An Analysis of Value-Added Taxes in Russia and Other Countries of the Former Soviet Union


WP/95/1-EA
An Analysis of Value-Added Taxes in Russia and Other Countries
of the Former Soviet Union Victoria P. Summers and Emil M. Sunley

Since the end of 1991, Russia and the other transition countries that
were part of the Soviet Union have adopted value-added taxes (VATs). The
VATs in Russia and in all the other countries except Estonia, Latvia, and
Lithuania (referred to in the paper as the other transition countries)
were originally almost identical to the VAT adopted by the Soviet Union in
December 1991, upon the eve of its dissolution. Although the laws of the
various countries have diverged over the past two and a half years, most of
them still share certain features derived from the 1991 Soviet model.

In principle, the VAT is an efficient, neutral revenue source at the
national level. And, in fact, these new taxes now generate a very
significant portion of total tax revenues in Russia and the other transition
countries. But large and growing arrears in the payment of interenterprise
obligations correlate closely with declining revenue performance. This
correlation arises in part because interenterprise arrears give rise to
liquidity problems, which lead directly to tax arrears, and in part because
timing asymmetries resulting from the unique structure of the Russian VAT
reduce VAT liabilities (but not VAT credits) in the presence of
interenterprise arrears.

The large number of exemptions and preferences found in the Russian VAT
causes both a loss of revenue and economic distortions. The major
structural anomalies found in the Russian VAT and in many of the laws of the
other transition countries include (1) accounting for VAT liability on sales
on a cash basis while allowing credit on inputs at the time the inputs are
put into production; (2) calculating the tax at the manufacturing and
production level on the credit/invoice method, and in the wholesale, retail,
and service sectors based upon the taxpayers' gross margins; and (3) denying
or delaying credits for the acquisition of capital inputs. The paper
recommends that all taxpayers ultimately use an accrual basis for both
credits and liabilities. The credit/invoice method should be extended
through final sales to consumers in all sectors. In Russia, credit is now
permitted for capital inputs, taken in installments over a six-month period.
The paper recommends that the countries that have not yet allowed any
capital input credits should begin to do so. Ultimately, all countries
should give immediate, full crediting for capital inputs. Excess credits
should be either refunded or, if carried forward, adjusted for inflation.

These transition countries must also decide how they will apply the VAT
to trade among themselves. The paper discusses the effects of adopting an
origin-method versus destination-method VAT as well as the issues raised by
using the VAT at the subnational level. It analyzes how, since the
inception of the Russian VAT, the approach to the problem of interstate
trade has evolved. The paper concludes that although administrative
considerations play a key role in how the VAT is applied, the basic choice
between the origin or destination method must depend upon the sort of
economic relationship the countries decide to establish among themselves.