By Darya Korsunskaya and Gleb Bryanski
MOSCOW (Reuters) -Russia's finance ministry proposed raising the rate of value-added tax on Wednesday to 22% from 20% in 2026 to fund military spending and help curb a swelling budget deficit, in what would be the fifth year of the war in Ukraine.
The proposal comes as U.S. President Donald Trump called Russia a "paper tiger" for "fighting aimlessly for three-and-a-half years" and said that Russia was in "big economic trouble".
President Vladimir Putin signalled last week that he was open to raising certain taxes during the war, noting that the U.S. had raised taxes on wealthy people during the Vietnam and Korean wars.
The government on Wednesday approved a new draft budget for 2026, called by some Kremlin officials a "wartime budget", and announced updated figures for 2025, with economic growth expected to plummet to 1% from 4.3% last year.
National defence spending will fall to 12.6 trillion roubles ($150.5 billion) in 2026 from a post-Soviet high of 13.5 trillion in 2025, finance ministry documents showed.
In 2025, the deficit is seen at 2.6% of national output, the highest since the start of the war, according to the documents reviewed by Reuters, exceeding the previous target by 53%.
TAX HIKE PRIMARILY TO FUND 'DEFENCE AND SECURITY'
The proposal is in line with a Reuters report last week. VAT, a consumption tax seen as easy to administer, accounted for 37% of budget revenues in 2024. Alexander Shokhin, head of a major business lobby, called the hike "unpleasant".
The ministry estimated that the increase would generate about 1.2 trillion roubles ($14.33 billion) in additional revenue in 2026. The government also plans to increase borrowing by 46% in 2025.
The finance ministry said the tax hikes would be "aimed primarily at financing defence and security". It proposed other tax increases, including on gambling businesses, and the elimination of tax breaks on small businesses.
The proposal will spur inflation, which has been receding in recent months, and make more key rate cuts more difficult for the central bank, which said it will take into account the effects of the VAT increase on inflation expectations.
A two percentage point 2019 VAT hike contributed 0.6 percentage points to inflation that year, according to the central bank, which has pledged to halve it from current levels and return it to its 4% target in 2026.
T-Bank analyst Sofya Donets estimated that in 2026 the tax hike would boost inflation by 1.5 percentage points, making the central bank's job more difficult as it navigates between worsening inflation and a further economic slowdown.
The rouble was little changed at 83.75 to the U.S. dollar on Wednesday, with analysts saying that a slower pace of key rate cuts supported the Russian currency. The average rouble rate is seen at 92.2 to the dollar in 2026 in the new forecast, about 8% stronger than in the previous one.
After meeting Ukrainian President Volodymyr Zelenskiy on the sidelines of the U.N. General Assembly in New York, Trump posted on his Truth Social platform: "Putin and Russia are in BIG Economic trouble, and this is the time for Ukraine to act."
Trump's tone was in stark contrast to his red-carpet treatment for Putin at a summit in Alaska last month, part of an ostensible push to expedite an end to the war.
'NO SUCH THING AS A PAPER BEAR'
Kremlin spokesman Dmitry Peskov told RBC radio on Wednesday the Russian economy had adapted to the conflict in Ukraine.
Brushing off Trump's "paper tiger" comment, Peskov said Russia was a bear, not a tiger, and "there is no such thing as a paper bear", while adding Putin valued Trump's efforts to resolve the conflict.
The finance ministry said the draft 2026 budget was "balanced and sustainable" while providing "financial support for the country's defence and security needs".
"The resources planned in the budget will make it possible to equip the armed forces with the necessary weapons and military equipment, pay salaries to military personnel and support their families, and modernise defence industry enterprises," it said in a statement.($1 = 83.7500 roubles)
($1 = 83.7455 roubles)
(Editing by Andrew Osborn, Alex Richardson, Sharon Singleton and Gareth Jones)
