The Kremlin will likely view anything short of Ukrainian capitulation as an existential threat to Russia’s ability to fight such a war

The above is a quote from the ISW’s latest report, which can be read in full here :

https://www.understandingwar.org/backgrounder/why-putin-remains-uninterested-meaningful-negotiations-ukraine?fbclid=IwZXh0bgNhZW0CMTEAAR3KOCoAnG4iIiucnjc8eiAbXgU_zpVPnsdhYijbUXLdbJG3Uh_z4Udc41I_aem_ZmFrZWR1bW15MTZieXRlcw

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A Ukrainian: Alexander Kolyandr in the Speccie explains:

How Putin plans to fund a forever war in Ukraine

Vladimir Putin’s costly war in Ukraine has transformed Russia as the president has forced the country to pivot onto a war footing to support it. Now, going a step further, Russia is embarking on a significant tax regime overhaul, a move that hasn’t been seen in almost a quarter of a century. The tax shake-up will allow the Kremlin to further prioritise military spending as it attempts to keep its invasion going.

In the early years of Putin’s rule, Russia sought to attract a lot of foreign investment, boost the number of small and medium-sized businesses, grow the middle class and encourage them to spend. As a result, in the 2000s, private investments poured into trade, services, and the production of consumer goods, not only into oil and metals. A simplified tax code with easier taxes for the self-employed and a flat income tax of 13 per cent helped Russians reach an unprecedented level of wealth and consumption.

The only way to solve the black hole in Russia’s finances is to raise taxes

But that has all changed now. The war in Ukraine has been raging for over two years, and there is no end in sight. The Kremlin needs the money to finance defence spending, which stands at about 6 per cent this year, up from around 3 per cent on average in peace time. Moscow also needs to incentivise investment in the domestic production of machinery and technology, rather than just trade and services.

But first the Kremlin needs to balance the books. Over the past twenty years, Putin has repeatedly said that uncontrolled military expenditures upended the Soviet Union. He doesn’t want that to happen on his watch; he needs to keep the country’s budget in balance.

The 2023 budget was balanced thanks to several one-offs taxes on commodities’ exporters. Spending from a rainy day National Wealth Fund, created to plug the gaps in the state finances in lean years with oil taxes collected during plentiful ones also helped. As a result, the deficit for 2023 stood at 1.9 per cent of GDP (quite an achievement for a country at war and under sanctions); in 2024 it’s expected to narrow to just 1.1 per cent. The drafts for the 2025 and 2026 budgets, which were presented in the Autumn of 2023, have also been neatly balanced, helped by higher oil revenues and a decline in government spending, including that on defence which was shrunk by a third from 2024. 

But those budgets haven’t really been balanced. Why? Because the figures the Ministry of Finance is relying on are not realistic. The budget projections are based on shaky assumptions about healthy oil revenue and declining spending. Russia’s oil revenue won’t grow, while the costs of selling oil Russia incurs are rising, due to the pressure from sanctions. This is resulting in a smaller income for the state coffers from every barrel sold. On the other hand, without any glorious victories, the Kremlin can’t cut defence spending without risking an economic slowdown, not to mention a military defeat.

So, the only way to solve the black hole in Russia’s finances is to raise taxes. The Ministry of Finance expects to collect an additional 2.6 trillion rubles (£22 billion) in 2025, the first year of the new tax regime. If current growth estimates hold up, the additional revenue would be about 1.4 per cent of GDP in 2025. A quarter is expected to come from higher income taxes on the rich; businesses will provide the rest.

The first change is to income tax. For two decades, Russians have paid a 13 per cent income tax. This will be replaced by a progressive income tax ladder. For salaries up to 2.4 million rubles (£20,600, or about £37,000 if purchase power parity (PPP) is taken into account), income tax will remain at 13 per cent. All earnings above that threshold will be taxed at incrementally higher rates, from 15 per cent up to 22 per cent.

There will be no personal tax-free threshold. Instead, the government offers a rebate on taxes paid by low-income families with two or more children, reducing their real income tax to 6 per cent.

The Finance Ministry is promising that only 3.2 per cent of taxpayers will face a high-income levy once the reforms kick in. So, the rich will pay more, and the poor will pay less. At least, that is the Kremlin’s message.

In reality, though, the number of affected taxpayers will be higher because of inflation. There is no plan to index tax thresholds, which means that the number of individuals facing higher tax bills will increase even if real incomes remain the same. The super rich, however, will get off lightly as capital gains tax, including that on investment, will not change. In Russia, the highest incomes are mostly based on investment returns, rather than salaries. As such, the majority of the richest Russians will not be affected by the new tax, which taxes salaries rather than incomes in general.

There is one part of this new tax regime, though, that the Kremlin has been at pains to keep quiet. The way in which this collected income tax is redistributed is also about to change: all the extra tax collected from the better offs will not be spent at a local level, as used to be the case. Instead, it will be sent to central government for it spend as it sees fit. In other words, all the extra collected income tax will flow into the Kremlin’s coffers to finance the war in Ukraine.

Pouring into Putin’s war chest alongside the extra personal taxes will also be higher corporate taxes. Corporate income tax will increase to 25 per cent from 20 per cent. From a revenue point of view, this is the most important change the Kremlin is bringing in: the Ministry of Finance has predicted it to generate 1.6 trillion rubles (£14 billion) next year.

Increasing corporate income tax will reduce company profits by an average of 6.3 per cent. Although tax breaks are available when money is spent on scientific research and the development of home-grown technology, be it civil, military or dual-use, these – by definition – apply to only a small number of companies. The trade and service sector – the bulk of medium-sized business in Russia – is unlikely to benefit, as it has neither the money nor the need to spend on science or expensive new technologies. 

Small and medium-sized businesses previously exempted from VAT, will now have to pay this tax from revenues exceeding 60 million rubles (£530,000). The state will also collect more money from metal and fertiliser producers through an increased mineral extraction tax.

The Russian government, has, over the past two or so years, become the country’s leading spender and its main investor. By changing these corporate taxes and increasing the taxes on the highly-paid, it is trying to reroute spending towards industry and manufacturing away from trade and services. Putin’s first major tax revamp in 20 years is yet another step towards a forever war in Ukraine.

WRITTEN BY

Alexander Kolyandr

Alexander Kolyandr is a researcher for the Centre for European Policy Analysis specialising 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.

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