VAT as It Is

Value-added tax is perhaps one of the most complex types of tax in Ukraine. Tax credits, different rates, requirements for mandatory registration as a VAT payer and the possibility of becoming one voluntarily, invoices and adjustment calculations—it is quite difficult to understand all the nuances, especially without knowledge or experience working with this tax.

At the same time, however, value-added tax is one of the taxes that brings in the most revenue for the budget. Thus, according to information from Lesia Karnaukh, Acting Head of the State Tax Service, a total of UAH 1 trillion 246 billion was received by the budget during 2025.

Almost UAH 363 billion came from personal income tax, while value-added tax ranked second, generating more than UAH 306 billion in revenue (including budgetary reimbursement).

What is VAT in simple terms

The Tax Code of Ukraine (hereinafter referred to as the Tax Code) states that value-added tax is an indirect tax calculated and paid in accordance with the provisions of Section V of the Code. This section contains all the key rules and requirements, but does not provide an exact definition of the term. Therefore, we will try to explain what VAT is in simple terms.

VAT is an indirect tax paid by purchasers of goods and recipients of services or works, but the obligation to assess and administer it rests with the seller of the goods or the provider of the services. In other words, an individual entrepreneur or LLC that sells products, performs certain works, or provides services acts as the client's tax agent—a kind of intermediary between the taxpayer and the budget.

Thus, VAT is a tax already included in the price of goods and services. When a business sells something to a client, it adds VAT to the cost—but in fact, this tax is paid by the final consumer. As an intermediary between the buyer and the state, the individual entrepreneur or LLC receives VAT as part of the payment and transfers it to the budget. This is why VAT is called an indirect tax—it is not paid separately but is included in the price.

We can say that VAT is a tax that is paid by the final consumer through Ukrainian entrepreneurs and businesses (individual entrepreneurs, LLCs, or entrepreneurs).

The role of VAT in the economy

VAT plays a key role in macroeconomics, serving as the main and most reliable source of government revenue in most countries around the world. This tax is effective for the state, while for businesses and citizens it is an important regulator of demand and production.

The main functions and role of VAT in the economic system are outlined below:

📊 1. Fiscal role (Generating budget revenue)

• Main source of revenue: VAT provides from 20% to 40% of all tax revenue to the state budget (depending on the country).
• Stability of revenue: Unlike corporate income tax, VAT flows into the treasury continuously, even when a business is operating at a loss or the economy is experiencing a downturn. People cannot stop consuming goods and services altogether.
• Difficulty of evasion: Thanks to the chain of credits (where each participant monitors their supplier), VAT is more difficult to conceal than direct taxes.

💡 2. Regulatory and social role

• Reducing inequality: Through differentiated rates, the state regulates the affordability of goods. VAT rates on socially important products (bread, milk, children's goods, and medicines) are reduced (for example, to 10% or 0%), while rates on luxury goods and alcohol are increased or supplemented with excise duties.
• Support for exports: A rate of 0% VAT applies when goods are exported abroad, while the tax previously paid is refunded to the company from the budget. This makes domestic goods more competitive on the global market.

🔎 3. Control role (Combating the “shadow” economy)

• Mutual business oversight: To receive a tax deduction (reduce its VAT), a company must require official documents and receipts from its supplier. Thus, businesses themselves are forced to monitor the legality of their counterparties, bringing the economy out of the shadows.

⚠️ Negative aspects of VAT for the economy

Despite its advantages, VAT has two significant economic problems:

1. Regressive nature: The tax hits lower-income groups harder. A person with a low income spends nearly all their money on basic goods, and therefore pays a larger percentage of their personal budget in VAT than a wealthy person.
2. Pro-inflationary factor: Any increase in the VAT rate by the government is automatically and immediately factored into the final price of goods, causing inflation to rise.

