Russia Mulls VAT Cut

by Tatiana Smolenskaya, Tax-News.com, Moscow

17 March 2008

The Russian government is currently debating the feasibility of a proposal by outgoing President Vladimir Putin to slash the rate of value-added tax as means of encouraging more investment and economic growth.

In his keynote speech at the State Council’s meeting last month, Putin, who is expected to become Prime Minister when President-elect Dmitry Medvedev takes up his new post, called for a reduction in VAT to between 12% and 13% (VAT is currently 18%).

This proposal was included in Medvedev's election programme prior to the Presidential elections on March 2nd. However, the Finance Ministry is expected to oppose the move.

According to Reuters, the proposal to cut VAT was included in a document recently passed from the Economy Ministry to the reluctant Finance Ministry, which argued that: "The main positive effect will be the change of the quality of economic growth - investment will go to sectors with high added value."

The document also suggested that a new 10% rate should be introduced for socially important goods such as food, and proposed the scrapping a 24% corporate profit tax for transactions involving stakes of over 10% in Russian firms.

Supporters of a cut in VAT, which has been debated for some years, argue that it would boost economic growth by 0.7% within two years and encourage more taxable activity, thus reducing the size of the black economy.

But Alexei Kudrin, head of the Finance Ministry, which has the responsibility of balancing the government's budget, is not in favour of the idea, and the ministry has warned that a 5% cut in the rate of VAT in 2012 could wipe 1 trillion roubles (USD40.7 billion) off of the government's tax take. Currently about one-third of tax revenues come from VAT, according to the Finance Ministry.

The VAT cut proposal has opened up a debate between the business sector - which believes that the Finance Ministry is overstating the potential revenue loss - and analysts over whether the initial drop in revenues could be made up later through higher economic growth.

Anton Danilov-Danilyan, Chairman of Business Russia’s Expert Council, is reportedly of the view that a cut in VAT to 10% would lead to a loss of revenues of less than half that being suggested by the Finance Ministry, although economists are less convinced about the viability of the proposal.

Even if the Finance Ministry is forced to accept the proposal to cut VAT or other taxes, however, these could not be introduced until 2010 at the earliest, as the government's budget for 2009 has already been approved.

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