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Analysis & Opinion
07.09.11 Earn More, Pay More
By Tai Adelaja

Russian President Dmitry Medvedev has consented to a government plan to introduce a two-tier payroll tax system starting next year, bringing some closure to a dispute that has pitted the Kremlin against Vladimir Putin's government. The government will impose a 30 percent payroll tax on salaries of up to 512,000 rubles ($17,393) per year and add a 10-percent levy on wages exceeding that amount, according to the plan announced by Presidential Aide Arkady Dvorkovich on Monday.

"The president gave his backing to a government proposal to impose a ten-percent levy on payroll contributions to social non-budgetary funds for all companies where the wages per employee exceed 512,000 rubles per year,” Dvorkovich said.

It remained unclear on Tuesday if the new package includes a long-awaited reduction in payroll tax for small and medium-sized businesses. Dvorkovich said the president expects the government to introduce measures that “will compensate for increases in the tax burden on high-tech and engineering companies.” The president also wants the government to bring down payroll taxes “for certain categories of small enterprises to 20 percent,” he said. Analysts say the government's plan has effectively scuttled one of president Medvedev's top policy goals to drastically reduce payroll taxes. Instead of the hyper-hyped tax reduction, the plan has instead redistributed the tax burden between low and high income segments of the economy, the Kommersant business daily wrote on Tuesday.

Sergei Borisov, the head of Opora, the country's largest association of small and medium-sized businesses, said the double-tier tax plan would discourage employers from raising wages. “The 30-percent rate is not much different from the current rate, which is considered too high for small businesses,” Borisov said. “We can see good companies dying off. Most of those that want to survive have no choice but to go underground.” Other experts and industry leaders have said the 34 percent payroll tax may stifle small and medium business, so crucial to president Medvedev's goal to diversify the economy. “It is not only because small and medium sized enterprises generate the most sustained economic activity, but so many of the innovations and modernizations and diversification aspects of the economy that the Kremlin hopes to carry out come out of small-sized businesses,” said Peter Necarsulmer, the CEO of PBN Company.

In January, the government increased the payroll taxes – payments which companies contribute to social funds depending on the level of their employees' salaries – to 34 percent, from 26 percent in 2010. Dvorkovich said the budget could lose from 400 billion to 500 billion rubles ($14.3 billion to $17.8 billion) if the tax was to be reset back to the previous level of 26 percent. He added that the government had expected to bring in 700 to 800 billion rubles by raising the tax. The shortfall could, however, be compensated for through hikes in alcohol and tobacco excise duties, and partially by increasing revenues from oil and gas exports, the presidential aide said in April.

President Medvedev first unveiled his tax cut proposal during a landmark speech in Magnitogorsk in March. He followed up at the St. Petersburg Economic Forum in June, ordering the government to find ways to reduce the maximum payroll taxes from 2012 to 30 percent from the current 34 percent, and to just 20 percent for small businesses working in manufacturing and the social sectors. However, Prime Minister Vladimir Putin told a business forum in May that while the government agreed with president Medvedev that the payroll tax, which finances pensions and the state healthcare system, should be cut, "we have to calculate, we cannot make any mistakes here." Local media reports suggest that there have been some behind-the-scenes wrangling between the White House and the Kremlin over the issue. Dvorkovich told journalists in June that there had been no unanimous decision on payroll tax cuts.

Last month, the Russian prime minister said he was backing a proposal to levy a payroll tax on higher salaries, to offset the cut cost to the budget, which he said could reach $16.4 billion in 2012. “The missing revenues are very substantial. In order to at least partially cover them we are proposing to introduce additional contributions to social security funds on high salaries,” Putin told a government meeting in July. Russia is expected to run a fiscal deficit equal to 2.7 percent of the GDP next year. But the new two-tier tax could bring up to $5.7 billion into the budget, and with the average annual salary in Russia at only $9,640 it will only affect the minority of Russians. The Finance Ministry expects the decision to affect only the high income sectors, such as banking and energy.

"Of course, this is somewhat of a disappointment,” Alexander Shokhin, the head of Russia's big business lobby, the Russian Union of Industrialists and Entrepreneurs, said. His lobby group had earlier suggested that government should pursue a more aggressive privatization policy and use proceeds from the program to compensate for shortfalls in the budget that could result from tax reduction. “This is a redistribution of the tax burden between low and high-paying industries, but not a [tax] reduction,” Shokhin said. “Months of discussions have failed to provide answers to that question.”
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