COMMENT: Russia between budget and political risks

By bne IntelliNews August 31, 2011

Natalia Orlova of Alfa Bank -

The news flow confirms that the extremely high Russian budget breakeven oil price at $125 per barrel calls for starting tax increases sooner rather than later. The Finance Ministry continues to insist on a 10% social tax on high salaries and plans to introduce a unified household property tax from 2013.

The higher social tax, which affects only 6% of employees, will be the litmus test of the government's seriousness and is likely to occur. With 80% of Russians owning property, a property tax would involve a much higher tax burden and thus be less likely to be enforced soon. Without proof of strong tax administration, higher tax rates may lead to lower tax collection.

Real tax

Introduction of a property tax promises to raise regional revenues severalfold. The news flow suggests that the high $125/b breakeven is calling for an increase in the household tax burden across the board. Instead of the current land and real estate tax, the government expects to introduce a unified property tax in 2013. With the key idea being switching from the current balance sheet value to the market value of property, the revenues from the property tax should exceed current tax collection by severalfold. This measure is expected to support regional and municipal budgets.

The 10% social tax is a litmus test for budget policy. For the short term, the Finance Ministry continues to insist on the introduction of a 10% social tax on high salaries. Next year's budget is calculated based on an expected RUB150bn coming from this measure; however, the presidential administration has indicated that this proposal is still subject for approval by Dmitry Medvedev.

The tax service proposed writing off personal tax arrears held for more than three years a couple weeks ago. The election cycle dictates a loose approach to tax administration. At the moment the proposed amount to be written off amounts to RUB30bn, of which around RUB18bn is from the transport tax.

Low tax burden

The household tax burden is low. The proposed increase in the household tax burden is not surprising given its present levels (see figure). Personal income tax provides the Russian budget with 4% of GDP, while other household taxes (real estate, land, personal cars) provide a tiny 0.4% of GDP. Thus, the total tax burden on Russian households is well below the 10-15% of GDP in developed countries.

The 10% social tax affects a small part of the population. The introduction of the additional tax on high salaries, in our view, is likely not only because it would help rebalance the State Pension Fund, but also because it affects only 6% of workers in the country, those who receive salaries above RUB60,000 per month. The widest share of employees (63% of total) receive salaries below the country average of RUB20,000 a month and will benefit from the cut of the regular social tax from 34% to 30%. However, the decision contradicts Medvedev's economic agenda that had appeared focused on the middle class, and thus the decision will not be very supportive during the upcoming elections. Furthermore, the increase in the tax rate is very likely to stimulate tax evasion, especially if economic growth remains modest.

Introduction of a property tax is much more uncertain. While the introduction of the 10% social tax will affect only a relatively small segment of the population, the property tax would have a more widespread impact. As 80% of Russians are real property owners, introducing tax payments based on market value will not be well received by the majority of population. In addition, at this time the land cadaster has been properly set up in only half of the regions, and thus introduction of the property tax is considered to be technically viable only from 2015 by a number of Russian experts on the matter.

A write-off of tax arrears is not an appropriate message to prepare for higher taxes. When preparing the population for higher taxation, the proposal by the tax services to write off tax arrears is not an appropriate message to send to ensure strong tax collection. Should this proposal be supported, motivated by the intent to reduce the high cost of administrating tax arrears, we believe that the fiscal impact of the higher taxation will be eroded.

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