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Moskovskiye Novosti, No 41, October 28, 2003

Government Lacks Credibility

By Boris Vishnevsky

The shadow (or latent) economy accounts for an estimated 25 per cent of gross national product. The question is: Is the shadow economy a negative economic factor that has to be eliminated?

Yes, it must be eliminated, the majority of experts say. A clandestine economic sector that is so large is bound to lead not only to a shrinkage of budgets at all levels, but also to smaller pensions than they could have been. This concerns both the fighters against the shadow economy and every inhabitant of the country.

Two methods are usually put forward to bring the shadow economy out into the open: the stick and the carrot. The first signifies tougher sanctions against covert economic activities; the second implies lower tax rates as an incentive to legalize such activities.

The stick is unlikely to produce the desired effect. The Russian entrepreneur has long learned how to circumvent any barrier. If the worst came to the worst, he would avoid severe punishment by bribing the taxman.

Things are more complicated with the carrot. It is true that lower taxes or the abolition of poorly collected taxes help to render some of the shadow economy transparent. For example, there are plans to lower the single social tax rate from the present 35.6% to 26% from 2005 - a measure that is hoped will make many entrepreneurs record the actual wages of their workers. True wage accounting is bound have positive results, given that up to 40% of wages in Russia have yet to be legalized, experts say. But at what price? Through a sharp drop in single social tax receipts, which would lead to lower pensions.

Here we perceive an obvious contradiction between the state’s long-standing lack of credibility, which dissuades citizens from paying their taxes, and the desire of the same citizens to get the state to resolve their problems. How can this contradiction be overcome?

The first thing is to make people see that the tax rates are just. For example an individual agrees to pay a 13% income tax, but flatly refuses to pay property tax assessed on the market (and not book) value of his apartment, as proposed by the Economic Development and Trade Ministry. If the tax is assessed on the market value of an individual’s apartment at the current rate, the individual will have to pay a property tax of $1,000 a year on a medium-sized apartment located in Moscow or St. Petersburg.

Secondly, state expenditures must be seen to be just. Unless citizens understand how their tax money is spent , and unless they believe the spending to be justified, no income tax reduction will help.

The situation can be rectified by making state expenditures transparent and by substantiating the need for various budgetary expenditure items. When the government’s priorities do not include higher pay for state-paid workers and proper funding of education and public health, and focus instead on the speediest possible repayment of foreign debt, citizens can hardly be expected to pay as much money as possible into the state coffers.


See also:

Tax Legislation

Moskovskiye Novosti, No 41, October 28, 2003

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