Russia's 2025 Budget: More Taxes and No Sign of Peace with Ukraine

This transcript was not edited prior to publication:

Margarita Liutova. Hello and welcome to Carnegie Politika from the Carnegie Russia Eurasia Center in Berlin. I'm Margarita Liutova and I'm joined today by Alexandra Prokopenko, a fellow at the Carnegie Russia Eurasia Center, a brilliant expert on Russian policymaking and the economy. Hello, Sasha. Great to have you here.

Alexandra Prokopenko. Hello Rita. Very nice to see you here.

Liutova. So we're keeping up our good old tradition of talking about the new Russian budget as soon as it is unveiled every autumn. Yet another wartime budget. And this time, as you wrote in your recent piece for Carnegie Politika, it looks more like a compromise. A compromise between the war camp and the economists. So, let's see who gets what and, more importantly, who's paying the bills. Let's start with the war camp. If this is a compromise, what is it that they didn't get and what is it that they actually got?

Prokopenko. So, yeah, Rita, thanks for your question. The government at the beginning of this week submitted the full budget package to parliament. It included budget plans for the next three years, from 2026 to 2028, a revision of the budget of the current year, and all annexes. There were no big surprises for us. In 2026, spending is held flat versus last year's plan. And the largest line, as you mentioned, defense, is trimmed quite slightly for the first time since the war began. And yet, unfortunately, this is not a peace signal or a signal that Russia's economy cannot bear this type of expenditures. If we look at the structure, the security bloc keeps roughly 8% of GDP for defense and national security items, which means that their part of the budget [will] remain relatively the same. The economic bloc—and I guess this was a victory for Minister of Finance Siluanov and Governor of Central Bank Elvira Nabiullina—they have no large increase in expenditures, and they will be financed in the least inflationary way: with higher taxes, which means that people will start directly paying for Putin's war effort. And actually, I find it significant that the Ministry of Finance put in their statement that we need more money [for] military and defense and that's the reason why we're raising taxes. Value-added tax will be rising next year by two percentage points, from 20% to 22%, and also, the government is planning to reduce the threshold for small and medium businesses which are paying the VAT. So, it was 60 million turnover per year. Now it is 10 million turnover per year, meaning that next-door shops, beauty salons and small, tiny services like IT firms are now subject [to the] new VAT. So people will directly pay for the war. That's very important. And yes, VAT is less inflationary. So that's why I'm saying that it's a compromise between militarists and monetarists. First, [they] have their money. Second, [they] got their effort from the government to fight inflation, which is also enemy number one. Enemy number two, sorry. Enemy number one is NATO, and enemy number two is inflation.

Liutova. So a lot of exciting points here to unpack. I'd like to get to this tiny reduction in defense spending that you've mentioned. So you're saying this is not, unfortunately, the signal that Russia is ready to stop the war against Ukraine. It is not a signal that the Russian economy can't bear this kind of spending anymore. But is it actually any kind of other signal? Maybe it's a way of saying something else? What do you make of it?

Prokopenko. Well, yeah, combined, all amounts, I mean, for military and national defence, it's a minimum reduction of 0.6% in 2026. But from 2027, both defense and security spending will increase again. So, if we split the two budget items: in defense, there is a slight decrease by 4% from 13.5 trillion rubles nominal in 2025 to 12.6 trillion rubles in 2026. But spending on national security and law enforcement, where expenditures on RosGvardia, security guards, the Federal Security Service (FSB), penitentiary system, these expenditures rise to 3.9 trillion, almost 4 trillion nominal. So combined, the reduction is quite slight. Overall spending in these categories remains at about 8% of GDP. In other words, war is still a priority. We don't see any blinking that peace is on the way. And unfortunately, we need to take this into account. What I find interesting is that in both of these categories, the biggest increase are for salaries and reserve contributions. The latter allows military and security forces more flexibility in managing their allocated funds within an already financed budget items. Procurement and capital expenditures are showing virtually no growth. Since all this stuff is classified and and we can only guess, my best guess is that this may indicate a shift in focus from investment, from capital investment, from building new facilities, to production, to literal production, serial production and maintenance. This approach reduces cash payments from the budget on a specific year. But long-term contractual obligations will be fulfilled; the money will simply be spent later. I also need to remind our viewers and readers that about a quarter, about 25% of budget items are classified. Although none of them are military related, a big chunk are. In addition, a significant proportion of military funding now comes via alternative channels — state guarantees to enterprises, treasury advances, purchases through state corporations, or even through volunteers, all this "people's military industry complex" [which is] assembling drones. It's not a part of the military budget, but part of the civil one. Some of these costs are to maintain the front; maintaining and supplying the front line shifts to businesses. These expenses are not formally classified as defense, but de facto they are used for military purposes. So, that's why we're not seeing any kind of reduction in the war effort.

