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Kyrgyz Republic: Selected Issues

Author(s):
International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
February 2016
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Policies to Underpin the Medium-Term Consolidation1

With an increased reliance on grants to finance its systemic budget deficit, the Kyrgyz Republic needs to accelerate consolidation by (i) strengthening its revenues by expanding its tax base, transitioning successfully to the EEU accession, and improving performance of corporate and personal income taxes; and (ii) streamlining its expenditure by reducing its public wage bill, rationalizing spending on goods and services, phasing out subsidies, and reforming social benefits.

A. Tax revenues

1. The Kyrgyz Republic still has room to increase tax revenues. Over the past 10 years, tax revenues increased from 12 to almost 21 percent of GDP in 2014, slightly below the regional comparator countries of 23 percent of GDP. Tax capacity is estimated at 22.3 percent of GDP while the realized tax-to GDP ratio of 16.7 in 2011 implied a tax effort of 74 percent, below the average of comparator countries.2

Tax Capacity Comparison 2011

Source: FAD staff calculations.

2. Good performance from taxes on goods and services should be preserved. VAT collection has performed about 1 percentage point of GDP above the regional average of comparator countries.3 However, the Kyrgyz VAT rate of 12 percent remains very low compared to regional comparators, where the average is 18 percent. Another source of concern is the phasing out of the sales tax, currently representing 1.8 percent of GDP in 2014, which will require new measures to compensate for its gradual loss.

Standard VAT Rate in Percent(In percent)
Actual
Armenia20
Azerbaijan18
Georgia18
Kazakhstan12
Kyrgyz Republic12
Tajikistan20
Turkmenistan20
Uzbekistan20
Russia18
Belarus20
Estonia20
Source: Authorities data.
Source: Authorities data.

3. While the accession to the EEU is expected to have a positive impact on overall tax revenues, the VAT collection is expected to weaken. The accession to the EEU is expected to increase customs revenues by about 1.5 percent of GDP. However, VAT collection on goods and services could decline due to the shift in the VAT collection from the customs services where the VAT was paid at the border, to the state tax services (STS) where the VAT is now paid based on self declaration after the good enters the territory. Recent experience from Armenia shows a drop in VAT because of trade diversion and a shift of VAT accrual reporting after joining the EEU.

4. Personal and corporate income tax performance is poor compared to other countries. In both categories, the Kyrgyz Republic is on the bottom tier portraying a narrow tax base combined with increase unfairness of the tax system. Rather than improving the revenue performance of broad-based indirect taxes, many special regimes and exemptions were introduced destabilizing the tax system. The exemptions, mostly from agriculture and processing sectors. According to the authorities, tax exemptions represent about 3.5 percent of GDP.

Corporate Income Tax

(Percent of GDP)

Sources: Authorities data and IMF staff calculations.

Personal Income Tax

(Percent of GDP)

Sources: Authorities data and IMF staff calculations.

5. Progresses on tax policy and administration to improve corporate income tax and not significant in terms of result. Some efforts to limit exemptions brought negligible additional revenues and significant measures, such as removing exemptions on agriculture, may be politically difficult to implement. Additionally, the introduction of a simplified system for accounting and reporting and the limitation of the patent system illustrate recent efforts in tax administration. However, the non-observed sector is still important, estimated between 244 and 405 percent of GDP. Fair taxation could be improved greatly by continuing to reduce exemptions, considering an increase in VAT rate, simplifying the corporate income tax and equalizing the corporate and personal income tax rates.6

B. Expenditures

6. There is plenty of scope to current expenditures. Both wages and goods and services rank high compared to the sample countries. The issue is not only the level of expenditures but also its inefficiency as it is not supportive of growth. Literature shows that high current expenditures are rarely linked to high growth in low income countries, where corruption and lack of transparency are common.

2014 Current Expenditures

(Percent of GDP)

Sources: Authorities data and IMF staff calculations.

7. Reducing the wage bill is a wage bill amounts to over 9 percent of GDP while it averages around 6 percent in regional comparators. A review of the wage bill is necessary to identify steps to reduce the bill. The World Bank recommended a reduction of supporting staff with increased role given to local authorities in the decision process and follow up on the implementation of the Program for Enhancing Civil Service Pay for 2013–20 aiming to improve the fairness, transparency, predictability of civil service salaries and the wage bill. As best practices, the authorities should refrain from ad hoc increase in wages but index wages to inflation.

8. Goods and services never the different crisis the country went through since 2008. Following the injection of the fiscal stimulus in response to the global financial crisis, most of the countries have cut spending, however the Kyrgyz Republic’s spending on goods and services stayed high with the one-off stimuli embedded in current spending. Similarly, ad hoc measures were taken to respond to the 2010 crisis. It is necessary to cut non priority spending and refrain from ad hoc measures becoming permanent.

Expenditure of Goods and Services

(Percent of GDP)

Sources: Authorities data and IMF staff calculations.

9. Social benefits are high but progresses to fight poverty and inequality are limited. Since 2008, poverty has increased to plateau at 37 percent in 2013. Social benefits keep on augmenting and are not well targeted. The pattern of social assistance expenditure still favors richer households. The social assistance system remains complex and fragmented and the pro-poor monthly benefit for poor families (MBPF), which coverage has declined and budget grew at a slower pace than other programs, covers less than a third of the poorest 20 percent. Furthermore, electricity compensations and subsidies are also not targeted to the poorest.7 The authorities need to work closely with development partners to improve the targeting of social programs, consolidate social benefits to avoid duplicate and reduce administrative costs, and review subsidies, especially by reforming the electricity sector.

Social Benefits

(Percent of GDP)

Sources: Authorities data and IMF staff calculations.

1

Prepared by Claire Gicquel and research assistance provided by Mbaye Gueye.

2

S. Caner, R. Krelove, and C. Waerzeggers (2014), The Kyrgyz Republic, Tax policy reforms and capacity building—the tax capacity is based on the latest available data. It is defined as the maximum attainable tax-to-GDP ratio given the economic structure of the country.

3

Armenia, Belarus, Estonia, Georgia, Kazakhstan, Tajikistan, and Russia.

4

National Statistics Committee.

5

Shadow Economies All over the World, New Estimates for 162 Countries from 1999 to 2007 Friedrich Schneider, Andreas Buehn, Claudio E. Montenegro.

6

A. Jewell, M. Mansour, P. Mitra, and C. Sdralevich, 2015, Fair Taxation in the Middle East and North Africa, SDN/15/16.

7

Kyrgyz Republic Public Expenditure Review Policy Notes, Social Assistance, 2014, World Bank.

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