Central bank assesses potential impact of tax increases on inflation

The National Bank has warned that the increase of certain taxes, which are under consideration in the Verkhovna Rada, will accelerate the rate of inflation in Ukraine. First of all, this concerns the military levy on the income of enterprises and the value added tax, according to the latest inflation report of the regulator.

The base scenario of the forecast already takes into account the increase in excise taxes, but not yet the introduction of new taxes or rate increases for existing taxes.

Each of these initiatives can have a different impact on inflation, the central bank warns.

An increase in certain direct taxes (in particular, on personal income) will reduce inflationary pressure due to consumption restrictions, thus offsetting the impact of higher budget expenditures.

Consumption taxes carry more pro-inflationary risks. Their increase will directly affect consumer prices. In particular, in the  case of an increase in the VAT rate, it will affect almost all components included in the consumer price index.

"As global experience shows, this effect is usually reflected in the annual inflation rate within 12 months and then fades away," the report says.

Pro-inflationary risks include the possible introduction of a military levy on the income of enterprises.

Such a tax can be largely passed on by businesses to consumers. The effect on prices can be multiplicative, since taxation will occur at every stage of the chain of production and sale of products, except in the case of vertically integrated companies.

"The introduction of such a tax can significantly increase inflation within a relatively short period," the NBU warned.

The bill of the Cabinet of Ministers proposes to increase the military levy from 1.5% to 5%, to extend it to sole proprietors and certain transactions, such as the sale of jewelry, real estate, the purchase of bank metals or new cars.

Minister of Finance Sergii Marchenko called on the Verkhovna Rada to support the draft law on raising military levy to finance the army. This is a difficult but necessary step, he said.

Russia has already raised taxes to finance the war against Ukraine. The aggressor state did this by introducing a differentiated personal income tax rate (PIT) and raising the income tax.