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. Last Updated: 07/27/2016

Federation Council Passes Tax Overhaul

The nation's upper house of parliament, the Federation Council, voted Wednesday to implement radical tax changes seen as crucial for balancing the budget next year and sustaining a recent economic recovery.

In a major victory for the government and President Vladimir Putin, the chamber, made up of regional leaders, voted 128 to 13 in favor of the tax package, with nine abstentions.

The Federation Council has been at loggerheads with the Kremlin for weeks over proposals to reform the chamber and curb the powers of regional governors, raising fears that the tax package might be held hostage to politics.

The governors had complained that the reforms would fill federal government coffers at the expense of the regions, but senior Cabinet ministers lobbied fiercely for the measures, stressing that the future of the economy was at stake.

Prime Minister Mikhail Kasyanov said the new tax laws would enable Russia to "make considerable steps forward and allow for rapid economic development." No region would suffer, he said.

The Russian economy is forecast to grow by up to 5 percent this year after 3.2 percent growth in 1999, but this has been largely due to higher energy and commodity export revenues in recent months and the 1998 devaluation of the ruble.

Finance Minister Alexei Kudrin called Wednesday's vote an "unquestionable victory for all branches of power.

"We can say now that our country is getting stronger," he said. Now the tax laws only need Putin's signature to take effect from 2001.

Western investors, international lenders and Russian businessmen have all maintained for years that substantial tax reform and a reduction in the tax burden on enterprises is needed to jump-start Russia's ailing economy.

The reforms include a 13 percent flat income tax rate to replace the current sliding scale from 12 percent to 30 percent and a unified social tax.

A controversial tax on turnover, which is levied on all enterprises regardless of their income, will be maintained but will be reduced from 4 percent to 1 percent.

One effect of the overhaul will be to centralize collection and distribution of tax revenues previously left to governors.

The stiffest criticism came from Moscow Mayor Yury Luzhkov, now closer to Putin after opposing his allies in the December 1999 parliamentary elections.

"The regions will now be forced to pass on most of their tax revenue to higher levels. We will get nothing; no region will be without a deficit," he told the chamber. "Everyone will be confined to a stall, with the state proffering handfuls of hay."

Federation Council Speaker Yegor Stroyev said any remaining differences could be ironed out by a special conciliation commission. Kudrin called earlier for creation of such a commission.

Analysts Wednesday hailed the vote as an important victory for the new administration and as setting the wheels in motion for further structural reform.

"It's a victory for federal control," said Philip Poole, head of emerging markets at ING Barings in London. "The change in the tax regime is a key element in Russia's structural reform program."

He conceded that the new Tax Code passed Wednesday was not perfect and was going to need more work to be improved. "But if you compare today's vote with what happened under [former President Boris] Yeltsin, then it's a real step forward. Under Yeltsin, no progress was made on tax reforms," he said.

The government had already been forced to bow to regional leaders' demands to retain the turnover tax in part. It had wanted to abolish the tax completely, but regional leaders set up a strong lobby in the State Duma and ensured a 1 percent tax was retained. Regional leaders had feared a loss of revenue from the tax, which mainly goes toward funding the road fund. There has been wide criticism that these revenues have been misused in the past.