Why there is still no regulatory competition in the Eurasian Economic Union

Evgeny Vinokurov

Director of EDB’s Centre for Integration Studies

When the Customs Union between Russia, Kazakhstan and Belarus emerged in 2011-2012 there were serious hopes and concerns (depending on the point of view) as to the evolvement of competing jurisdictions. Experts talked about thousands of small and medium-sized companies that would move, for example, from Russia to Kazakhstan to enjoy lower taxes. There were grounds to believe that this would work. The countries’ foreign policies were unified very quickly. Technical, sanitary and other regulations within the Eurasian Economic Union (EAEU) are also being gradually harmonised. However, financial, tax and administrative issues continue to be governed by national legislations.

It is believed that regulatory competition induces governments to lift administrative barriers. If these are not removed in a country, businesses will flow to another one. This is an advantage of regulatory competition. It is also believed that direct participants in and beneficiaries of regulatory competition should be small and medium-sized businesses, as well as international players. They are usually those who vote with their feet. As a result, the country businesses move from has a loss in fiscal revenues while the beneficiary country enjoys a boost of business activity and increases in fiscal income.

The Customs Union that has zeroed customs duties and introduced a single external customs tariff has been on the stage for six years. Armenia and the Kyrgyz Republic joined it in 2015 after accession to the Eurasian Economic Union. If to compare tax burdens in, for example, Russia and Kazakhstan, we see a significant difference of 47% and 24% of commercial profits, respectively (according to the World Bank). The VAT rate, which is of key importance to businesses, is also higher: 18% in Russia vs. 12% in Kazakhstan.

However, here is where theory ends and practice begins. Despite the considerable difference between the tax burdens in the EAEU countries, there has been no significant flow of businesses between them. Mutual investments in the EAEU are substantial. Russia, for example, has accumulated US $7.1 billion of FDI in Kazakhstan (according to EDB). However, there was no extensive movement of companies between the jurisdictions.

Why hasn’t it happened over the six years of the Customs Union’s existence?

First, the public sector’s share of GDP in the EAEU countries is very high. This is the main reason. In Russia, the public sector’s share raised from 35% to 70% of GDP in 2005-2015 (as estimated by the Federal Antimonopoly Service). In Kazakhstan it approximates 60%. In Belarus the figure is 70-75%, according to the European Bank for Reconstruction and Development. The world’s average is 30-40%. Apparently, state-owned businesses would not change jurisdiction because they are public. Therefore, if to deduct large and micro businesses that have strong geographical anchorage from the remaining 30%, the share of potentially mobile small and medium-sized enterprises will be below 10%.

Second, the EAEU countries protect their markets with non-tariff barriers. These have been the key problem of Eurasian integration since the establishment of the Customs Union. The Eurasian Economic Commission and respective ministries and institutions are working systematically to improve this, as confirmed by the White Book on 60 barriers that was published in April. In fact, there are more of them and none of the countries is an exception. Belarus, for example, offers a lower VAT rate for some goods in its territory. However, this rate does not apply to similar goods made in other EAEU countries. In Kazakhstan, the rules of a single construction market won’t apply until 2025.

Third, private companies focus, to a significant extent, on working with the government and state-owned companies. Public procurement in the EAEU countries is huge, reaching some US $270 billion. At the same time, their cumulative exports approximate US $300 billion a year. Although the common public procurement market exists in the EAEU already (the Russian market is, of course, of greatest interest to companies), the opportunities for effective work in it are limited, especially for small and medium-sized businesses, because there is no mutual recognition of electronic digital signatures and for other reasons.

So, there won’t be any regulatory competition in the EAEU in the near future. For the countries that can become potential “magnets” for businesses this is a disadvantage. For the potential “donors” it is an advantage since they don’t lose their taxation base. For the EAEU overall, it is also a disadvantage: greater mobility of businesses and capital would improve the effectiveness of the union and stimulate the countries to compete for businesses and improve their investment climates.