03.09.08

In the fall of last year, Russia's fiscal organs were merciless. They forced almost every enterprise that once paid wages "under the table" to start paying over it. This helped account for a 58 percent increase in VAT collected in the first quarter of 2008, and a 53 percent increase in collections for Unified Social Tax. This gave a serious boost to the federal budget. However, the majority of the weight was borne by the processing sector, which is made up of mostly mid-sized businesses.

As a result, the profitability of enterprises – which before had margins of 5-7 percent – decreased by 6-10 percent; Many Russian manufacturing enterprises became unprofitable. A 42 percent increase in imports in the first quarter of 2008 was another consequence as was a serious decrease in the output of the processing sector in June.

A couple of years ago ex-prime minister Mikhail Fradkov tried to push VAT down to 13 percent, but he met extreme opposition from Alexei Kudrin, the head of the Ministry of Finance. Now circumstances are compelling a reduction. Experts predict that lowering VAT to 12 percent would cause a whole complex of positive changes in the economy, including an increase in investments in human capital. Businesses would be free to invest the money that is currently spent on VAT into production infrastructure.

The processing sector has long needed to modernize equipment: across the country, wear and tear is approaching 80 percent. Investing in innovations is a must in order to compete with countries where equipment is renovated every 2-3 years.

There is strong reason to believe that renovating the economy's structure, which lowering VAT would help bring about, would be the best insurance against a potential fall in the price of oil. Sergei Belyakov, the Vice President of the Committee on Tax and Budget Policy of the Russian Union of Industrialists and Entrepreneurs, believes that the positive effects of lowering VAT would outweigh the negative. Both presidential aide Arkady Dvorkovich and head of the Ministry of Economic Development and Trade Elvira Nabiullina support lowering VAT. Not long ago in a meeting in the Smolensk Region, President Dmitrii Medvedev emphasized that business cannot be looked at a simple fiscal mechanism because people stand behind it. However, Aleksei Kudrin, head of the Ministry of Finance, won't budge: he believes the budget would lose too much by lowering VAT, and that it could be the decisive factor in speeding inflation.

In the West, VAT experienced a revival after the Great Depression in the 1930s as a reaction against overproduction. But Russia is facing an entirely different problem – a shortage of domestically produced goods.

In the beginning of July, 70 company executives of small and mid-sized businesses, representatives of the all-Russian Non-Governmental Organization “Delovaya Rossiya,” sent a petition to Igor Shuvalov, the Vice Prime Minister of the Russian Federation, and Elvira Nabiullina, Minister of Economic Development. “Russian enterprises are reducing manufacturing activity and are closing on a large-scale,” the petition reads. The authors also note that manufacturing has become unprofitable: it makes more sense to buy goods in China and sell those instead of producing domestically.

According to some businessmen, the only way out of this complicated situation is to lower VAT to 12 percent as soon as possible, before September 1. “Otherwise by the end of the year, Russia will lose up to 40 percent of its manufacturers, output will decrease, and so will tax collection,” conclude the authors.

It makes sense that the members of Delovaya Rossiya are calling for a decrease in VAT, since that organization represents the interests of enterprises from the processing sector. According to the estimates of experts, this sector bears more than 65 percent of the tax load. This is two times higher than that borne by the extractive industry. The commercial sector, for example, bears about 2 percent.

VAT has long been a subject of controversy because it is burden for all of Russian business. Research shows that in Russia the overall tax load is two to three times higher than in countries with developed free-market economies. For example, in the US, the tax load is about 35 percent, while in Russia it is two times higher. Businessmen believe VAT is the greatest burden – it makes up 70 percent of the tax load, while in the US it does not exist at all. During the first year of VAT’s existence in Russia it destroyed half of the enterprises and wreaked havoc with light industry. VAT creates conditions that make it more profitable to sell raw materials and consumables abroad rather than domestically. Many blame VAT for the shortage of coal and iron ore in Russian industry and the enormous quantities of lumber that flow abroad rather than being processed domestically.

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