US embassy cable - 05YEREVAN52

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