Armenia Taxes Time: A Game with Economic Growth
In recent years, Armenia’s tax system has undergone significant changes. Starting in 2018, the growth of tax revenues became one of the key performance indicators for the government. However, this approach, which initially yielded positive results, has now begun to lead to a number of problems.
As I noted in a recent interview, “The Armenian government has made tax collection a KPI (Key Performance Indicator), by which the government evaluates its performance”. In this article, we will discuss how this approach has affected Armenia’s economy and what consequences it may have in the future.
Chart 1.
Tax Revenue Trends (2018-2024)
Since 2018, Armenia’s tax revenues have recorded significant growth. According to official data, between June 2018 and June 2024, tax revenues increased from 1208.97 billion drams to 2306.05 billion drams, which represents a 90.7% growth. It should be noted that in 2020, due to the pandemic, a 6.3% decline was recorded. Despite this decline, the average annual growth for 2018-2024 was 15.7%, which is significantly higher than the 7.2% average growth for 2014-2017.
However, recent data shows that this growth rate is slowing down. In the first half of 2024, compared to the same period last year, tax revenues increased by only 6.4%. This is a significant drop compared to the double-digit growth of previous years. This trend is explained by several factors, which we will address in the next section.
Chart 2.
Analysis by Tax Types
To fully understand the overall picture of tax revenues, it is necessary to examine the dynamics of individual tax types. The third chart shows that different tax types exhibit different trends.
There has been a noticeable decline in the collection rates of indirect taxes, specifically VAT and excise tax. Despite some remaining growth, the growth rate of tax collection is decreasing. This is concerning, as indirect taxes typically reflect economic activity and consumption.
Income tax still shows an upward trend, but the growth rate has stabilized. This may indicate a slowdown in wage growth or a decrease in the rate of job creation.
The decline in profit tax indicates the main problems existing in the country, particularly capital outflow. As I have noted before, Armenia currently has a capital outflow and a reduction in inflow.
It should also be noted that the special duty on the export of copper ore applied in 2021-2022 is seen in the third chart by a sharp increase and decrease in state duty. As a result of this duty, Zangezur Copper Molybdenum Combine (ZCMC) was forced to gift 21.8 percent of its shares to the government, after which this duty was removed. Although this increased state budget revenues in the short term, it may negatively affect the development of the sector in the long term.
The significant drop in customs duties is due to specific factors, which we will discuss in the next section.
Chart 3.
The Gold Transit Factor
From November 2023 to May 2024, Armenia became the main transit country for Russian gold. According to our estimate, in the first 3 months of 2024, 88.4% of Russia’s gold exports passed through Armenia. During this period, 76% of Armenia’s total exports consisted of precious and semi-precious stones and metals.
This extraordinary situation served as a temporary stimulus for Armenia’s economy, but at the same time, it masked existing problems in other sectors of the economy. Volumes of traditional export goods have actually decreased, which is concerning from the perspective of long-term economic growth.
Chart 4.
The Government’s Tax Policy and its Consequences
The government’s approach of considering tax collection as a key performance indicator (KPI) initially yielded positive results. This method worked in 2018, 2019, and 2020, when a fairly large number of organizations came out of the shadows and began paying income tax.
But now this approach has begun to lead to unintended consequences. The government, striving to ensure continuous growth in tax revenues, resorts to introducing new types of taxes or raising the rates of existing taxes.
For example, the possibility of re-taxing the income tax returned to citizens from mortgage loans is being discussed. According to a publication by “Hetq”, “Discussions have started about considering the income tax returned to citizens from a mortgage loan as income and taxing it”.
In addition, starting in 2025, the turnover tax will increase from 5 to 10 percent, while the tax privileges granted to the IT sector are gradually being eliminated. A portion of the tax privileges provided to encourage the development of the IT sector expired in early 2024, and the other part will expire in early 2025. This approach, however, may have the opposite effect. In economics, the well-known concept of the Laffer curve shows that a continuous increase in the tax burden can lead to a decrease in tax revenues after a certain point. This can happen because high taxes may stimulate the shadow economy or reduce economic activity.
Chart 5.
Conclusion
The current tax policy is having a significant impact on Armenia’s economy. Capital outflow and reduced investments pose a major challenge to the country’s economic growth.
An analysis of Armenia’s tax system and tax collection shows that the country faces serious challenges. The approach of treating tax collection as the government’s primary performance indicator (KPI), which initially yielded positive results, has now begun to lead to undesirable consequences.
The slowdown in the growth rate of tax revenues, the decline in the collection of indirect taxes, and capital outflow indicate that the current tax policy needs to be reviewed. Introducing new tax types or raising the rates of existing taxes may provide additional revenues in the short term, but in the long term, they can hinder economic growth and the attraction of investments.
It is particularly important to pay attention to strategic sectors such as the IT industry. The elimination of tax privileges may lead to an outflow of professionals and a decline in the sector’s competitiveness.
To ensure sustainable economic growth in the future, it is necessary to develop a more balanced tax policy. It should be aimed not only at increasing tax revenues but also at improving the business environment, encouraging investments, and diversifying the economy.
External factors must also be taken into account, such as the transit of capital and later also gold from Russia, which temporarily improved economic indicators. However, such external factors should not distract attention from the need for long-term sustainable development.
Finally, it is important to continue monitoring the effectiveness of the tax system and flexibly responding to changing economic situations. Only in this way will Armenia be able to overcome current challenges and ensure long-term economic growth and prosperity.