How Ukraine сan defend its fiscal sovereignty

As troops are battling in the East to protect Ukraine's territorial sovereignty, Kyiv is looking West for long-term security as it attempts to become a member of the European Union. A wartime accession process will likely challenge Ukraine's tax sovereignty more than any other in the EU's history - and negotiators must be vigilant to set Ukraine up for success. When the war is over, Ukraine will need to rebuild.

But to revive its economy, it's going to need the freedom to enact pro-growth tax policies, which might be significantly restricted by this unusual EU accession process. Following standard protocol, EU and Ukrainian negotiators must now agree on tax reforms that align Ukrainian tax law with the EU - but Ukraine's unique predicament risks ceding governing autonomy to international creditors as well. Because of the war, Ukraine needs more than legal alignment.

It requires short- to medium-term financial assistance for reconstruction (to the tune of £14 billion in 2023 alone) and long-term tax policy reforms that reduce corruption and increase foreign direct investment. The Ukrainian finance ministry said as much in a recently announced Reform Matrix detailing the government's reform needs.

This Reform Matrix departs from previous EU member candidates by uniquely involving an international coalition in the negotiation process. Whereas the EU already reached a £50 billion conditional agreement on its plan to support Ukraine, additional carrot-and-stick provisions in the Reform Matrix have also involved international groups - such as the IMF, U.S., World Bank, and G7 - in Ukraine's domestic tax reform.

Additionally, the European Commission is much more involved in shaping tax policy than it was during previous accession negotiations. This means that EU negotiators may not only be trying to implement current EU tax law in Ukraine but could also be recommending reforms based on future EU tax policy aspirations. Despite these external pressures, Ukrainian negotiators must stand firm in defending their right to tax sovereignty and should rely on historical lessons of wartime financing to guide their path forward.

According to Tax Foundation Europe research, the first lesson is that the U.S. Marshall Plan of 1947 gave European governments the necessary fiscal space to liberalize their economies after World War Two. However, it was the pro-growth tax policies, not the Marshall Plan itself, that led to Europe's economic recovery.

The same liberalizing principles also apply to Ukraine's post-war recovery plan. Second, international grants are better than loans. By one account, World War Two left Britain "the greatest debtor in the history of the world," and Germany's debt was four times its national income.

The goal of war is to protect a country's sovereignty, but borrowing from abroad weakens that sovereignty. Previous Tax Foundation Europe research suggests that Ukraine has under-utilized "war bonds" to fund the government and should consider launching a major campaign to raise funds from its citizens and ex-pats. Third, aside from wartime tax policy measures, Ukraine's current tax code is fairly conventional by EU standards and its rates are in line with other EU nations.

Using Tax Foundation's European Tax Policy Scorecard, Ukraine would rank as the 7th-most competitive tax system in the EU out of 27 if it joined today. To further improve its competitiveness, Ukraine should adopt its own version of the various flat tax reforms championed by fellow former communist countries such as Bulgaria, Estonia, Latvia, and Slovakia. A flat tax, or cash flow tax, better suits Ukraine's economic and governance needs than a Western-style tax system.

Undoubtedly, Russia's illegal invasion puts Ukraine in a vulnerable negotiating position with the EU and broader international community. But Ukraine should not battle Russian troops for territorial sovereignty just to cede fiscal sovereignty to policymakers outside of Kyiv. Instead, Ukrainian negotiators must protect their tax sovereignty and fight for pro-growth tax reforms that will help the country rebuild.

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