Jason Pugh [email protected]
Cory Winchell [email protected]
Marina Yakolina [email protected]
Dmitri Maslitchenko [email protected]
An Economic Overview
Major changes are taking place in Kazakhstanís fiscal system. The breakdown of past revenue sharing procedures, under the centrally planned budgetary system require significant adjustments to the entire process. The banking scheme is currently being changed. The governmental accounting system is undergoing a complete overhaul. (Am. Embassy Rpt., April 1996) Currency stability continues to plague the country, and inflation remains a key concern. Investment is weak, and budgetary process reforms are stagnant. Discretionary government expenditures have fluctuated, while mandatory expenditures are expanding rapidly.
These are just some of the problems that plague Kazakhstanís government. A 1995 growth prospects index rated Kazakhstan last among other FSU countries. (Economic Overview of Kazakhstan, June 1996) The composite index considered ten different factors which contribute to a countryís capacity for growth. Some of the factors influencing this ranking, like the external deficits debt burden and relatively high inflation, may harm potential growth prospects. In industrial productivity, Kazakhstan was fourth from last with -34.2 change in industrial output per worker from 1990-1994. (Am. Embassy Rpt., February 1996)
Budgetary Policies and Fiscal Developments
Inflation is a problem that has plagued Kazakhstan since its independence. There are several possible reasons that might explain this problem. The first is the movement in exchange rates. Another reason is the persistence of conventional budget deficits as well 1993 as quasi-fiscal deficits. And the final reason is attributed to monetary developments. (Kazakhstan: IMF Review, April 1995)
Kazakhstan has gained more control over monetary policy, but with it comes more responsibility to maintain stability. In 1993, Kazakhstan introduced the national currency, the tenge. It is a free floating rate currency that has experienced large real rate deprecations. This rate of depreciation is common in the early years of economic liberalization, but it has continued to plague Kazakhstan recently. This problem provokes inflationary pressures that destabilize the economy and discoural to 2.6% in 1994. (Kazakhstan Country Report 2nd Quarter, 30) Agricultural production in Kazakhstan remains a critical aspect of government subsidies, as the government is concerned about falling agricultural production. As agricultural production declines, the working class puts pressure on the government to maintain price controls on bread and other staple foods. These price controls only serve to increase inflationary pressures and undermine the governmentís fiscal austerity.
Restrictive monetary policies allow for stabilization, but in Kazakhstan the convertibility of the currency is still minor and structural liberalization is slow to take place. To allow restrictive policies to occur, the government must desist in subsidizing industries. Loose monetary policies promote drops in output and are tied to hard budgetary constraints. The discount rate in real terms from 1992-1994 was -31%. However, the rate has climbed to 4% by the end of 1994, reflecting an improvement in the allocation of resources. (Kazakhstan Country Report 3rd Quarter, 25) The progression of reforms in Kazakhstan are reflected in the monetary policies and the movement in interest rates.
In any transitional economy, it is necessary to develop a system of reliable, stable financial intermediaries. There are currently about 200 banks in Kazakhstan, while only 20 have a license which permits them to correspond with foreign banking institutions. The largest banks serve as conduits for credits and subsidies to farms and state owned enterprises. (Banks and Banking in Kazakhstan, November 1995) On September 25, 1995, the Bank and Banking Activity Law was passed by presidential decree, giving additional responsibilities to the NBK. The new law allows the NBK to issue licenses to banks. Importantly, it also permits foreign capital to enter into the banking system. However, it places restriction upon foreign banks wishing to enter the country. (Am. Embassy Rpt., October 1995) In an effort to strengthen the national banking system several mergers have taken place, presumably to prepare the system to withstand the entrance of foreign banks into Kazakhstan.
