Russia's Finance Ministry backs VAT cut

By bne IntelliNews February 15, 2007

Ben Aris in Berlin -

In the latest sign of the Kremlin's increasing confidence that Russia is on the path to sustained growth, the government has announced a series of reforms to the tax system in the last two weeks.

The first thing President Vladimir Putin did on taking power - even before bashing the oligarchs into line - was to introduce a radical tax reform that saw personal income taxes cut to a flat 13% rate and a reduction in key corporate taxes. And for the last few years, the Finance Ministry has promised faithfully that it wouldn't hike income taxes; despite swelling tax receipts, experts believe only one in four Russians pay any tax at all.

However, after six years of strong economic growth the government clearly thinks that such drastic incentives are no longer needed and it is preparing to introduce more sophisticated progressive taxes, shifting the emphasis from stimulating growth to broadening the tax base to collect more revenue.

Mining for tax revenue

Last week, the government floated the idea of re-introducing progressive income taxes that would tax the growing middle class a bit more heavily and hit the rich harder in the pocket.

And this week, Finance Minister Alexei Kudrin said VAT could be cut from 18% to 15% if mining taxes are increased. The move, it is argued, would stimulate more economic diversification.

The suggestion is a more radical extension of the existing tax policies. The government has been loading taxes onto the natural resources sector - especially oil - to finance tax cuts in the rest of the economy. This movement has been a major contributing factor to Russia's strong economic growth over the last six years.

However, cutting VAT is especially noteworthy, as this tax accounts for a third of the government revenues by itself and is by far the most important tax in the taxman's arsenal. However, since the government has been running budget surpluses of more than 7% a year, it obviously feels it can afford to lighten the load a little to boost growth further.

The debate now is over exactly how far to cut VAT and when to introduce the change, as the decision to cut in principle appears to have already been made. Kudrin wants to cut the rate to 15% in 2009; Prime Minister Mikhail Fradkov wants to go further and cut the rate to 13%. The business lobby has already forced one tax cut on Kudrin earlier than he wanted in 2003.

Running in parallel with this debate is another on whether to abandon VAT altogether and replace it with a sales tax, which is being championed by Arkady Dvorkovich, head of Putin's economic advisory unit. At this point it seems as if the VAT lobby has the upper hand.

Reducing VAT to 15% would chop RUB357bn ($13bn) off government revenues. The mining tax currently contributes RUB1.1 trillion to revenues. The Finance Ministry proposes to increase tax this year by 30% to bring in an additional RUB400bn a year.

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