Ukraine’s Parliament passed the much-needed 2016 budget

Adoption of a budget in the last days of December has become a Ukrainian political tradition of sorts. Many MPs usually have their suitcases packed, awaiting their winter vacations overseas, with only one box to tick. The urgency in past years stemmed largely from the inability to adopt local budgets without the state budget. This is less of a problem this year, as new legislation allowed for local budgets to be passed even without the central one.

This year, the IMF program has been looming large over discussions of the budgetary process. Mindful of some infantile MPs calling on postponing the review of the budget till January, ambassadors of key Western partners even had to remind the Ukrainian parliament of the need to pass an IMF-compliant budget before year’s end. These warnings seem to have been heeded: the Rada has passed the budgetary package that is in line with the IMF requirements.

Tax Reform: useful corrections

The changes to tax legislation generally alleviate some pressure for business, seek to de-shadow the economy and increase taxes for the richer Ukrainians. Although the Finance Ministry unveiled its draft tax reform at the beginning of December, members of parliament mounted a fierce opposition to that draft. As a result, the Ministry and the parliament spent the past days trying to reconcile their positions for a “compromise” version of the draft law.

The key changes that were finally adopted do not augur any disruptive change, but give reasons for cautious optimism.

• The payroll tax (officially called “single contribution to the social fund” in Ukrainian), which used to be among the highest in the world, has been almost halved: from an average of 41% to 22%. This sharp reduction is supposed to stimulate companies to pay official salaries rather than just hand over money to their employees “in envelopes” (still a rampant practice in Ukraine), and thus slowly bring the economy out of the shadow.
• Despite palpable resistance in the Rada, there’s a visible progress on gradually eliminating the current VAT tax breaks for agri-producers. As a compromise between the government and lobbyists in the Rada, a share of VAT will now be retained by producers (e.g., 15% in case of crop and 50%/85% for livestock), while the remainder is to be paid to the state budget. As agriculture is increasingly taking a more sizeable share of Ukraine’s economy and exports, agri-producers will contribute more to the state budget next year.
• The government has picked some low-hanging fruit to boost the state revenues. There is a big increase in the excise duties for alcohol (by 50%) and tobacco (by 40%). Fixed taxes have been introduced for luxury cars (costing over 40 000 USD) and large houses (over 300 sq. metres). Also, local authorities were allowed to impose higher property taxes: up to 3% of the minimum salary per 1 sq. m. (about 40 UAH) above certain limits. The latter measures will primarily affect the richer Ukrainians, but the success of revenue-collection will ultimately depend on the law-enforcement.
• In line with its commitments to establish the Deep and Comprehensive Free Trade Area with the EU, Ukraine has eliminated the special import duties (5-10%, introduced in 2015 to improve the country’s balance of payments) starting from 1 January 2016. This will make most imported goods cheaper for Ukrainians and improve competition.

These tax law changes were narrowly passed mostly by members of three parliamentary factions: pro-presidential Petro Poroshenko’s Bloc, Yatseniuk’s People’s Front and the Samopomich, self-styled defenders of the middle class. However, the real credit for this accomplishment should go to Finance Minister Natalie Jaresko, whose patience and perseverance preserved the crucial parts of the tax reform, even though she had to deal with resistance within her own coalition.

Transparent Public Procurement

Another appetizer to the state budget was Rada’s adoption of the law that moves all purchases by state institutions to an e-based platform calledProZorro (“transparently” in Ukrainian). This brainchild of the Economy Ministry has been running as a pilot project for a while already. The platform has reportedly saved the country almost half a billion hryvnia in expenditure this year only due to easier ways to submit procurement bids and online monitoring of the past tenders.

The adoption of law mandating the system’s extension to all state purchases is a crucial step in eradicating corrupt, opaque practices from public procurement. As bigger procurement orders exceeding the previous thresholds are moved to the ProZorro, the scale of savings is sure to increase substantially. Economy Minister Aivaras Abromavicius and his deputy Max Nefyodov are to be commended for pressing forward with this draft law. As a pal of mine working in the Ministry texted to me, the team could initially hardly believe that this law had been passed by the Rada. Well, Christmas miracles happen after all.