Impact of the requirements on the economy

Fulfilling the requirements of the IMF and the European Union to reform and potentially increase VAT is one of the most difficult compromises for Ukraine. On the one hand, it is a mandatory condition for receiving multibillion-dollar financing tranches; on the other, it is a severe test for a wartime economy. [1, 2, 3]

Under the agreements and ongoing reforms (including bills introducing VAT on parcels worth up to €150, plans for a temporary increase in the rate to 21% to fund insurance against military risks, as well as harmonizing the rules for individual entrepreneurs by 2028), the reform’s impact will be divided into two opposing stages. [1, 2, 3, 4]

⏱️ Short-term outlook (1–3 years): Shock impact

In the first months and years after the changes are introduced, the economy will face negative side effects that the government is deliberately incorporating into its forecasts:

• Inflation spike and rising prices: Since VAT is an indirect tax, any expansion of its scope or increase in the rate (for example, on international parcels or an overall increase to 21%) is automatically factored into the final cost of goods on store shelves. This will accelerate price increases for basic goods and imports. [1, 2, 3]
• Declining purchasing power: Against the backdrop of inflation and a prolonged war, the population’s real incomes will decline. Citizens with low incomes will suffer the most, as they spend a larger share of their budget on current consumption.
• Impact on small businesses and IT: The IMF requirement to oblige some individual entrepreneurs (especially those in Group 3 with a turnover exceeding UAH 1 million) to register as VAT payers will increase their tax burden. This may temporarily reduce the profitability of small businesses and prompt some entrepreneurs to move into the “shadow economy” or shut down small online stores. [1, 2, 3]
• Positive shock — budget stability: The main advantage will be felt immediately — the state treasury will receive billions of hryvnias in critically needed domestic revenue. This will allow Ukraine to finance the army and social obligations without delay. [1]

🌐 Long-term outlook (3–5 years and beyond): Macrostability and integration

If the short-term shock is overcome, the reform will lay the foundation for recovery in the long term:

• Guarantee of Western support: The main economic effect is preserving access to the EU’s macro-financial assistance programs (the Ukraine Facility program) and IMF tranches. Without this money, the country’s economic stability is fundamentally impossible.
• European integration and a level playing field: Bringing Ukraine’s Tax Code into line with EU directives (including VAT rules) is a mandatory step toward full accession to the European Union. This will eliminate schemes involving the artificial “fragmentation” of large businesses into dozens of individual entrepreneurs to evade taxes, leveling the competitive environment.
• Reducing dependence on loans: By expanding the tax base and bringing the shadow economy into the open, Ukraine will be able to cover a larger share of its budget expenditures itself, reducing the risks of a debt crisis in the postwar period.
• Investment through risk insurance: If the Economy Ministry’s initiative to temporarily increase VAT by 1% to fill a military-risk insurance fund is implemented, it will make it possible to attract up to $2–3 billion in co-financing from donors. In the long term, this will bring major foreign investors back to the country, as they are currently afraid to invest because of the risk of destruction. [1, 2, 3, 4, 5, 6, 7, 8, 9]

Conclusion

For Ukraine’s economy, an increase in VAT is a “bitter medicine”. In the short term, it will slow economic recovery, accelerate inflation, and make life more difficult for retailers and individual entrepreneurs. However, in the long term, this step is unavoidable: it keeps the country from default, guarantees support from its allies, and opens the doors to the EU. [1, 2, 3, 4]

Alternatives to increasing VAT that would reduce the payment burden on the poor and increase it on the wealthy

There are effective alternatives and modifications to the tax system in global economic practice that make it possible to shift the fiscal burden from low-income groups to more affluent citizens. In economics, this approach is called progressive taxation.

Since VAT is regressive by nature (the poor pay a larger percentage of their income in this tax than the rich), governments use the following instruments to achieve social justice:

📈 1. Introducing a progressive personal income tax scale (Personal Income Tax)

Instead of a flat scale (where both a teacher and a top manager pay, for example, the same 18%), a flexible system is introduced:

• How it works: The higher a person’s annual income, the higher the tax rate on the portion of income exceeding the established limit.
• Example in the EU: In Germany or France, the rate for exceptionally high incomes can reach 45%, while minimum incomes are subject to almost no tax.

🌟 2. Differentiating VAT rates themselves

Rather than raising the basic VAT rate for everyone, the state can divide it by categories of goods:

• For the poor: Establishing a zero (0%) or super-reduced (2–5%) VAT rate on socially important goods (basic food products, medicines, children’s goods, utilities).
• For the wealthy: Introducing an increased VAT rate (Luxury Tax) or high excise duties on luxury goods (yachts, sports cars, luxury real estate, jewelry, expensive designer goods).

