PRESIDENT KOCHARIAN: 2005 TO BE THE YEAR OF TAX AND

UNCLAS SECTION 01 OF 02 YEREVAN 000052

SIPDIS

SENSITIVE

DEPT FOR EUR/CACEN, EUR/ACE

E.O. 12958: N/A
TAGS: ENRG KNNP ECON AM
SUBJECT: PRESIDENT KOCHARIAN: 2005 TO BE THE YEAR OF TAX AND
CUSTOMS REFORMS

Ref: 04 YEREVAN 1899


1. SENSITIVE BUT UNCLASSIFIED. PLEASE PROTECT ACCORDINGLY.
NOT FOR INTERNET DISTRIBUTION.

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SUMMARY
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2. (SBU) Armenia's President Robert Kocharian has publicly
said that 2005 will be a year of reform for the customs and
tax services in Armenia. Besides increasing tax revenues,
Kocharian called on the revenue services to "act legally"
and not to create "privileged conditions for anybody." In
these words Kocharian acknowledged the dominant concern of
the Armenian economy and perhaps the heaviest burden on
small and medium enterprise development. Armenia's revenue
services systematically either fail to tax or undertax
Armenia's oligarchs, and systematically overtax medium-sized
and foreign firms to compensate. Besides limiting tax
revenues, this has created virtual monopolies for favored
oligarchs in various basic sectors where competition should
be stronger. Reform of the revenue services will damage
entrenched interests of powerful people, and will require
political will at the highest levels of Armenian government.
End Summary.

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KOCHARIAN SAYING THE RIGHT THINGS
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3. (SBU) In his January 11 address to the State Customs
Committee, Kocharian clearly laid out the problem of
corruption in the revenue services, echoing what the
international business community, the International Monetary
Fund and we have been saying for years. Along with
addressing the longer-term task of increasing revenue,
Kocharian acknowledged corruption and nepotism in the
customs service, and said that it must change to treat all
businesses "equally and fairly." "I am sure that if you
start from yourself, from taxing your friends and relatives,
you will not let others escape taxation either," Kocharian
said, according to his own press office web site, "We cannot
forbid your friends from doing business. We encourage free
enterprise. What we don't encourage is the creation of
privileged conditions for anybody." Kocharian made a
similar address to the tax service officials the next day,
saying, "There are enterprises which have not been inspected
for years and those which are inspected several times every
year."

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TAX AND CUSTOMS: TOOLS OF THE OLIGARCHS
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4. (SBU) The tax and customs services have long been tools
of the oligarchs. Rather than following Armenian law and
WTO procedures on customs valuation, the customs service has
used different valuations for different importers, often
resulting in a laughably low tariff burden for favored
importers and a prohibitively high tariff burden for new
market entrants (reftel). The result has been virtual
monopolies on the import of several basic goods such as
wheat, sugar, tobacco, salt, beer, gasoline, for which there
is no economic justification for a natural monopoly or lack
of competition.


5. (SBU) Similarly, the tax service has failed to enforce
tax provision against some of Armenia's largest businesses.
Kotayk Beer, owned by Armenia's most ostentatious oligarch
and Deputy of Parliament Gagik Tsarukian (aka Dodi Gago) is
indisputably Armenia's largest beer company. Nevertheless,
it does not appear on the list of Armenia's large taxpayers
despite the fact that Kilikia, its weaker competitor is one
of the top ten taxpayers. Small and medium-sized
enterprises, on the other hand, complain of overtaxation.
Members of the Yerevan American Chamber of Commerce complain
of harassing and unjustifiable tax inspections, illegal
demands for prepayment of tax liability, and the failure of
the Armenian government to refund tax overpayments for
several years.

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CONSTANT PRESSURE OF INTERNATIONAL COMMUNITY
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6. (SBU) Corruption in the tax and customs services has come
under increasing pressure from the international donor
community in the past two years. The American Chamber of
Commerce has raised it to the Prime Minister, the chair of
the High Business Council. The IMF has made tax and customs
reforms conditionalities in its reviews of Armenia's PRGF
arrangement, and we have raised concerns about tax and
customs consistently at the US-Armenia Task Force (USATF).

7. (SBU) Speaking about the possibility of a new Poverty
Reduction and Growth Facility (PRGF) arrangement, IMF
resident representative James McHugh told us that the
government has completed all the reforms that are
politically easy to complete. (Note: The last tranche of
the last PRGF arrangement was disbursed in November 2004.
End Note.) "The question we are asking them now is," said
McHugh, "are they willing to tax rich people." The
international community has constantly emphasized the need
for reform of the tax and customs administration in order to
create a competitive business environment and to increase
overall tax revenues, which is necessary to meet the social
demands called for in Armenia's Poverty Reduction Strategy
Paper. (Note: At 15 percent of GDP, Armenia's tax base is
the lowest in the CIS. End Note.)


8. (SBU) In a November letter to the IMF asking for a follow-
on PRGF arrangement, the Minister of Finance and the Prime
Minister promised reforms of the two revenue services,
specifically promising to bring them under the control of
the Minister of Finance. To move revenue collection and
expenditure under the same roof could be a boon for the
Armenian economy, but it will take the support of Armenia's
highest officials to effect.

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COMMENT: EASIER SAID THAN DONE
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9. (SBU) We welcome President Kocharian's comments about
reforms in the tax and customs service, but are skeptical of
the President's will and, even, ability to push them
through. Reform of these two agencies will require breaking
down entrenched interests in nepotism and corruption, and
replacing powerful officials who have close ties to the
President and Minister of Defense. Although some GOAM
officials recognize the need for reform, we don't think that
they have the power to change the leadership or practices of
the powerful revenue services. In the past, our demands
(and those of other donors) for reforms in the revenue
services have been received positively by the Minister of
Finance, but shrugged off by the heads of tax and customs.
At the May 2004 USATF in Yerevan, the point about illegal
customs valuation created a publicly awkward moment between
Armenia's Minister of Finance and General Avetissian, the
Head of the Customs Service, where the General suggested
that he does not report to the Minister. Now that Kocharian
has stated the problem and the direction of reform, what
progress he makes will be a test of Armenia's political will
to move from familiar ways of nepotism and corruption to a
true market economy.
EVANS