Businesses Are Subsidizing the State Budget: Tax Credits Exceeded 260 Billion Drams by the End of 2015

February 21, 2017

" External challenges are having an increasingly adverse impact on Armenia’s economy. During 2010-2013, our economy grew by 4.3% on average, while in 2014-2016 it fell to 2.3%. Obviously, the excess tax payments of 260 billion drams, which account for 20% of annual state budget revenue, would not be possible to refund to taxpayers within one year. "


Gohar Gyulumyan, Senior Economist at the World Bank Armenia Country Office, answers questions from Hetq

Gohar, the World Bank recently released a new study on Armenia's public finance. According to that study, taxpayers have subsidized the State Budget in recent years. Excess tax payments collected exceeded 10 percent of annual tax revenues. Had no tax credits been collected from taxpayers, would Armenia's budget deficit have been larger?

Yes, at the end of 2015, tax credits exceeded 260 billion drams. Had the Government taken loans or issued treasury bonds equivalent to that amount, not only would such borrowings have to be repaid according to the established schedule, but also an interest equivalent to 56-60 million dollars per annum (10-12 percent on average per year) would have to be paid from the state budget.

However, based on scarce information available on tax credits between 2012 and 2015, it can only be stated that the stock has increased further by almost 30 billion drams. It is now being stated that the practice of collecting advance tax payments has been stopped. However, as of the end of 2016, respective data have not been released yet to make comparisons and conclusions. Time and dynamics in numbers will show whether the practice of collecting excess tax payments has lessened or not. 

A tax credit arises when a taxpayer pays an additional tax on top of its current tax liabilities, which could include the amounts of VAT credits not refunded in the case of exports, as well as advance payments driven by a desire to accommodate the addresses of the tax authority with an expectation that they would be offset against future tax liabilities. In Armenia, tax arrears are also significant and amounted to 120 billion drams at the end of 2015. I think that tax credits and tax arrears are distributed asymmetrically. It is known that 10-15 years ago, large taxpayers contributed more than 70 perent of the state budget revenue, and it used to be an objective reflection of the realities in the economy.

It meant that the role of large taxpayers in the economy was commensurate with their role in tax collections. Payments by large taxpayers have fallen to 52-53 percent in recent years. The Government states that improvements in collections from large taxpayers in the last months of 2016 resulted in perhaps up to a 55 percent share; however, it is still a distorted picture. At least 70-80 percent of the tax revenue should be generated from the taxes paid by large businesses.

So, are tax collection targets mainly achieved from small and medium-sized businesses?

The numbers above show that more than half of the tax revenue in the budget is still contributed by large businesses. However, the contribution of SMEs is not proportionate to their role in economic activity. It should be noted, that from the tax policy perspective, the situation in Armenia has been unclear after increasing the VAT threshold abruptly from 58 million drams to 115 million drams as a certain number of large taxpayers fell under a softer tax regime intended for the SMEs, which led to erosion of the tax base and also created un-level playing field for real SMEs. Considering also the latter’s “contribution” to tax credits, SME’s end up having a higher tax burden.

What would be the projection for the state budget if taxpayers are discontented with such a policy, and would at some point decide to protect their rights and stop paying taxes until advance payments are repaid?

The Tax Code, which is coming into effect in 2018, has already provided for a legislative solution to this issue and hopefully, by that date, the Government would also establish the technical and administrative procedures for automatically offsetting debits and credits of taxpayers. However, this is still not the case. Sadly, there is no plan or concept note for reducing the stock of tax credits and tax arrears. Under the current economic situation, the Government should form an approach to this critical issue for the business climate.

External challenges are having an increasingly adverse impact on Armenia’s economy. During 2010-2013, our economy grew by 4.3 perecnt on average, while in 2014-2016 it fell to 2.3 perecnt. Obviously, the excess tax payments of 260 billion drams noted above, which account for 20 percent of annual state budget revenue, would not be possible to refund to taxpayers within one year. No matter how difficult the problem is, the current Government has inherited it from its predecessors and could take an approach to it. For instance, one option would be to offset tax credits within 5 years, based on specific criteria and schedule.

A number of economic sectors, such as energy, transport, water, agriculture, irrigation, railways, etc. are subsidized from the state budget. Have researchers assessed if these subsidies are effective and targeted and whether it is appropriate to continue them?

Including the subsidies in the public expenditure review pursued the objective of also identifying how effective and targeted was the financing of these sectors through subsidies. The current fiscal situation is very complicated, and reducing public expenditure could have negative implications for the already low economic activity and social situation, under the same efficiency indicators. However, the unsustainable fiscal deficit in 2015-2016 makes it imperative to enhance revenue mobilization on one hand, and to reduce inefficient expenditure, on the other.

One of the findings of our review is that it is possible to improve the efficiency of spending programs. If a sector is subsidized from the state budget, the Government should introduce performance indicators and estimate what outcome it wants to get against the subsidy provided. Under budget subsidies in many sectors, there is no clear link between the spending and expected outcome. The system of monitoring subsidies should be institutionalized.

Some sectors, such as energy and irrigation, where significant loans were invested in past years, are projected to become self-financing after some time. However, no sector is seen as having overcome dependence from the subsidy. Can this be only attributed to poor administration in these sectors?

Apparently, the structural credits provided by the World Bank since the end of 1990 have periodically addressed the self-financing issues in the sectors you mention. Previously, the Governments prepared schedules several times as to how the irrigation tariff policy should change by years, to allow the system to achieve cost-recovery. The strategy for this sector has been periodically reviewed, with the most recent revision happening last year.

There are many crosscutting issues, not just administration; the tariff policy is impacted by the quality of administration in the sector, financial discipline, accountability and supervisory mechanisms. Tariff policy in our country, not only in irrigation, but also for other public services, is highly sensitive to political developments.

Undoubtedly, it is not desirable and sustainable to achieve cost recovery by only relying on the tariff policy, if there are structural issues in the sector, such as in the energy sector. Key reforms took place between 1998 and 2005 resulting in a situation where the sector was self-reproduced without creating any major tariff policy or governance issues. However, since 2010, due to certain changes in the governance area of the sector, the financial performance of the system deteriorated and resulted in major problems.

Just by increasing the tariff, and including all types of expenses in the tariff, and forcing the consumer to solve all those problems is not the right approach. It should be examined how such financial flows have been generated, ultimately leading to accumulation of arrears in the sector, and then later assess how justified their incorporation is into the tariff calculations.

If a specific sector still requires time to achieve self-cost recovery, even in such a case only specific expenses can be targeted, for instance, only subsidizing capital spending for the sector from the budget. Poor administration is part of the problem, but it is not less important today. There are sectors - for instance, the water users’ associations in irrigation - the financial statements of which are not audited, raising questions as to their trustworthiness.

As a result, despite the provision of 5-6 billion drams in annual budget subsidies, 5-6 billion drams of arrears have been accumulated in the sector, only a part of which could be explained by increased energy tariffs from previous years. Here also, an approach has to be taken to prevent further accumulation of arrears and clean the stock of inherited arrears within a specific timeframe.

Read the full interview


The interview was conducted by Sara Petrosyan.

Orginally published on Heqt.am on February 17, 2017

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