Armenia is embracing trickle-down tactics in an effort to foster economic growth. The Armenian parliament has adopted unprecedented budget and taxation legislation for 2001 aiming to streamline revenue collection and encourage business activity. Its main components are a substantial cut in two taxes -- income tax and compulsory social security payments (CSSP).
These two taxes have greatly hindered employers from attracting skilled workers by leaving them unable to offer competitive take-home wages. Previously the income tax rate varied progressively from 15 to 30 percent of gross wages, and the CSSP ranged from 28 to 22 percent under a regressive scale. As a result, an employer formerly had to pay upwards of 50 percent of the overall payroll to the state.
Under the new legislation, the integral value of income tax and CSSP is fixed at 28 percent -- starting with monthly salaries that are 20,000 drams (about USD 36) a month or higher. The share of income tax and CSSP in this payment vary depending on the size of the salary, but it makes no difference for the taxpayer. Armenia becomes the first CIS country to undertake such a radical tax cut. (While Russia has lowered the income tax to 13 percent flat, the CSSP rate in Russia has remained well above 20 percent for the most part of the ordinary salaries range).
Parliament offered small- and medium-sized business an additional break by raising the threshold of VAT taxation from 3 million drams (about USD 5,400) of annual turnover to 10 million drams (about USD 18,000). Also, the introduction of a single rate of 20 percent for the company profit tax is set to replace the previous two-rate (15 percent and 25 percent) system.
To compensate for the decrease in revenue, some tax privileges have been abolished, including VAT exemptions on drugs and infant food. Interest on bank accounts also is now subject to taxation. Officials additionally hope that events related to the celebration of 1700th anniversary of adoption of Christianity in Armenia will help boost income from tourism.
Nevertheless, there is some concern that new revenue streams will not be enough to compensate for the reduction in CSSP, which is the source of income for the State Fund of the Social Security, the sole agency responsible for pensions and social security payments in the country.
The tax cuts come at a time when state coffers are squeezed. According to the State Revenue Ministry, tax collection in 2000 fell 11 percent short of targets. Budget revenues were only 84 percent of those planned, and expenditures were even lower about 74 percent of original projections. As a result, state payment arrears, already significant (they started to accumulate as a result of the 1998 financial crisis in Russia) grew even higher. Political turmoil was a major factor in Armenia's poor revenue collection record in 2000, due mainly to the fallout from the October 1999 shootings in Parliament, which left eight top politicians dead.
The Armenian business community was pleasantly surprised by the tax cut. The government originally discussed cutting taxes in August 1999, when the late Prime Minister Vazgen Sargssian was in office. The prolonged period of instability in the wake of the parliamentary assassinations delayed the adoption of the new legislation until late 2000. So far, the government of Andranik Margarian has proved to be consistent in implementing these amendments, providing an important indicator that political instability has been largely overcome.
Many observers have high hopes that tax reduction will have the desired impact on economic activity, specifically in promoting the growth of small businesses and a rise in wages. Today, most businesses in Armenia are small in scale with limited profitability, and some believe that onerous tax rates have discouraged expansion. High taxes have also kept a lid on salaries. Currently, the official average monthly salary is 20,612 drams or USD 37 per month).
Seeking to stabilize the economic environment, the government has declared its intention to maintain the existing tax rates for at least the next three years. Meanwhile, officials hope the new legislation may also lead to some reduction in the shadow economy. Experts caution, however, that the tax moves will have little impact on businesses paying salaries below 20,000 drams a month. Such small businesses employ a significant part in the labor market in Armenia.
Haroutiun Khachatrian is a Yerevan-based writer specializing in economic and political affairs.