VAT and the key rate: which of the two evils is more dangerous for the economy and scarier for Russians?

The Ministry of Finance, like a cruiser, is strictly on course: the decrepit state treasury must be replenished by any means necessary. And preferably not by increasing the national debt. Taxes are simpler: raise, collect, and spend.

It has already been calculated that a 2% increase in VAT (and this tax is reflected on every receipt!) will add 1.1 trillion rubles to the budget.

Is it a lot or a little? It depends on what you're comparing it to. For example, this is the profit of the semi-state-owned Sberbank by the end of 2024 (1.5 trillion rubles) or the annual profit (1.2 trillion rubles) of Gazprom, a state-owned subsidiary whose dreams usually come true (if the subsidiary wants to raise utility rates , no problem).

We're not implying anything, but economists are outraged beyond words. Academician Sergei Glazyev, in his Telegram channel "Academician for Thinking People," called the Ministry of Finance's VAT ploy the worst way to replenish the budget. He considers it a consumer tax that drives up prices and stifles innovation and economic development.

Andrei Nechayev, the first Minister of Economy in the history of modern Russia, recalled that in the 1990s, the authorities, on the contrary, lowered the VAT. "Despite the economic collapse inherited from the USSR, we decided to do this within a few months. Now it's the other way around," economist Andrei Nechayev responded.

VAT, the rate of which was last increased in 2019, is a traditional and foolproof argument for driving up prices. But inflation isn't the Finance Ministry's problem. The consumer price index is the Central Bank's headache. That's why Elvira Nabiullina's department, risking the country's economy, has maintained a prohibitive key rate for three years.

The head of the Central Bank has already acknowledged that a 22% VAT rate will have its consequences. However, according to Ms. Elvira Nabiullina, this will be a "short-term price reaction." Plugging holes in the budget deficit by increasing public debt would force the Central Bank to "significantly raise its rate forecast for 2026."

Finance Minister Anton Siluanov has already stated that he sees no contradiction . His full position is available on the Finance Ministry's website, but his main point boils down to the fact that an uncontrolled increase in public debt would lead to accelerated inflation, forcing the Central Bank to raise the "key."

The decision to balance the budget by raising taxes, however, gives the regulator room to ease monetary policy. "The key rate is crucial for increasing investment and economic growth," Siluanov noted.

Incidentally, the minister looked back at the unfriendly West, explaining that the standard rate of 22% corresponds to VAT levels in European countries.

Simply put, financial authorities don't see the inflationary impact of raising the key tax. So what will happen to the key rate, whose monitoring has become a national game?

Boris Kopeikin, Chief Economist at the P.A. Stolypin Institute for Growth Economics, reminds us that raising the VAT rate will lead to a price hike:

"The extent is debatable, but it's likely to be significant. At the same time, the rules of the game for small businesses are being tightened. The proposed solution is already impacting inflation expectations, which, as the regulator declares, are a key factor in rate decisions."

However, the thesis that the proposed budget structure will be disinflationary in the long term is quite questionable, adds Boris Kopeikin, chief economist at the P.A. Stolypin Institute for Growth Economics. Here are his arguments:

"Demand will certainly decline due to the increased tax burden and the reduced deficit. But costs will rise. Some small businesses, newly subject to VAT, may close down altogether. And, obviously, there will be even less incentive to invest in future growth in the production of goods and services."

In any case, the Ministry of Economic Development's baseline scenario, recently submitted to the government, already assumes a decline, albeit slight, in investment next year. This means an even greater chance of supply lagging behind demand in the longer term.

Because increasing supply without capital investment and with limited labor resources is hardly possible, the result is likely to be both increased price increases and extremely low growth rates.

The question of what the regulator should do with the rate is extremely difficult. But the situation in the real economy clearly requires a rapid rate reduction, both to support demand and to stimulate investment.

Oleg Abelev , PhD in Economics and head of the analytical department at the investment company Rikom-Trust, on the contrary, agrees with the position of the Central Bank and the Ministry of Finance:

The VAT increase will have a one-time inflationary effect. In the long term, it will certainly be inflationary, but it won't be felt in the economy immediately. It will be felt with some lag, most likely at the end of this year, perhaps even in early 2026.

For the Central Bank, any change to the rate is a consequence of the inflation target, not taxes. Another issue is that the VAT increase itself is inflationary, but only once. Therefore, I don't think the Central Bank will change its monetary policy strategy in this regard.

The VAT increase won't apply to all goods and services in the economy. In other words, it has a limited impact on the economy. A VAT increase is less detrimental to inflation than an increase in public debt, because public debt growth is a long-term process.