• 13/04/2024 18:35

More taxes, less income. What could a wartime economy be like and what will it give the country?

 Больше налогов, меньше доходов. Какой может быть экономика военного времени и что она даст стране

The wartime economy provides for a reduction in import consumption (collage: RBC-Ukraine) Author: Ruslan Kislyak

To win the war with Russia, the Ukrainian economy can go on a “war footing.” One should prepare that certain steps in this regard could happen as early as 2025, warned Finance Minister Sergei Marchenko. RBC-Ukraine looked into what the “war rails” of the economy generally envisage and how the transition to them will change the life of the country.

In preparing the material, we used statements from Finance Minister Sergei Marchenko, professor at the University of California at Berkeley Yuri Gorodnichenko, exclusive comments from lawyers, the NBU press service, as well as deputy director of the National Institute for Strategic Studies Yaroslav Zhalilo and head of the parliamentary committee on finance, tax and customs policy Daniil Getmantsev .

What are the “war tracks” that, according to Finance Minister Sergei Marchenko, the Ukrainian economy must switch to in order to win the war against Russia? And on what “rails” has the Ukrainian economy been moving for almost two years of full-scale war, not to mention the fact that Russia’s war against us has been going on since 2014?

What did the Minister of Finance say?

Ukrainian Finance Minister Sergei Marchenko said last week that Ukrainians will likely have to reduce their consumption of goods and services several times. In his opinion, Ukrainians consume too many imported goods, which is why huge amounts of foreign currency are spent not on military purposes, but on consumer goods. This in turn weakens Ukraine's economic potential.

“I will say as Minister of Finance that the war effort is not only about the military industry, it is also about society’s understanding that we are at war. Unfortunately, we still live in a rather specific reality, when everything is fine with us, macroeconomic and exchange rate stability. But this reality will require correction if we want to go on a war footing. This is a limitation of public consumption. We need to reduce it several times, because we consume mainly imported goods and services, this determines our economic potential,” Marchenko noted .

 Больше налогов, меньше доходов. Какой может быть экономика военного времени и что она даст стране

Finance Minister Sergei Marchenko (photo: Getty Images)

According to the minister, military economic “rails”, in particular, will provide for other tax and expenditure regimes. “We must prepare for this and, thinking about 2025, we must lay down appropriate scenarios,” the minister warned.

What questions should you answer?

First of all, you need to understand what a war economy involves. To do this, in particular, you should answer three sets of questions.

No. 1 What does the transition of the economy to a war footing mean for citizens?

  • How can citizens' incomes change?
  • To what extent can consumption be reduced?
  • Are individuals, for example, threatened with confiscation of foreign currency deposits in banks in favor of the state? What does the legislation say about this?

No. 2 What does the transition of the economy to a war footing mean for business?

  • What does this mean for business – public and private?
  • Are legal entities threatened with confiscation of foreign currency funds in bank accounts in favor of the state?
  • To what extent can the list of critical imports be narrowed?
  • What can exporters count on—stimulating assistance from the state or, for example, tightening requirements for the sale of foreign currency earnings?
  • How can the system of collecting taxes, excise taxes, customs duties, etc. change?

No. 3 What does the transition of the economy to a war footing mean for the state?

  • How will government spending priorities change?
  • How will government priorities in the production sector change?
  • What changes should we expect in taxation?
  • How will the role of security and “semi-security” (fiscal) bodies in the economy change?
  • How exactly will the regulatory authorities, Customs, and Tax authorities “tighten the screws”?

What does war economics imply?

The war economy is formed by the state taking into account restrictions on the economic, social and other freedoms of citizens during war on the basis of martial law legislation. In Ukraine, the legal regime of martial law is determined by the Law “On the Legal Regime of Martial Law”.

The economy generally influences the course and outcome of the war. Firstly, economics is the objective basis for the emergence of social conflicts that are resolved through war. Secondly, the economy is the material and technical basis of armed struggle. To wage a war, you need weapons and many other things that the economy provides. It is the economy, with the help of military equipment and human resources, that determines the organization, forms and methods of armed struggle, military tactics and strategy.

The relationship between economics and war is two-way:

  • war diverts significant financial, material and human resources from the productive sphere to the unproductive non-productive sphere;
  • war and military needs shape the structure of the economy itself;
  • war leads to the direct destruction of productive forces, and in this regard the task of preserving production, labor and ensuring the survivability of the economy arises.

How it was in the USA during World War II

University of California at Berkeley professor Yuri Gorodnichenko, in an article for Vox Ukraine, in the first months of the full-scale Russian invasion, listed the lessons that Ukraine should learn from the experience of World War II.

