The abolition of the uniform social tax in 2010

On their meeting on October 1, 2008, the RF Government made a decision to complete in 2010 a major overhaul of the uniform social tax.

The uniform rate of insurance contributions on the compulsory pension insurance will make up 26% (prior to the reform, the basic rate was 14%, while another 6 p.p. of the uniform social tax (UST) was collected into the federal budget, to be consequently transferred to the budget of the Pension Fund to pay the basic part of the labor pension). With account of contributions to the medical and social insurance, in 2010 the overall amount of the respective payments will grow up to 34% of the labor compensations fund. Meanwhile the rate of contribution to the compulsory medical insurance funds will reach 5.1% (vs. the current 3.1%), while the rate for the Social Insurance Fund remains unchanged (2.9%).

In addition, it is planned to accomplish transition towards a two-stage taxation system, with a newly introduced marginal value of the taxed base (Rb. 415,000 a year, or roughly 145% of the average wages). Salaries and wages up to the noted amount will be subject to insurance payments at the 34% rate, while the amount of wages in excess of the said amount is subjected to 0% rate of taxation. In parallel with that, it is planned to introduce a uniform for all organizations and employers tariff of insurance contributions, regardless of their sectoral attribution1.

Whilst being in principle in agreement with the need in indexation of the SST scale, it must be noted that the version put forward by the RF Ministry of Social Development will result in an excessive rise of the tax burden, which might have fairly painful for the national economy effects.

First, most enterprises will see the tax burden on the labor compensations fund rise, which may result in a lower official employment rate. If compliance costs exceed those of dodging, there arise incentives to breaking legal relations with low-paid employees. As a result, a part of them moves into the shadow sector. Plus, if the rate of contributions for an individual corporation exceeds 31.5%, it finds it more profitable to pay for its employees’ labor out of net profit. Due to this, numerous corporations may renew the so-called “salaries-in-envelopes” practice. Rise in the tax burden on the labor compensations fund combined with a simultaneous deterioration of the state of affairs on external markets can result in a lower rate of employment (both the official and unofficial ones) and deceleration of the pace of economic growth.

Secondly, most likely in the current socio-political conditions a considerable rise of the tax burden due to payment of social contributions will have to be compensated by lowering other taxes. Hence, there arises the risk of a greater political pressure in favor of a lower VAT rate2.
Third, in the situation in which revenues to the pension fund are on the rise, the ruling elite may have an illusion that there appears a stable source of financing the pension system and no reform in this sector is needed. This will result in postponement of the decision to raise the pension age for long, while reserves accumulated at the expense of oil and gas revenues will be spent on purposes other than a most rapid transition to the savings pension system. As a result, even under very high rates of social contributions the pension system will face hard times.

Finally, all rules and procedures of the tax administration are presently regulated by Part 1 of the Tax Code. Once UST is abolished and transition to collection of social taxes is in place, there will arise the problem of identification of procedures of regulation of such contributions. Should they have the insurance nature, there must be identified all the substantial elements of the insurance system, that is, the insurer, the insured, insurance premiums, etc. This would require a radical reform of the medical and social insurance system. Hence, there arise the risk of failure to implement a qualitative reform of the said spheres by the declared timeline for introduction of the insurance payments (2010).

V. Nazarov, Head of the Budget Federalism Division

2 Raed more Е. Гайдар, А. Чубайс. Экономические письма. – М.: РОССПЭН, 2008.