Tax Shortfall Threatens Budget

Economics is not everybody's chosen interest, but recent horror stories about Russia's budget will have been noticed by even the most occasional eco-pundits. The International Monetary Fund, usually tight-lipped, says the budget is "alarmingly tight." And Mikhail Zadornov, the widely respected chair of the Duma's Budget and Banking Committee, is forecasting fiscal Armageddon.


In the first quarter of 1996, preliminary figures indicate a budget deficit of 5 percent of GDP by the Finance Ministry's definition -- rising to 6.3 percent if, as the IMF suggests, interest payments on domestic government debt are included. This seems broadly in line with the agreement between the government and the IMF. Perhaps the planned "indicative" deficit target for March was dented slightly, but nothing really serious. So why the current scare-mongering?


On the expenditure side, Russia has conducted a remarkably restrictive fiscal policy since the days of the Soviet Union. As recently as 1992, consolidated government expenditures were 60 percent of GDP. But by 1995, planned federal expenditure had fallen to 26.7 percent, with the government eventually spending only 17.5 percent of GDP. And during the first three months of this year, government expenditures have been only 75 percent of those envisaged in the 1996 budget law.


The problem is not expenditure, but revenue. Although Russia inherited a budget deficit of 32 percent of GDP from the Soviet Union, it did not simultaneously inherit a ready-made tax collecting mechanism. Under central planning, taxes were withheld by the state, rather than declared by firms. Russia is currently having problems collecting taxes because a burgeoning private sector is barely included among official measurement of economic activity, and therefore cannot be taxed. Other former communist economies have not suffered as badly: In 1995, consolidated (federal and local) revenues were 36 percent of GDP in Bulgaria, 45 percent in Poland, but only 25 percent here.


The reason much of Russia's economy remains "informal" is the tax system itself. In Russia, the tax take is low because punitively high rates of tax mean private sector activity is not declared, resulting in widespread non-compliance. Up until now, the government has been able to scrape together enough tax rubles to prevent the alarm bells ringing. But in the first quarter of 1996, preliminary figures indicate government revenues were only 8.2 percent of GDP, compared with 14.1 percent in 1995. This is some 46 percent off target. The deficit has been kept close to the IMF's target by a combination of expenditure cuts and creative accounting on both sides. But there is no denying the current revenue performance is dire.


An unwillingness to believe that money given to the government will ever be used productively -- easily explained by several generations of state confiscation and oppression -- means tax collection in post-communist Russia was always going to be difficult. But since 1992, this sentiment has given way to profound cynicism among entrepreneurs watching a government repeatedly break its own law -- imposing taxes retroactively, doling out selective exemptions for no good reason and refusing to refund advance taxes paid in excess.


But there are reasons why the last three months, in particular, should have seen a reduced tax take. Taxes are generally lower in the first quarter due to slower order books and more days off. In addition, the revenue side has this year withstood the abolition of the excess wages tax, the removal of "special tax," the reduction of export tariffs and the partial reduction of the profits tax base.


Probably the most important reason behind the current revenue crisis is that entrepreneurs are waiting to see who will win the election. In the old days, powerful positions such as those in the State Taxation Service were political appointments. In the event of a victory for Gennady Zyuganov, perhaps the face of the tax authorities will change, perhaps not. Until the doubt is removed, Russian entrepreneurs are even less willing than usual to pay tax because they simply do not know who they are paying.


One reason why Russia's private sector is so put off is that Russia's existing tax system was originally designed to collect revenue despite the absence of an efficient tax administration. For this reason, the current tax structure underplays the taxation of individuals and property, placing too much weight on VAT, excise and especially profit. Federal and local profit taxes, slated at 13 percent and 22 percent to 25 percent respectively, are in reality much higher as several "business" expenditures such as insurance, advertising and interest payments are also liable to tax. Whereas profit tax typically provided 7 percent of budget revenue in the West last year, in Russia it accounted for 26 percent.


Since the beginning of the year, tax arrears -- money the government knows it is owed -- have increased by almost 40 percent in real terms. This increase happened despite a January decree allowing arrears to be rescheduled provided current tax liabilities were met. The decree was part of a piecemeal effort to restructure the tax system, which also included the abolition of the so-called 30:70 rule. The rule allowed firms to ring-fence 30 percent of their revenue from tax inspectors in the name of guaranteeing wages payments: Abolishing the rule, the government and the IMF thought, would increase revenue, offsetting the removal of other distortional taxes. But rather than paying more tax, enterprises reacted to the 30:70 abolition by compounding the problem of wage arrears.


Much hope has been placed on Russia's new tax code, which could potentially change Russia's entire tax landscape for the better. But because the draft code has disappeared in the Duma, refusing to learn the lesson of the January round of decrees, Yeltsin's administration has again undertaken to re-write Russia's tax laws bit by bit. On the one hand, the recent "amnesty" decree lowers the extortionate late payments charges -- from 0.7 percent to 0.3 percent daily -- which have been driving the private sector underground. On the other hand, by cancelling the penalties accruing to late-payers, Yeltsin has increased tax cynicism by inadvertently rewarding dishonesty.