Economic effects of changes in VAT rates in Russia

Tikhonova Anna Vital'evna ORCID: 0000-0001-8295-8113 PhD in Economics Associate Professor, Leading Researcher, Department of Taxes and Tax Administration, Financial University 127083, Russia, Moscow, Verkhnyaya Maslovka str., 15, room 507 samozvanka_89@bk.ru Other publications by this author

Zas'ko Vadim Nikolaevich Doctor of Economics Dean of the Faculty of Taxes, Audit and Business Analysis, Financial University 15 Verkhnyaya Maslovka str., Moscow, 127083, Russia VNZasko@fa.ru

Introduction

The popularity of VAT is due to its characteristics of tax neutrality and avoidance of double taxation, as well as, more importantly, its role as an effective means of tax administration. Value added tax is not only a budget-forming payment that performs an important fiscal role, but also a significant economic regulator.

The high regulatory potential of VAT is ensured by the fact that a whole chain of counterparties from producers of resources and means of production to end consumers participates in the process of creating added value in the production of goods, works, services (hereinafter TRU). Since the purchases of one firm are sales of another, the buyer's tax evasion by understating or failing to provide information about purchases may make it difficult for the seller to understate or fail to provide information about sales, since the same transaction in intercompany trade is registered on both sides in the form of incoming and outgoing VAT. All elements of such a chain are interconnected through the mechanisms of accrual and deduction of tax, and therefore, by transforming individual elements of this payment, the state affects the entire chain of counterparties to varying degrees. Thus, VAT naturally has the properties of self-fulfillment. Table 1 below shows the potential impact of individual VAT calculation mechanisms on economic agents.

Table 1 – Matrix of the impact of individual VAT calculation mechanisms on economic agents

Source: compiled by the author himself.

Within the framework of this study, we will analyze the emerging effects of a number of these areas, paying attention, first of all, to the change in the tax rate within the framework of the Russian reform 2018-19.

Literature review

The issues of assessing the effects of changes in the value added tax do not lose their relevance in the research of domestic and foreign authors. Traditionally, research has focused on the impact of indirect taxes on consumers through the impact on prices. At the same time, most of the work is devoted to the study of the impact of changes in VAT rates. In a number of works, various coefficients of the transfer of VAT changes to prices are estimated ^{[1, 2]}, and in some of them an important asymmetry in the effects of increasing and reducing VAT rates is documented ^{[3, 4]}. Thus, the work of Mexican scientists reveals the effects of a reduction in the VAT rate of 16 to 8% on the country's northern border with the United States in 2019 ^[5]. According to the authors' calculations, the reduction in the VAT rate led to a decrease in the consumer price index by 2.57%, this effect manifested itself quickly within one month. A similar decrease in inflation with a drop in the VAT rate was also revealed in a domestic study by Elkina M.A. ^[15]. In turn, the assessment of the effects of the VAT rate increase in 2019 by Russian scientists showed the following trends: a decrease in the purchasing power of the population, an increase in inflation ^[6].

Recent studies of the application of consumption taxes show that they have a direct impact on results that go beyond prices, such as corporate profits, investments, innovations. VAT differs from direct corporate taxes in terms of its potential impact on business, since it is a turnover tax, which, in accordance with classical economic views, has the characteristics of tax neutrality. However, VAT is not always completely neutral for a number of reasons ^[7]. Firstly, not all enterprises can carry out a full transfer of the tax burden through various market operations, which makes VAT non-neutral. Moreover, VAT is more likely to affect the operating activities of enterprises, the demand for products and cash flows and, ultimately, will affect the size and duration of debt financing. The effects of the VAT rate increase in 1995 ^[8] and 2014 ^[9] were estimated on the example of Mexico. In the work of Aportel and Werner, a number of effects (not only price effects) have been studied. Firstly, the VAT increase led to an increase in prices, but this increase was lower than the nominal rate increase. This refutes the conclusion that the VAT increase is fully transferred to consumers. In this context, it is important to take into account the specifics of the national economy, since a similar study on the example of European countries showed ^[10] that the VAT increase is fully transferred to consumers three months after the tax reform. Secondly, the VAT reform had a negative impact on wages (reduced it by about 2.0%) without affecting the level of employment. A similar reverse effect was revealed by Benzarti and Carloni ^[11]: the authors show that the wages of employees can increase with a decrease in VAT. Researchers of the Russian Academy of Sciences have found another effect of the impact of the increase in the VAT rate on wages on the example of Russian practice: the total inflow to the country's budget from the increase in the rate amounted to about 800 billion rubles, of which more than half are aimed at increasing public sector salaries, pensions, scholarships, social benefits; infrastructure development, sports, financing of healthcare and education ^[12]. At the same time, if the purchasing power is limited and price growth is not possible for each of the participants in the chain, an increase in the VAT rate by 2% will affect a decrease in the profitability of each participant in the chain ^[13].