Despite these serious developments there has been some headway in reforming fiscal policy. Some main extrabudgetary funds have been incorporated into the budget and the project to set up a Treasury is complete. Throughout 1993 and 1994 efforts focused on containing the overall fiscal budget deficit. In 1993, the government made significant improvements over 1992 in expenditure control and revenue collection. The overall budget deficit was just 1.2% of the GDP, as compared with the 7.4% in 1992. Most of the deficit was financed through borrowing, sales of treasury bills, and foreign financing. (Kazakhstan: The Transition to a Market Economy, 24)
1994 saw a sharp increase in the deficit over the previous year at 6.8%. The extrabudgetary funds widened to include the Road Fund, the Employment Fund, the Pension Fund, the Social Insurance Fund, the Fund for the Protection of Natural Resources, and the Fund for Promoting Entrepreneurship. However, in mid-1994 the Pension Fund was detached from the budget. The inclusion of these funds is important to ascertaining the extent of government liabilities, without which the deficit numbers will continue to be skewed. The deficit target for 1994 was 4.6% of GDP. The gap between the actual and predicted deficit is accounted for by unexpected expenditures and declining revenues. (Kazakhstan : IMF Economic Reviews, 17)
In 1995, Kazakhstan had many difficulties with some sixty enterprises that defaulted on loans guaranteed by the government. The Deputy Prime Minister expects that the government will have to repay the obligations out of budgetary appropriations. This type of problem is common to transition economies, which privatized poorly managed enterprises. Kazakhstan also experienced continuing inflationary problems with an annual rate of 60.3%, and the tenge continued to fall against the dollar. The Treasury project finally received approval and began the process of transition. The Treasury was established as part of the Ministry of Finance, rather than the Ministry of Economics, perhaps signaling a shift in budgetary power. President Nazarbayev struck back by criticizing the lack of ìproper coordination among the activities of the economic ministries, the government, and the national bank.î(Am. Embassy Rpt., December 1995) He cited the lack of coordination of macroeconomic policies at the regional level, as the reason for his censure.
Following elections in 1995, the legislature also created several new committees to oversee and facilitate the budgetary process. The economic, finance, and budget committees were instituted as a means to check the growing power of the President in budgetary issues. The Prime Minister summarized the three primary features of the economic policy: 1) to defeat inflation, 2) to roll back certain legislation passed by the previous parliament, which could not be supported under current conditions, and 3) to increase government financing to non-producing sectors. This approach signaled the shift towards concentrating on entitlement programs. (Am. Embassy Rpt., January 1996)
In 1996, President Nazarbayev struck back at the legislature by Issuing a decree which established an economic commission and effectively neutralizing the legislatureís monetary policy influence. The edict placed the NBK firmly under the Presidentís authority and erased all mention of Parliament from the constitution. With this decree, the President can change monetary policy or allocation of credits at will. (Am. Embassy Rpt., January 1996)
Other significant developments in 1996 were the shift to a focus on investment, from inflationary stability, and the establishment of accounting reform measures. Another important focus was on substantially increasing minimum wages, as well as pensions and allowances. Social protection issues will likely dominate the foreseeable future.
The Shadow Economy in Kazakhstan
In Kazakhstan estimates on the shadow economy range from the conservative to the outrageous. However, corruption, fraud, theft, extortion, and tax evasion remain crucial problems for the government. There are many ways to combat the shadow economy, but it is first important to understand it. Information on the shadow economy in Kazakhstan is still spare, but some general principles apply. Reform in the tax structure and revenue collection process are necessary to alleviate some of the problems encountered with the presence of an extensive shadow economy.
Tax Policy, Tax Structure, Tax Administration
The taxation system in Kazakhstan is constantly changing as part of the development of a young sovereign state. The new tax code came into force on 1 July 1995, and was considered to be among the most comprehensive pieces of tax legislation in the former Soviet Union.
Income Tax for Legal and Physical Persons
The new tax code prescribes a tax base similar to that in western countries, upon which tax is levied at a rate of 30% (unless the income is derived from the utilization of land when a 10% rate applies). Expenses are generally deductible to the extent that they relate to the realization of taxable income. The most significant deductible expenses are:
interest up to the level of 150% of the rate set by the National Bank of Kazakhstan for Tenge-denominated loans and the World Bank for dollar-denominated loans;
research and development costs;
depreciation (see further below);
repairs (up to 10% of the amount still available for tax depreciation at the end of the year, with the excess being capitalized and depreciated in future years);
Gains and losses arising from foreign differences in the course of business activity are neither taxable nor deductible.
Fixed assets are depreciated using a ìpoolingî basis. Assets are allocated to one of five pools and depreciated using a reducing balance method at prescribed rates for each pool. The rates vary between 7% and 20% per annum. Intangible assets may also be depreciated.
