Comparison Of Political And Economic Context In Georgia And Ukraine
Georgia’s transition experience is different from those of Eastern Europeans. Soon after independence, country was involved in civil war and at the same time, separatist movements in Abkhazia and South Ossetia took an advantage and broke away from central government’s control. This experience dramatically weakened reform process and had a great impact on the political and economic landscape of the country. Political instability led to first wave of internally displaced people. Later, in 2003 Georgia experienced peaceful revolution and after it launched the neoliberal reform agenda. In 2006, Russia (largest partner that time) banned the trade with Georgia, put an embargo on wine, significantly increased price of natural gas, cut the gas supplies and deported tens of thousands of labor migrants. In 2008 between Russia and Georgia war broke out leading to second wave of internally displaced people, serious socio-economic and political problems and 20% of occupied territories. In 2012, country experienced first democratic change of government. Country had neither experience nor favorable context for transition. Despite these challenges, Georgia took very radical way of liberal reforms and as a result established itself as liberal market economy with progressive GDP growth, even in the light of creeping occupation from the Russian side. Ukraine did not experience similar political instability after the independence, as in case of Georgia. Its first years of independence were not characterized by military or political clash, but still it failed to transform its economy structure.
The leaders in 1990s cared more about staying in power than reform the country. First president of Ukraine was actually from Communist Party of Ukraine. This underlines the fact that people did not know what to do with sovereignty, they had to learn how to lead the country and how to turn themselves from communist to capitalist leaders. Due to this, Ukraine for a long time after independence was still using soviet institutions with a minor change (for example changing the soviet nomenklatura took a quite long time). Back then nation-building became prioritized in order to distinguish itself from Russian past and legacy. Ukraine has never existed before in the same boundaries as today, its territories were divided between empires, thus nation-building became priority. However, as appeared in 2014, even nation-building strategy was failure. The first serious political clash happened in 2004 and as a result Orange Revolution took place-one year after Georgia’s Rose Revolution. However, in contrast to Georgia, in 2014 Ukraine experienced another revolution, known as Euromaidan. In the same year, Crimes has been annexed by Russia and war in east Ukraine continues. Today Ukraine is in economic and political crisis with an urgent need to reform and rebuild economic and political institutions. Widespread corruption appears as the main obstacle for reforms, country has high level of unemployment and unstable GDP growth with other problems. Ukraine and Georgia share similar history under Russia Empire and later under Soviet Union. Both were relatively developed and rich economies in Soviet Union. Both states experienced conflict with Russia due to their pro-European path of development. In both states, Russia several times used economy for political purposes and both states experienced military conflict with Russia. Exactly this military invasion has the remarkably impact on both state’s socio-economic development.
Besides military conflict, Ukraine faces the same challenges that Georgia was facing back in 2003, before revolution: high level of corruption and unemployment, so-called shadow economy, practice of tax avoidance, weak institutions, lack of rule of law and etc. Ukraine is still reforming/creating the main economic systems while Georgia is improving already existing systems. From current perspective, Georgia’s economy is more stable and free. Regimes in both states can be described as combination of democratic rule and authoritarianism. Annex1 demonstrates the main socio-economic indicators of both states. Ukraine and Georgia can be generally characterized as liberal market economies (LMEs). Despite the difference in the size of economy, both states are vulnerable to external shocks, oil prices and geopolitical developments in the region. Both states are members of EaP and seek deeper European integration. Both have signed DCFTA and AA with EU.
Tax System in Georgia
Georgia experiences the worst economic failure among former soviet states. Budget failure was the major problem caused by the weak tax system. New tax code was proposed by International Monetary Fund (IMF) and adopted in 1997. However, as appears later, one of the problems of weak taxation was exactly this tax code. IMF draft was based on experience of European taxation and did not consider the major difference existing between Georgia and other transition economies. Georgia could not control its entire territory as Abkhazia and South Ossetia were out of government’s control. Besides, Autonomous republic of Adjara was another headache for the government as its autocrat leader refused to transfer taxes collected in the region to central government. In order to get the additional funding from IMF, government had to adopt the new tax legislation, however, as mentioned above, it was not compatible with Georgian context. As a result, government worsened already bad tax code. With a lot of amendments (74 amendments between 1997-2003) tax code became the confusing document and gave the hand to already widespread corruption. Government failed to implement IMF programs in time. Because IMF requirements were not met, Georgia was denied to get more aid in 2002. This suspension very negatively affected country’s economy and demonstrated government’s inability and lack of political will to reform country.
