Russian Authorities Could Raise the VAT to 20%
Giving Them Two Trillion Rubles to Execute Putin’s May Decree
Yelizaveta Bazanova and Filipp Sterkin
May 27, 2018
Prime Minister Dmitry Medvedev has promised to find the eight trillion rubles [approx. €110 billion] the government lacks to carry out Putin’s new May decree. We have learned the government and the Kremlin will go looking for a considerable portion of this sum in the public’s pockets. Approximately two trillion rubles could be collected over six years by raising the VAT from 18% to 20%. Our sources, three federal officials, said this option had been discussed and was one of the most likely options, although a final decision had not been made. However, one of our sources said the Finance Ministry had proposed abolishing the 10% preferential VAT rate and replacing it with an allowance.
Another two trillion rubles or so would be supplied by an increase in the retirement age, which Medvedev had announced, said two of our sources, without specifying how quickly it would be increased and by how much.
The final four trillion rubles would be provided by measures that have already been made public. The state would raise three trillion rubles for infrastructure projects by floating fixed and variable federal bonds, and establishing a temporary fund within the budget. The remaining one trillion rubles would be supplied by reforming taxation of the oil industry, nullifying export duties and raising the severance tax to offset them.
However, some of the decisions could still be revised, our sources said. As one of them noted, everything was in a state of rapid, constant flux.
Who Will Pay the VAT Increase?
Officials have long discussed an increase in the VAT, but as part of an overall taxation maneuver, as proposed by the Finance Ministry, that would have involved reducing pension deductions while raising the VAT to a flat rate of 22%. The Finance Ministry’s idea was to sanitize the economy and pump an additional 500 billion rubles into the budget. The idea was rejected, but several officials said it had proven impossible to find the money to carry out the May decree without raising taxes. Increasing the VAT without reducing pension deductions was a common trick, said a member of the board of the Russian Union of Industrialists and Entrepreneurs (RSPP).
The VAT was pegged at 20% until 2004, when it dropped to 18%. Returning it to 20% would be a less painful solution than the other options on the table—increasing the personal income tax rate and introducing a sales tax—argued two officials. Although, as one of them noted, if the state wanted to stimulate economic growth, it should not rob it of resources.
By increasing the VAT, the state would be primarily confiscating resources from the general public, which has experienced a four-year-long slide in incomes, while businesses would be able to compensate a considerable portion of their costs by embedding them in prices and thus passing them on to consumers.
As research by the UK’s statistical service has shown, companies raise prices ahead of time when an increase in the VAT is expected. Natalia Orlova, chief economist at Alfa Bank, has calculated that a two-percent increase in the VAT would accelerate a rise in prices of 0.8% to 1%, which would not be terrible during a period of low inflation. (In April, inflation was 2.4% in annual terms.) But along with abolishing the preferential rate, raising the VAT could deal a serious blow to the general public and have a knock-on effect on consumption, warned Alexandra Suslina at the Economic Expert Group. The preferential rate is currently valid for food products (except luxury items), children’s goods, books, textbooks, and medicines. In 2017, the preferential rate deprived the federal budget of an additional 550 billion rubles or about 0.6% of GDP.
According to a study by Alexander Isakov, chief economist at VTB Capital, when prices suddenly rise, people are less inclined to skimp on food, alcohol, and transportation. A one-percent increase in prices leads, most of all, to decreased spending on communications and medical care.
Business would pass on costs to domestic consumers, but the VAT for exports is zero percent, said the RSPP board member. There would also be victims, however. A tax increase would hit sectors where competition is intense the hardest, warned Vladimir Salnikov, deputy director of the Center for Macroeconomic Analysis and Short-Term Forecasting (TsMAKP). This was borne out by an IMF study performed in the wake of an increase in the VAT in Germany in 2007. When competition is intense, companies find it harder to retain their market share after price rises. Retailers, who have already slashed their profit margin amid weak consumer demand, would suffer, said a tax consultant at a major retailer. Salnikov warned the structural effect would be bad, increasing the burden on manufacturing industries, not on raw materials exporters.
Most of all, it would increase the burden on the machine-building and transportation sectors (by 6.8% and 6.6%, respectively), the electricity sector (by 6.8%), construction (by 5.6%), the information sector (by 5.4%), and the hotel business (by 4.4%), according to Salnikov’s calculations. On the other hand, it would decrease the burden on chemicals manufacturing, wood processing, and agriculture.
Officials have little time to decide who will pay for Putin’s May decree. The cabinet has drafted proposals for the tax system, and final decisions would have to be made during the State Duma’s spring session, Anton Siluanov, appointed first deputy prime minister and finance minister, said earlier. Currently, no decisions had been made, his adviser Andrei Lavrov confirmed, but in the near future the government would be deciding on measures for adjusting the tax system. Natalya Timakova, the prime minister’s spokesperson, would not comment on the subject, while Dmitry Peskov, the president’s press secretary, was unavailable for comment on Sunday.
Performance of actual pensions and wages vis-à-vis the same period during the previous year. Red line=actual amount of allocated pensions; blue line=actual paid wages; *=lump-sum payments taken into account. Source: Rosstat. Courtesy of Vedomosti
Working for the Decree
Saving two trillion rubles over six years would mean raising the retirement age by at least one year annually for both women and men, noted Yuri Gorlin, deputy director of RANEPA’s Institute for Social Analysis and Forecasting. This would make it possible decrease transfers from the federal budget by two trillion rubles, agreed Tatyana Omelchuk, senior researcher at the Finance Ministry’s Financial Research Institute (NIFI). This option for increasing the pension age was tabled by the Center for Strategic Research when it was headed by Alexei Kudrin, who has now been tapped to chair the Accounting Chamber. Annually, around 40% of the Pension Fund’s income is provided by the federal budget. In 2018, 3.34 trillion rubles will be transferred from the budget to the Pension Fund.
The pension age should be raised not only to save two trillion rubles for executing Putin’s decree but also to generate resources for increasing pensions at the same rate as salary increases, said an official. There was the danger the government would try to minimize the transfer as much as possible, and then there could not be enough money to step up the indexing of pensions, Gorlin noted.
Options for raising the pension age were discussed even before Tatyana Golikova was appointed deputy prime minister for social issues. In an interview with RBC, she said the government had only discussed the decision. The final parameters had not been agreed. Her spokesperson declined to comment.
Gorlin said the main goal of raising the retirement age was to ensure a more acceptable increase in pensions. An excessively radical approach to the problem would significantly increase the danger of unemployment’s rising, while also spurring the demand for disability pensions, he argued. Referring to the findings of a sociological survey, experts at the Higher School of Economics have claimed the most acceptable option for raising the retirement age would be sixty years for women and up to sixty-three years for men. Gorlin argued the most rational option would be between sixty-two and sixty-three years for men, and between fifty-nineand sixty-one years for women.
Translated by the Russian Reader