Analysis of Tax Cuts i

Analysis of Tax Cuts in the Kyrgyz Republic

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Analysis of Tax Cuts ii

Abstract

One of the most commonly discussed issues in economics is

how tax rates relate to economic growth. Advocates of tax cuts

claim that a reduction in the tax rate will lead to increased

economic growth and prosperity. Opponents claim that tax cuts

will decrease government revenues, adversely affect to the

fiscal balance. Keynesians often claim that tax cuts hurt job

and wage growth. Others claim that if we reduce taxes, almost

all of the benefits will go to the rich, as those are the ones

who pay the most taxes. The paper analyzes the effect of tax

cuts on the economy of the Kyrgyz Republic, which took place in

several stages during 2006-2009.

Analysis of Tax Cuts 1

Analysis of Tax Cuts in the Kyrgyz Republic

In the Kyrgyz Republic the tax reform was introduced in

three stages.

In 2006 the tax rate for personal income has been changed

from a progressive rate (the top rate was 20%) to a flat rate

(10%). In context of the Kyrgyz Republic the importance of

personal income tax is difficult to overestimate, because

personal income tax revenues are the second largest source of

tax revenue (after VAT tax revenue).

In January 2007 were undertook a major cut in corporate

income tax from 20 to 10 percent and decreased payroll taxes

(labor taxes and contributions) by three percentage points. The

payroll tax is used to pay Social Security benefits, Medicare

and unemployment benefits.

In January 2009 the authorities introduced a new tax code.

The reform has been driven by the criteria of efficiency and

simplicity considerations. In the new Tax Code VAT has been

reduced from 20% to 12%. Also, the rate of unified tax for small

and medium businesses, working under the simplified system of

taxation has been reduced from 10 to 6 percent. In order to

stimulate investment activity provides income tax exemption of

dividends received from investments in domestic organizations,

interest and incomes of securities of listing companies,

reduction of income tax non-residents from 30% to 10% of the

services provided to domestic organizations. To offset some of

the expected revenue loss was introduced a new turnover tax.

Economic growth - the purpose of any country in the world.

A number of factors must converge to produce economic growth and

jobs, tax policy being only one of them.

There are three most common views on tax cuts and the

impact of policies on the economy:

1.According to Gregory Mankiw’s textbook economic growth is

essentially a function of

productivity – output per man-hour. How much a worker can

produce is a function of several things: physical capital

(machines, equipment, public infrastructure), human capital

(education and training), natural resources (energy, land), and

scientific and technological knowledge. The key determinant of

the amount of capital available to workers is saving – foregone

consumption from current production. In general, more saving

will lead to more investment, and more investment will raise

productivity and growth.

Also, Gross Domestic Product (GDP), a measure of a nation's

wealth, is also directly affected by federal taxes. An easy way

to see how taxes affect output is to look at the aggregate

demand equation:

GDP=C+I+G+NX

where:

C = consumption spending by individuals

I = investment spending (business spending on machinery,

etc.)

G = government purchases

NX = net exports

Consumer spending typically equals two-thirds of GDP. As you

would expect, lowering taxes raises disposable income, allowing

the consumer to spend additional sums, thereby, increasing GDP.

Reducing taxes, therefore, pushes out the aggregate demand curve

as consumers demand more goods and services with their higher

disposable incomes. Supply side tax cuts are aimed to stimulate

capital formation. If successful, the cuts will shift both

aggregate demand and aggregate supply because the price level

for a supply of goods will be reduced, which often leads to an

increase in demand for those goods.

Analysis of Tax Cuts 2

2.The effect of tax cuts is often debated. Free marketers

tend to claim that tax cuts, most notably in capital gains and

corporate income tax rates, inevitably spur economic growth.

Keynesian often claim that tax cuts hurt job and wage growth.

3.Another problem for tax cut advocates is balancing the

budget. Cutting taxes, at least theoretically, reduces

government revenues, which creates a budget deficit.

The Kyrgyz Republic in the last 7 years has experienced two

revolutions, and ethnic conflict that adversely affected on the

economy. However, the country began a major reform, one of which

is tax reform. The main purpose of such dramatic changes was to

give significant stimulus and incentives to business and

individuals to promote economic growth.

This paper considers and analyzes the effect of tax cuts on

the economy of Kyrgyzstan. The results are compared with the

aforementioned views of leading economists of the world. Also

defined features of the kyrgyz economy.

Analysis is carried out by exploring the effects of tax

cuts on growth, tax revenues, budget deficit, real wages,

investment, and savings.

Real GDP Growth and Tax Revenues and Structure.

Tax cuts, when used properly, have stimulated the economy.

