Is Russia Becoming a Country of Indirect Taxation?

Strategy-2020 has raised the questions of modernizing Russia’s tax legislation and, possibly, increasing taxes on consumption and property. Earlier this year, Russian Prime Minister Vladimir Putin also suggested that the country needed a ‘tough fiscal manoeuvre’.

Strategy-2020 is a long term plan of socio-economic development of the country until 2020. Work on this document started in 2005. In 2011, on instructions from Vladimir Putin, the document was significantly modified. Though originally the final version of Strategy-2020 was expected by December last year, it has not been approved yet.

Several options for ‘fiscal manoeuvre’ were suggested during the preparation of the Strategy 2020. The proposals, among other things, included: lower rates of national insurance contributions, progressive taxation of personal income tax, progressive taxation of the commodity sector (of oil, natural gas, coal, potash, metals and other raw materials), luxury tax (on ‘prestigious' consumption: on luxury goods and expensive real estate), raising VAT and excise duty (on alcohol and tobacco products) by 2-4%, replacing (partially) of VAT by sales tax and etc.

These initiatives indicate the general intention to increase the tax burden on the economy. Escalating spending on defence and the state apparatus as well as the need to fulfil social commitments was named as the cause of the increase. Indeed, bigger taxes are the easiest way to fill the budget deficit.

Opponents argue that instead of raising taxes or introducing new one, the existing taxes can be optimised, for instance, by redistribution of tax revenues between the budgets of different levels. They also point out that the tax increase can negatively affect the investment attractiveness of Russia, which is not very high already.

It is well-known that the main burden of indirect taxes falls on consumers as VAT and excise duties are included in the price of goods and services. The increase in indirect taxation can adversely affect the demand and, consequently, business as a whole. As a result, it does not necessarily produce the desired results: as in the case of higher national insurance contributions, the unwillingness to pay more and the move to the ‘shadow’ sector, by contrast, can lead to reduction in revenue.

Reasonable increase in rates of indirect taxes (VAT and excise), in some cases (and for certain countries) can be a suitable measure. Russia is not the only country which is trying to solve its social problems by increasing indirect taxation. In recent years the share of direct taxes is falling and the share of indirect taxes is growing in many countries (like Belgium, Germany, Italy, Japan, Netherlands, Switzerland and others). Last year the rate of VAT was increased in France.

In Russia, however, such measures would be premature. Experts have repeatedly pointed out that raising taxes in the emerging countries does not improve the investment climate and / or create a competitive advantage and may hinder the development of the market.

The final report on results of the work of expert on the socio-economic strategy of Russia until 2020 has been published in March 13. It suggested, in particular, to ‘optimize’ tax benefits; to increase the rate of excise duty on alcohol and tobacco products; to introduce a progressive scale of taxation of income and property; to review the taxation of oil and gas sector (in particular, by increasing the severance tax and tax on additional income); to keep the rates of national insurance contributions at the same level and to consider the return to the unified social tax; to simplify and improve tax and customs administration.

As indicated in the report, higher taxes on consumption and lower taxes on labour and capital should increase the competitiveness of the economy. The matter of raising VAT rates in the final report has not been touched; it has been suggested to introduce a uniform rate at the current base rate (18%).

In the last meetings in March the tax reform, including the questions of increasing VAT and / or of the administration of sales tax, has been discussed at the government level.

It is important to note that the general trend of all the initiatives, projects and suggestions is the gradual shift of the tax burden from production to retail (in particular, this is indicated by the initiative to introduce the sales tax) and consumption. Most likely, the changes will, as proposed, concern the property tax (in the form of a single tax, calculated on the basis of the market value of property), the luxury tax (in the form of a special tax or as a variation of the existing personal income tax), tax on the commodity sector and an increased excise tax.

As for VAT and sales tax, their fates are not sealed. In early March, Vladimir Putin and Dmitry Medvedev suggested that the rate of VAT and income tax as well as personal income tax would remain the same. Most probably, the sales tax will not replace VAT. However, these issues are still under discussion and the final version of tax policy, approved at the highest level, does not yet exit. The relevant bills should be prepared by May. It is obvious that the final decision on the matter will be taken after the inauguration of new President and formation of a new government. We just hope that these decisions will be reasonable.

At this stage, it is premature to give a detailed analysis of the ‘fiscal manoeuvre’ and forecast the results of its implementation. One thing is important: in one form or another, the reform of the tax system will give to the representatives of Russian business and foreign investors certainty and predictability of the fiscal policy at least in the medium term, which will be an absolute advantage and will allow planning of economic activity and assess the feasibility and profitability of investments in various sectors of the economy.

Muranov, Chernyakov & Partners