Less than a month ago, the Ministry of Finance’s struggle to raise taxes began. On July 18, Parliament received a bill introducing new military taxes, new taxes on entrepreneurs in general, and stricter controls on tax audits.

The goal: This year, an additional 500 billion hryvnia (12.5 billion dollars) will be made available for defense. Higher taxes will account for 140 billion hryvnia (3.5 billion dollars) of this.

Ukraine’s defense spending, which must fend off Russia’s large-scale invasion, exceeds its entire pre-war spending. But another part of the problem is that U.S. military aid has been delayed for six months.

In addition to the Russian advance in the Kharkiv region and a critical shortage of ammunition, the delay also resulted in a liquidity crisis for the country.

While the US House of Representatives was debating whether or not to approve a $61 billion US aid package, Ukraine had to reallocate spending planned for the second half of 2024 to the first half of the year and buy weapons out of its own pocket.

A source familiar with the matter told the Kyiv Post that Ukraine was already threatened by a liquidity crisis in July, but timely financial assistance from the EU covered social spending. Now Ukraine faces another, similar risk in the autumn.

“If we do not find these funds, there may be interruptions in cash payments as early as September,” said Ukrainian Finance Minister Serhiy Marchenko in an interview for RBK-Ukraine.

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Taxes are a quick solution.

The draft law presented by the Ministry of Finance is still in the discussion phase and has not yet been passed by Parliament and made into law.

The biggest change from the ministry is an increase in the military tax, first introduced in 2014 – a 1.5 percent tax on personal income intended for the Ukrainian armed forces when Russia occupied Crimea and Donbass and launched military action against Ukraine.

The new bill proposes an increase in the military tax on personal income to 5 percent. Companies will be subject to a military tax of 1 percent on their corporate income. For companies that trade in jewelry, the state will impose a 30 percent military tax on their sales.

In future, private customers will have to pay military taxes on goods: 15 percent from the first car purchase, 5 percent on telecommunications services. Manufacturers and importers of sugary drinks will have to pay a consumption tax of 0.1 euros per liter. VAT is also planned for postal packages.

When the law comes into force, companies that sell fuel to B2C companies will have to pay taxes on their profits up front. If they pay on time, they will pay less taxes on their profits later. However, if they overpay, subsequent taxes will not be lower – payments made in error cannot be refunded, nor can companies pay too much.

Taxes for fuel companies are estimated at 0.5 of the minimum wage per cubic meter of tanks for storing gasoline, diesel and LNG. For companies, taxes are over 3,500 hryvnia ($88) per cubic meter of tank.

The bill allows local governments to levy a minimum amount of income tax.

Sole proprietorship companies (also known as FOP in Ukraine) have not paid military tax so far – but the new law would force them to do so.

Sole proprietorships in Ukraine have four tax groups. The draft law provides for a military tax of 1 percent for the third group. This group is most often used by freelancers and employees in companies who want to avoid paying standard taxes on their salaries.

Sole proprietors in other groups are expected to pay 5 percent of two minimum wages during the reporting period – 710 HRK (18 USD) from 2024.

The bill also provides for greater discipline by ensuring that letters from tax authorities are read online and that regular inventory of assets is carried out in the presence of tax officials during the proceedings.

Critics raise their hands

Lobbying for a tax increase is never easy – few people are willing to pay taxes voluntarily, let alone pay more.

“It’s loss aversion – people find losses more painful than gains. If it’s profitable to avoid taxes, they’re more likely to make such risky decisions – even if they get caught and have to pay the penalty afterwards,” Dr. Volodymyr Vakhitov, director of the Institute of Behavioral Sciences at the American University of Kyiv, told the Kyiv Post.

A few days after the ministry submitted the bill to parliament, Ukrainian MP Yaroslav Zheleznyak described it on his Telegram blog as “a disgrace, a mixture of Fanta and borscht”.

“The ministry submitted the plan on the grounds that it urgently needed money, but it provided neither estimates for new taxes nor assurances that they would not increase the shadow economy,” he wrote.

