Tax reform is in the air in Russia. In theory, when the State Duma reconvenes this week, it will consider a law on tax reform designed by the government to lift the tax burden off the corporate sector and spread it elsewhere.


The main ways the government is proposing to lighten the corporate tax burden is to reduce the rate of corporate profits tax and to cut out completely the tax on excess wages. This much-detested tax requires companies to pay profits tax on wages deemed "excessive" (over about $60), whether or not the company is making a profit.


Western companies have been underwhelmed by the proposals for cutting the profits tax. They are more interested in relief from features of the tax system which, like the excess-wages tax, mean they are taxed whether or not they make a profit.


Nevertheless, agreeing on which taxes to reduce will be relatively easy. The hard bit is always working out which taxes to raise in order to make up for the lower corporate taxes.


Deputy Finance Minister Sergei Aleksashenko, who has been making the running on tax reform (presumably, acting Finance Minister Sergei Dubinin has more important things to do with his time), has not been too convincing on what he is going to do to increase taxes.


He has suggested he will raise personal income tax marginally. This will not raise that much money given the small share of personal income tax in the Russian tax mix.


His main proposal has been that he will wipe out tax avoidance loopholes and various special exemptions which are costing lots of money.


This sounds politically popular since no one likes the idea of people getting special privileges over others. But what exactly does Aleksashenko have in mind?


He gave a few examples in an article in Izvestia this week. One would end the current exemption on personal income tax from interest earned on deposits in commercial banks.


This may seem like a small issue, but it is in fact a way of cracking down on a thriving tax avoidance industry. As Aleksashenko points out, companies can use this to avoid paying payroll taxes and workers to avoid income tax.


How? Banks do deals with companies under which the companies formally pay their workers a minimal income which is then formally invested in the bank. The bank then pays a very, very high rate of interest to the worker.


The company pays payroll taxes only on the fictitious declared wage and the worker does not pay any tax on the great bulk of his wage which, by means of this cunning ruse, is structured as tax-free interest, not wages.


A similar trick applies in the life insurance industry, but at least there some tax is payable.


Canceling this exemption will net the government a lot of money, but commercial banks will scarcely be pleased if they lose this wonderful source of income.


Aleksashenko has also got his sights on a few other juicy exemptions. He would like to extend personal income tax to people in military organizations, who are currently exempt. That means taxing a lobby group of about 3 million Russians, something that is bound to arouse a howl of political protest.


He would also like to get rid of a series of exemptions on the value-added tax. The main target is to extend the VAT to imported food, which for some mysterious reason is currently exempt. He would also like to tighten a system in which a vaguely defined group of products qualify for a reduced VAT rate of 10 percent rather than the normal 20 percent.


What, then, is Alekshashenko proposing? Annoy the commercial banks, who are Russia's richest and best organized lobby group. Annoy the military, potentially Russia's most threatening force. Raise the price of basic foodstuffs, which will annoy almost all Russians.


These objectives all have very sensible economic justifications, but can they be made to fly politically?


Clearly, the fact that a relatively minor player like Aleksashenko is spearheading such a crucial issue means that at this stage the government is leaving itself plenty of room for a backdown. It could be a long time before any consensus emerges on tax reform.





Geoff Winestock is a Moscow -based correspondent for The Journal of Commerce.