To be sure, Russia's problems in this area are not unique. But the issue is not just revenue. Russia's current tax system is perhaps the most visible blight on the investment environment. It discourages new capital formation in the formal sector, and it distorts existing economic activity. Russia's economic team and the Duma have to work together to reduce VAT exemptions and establish a corporate profits tax that defines profits according to internationally recognized practice.
Tax administration presents equally fundamental challenges.
The institutions for tax collection have to be strengthened, and the incentive structure transformed so that paying taxes becomes widely perceived as rational behavior. Now, Russian firms often reckon that the expected costs of compliance with the tax code exceed the expected costs of noncompliance. This is not just a simple question of tax evasion. With high tax rates, unpredictable application of tax rules, and extreme tax penalties, the act of paying your taxes puts you in jeopardy of facing large additional obligations. I discussed these issues at length with Prime Minister Chernomyrdin and First Deputy Prime Minister Chubais during my visit to Moscow last month.