Many credit President George W. Bush's tax cuts for moving the

economy out of recession. Similarly, in 1964, Congress enacted

an 18% cut in personal taxes to spur growth (N. Gregory Mankiw,

Macroeconomics, seventh edition, New-York, Worth Publishers, p.

296). The legislation was designed to encourage consumer

spending - many believe that it succeeded admirably as consumers

delivered a textbook reaction.

According to a December 2004 article in Celtia.info, a

magazine distributed in Celtic

Analysis of Tax Cuts 3

countries, tax cuts have also shown positive results in other

countries as well. Ireland's recent tax cuts are believed to

have improved living standards significantly. For years, the

Irish were faced with high unemployment, budget deficits and

high taxes. In 1986, Ireland faced a fiscal crisis. After

reducing government spending, the government lowered taxes on

both individuals and corporations. Over the next 13 years,

Ireland's per capita income went from only 63% of the United

Kingdom's average to besting it in 2000. Ireland now enjoys one

of the highest standards of living in Europe.

According to a May 2007 article in the Herald Tribune, tax

cuts in Poland, Slovakia and Hungary before their entry in the

EU have spurred economic growth in those countries.

In the case of the Kyrgyz Republic due to rising oil prices

and gas prices, the global financial crisis, the decline in

remittances from abroad and the unstable political situation in

the country the real GDP declined from 2007 until a negative

value in 2010.

However, tax collection steadily increased. During the

period of reforms, tax revenues increased by about 5 percentage

points, to 23,2 percent of GDP in 2010. Improved customs

administration, streamlined tax procedures, and effective

arrears management contributed to improved revenue collection

(Figure 1).

Source: National Statistic Committee of the Kyrgyz Republic, State Tax Service

Analysis of Tax Cuts 4

Despite political turmoil and ethnic conflict, tax collection

performed adequately in 2010. Fiscal

revenue performance has held up well despite the crisis, largely

as a result of strong gold-related tax receipts—both from higher

prices and output—and continued emphasis on tax administration.

While the authorities have generally avoided using tax breaks as

a crisis response, they have provided relief to businesses in

the south (area of ethnic conflict) until 2012; the impact of

these measures on tax collection is likely to be small as the

south has a small share of national tax receipts.

As expected, the share of VAT in total tax revenue dropped

sharply in 2009. However, the sharp drop in overall revenue did

not materialize, with tax to GDP declining from 23.0 percent in

2008 to 22.7 percent in 2009. Tax revenue in 2009 was boosted by

strong gold-related tax receipts from the Kumtor mine, and

strengthened tax administration, including tax arrears clearance

(Figure 2).

Source: State Tax Service of the Kyrgyz Republic

Tax Cuts and Budget Deficit

Another problem for tax cut advocates is balancing the

budget. Cutting taxes, at least theoretically, reduces

government revenues, which creates a budget deficit. To counter

this deficit, the government could cut spending.

Analysis of Tax Cuts 5

In the Kyrgyz Republic after the tax cut tax revenues grew

from 2006 to 2008, only in 2009, tax revenues fell slightly by

0.8% from 23% to 22.2% of GDP. And the government did not have

to radically reduce costs. Only in 2008 the government cut

spending, achieving zero overall balance and reducing public

debt from 56.8% to 48.5% of GDP, but in subsequent years due to

construction of large hydroelectric power station and the April

Revolution, which caused major damage to infrastructure, the

Government increased spending , bringing in 2010 overall balance

to -6.5% and the national debt to 65.1% of GDP (Figure 3).

Source: National Statistic Committee of the Kyrgyz Republic, Ministry of Finance

Tax Cuts and Real Wages

The effect of tax cuts is often debated. Free marketers tend to

claim that tax cuts, most notably in capital gains and corporate

income tax rates, inevitably spur economic growth. Keynesians

often claim that tax cuts hurt job and wage growth.

Figure 4 shows that before the first tax cuts in 2001-2006

the average real wage growth was 15.7% in subsequent years, the

average real wage growth was 22.7%. Investments and savings

after a long recession began to rise in 2009.

Analysis of Tax Cuts 6

Source: National Statistic Committee of the Kyrgyz Republic

Conclusion

The analysis of tax cuts in Kyrgyzstan shows that tax cuts

eventually lead to higher investment and savings, increase real

wages. Should be noted that in developing countries, such as

Kyrgyzstan, such negative factors as imperfect legislation,

corruption, informal economy hampered economic development. But

at the same time namely it has a huge potential for economic

growth. Proper tax reform, tax cuts, improved tax administration

and other measures can use this potential. Tax cuts together

with proper fiscal policy, by creating conditions for reducing

the informal economy can increase tax revenues and, together

with an increase in investment, savings, real wages reduce the

budget deficit and lead to economic growth.

Analysis of Tax Cuts 6

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