Kudrin Prevails Over Fradkov in VAT Spat

The government has decided to keep the rate of value-added tax flat at 18 percent despite calls from Prime Minister Mikhail Fradkov to boost growth by cutting it, Finance Minister Alexei Kudrin said Friday.

Kudrin told reporters after a special budget committee meeting, chaired by Fradkov, that the government would not review the matter for three years.

"The prime minister has agreed with the proposal," Kudrin said. "But the final decision will be taken at a Cabinet meeting when a draft law is considered."

The decision to leave VAT unchanged for at least three years appeared to be a tactical victory for Kudrin, who has resisted calls to cut the tax on the grounds that it would undermine the government's attempts to bring inflation down to single figures.

Fradkov had championed a cut in VAT to 13 percent, believing it would help deliver President Vladimir Putin's goal of doubling the size of the economy.

But the highly cautious Kudrin has argued that lower VAT could endanger ruble stability and prompt the government to raid oil windfall revenues piling up in a stabilization fund meant for purposes other than repaying debt.

"It looks like this round has gone to Kudrin but there are many more rounds to come," said Roland Nash, chief strategist at Renaissance Capital.

Victory for Kudrin in the battle over VAT has come at a price. News agencies reported Kudrin offered to raise the threshold above which oil revenues are siphoned into the stabilization fund to $23 per barrel from $20 now.

But an official who participated in the meeting said Fradkov wanted the threshold of $27 per barrel, while Deputy Prime Minister Alexander Zhukov said the price should be above $23.

Economists say the higher the threshold, the greater the amount of tax revenues flowing straight into state coffers.

Russia's Urals blend of crude is trading at around $47.50.

Once the stabilization fund is bigger than 500 billion rubles ($18.21 billion), the law allows the government to spend it for purposes other than plugging budget gaps. The fund now stands at more than $26 billion.

Fradkov wanted to use some of the money to compensate for any shortfall that would have resulted from lower VAT. Kudrin, instead, wants the oil windfall money spent on repaying foreign debt and Russia is now in talks with the Paris Club of creditor nations to repay $15 billion of debt early.

"It was a compromise ?€” VAT is intact, but the ceiling was raised, increasing budget dependence on the oil price," said Vladimir Tikhomirov, a UralSib analyst.

"The ceiling does not matter very much at current prices as the budget and the fund would get equal money from oil, but oil prices are cyclical."

He said that the very idea of lower VAT was faulty as it increased budget dependence on the energy sector.

Kudrin also said the Finance Ministry was drafting a budget forecast for the next three years, taking a crude oil price of $32 to $34 per barrel as a basis.

Kudrin said that approving higher spending was the key issue at the meeting.

"A political decision has been taken to double salaries in the public sector by the middle of 2008, which increases spending significantly," he said.

Russia will hold presidential elections in March 2008.

"The government is raising wages but it does not require higher productivity," Tikhomirov said.