🏡 3. Tax on wealth and luxury property (Wealth Tax)

A direct tax on the net value of assets exceeding a certain high threshold.

• How it works: The tax is imposed not on the purchase of goods (as with VAT) or current earnings (as with personal income tax), but on accumulated capital—ownership of several expensive real estate properties, shares worth large sums, or luxury cars.
• Effect: This affects only major capital owners, without affecting low-income people at all.

📊 4. Windfall tax on corporations (Windfall Tax)

An additional extraction of income from companies that earned abnormally high profits due to external factors (for example, energy giants during a rise in commodity prices or banks due to high policy rates).

• Effect: It allows the budget to be replenished at the expense of large businesses without passing the burden on to the end consumer through prices.

⚠️ Why are these alternatives difficult to implement in Ukraine right now?

Although the IMF and the EU support the principles of social justice, under Ukraine’s current circumstances they insist specifically on expanding VAT and excise duties for several reasons:

1. Ease and speed of administration: VAT is administered automatically through electronic systems. A wealth tax or progressive personal income tax requires complex oversight, well-developed declaration systems, and transparent courts, which are more difficult to achieve in a country at war.
2. Risk of capital flight: If taxes on the income of wealthy citizens or large businesses are sharply increased, under wartime conditions this could trigger a mass exodus of the remaining capital from the country or its complete transition into the “shadow” economy.

Pros and cons

If we rely on the official results of Ukraine’s state budget execution, then total VAT collections consist of two key parts: UAH 306.5 billion came from domestic VAT (goods produced in Ukraine, taking refunds into account), while another UAH 542.4 billion was provided by VAT on imports. In total, the entire VAT base amounts to approximately UAH 848.9 billion. [1, 2, 3]

Below is a rough economic estimate (modeling) of both scenarios, taking all limiting factors into account.

📊 Scenario 1: Increasing the basic VAT rate by 1% (from 20% to 21%)

A basic mathematical calculation shows that a 1-percentage-point rate increase (a 5% increase in the burden) should generate: (848.9 × 0.05 = UAH 42.45 billion). However, the actual net effect will be significantly lower due to the “limiting” factors.

Impact factor. Economic effect / Estimated losses

📉 Decline in purchasing power

The tax increase is incorporated into prices. Consumption of basic (non-preferential) goods falls by 1.5–2%. Budget losses: ~UAH 6–8 billion.

📈 Inflationary pressure

Rising prices devalue the hryvnia itself. Nominally, collections will increase, but in real terms (the budget’s purchasing power), the effect is diluted by ~UAH 3–4 billion.

🤝 Subsidizing the impoverished

It will be necessary to expand subsidy programs for utility services and basic assistance. The government will be forced to return approximately ~UAH 2–3 billion from the new collections to vulnerable groups.

🥷 Moving into the “shadow” economy

Some small retailers and smugglers will become more active in order to avoid paying the extra percentage point. Losses: ~UAH 2 billion.

➡️ The actual net result of raising VAT by 1%: Ukraine will receive approximately UAH 30–32 billion in actual funds. The main advantage for the Ministry of Finance is that this money will reliably begin flowing into accounts as early as the month after the law is adopted, since VAT administration is fully automated. [1]

📈 Scenario 2: Introducing a progressive tax (personal income tax on the wealthy)

Basis for comparison: in 2025, personal income tax together with the military levy brought the budget UAH 362.9 billion (with a flat personal income tax rate of 18%). At the same time, citizens officially declared approximately UAH 299 billion in additional payments. [1, 2, 3]

If a progressive scale is introduced (for example, maintaining an 18% rate for incomes of up to UAH 30,000, but raising the rate to 25–30% for the top 10% of citizens with high official salaries):

• Nominal calculation: A higher rate on excess income could generate on paper up to UAH 50–60 billion.
• Realistic calculation taking the Ukrainian context into account: Wealthy people and top management in Ukraine have a high degree of flexibility. In response to a sharp increase in personal income tax, big business would begin massively transferring top managers’ salaries to the “minimum wage” + payments through individual entrepreneurs (where the tax is fixed), or bring back the practice of “envelopes.”
• Administrative costs: The tax service would need enormous resources and years to reform the universal declaration system, search for hidden assets, and combat tax-optimization schemes.

