Kateryna Bornukova, Nataliia Leshchenko, and Mikhail Matytsin1 Are taxes in Ukraine progressive? Do social protection programs in Ukraine help reduce poverty and inequality? Which programs are more effective in alleviating poverty, per hryvnia allocated to them? These are the questions that a recent Commitment to Equity analysis for Ukraine aims to address. This brief lays out the main aspects of the CEQ approach 2, and the main results. The analysis finds, for instance, that household at the bottom of the income distribution derive most of their final income from transfers of various types. The tax benefit system overall is quite progressive and contributes significantly to the reduction of poverty and inequality. However, not all programs are equally efficient in reducing poverty and inequality. Direct transfers, in particular means-tested poverty benefits, as well as child benefits have larger poverty and inequality impact per hryvnia allocated to them, then some of the indirect subsides. Efficiency of HUS depends on the choice of the poverty threshold. There is room for improvement in program design. The Government of Ukraine collects roughly a third contraction following the Maidan and the continued of GDP in tax revenues, on par with countries with conflict in Eastern Ukraine, as expenditures on similar levels of development, such as Poland (34 defense, public order and safety amounted to 5.5 percent), Latvia (30 percent), Czech Republic (34 percent of GDP in 2016-2017. Poverty rates decline percent) and Estonia (35 percent). Social notably, from more than three quarters of the expenditures are a priority for the Government of population in 2002 (according to World Bank Ukraine, and 19 percent of GDP are allocated in the methodology) to 14 percent in 2013, but poverty form of total social expenditures of the general spiked to 26.7 percent by 2016. While the period up government in 2017. This is on par with the OECD to 2013 has been associated with an expansion of a average, but higher than in countries like Estonia (18 population group that can be deemed as percent), Canada (17 percent), the Netherlands (17 economically secure (above the PPP USD 15/day percent) or Latvia (16 percent). threshold), who have a low associated probability of falling into poverty, this group contracted notably Is the fiscal system effective in alleviating poverty and after 2013, such that based on most recent data, protecting low-income households? This question is more than three quarters of the population are either especially relevant in light of the economic poor or vulnerable to poverty. 1 This policy brief is based on Bornukova, Kateryna; Leshchenko, Nataliia; Matytsin, Mikhail. 2019. Fiscal Incidence in Ukraine: A Commitment to Equity Analysis (English). Policy Research Working Paper; No. WPS 8765. Washington, D.C.: World Bank Group. 2 Lustig, Nora and Sean Higgins (2013). Commitment to Equity Assessment (CEQ): Estimating the Incidence of Social Spending, Subsidies and Taxes. Handbook. CEQ Working Paper 1, Center for Inter-American Policy and Research, and Department of Economics, Tulane University and Inter-American Dialogue. Against the background of significant financing The degree of reliance on the tax-benefit system in needs in the near term, and existing social Ukraine varies considerably across the population, vulnerabilities, it is instructive to examine the but the benefits do increase as market incomes incidence of the fiscal system in Ukraine, to see how decrease. If we consider pensions as a source of household welfare is affected once all taxes are paid deferred income, rather than pure transfer, and we and all benefits for which the household is eligible line households up in deciles according to their are received. The CEQ approach (Lustig and Higgins, market income (from poorest to richest), then we can 2013) zooms in on fiscal incidence by defining, in see that in the bottom decile a full 62 percent of the Household Budget Survey data, a set of income final income is generated by net transfers (total concepts (Figure 1), starting from market income, benefits received minus total taxes paid). If we also and then moving to disposable income (which take into account pensions, the share of transfers accounts for direct taxes like the income tax and inclusive of pensions in the first decile accounts for direct cash transfers), then to consumable income 97 percent of final income, meaning that only 3 (which subtracts indirect taxes like VAT and adds percent of final income in the bottom decile comes indirect subsidies and finally, to final income (which from market income. also includes the cash equivalent of the cost of public Figure 2: Incidence of main components of tax-benefit system, health and education services). share of final income, percent. Figure 1: The CEQ income concepts 80 30 -20 -70 Direct Taxes Direct Transfers Indirect Taxes Indirect Subsidies In-kind Health In-kind Education The income concepts allow us to calculate the incidence, for each income type, of that income Notes: Deciles based on market+pensions income. across the population, as well as measures of poverty and inequality. In this way, we can gauge (i) which Much of the income (45 percent) comes from direct population groups are the main recipients of transfers, with in-kind education and health services particular social programs; (ii) how various taxes are also making a notable contribution. Given low levels distributed across the population; and (iii) how of market income, most of the tax outlays in the poverty and inequality levels change once you move bottom decile are in the form of indirect taxes. For from one income concept to another. comparison, in the 6th decile only 6.7 percent of final income comes from net transfers (exclusive of pensions), because household both receive less in from inequality in the space of market incomes to transfers and pay more in taxes. Households in the inequality in the space of market income + pensions. richest 10th decile pay more in taxes, particularly in This is not surprising, given that for many recipients direct taxes, than they receive in transfers, such that of old-age pensions, this may be the only source of they are net contributors