Higher taxes for Russia

What is Russia’s economic policy likely to be in the near future? Invest Foresight has already reviewed that policy’s probable components but left aside such an essential matter as taxation. Nowadays though, many feel certain the political decision on increasing taxation has quite possibly been made already. Such an opinion has been recently voiced by a number of reputed experts such as Sergei Alexashenko, former Deputy Chairman of Russia’s Central Bank, and Natalia Orlova, Alfa-Bank’s Chief Economist. Everyone seems to be concerned that over the past few weeks, tax issues have frequently been the subject of the comments of top officials.

Ministerial signals

First of all, two statements by Arkady Dvorkovich, Deputy Prime-Minister, draw public attention. In one of those statements he noted that a decision on raising income tax from 13% to 15% is in fact made. In his other statement at a meeting at the Transport Ministry, he said that to fund construction of new roads taxes will need to be increased.

At the same time, Maxim Oreshkin, Economic Development Minister, pronounced himself against raising taxes since that will have a negative impact on the national economy and the budget proceeds.

Elvira Nabiullina, Russian Central Bank’s chairperson, expressed her view in a vague manner so typical for all heads of all central banks. According to her, any taxation novities should be introduced subject to consideration of the nation’s needs and the state of the economy, and all inflation risks must certainly be taken into account.

Finally, Finance Minister Anton Siluanov mentioned that expected adjustments to the taxation system will leave the overall tax burden intact.

The specifics of the anticipated adjustment are yet unknown. It was said though, the reform envisages revoking current tax benefits. Most likely, that means effecting the so called 22/22 Taxation Shift proposed by the Finance Ministry early last year. The core of the proposal is reducing social taxes payable by employers from 30% to 22% of corporate wages while increasing VAT from 18% to 22%.

Catch 22

That move’s economic efficiency is highly doubtful. The reform will first of all undermine the social pensions system. It will in fact abolish defined contributions and ultimately mean financing pensions from the government budget. That in the long run will reduce the nation’s investment resources. Besides, the proposed move will stimulate labor-intensive industries and discourage enterprises which by employing advanced technologies generate substantial added value.

In theory, such a reform could stimulate creating new jobs, but Russia has had no unemployment problems. It is also possible, the Finance Ministry hopes to thus raise income of the population, as such income has been gradually decreasing ever since 2014.

The Ministry of Finance is certainly expecting that cutting social taxes will entail lower shadow salaries. Coupled with higher income tax, that would mean that the promise not to increase a taxation burden was not absolutely sincere.

A year ago, all business associations were strongly against the proposed 22/22 principle.

According to Professor Sergei Kolchin of Accounting and Taxation chair at Plekhanov Russian University of Economics, the Finance Ministry is only pursuing its selfish goals. The matter is, VAT collection has been successfully administered contributing to budget proceeds even in times of an economic recession when the added value generated by the economy is decreasing for objective reasons. No progress in improving efficiency in collection of taxes on wages has been observed though. Should the said proposal be implemented, it will cause a negative macroeconomic impact due to a drop in demand and domestic investments and a rise in inflation.

“It may not be expected the ideas of the Finance Ministry will be supported”, Sergei Kolchin forecasts.

The expert also finds it highly unlikely the income tax may be raised since such a step will negatively affect the living standards of the people and result in lower demand for goods and services thus changing the consumption structure and complicating collection of various taxes.

Sergei Kolchin also believes there is a chance excise duties may be raised through elevating respective tax rates and expanding the variety of goods which are subject to excise. It is also probable a tax on hydrocarbons extraction may be imposed. A respective draft Tax Code chapter has been already prepared.

Tax collection secrets

Nikolai Alexeev, Civil Initiative party’s Federal Political Council member, believes the taxes are growing anyway. According to the Finance Ministry, the proceeds of the federal budget from the VAT on domestic production (in comparable prices) have since 2013 gone up by 64% while aggregate excise duties nearly doubled (97% up) and income tax rose by 116%. In the aggregate, in 2017 domestic production generated extra 77% of taxes for the federal budget. Less the inflation rate, the taxes amount has increased by 40% while the national GDP has over the same period dropped by 0.4%. How does the government manage to significantly raise taxation collection without amending tax laws?

“Federal Taxation Service’s branches supervise taxpayers on the basis of instructions of the agency”, Nikolai Alexeev says. “Those instructions set aggregate tax deductions for the companies depending on their revenues. The percentage varies depending on the industry and region where taxes are paid. The authorities and the businesses adhere to an implicit mutual understanding of the fact in case all taxes are paid in full, most businesses will go bankrupt and the national economy will be totally stalled. Nevertheless, over the last five years, the government has been raising the rates of deductions which are set by the Federal Taxation Service’s in its instructions. In a situation like that, businesses are deprived of the predictable rules of the game. That results in a vicious circle of investments shrinking and capitals fleeing the country”.

Was the decision made already?

Why the government needs extra revenues, is a separate story. The question was partially answered by the Russian Accounting Chamber which assessed that to meet the targets of the president in fighting poverty and increase spendings on the healthcare, education and infrastructure development, additional RUR 8 trillion ($150 billion) will be required over the next six years.

There is no hope the financial problems may be sorted out in a traditional manner, i.e. by increasing the oil industry taxation, since the latter has been successfully lobbying tax relieves for itself as compensations for the taxation policies of the previous years. Such tax benefits are called means of stimulation and Finance Minister Anton Siluanov has publicly declined a possibility of any increase in a tax burden on oil and gas industries.

Many representatives of the expert community recommend the authorities to refrain from raising taxes but to expand borrowings. Over the past few days, such an option was voiced by Alexei Kudrin, former Finance Minister and current President of the Center for Strategic Development, and Valery Mironov, Deputy Director of the Development Center Institute at the Higher School of Economics. Still, apart from the regular risks associated with a sovereign debt growth, the present foreign policy crisis brings about the danger that international borrowings for Russia as a toxic borrower may become too expensive and subjected to further restrictions. It is known, for instance, that in relation to the case of Skripal, the UK has discussed the limitations on servicing Russian securities.

By Konstantin Frumkin