Russia's Taxman Cometh Very Carefully

As tax police are gunned down, the Duma weighs a new code

Mikhail Nikolashin and Valentina Yaroslavtseva jump out of their battered Zhiguli and walk briskly to the door of a plumbing supply shop in the Moscow suburb of Podolsk. Ducking under toilet seats hanging from the ceiling, they approach a sales clerk and flash their badges. A few days earlier, an undercover colleague made a purchase that wasn't rung up on the register. Now, Nikolashin and Yaroslavtseva are investigating whether the business is underreporting sales to avoid paying taxes. Two burly policemen in bulletproof vests stand guard as the investigators confiscate owner Vladimir Zolotov's records. "We pay our taxes on time. We are law-abiding citizens," he protests.

Although Russian authorities make hundreds of such raids every week, they are losing the fight. The government collects only 60% of estimated taxes owed. Tax collectors have tried everything from military-style raids to television spots urging deadbeats to pay up. Now, Russian President Boris N. Yeltsin's government wants to overhaul the country's punitive tax system. Yeltsin is pressing the parliament to adopt a new tax code to replace the hodgepodge of laws enacted since the Soviet Union's breakup. The law would streamline tax rates, cut special levies, and lower the overall burden on taxpayers from 35.1% to 32.4% of gross domestic product.

NUISANCE LEVIES. Pressure has been mounting on Russia to clean up its tax morass. The government is borrowing heavily to make up a revenue shortfall averaging more than $2.5 billion a month. Even so, it will have to push for spending cutbacks of 20% this year. The International Monetary Fund has warned that it will not release additional payments of a $10 billion loan to Russia unless there is progress on a new tax code. And the tax system still scares away investment, while spurring capital flight.

The current system is a nightmare. Domestic and foreign corporate taxpayers pay a 4% tax on annual revenues, even if they make no profit. On top of that, the marginal tax rate on profits runs up to 35%. Companies can't take deductions for expenses such as travel and insurance. And they are saddled with nuisance levies such as a tax on the use of the word "Russia" in advertising. As a result, some businesses pay an effective rate of 100% of their profits, while others pay much less by abusing tax breaks for invalids and charitable organizations. "Even our specialists have trouble sorting out this web," says Anatoly Gara, spokesman for the Federal Tax Police Service, which investigates criminal tax violations.

Many people simply don't pay. The State Tax Service, the government's tax collection agency, says that a third of businesses operating in Russia pay no taxes at all. Another 49% pay only sporadically. Millions of individuals report little of what they earn. The tax system's shortcomings have spurred the growth of a shadow economy, which accounts for some 30% of Russia's GDP. "Once you force people to do things under the table, it becomes endemic," says Trevor Link, a partner at Arthur Andersen & Co. in Moscow. "The situation here has gotten out of control."

NONCOMPLIANCE. More people would file tax returns if the laws were clearer and penalties weren't so steep. Fines can amount to three times taxes owed, even when a taxpayer makes an honest mistake. Tax authorities may seize taxpayers' property and freeze bank accounts during investigations. But noncompliance is so huge the authorities can't keep up.

As the Duma hunkers down on the tax code, lobbyists are at work on deputies to keep loopholes. But Yeltsin is pushing for quick passage. Indeed, officials are even hinting Yeltsin might dissolve the parliament if it does not pass the new code by the end of June. "Our economy and our people cannot wait," First Deputy Prime Minister Anatoly B. Chubais recently declared.

For now, the tax police are stepping up their raids. The job can be dangerous. Last year, 26 tax officials were killed and 74 wounded, while 18 tax offices were bombed or sprayed with gunfire. In Podolsk, Vyachislav Kuznetsov, head of the tax police unit, feels under the gun. "We are not magicians," he says. Until the new law is passed and more Russians pay up, the tax police will face a near-impossible task.

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