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How to Overcome Shadow Economy in Ukraine?

Business in Ukraine

Recently, the Ministry of Economy of Ukraine published an analytical note concerning the Ukrainian shadow economy trends for 2020. According to these data, the level of the shadow economy in the country last year was 30% of official GDP. What is the reason for such a large share of the shadow economy in Ukraine, and what consequences may arise?

Nobody knows the real size of the shadow economy. The figures released by the Ministry of Economy are the result of calculations under a methodology that is, one way or another, based on a number of assumptions. However, the size of the shadow economy ranges from 30% to 40%, depending on the methodology used by the agencies that carry out estimations. And this is probably one of the largest figures in Europe.

It is important not only to crunch numbers but always to find out the reasons. The key is that the participants in Ukraine’s economic processes are in unequal conditions. Some of them can optimise taxes, significantly reducing the burden on business and, consequently, increasing its profitability. Others try to work in legal framework, so they lose from the very beginning, earning less, and most even leave the market. Thereby, the latter also begin to use grey tools to stay afloat.

Thus, the main reasons for switching to the shadow economy are the following:

Lack of fair justice and efficient judicial system. If we have strict laws that determine how the system should work exactly but there are no authorised instruments to make it function, the rules will not work. That is why the strictness of Ukrainian laws compensates for the non-binding nature of compliance with them.

Banks cannot lend to Ukrainian companies, precisely because of their optimised reporting. According to bankers (this is subjective data), about 95% of Ukrainian companies optimise taxes. This means that companies incur costs to optimise the tax burden. For example, the optimisation of income tax ranges from 7% to 12%. This money goes into the shadows and then returns to the enterprises in a certain way. That is, a whole grey industry works towards this in cooperation with the tax officer.

Officials who are not interested in unshadowing. Tax officers allow the shadow economy to operate. They really see who is optimising and who is not, and they get a corrupt rent from it, in fact, a bribe.

If we talk about VAT, then, according to various estimates, the annual tax cheating and the corresponding budget losses exceed UAH 50 billion. And this is the specific interest of individual officials who make a big, illegal profit.

High tax burden and lack of finance for development. Ukrainian companies do not have a bank resource for lending, respectively, they increase the turnover of their investment or working capital by saving on taxes.

However, there are a number of tools, the introduction of which will eventually allow overcoming the shadow economy in Ukraine:

  1. Judicial reform. Only this measure will force everyone to work on equal terms.
  2. Liberalisation of tax legislation. Only the introduction of distributed profit tax, according to the Ukrainian Institute for the Future, will halve the economy shadowing. For example, the same income tax will not need to be optimised to smooth the companies’ reporting: it will be easier for them to get loans, so they will increase their capitalisation, profits, and scale of activity.
  3. Automation of all processes. In particular, the introduction of “e-government.” i.e., reducing the impact of the human factor in all processes of the assessment of taxpayers. Perhaps, this will be one of the most important tools in the fight against the shadow economy.
  4. Greater liquidity, lending, support for producers, and consumption. Then, the companies will not need to avoid official payments because they will have liquidity, demand, and tools to develop their business.

Anatoliy Amelin, Director of Economic Programmes at the Ukrainian Institute for the Future

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