Liutova. Wow, that that's really interesting. Getting back to this compromise between the war camp and the economists, you've mentioned that what we're seeing is a kind of a victory of the economic bloc of the government, and the VAT increase is actually less inflationary than other options that could have been on the table. Could you please get a little bit into this? Why exactly is this a victory? Why exactly is a tax hike in an actually alien economy a victory for the economic bloc? And what were the other options, the more damaging ones?

Prokopenko. Well, here I guess I need to reference Central Bank comments when Nabiullina welcomed tax over borrowing. VAT is considered less inflationary in the medium term because it goes directly toward reduction of demand. Even if there is a one-off inflation bump at the beginning of implementation, later the purchasing capacity of people will decrease and this will bring inflation to a more moderate and steady pace. That's why it's more favorable for the MinFin (Ministry of Finance) and for the Central Bank, for the economic bloc of the government who are hoping that the economy will come back from its overheating stance in 2025 to some sort of potential growth in 2026. Normal potential growth and low inflation is the key here. Otherwise, the Central Bank would be forced to keep rates above 12 or 13% in 2026. Other options were issuing bonds, increasing state debt or... I know that there was some talk about issuing some sort of war bonds and making people and corporations buy them. But of course, issuing new debt, even if that level is quite comfortable for the MinFin, is quite pro-inflationary. This would prevent the Central Bank from cutting the key rate and softening monetary policy. So, that's what's considered unacceptable. As far as I know, in the summer, members of the economic bloc of the government tried to convince Putin that 7 to 8% of GDP was the maximum [of] what the economy can bear on military expenditures. This was a position opposite to industry lobbyists and to the Minister of Defense, Andrey Belousov, who is a economist by training, who tried to convince Putin to double down on military expenditures because of the multiple effect which defense spending can give the economy. Well, in theory, it's possible, but it's possible if you have an open economy and demand is backed not only by the state, but by non-state players and by experts, as it was in the United States in the 60s. Russia [is in] a very different situation. So, that's why the current budget parameters are a big victory for the economic bloc, mostly. But in general, it is a sort of managed stagnation. It's not a development budget. The baseline scenario lacks growth, real GDP will decline to 1% in 2025 after 4.3% in 2024. So, it would be still positive growth but only one percent after four. And in 2026 it goes to 1.3%, drifting to 2.8% in 2027, which I find quite optimistic. Inflation slows from 6.8% by the end of 2025 towards the target of the Central Bank, so, near 4%. This is a soft landing, but this soft landing is bought by demand compression. We see that in expenditures. After a three-year fiscal surge, which was relatively near 10% of GDP in 2024, the fiscal stimulus in next year's budget shrinks to near 1.7 or 1.8% of GDP. Investments turn negative, which means that the state will substitute the private sector in investments. The MinFin is trying to anchor the budget with a budget rule. There's a cutoff of oil prices with one per year, pushing oil and gas revenues towards 3.5% of GDP in the structure by 2028, which I also find optimistic. On the whole, spending is projected to fall from 20% of GDP in 2024 to near 18% of GDP in 2028, which is also optimistic. A key feature of all this is very weak growth in industry, which is backed only by military-led manufacturing. So, it means that the military-industrial complex is now structural for the Russian economy. Electronics, electrical equipment, machinery, other transport—all this is growing. But consumer-facing sectors lag; [the automotive sector will] only claw back to 2024 levels by 2028. The manufacturing of furniture and other goods is stagnating. And this gives us a clue that... It's inevitable that all wars end, and when this war ends, then comes reconstitution of military forces, which will last for a while. But the Russian economy inevitably, at some point, will need to return to a civilian footing. But because the share of the military-industrial complex is now structural, it's not possible to make [the transition] without falling into another crisis. An internal constraint: the labor market remains tight. The Ministry of Economy projects unemployment around 2.3 or 2.5% across a three year horizon. That also means that rates will stay high for longer. There's one more interesting feature about the budget and [then] I'll stop my long monologue. It was interesting to see sanctions assumptions on the budget. Even in both baseline and conservative forecasts, [economic planners] assume that there will be no further escalation of sanctions. In the conservative forecast, it's said explicitly that tightening of the external environment is possible if another financial crisis comes, but not because of tightening sanctions. I see [in that] not a huge [amount of] optimism from the Russian state, but [that] the Ministry of the Economy and the Kremlin treat adaptation channels as institutionalized. Logistics, parallel imports, the shadow fleet, insurance payments—it's all now solid enough to sustain additional sanctions pressure if it goes the same way as before. And here, it's worth mentioning that in 2025, the European Union and United Kingdom tightened sanctions. The United States hasn't significantly increased or tightened sanctions since the new administration took office. There were lots of verbal invectives, there were lots of threats, but few deeds. The budget already embeds an Urals discount and narrow export geography. So, the main risk for these kind of projections is not new sanctions packages, but tighter enforcement of the current one: tightening export controls, shipping and insuring choke points, and closing payments and logistical gaps.

