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. Last Updated: 07/27/2016

Tax Tricks




Ronald Reagan tried it in the 1980s and new State Tax Service chief Georgy Boos says he is trying it here in Russia. By cutting tax rates, he says, he can raise tax revenues.


Reagan's version resulted in the highest deficits the United States has ever seen. But Boos, undaunted, claims he has a formula that will allow him to cut tax rates while at the same time producing a virtuous cycle of growth that will boost the government's gross tax revenues. Value-added tax, profits, income taxes and payroll taxes will all be cut.


Most of the world is not impressed. They say Boos' proposals will starve the federal budget at a time when it desperately needs revenues. The result will be a massive deficit, printing of money and hyperinflation.


The International Monetary Fund has poo-pooed Boos' proposals for cuts to the VAT. Finance Minister Mikhail Zadornov, whose task is to produce a realistic budget, fought a bitter battle to stop Boos from cutting the VAT even further.


Formerly head of an electrical contractor for Moscow City Hall, the laconic, almost monotonous Boos is unmoved. He has a mission to cut Russia's tax rates.


"No economy can afford to pay 70 percent of gross domestic product in taxes," Boos said recently. "That is unreal and we are still living in an unreal tax world."


Boos' sums are a little confused: Taxes make up around 30 percent of GDP in Russia on most reckonings.


But Boos may have the political skills to put his plans into effect. He initially referred to his ideas as "revolutionary" but later softened his rhetoric. And while talking loudly of his tax cuts, Boos has downplayed increases on excises, property and sales taxes.


Boos' political skills should help the plan sale through the State Duma, parliament's usually hostile lower house, which is due to consider the changes over the next couple months. Boos used to run tax policy in the Duma and he will also benefit from the chummy relations between Prime Minister Yevgeny Primakov and the deputies.


It may be a harder sell in the Federation Council, parliament's upper house composed of regional leaders. Many of the taxes Boos is cutting will actually come out of the regional budgets. Regional governors will not be pleased.


The most costly of Boos' tax cuts is the reduction in VAT to 15 percent from the current 20 percent. As former head of the State Tax Service Boris Fyodorov put it, it amounts to "sawing off one of the two branches on which the budget sits" (the other being revenues from the State Customs Committee).


Boos initially proposed slashing VAT to 10 percent. He only accepted the more moderate cut after Zadornov threatened to quit and a number of other ministers complained there would be no money to pay the army.


The IMF is appalled even with a 15 percent cut. Although Boos claimed recently that the fund's managing director Michel Camdessus was reconsidering his position on the issue, the fund's deputy director Stanley Fischer singled out the planned VAT reduction when criticizing the government's economic program last week.


The cut in VAT is all the more daring in that it is one of the few taxes Russia actually manages to collect well, despite rampant evasion of other taxes. VAT brings in roughly 28 percent of Russia's consolidated budget revenues (that includes federal and regional budgets and the various social security funds). According to official estimates, about 50 percent of VAT is collected, a high figure by Russia's lamentable standards.


VAT is calculated as the sales price of a good minus costs. This gives corporate taxpayers an incentive to disclose all their costs and hence minimize their tax base. The tax office can then double-check the costs back down the production and distribution chain. For a cash-strapped government seeking to improve compliance, VAT would seem like the last tax to cut.


But cutting the rate, Boos argues, is an admission that many companies simply cannot pay the tax, often because they themselves are not paid for what they produce or are paid in barter.


Perhaps. But those companies that can afford to pay will get a windfall from the VAT cut. The Economics Ministry estimates losses to the consolidated budget at about 20 billion rubles ($1 billion) or 0.5 percent of GDP.


Politically, it will be easy to convince the Duma to pass a cut in VAT but there is a sting in the tail of the new law which will cause problems in the Federation Council.


The new law will reallocate the federal and regional shares of VAT. Regions are currently entitled to a quarter of VAT revenues but usually find a way to keep a third or more. But after next March, when the bill is to take effect, all VAT revenue will go directly to the federal government.


The governors will be out of pocket but the federal budget's revenues from VAT will be more or less stable since the cut in the rate will be compensated by the reallocation.


The governors may find this hard to swallow. "The most heated debates should be expected over the issue of VAT. Regions will not want to lose this revenue," says Alexander Zhukov, chairman of the Duma's budget committee.


