Uzbekistan:

Base Broadening with a Lower Rate

Introduction

Since gaining independence from the Soviet Union in 1991, Uzbekistan has transitioned from a centrally planned to a market-based economy. For many years, the state retained significant control over key sectors to maintain social stability. Beginning in 2016, however, Uzbekistan launched an ambitious reform agenda aimed at modernizing the economy and promoting private-sector development.

A central element of this transformation was the comprehensive reform of the tax system, particularly the VAT. With technical assistance from the International Monetary Fund, Uzbekistan restructured its VAT by moving from a narrow base and high rate to a broad base and lower rate. The reform enhanced efficiency while maintaining, and eventually increasing, revenue performance.

This case study reviews Uzbekistan’s VAT reform, contrasting its structure and performance before and after the reform, and drawing lessons that may inform similar efforts elsewhere. It shows that comprehensive VAT reform—combining base broadening, administrative modernization, and targeted social protection—can improve both efficiency and equity. Despite lowering the standard rate from 20 percent to 12 percent, revenues rose from 4.6 percent to 5.4 percent of GDP, and C-efficiency more than doubled.

VAT Reform Overview

The number of exemptions was reduced from 45 to just 7—limited to financial services, residential accommodation, certain educational and medical equipment, and specific organizations. This streamlined exemption regime positioned Uzbekistan among the countries with the broadest VAT bases globally.

Because the new VAT applied even to basic goods consumed by poor households, a compensatory cash transfer system was introduced. Qualifying households receive the full amount of VAT paid on selected items directly into their bank accounts.

As the table and figure illustrate, broadening the base enabled successive rate reductions without undermining revenue. The standard rate was lowered from 20% to 15% in 2019, causing a brief dip in 2020, but revenues recovered as new measures expanded coverage. In 2023, the rate was further reduced to 12%.

These measures significantly improved VAT efficiency: the C-efficiency rose from 0.30 to 0.65, reflecting a major reduction in compliance gaps and distortions. The lower rate also improved neutrality across sectors.

Administrative reforms complemented these policy changes. The VAT refund period was cut in half, from 60 to 30 days, easing liquidity constraints for businesses. Restrictions on input tax deductions for capital acquisitions were lifted, preventing cascading taxation and encouraging investment.

Key Takeaways

  • Many countries design VATs primarily to meet revenue targets, often overlooking the trade-off between rate and base. A narrow-based VAT taxes production rather than consumption, creating economic distortions and complicating administration. To compensate for a limited base, governments often adopt higher rates, which further increase compliance costs and opportunities for evasion.

    Uzbekistan’s experience demonstrates that a broad-based VAT with a low rate can achieve comparable or greater revenues with fewer distortions. Broadening the base reduces opportunities for fraud, simplifies compliance, and enhances fairness. Moreover, rate reductions are politically appealing—broad-base, low-rate reforms are often perceived by the public as lowering the tax burden while preserving revenue.

  • Governments typically address VAT equity concerns either by exempting or zero-rating essential goods, or by collecting VAT and redistributing revenues through targeted transfers. The appropriate approach depends on administrative capacity and the structure of the economy.

    In economies with large informal sectors, low-income consumers often purchase from unregistered suppliers who do not charge VAT directly but still pass on embedded VAT in prices. In such contexts, cash transfers linked to VAT paid may not accurately reflect the burden borne by the poor and can be vulnerable to misuse.

    A general cash transfer system, independent of VAT payments, can be more effective if it reliably reaches low-income households. However, weak targeting mechanisms and limited financial inclusion can reduce its impact or even make it regressive.

    In more formalized economies, direct transfers are preferable to exemptions. They can be tightly targeted to poor households, whereas VAT exemptions tend to benefit higher-income groups that consume more of the exempt goods. Retaining a broad base also preserves efficiency, allowing revenue collection at lower administrative and economic cost.

    Where feasible, equity objectives are best achieved through targeted expenditure programs rather than VAT exemptions or rate differentiation.

  • Sound administrative design is essential to a well-functioning VAT. Although such measures may not directly alter revenues, they can strongly influence the investment climate. Uzbekistan’s decision to shorten the refund period from 60 to 30 days improved liquidity, reduced the cost of doing business, and increased investor confidence.

    By accelerating refunds, firms faced fewer cash flow pressures and reduced exposure to exchange rate risk. Allowing input VAT deductions on capital goods further removed distortions in production and encouraged investment. These measures illustrate how administrative efficiency can reinforce policy outcomes, fostering a more conducive business environment and supporting growth.