Russia has embarked on its first significant tax overhaul in almost 25 years. While the Kremlin sells it to the people as an act of social justice, it’s more an acknowledgment that the country needs to balance the books and reshape the economy for a long war with Ukraine and its wealthy Western backers.
The need for tax rises has been clear ever since the government presented its budget draft for 2024-26 in the fall of last year. This became explicit after Vladimir Putin re-assumed his presidential post in May and promised more spending — although, at that point, it was unclear who would shoulder the additional burden.
In June, the Finance Ministry said it expects to collect 17.7 trillion rubles ($198bn) between 2025, when the new tax regime comes into force, and 2030. Of that sum, it expects to take 2.6 trillion rubles ($29bn) in 2025.
Putin’s additional spending pledges amount to an estimated 10 trillion rubles, but the extra spending won’t end there.
The fiscal draft for 2025 and 2026, presented in the fall, saw a 2.3 trillion ruble cut in defense spending compared to 2024. It’s unclear how the Kremlin will reduce its military spending by 1.3% of GDP with the war raging and the economy dependent on military contracts. With the new taxes in place, this can be revisited.
The Kremlin promotes the tax hike as a step towards social justice. This has some truth to it.
For two decades, Russians paid a flat 13% income tax. At the very start of his rule, Putin introduced it as an incentive for his people to pay taxes and for private capital, both foreign and local, to be more transparent.
It paid off, as the shadow economy declined to about a fifth of GDP now from about a third of GDP when Putin became president for the first time in 2000.
From 2025, it will be replaced by a progressive income tax ladder. Income tax will remain at 13% for annual salaries up to 2.4 million rubles ($27,000.) All earnings above that threshold will be taxed at incrementally higher rates, ranging from 15% to 22%.
Some higher earners might return to the old practice of hiding incomes, but it would not be widespread. Firstly, Russians are now familiar with receiving their salaries over the counter in their bank accounts rather than in brown paper envelopes, and they were ready to pay low-income taxes in exchange for social guarantees and all the benefits of official employment. Secondly, a digitalized Russian state is more able to collect taxes than before.
There will be no personal tax-free threshold. Instead, the government offers a rebate on taxes paid by low-income families with two or more children, reducing their effective income tax rate to 6%. The Finance Ministry said about half of families with more than one child would receive a rebate, and only 3.2% of the workforce would pay more income tax.
So the rich will pay more, and the poor will pay less? Mostly, yes.
However, with inflation hovering around 8%, more people would find themselves in higher tax brackets with time, as these do not rise with inflation.
Moreover, with taxes on dividends and interest payments remaining, the wealthiest Russians, whose income depends more on unearned income than salaries, will be better off than high-paid professionals.
But the big loser is business. Companies will bear the main burden, paying about ⅔ of the additional tax as the profit tax increases from 20% to 25%.
Total labor tax receipts will be just about 8% higher, given the recent figures of the total income taxes collected in Russia and the Finance Ministry’s expectations.
To keep companies investing, the Kremlin offers a sweetener: tax rebates are possible when money is spent on scientific research and Russian-made technology. The aim is to replace imported produce targeted by the sanctions now or in the future. The trade and service sector — the bulk of medium-sized businesses — is unlikely to benefit from this tax support.
On the other hand, it will be difficult for them to pass on the higher costs to consumers, as they compete not only between themselves but also with imported food and consumer goods.
So, tax reform is not only aimed at highly paid workers but also at rerouting investment towards industry and manufacturing from the currently booming sectors of construction, trade, and services. It will also help the state better compete for a diminishing workforce in the industrial sector. In short, it shifts the economy from imported butter to home-made guns.
Tax reform is less an act of social justice and more a means of financing the war and fostering home-grown technology. The first significant tax revamp in 20 years is another step towards a forever war and economic self-reliance.
Alexander Kolyandr is a Non-Resident Senior Fellow at the Center for European Policy Analysis (CEPA) specializing in the Russian economy and politics. Previously, he was a journalist for the Wall Street Journal and a banker for Credit Suisse. He was born in Kharkiv, Ukraine, and lives in London.
Europe’s Edge is CEPA’s online journal covering critical topics on the foreign policy docket across Europe and North America. All opinions expressed on Europe’s Edge are those of the author alone and may not represent those of the institutions they represent or the Center for European Policy Analysis. CEPA maintains a strict intellectual independence policy across all its projects and publications.
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