« back to menu

Letter published in The Times of Central Asia

November 15, 2001

155 Chui Avenue (ZUM Building)
6th Floor, Office 607
Bishkek

Dear Sir:

I am writing to express my disappointment about the article by Mr. Fiacconi printed in the November 1 edition of the Central Asia Times. The article contains factual errors and misrepresents the picture by choosing to focus on only one part of a comprehensive tax package discussed between the Kyrgyz government and the IMF. I would like to take this opportunity to express the IMF’s point of view on the issues raised by Mr. Fiacconi.

In the summer this year the parliament introduced a uniform personal income tax rate of 10 percent, to replace the previously progressive brackets ranging from 5 percent to 33 percent, and lowered the corporate profit tax rate from 30 percent to 10 percent, effective January 1, 2002. The IMF have instead proposed a personal income tax rate of 10 percent for annual incomes upto 60,000 soms, a rate of 20 percent for annual incomes in excess of that level, and an increase in the standard deduction by 3,000 soms per anum. As regards the profit tax rate, the IMF fully supports the Kyrgyz government’s proposal to lower the rate to only 20 percent, but to compensate for the higher than envisaged tax rate by lowering the social security contribution rate for corporations from 29 percent to 25 percent. Since these tax proposals agreed between the government and the IMF will also entail substantial revenue losses, the tax package also envisages measures, that seek notably to eliminate several exemptions and subsidies, and to bring into the tax net lightly taxed sectors of the economy.

In our view, an amendment of the personal income tax that would have led to an increase in the tax burden of more than three-quarters of the tax paying population, while benefiting only a handful of the most wealthy individuals, is unfair. Yet, due to the heavy concentration of taxpayers in the lowest income brackets, adoption of the proposal approved in the summer would have done just that. By contrast, under the IMF’s proposal, more than 80 percent of the population will experience a lower tax burden and no one will experience an increase. The introduction of a 20 percent bracket for high income earners was needed to curtail the revenue losses, but we believe that this is a small price to pay in order to ensure that the benefits of the tax reduction are equitably distributed.

On profit tax related issues, a combined reduction of the profit tax rate to 20 percent and a lowering of the social security contribution rate for corporations to 25 percent is at least as favorable to the business sector as a reduction in the profit tax alone to 10 percent. This view is based on the estimated decline in social security contribution collections, which is at least as large as the increase in revenue associated with limiting the reduction in the profit tax rate to 20 percent. While the distribution of benefits across the business sector associated with these alternative packages is not the same, and it may well be that Mr. Fiacconi and his colleagues in the IBC would have preferred to see only a reduction in the profit tax, the government’s proposal will favor a broader segment of the corporate sector, notably since the benefits will extend even to newly established businesses that are struggling to achieve profitability. Thus, in a capital starved economy, the favorable impact on such firms’ cash flow will provide a significant incentive to investment, and hence help to boost business activity in the country. Moreover, a reduction in the social security contribution rate, which is a tax on labor, will promote more labor intensive investment, and hence have a relatively greater impact on reducing unemployment.

A further reduction of the profit tax rate to 10 percent cannot be afforded. Spending in critical areas such as education, health, and social sectors are under tremendous pressure. International experience indicates that the long term growth potential of the country would be severely damaged, if this trend is not quickly reversed. In order to do so, the country needs to urgently resolve its external debt problems, and to significantly raise its revenue collections. On the debt issue, the IMF has lent its support to the Kyrgyz Republic’s request to bilateral Paris Club creditors to reschedule its debt on concessional terms. In considering the Kyrgyz government’s request, these creditors will carefully review the country’s own adjustment efforts. Against the background of revenue collection rates that are among the lowest in the region, creditors would have viewed a reduction of the profit tax rate to 10 percent as a step in the wrong direction. Estimates made by the IMF staff, who cooperated closely with international tax policy experts working with the Kyrgyz authorities, indicate that the adverse impact of such a measure on revenue collections in the next 2 to 3 years would have been substantial. International experience too does not support the hypothesis that very large reductions in tax rates can be substantially offset in the near term by increased economic activity or improved compliance.

Mr. Fiacconi is, however, correct to note that the inefficiency and corruption which characterizes tax administration in the Kyrgyz Republic needs to be speedily addressed. The IMF’s advice is cognizant of this need. It is now widely accepted that a straightforward system with a small number of taxes, each of which has a significant revenue earning potential, can contribute significantly to improving the quality of tax administration. Income taxes, personal and corporate, are major sources of revenue in virtually all well functioning tax systems, and in the Kyrgyz Republic their rates need to be a set at a level that will permit them to fulfill this role. Over the medium-term this will allow the plethora of small taxes that characterize the tax code to gradually be eliminated, contributing to a sustainable improvement in the business environment. From the standpoint of tax administration, it is also desirable that the profit tax rate and the highest income tax rate are equal, so as to eliminate the opportunity to arbitrage between sources of income.

The investment environment in the Kyrgyz Republic is indeed in need of reform. But the tax code will, with the approval of the amendments now under consideration by the parliament, be among the most competitive in the region, and well in line with international norms. Further tax reductions will in fact damage the investment climate by seriously compromising the government’s ability to maintain a stable macroeconomic environment. The absence of such stability in the recent past has in fact been one of the key reasons for the slowdown of private investment in the country. We, along with our partners in the donor community, are engaged in helping the government undertake structural reforms that will improve the investment climate in the country. But by their very nature, structural reforms take time to complete and their benefits become apparent only gradually. By contrast macroeconomic stability can be achieved relatively quickly, and the implementation of responsible policies to maintain such stability, can provide the surest, and most credible signal of the government’s commitment to a business friendly environment.

I had the opportunity to explain all the economic arguments supporting the IMF’s position on the tax issues at a recent meeting of the IBC. Considering that Mr. Fiacconi was present at the meeting, it is indeed unfortunate that he chose to accuse the IMF of adopting a dogmatic approach and blackmailing the government. To the contrary, the recent discussions point to the growing skill of the government in articulating well conceived policies and cooperating with the IMF to achieve a desirable result. As I have noted above, the proposal to trade off an increase in the profit tax rate from 10 percent to 20 percent for a reduction in the employer contribution rate from 29 percent to 25 percent came from the government, and they were able to convince the IMF of the merit of this approach. Similarly, the government was open to the arguments provided by the IMF for introducing the 20 percent bracket for the personal income tax. The result has clearly been a tax proposal far superior to the one approved in the summer.

Sincerely yours,

Bhaswar Mukhopadhyay
Resident Representative
Kyrgyz Republic

cc: Mr. Giorgio Fiacconi
Founder and Publisher
Central Asia Times

« back to menu

print page

top