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Russia Turns to Tax Hikes, Other Measures to Fund Its War

The Russian authorities understand that they would be wise not to distract ordinary people from their daily concerns at a time of war, and that they must be inventive and flexible, avoiding any sudden moves.

Published on June 7, 2024

With Russia’s war against Ukraine now in its third year, a question asked with increasing frequency is where Moscow is getting the money to keep its economy afloat. Raw material exports are declining; foreign borrowing is insignificant; and nearly half of the country’s gold and foreign exchange reserves have been frozen for over two years. Despite all this, the Russian economy is growing rapidly, as are the incomes of many Russians, and the government has announced an increase in military spending this year of 70 percent on national defense alone compared with 2023 to almost 11 trillion rubles ($122 billion).

Since the beginning of the war, many economists and political analysts have been predicting that it can only be a matter of time before an economic mobilization takes place, with the nationalization of manufacturing, and ordinary Russians forced to buy government bonds. But that moment has still not come. The Russian government prefers to dangle economic carrots and search for reserves rather than resort to the stick just yet. Instead of a new wave of mobilization, for example, the state is offering large salaries to those who voluntarily sign military contracts, and instead of directly confiscating funds from private individuals, it is raising taxes and looking for new tools to attract the savings of ordinary people and companies.

Last year, the authorities employed a series of one-off measures to fill the treasury’s coffers. Among them was a windfall tax on companies making a profit of over 1 billion rubles that came into effect on January 1, 2024, and raised 319 billion rubles (more than $3.5 billion).

The authorities also introduced a temporary exchange rate duty on exports from October 1, 2023, until the end of this year. In the fourth quarter of last year alone, that measure injected an additional 140 billion rubles (about $1.5 billion) into the state budget.

Finally, the Russian budget also now gets a slice of the pie whenever Western companies leave the Russian market. By the start of 2024, however, the Russian authorities had begun to realize that the hardships of war are not going anywhere anytime soon, and have now started to move from one-off measures to more permanent ones.

At the beginning of the year, President Vladimir Putin announced tax increases, which officials euphemistically refer to as a “fine-tuning” of the tax system. The concrete details of this “fine-tuning” were unveiled immediately after his inauguration in May. The changes will affect two direct taxes that showed the biggest growth rates in 2023: income tax, which grew 14 percent, and profit tax, which grew 25 percent. In the last five years, the total sum raised via these two taxes averaged 7–8 percent of GDP.

Income tax will now consist of a five-band scale ranging from 13 percent to 22 percent. A cautious move away from the flat rate of 13 percent began back in 2021, when the rate was raised to 15 percent for individuals earning more than 5 million rubles a year (about $55,000 at today’s exchange rate). In 2023, those additional 2 percentage points provided the budget with 160 billion rubles ($1.8 billion).

Now the 13 percent rate will only apply to those who earn less than 2.4 million rubles a year (about $27,000). That is a relatively high rate for the population segment with the lowest income, compared with most countries.

The Finance Ministry claims that the changes will only affect 3.2 percent of workers, or 2 million people. But the impact on the country’s finances will be far from insignificant. The previous increase in income tax to 15 percent applied to less than 1 percent of taxpayers, but they provided almost a quarter of the total personal income tax collected. And now the top rate will be not 15 percent, but 22 percent.

The authorities have also promised tax relief for low-income families with two or more children. That measure should affect about 4 million families, but will only come into force in 2026, by which time inflation may have significantly reduced the number of eligible families. Even taking into account those deductions, the Finance Ministry still expects to raise an additional 530 billion rubles ($6 billion) by increasing the personal income tax rates.

The increase in profit tax is even more radical: from 20 percent to 25 percent. At its current rate, this tax brought the treasury almost 8 trillion rubles ($89 billion) in 2023. The proposal to increase profit tax came from none other than Russian business quarters themselves—in order to be rid of unpredictable measures such as last year’s windfall tax and exchange rate duty. The Russian authorities readily agreed to cancel the latter in exchange for the increase in profit tax. It is expected that when investment payments are taken into account, the new rate will bring an additional 1.6 trillion rubles ($17.8 billion) to the budget.

The Finance Ministry is also proposing to increase the mineral extraction tax (MET) in certain industries. The biggest increase will be seen by producers of mineral fertilizers. The MET on gold was already temporarily increased for a period of six months.

The Kremlin is keen to pass the relevant laws this summer so that the changes can come into force on January 1, 2025. The official line is that this “fine-tuning” will not affect most people, but will make Russian society more fair.

The increased rates will apply to a significant number of people living in and just outside Moscow and St. Petersburg, as well as some in Russia’s other major cities. So another way of looking at this “fairness” is that the provinces are sending volunteers to war (recruits have come disproportionately from poorer Russian regions), while the main cities will pay more.

Together, the increased rates of profit tax, personal income tax, and MET could bring next year’s consolidated budget an increase of up to 1.6 percent of GDP: about 2.5–2.7 trillion rubles ($27.7 billion). Over five years, that’s an additional 17 trillion rubles (about $190 billion at the current exchange rate), enabling the government to replenish the treasury quickly and reliably.

It is also entirely possible that these estimates err on the conservative side. Back in March—under the previous tax rates—the Federal Tax Service predicted a 12 percent increase in tax revenues to the budget up to 52.5 trillion rubles ($570 billion). Given that the new rate thresholds are fixed in rubles, then without timely revision, inflation will push more and more people into higher tax brackets.

In addition to raising taxes, the government is also looking for ways to bring private savings under closer control. According to Finance Ministry estimates, Russians held a total of 40 trillion rubles ($445 billion) in savings as of the end of 2023. That is more than Russia’s annual budget for 2024.

High interest rates encouraged growth in bank deposits by more than 7 trillion rubles ($78 billion) in the last seven months. People’s incomes have increased, and there is still trust in the banking system. Still, Russians are cautious, preferring not to lock away their savings for longer than six months to a year.

The central bank’s goal is not only to retain existing deposits, but to attract new ones too. In anticipation of a possible increase in the central bank rate, several major Russian banks, including Sberbank and Alfa Bank, have increased interest rates on even short-term deposits up to 17–19 percent.

Amid growing military spending and a deficit in external borrowing, higher interest rates are not the only carrot Russians are being offered in exchange for entrusting their hard-earned money to financial institutions. The Russian government has been tasked with raising about 250 billion rubles (about $2.7 billion) of long-term savings this year, reaching 1 percent of GDP in 2026. (Russia’s GDP in 2023 was more than 170 trillion rubles, or $1.9 trillion.) To meet that goal, the government has launched a whole series of financial products this year aimed at attracting long-term investments, including long-term savings programs.

A clue as to the possible fate of these long-term investments can be found by recalling that just ten years ago, the authorities quietly froze and then effectively confiscated 500 billion rubles from people’s pension contributions and used them for the development of newly annexed Crimea.

Many of the decisions on taxes and savings now being implemented were already being discussed long before the war, but they might never have been adopted if it were not for the state’s pressing new need for financial resources. For the Russian leadership, it seems that people are the new oil. At the same time, the Russian authorities understand that they would be wise not to distract ordinary people from their daily concerns at a time of war, and that they must be inventive and flexible, avoiding any sudden moves.