Ukraine’s parliament voted to approve a tax hike for the first time since the full-scale war broke out, turning to a politically unpopular move as the country continually struggles to find new sources of funding for its growing wartime budget.

The bill passed in parliament as part of a plan to fund a newly approved Hr 500 billion ($12 billion) defense spending increase for the year.

The country is facing a $35 billion budget deficit next year, and as Russia’s war continues in its third year with no end in sight, the country needs to find funding to keep its economy afloat and finance its war effort.

“(Raising taxes) was put off to the last possible moment, when it really became obvious that if we do not collect this money, we will not have money to pay salaries to service people,” Yuri Gaidai, senior economist at the Kyiv-based Center for Economic Strategy (CES), told the Kyiv Independent.

“There aren’t many similar situations in history when a country in a war of such scale doesn't raise taxes,” he said, “but there is an unwillingness (in the government) to make unpopular decisions.” The tax hike will fund around Hr 60.2 billion ($1.45 billion) in 2024 and Hr 122 billion ($2.94 billion) in 2025, according to the Finance Ministry.

The majority of the $12 billion defense budget increase will be financed through issuing domestic government bonds and reduced expenses from refinancing existing state debt. The tax law still needs to pass a second reading, which is not expected until next month, and then it will need to be signed by the president.

“The Government of Ukraine has already exhausted all possibilities to quickly meet the additional needs of the military state budget without revising taxes,” the Finance Ministry told the Kyiv Independent in a statement.

“The Finance Minister and his deputies held dozens of meetings with representatives of leading Ukrainian economic and financial organizations, as well as analytical centers and associations from various sectors of the economy. All the participants in the discussions expressed their understanding of the importance and necessity of the prompt search for resources to meet the additional needs of the security and defense sector,” the statement read.

The bill will increase the added military tax from 1.5% to 5%, set higher taxes for self-employed people, retroactively double taxes on bank profits in 2024 to 50%, and raise taxes on the profits of other financial institutions to 25%, among other changes.

The increased tax on bank profits was not originally included in a draft of the bill that failed to pass earlier in the month but was expected by many after Ukraine’s banks made record profits in 2024 and after a similar retroactive hike was carried out in December 2023 for profits that year.

In August, Prime Minister Denys Shmyhal said that Ukraine faces a budget deficit of $35 billion next year, with $20 billion expected to be covered by the EU's Ukraine Facility program and by assistance from the International Monetary Fund. The remaining $15 billion needs to be sourced from partners or domestically.

An imperfect tool

The government has moved to raise taxes despite significant pushback from Ukrainian businesses, who argued the burden was unfairly placed on law-abiding businesses and that the government should do more to boost revenues from tax dodgers first.

Several prominent business leaders spoke out against the move when it was proposed over the summer.  In a July statement, the American Chamber of Commerce in Ukraine said that the proposed tax hike discriminates against “bonafide transparent taxpayers,” adding that “losses from the illicit markets of excisable goods over the last year alone exceed $1 billion.”

“All efforts must be made to ensure that individuals and legal entities operating in Ukraine pay their fair share of taxes in effect today,” the chamber said.

Raising taxes was a “necessary and unavoidable decision,” said Gaidai of CES. “But in my opinion, this is not the best tax increase design possible, because it puts all the burden on those who already pay their fair share of taxes.”

Even prior to the tax hike, Ukrainian men were increasingly avoiding official employment over fears of mobilization, moving into “grey” markets, or ceasing work altogether where they are harder to track by conscription officers. The burden of the new law falls disproportionately on those who have continued operating above board.

Separately, the decision to raise bank profit taxes was made over the objections of Ukraine’s central bank, which noted that banks were already taxed higher than any other sector of Ukraine’s economy.

“We do not support the reapplying of the 50% income tax rate for banks this year,” said Andrii Pyshnyi, head of the National Bank of Ukraine, during the bank’s monthly press briefing on Sept. 19.

“Unfortunately, we see that the risks and harms of this decision may actually outweigh the fiscal effect,” he said, noting that the central bank already restricts bank profit distribution. “All the profit of the banking system remains in the system and works for capital growth. Capital, accordingly, creates additional opportunities for credit support of Ukrainian business.”

Pyshnyi said the bank is planning to discuss this with the Finance Ministry prior to the law’s second reading.

Facing pressure to take action on illegal markets, Ukraine’s parliament also passed a new law to reform the customs service. Major business associations in Ukraine had championed the bill.

However, the change is not expected to increase budget revenues any time soon, because of the time needed to implement the reforms, which include a competitive process to select an independent leader and help with vetting from international partners.

“I would say that this situation with the budget was one of the political enablers for this reform to actually be voted on. Because there is huge pressure from people and from businesses to actually not only raise tax rates but to work on more even tax compliance and on leveling the field,” said Gaidai.