Tax losses incurred after 1 July 1995 are available for carryforward for up to five years, regardless of the type of business.
Taxpayers may choose either the cash or accruals method for tax accounting, but all income and expenses must be accounted for in Tenge using the official rate of exchange on the date of the transaction. An inflation adjustment is to be prescribed in the Instructions to limit the effects of inflation and any consequent devaluation of the Tenge that may occur.
Local companies are required to make monthly advance payments of income tax based on their financial profit for the previous month. Tax returns should be filed by 31 March of the following year; local enterprises should pay any remaining tax due and non-resident taxpayers must pay all tax due by 10 April of the following year. All tax payments must be made in Tenge.
There are substantial fines and penalties for the late payment of tax and any under declaration of income, regardless of the reason.
The definition of a permanent establishment under the new tax code is very wide and includes, for example, the provision of consultancy services. Branches of foreign companies are, in addition to income tax, subject to a branch profits tax at the rate of 15% of net income.
The following withholding taxes apply to payments to non-residents:
dividends and interest 15%
insurance premiums 5%
telecommunications and transport services 5%
royalties, provision of services 20%
Kazakh entities that do not withhold tax from payments to non-residents become liable themselves to account for the tax due.
In 1994 Kazakhstan renounced the double taxation treaties negotiated by the former USSR with effect from 1 January 1995. It also has concluded new treaties with Poland, Hungary, Italy, the UK and USA.
Income tax paid outside Kazakhstan may be credited against income tax payable in Kazakhstan up to the level of the Kazakh tax due on that income.
Individual Income Tax
Individuals present in Kazakhstan for more than 183 days in, broadly, any 12 month period are deemed to be resident for Kazakh tax purposes and subject to tax on their worldwide income. Individuals present in Kazakhstan for less than 183 days are non-resident and subject to tax only on Kazakh-source income. The code imposes income tax and a requirement to file a tax declaration on any employee working in Kazakhstan in a tax year; this is clearly an onerous provision, particularly as few double tax treaties are in exchange force.
Employment income is taxed according to a progressive system, with a top rate of 40%, currently on income over approximately $200 per month. Benefits in kind are generally taxable.
Local companies and permanent establishments in Kazakhstan are generally required to withhold income tax from the payment of wages and salaries to their employees. Such entities are also generally required to make contributions to the Employment Fund, Social Insurance Fund and Pension Fund totaling up to 32% of the employeeís gross salary; other individuals are themselves required to contribute a total of 5% of their gross income to these funds.
Value Added Tax ( VAT)
VAT is applied at a rate of 20% on turnover arising from the sale of goods, works and services within the Republic of Kazakhstan, subject to a number of exemptions, including financial services and leases of land or buildings.
VAT is now also applied to the import of goods. The export of goods is zero rated.
VAT on the acquisition of most fixed assets may now be reclaimed.
VAT registration is required when turnover in any month exceeds 1000 monthly minimum wages (around $4,000). The new code also provides for a system of voluntary registration. Following registration, VAT must generally be accounted for monthly.
Various goods (mainly alcohol, tobacco and luxury items) are subject to excise taxes if they are produced in or imported into Kazakhstan.
The issue or transfer of ownership of shares is subject to a tax on securities transactions at rates between 0.1% and 0.5% of the sale price, or face value in the case of an issue of securities.
A special regime for the taxation of mineral resource users is prescribed in the code.
Those in possession of land or making use of land are subject to a land tax. The tax is assessed by reference to the area, quality, type of land and the district or city in which the land is located.
Owners and users of vehicles are subject to a tax on vehicles assessed by reference to the kilowatt power of the vehicle.
Those owning or having rights over property are subject to a tax on property assessed by reference to the value of the property at a rate of either 0.1% or 0.5%.
After the disintegration of the social protection system from the USSR, Kazakhstan has faced two related tasks:
1. Prevent further disintegration of the positive aspects of the existing system of social protection;
2. Lay the foundation for social protection in a free market economy.
This includes reducing the burden on states budget for social expenditures, encouraging the population to make some of their own contributions toward their future pension plans, developing a private market for social services, ensuring pension provision, and executing targeted social assistance through transfers to the regional level.
