Budget Problems Will Be Passed On To Wealthy Russians

Nezavisimaya Gazeta, an independent newspaper, publishes this analysis by the FBK Institute of Strategic Analysis, a pro-business financial analysis company. They argue that Russia’s deepening economic crisis has forced the government to debate moving to a progressive tax, which could hurt Russian business interests.

It’s an interesting read, though there may be problems with the data set. For instance, the argument being made is that, in general, countries that increased their top marginal tax rates see economic stagnation or recession, but it’s unclear if this data would apply to Russia. Russia currently has a flat tax at 13%, and the countries in question are taxing top earners at rates 2-3 times larger than this. Also, the United States is conspicuously left out of this discussion. The U.S. increased their top tax rate from 35% to 39.6% in 2013. If Russia were to move to a progressive tax, more study would have to be done in order to really gauge the long-term impact.

Regardless, the debate demonstrates that Russia may be forced to look at more leftist policies in order to reduce its budget (and keep its populous happy), and it is unclear what the greater impact of those policy changes may be in the end. – Ed.

Many countries are trying to solve budget problems by raising taxes on the rich. So did France, Greece, Spain, UK, Ireland, and others. Now the introduction of a progressive personal income tax (PIT) looks likely also in Russia, where the fiscal crisis becomes more severe. Yesterday a study was presented in Moscow on the impact of increased taxation of the rich in different countries. Economists believe this study is very relevant for Russia.

In recent years, some countries have increased the tax burden on the rich to reduce the budget deficit and obtain additional funds to stimulate economic growth. Among them Armenia, Great Britain, Greece, Ireland, Israel, Spain, Portugal, Finland, and France. However, an increase of the tax burden on the rich was usually accompanied by economic recession or slowdown, but the budget deficit declined only slightly. This was the conclusion the economists from the FBK company made yesterday.

In 2009, Ireland raised the marginal rate of income tax, applied to wealthy citizens, from 41 to 46%. ”The marginal rate increase was accompanied by a deepening recession. The total taxes collected was even less than before the top rate increase,” the report says. In 2009 the economic downturn amounted to almost 6%. In France the top marginal tax rate was raised from 41 to 45% during 2010-2012. At the same time the economic growth slowed from about 2 to 0%.

And there are many such examples. Perhaps the exception to this trend was the UK, where in 2010 the maximum rate was increased from 40 to 50%. This measure was accompanied by a GDP growth of almost two percent. However, researchers believe that in this case it is indicative that the government postponed the increase of the marginal rate from 2008 to 2010, and did not dare to increase the burden in the midst of crisis.

There are also examples of countries that, on the contrary, eased the tax burden on the rich. Among them are Poland, Denmark, Croatia. For example, in 2009, Poland reduced the marginal rate from 40 to 32%, and ”unlike many other countries, Poland has not slipped into recession.”

As noted by the Director of the FBK Institute of Strategic Analysis Igor Nikolaev, although we definitely cannot speak of a direct dependence of economic growth on income tax rates, a certain correlation could be observed. An increase of the tax burden on the rich, many of whom are businessmen, in one way or another leads to a decrease in business activity, and businesses move to the shadow economy or abroad.” An increase of the fiscal burden on the rich in times of crisis, or even during a period of recession, is a mistake, unfair as it may look,” concludes Nikolaev.

Now the country has a flat rate, regardless of income level citizens pay 13 percent tax. With a progressive scale starting from a certain level the tax rate is higher. Moreover, it does not necessarily mean that the increased rate applies only to oligarchs, it often affects citizens who are just well off. In Russia, it could theoretically affect those whose wages are higher than a regional average.

Signs of the budget crisis in Russia are obvious. Late last week, the first Deputy Finance Minister Tatyana Nesterenko said that based on the results for 2013, the country might need to take 100 billion rubles from the Reserve fund in order to solve the current problems. Such statements were made against the background of the $7 billion already borrowed by Russia on the international market, and while oil prices were high – about $110 per barrel. A month ago, Finance Minister Anton Siluanov assured that without an urgent need the Reserve Fund would not be tapped into. It turns out the “urgent need” is here.

In January-September 2013 the deficit of the consolidated regional budgets amounted to almost 74 billion rubles, compared to the same period of last year when this number stood at 250 billion rubles. ”A large part of budgetary expenditures is traditionally concentrated at the end of the year,” said Andrei Chernyavsky, a leading researcher at the Higher School of Economics Center for Development. According to his estimates, it is possible that by the end of the year the regions could face a deficit of 0.8-1 trillion rubles, that is about 1.1-1.5% of GDP.

In other words the authorities have enough reasons to increase the tax burden. Given the populist nature of many initiatives of the Russian authorities, it can be assumed that it will be the affluent Russians who will fall victim to this tightening of taxation. After all, according to Nikita Maslennikov, an adviser of the Institute of Contemporary Development, the Russian authorities usually opts for what it considers the most straightforward solution to a problem. But with the introduction of a progressive scale of personal income tax the authorities will then have to reduce the burden in the area of ​​insurance premiums, notes Maslennikov.

The Kremlin and the government are discussing a progressive scale of personal income tax. Speaking at this year’s St. Petersburg International Economic Forum, the First Deputy Prime Minister Igor Shuvalov said that the introduction of a progressive personal income tax scale seems appropriate only in the next political cycle, that is after 2018. Then, in November, President Vladimir Putin mentioned a possibility of introducing a progressive personal income tax scale. Moreover, according to him, de facto it has almost been introduced in the form of taxes on expensive cars and real estate. “Of course, it looks like a more equitable form of taxation when a person with higher income pays more… Of course, once we will have to think about switching to a differentiated scale… In some areas we are in fact almost there: an expensive car, expensive real estate. So we have to think about it, but we should act carefully,” said Putin.

But Russia missed its “window of opportunity” to increase the tax burden on the rich, says Nikolaev. This measure was relevant in 2006-2007, it has to be resorted to “only once the country has recovered from an economic crisis.” Meanwhile, according to FBK projections, the crisis continues: in 2014 the Russian economy will finally “go into the red.”