 Больше налогов, меньше доходов. Какой может быть экономика военного времени и что она даст стране

Professor Yuri Gorodnichenko (photo: Getty Images)

First, war requires a huge mobilization of the economy . At the height of World War II, government spending on the military accounted for a very large share of GDP: 42% in the US, 55% in the UK, 70% in Germany and 74% in Japan. This meant that personal consumption had to be limited. This goal was achieved through a combination of several strategies, from stimulating savings to outright bans on the purchase of goods for private consumption. For example, between 1943 and 1945, American consumers were unable to buy new cars.

Second, although capitalist countries maintained market economies during the war, governments played a decisive role in resource allocation .

Thirdly, the most bottlenecks were strategic materials . All countries had to deal with shortages of food, rubber, and oil. The inability of Japan and Germany to secure supplies of raw materials made their military operations limited.

The fact that Russian troops made little progress in the first weeks of the invasion of Ukraine in 2022 (Russian equipment literally ran out of fuel) underscores the importance of logistics.

Fourthly, government procurement took place differently . In order to ensure quick and stable supplies, the US government has moved from tender contracts to direct negotiations. The government gave large, complex orders to large firms because they had more organizational capital and were more likely to produce the products. Mass production was critical to reducing costs.

Fifth, wars are very expensive, which means there must be a reliable funding model that will support the high pace of the war economy . For example, in Ukraine it was calculated that to support military operations and the economy, the country needs 5-7 billion dollars a month (about 40-50% of the monthly pre-war GDP).

Due to the enormous costs of purchasing weapons during World War II, governments were forced to increase taxes. For example, the number of US households paying income taxes grew from 4 million in 1939 to 50 million in 1945. In addition to expanding the tax base, the Roosevelt administration increased tax rates; while the rate for the highest income levels reached 90%. However, even this enormous increase in tax revenue was not enough. And in fact, most wars are not financed by taxes.

The Federal Reserve not only printed money to directly purchase government debt securities, but also kept interest rates low to minimize the cost of servicing the government debt. 85 million Americans (out of a total population of just under 140 million) purchased government securities between 1941 and 1946. Many chose automatic deductions from their paychecks to purchase war bonds.

Returning to the war in Ukraine, Professor Gorodnichenko notes that if the country wants to win the war of attrition, the domestic economy must work. Obviously, Ukraine cannot blindly copy World War II strategies, but many of the lessons from then—mobilization, centralization, focus on protecting supplies and production lines, mass production—remain relevant. A war of attrition with an empty budget is impossible.

Scientists and lawyers warn

Deputy Director of the National Institute for Strategic Studies Yaroslav Zhalilo states: the transition of the Ukrainian economy to a war footing is already happening. And it should continue intensively in the future. The key condition is the ability of the economy to function stably in the long term, ensuring both military production to the extent possible and the current functioning of the country.

The expert recalls the words of the President, who noted that to provide for one soldier of the Defense Forces, six people must work in the civilian sector – not only employees, but also entrepreneurs – taxpayers. By steadily filling the budget, the economy creates opportunities for financing the Defense Forces. And the functioning of the economy is ensured to a large extent by consumption, military production itself, exports, construction and restoration.

“The financial system should work accordingly. Without allowing games in the pyramids of certificates of deposit, putting into circulation the available liquid resource, which largely comes from the same budget expenses,” explains the interlocutor of RBC-Ukraine.

He is also confident that under no circumstances should local budget expenditures for development be blocked. But they should be directed so that they maximize domestic demand.

Well, the eternal thing is that we need to block inappropriate, unreasonable use of funds and especially corrupt actions.

“The Ukrainian economy began the transition to a war footing with the outbreak of the war in 2022. As we see, such a transition is still taking place and is associated with the systematic transfer of the national economy to functioning under the conditions of a special period and the targeted application of measures of the legal regime of martial law in Ukraine. Some of these measures have already been introduced, and some were not applied so actively and en masse,” states Andrey Litvin, lawyer at the law firm “Ilyashev and Partners.”

In his opinion, the further transfer of the economy to a war footing, taking into account statements by top officials about the need to reduce public consumption, can be understood as a more active use, for example, of labor conscription for citizens, the introduction of rationed provision of food and non-food products to the population, increased use of enterprises and their workers for defense needs, increased confiscation of private property for defense needs, etc. The Cabinet of Ministers must formulate a list of more specific measures to ensure the functioning of the economy during a special period.

“Is there a threat of confiscation of the currency values of individuals and legal entities in favor of the state? This is possible. After all, the law provides for such a measure of the martial law legal regime as forced alienation of property. In turn, businesses can expect increased use of their production facilities and employees, or confiscation of their property for defense needs. It should be remembered that the viability of Ukraine is at stake. And if the state needs additional resources, then it has the right to do so,” the lawyer warns.

At the same time, Andrei Litvin believes that if the state applies the above measures, it will not be en masse and gradually. Most likely, the state will take the path of changing tax regulations, increasing taxes, duties and other fees. This is especially true for imported goods.