➡️ The real net result of a progressive tax: In the short term (1–2 years), because of evasion and optimization, the budget would receive no more than UAH 15–20 billion. In the long term (3–5 years), provided that loopholes involving individual entrepreneurs are eliminated and the labor market is brought out of the shadows, this measure could generate a stable UAH 40–45 billion per year, completely removing the burden from low-income people.

💡 Summary of the economic compromise

For a country at war, an increase in VAT is a bad but guaranteed and immediate way to plug the budget hole here and now (since the tax is collected on every purchase, including critical imports). Progressive taxation is more socially just, but under current Ukrainian realities it cannot provide quick money because of the deep shadowing of high incomes. [1, 2, 3]

Conclusion

“Wealthy people and top management in Ukraine have a high degree of flexibility. In response to a sharp increase in personal income tax, big business would begin massively transferring top managers’ salaries to the ‘minimum wage’ + payments through individual entrepreneurs (where the tax is fixed), or bring back the practice of ‘envelopes.’” — if these are the people for whom the Defense Forces are fighting and both military personnel and civilians are dying, is this war worth continuing?

Raising VAT to 30% and introducing progressive taxation is the only real path to achieving Ukraine’s genuine economic sovereignty and agency.

If we model a hypothetical situation in which VAT is raised to an extreme 30% (the basic rate is currently 20%, while the Cabinet of Ministers is cautiously including an increase of just 1%, to 21%, in the draft budget for 2027), but a progressive tax scale is introduced at the same time, and wealthy citizens demonstrate 100% honesty (they do not hide income and pay everything in full), the economy would gain a unique combination of significant strengths and serious risks. [1, 2]

Below is a balance of the pros and cons for this idealized model.

⏱️ Short-term perspective (1–2 years)Pros:

• 🚀 Astronomical budget surplus: The combination of 30% VAT (which is collected on all consumption and imports) and honest high taxes on the wealthy would immediately flood the budget with money. The state would be able to fully and without delay finance the army, weapons purchases, and social programs, and launch large-scale reconstruction funds. [1, 2]
• 🤝 Maximum social protection (thanks to the honesty of the wealthy): Since affluent citizens pay their taxes honestly, the treasury would receive enormous resources to pay subsidies, benefits, and compensation to low-income people. This would partially offset the regressive impact of VAT.

Cons:

• 🔥 Inflationary explosion: 30% VAT would instantly raise prices for absolutely all goods and services by approximately 8–10% above the current level of inflation. Prices on store shelves would become shocking.
• 📉 Paralysis of consumer demand: Even taking subsidies into account, the middle class and poorer segments of the population would sharply reduce their purchases. People would switch to strict austerity, buying only bread, medicines, and utilities. This would lead to a decline in retail turnover.
• 📦 Cash-flow gap for businesses: Businesses would need enormous working capital simply to pay output VAT until the goods were sold to the end consumer.

🌐 Long-term perspective (3–5 years and beyond)

In the long term, this model will radically restructure the economy, giving rise to deep systemic contradictions.

Pros:

• 🦾 The state’s financial independence: Ukraine will be able to completely abandon external IMF loans and EU macrofinancial assistance to cover the budget deficit. The country will fully provide for itself using domestic resources.
• 🏗️ An economic miracle through state investment: With an enormous budget, the state itself will be able to become the main investor: building factories and roads, funding science and the defense industry, and compensating war-affected businesses for their losses through special funds.
• 🕊️ Ideal social equality: Progressive taxation under conditions of honesty will narrow the gap between the rich and the poor. The Gini coefficient (a measure of inequality) will fall sharply. [1, 2, 3]

Cons:

