Russian President Vladimir Putin promised a planned tax overhaul would increase inflows to the state budget, benefit low-income families and provide long-term stability for Russian corporations at a meeting with the big business lobbying group, the Russian Union of Industrialists and Entrepreneurs (RSPP), last week.

Russia’s tax regime has had a dramatic makeover for several years. When current Prime Minister Mikhail Mishustin was in charge he introduced an extensive new IT system that successfully stamped out many scams and closed loopholes that led to an increase in the tax take by 20% in a period when the tax burden increased by only 2%.

Now the government is looking to raise taxes for almost the first time since Putin took over in 2000 and introduced a highly popular and very effective flat tax regime of 13% income tax and 20% corporate profit tax – amongst the lowest rates in Europe. Since then, the only major change has been an additional 2% on VAT introduced in January 2019.

But with a war to fund, the Ministry of Finance (MinFin) intends to slowly move towards a more progressive system of taxes to boost revenues. At the same time Putin made expensive spending pledges to the population in March as part of the 12 National Projects that were launched in 2019 and need funding.

At the meeting, Putin assured Russia’s captains of industry that the changes would result in a fairer redistribution of the tax burden, particularly favouring low-income populations.

Russia’s industrialists are used to being hit up by the Kremlin for money. Last year Russian Finance Minister Anton Siluanov persuaded them to pay a special windfall tax on large enterprises that brought in an extra RUB300bn ($4bn) in revenues. However, MinFin has so far avoided blanket tax increases. For their part the industrialists said they were not against tax increases in principle, adding what they really wanted was long-term predictability in the tax regime so they could plan.

Now the most comprehensive overhaul of the tax system is on the cards, but only a few general details have been released so far. The change is expected to be implemented by the new government following Putin's upcoming inauguration for a fifth presidential term on May 7. The Duma could make the requisite legislative changes as soon as June.

Tax hikes

Among the proposed measures are increases in income tax for individuals and profit tax for businesses. Andrei Klepach, chief economist for Russia's Vnesheconombank, estimates that the corporate tax rate could rise to 25% from 20%, potentially adding an additional RUB1.5 trillion-RUB1.9 trillion ($16bn-$21bn) annually to state coffers.

To put that into context, this year’s budget deficit target is for RUB1.6 trillion and in March Putin promised more than RUB11.5 trillion ($126.5bn) in infrastructure and social spending over the next six years. Russia’s military spending in 2024 will increase to RUB12.8 trillion ($140bn) or 7.1% of GDP, accounting for 35% of total government spending.

Russia's total budget spending this year has been pencilled in at RUB36.6 trillion ($420.9bn), with military expenditure set to exceed social spending for the first time ever. However, as the deficit is expected to fall from 1.9% of GDP last year to a modest 0.8% this year and a flat budget in 2025, the current tax regime can already comfortably pay for the Ukraine war.

The tax overhaul is not without its challenges, especially for industries like oil and gas, which has seen tinkering with the tax system for raw material extraction to account for sanctions. The mineral extraction tax (MET) has been comprehensively reformed to more efficiently tax the extraction of metals and hydrocarbons.

The government also hopes to stimulate investments in the oil and gas sector using tax changes to counterbalance high dividend payouts that will potentially reach RUB3 trillion ($33bn) for 2023, according to Russian bank SberCIB.

It is not clear what the plan is with income taxes, but it seems likely some sort of progressive tax based on income levels will be introduced.

Siluanov ruled out progressive income taxes in 2018, but the government changed its mind and Putin pushed through the first change to income taxes since he took office in 2020. Starting in 2021, the personal income tax rate rose from 13% to 15% on incomes over RUB5mn (about $65,800 at then current exchange rates).

Given the average annual income in October 2020 was RUB590,000 ($7,900) the change in the tax rate affected a tiny share of the population and the initiative was as much a trial balloon as a real change. The change generated an additional RUB60bn – a drop in the Russian federal budget bucket – and Putin said this money would go towards funding treatment for children with "severe and rare" illnesses.

What remains to be seen is if MinFin will lower the bar on the higher tax bracket to affect a much larger share of the population, or if it will also introduce a set of brackets to more equitably tax the citizens.

As bne IntelliNews reported, Putinomics has dramatically changed its strategy since the war started, switching from a policy of paying down debt and hoarding dollars, to one of spending freely and starting to modestly leverage up the economy.

Changes to income tax could generate a lot more money than higher corporate taxes. In the first three months of this year oil and gas taxes generated a total of RUB2.9 trillion, but the non-oil and gas sector generated RUB5.8 trillion – almost twice as much – with VAT alone accounting for RUB3.4 trillion of that. Even a modest change in income taxes could increase revenues by several trillion rubles.

And the Kremlin will need more money as Putin plans to spend a lot in the coming years, in addition to what is being spent on the war. As the spending promise list below shows, part of Putinomics is to keep the population happy by improving the quality of life, using the de facto subsidy that is oil and gas tax revenues.

Other income

Putin also reiterated his 2000 “oligarch meeting” promise that oligarchs could keep the companies they had. Putin said there are no plans to review past privatisation results, as the state has nationalised a string of companies in recent months – not only those belonging to foreign companies in tit-for-tat nationalisations after Europe seized several Europe-based Russian companies. Putin said the cases of asset returns to government control were due to actions undermining national security and interests.

Privatisation is also being restarted as a result of the huge corporate shake up that sanctions have caused. Siluanov said that Moscow aims to raise over RUB100bn rubles ($1.1bn) this year from the sale of such assets.

Putin’s election spending promises

Infrastructure:

- RUB4.5 trillion for modernising public infrastructure such as housing and communal heating;

- RUB1 trillion on the construction, repair and equipping of hospitals;

- RUB400bn to overhaul schools and kindergartens;

- RUB400bn on the construction of university campuses;

- RUB360bn for parks and public spaces;

- RUB250bn to modernise airport infrastructure;

- RUB150bn for renewing public transport;

- RUB124bn to overhaul universities;

- RUB120bn to repair and equip colleges;

- RUB120bn on constructing residential areas;

- RUB100bn to update the infrastructure of museums, theatres, libraries, art schools and cinemas;

- RUB66bn for buying school buses;

- RUB65bn for sports grounds.

Social:

- RUB1.5 trillion on the preferential family mortgage programme over the next six years. Additional spending on the programme in 2024 will cost RUB260bn roubles.

- RUB600bn on maternity capital programmes by 2030;

- RUB100bn on social payments for families with children;

- RUB75bn allocated to regions with below average birth rates by 2030.

Industry & technology:

- RUB700bn to create digital platforms in key economic and social sectors;

- RUB300bn to the Industrial Development Fund to support high-tech projects;

- RUB200bn to subsidise interest rates for industrial production projects;

- RUB120bn in subsidies to companies for scientific research and industrial mortgages;

- RUB116bn to access high-speed internet, build up satellites.

Regions:

- Write off two thirds of the Russian regions' debt on budget loans. This will allow them to save about 200bn a year from 2025 to 2028.

Source: Reuters.