As for the list of critical import goods, if it is narrowed, it will only be for the sake of stimulating its production within the state. This is exactly how they will try to increase the filling of the budget and accumulate funds in the national economy, Andrei Litvin is sure.

His colleague “in the shop” – managing partner of the law firm “Sirota Dzis Melnik and Partners” Dmitry Sirota warns: if the “war economy” is understood as an increase in taxes, pressure on business, total confiscation of property for the needs of the Defense Forces, then this will significantly affect business and can lead not only to a lack of investment, but also to a massive exit of businesses outside of Ukraine. Such an approach would be clearly unreasonable and would lead to the bankruptcy of the state and the loss of its last resources.

According to the lawyer, transferring the economy to a “war footing” should always take into account two key factors.

The first is the abandonment of expenses that are unnecessary and not key to the country’s survival. For example, landscaping, parks, paved sidewalks, new roads, and the like can definitely wait. All these resources should be devoted exclusively to defense.

The second factor is that there must be maximum liberalization of business, which will create conditions for attracting investment and powerful business development now.

Among the urgent needs is the introduction of multi-year tax breaks on income tax and VAT. It is necessary to ensure stability of the legal regime for foreign investors in most sectors of the economy.

“There is no need to be afraid of non-receipt of funds into the budget. Scaling a business through liberalization will ensure its growth. While tax pressure will only lead to the curtailment and exit of an operating business. As a result, a decrease in budget revenues,” warns the lawyer.

War risk insurance must be fully operational through a fund guaranteed by the government. Other requirements of the time include maximum simplification of regulatory and permitting procedures for the implementation of business projects; creation of investment platforms ready to launch in the shortest possible time after finding investments; ending pressure from law enforcement and tax authorities on business.

“War economy” is not confiscation and repression, but the direction of state resources, first of all, for military needs. These are maximum preferences for the military-industrial complex and related industries with simultaneous liberalization of the economy in order to attract investment,” sums up Dmitry Sirota .

Daniil Getmantsev against

The head of the parliamentary committee on finance, tax and customs policy, Daniil Getmantsev, in a commentary for RBC-Ukraine, notes that of all the tools provided for by the legislation on the legal regime of martial law, the government uses only those that are exclusively necessary or without which solutions to defense problems will be impossible.

 Больше налогов, меньше доходов. Какой может быть экономика военного времени и что она даст стране

Daniil Getmantsev (photo: Getty Images)

“During the 22 months of a full-scale war, no one from the top military-political leadership even suggested, for example, “labor conscription.” Instead, within the framework of the state program “Reconstruction Army”, temporarily unemployed citizens were offered voluntary participation in feasible public works. With a level of payment that significantly exceeds unemployment benefits, and the ability to stop such activities at any time,” notes Daniil Getmantsev.

He assures us that the authorities have never made proposals, for example, about “housing duties” or “trade restrictions.” With the exception of alcohol, this is not a complete restriction, but within a certain time frame.

Getmantsev notes: thanks to stable funding from partners, their provision of military assistance, maintaining macroeconomic and exchange rate stability, and increasing budget revenues, it is currently possible to avoid deviations from the usual framework of economic activity. Including avoiding changes to the taxation system, the reform of which, according to European standards, will take place after the end of the war as part of negotiations on accession to the EU.

“Despite significant military expenditures, in 2024 the state will increase the minimum wage in two stages, carry out the next indexation of pensions as planned, and will continue to fulfill all its social obligations provided for by the legislation of Ukraine,” assures Daniil Getmantsev.

Optimistic National Bank

The National Bank of Ukraine, in response to a request from RBC-Ukraine, noted that the parameters under which the economy will operate in the event of a transition to a “war footing” are unknown. Therefore, the regulator limited itself to the forecast included in the NBU’s basic October macro forecast.

Thus, according to the macro forecast of the NBU, consumption next year will continue to recover – it will grow by 5.7% after the current increase of 3.8%. It will remain below potential levels due to the consequences of a full-scale war. At the same time, the gradual resumption of consumption will support the Ukrainian economy.

The revival of private consumption will be facilitated, in particular, by the expected growth in citizens' incomes both in real (that is, taking into account inflation) and in nominal terms. Thus, according to the NBU forecast, in 2024 nominal incomes will increase by 15.8%, and real incomes by 6.9%. In 2025, income growth in nominal terms will be 14%, in real terms – 6.2%.

The increase in income will be facilitated by the restoration of economic activity and the continuation of a soft fiscal policy.

The NBU notes: economic stability in wartime can be achieved, in particular, by the central bank pursuing a strict and independent monetary policy, fiscal consolidation by the government, structural reforms and the use of market instruments to fill the budget.

www.rbc.ua

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