Lev Roketsky, governor of the Tyumen region, has already dismissed Boos' plans, saying they do not take into account regional interests.


While the federal budget will be more than compensated for the cut in VAT by the fact that it will get 100 percent of tax collections, some warn it may not be that simple. "Regional authorities will lose interest in collecting the tax since they will not get a share of it any more," says Sergei Don, a Duma deputy on the budget committee.


Boos may be relying on his influential political ally Moscow Mayor Yury Luzhkov to push the bill through the Federation Council. But he is also offering the governors a sweetener.


Regional budgets will be compensated for the loss of VAT by the introduction of a sales tax - 10 percent on excisable goods and 5 percent on other goods, with no sales tax on certain staple products. According to the State Tax Service, revenues from the tax, all of which would remain in the region where it is levied, would bring local budgets a total of about 32 billion rubles - about 12 billion rubles more than the projected losses from the VAT cut.


A sales tax will be hard to sell to the Duma, which rejected the same idea when Prime Minister Sergei Kiriyenko proposed it six months ago.


It may also not satisfy the governors. Don of the Duma's budget committee says that the example of excise taxes shows how hard it will be for the governors to collect a sales tax. Despite enormous effort, tax officials have little success collecting excises, even though they are set at very low levels.


"If you take cigarettes, for instance, currently, the excise accounts for 50 kopeks in a 25 ruble pack. A 10 percent sales tax would be the same as increasing the excise five-fold, only without the same level of control," Don said.


The sales tax proposal will probably help big cities like Moscow and St. Petersburg which have a huge retail turnover but it will do little for remote regions with no retail base. Former Prime Minister Yegor Gaidar said the combination of VAT cuts and sales taxes was designed to help Luzhkov, Boos' former customer.


While VAT is the most important of the tax cuts proposed by Boos as part of his philosophy of cutting taxes to boost growth, he is also offering other goodies, including small cuts in profits tax and income taxes.


Profits tax will drop to 30 percent from the current 35 percent, a marginal fall which tax accountants say does not go to the heart of the problem. Russia's profits tax rate is moderate by world standards: The problem is that legitimate expenses like advertising, insurance and training cannot be fully deducted.


The pain on the profits tax is evenly divided between the federal and regional budgets. The federal budget's cut will fall from 13 to 11 percent while regions will drop from 22 to 19 percent. But these reductions will cost relatively little in absolute terms. Income tax changes involve raising the marginal tax thresholds, once again only a minor change.


Not all of Boos' tax changes amount to cutting taxes. Excise tax rates on alcohol, tobacco, gasoline, jewelry and cars with engines over 2.5 liters are to go up by between 20 and 50 percent. Crude oil and natural gas excises will remain unchanged.


The rise in excise is less severe than it seems. Excise taxes are set in rubles per good sold rather than as a percentage. This means that the tax rise will only barely compensate for the rise in inflation. Moreover, Boos wants to delay the increase in excise tax rises until July, a move he says is needed to give traders time to adjust.


Observers have praised Boos for a proposal to transform the current excise tax, which is paid entirely by producers, into a tax that is split between wholesalers and producers and should encourage inter-regional trade.


Because only producers now pay the tax, many regional governors restrict sales of alcohol produced outside their regions, protecting local producers who pay them taxes. "When local wholesalers are taxed, the governors should be more willing to allow such imports," Don said.


Similarly, Boos intends to impose excise taxes on gas stations, as well as on the refineries who now pay all the tax. While excise taxes will remain unchanged for producers, the tax on retailers would rise.


But implementing these tax rises will be complicated because bootlegging of excisable goods is already widespread. The gasoline excise, for instance, could be a mine field.


"Again, this is a very reasonable move," Don says. "It's also very courageous given the criminal situation in the sector. And of course, it is much harder to tax thousands of gas stations compared to several dozen refineries."


As part of his tax-cutting program, Boos has also proposed reducing payroll taxes. Social funds will fall to 27.7 percent from the current 38.5 percent. The bulk of this will be achieved by slashing payments to the State Pension Fund to 19 percent from 28 percent of wages.


But what Boos gives with one hand, he taketh away with the other. An increase in taxes on individuals will make up for the payroll tax cuts on companies: Individuals will now have to pay 4.5 percent of their income to the pension fund and 0.5 percent to the other funds. Currently, individuals pay only 1 percent to the pension fund.