The “shadow economy” argument is the most frequently used among Ukrainian entrepreneurs. They believe that tax increases would only exacerbate the problem.

Business associations – the European Business Association, the Union of Ukrainian Entrepreneurs, the Diia City Union and the American Chamber of Commerce – have common counterarguments to the Ministry of Finance’s initiative:

• Higher taxes burden transparent companies, not those that avoid taxes
• Tax administration should be better organised
• Ukraine needs to reform the State Tax Service and the State Customs Service to combat corruption and work effectively
• Ukraine should also combat illegal trade in excisable products, especially smoking products
• Government spending should be cut.

Entrepreneurs have good reason to be concerned about the shadow economy and independent analysts partly share this view.

The business community criticized the proposed one percent sales tax on corporate profits, saying that this new tax discriminates against the existing VAT system. “They should have planned the VAT increase from the beginning and not played with the introduction of a new tax,” Oleksandra Betlii from the Institute for Economic Policy and Development told the Kyiv Post.

In addition, a military tax of 5 percent on personal income is too risky.

“Although I think it is OK to introduce military taxes on individual entrepreneurs (FOP), five percentage points of official personal income is too much – this will actually lead to an increase in the shadow economy,” a Ukrainian financial policy expert who took part in a discussion with the finance minister told the Kyiv Post.

When it comes to smuggling at customs, business is right, but ending it completely requires political will. Customs reform has actually been underway since 2023.

“And here we have achieved considerable success, which the European Union and its experts noted in reports in February 2023 and November 2023. At about the same time, the President of Ukraine dismissed virtually the entire customs leadership precisely because of the high level of smuggling and non-fulfillment of state budget revenue plans. This is a paradox,” Oksana Kuzakiv, executive director of the Institute for Economic Research, told the Kyiv Post.

“Unfortunately, few experts are ready to provide their estimates – without them, you cannot discuss policy with the government. Many people have already stopped at the hypothesis stage, and there was no point in dealing with estimates either,” one panelist told the Kyiv Post.

Serhiy Marchenko publicly refused to meet the demands of the business community and cut budget spending.

“There is nothing left to cut – the parliamentarians’ proposals to cut a few billion from some programs are nothing when we need 500 billion hryvnia (12.5 billion dollars),” the finance minister told RBK-Ukraine.

Overall, the experts present described the discussion as productive. The minister and the MPs were willing to listen to suggestions for changes and present all estimates. The ministry is apparently willing to talk everything through and find a compromise.

“They decided to convert the tax from ‘one percent of total turnover’ into a VAT increase,” one participant told the Kyiv Post.

Another stressed that Marchenko’s claim that there is almost no room for budget cuts is correct. And the remaining spending may never be voted on by parliament. “Nobody will allow salary cuts for prosecutors,” he said.

The Prosecutor General’s Office has a stable top position among state institutions in terms of unspent salaries, the Fiscal Center estimates. “This source can be reclaimed for defense,” Fiscal Center Chairman Victor Maziarchuk told the Kyiv Post.

Difficult decision for everyone

In addition to the general unwillingness to pay taxes, there are other dilemmas. “In our culture, individual well-being is put before collective well-being. Taxes are distributed by the individual to society, but the collective benefit is often not obvious,” Dr. Vakhitov told the Kyiv Post.

In addition, the lack of trust in tax institutions is deeply rooted in Ukrainian society.

“Nobody wants to finance other people’s luxuries, such as an illegal cigarette factory or illegal assets of prosecutors. People have the impression that officials close to the flow of state money are stealing money – nobody wants to pay for it,” Vakhitov added.

But there is no room for whims anymore. “Many people put on rose-colored glasses before talking to the Ministry of Finance. They thought everything was fine because someone had cast a good spell and brought money into the budget. But the tax increases are a reality – I say this after carefully analyzing the budget,” Maziarchuk wrote in his Facebook post.