MOSCOW BLOG: The economic Putin hikes taxes

MOSCOW BLOG: The economic Putin hikes taxes
There are two Putins: an economic one who has put through a series of high effective reforms that have transformed the country, and a political one who starts wars, invades countries and murders opposition leaders. / bne IntelliNews
By Ben Aris in Berlin May 30, 2024

Russian President Vladimir Putin has just hiked taxes on everyone for the first time in more than 20 years (apart from a small experiment with progressive taxes in 2020 that hardly affected anyone) and has introduced a progressive tax system.

For those that remember, the tax system under Yeltsin was absolute chaos. After one reform the profit taxes on some businesses was briefly 105%. When Putin took over one of the first things he did was introduce a flat tax regime – 13% income tax and 20% corporate profit tax – that was based on what the Kremlin thought it could actually get. It was an overnight success and Kremlin Inc immediately went into profit.

It was also extremely popular as Russians pay some of the lowest taxes of any major economy – and even after this reform this is still true. But clearly Putin has been very reluctant to hike taxes as he is allergic to doing anything that would undermine his base. The one major tax hike he has made was to increase VAT by 2%, which was buried with an announcement in the middle of the Russian World Cup in 2018 but still went down like a lead balloon.

So, the fact he has raised them now is very significant. The new taxes will raise an estimated RUB2.6 trillion for the budget. To put that into context, the budget deficit last year was RUB3.4 trillion (1.9% GDP) and this year is supposed to be RUB1.6 trillion (0.8% of GDP), so these new taxes, which come into force next year, mean the budget will be balanced in 2025, despite the massive military spending. Pretty impressive all said and done.

Tax reform in general has been revolutionary. Prime Minister Mikhail Mishustin's job before he was promoted was as head of the tax service and he increased the tax take by 20% at a time when the burden was increased by only 2%.

When the first tax reform was put in place I wrote an op-ed saying there are two Putins: the economic one (tax, labour, maternity reforms – all highly successful) and the political one (Chechen war, Khodorkovsky arrest etc), but only the political Putin gets any attention.

The failure to appreciate the economic Putin is a big problem as the West has constantly written Russia off as a “gas station masquerading as a country” when it’s a lot more sophisticated than that. In parallel with the flat taxes, the other thing Putin did was to increase public sector wages by 10% every year for a decade. That totally transformed Russia and made it a more or less normal country today. He could afford to do this thanks to the oil export taxes.

While Russia is seen as a kleptocracy, in reality Putin has shared the country’s wealth with its people as he realised that too big a differential between public and private sector wages is a social time bomb. While the government has run surpluses for almost all Putin’s time in office, the real budget (if you count out the oil export tax revenues) has always been in deficit of between 4% and 13% of GDP, depending on if there was a crisis. In other words, Putin has used Russia’s mineral wealth to subsidise the economy. Other countries use debt to do this (Trump’s unaffordable tax cuts). Russia has the blessing of a stream of raw material exports to pay for it.

Now Russia is at war and under sanctions, this economic Putin is going to be even more important as it's going to be a game of who can take the most pain. And at this point Putin is winning that game as Russia is the fastest growing major economy in the world, while its budget position is constantly improving.

Having said all that, I have another piece saying that domestic banks are becoming increasingly reluctant to buy the OFZ bonds, MinFin’s main workhorse. This is due to the fact that the CBR is failing to curb inflation, the main macroeconomic headache. There is talk that CBR governor Elvia Nabiullina will hike rates by 200bp to 18% in June and that could trigger a sharp economic slowdown that will cause all sorts of problems so Russia’s economy is not without its dangers. Still, for now this week’s tax hike is more of the new smart Putinomics that has been a big success so far.

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