Widespread corruption, high level of poverty and unemployment, inability of the government and extremely dramatic situation (lack of basic public goods like electricity, food, unpaid salaries/pension, healthcare and etc. ) has led to the mass dissatisfaction and resulted in revolution in 2003, which became the first color revolution in post-soviet space. Tax reform was occupying central position in new government’s agenda. Their priorities were to make Georgian market attractive for foreign business, to collect taxes efficiently and transparently and to simplify tax code and decrease numbers and rates of taxes. Considering that there were more than 20 taxes and their rate was very high, also collecting taxes in three region of Georgia was practically impossible, almost no one was properly paying the taxes and there was no proper control mechanism for that. To address this issue, Parliament adopted the tax amnesty that has covered all the undeclared tax liabilities until 1st of January, 2004 and wrote off $1 billion in tax liabilities. Georgia adopted flat rate tax system with unified tax rates and very rare tax exemptions. Several initiatives and policies were taking in order to improve the tax system in Georgia. During 2004-2008 20 out of 26 taxes were repealed (first to eight and then to six (2008)). Several taxes were reduced. For example, Value added tax (VAT) decreased by 2% while corporate profit tax decreased by 5% (Gugushvili, 2016). Price controls existed only for natural monopolies. National Bank’s monetary policy was following the practice of “less interventionist exchange rate policy” and was focused on price stability. The government followed the same strategy and reduced number and rates of tariffs in order to attract more investments and promote international trade. As a result, in 2006 16 tariffs were eliminated and majority of the goods fall under zero tariff rate (The World Bank, 2012). As a result, in 2010 Georgia had fifth lowest average tariff among WTO members and the lowest trade barriers among European States. In order to attract FDI and investors, government in 2008 introduced several sectors where making investments was free from taxation. As a result of new reform, foreigners practically had the same property rights as citizens of Georgia. They did not need any legal document, like visa or residence permit in order to start working in Georgia. Forbes in 2009 placed Georgia as the fourth country, were taxes were the lowest. Due to these friendly business climate and tax code, Georgia’s economy experienced boom and developed incredible fast.
GDP growth was 10% from 2005 until 2008. War with Russia declined development, but country’s economy recovered faster than expected due to the great support from International financial institutions. FDI was also flowing in the country. The title of “top reformer of the year” was given to Georgia twice, in 2006 and in 2008 by the World Bank. By 2010, Georgia’s tax regime was rated as one of the most liberal in the world. However, it is important to understand that government was implementing all these reforms together with anti-corruption reform. Strict administration and zero tolerance for corruption contributed to the effectiveness of tax reform, as well as to other economic reform undertaken during that time. In order to avoid any future changes that could negatively effect on liberal taxation, Liberty act was introduced in 2014. This mainly means that it is impossible to introduce new taxes or increase already set tax rates without referendum. Through its tax reforms, Georgia increased its tax revenues from 14. 5% in 2003 to 25. 8% of GDP in 2007. Now it is stabilized at 23,6%. Today Georgia’s tax system consists of six taxes and neither of them is higher than 20%. Corporate Income Tax (CIT 15%), Value Added Tax (VAT 18%) and Personal Income Tax (PIT 20%) are the main taxes. For goods, such as fuel, tobacco, alcohol, excise taxes are imposed. Imported goods are subject to custom taxes of 0 percent, 5 percent and 12 percent depending on categories and the last tax is property tax.
Tax System in Ukraine
Since Ukraine got independence in 1991, there was a clear need to reform the tax system, however, every attempt by new government to reform the country was associated with hope and ended up with failure. The main measures that different governments were introducing in order to reform the taxation in Ukraine were mainly dealing with number or rates of taxes. Without the general policy/agenda or the framework, previous reforms appeared to be ineffective. After the revolution in 2004, new government tried to create favorable business environment through the reforms in tax system. However, result has not been accomplished. As can be observed in annex 3, Ukraine was developing slower and in 10 years almost nothing changed.
As discussed above, governments did not have the interest to move quickly on economic reforms. While economic development was stopped, democracy was way better in Ukraine than in other ex-soviet states. It appears that political transition was easier and less painful for Ukraine that fighting corruption and rebuilding economic institutions. During Yushchenko’s presidency (He was backed by the West and there were high expectations from Orange Revolution, especially after the progress that Rose Revolution brought in Georgia) corruption index of country deteriorated as well as other economic indicators. In 2010, there were no real improvements. New tax legislature (2010) did not help with easing the business environment (Ukraine had 23 taxes and its rates were high). Due to the new amendments and changes, tax law remained complicated. New attempt to implement reforms has failed and as a result business environment has deteriorated and state has intervened in business and market. With deep economic problems, high unemployment and corruption level, authoritarian nature of regime and lack of rule of law, President Yanukovych’s decision to abandon European integration played the decisive role and led to mass protests. In 2014 Ukraine experienced second revolution, Euromaidan. Soon after Crimea was annexed and war in east Ukraine broke out. After the Euromaidan, tax reform became one of the main goals of new government. Through tax reform, they wanted to improve the control system of taxes, decrease the number of taxes, as well as rates of it, introduce 0% rate of taxes for excise tax for alcohol supply, improve VAT tax rate and etc. Latest amendments to Tax Code were introduced in 2018.
