How much does the budget lose due to the lack of good governance?

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The lack of the rule of law in Ukraine has been repeatedly called as one of the main reasons for underinvestment, hence the slow economic growth in the country.

The positions of Ukraine in the international ratings remain extremely mediocre:

  • according to WJP Rule of Law index Ukraine holds 77th place out of 113 countries with the score of 50 points;
  • according to Corruption Perception Index (CPI) Ukraine is at 130th place among 180 countries with 30 points;
  • according to Rule of Law WGI dimension Ukraine with -0.77 score points holds 160th place among 209 countries;
  • according to Control of Corruption WGI dimension Ukraine with -0.84 points holds 168th place among 209 countries.

Corruption and lack of trust in the judiciary for three years in a row remain the main obstacles for foreign investors. We obtained the same results during a survey of strategic and portfolio investors conducted by the Dragon Capital, the European Business Association (EBA) and the Center for Economic Strategy (CES) in August-September 2018.

In the study «How much does the budget lose due to the lack of good governance?»  the analysts of the Center for Economic Strategy have calculated how much the ineffective management of a country costs.

Expected total budget revenues from the rule of law enhancement are estimated at least $26,6 billion as a one-off sum and an additional $8.6 billion annually. So, for a five-year period, one-time losses or inadequate revenues for state finances are $70 billion.

In the study the authors examined several industry examples using a concrete-to-general approach:

Tax evasion in labour taxation – distrust of the state, low quality of public services and low expected pension combined with weak monitoring by law enforcement agencies have become an environment for spreading “gray” and “black” wages. Because of this, the state loses $6 billion in revenues ($2.8 bn on single social contribution tax and $3.2 bn on personal income tax).

Transparent land market instead of semi-official rent market would bring $12.4 bn  to the budget as a one time gain and would be bringing additional $150 mln annually. Meanwhile, the government and the Verkhovna Rada can not find a common vision of the design of the market and for years prolong the moratorium on the sale of land.

Toxic debts in the portfolios of the Deposit Guarantee Fund, state-owned banks and the Privatbank will be repaid, probably in very small amounts – the quality of legal proceedings and weak enforcement mechanism lead to the fact that in court the bank can only return 0.01-0.3 UAH from the issued hryvnia. In countries with a high level of the rule of law, working bankruptcy procedures and a better system for settling problem debt the return could be even 70 cents per dollar. The difference in bad debt recovery under the ‘blue sky’ scenario vs poor rule of law framework totals $10 bn for the four state-owned banks and the Deposit Guarantee Fund.

Improving governance in infrastructure could bring additional $324 mln annualy if the road user charge will be implemented and $1 bn annually from the Public Private Partnerships.

Tax evasion in export and import operations.  Corruption in the customs authorities allows imports of “grey” goods of $ 4.05 billion and “grey” exports of $ 4.5 billion. As a result the budget losses $1 bn. This is a very conservative estimate, since the grey foreign trade is also used to hide profits.

Privatisation of state-owned enterprises could help to bring down corruption in public sector and thus decline the public losses via state-owned enterprises. The weak rule of law is partly the reason why the privatization still sluggish and foreign investors do not pay much attention to it. Our evaluation suggest that selling 53 state-owned companies using the multipliers of countries with better rule of law will bring $5.9 bn. Privatising those companies under the current level of rule of law would bring only $1.7 bn.

Shadow industries  – timber sales, amber extraction and gambling industrycould be brought to the daylight and the government could receive additional revenues. The total amount of fiscal gain could be approximately $0.2-0.4 bn on extremely conservative assumptions.

This list is not full of cases where the state loses money, these directions have been selected for analysis among others according to the following criteria:

  • lack of proper management, control of law enforcement or corruption;
  • a significant amount of abuses or missed opportunities;
  • available data for evaluation.