The 2016 Budget: cautious austerity

The key macroeconomic assumptions that the 2016 budget is based on are: GDP growth of 2%, inflation of 12%, the average exchange rate of 24 UAH/USD and gas price of $225/tcm. With state revenues of 595 bln UAH (increase by 15% y-o-y) and expenses of 668 bln UAH, the maximum deficit will amount to 3.7% of GDP. The latter figure is in line with the requirements of the IMF program.

It is too early to give a comprehensive analysis of the budget, so I will try to pinpoint some of the most important anchors here to illustrate the philosophy behind the document.

The budget includes some measures to reduce income inequality. On the one hand, there is now a ceiling of 10 thousands hryvnia (about 400 USD) for so-called “special pensions” received by former officials, which has often been criticized as a source of sinecure for the unworthy and the drain on the country’s budget. At the same time, the government has increased expenditure on social security for the poorest in line with the projected inflation rates next year: Prime Minister Yatseniuk claimed a 12% increase in social spending in the 2016 budget. Hopefully, this will also be sufficient to cover the utility subsidies for the most vulnerable groups, amid the steep tariff increase this year.

The newly-created anti-corruption agencies have been allocated independent funding from the state budget, contrary to previous fears of crippled financing. Almost half a billion UAH (approx. 21 mln USD) has been earmarked for the National Anti-Corruption Bureau (NABU), the agency that is tasked with investigating high-level corruption. The Special Anti-Corruption Prosecutors’ Office is to receive 74 mln UAH, making it financially independent from the General Prosecutors’ Office to which it formally reports. The National Agency for Prevention of Corruption (not formed yet, but in progress) has been assigned almost half a billion UAH, with most of its budget to be spent on financing political parties that are elected to parliament.

The budget supports the ongoing fiscal decentralization, which aims to increase the financial resources of the local authorities. Some CSO expertshad criticized that the proposed budget would provide insufficient funds for local communities compared to their extended expenditure, and it still remains to be seen if changes have been made since to tackle those concerns. However, the general philosophy of delegating more resources and more responsibilities to the lower levels of governance seems to have been preserved in the budget. The speaker of parliament Volodymyr Hroysman, who is widely considered to be the political driver of decentralization, was especially vocal in emphasizing this component of the newly-adopted budget.

The budget for Ukraine’s national defence and diplomacy has been increased. The expenditure for defence and security has been increased to 113 billion UAH (5% of Ukraine’s GDP). Defence Minister Stepan Poltorak has already announced the increase in salaries of Ukrainian servicemen. There were previously fears that the draft budget would cover only 67% of the requested expenditure of Foreign Ministry, but some MPs (Hanna Hopko and Iryna Herashchenko) spearheaded a campaign to boost the Ministry’s funding amid the ongoing war with Russia. In the end, the budgetary expenses have covered the minimum requested by the Ministry. Foreign Minister Klimkin has already said he “couldn’t expect a better gift” for holidays.

Political Scores

The patterns of voting for the budgetary package let us make at least two conclusions about the political dynamics behind the budgetary process.

First, the coalition is not quite as dead as some had proclaimed it to be. As much as MPs from Poroshenko’s Bloc and People’s Front might dislike (or even hate) each other, they formed the core of the needed vote mass. This “core” was successfully supplemented by Liashko’s Radicals and two deputy groups created by MPs from the former Party of Regions. It remains to be seen what the latter got in return, but Poroshenko and Yatseniuk showed that they are good at “diversifying” MP votes when needed.

Second, the populists have failed to gain a “golden share” in the vote on state budget. Yulia Tymoshenko’s furious invectives from the pulpit lacked novelty, and the vote of her faction against the budget sealed their status as a “ghost partner” of the ruling coalition. Samopomich continues to diligently play its role as “the opposition within the coalition”. Young MPs calling themselves “Euro-Optimists” have failed to provide any substantive criticism of the draft budget, apart from moaning about the belated, hasty hearing of the budget or picking up “strawman” expenses in the draft budget.

Just as I had cautiously hoped half a year ago, populist politicians have failed to derail the right policy steps even amid the growing expectations of a possible snap parliamentary election. Sincere congratulations to the technocrats in the Ministries of Finance and Economy who have held firm against this populist onslaught, well done.