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Putin’s scenario for Russia

February 12, 2008 | RBC

To be staged by state companies and the government

By 2020, Russia will cease to be a raw material base for the West, becoming a developed innovation society, according to the picture painted by Russian President Vladimir Putin at the State Council’s meeting on Friday. Among the many targets outlined by Putin, two seem to be the most important: first, the President ruled out the risk of the government’s excessive interference in the economy, and second, he called for tax cuts, which could be seen as a sign of a new tax reform, putting some of the burden onto the population.

Almost half of Putin’s speech was about Russia’s achievements during his 8-year presidency. Indeed, there was something to boast about. According to official statistics, foreign investment in Russia increased 7-fold, from a net capital flight of between $10 billion to $25 billion in the early 2000s and to a record influx of $82.3 billion last year, while trade with foreign countries increased fivefold. "We have entered the ranks of the seven biggest economies in the world,” Putin said, adding that in 2007, Russia enjoyed the highest GDP growth of the past seven years, at 8.1 percent. Ranked by GDP growth in terms of purchasing power parity, Russia surpassed Italy and France, two countries in the G8 group of the world’s leading industrial nations. Real personal incomes increased 2.5-fold from 1999 to 2007, and pensions rose accordingly, while unemployment and poverty rates were cut in half.

“The underlying idea was that all targets have been achieved,” says Igor Nikolayev, chief strategic analyst at FBK. A top priority for a new government, which is expected to be headed by Putin himself after he steps down as President in March, will be to build an innovation society. Putin stressed the need to remove excessive pressure on the economy. The public sector, which currently employs 25 million people, is to be reduced over the next few years. “The President made it clear that there are no risks of the government’s excessive interference in the economy,” said Sergei Belyakov, Deputy Chairman of the Tax Committee of Russia’s Union of Industrialists and Entrepreneurs. “Apparently, large state corporations are being created for a short term,” he added.

According to Nikolai Freitak, Vice President of AGA Management, the President wants to give unprofitable companies into private hands. And Eduard Kucherov, the head of the Tax and Legal Department at Baker Tilly Rusaudit, believes that, speaking about plans to reduce the public sector, the President did not mean to reduce the number of large state corporations and abolish companies wholly owned by the state, but that he spoke of plans to reduce bureaucracy and slash the number of companies financed from the state budget.

Another important aspect of President’s statement was a call to cut VAT. “It’s necessary to introduce a single VAT rate, and it should be as low as possible,” Putin said. Arkady Dvorkovich, the head of the Presidential Expert Directorate, said VAT rates could be reduced to 12-13 percent. The business community welcomed Putin’s initiative. Boris Titov, Chairman of Business Russia, said he was particularly pleased with Putin’s pledge after the Finance Ministry’s statements that the tax reform was over.

According to Belyakov, VAT rate cuts would “ensure structural changes in the economy, stimulate the development of manufacturing and ease Russia’s dependence on world energy prices.”

But it is not concrete VAT rate proposals that matter, but the publicly voiced idea of cutting one of the keystones of Russia’s fiscal system. Other taxes, such as the single social tax and the profit tax, could be changed as well. According to Nikolai Freitak, it will be impossible to slash the single social tax over the next few years as it is crucial for the financing of pensions and social programs. The profit tax will not be reduced significantly, either, but new tax benefits could be introduced, for example, for research and development projects.

Apparently, the reduction in corporate tax revenues will be offset by personal taxes. Eduard Kucherov expects Russia to return to the idea of a progressive income tax rate by 2020. “Most likely, property tax rates and land rental fees will be raised, in line with global tendencies,” he reckons.

Valery Protashchik, a consultant at Business Systems Development, hopes that the tax administration system would not be too strict. “Russia’s tax system, despite multiple law amendments, is quite simple and clear,” Protashchik said. “Oversimplification leaves more opportunities for lawlessness than detailed tax regulations,” he said, noting that it would be more important to bring order to law application practice by fiscal and judicial bodies.

Analytical department of RIA RosBusinessConsulting

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