Recently, Kazakhstan has made a legal and complex program base for social protection of disabled pensions.
The establishment of retirement age criteria is a problem. Currently men may work 25 years and women 20 years before being eligible for retirement. The population seems to feel that the age ceiling should be recommended rather than a mandatory work limit. The result has not been perfect, however, they are trying to be guided by the state system of social protection. The main focus point has been the creation of a pension fund. This has been created in direct relation to the pensioners and their benefits after looking at the inflation rates. There are three main pensions that have been created in regard to this request:
Labor is then divided into retirement, long-service, disability, and family pensions for loss of primary wage earner. However, senior citizens and juvenile invalids are also entitled to social pensions(http://www.undp.org/kazakstan.htm).
There are nearly 3 million pensioners, and pensions account for nearly half of total cash benefit expenditures.
Financing pension payments remains a problem due to a number of causes: falling production, delays in wage payment, evasion of payment of insurance contributions and untargeted expenditures. These delayed payments build up quickly. Currently the debt is $3.3 billion. Another factor that has pulled the Pension Fund into near failure is the existence of numerous pension privileges, especially those dealing with early retirement.(anywhere from 5-20 years before the official age). This use of Kazakhstanís resources makes it difficult to increase pensions for those who really need and have earned them. It also serves to discredit the pension system. One-fourth of every pensioner is below the official age. Therefore the percentage of pensioners in the population has risen from 14% to 17% in the past two years. (http://www.worldbank.org.html)
In addition to pensions, various types of allowances have also been established to help support families with children. Some examples include: one-time payments at child birth, single mother support, and support to mothers with juvenile invalids. In addition, senior citizens are eligible to live in boarding homes in which care is provided by the state.
In the former Soviet Union these types of state support programs came in many different forms such as discounts, sanitarium treatment, subsidies, and travel transport. These privileges were granted irrespective of the citizens income. Today, increasing difficulties in the financing system have brought about a crisis. In such a situation, some pivotal points of social protection have emerged that require thought and consideration.
If the economy is going to get back on track, child and family allowance expenditures must be reduced. This should be done by targeting only those groups that are in direct need of the transfers. In the future, a more rigorous testing system must be used in order to establish and monitor the money transfers correctly. In the short-run, the allowances must be kept at a flat-rate benefit while reducing their value in real terms.
The Ministry of Social Welfare of the Population must identify a strategy for reform of the social safety net. Currently, they have come up with a three stage system that will work to improve the current system over the next three years. First, they must plan the provisions to target the most vulnerable low-income families and to maintain a base level of social services. The intention is to redistribute the available resources in order to provide assistance to the families that need it the most. This will help to reduce the social pressures on the progress of economic reform. The second stage envisages more active participation of society based on the principles of self support. This will be possible on the basis of a compulsory social insurance system and the development of numerous non-state voluntary funds. In the longer term, the plan will be to decentralize main expenditures for social support from the national to the regional level, from the state budget to the private savings of citizens, and from budgetary financing to social insurance. In turn, this will lead to the end of inequities apparent in the present system of social protection. When this occurs, social insurance will have a reliable financial base and be able to satisfy a wide range of citizenís individual needs.
Intergovernmental Fiscal Relationships
There are essentially two levels of government in Kazakhstan: central and oblast - local governments. Responsibilities for stabilization policy are assigned to the central government; the centralized system provides service standards to each locality, applies equal taxes, and facilitates regional and personal redistribution.
Kazakhstan government attempts to simultaneously restructure its economic system, protect the well-being of its citizens, stabilize prices, achieve external balance, and establish a system of governance acceptable to 19 oblasts whose cultural identities, natural resource endowments, and degree of economic development differ widely. The primary intergovernmental fiscal issue is to what extent decentralizing expenditure functions and tax collection to oblast - local governments is economically desirable.
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De Melo, Martha. ìFrom Plan to Market: Patterns of Transitionî. Policy Research Working Paper 1564. The World Bank Policy Research Department, January 1996.
De Melo, Martha. ìThe Cultural Foundations of Economic Reform.î Policy Research Working Paper, 6819. The World Bank Policy Research Department, June 1997.
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