The impact of the VAT rate on the Chinese economy is different: the reduction of the VAT rate in 2018 significantly reduced the share of borrowed funds and the current debt ratio of enterprises, but did not have a significant impact on the long-term debt ratio. Further research shows that the effect of deleveraging as a result of the reduction in the VAT rate was more significant for state-owned companies with a high share of borrowed funds, small and medium-sized enterprises and companies in eastern China. In western China, the total leverage ratio of enterprises has not undergone significant changes.

Thus, as the review of scientific literature has shown, the impact of the VAT reform is differentiated, it manifests itself not only in pricing policy and inflation, but also in the indicators of financial condition, profit and debt financing of companies. At the same time, the impact of VAT changes on various economic parameters depends on the context of their implementation and the state of the economy not only of a particular country, but also of its region (zone).

Research results

Effect 1 is inflationary. The last significant change in the VAT rate in Russia occurred in 2019, when it was increased from 18 to 20%. Even at the stage of approving the law , analysts of the Central Bank of the Russian Federation noted: "How significant the impact of the VAT increase on inflationary processes will be and how it will be distributed over time depends on various factors from the supply and demand side in the markets of goods and services, as well as on the dynamics of inflation expectations... The assessment of the Bank of Russia included in the June macroeconomic forecast is about 1 percentage point" ^[14]. Table 1 below shows the dynamics of the consumer price index during the period of VAT rate increase.

Table 1 – Quarterly consumer price indices for goods and services in the Russian Federation in 2005-2023. (quarter to the corresponding quarter of the previous year)

Source: compiled by the author according to Rosstat.

As can be traced according to Table 1, inflation in 2019 increased sharply, and for food products – almost twice, which most strongly affects the reduction in purchasing power. It is important to note that this effect has been achieved despite the fact that 33% of the population's spending is on goods and services that are taxed at preferential VAT rates ^[14]. Similar reverse inflationary effects when the VAT rate was reduced from 20 to 18% in 2004 were revealed by Elkina M.A.: reduction of the standard VAT rate and the abolition of sales tax (with an effective rate of about 4%) in early 2004 led to a reduction in inflation by 0.6–0.7 percentage points, while the effect of the transfer was quite distant from the full, and a significant part of the benefits from tax cuts were received by producers and sellers of products, not consumers ^[15]. It is necessary to agree with the author in this context, since the reduction of rates is considered an element of increasing the fairness of taxation only if the tax reduction is fully transferred to consumer prices. However, in practice, manufacturers do not always transfer a full VAT reduction to the consumer. Otherwise, such a reduction in VAT is considered as an indirect subsidy to producers, which does not directly affect the demand for goods and increase its availability.

Effect 2 – budget. It is possible to justify the government's decision to raise the VAT rate as effective with a significant budgetary effect, since this aspect was the reason and was fundamental in promoting the reform (Table 2).

Table 2 – Budget effect of increasing the VAT rate in 2019, billion rubles.

Source: compiled by the author according to the Ministry of Finance of Russia.

The increase in the VAT rate has led to a positive effect for the budget, the growth rate of tax revenues has increased by 20% over 3 years, despite the negative consequences of the pandemic that have already manifested in 2020. They largely exceeded the growth of consolidated budget revenues. It is important to take into account the impact of the tax rate on business (Figure 1).

Source: compiled by the author according to Rosstat and the Federal Tax Service of Russia.

Figure 1. Dynamics of tax burden indicators during the sanctions period

The data in Figure 1 show the absence of a significant increase in the tax burden on business in 2019 compared to 2018, which indicates the absence of a sharp negative impact of the VAT rate on producers, at the same time, the question arises about the nature of such an impact on consumers of labor.

Effect 3 – consumer. One of the manifestations of the regulatory role of VAT is a possible reduction in consumption volumes with an increase in tax rates, which was revealed in the framework of a review of the scientific literature. To assess the impact of the VAT rate on consumer preferences, we will analyze the dynamics of the consumer confidence index, which characterizes the degree of optimism of the population about the state of the economy, which is expressed through consumption and saving (Figure 2).