Currently Ukraine has 11 taxes, out of which 4 are local taxes. The most important tax for the economy is VAT with a rate of 0, 7 or 20%. 0% and 7% VAT applies to export of goods and import of registered medical goods and equipment respectively. The rate of 20% applies to almost all transactions subject to VAT except those subject to 7% and 0% VAT. Corporate Tax and Personal Income tax rate is 18%/. Since 2014, military tax with the rate of 1,5% was added to personal income tax. Another important tax in Ukraine is unified social contribution (USC) with rate of 22% rate. From 2016, Employers are obligated to pay this tax from the salaries of each employee. Income received as an inheritance or gift is subject to tax with a rate of 0, 5 or 18%. Since 2015, almost all property owned by citizen or non-citizen is subject to property tax. Current tax revenue of Ukraine is 20% of GDP, according to World Bank 2017 report.
Comparative analysis
As already described above, Ukraine and Georgia had similar history and context after the independence. However, while Georgia faced the worst scenario after the independence, Ukraine was relatively peaceful and stable. Revolutions in both countries occurred at the same time, with one-year difference, but for Georgia it came out to be successful regarding economic development while for Ukraine it did not change anything. Georgia adopted shock therapy approach back in 2003 for transforming its economy, while Ukraine preferred to stick to gradualism. While corruption was significantly decreased in Georgia, in was increased in Ukraine since revolution. Only some minor changes can be observed since Euromaidan. While economic development was more prioritized in Georgia, democratic indicators were not improving that well. On the contrary, Ukraine had better democratic performance. The success of Georgia’s tax reform can be explained by: First, radical anti-corruption agenda which was accompanying all other reforms; Second, taxes were reduced gradually and with decreasing the tax rates, government has also simplified tax administration system; Third, creating the strict control mechanism that could enable government to punish those who do not pay taxes and thus contribute to successful collection of taxes. These three issues were addressed together and due to their interrelation tax reform came out to be successful.
On the contrary, Ukraine failed to secure its budget because of widespread tax avoidance practice. Government that fails to collect taxes, will not be able to address social inequality and provide public goods. Institutional weakness of the country is important to mention as Ukraine still does not have stable political and economic institutions. Lack of these institutions negatively effect on reforms. Besides, Ukraine’s economy mostly consists of large and extra-large business in contrast to Georgia. This basically means that oligarchs are strong and with the corruption, spread in all spheres, their positions are even stronger. Without eliminating corruption, all the reforms are destined to fail. When analyzing the tax system of both states, economic reforms as well as political should be addressed. Interrelations of both system, economic and political, are important for effectiveness. Many would argue that economic and political spheres are intertwined and that economic development stimulates democratization. Economic factors have been found to be an important determinant of demands for democratization. Excessive political repression in the face of economic stagnation, rising income inequality and increasing poverty and unemployment play important role in the process of rebellion for democracy. However, experience of Georgia show that economic factors are not a sufficient condition for causing mass movements for democratization, as can be argued in case of Georgia. Economy was prioritized over politics and thus democratic transformation was compromised for the sake of fast economic development. While CEE states were able to transform their economies and regime type, Ukraine and Georgia failed to do so. They were not able to do both levels of transition-political and economic.
One was compromised for the sake of another. The tension between democracy and economic reforms is usually very visible in new democracies as these democracies are fragile and economic reforms there are relatively costly. On the one hand, publics in these new democracies are usually undependable as their attitudes change very easily and on the other hand, elites are also limited in their capacity to shape public opinion. What else we have to consider is the fact that people are sensitive to their economic experiences. Economic decline and unpredictable regime transition may lead to populist movements. Another supporting condition for tension in new democracies are cultural legacy (elites can easily abandon democratic rules and public does not have real strength to stop them) and weak democratic institutions (hard to establish and implement certain policies and reforms). Both, cultural legacy and weak democratic institutions are applicable for Ukraine as well as for Georgia. Besides, Legacies of long and repressive Russian rule still has the effects on both state and their society, especially in the light of Russia’s military involvement in both countries.
