IMF Group Ukraine press release on consequences of raising minimum wage (updated)

IMF Group Ukraine apologizes to readers for several errors calculating the effect of raising the minimum wage to UAH 3,200 in its previous press release, dated November 1.

We thank our colleagues, who noticed on the inaccuracies of our calculations and forecast and helped us to correct them. Nevertheless, our basic conclusions and trend analysis remain valid: The increase in domestic consumption as a result of increasing wage payments by UAH 25 billion and the positive balance of payments to the budget resulting from the innovation will not negatively impact on the 2017 budget deficit and will therefore not be factor in monetary inflation next year.

We present below a revised version of our forecast of the impact of raising the minimum wage on budget and economic indications for 2017.

Independent Macroeconomic Forecast Group (Ukraine), an independent group of Ukrainian economists that attempts to forecast basic trends in the development of the country’s economy and analyze decisions taken by government finance officials, has completed its econometric analysis of raising the minimum wage to UAH 3,200 in 2017.

This brief relies on open-source statistics of budget, monetary and fiscal policy, in addition to statements (including the press conference by the Ukraine’s deputy minister of social policy and Ukraine’s prime minister), as well as press releases and data published on official government websites. It also includes commentary by critics (economists and leading journalists) of the government’s decision.

IMF Group has concluded the following:

1. The decision to raise the minimum wage to UAH 3,200 will result in a UAH 25 billion increase in economy’s wage fund, including UAH 13 billion in the state sector and UAH 12 billion in the private sector. Taking into account that payments will be directed first and foremost at poorer segments of society, we can predict with confidence that purely domestic demand will grow as a result the former, mostly for domestically produced basic food stuffs. Taking into account that payments will target at poorer segments of society, we can predict with confidence that DOMESTIC DEMAND ALONE will increase as a result, mostly for domestically produced basic food stuffs.

2. Irrespective of whether businessmen avail themselves of personal income tax breaks, this will lead to an increase of receipts from UAH 330 million to UAH 4.5 billion, and UAH 400 million from military tax contributions.

3. Unified social insurance contributions (to the Pension Fund) will increase to UAH 63.2 billion, and unified tax payments to local budgets to UAH 2.6 billion.

4. Payments of Ukraine’s consolidated budget as a result will increase to UAH 15.8 billion, while inflows from all taxes will rise to UAH 19.5 billion. «Purely additional tax revenues» to Ukraine’s consolidated budget (including the Pension Fund) will total UAH 3.7 billion as a result of raising the minimum wage to UAH 3,200 in 2017.

5. We negatively appraise increasing the «fiscal percent of GDP» (an increase in the level of the tax burden on the economy) of 0.7% of GDP to 40.7% (based on the IMF forecast of GDP in Ukraine at UAH 2,571 billion). This is not even taking into consideration the positive effect for increasing domestic demand by 3.1% of GDP.

(Basic household expenses in Q2 2016 comprised UAH 355.9 billion. If we double the amount and combine GDP growth trends in 2017, we arrive at UAH 809.5 billion total domestic demand, plus UAH 25 billion, increased by 3.1%.). This leads us to conclude THE INCREASE IN MINIMUM WAGE WILL HAVE LIMITED IMPACT ON CONSUMER INFLATION IN 2017. According to our calculations, inflation in 2017 will not exceed 8-10%.

6. We refute not only the existence of a negative influence of the decision to raise the minimum wage to UAH 3,200 in 2017 on price levels by means of «monetary inflation», but also any related risks. The reason is because 2017 budget deficit will not increase. Indeed, according to our calculations, it will decrease because of additional revenues totaling from UAH 3.8 billion to UAH 7.8 billion. The “fiscal deficit” of the 2017 budget will correspondingly decrease, as will the necessity for the National Bank of Ukraine (NBU) to cover it by purchasing sovereign bonds.