Liutova. Getting back to the economy in general, and actually getting back to the consumers: You've already mentioned how purchasing capacity will go down. So basically, Russian consumers and private businesses are the ones who are paying the bills, right? Is this the final bill? Is it enough? Because it seems like this redistribution of financial resources from the private sectors of the Russian economy to those connected with the state—actually, with the military—will go on. What's your point here?

Prokopenko. In terms of resources, it seems that it is enough resources for Putin to continue the current military effort; to pay social payments, which are growing, not only because of inflation, but also because of additional social obligations that the state carries. For 2026, it seems realistic, if the MinFin keeps the parameters and the Central Bank reduces the key rate, which will give the economy some more air and hope for some sort of moderate growth. The non-oil part of the economy will bring in additional money and taxes. Then we can talk about not a sustainable development, but a moderate stagnation with lowering standards of living, with closed export markets besides the commodities market, with narrow and shrinking geographies. The industrial engine of the economy remains, and if you are keeping the industrial engine high, you need resources. In a semi-closed economy, you can get resources only from the civil one. We have a two-tiered economy where the military part is vacuuming resources from the civil one. And by resources, I mean not only money, but also our human resources and other stuff. It is some sort of hope. It's possible in theory to have a breakthrough in growth. It would be a breakthrough in productivity. But we do not expect this because of sanctions, because of past dependence of the Russian economy, and we don't see it in the budget. If we return not to our prior knowledge of how the Russian statecraft machine functions, but rather to the documents they are publishing, we don't see any glimpse of potential growth or potential breakthrough. It looks quite gloomy. I also want to point out that annexed territories are a priority for the Russian authorities, and the financing for DNR, LNR, Zaporizhia and Kherson runs 300 billion [rubles] per year. It's roughly the size of all federal spending on culture. And the focus is on utilities, housing, infrastructure, roads, and social payouts. Mostly on the infrastructure which was destroyed by Russian military forces. It's an interesting way of spending people's money. And on taxes, increasing tax rates this year of course shrinks [the government's] room for manoeuvre in the [coming] years. If we don't assume that Russia will get more oil and gas revenues—and we see such projections neither in the Economic Ministry's forecast nor in forecasts from major organizations that are watching oil prices—it seems that next year, in the 2027-2029 budget, if Putin keeps the military a priority, which will be with us for much longer than a one, two or three-year period, it will be quite complicated to fulfill the needs of the military-industrial complex, of military-industrial lobbyists, because there is no room for tax increases. The Russian government has increased taxes [for] three years in a row. In the last two years, it was taxes on corporations and people directly. This year it was the VAT. Last year, it was income tax. But before that, I think everyone has forgotten that there was a windfall tax on additional profits for commodity companies. And there were one-off payments from Gazprom and oil companies. Having tax creativity for four years in a row would be quite complicated.

Liutova. Although this tax creativity has definitely developed in those previous years. To wrap things up: for the past three years or so, you and many experts described the Russian economy as a marathon runner on budget steroids, implying the role of the government spending in the boom that we were seeing. The steroids seem to have stopped working, and this runner that we're watching is slowing down more and more. What's your go-to metaphor now? Is the budget kind of a painkiller for this tired runner? What's your view now?

Prokopenko. Well, I like the metaphorical exchange between [U.S. President] Donald Trump and [Kremlin spokesperson] Dmitry Peskov, when one called the Russian economy a paper tiger, and immediately the second answered that we're an invincible bear. My assumption is that the Russian economy is neither a paper tiger nor an invincible bear. For now, we are at the point when Russia settles into low growth, a high key rate, a high percentage rate within the economy, a tax-financed equilibrium that keeps 8% GDP for the military and defense. Macro-stability is achieved not by growth of the economy, not by technological breakthrough, and not by opening new export markets, but by collecting more and borrowing steadily while compressing demand. The industrial engine is almost [entirely] based on the military-industrial complex. People's living standards are eroding slowly. Private investment stays cautious. I will guess that the Russian economy is still a predator. It's a large predator, but on a very strict fiscal diet now.

Liutova. Let's see how this predator manages with such nutrition. We'll leave it here for today. Sasha, always a pleasure to talk budgets and the economy with you. This was Alexandra Prokopenko, a fellow at the Carnegie Russia Eurasia Center in Berlin. Thank you.

Prokopenko. Thank you.

Liutova. And for our audience, if you enjoyed this conversation as much as I did, please don't forget to share, leave a comment, like. We really value your support and your feedback. I'm Margarita Liutova, and see you soon on Carnegie.