• 🛑 Suffocation of private business and investment: A 30% VAT makes domestic production uncompetitive compared with imports from countries with low VAT rates (the average VAT rate in the EU is 21–22%). Foreign investors will not want to open factories in Ukraine, since selling products on the domestic market will be economically unviable.
• 💸 Capital and brain drain (even with a high level of civic consciousness): Patriotism and civic consciousness have their limits when economic survival is at stake. Faced with higher prices inside Ukraine due to VAT, while progressive taxation takes a significant portion of their income, wealthy people and highly qualified specialists (for example, those in the IT sector and top management) will begin to physically change their tax residency. They will leave for countries with a more favorable climate for capital (for example, the UAE, Cyprus, or Poland).
• 👻 The risk of a “black market” and smuggling: The profitability of illegal business will become too high. If the difference between the price of a product with VAT and without it is 30%, smuggling electronics, clothing, and even fuel will become extraordinarily profitable. The state will have to turn into a harsh police authority in order to maintain control over the circulation of goods. [1, 2]

⚖️ Result

Even with the wealthy acting with perfect honesty, a 30% VAT rate is a toxic dose for a market economy. This balance will turn Ukraine into a state with elements of “Scandinavian socialism,” but under conditions of war and destruction, this could lead to stagnation in the private sector. The economy will become completely dependent on government contracts and subsidies, losing the flexibility of a free market.

Proper measures

Avoiding explosive inflation when VAT is raised to an extreme 30% cannot be achieved directly through an artificial “reduction in added value”—added value (workers’ wages, depreciation, and business profit) will already be under enormous pressure from market forces. [1]

However, in order to compensate for the 10% tax shock and keep prices from surging explosively, businesses and the state will have to resort to a forced reduction in trade margins, cost optimization, and fiscal maneuvers.

In economic modeling, to keep inflation within manageable limits (up to +3–5% instead of the baseline +10%), retail prices must be adjusted. This can be done with minimal harm to producers in the following ways:

1. Reducing retail and distribution net profit by 4–5%

The main burden should be borne not by the production sector (producers are already operating on the edge of profitability), but by the trade and logistics sectors.

• How it works: Large retail chains can use their scale to reduce their internal markup (margin) from an assumed 25–30% to 20–21%.
• Effect on inflation: This will make it possible to compensate for approximately half of the tax shock (about 4–5% of the final price), without forcing the factory to reduce its selling price below cost.

2. Reducing production costs by 3–4% through energy efficiency

For a producer to be able to sell goods more cheaply without jeopardizing its survival, the state must subsidize or temporarily exempt from duties technologies that reduce fixed costs.

• How it works: The introduction of distributed generation, automation of production lines, and a switch to cheaper local raw materials.
• Effect on inflation: Makes it possible to reduce the base price of the product (before VAT is charged) by 3–4%, which partially absorbs the 30% tax rate.

3. Government regulation: VAT differentiation

Instead of strangling producers by demanding that they lower prices, the state must apply a “soft maneuver”—introduce a zero (0%) or preferential (5–7%) VAT rate on raw materials and critical components for strategic industries. [1, 2]

• How it works: The producer pays no VAT when purchasing metal, grain, flour, or equipment, thereby building up a huge “input tax credit.” At the end, even with a nominal 30% VAT on the shelf, the base price of the product will be so low that the final consumer will not feel a sharp jump. [1]
• Effect on inflation: Completely eliminates the cumulative (cascading) effect of the tax in the production chain, keeping inflation for socially important goods within 1.5–2%. [1]

📉 The point of critical harm to the producer

Mathematically, if VAT is raised to 30%, a producer will be able, without jeopardizing its existence, to give up no more than 2–3% of its net operating profit in price. Any forced price reduction beyond this limit (of 5% or more) will lead to:

1. Freezing and cutting workers’ wages (a social crisis).
2. A complete halt to investment in modernizing factories.
3. Mass bankruptcy among medium-sized enterprises and market monopolization by the surviving giants.

Summary

To prevent 30% VAT from causing an inflationary collapse, the 10% delta must be divided three ways: ~4% is taken on by large retailers through margin cuts, ~3% is offset by the producer through reduced operating costs, and the remaining ~3% is taken on by the state through targeted benefits on raw materials for businesses. [1]

In any case—there is a war for Ukraine’s survival; the Ukraine of the past must change radically; the economy remains civilian, not military; and it is foolish to hope for endless assistance from partners if we ourselves are not ready to change for our own sake.