Military personal income tax withheld: how will frontline communities survive?

On November 8, the Verkhovna Rada, Ukraine's parliament, passed amendments to the Budget Code of Ukraine with the aim of "ensuring support for the state's defense capability and the development of the defense industry of Ukraine." The amendment directs the personal income tax paid on military salaries, previously allocated to local and regional budgets, to the state budget for the procurement of drones and artillery systems. The financial impact is substantial, with nearly 26 billion hryvnias earmarked for the remainder of this year and around 94 billion projected for the next year. However, concerns arise about the impact of this reallocation on local budgets, as the amendment treats both relatively secure cities in the west and frontline communities—where military income tax and public sector salaries are crucial—as equals.

The text covers the following topics:

• Military personal income tax as a gold mine
• Dnipro city alone lost UAH 4 billion due to changes
• Communities can no longer eliminate the consequences of strikes quickly 
• Does the law comply with the Constitution

Military personal income tax as a gold mine

Personal income tax is the main source of local budget revenues. This includes employee salaries and salaries for the military and security forces. Since the start of the full-scale invasion, the number of military personnel has increased significantly, and so has the personal income tax on their salaries. However, community expenditures have also surged. For instance, during the heating season, in the face of power outages, communities have to purchase tons of fuel for generators and the generators themselves.

At the same time, the government's draft law stipulates that the military personal income tax withdrawn from communities this year will be used to purchase drones and artillery systems (approximately UAH 13 billion each).

Next year, 45% will be allocated to the State Special Communications Service for drones, another 45% to the Ministry of Strategic Industry for the deployment of ammunition and weapons production, and 10% to the security and defense sector managers for automatic distribution among military units.

"The Parliament has effectively deprived local authorities of the opportunity to help the Ukrainian Armed Forces and direct funds from municipal budgets to our defenders," said Kyiv Mayor Vitali Klitschko. "By taking away military personal income tax from cities and towns (and retroactively), the Verkhovna Rada and the government are demonstrating that the central government has failed to finance the army. And now it is trying to shift this onto local governments. This is despite the fact that all cities already pay 40% of their communities' personal income tax to the state budget. And Kyiv pays 60%. And all cities also additionally allocate funds from community budgets to help the defenders." 

According to him, this decision will especially hit small towns and cities where military personal income tax used to be a significant part of the budget. 

For instance, in the Yavoriv community with a population of 52,000, the council's military personal income tax revenues as of November 1 totaled approximately UAH 1 billion. Simultaneously, this year, the community budget allocates 374 million for a subvention to the state budget, catering to military units' logistical support upon their request. An additional 365.4 million from the Yavoriv budget is being redirected to the state budget as a reverse subsidy.

Dnipro city alone lost 4 billion due to changes

Many representatives of local communities call the pickets outside local councils with the slogans "first drones, then stadiums" a "long-shot game" played by the authorities. Of course, it wouldn't have gained traction if certain local councils, upon obtaining access to resources, hadn't started spending them on, to put it mildly, inappropriate purchases during the war—such as expensive sports complexes, ski roller tracks, etc. 

“In fact, the problem with non-critical procurement could have been easily addressed by simply regulating what money can and cannot be spent on during martial law. But they didn't even try to do this," says Nina Yuzhanina, a member of the Verkhovna Rada, in a comment to Espreso. "We witnessed how the situation in society was escalating. For instance, the protests against the spending of billions by Dnipro city, allegedly in areas deemed less essential. Maybe they are. But there needs to be regulation. Yet, you can't strip away all military personal income taxes from Dnipro — it struggles from constant strikes: in the city center, on the outskirts, in satellite cities. It's just a ruin there."

Meanwhile, Dnipro Mayor Borys Filatov said that UAH 4 billion were taken away from Dnipro alone.

I take off my hat to our parliamentarians and government officials who have played such a technical trick on local self-government. So, dear colleagues, you have now received an insanely large amount of money. I hope you will manage not only to spend them rationally for the needs of the Ukrainian Defense Forces. But also openly report to the public on the effectiveness of these expenditures," Filatov wrote, calling the activists who protested against non-critical procurement "useful idiots." 

According to Yuzhanina, there was an appeal from the head of the Kharkiv City Council and deputies from the frontline regions, who explained that the funds were being used to build fortifications.

"They've initiated the reconstruction of fortifications, focusing on reinforcing the third line of defense due to the acknowledged potential risks. However, as they engage in these efforts, their resources are being taken away from them. How do you feel about this? I have different opinions on this," says the MP. "If we say that we lack 25.8 billion by the end of this year to buy shells and other needs, then let's find it now, let's find it very quickly. Even based on the 45 billion we have in receivables from the Ministry of Defense. I agree that other items of expenditure should be reviewed, even our salaries should be cut if necessary, but it is unacceptable to take away a source of income from frontline communities."

Communities can no longer eliminate the consequences of strikes quickly 

"We understand that there is a large budget deficit: this year we do not have enough money to buy shells, as the authorities say, not enough to restore or build the defense complex. But since September, when this government bill was submitted, we had to hear from the frontline regions. There, local communities spend not only 100% of this tax, which is paid by distribution to the local budget. They spend more than this," says MP Nina Yuzhanina, "There are a lot of problems on the ground that they solve without waiting for any subventions from the state budget. Upon arrival, local authorities find opportunities to respond as quickly as possible and provide people with some kind of temporary housing."

At the same time, it is the communities where military facilities are located that are more often subject to enemy missile attacks. Russia regularly attacks Starokostiantyniv, Khmelnytsky region, with missiles and drones, and civilian facilities are being damaged. 

"For frontline communities, on the border with Russia, in the area of active hostilities, military personal income tax was the main income, and the basic subsidy for 2021 does not provide compensation for revenues and, most importantly, the funds necessary to maintain infrastructure and social programs," Oksana Prodan, Advisor to the Head of the Association of Ukrainian Cities, told Espreso. "There are communities that will have a budget deficit of up to 40% next year due to the withdrawal of military personal income tax. And these are the ones that need to be rebuilt and restored, because they have suffered the greatest destruction due to shelling. And they continue to be shelled."

Is it possible to challenge the bill in the Constitutional Court?

Although the parliament passed the draft law on the redistribution of military personal income tax on November 8, the money should be withdrawn from local budgets from October 1 until the end of martial law. That is, retroactively, which is legislative nonsense.

"The withdrawal took place "retroactively", and therefore with violations. Moreover, such changes not just in the middle of the budget year, but in the last quarter is also a violation. No proper compensation was provided to the communities for which this will be critical in 2024," says Oksana Prodan.

Meanwhile, Nina Yuzhanina believes that if the law stipulates that the withdrawal should take place on October 1, it means that the Treasury has been withholding these funds since October and not transferring them to the communities.

"I am surprised that the law was adopted retroactively to transfer personal income tax to the special fund of the state budget as early as October 1. This means that since October 1, the Treasury has already delayed these transfers. "It's already November, so at least two transactions have been delayed," says the MP. "I heard that lawyers were quietly talking about the fact that this is a reason to file a lawsuit with the Constitutional Court for non-compliance with the law. But it seems to me that everything will now be covered by martial law and extreme necessity."