Analysts say that the net effect will be minor. "The result of this will be that a total of $230 will have to be paid on a $1,000 salary compared to about $250 now," Don says. "That is not a radical enough change to encourage higher compliance. From talking to businessmen I understand the maximum payroll tax they would be prepared to pay is 20 percent. Anything on top of that is hypocrisy."


Stuart Naunton, tax partner with Coopers & Lybrand, said the changes do nothing to alter the complexity of the payroll tax system which is a major cause of non-compliance. "The government continues to live in a vague dream world. Those changes would leave Russian employers and employees conspiring to pay as little as possible through perfectly legitimate but also very artificial avoidance schemes." The most popular of such schemes have been payments through life insurance policies and interest on bank deposits.


Boos' great hope is that he can increase compliance by smarter tax collection. One of the bills would give the State Tax Service the right to information on private bank accounts.


But the banking sector has already defeated several previous attempts to do just this. Don of the budget committee believes this attempt is also doomed. "This proposal will simply never pass the Duma."


Apart from cutting taxes, Boos also likes to talk about shifting tax from the producer to the consumer. The cut in VAT in favor of sales tax and the shift of payroll taxes from corporates to individuals are two examples.


Boos is also planning to raise property taxes to 0.5 percent from the current 0.1 percent, a move that will hit many small property holders. The tax service hopes to raise 2.65 billion rubles by hiking the tax which is levied on everything from apartments to dachas to cars.


However, local governments may find the duty difficult to collect from low-income earners, especially if they use market prices for evaluating the property.


Another Boos credo is elimination of unjustified tax exemptions, which are supposed to cost the budget tens of billions of rubles in lost revenue.


Boos has proposed deleting all tax breaks, except for construction projects. But this would mean axing exemptions for things like prizes of under $50 won by sportsmen, summer earnings by students, all gifts by the employer to the employee and others.


These cuts show an unusual lack of political savvy. "Those privileges cost the budget peanuts, and it looks like Georgy never looked into what he was cutting," Don says.


A more practical change would be the proposed reduction of the untaxable portion of proceeds from real estate sales. Currently, when an apartment owner sells his apartment, an equivalent of 5,000 minimum wages is deducted from the taxable base and the surplus is taxable income. At the current minimum wage of 83 rubles, or $4, the exemption allows people to sell flats with a value of up to $20,000 without paying extra income tax. In Moscow this is only enough for a modest one-room apartment but in the provinces it provides a tax break for almost all property transactions.


The devaluation of the ruble has already effectively reduced the threshold but the tax service's plan is to reduce the untaxable threshold to only 1000 minimum wages, or $4,000. This would cover almost all sellers of real estate in Russia. They could pay the tax or, more likely, they could try to use schemes like fake registrations or "gifts".


"Many of those who are selling their flats are buying smaller ones immediately and live on the difference for several months," says Don. "They will certainly do everything they can to avoid having to pay the 35-percent income tax."


Boos will also have the responsibility of implementing one of the few tax measures proposed by the former government that was approved by parliament - an "imputed" tax on small businesses in the retail and service sectors. Boos says this tax will compensate for the cut in VAT, raising 23.2 billion rubles of revenues for the consolidated budget.


Others disagree. The tax is set at 20 percent of turnover but it is up to the local branch of the tax service to impute what total sales are, based on its assessment of the average revenue for that kind of business.


The arbitrariness of the process of assessing the "imputation" opens plenty of avenues for corruption and incompetence. Some say Boos has no intention of implementing a tax which would hit powerful kiosk and wholesale traders hardest.


"I insist that Boos while serving as deputy chairman of the Duma's budget committee did everything to make this tax uncollectible," former Economics Minister Yevgeny Yasin wrote in a recent critique of the tax plan. "It was on his initiative that the method of calculating the tax was left to local authorities - that's all it takes."


The implication is that while a tax office cannot change the imputed tax rate, it would be free to use almost any figure as an assessment of a business's turnover and use it as the taxable base.


Boos will have to be fighting on several fronts at once. Battling local and regional lobbies, fighting for higher federal revenues and also defending his great idea of cutting taxes.


Some say Boos cannot but fail. It is a bold, some would say foolhardy experiment at a time when Russia is on the brink of bankruptcy.


"The rule is that any serious change in the tax system leads to a temporary decline of revenue. The taxpayer needs to get used to paying and the collector needs to get used to collecting," says Don.