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Ukrainian Crisis is all about Taxes

Ukraine Help

The bloody crisis between the pro-Western two thirds of Ukraine and pro-Russian third of the country is about taxes.  The recent $17 billion International Monetary Fund (IMF) loan required Ukraine on May 1st to raise taxes and increase natural gas prices by 50%.  With about 58% of the Ukraine’s industry in the eastern zone and workers there make about 50% higher wages, the east is paying the majority of the tax increase.  Although residential users will not feel pain from the natural gas price increase until fall, eastern heavy industry is feeling the pain immediately.  With the corrupt west raising taxes for the IMF, why is there any surprise the east is rebelling?

About 70% of Ukrainian residents say they consider themselves Ukrainian, but more than 40% of the country primarily speaks Russian.  Language differentiation is often used to explain why the eastern third of the country that speaks Russian, favors Russia; and why the non-Russian west favors Europe.  But the real divide is about money.

The $7,400 per capita GDP of the Ukraine is less than half of the $18,100 of Russia.  But within Ukraine, the third of the population in the east account for approximately 58.1% of the industry.  Consequently, the per capita income in the east of $12,900 identifies much closer with Russia, than the other two thirds of the country at $4,900.

The average personal income tax rate in the Ukraine is 17%.  But the nation has a progressive tax rate that varies in steps between 0%, 1%, 5%, 15%, 17% and 30%.   Consequently, the eastern Ukrainians are undoubtedly paying a much larger percentage in taxes than their 50% higher wages compared to the west.

Ukraine is also the most corrupt country in Europe, ranking number 144 out of 195 nations for corruption in the world.  Russia is only number 127.  A favorite Ukrainian proverb is:

You don’t grease – you don’t ride.”

Since 2007, the Ukrainian sovereign debt has risen from $17.5 billion to over $85 billion.  Ukraine is the third largest aid-receiving nation in Europe, after Turkey and Serbia.  The EU, IMF, USAID and the World Bank have been the main donors to the country since the fall of the Soviet Union.  Under these Western organizations, post-socialist liberalization was supposed to promote markets and democratic institutions.  But with all the cash going to the government, the common people have fallen farther into poverty and the “blat” (bribery) and corruption dominates the economy.

Bribery, extortion and use of personal connections are a common reality for 60.1% of adult Ukrainians, according to the USAID-funded 2011 representative survey. On average 25.8% of respondents reported having been extorted for bribes in the preceding year; including 47.1% for government permits, 40.2% for business regulation and inspections, 36.1% for customs and 30.2% for the judiciary.

The International Monetary Fund (IMF) approved a $17 billion aid package for Ukraine on April 30th that is scheduled to begin distributions this week.  Before the fighting began, this support would have covered about 2/3 of Ukraine’s forecasted annual deficit of approximately $25 billion.  Austerity spending cuts might have been enough to balance the nation’s budget.  But with rebellion in the eastern Ukraine manufacturing belt, the financial shortfall is exploding.

As a condition for granting Ukraine new loans, the IMF required Ukrainian authorities to implement a wide array of austerity measures.  On May 1st, Ukraine enacted tax hikes and raised natural gas prices by 50%.  Although the pain for residential gas users will not be felt until the weather get cold in the fall, eastern Ukraine heavy industrial users are already suffering from a 5% loss of competitiveness due to higher energy costs.

According to a research by Stratfor Intelligence, an April IMF staff report warned that the bank’s loan with Ukraine will have to be restructured if the government loses control of Ukraine’s eastern regions.  The report highlighted that eastern Ukraine is the country’s industrial heartland, where most of Ukraine’s largest factories and mines operate.  Continued instability could therefore lower Ukraine’s industrial exports, and a loss of control over eastern oblasts could mean a significant loss of tax revenues, which would make it virtually impossible for Ukraine to comply with IMF loan covenants.   

Russia fought three wars with Western Europe in the 20th Century; losing 16 million in WWI, 1 million in the Civil War and 20 million in WWII.  The Ukraine in each war was the main entry point for invaders, since Moscow is only a flat 250 mile drive from the eastern Ukrainian border.  Russia will never allow a Western aligned government to control the Ukraine, but would be happy to support a neutral Ukraine.

The interim Ukrainian government is a coalition of factions that participated in coup to overthrow the elected Ukrainian government.  Without militarily recapturing the eastern tax base, the government cannot get external financial assistance from IMF, EU, USAID and World Bank loans.  Despite the threat of war with Russia, the Ukrainian government is being forced by its lenders to try to military recapture their eastern tax base.

The author welcomes feedback and will respond to comments by readers

The post Ukrainian Crisis is all about Taxes appeared first on Chris Street.

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