Currently, a discussion is taking place on whether the prevailing value added tax (VAT) is the appropriate indirect tax for Ukraine or whether it should be substituted by another indirect tax. In particular, critics of VAT highlight the extensive VAT fraud and evasion, as well as the problems to administer VAT. While this discussion is certainly not new in Ukraine, the current debate shows the need for a fresh assessment. Consequently, in this paper we try to answer the question whether substituting VAT by another indirect tax would be a good idea from a fiscal point of view or not.
As a first step, we shortly assess the fiscal performance of VAT in Ukraine. In 2011, VAT revenues in Ukraine accounted for 10% of GDP. The corresponding EU average amounts to only 7.1%. Thus, Ukraine compares rather good when compared to the EU. While this short comparison cannot replace a thorough and deep analysis of VAT performance in Ukraine, it nevertheless suggests that VAT performance cannot be very bad. This poses the question whether the critique on VAT performance is based on hard facts, or only on guesses. As long as no hard evidence exists on the presumed poor fiscal performance of VAT in Ukraine, no policy steps towards substituting should be even considered.
But even assuming that VAT’s fiscal performance is poor, replacing it with another indirect tax would not necessarily be a good idea, as shown by our quantitative assessment. A general (retail) sales tax would generate less revenues for the government and is more susceptible for tax evasion, as the amount of taxes evaded is much higher than in the case of VAT, in which the seller of a good can deduct the input VAT. As for the turnover tax, the second major alternative to VAT, it would have major negative structural effects on the economy, due to its cumulative, cascading effect. Besides, it would hurt exports and economic growth, thus eroding its tax base. Finally, it should be emphasised that maintaining VAT is necessary for the conclusion of a DCFTA with the EU, which is a major priority of Ukraine’s trade policy. Thus, VAT should not be replaced.
A much promising approach in our view would be the improvement of VAT administration. For this purpose, we recommend first to introduce measures to increase the probability to catch tax fraudsters. Second, VAT privileges should be cut. Third, data sharing between central executive bodies should be improved.
