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. Last Updated: 07/27/2016

Cabinet Approves VAT Cut, Sales Tax

The Cabinet approved a package of radical tax changes Wednesday, while cutting the government's planned expenditures to meet the lower revenue projections.

In deciding to slash a number of key taxes, the government is hoping to stimulate production. The tax cuts, proposed by the State Tax Service, were strongly opposed by the Finance Ministry and the International Monetary Fund, which argued that Russia cannot afford the loss of revenue.

Georgy Boos, who heads the State Tax Service, said the Cabinet gave its final approval to the plans to cut value-added tax to 15 percent from the current 20 percent, and profit tax to 30 percent from 35 percent, while introducing a sales tax of 5 percent to 10 percent and raising excise tax for alcohol and other items.

Boos also said the government was studying options for re-introducing oil export duties, which were canceled in 1994 at the IMF's insistence, but that no decision has been made.

The lower VAT and profit tax rates will go into effect in March, but the excise tax will not go up until July, Boos said. Although this creates a gap, he said wholesalers need time to clear stocks they imported under current regulations.

"The government has made its first move, and it is a courageous one," Boos said at a news conference. "No economy is capable of paying 70 percent of what it produces. We have been living in an unreal tax environment."

Experts have criticized the plans to cut taxes, especially VAT, which has been the most collectible duty in Russia. Boos has insisted that the reduction would improve compliance, as well as help cash-starved companies.

The lower VAT rate will not cut actual revenues as much as it might seem, he said, since not all companies have been able to pay the full amount under the current rate.

"Currently, companies on the whole pay only 50 percent of the VAT that's due. If the requirement goes down by a quarter, the same payments will account for a larger proportion of the plan," Boos said.

However, the main consequence of the VAT and profit tax cuts will be reduced revenue, said Anton Siluanov, head of the Finance Ministry's macroeconomic department.

Prime Minister Yevgeny Primakov announced 10 days ago that VAT would be set at 14 percent, but the figure was amended after two deputy prime minister, Vadim Gustov and Gennady Kulik, later asked for a 1 percent increase. They said the additional revenue was needed to finance the army and agriculture.

The previous draft budget allocated 2.6 percent of GDP to the Defense Ministry, while Defense Minister Igor Sergeyev said the army could not function on less than 3.5 percent of GDP. Sergeyev said the government agreed Wednesday to finance the armed forces at 3.1 percent of GDP.

The tax package was approved after heated disputes between Boos and Finance Minister Mikhail Zadornov and despite indirect warnings from the IMF, which is still considering whether to resume lending to the government.

Boos said Wednesday that the fund's managing director Michel Camdessus may be rethinking his opposition to the measures following his visit to Moscow last week.

"[Camdessus and I] met for about one hour, and he is not unshakable in his belief that taxes must not be lowered," Boos said. "On the contrary, he believes it is necessary. He said he would be revising his position."

But experts said the planned sales taxes will not compensate for the VAT reductions.

"A lot of goods produced in Russia are then sold in the shadow economy, which cannot be taxed at all," said Yelena Panova of the Russian-European Center for Economic Policy.

The Finance Ministry, meanwhile, insists next year's inflation will be 30 percent, the average exchange rate to the dollar will not exceed 21.5 rubles, while the Central Bank will have to print a total of 32.6 billion rubles ($1.6 billion), up from the previous estimates of 31.8 billion rubles. Analysts have said the forecasts are overly optimistic.

"Other countries that have had financial crises have suffered much larger slumps of GDP, and I don't see how Russia could manage to keep the decline at 3 percent next year," said Rudiger Ahrend of the RECEP.

The latest version of the 1999 draft federal budget has revenues of 473.8 billion rubles, expenditures of 571.1 billion rubles, and a deficit of 101.3 billion rubles, or 2.5 percent of gross domestic product, said Siluanov of the Finance Ministry.

The ministry's previous draft had revenues of 482.91 billion rubles, expenditure of 587.39 billion rubles and a deficit of 104.47 billion, or 2.75 percent of GDP.

GDP itself will total 4 trillion rubles, having shrunk by 3 percent on the year-to-year basis by the end of 1999..