VAT replacement or better administration?

VAT revenues in Ukraine are undermined by numerous privileges and low tax compliance due to manipulations and/or outright fraud causing inadequate tax collection and high tax refunds claims. Besides, there are both strong concerns about the vulnerability of the VAT system to corruption and complaints from businesses about delays in refunding. Feasible options to overcome the low VAT revenue problem include replacing VAT, e.g., with a general sales tax (GST), or improving VAT administration. We argue that a VAT is superior to a GST in Ukraine. However, VAT administration can be significantly improved. Especially, we recommend to introduce VAT accounts tied to supporting measures such as the cash method and automatic refunding of VAT; to increase spending on tax administration combined with a reform of the tax administration body (STA), simplify legislation, and favor law enforcement. We argue that the problems of tax evasion and privileges are closely related. A reduction of tax privileges potentially pushes firms towards more fraud. Better administration (such as due to VAT accounts) makes fraud schemes more expensive such that firms may be inclined to lobby for privileges. Therefore, we argue in favor of further and sustainable reductions of VAT privileges, in particular sector-specific privileges, as a necessary complement to improved tax administration. In this respect, we recommend to re-draft and to enforce the Law on State Aid and to include an assessment of all different forms of direct and implicit subsidies, including tax expenditures, in the regular reports of the Anti-Monopoly Committee to Verhovna Rada. Resulting higher tax compliance due to better administration and a growing tax base due to diminished privileges might then justify reducing the VAT rate.