Tax reform as a condition for the IMF

Ukraine has passed the fourth review of the Extended Fund Facility program. The country has fulfilled all the quantitative criteria, all the structural benchmarks, and in early July we will receive $2.2 billion to finance the budget deficit. What does this mean and what's next, Ekonomichna Pravda asks.

OnJune28 , theIMF Board of Executive Directors approved the fourth revision of the program for Ukraine, according to Danylo Hetmantsev, chairman of the Verkhovna Rada Committee on Finance, Taxation and Customs Policy.

This means that the country has fulfilled all quantitative criteria under the program as of the end of the first quarter, all structural benchmarks as of the end of April 2024, that in early July we will receive the fifth tranche under the program in the amount of $2.2 billion, which will be used to finance the budget deficit, that we remain in the program, which is an umbrella for the lion's share of the external financing package in the amount of almost $122 billion.

The allocation of this package is designed for the duration of the EFF program (second quarter of 2023 - first quarter of 2027). The next, fifth quarterly review is due to be completed in the second half of September. The assessment will include quantitative criteria as of the end of the first half of 2024 and structural benchmarks as of the end of July. The assessment will be based on an updated memorandum of economic and financial policies and a revised set of structural benchmarks.

In terms of reform commitments, I do not see any significant problems with the fifth review. In terms of structural benchmarks, Ukraine should be credited with the adoption of the law on the BES reset, which was supposed to be adopted by the end of June (already signed by the president). There is also a permanent criterion for state capitalization of systemic banks and non-participation in the capital of other banks.

If the revision is successful, Ukraine will receive the sixth tranche of the program in September, worth $1.1 billion. I will now focus on the content of the updated memorandum with the IMF and the set of structural beacons under the EFF program. After the memorandum was updated, the number of structural beacons increased to 37, of which 23 have been fulfilled. This leaves 14 beacons to be fulfilled, of which two more have been added.

Amendments to the Customs Code by the end of October 2024 to: simplify customs procedures; clarify the interpretation of customs debt; create a legal framework for the dismissal of customs officers, including their integrity checks as part of periodic re-certification; establish a disciplinary committee; introduce contractual hiring of customs personnel; ensure compliance with EU legislation and regulations; strengthen the subordination and accountability of the State Customs Service to the Ministry of Finance.

In addition, a transparent and merit-based selection process for the management should be introduced, with integrity checks and substantial participation of experts with international experience. The draft law will also prevent the rehiring of customs personnel previously dismissed from the civil service for ethical violations.

Amendments to the Criminal Procedure Code (CPC) by the end of October 2024, which should: allow the Prosecutor General to delegate to the SAPO the management of extradition and mutual legal assistance requests in connection with corruption investigations; abolish the mandatory closure of pre-trial investigation due to the missed deadlines for pre-trial investigation after notification of suspicion; upon expiration of the deadlines and at the request of the accused or the injured parties, empower the investigating judge to timely oblige prosecutors to make a decision on the

The content of the two beacons has been modified, and the deadlines for their implementation have been postponed.

First, the task to develop a methodology for assessing the impact of tax benefits, including their cost to the budget, in order to apply a unified approach to reforms has been more clearly defined (the deadline has been postponed from the end of July to the end of September 2024).

Secondly, the task of analyzing debts and assessing the financial condition of district heating companies based on a desk audit by a reputable audit company was clarified, in particular by separating debts before February 2022 and after February 2022 (the deadline was postponed from the end of June to the end of October 2024).

The deadline for fulfillment of one lighthouse was simply postponed. It is about creating a court to replace the liquidated DACK: "Adopt a law on the establishment of a new court that will hear administrative cases against national state bodies (e.g., NBU, NABU, NAPC) by judges who have passed a proper test for professional competence and integrity" (the deadline has been postponed from the end of July to the end of December 2024).

To summarize, broken down by months and program revisions, we have

• one milestone (restart of the BES) should be counted as completed by the end of June 2024;
• three milestones (assessment of tax privileges, review of fiscal and quasi-fiscal expenditures of state-owned enterprises, external audit of NABU) - by the end of September 2024
• five milestones (amendments to the CPC, amendments to the Customs Code, development of the state property management policy, analysis of the debts of the heating companies, review of medium-term budget planning) - by the end of October 2024;
• four lighthouses (adoption of a government resolution that will strengthen the link between medium-term budget planning and capital expenditures, preparation of mechanisms for bank rehabilitation, introduction of a risk assessment methodology in the field of banking supervision, creation of a court to replace the liquidated DACK) - by the end of December 2024;
• one permanent lighthouse (for capitalization and non-capitalization of banks).

In my opinion, we will have a relatively predictable fifth review in September and a very tight sixth review at the end of 2024 in terms of commitments. There is no point in looking beyond 2025: the memorandum and the set of structural beacons may be expanded and modified during this time, and the timing of their implementation may change.

Now, as for the broader "set of policies" that Ukraine is committed to under the memorandum. These are not strictly defined reforms (structural beacons), but rather soft commitments that are important for the implementation of the entire EFF program , and which the borrower declares its readiness to implement. These are intentions, however, as practice shows, some of these intentions, which need to be strengthened, can be transferred to the category of structural beacons.

