Putin's new sales tax shows pain of Russia's policy dilemmas

Russia's new tax on sales, backed by President Vladimir Putin, illustrates growing economic strains from Western sanctions over Ukraine - and the lack of easy solutions. Under the tax plan, regional governments will have the option from next year to introduce a 3 percent tax on sales to cover their budget shortfalls.
Analysts say such hikes will boost already stubbornly high inflation, increase the burden on business and add to the restraints on economic growth. Yet Russia needs to plug the tax holes left by a slowing economy.
Economists polled by Reuters project that Russia's economy will grow by a feeble 0.3 percent this year. If Russia introduces the sales tax, "business sentiment will remain depressed and will probably decline further - which is clearly not the best recipe for a recovery in investment", said Vladimir Kolychev, chief economist at VTB Capital in Moscow.
"Secondly, (the tax) will certainly put a dent into consumer budgets and will continue to restrain consumption into next year via higher inflation."
The planned tax, which will be on top of an existing 18 percent Value Added Tax levied by the federal government, is a response to a serious shortfall in regional tax revenues that is now being exacerbated by the economic slowdown.
"The goal of this (sales) tax is to make regional budgets more balanced - at least to help them narrow the budget deficit," said Vladimir Redkin, senior director at Fitch Ratings CIS. "In 2013 the deficit increased significantly and this trend is continuing in 2014."
The Ministry of Finance projects that in 2014 regional governments will run a combined deficit of some 857 billion roubles ($24 billion), some 1.2 percent of gross domestic product (GDP) - a figure that has grown steadily from just 35 billion roubles in 2011. The trend illustrates how the seemingly healthy federal budget, projected to run a 0.4 percent surplus this year, masks deep structural problems with overall government finances.
Whereas the federal government raises around half of its tax revenues from oil and gas, an income source that depends on global energy prices, regional governments are more dependent on local taxes and hence on the state of Russia's own economy.
Fitch's Redkin said that regional deficits have grown as a result of Putin's policy of boosting public sector pay. The problem has lately been exacerbated by stagnant proceeds from corporate income tax, the regions' main revenue source, as the slowing economy bites into businesses' profits.