Ukraine - shattering those flat tax myths

There was a fascinating story in the Kyiv Post yesterday (and yes, it always surprise me quite what it's possible to find on the Internet). The Ukraine is, of course, one of the so-called 'flat tax' states. It's had a 13% flat tax since 2004. But all is not well.

First of all, the rate is going up to 15% in 2007. Second, and more importantly, as the paper says:

As a result of Ukraine's still complicated and cumbersome tax system - often cited as a major reason why foreign investors avoid the country - specialists say that employers continue to declare lower official salaries to the authorities for tax purposes while paying their employees higher salaries under the table.

Which somewhat shatters two myths. The first is that flat taxes simplify things, and the second is that they end tax avoidance. Far from it, it seems. The explanation is obvious:

According to Ukraine's tax legislation, employers currently pay 36 percent of their employees' salaries to a social fund used for pensions, workers compensation, etc. In addition, employers contribute to a social insurance fund, the rate of which varies from 0.67 percent to 2.5 percent.

As a result, employers currently pay up to 51 percent of their employees' salaries [in direct taxes], and starting in January, that rate will be as high as 53 percent, according to Ksenya Lyapina, the head of the Council of Entrepreneurs under the Cabinet of Ministers.

"Therefore, they [employers] prefer to pay low salaries officially, and market-based salaries in envelopes," she said, adding that the 2 percent tax increase is unlikely to affect what people are paid in the workplace.

"It's well known that people really have incomes double those that are declared," she said.

So, no flat tax miracle there then. Which is exactly as I predicted in my report on flat taxes for the ACCA.