himself not to pay them, tomorrow such a person should become the subject of public admonishment. If we are unable to ensure it, the issue whether the Tax Code is good or bad will no longer be relevant. - It is outside the domain of the tax legislation. More likely, it is a political issue. - Some people who for years have built their wealth feeding on unfair competition and have never voiced their concern about the increasingly growing migration, speak out about it today But migration and other negative phenomena are not new, are they? Or some people who have been providing consumer lending at 24 percent nominal rate to the population for purchasing refrigerators or other low-value household items, today speak out about the TC-related issues, because it envisions taxation of dividends paid to their shareholders. It is a matter of interests. Interview conducted by: Babken Tunyan, Originally published in 168 Zham (168 hours) daily on June 23, 2016