This, in turn, will allow the NBU to conduct a more conservative monetary policy, not increasing the rate of money base growth for the sake of financing the budget deficit and mitigating additional “monetary inflation» risks.

7. Projected «unreceived payments» to the Pension Fund this year is estimated at UAH 80.45 billion due to the decrease in unified social insurance contributions to 22% in 2017. The amount will be covered by the stated hike in minimum salary for a minimum of UAH 16.2 billion. This, we hope, will end the discussion about whether to decrease tax fund salary payments in the country.

8. In conclusion, we again emphasize that despite recent criticism (which has mostly not been backed by the requisite calculations required for the professional study and discussion of the decision), the planned hike in the minimum wage in 2017 will not result in any increased inflationary risk or an increase in the budget deficit. To the contrary, the move may, albeit insignificantly, but positively, increase domestic demand.

Technical commentary:

Some 16.4 million Ukrainians were employed in 2015, 5.9 million of whom worked as contract employees in the state and private sector, 3.46 and 2.44, respectively (1.4 to 1 ratio).

The division of contract labor between the private and state sector can be calculated using the OECD formula, according to which 21% of the employed population is employed in the state sector. Despite the fact his calculation was made in 2013, the 21% marker remains valid today: zero change in the number of workers in the state sector from 2009 to 2013 makes the statistic a constant marker.

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The next group of employed persons are individual entrepreneurs, who in 2015 numbered 2.3 million, with the remaining 8.3 million self-employed and legally exempt from the single unified tax.

Raising the minimum pay wage to UAH 3,200 will result in a number of significant changes, which will be reflected in budget inflows and outflows.

Using State Statistics data on the diversification of salary payments for contract employees in June 2016 we can calculate the number of workers to whom employers will be obliged to pay the UAH 3,200 minimum salary.

To determine increased government and business costs in raising the minimum wage to UAH 3,200 it is necessary to correct State Statistics calculations envisioned through the end of 2016 and in the 2017 draft budget. It is correct to assume that the private sector, in light of its capacity, will prefer not to increase official salaries and corresponding tax payments. Therefore the increase of salary payments starting in 2017 will impact only the state sector and that portion of the private sector receiving the minimum salary. As a result, total costs for increasing the wage labor fund will amount to UAH 25 billion, UAH 13 billion from the state budget and UAH 12 billion from the private sector. Correspondingly, social security, pension fund and military tax contributions will grow.

The change in unified social insurance contributions may vary, defending on the desire of employers to use tax breaks. An estimate of the increase is calculated below, assuming all employers avail themselves of same.. If employees do not avail themselves of the tax breaks, increases from social security tax and military tax contributions total UAH 4.5 billion and UAH 375 million (1.5% multiplied by UAH 25 billion), respectively.

The second important element of the calculation is the change of revenues from the unified social insurance tax. It is easy to see that for contract employees this amount totals UAH 5.5 billion, however it is necessary to take into account that an increase in the minimum wage will also impact on single unified tax payments and other payments withing the simplified system. Assuming that the absolute majority of workers in this category pay the minimal amount, it is easy to calculate that the increase in the minimum wage from UAH 1,434 in 2016 to UAH 3,200 in 2017 will result in a increase from this given category from UAH 8.7 billion in 2016 to UAH 19.4 billion in 2017. The resulting increase of is UAH 16.2 billion.

Unified tax. Based on the latest data from the Finance Ministry showing that 170,200 entrepreneurs were in the first group and 527,300 in the second, we can calculate the influence of the increase in minimum wage on unified tax payments. It equals UAH 2.6 billion.

Conclusions:

Increasing the minimum wage will increase the volume budget outlays by UAH 15.8 billion (UAH 12.97 billion on salary and UAH 2.85 billion – unified social insurance tax)

Budget inflows as a result of same total UAH 19.5 billion to UAH 23.6 billion.

The balance of payments to state budget and Pension Fund will total from UAH 3.66 billion to UAH 7.8 billion.

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