into the fiscal system. income. What is notable in Ukraine, is a relatively significant further reduction in inequality from Given the incidence of taxes and transfers, the overall market+pensions to disposable income. This is also impact of the fiscal system is that of reducing poverty observed in Poland, but not in Belarus or Russia – in and inequality. Direct non-pension transfers and Ukraine the net effect of direct transfers and direct direct taxes together, relative to market income + taxes is much more inequality-reducing. In all pensions, reduce the Gini index of inequality from countries, indirect taxes and transfers, on net, 0.33 to 0.24, or by 27 percent. Poverty after direct increase inequality. Finally, the redistributive effect of transfers (exclusive of pensions) and taxes is 10 in-kind education and health benefits in Ukraine percentage points lower than that associated with appears to be fairly subdued vis-à-vis comparator the market+pensions income concept. Notably, countries, where these in-kind benefits produce a poverty increases when we move from disposable to greater reduction in the Gini index of inequality. consumable income, indicating that the net impact of indirect transfers and indirect taxes at the bottom of the income distribution is negative. This is because the effect of indirect taxes (VAT, excises) is to increase poverty, while the indirect subsidies are not very well targeted and their impact on poverty is marginal. A program may be effective in reducing poverty simply on account of having a large budget, even if Figure 3: Changes in poverty and inequality measures after various the allocation of this budget is suboptimal. Other fiscal interventions programs may have a small effect on poverty largely Inequality Gini index Poverty International because the amount of money they disburse, Poverty Official Poverty Moderate however well targeted, is very small. An interesting 50 40 question to ask is that of program efficiency – how 30 much reduction in poverty (or inequality) can be 20 obtained per Hryvna allocated to that program. 10 0 We compute, for each transfer, the total program market market + disposable consumable pensions budget that would be necessary in order to achieve Income concept a 1 percentage points reduction in either the official or (separately) moderate poverty. Here, a smaller The redistributive effect of the fiscal system in budget is indicative of higher program efficiency – it Ukraine is broadly comparable to that in some of the takes less money to reduce poverty by the same neighboring countries for which a CEQ analysis has amount. On this measure, the most efficient transfers been undertaken recently. In Ukraine, but also in in reducing poverty, focusing on the moderate countries like Belarus, Poland, and Russia, the Gini poverty concept, are the last resort social assistance index of inequality falls considerably, when going program, as well as scholarships, child benefits, and HUS. If the same exercise is instead repeated in system, and the top four deciles are net payers into reference to the official poverty threshold, as the tax-benefit system. Household at the bottom of opposed to the moderate poverty threshold, then the income distribution derive most of their final there are several important differences, namely HUS income from transfers. Most of the components of and scholarships become very inefficient, whereas the tax-benefit system in Ukraine (pensions, other means-tested poverty benefits, child benefits and direct transfers, direct taxes and pension unemployment benefits continue to perform well. In contributions and in-kind health benefits) are other words, HUS does worse in reaching households progressive. Given the incidence of taxes and with very low incomes (the official poverty threshold transfers, the tax benefit system contributes to a is lower). Utility privileges and other privileges are notable reduction in inequality, as well as an rather cost-ineffective, at either poverty threshold – amelioration of spatial disparities. Poverty also is it takes a much larger budget in order to reduce considerably lower after fiscal interventions. poverty by 1 p.p. This is because a relatively smaller share of the program budgets is allocated to the Not all programs are equally efficient in reducing bottom 40 percent, and a fairly high share of the poverty and inequality, and there is room for program budget goes to the richest, 10th decile. improvement. Currently, many programs designed to support low-income groups transfer non-negligible In a similar fashion, we can compute how much shares of their budgets to the top income decile. money can be collected, in taxes, for a 1 p.p. increase Restricting access of the top decile to direct transfers, in the poverty rate. Such an exercise reveals that the total savings could amount to UAH 8,890 million Personal Income Tax (PIT) is the most efficient direct annually. Eliminating this inefficiency in indirect tax in terms of redistribution effects – it decreases subsidies would save another UAH 4,710 million. inequality and has the highest tax collection for 1 p.p. of poverty increase. Other direct taxes, as well as pension SSC contributions, because they do not have exemptions or deductions for low-income and vulnerable households, would be associated with a ABOUT THE AUTHORS greater simulated increase in the poverty rate for a Kateryna Bornukova is a Consultant at the World dollar of tax collected. Bank’s Poverty and Equity Global Practice (GPV). Nataliia Leshchenko is a Consultant at the World Bank’s Poverty and Equity Global Practice (GPV). Mikhail Matytsin is a Research Analyst at the World The fiscal incidence analysis reveals that in Ukraine Bank’s Poverty and Equity Global Practice (GPV). the tax-benefit system is quite pro-poor – the bottom mmatytsin@worldbank.org six deciles of the population are net recipients of the This note series is intended to summarize good practices and key policy findings on Poverty-related topics. The views expressed in the notes are those of the authors and do not necessarily reflect those of the World Bank, its board or its member countries. Copies of these notes series are available on www.worldbank.org/poverty