There are a lot of such soft covenants. Some of them, usually permanent or long-term, are transferred from one memorandum to another, some are modified, some are withdrawn. Given my professional interest, I will focusprimarily on those related to fiscal policy and fiscal structural reforms.

Revenues in general. The Ukrainian side undertakes to refrain from any measures that erode the revenue base. The exception is the privileges for the security and defense sector, which should be targeted, limited in time and controlled. It is once again emphasized that the National Revenue Strategy (NRS) is the basis for the implementation of fiscal policy and fiscal reforms.

Additional sources of revenue in the short term in addition to the structural beacon by the end of September 2024 to develop a methodology for assessing the impact of tax privileges. The Government has submitted a draft law to increase excise taxes on tobacco and fuel in line with EU directives (for the second half of 2024-2028) and to introduce an excise tax on sugary drinks.

Work is underway to develop legislation on the introduction of advance income tax payments for gas stations and taxation of medical cannabis. An electronic excise tax stamp for alcohol and tobacco products is to be launched on January 1, 2026 to minimize tax losses. If necessary, the Ukrainian authorities are ready to introduce additional fiscal measures to reduce the risks of a fiscal gap.

Fiscal reforms and revenue mobilization in the medium term. In 2024-2027, Ukraine will strive to mobilize additional revenues of +3-4% of GDP to meet the needs of defense, social protection, and recovery.

Fiscal reforms for the medium term, including those identified by the NDS, include: developing a comprehensive package of measures for the post-war period to reform carbon taxation; analyzing and assessing the taxation of extractive industries; defining the principles of taxation of virtual assets in line with EU/OECD rules; increasing the progressivity of the personal income tax (when conditions allow); and implementing anti-avoidance rules that take into account the requirements of the EU directive and international best practices.

Reform of the tax service. The STS reformswill focus on strengthening public trust in the service and developing modern compliance risk management practices: a pilot of the new compliance risk management system will be launched (by the end of June 2024); the results of the second survey of satisfaction with the STS services will be published (no later than August 2024); a digital development plan for the STS will be approved (no later than the end of 2024); aconcept for the use of anonymous data (masked data) will be developed to increase theconfidentiality of tax data held by the STS.

Work is ongoing on: organizational restructuring of the STS, which will reflect the results of its functional review (by the end of 2024); determining criteria for assessing the impact and effectiveness of the STS anti-corruption program; implementing IT solutions for SAF-T UA; and improving the efficiency of information exchange with foreign authorities.

Reform of the Customs Service. The reforms of the SCS will focus on areas critical for reducing corruption risks (in addition to the adopted laws on criminalization of smuggling and the structural beacon for the end of October 2024 on amendments to the Customs Code) and include: amending legislation to revise administrative liability for violation of customs rules (by the end of 2024); launching an initiative to define criteria for assessing the impact of the SCS anti-corruption program (by the end of September 2024).

The evaluation will be supported by regular (biannual) independent surveys on the perception of the level of integrity at customs. In addition, work will continue on: reforms of the HR and compensation policies; improvement of the operational management of the customs; transfer of verification and inspection of customs documents from border crossing points to the internal offices of the SCS.

Finally, we will talk about the changes in the IMF macroeconomic forecast, which is updated quarterly. This time, there are few changes compared to the previous forecast. I would like to draw attention to the main one. There are significant differences in the estimates of GDP for the first quarter. According to the IMF, real GDP in the first quarter (year-on-year) preliminarily increased by 3.8% (with some potential for growth), while according to the preliminary estimate of the State Statistics Service, this figure grew by 6.5%.

Hence the widening difference in GDP forecasts for 2024. The IMF has downgraded its annual estimate of real GDP growth to 2.5-3.5% (from 3-4% in the previous revision), while the government maintains last year's forecast at 4.5% (4.6% when the budget for 2024 was adopted).

Accordingly (and also taking into account a more intense slowdown in inflation), the Fund lowered its estimate of nominal GDP for 2024 to UAH 7,485 billion from UAH 7,748 billion, which is almost a quarter of a trillion hryvnia, which means a potential reduction in the tax base. Let me remind you that the government's current forecast of nominal GDP for 2024 remains at UAH 7,643 billion.

Obviously, the main risk and deterrent, in addition to the war, is the destruction of energy infrastructure. Here is a quote from the Fund's report: "The massive attacks on energy infrastructure, which resulted in about half of the generating capacity being severely damaged or destroyed, undermined business confidence, which fell below the neutral level in May; energy shortages are affecting households and industry as repairs take time amid scheduled maintenance of nuclear power plants. The negative impact of energy supply will carry over into 2025 and will hold back growth."

What does this mean? The war continues to generate significant uncertainty. This, among other things, complicates current assessments, planning, and forecasting, as evidenced by the almost twofold gap in the IMF and the State Statistics Service's estimates of real GDP change for the first quarter of 2024.

Stabilization measures should take into account the potentially worse GDP dynamics due to the destruction of the energy infrastructure, the impact of which will become more noticeable from the second quarter of 2024 and will intensify with the onset of the heating season. This may negatively affect the revenue base and the collection of domestic taxes and fees. The updated memorandum lists possible ways to close the fiscal gap using domestic sources, which we should be prepared to implement in case of a baseline or negative development.