Source: compiled by the author according to Rosstat and the Federal Tax Service of Russia.

Figure 2. Dynamics of the consumer confidence index

As the data in Figure 2 show, a significant decrease in the index (almost 2 times) occurred in the 3rd quarter of 2018, it was during this period (July 2018) that an increase in the VAT rate from 18 to 20% was announced. At the same time, the index stabilized only by the 1st quarter of 2020.

The volume of consumption is estimated through the index of the physical volume of retail trade turnover, which decreased on average in Russia in 2019 compared to 2018 by 0.9 percentage points (with the maximum drop in the Republic of Ingushetia by 7.6 percentage points and the maximum growth in the Republic of Dagestan, where extremely low index values were obtained in 2018 - by 10.8 At the same time, in 27 subjects of the Federation, the growth rate of physical trade turnover in retail in 2019 did not exceed one percent.

Effect 4 – investment. The assessment of investment effects can be carried out through the analysis of the system of indicators characterizing investment processes and investment attractiveness of the Russian economy (Table 3).

Table 3 – Indicators of investment activity results in 2018-19

Source: compiled by the author according to Rosstat.

According to the data presented, in general, the investment situation in 2019 is positive: there is an increase in gross accumulation (even despite a decrease in its source – gross savings by 2.9%), the volume of fixed assets introduced and investments in fixed assets. The growth rates of prices for investment products became lower in 2019 compared to 2018. Thus, on the scale of the entire economy, the negative impact of the VAT rate increase on investment processes has not been revealed.

At the same time, it is important to take into account that the existing types of economic activity are heterogeneous in terms of contribution to GDP and value creation. In particular, V.G. Panskov argues that an increase in the VAT rate will have the most negative impact on the state of high-tech sectors of the economy with higher wages ^[16]. Moreover, from the point of view of the role of VAT, individual foreign economic activities and industries are exempt from taxation either completely or in a significant part (for example, the financial sector, education, medicine, etc.). Therefore, the assessment of the investment effects of the VAT rate increase should be carried out in the sectoral context (Table 4).

Table 4 – Commissioning of fixed assets, billion rubles.

Source: compiled by the author according to Rosstat.

In general, the bulk of industries developed investment activities after the VAT rate increase, with the exception of housing and communal services, hotels and catering, as well as other types of services, where there is a decrease in the volume of fixed assets introduced in 2019 compared to 2018. Thus, the significant impact of the increase in the VAT rate from 18 to 20% in Russia on the investment activity of companies in the sectoral context has also not been revealed.

Limitations of the research methodology.

The limitations of this study consist in the absence of separation of the identified effects from various potential sources of their occurrence. The authors consider the economic effects provided that the influence of other factors that are not included in the assessment of the VAT reform is "frozen". This is due to the fact that global economic shocks (financial crises, pandemics, etc.) are not typical for 2018-19, which could have a significant impact on the analyzed parameters. It is also important to take into account that the extension of the dynamic period for analyzing the long-term effects of VAT changes is also not carried out due to the fact that in 2020 the COVID-19 pandemic had the most important impact on the change in individual economic indicators, this makes it impossible to compare this time period and the period 2018-19.

Conclusions and suggestions.

As the results showed, an increase in the VAT rate leads to a number of economic effects. As a positive effect, it is worth noting the increase in the volume of tax revenues of the budget from this payment, which is ensured, among other things, by high-quality tax control. The identified negative effects should include an acceleration in the rate of inflation, as well as a reduction in the growth rate of TRU consumption in the short term. Thus, the results of this study are consistent with the estimates of research by domestic and foreign scientists in the field of the inflationary impact of VAT. At the same time, the hypothesis of a significant impact of the increase in the VAT rate on the level of the tax burden on the economy and inflationary processes in business was not confirmed (the negative effect is manifested only in the context of certain types of activities).

From the point of view of assessing the joint effects for the state, business and the population, it has the most negative impact on the latter. This negative influence is manifested largely due to the regressive nature inherent in VAT and manifested with a significant decrease in the share of tax in the income of the population with their increase ^[17]. The potential directions of practical use of the results obtained are the possibility of developing tax policy tools. In particular, based on the results obtained, it seems appropriate to increase the amount of social transfers to the population (pensions, allowances, scholarships) by a multiple when the rates of indirect taxes increase without taking into account the annual inflationary growth, since it is it that bears the greatest losses from this kind of tax reforms.