As economic growth stalls and revenues decline, Moscow is no longer able to pump up the fiscal stimulus that fueled earlier wartime expansion, instead embracing austerity measures that threaten to further strangle the civilian economy.
While the budget figures are not final — the fiscal plan requires parliamentary approval — Moscow’s financial strategy for the fifth year of war is unmistakable.
Amid slower growth and lower revenues, the Kremlin will attempt to muddle through without major expenditure increases, instead passing the war’s costs to the whole of society.
For three years, rising fiscal spending stimulated both economic growth and climbing incomes. However, due to physical constraints including labor force shortages, sanctions, and limited production capacity, this high government spending has also fueled inflation, which the Central Bank is combating with prohibitively high interest rates.
This policy has yielded results — inflation slowed to 8.1% in August, albeit while remaining higher than the Bank of Russia’s target. But the side effect of monetary tightening is the suffocation of lending, both corporate and private, notably in the civilian sector. The high rate and overly high government spending became a means of suppressing civilian demand and of transferring resources towards the military economy.
The economy, with the anticipated exception of the defense industry, is grinding to a halt. The new economic outlook reflects this reality: the economy is entering stagnation.
Officials now expect 1% growth this year, down from the 2.5% predicted in April. For 2026, the projection is 1.3% rather than 2.4% from the previous forecast. Expectations for investment, real incomes, and industrial production have also been cut. A lower inflation forecast is theoretically good news, but it has been achieved largely by removing budget stimulus and imposing high interest rates. Thus, prices are stabilizing due to demand suppression, not increased production.
A slowing economy combined with low oil prices and a strong ruble continues to limit budget revenues, which in turn calls for fiscal frugality.
For 2026, the government expects to spend 44.07 trillion rubles ($530bn). Accounting for inflation, forecast at 6.8% by year-end, spending will be virtually unchanged from 2025 (41.47 trillion rubles) and just 2% higher than what the government projected last year for 2026 . While keeping spending under control represents a significant achievement for a wartime government’s bookkeepers, it’s insufficient to balance the budget.
Revenue, meanwhile, is set to fall in both nominal and real terms, compared to both 2025 projections and estimates from a year earlier. The government expects to bring in 40.28 trillion rubles ($482bn at current exchange rates), compared with 41.84 trillion rubles envisaged for 2026 a year ago.
The Finance Ministry expects a 2026 fiscal deficit of 1.6%. This may prove overly optimistic.
Over the past two years, the finance ministry has failed to keep deficits within its original limits. For instance, this year the government initially expected a shortfall of 0.5% of GDP. By June, that was revised upward to 1.7%, and this week’s forecasts show plans for a year-end deficit of 2.6% of GDP, with no guarantee the final figure won’t be worse.
One of the finance ministry’s most important tasks is maintaining a balanced primary budget, meaning basic expenditures (official salaries, social payments, defense, investment) minus debt servicing are fully covered by revenue. Since no external revenue growth is expected, and drastic spending cuts are politically impossible, the government has no choice but to raise taxes to escape a significant surge in high-rate borrowing.
The government proposes increasing sales tax (VAT) from 20% to 22%. Such a hike could generate approximately 0.5% of GDP in additional budget revenues, or 1.2 trillion rubles annually. Because this is a sales tax, any increase falls primarily on consumers, since businesses pass higher costs to shoppers. The bright side is that the VAT rise represents a one-time hit rather than a source of prolonged inflation, potentially enabling the Bank of Russia to cut rates and provide oxygen to suffocating businesses. However, for some businesses, this relief wouldn’t be enough to survive, as the government plans to hit them with additional taxes.
Citing the need to curb tax evasion, the government wants to raise taxes on small and medium businesses by lowering the VAT revenue threshold from 60 million to 10 million rubles annually. In effect, all small businesses will face higher taxes. The threshold will impact any business earning more than 800,000 rubles ($8,500) monthly — roughly what a street kebab stall might earn — making them liable for the 22% VAT rate instead of the current simplified 6% tax rate.
However, even this is not enough, as the government would need to borrow more than it had expected a year ago and at higher rates.
The combination of higher taxes and increased borrowing strikes the economy from two directions. Business faces a direct hit from rising rates and fees, plus an indirect blow from the crowding-out effect that occurs when the state actively borrows money domestically, thus competing for bank loans and investments. The public also faces a double bind: the tax burden rises while budgetary priorities shift even more toward the military. Individuals and businesses pay more to the state but receive fewer or lower-quality services in return. All resources continue flowing into defense, starving the civilian economy.
The government cited military needs to justify tax increases. On the surface, military spending appears under control. In 2026, the defense budget is set to fall for the first time since the Ukraine invasion, from 13.5 trillion rubles ($161bn) to 12.93 trillion rubles. This roughly aligns with last year’s plan, which projected expenditures of 12.8 trillion rubles.
However, spending on national security and law enforcement is set to rise from 3.56 trillion rubles in 2025 to 3.91 trillion rubles in 2026. As a result, combined defense and national security spending will remain at record levels of just below 40% of federal spending and roughly 7% of GDP.
There are several explanations for the apparent stability in defense spending:
- Production shifts: After the 2023-2024 surge in military-industrial capacity, the system is transitioning from capital investment to ongoing production and maintenance. This reduces immediate cash payments, although long-term contractual obligations remain substantial — the money will simply be spent later.
- Cost shifting: The government is attempting to transfer some of the military financial burden to local authorities and large corporations. This is evident in efforts to make them pay for defense against Ukrainian drone attacks on refineries and other infrastructure. However, such creative bookkeeping results in lower corporate tax receipts and higher regional financial needs. Like military-industrial complex spending, this doesn’t resolve the issue but postpones it.
- Hidden expenses: Part of military spending is concealed in other areas, such as regional programs, state-backed military-industrial loans, treasury advances, and purchases through state corporations. Officially, this isn’t classified as defense spending, but in reality, it supports military needs.
As Russia enters the fifth year of its war in Ukraine under Western sanctions, the government is attempting to stabilize its war-ravaged public finances not through economic growth or market liberalization, but by increasing revenues. The budget will be supported by tougher taxes, reallocated security spending, and expensive borrowing.
The economy is now moving into a protracted low-speed regime where the state consumes more than it can afford, the military-industrial complex operates at the limit of its workforce and production capacity, and civilian production is constrained by higher taxes and suppressed demand.
Tax increases confirm that the Kremlin is preparing for long-term military financing, for which consumers are beginning to pay, and on which the military-industrial complex continues to flourish.
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.
More on this and other aspects of the Russian economy in a weekly summary produced by the independent publication, The Bell.
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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