Putin’s war will soon reach Russians’ tax bills

Berlin: President Vladimir Putin of Russia is about to institute a rare tax increase on corporations and high earners, a move that reflects both the burgeoning costs of his war in Ukraine and the firm control he has over the Russian elite as he embarks on a fifth term in office.

Financial technocrats in Putin’s government are searching for new ways to fund not just an expensive war in Ukraine but also a broader confrontation with the West that is likely to remain costly for years. Russia is allocating nearly one-third of its overall 2024 budget to national defense spending this year, a huge increase, adding to a deficit that the Kremlin has taken pains to keep in check.

The proposed tax increase underscores Putin’s rising confidence about his political control over the Russian elite and his country’s economic resilience at home, showing that he is willing to risk alienating parts of society to fund the war. It would represent the first major tax overhaul in over a decade.

“I think that this is a real sign of how comfortable he is,” said Richard Connolly, an expert on the Russian economy at Oxford Analytica, a strategic analysis firm. “The fact that they are doing it — they are looking to repair the house whilst the weather is good, or at least reinforce the walls from a fiscal point of view.”

Military spending and high oil prices have buoyed the Russian economy and driven up wages, despite causing higher inflation and shortages in the labor market; that is probably leading financial officials to see the current moment as a good time to push through tax increases.

Those responsible for paying Russia’s bills cannot predict how much Putin’s future geopolitical moves will cost or whether Western sanctions will further limit income.

“From Moscow’s point of view, they are looking in pretty good shape, and now is a good time to do these things,” Connolly said. “Even the people who it will fall on have had a good couple of years and look like they are going to have a good year ahead.”

Few details are known about the planned increase. In a speech Wednesday, Putin said his government was assessing various proposals. He said the new tax arrangements would remain fixed for a long period to ensure stability.

“Modernization of the fiscal system should ensure a more equitable distribution of the tax burden, while stimulating businesses that develop and invest, including in infrastructure, social and training projects,” Putin said.

Most Russians pay income tax at a flat rate of 13 per cent, significantly lower than what taxpayers in the United States and Western Europe typically pay. In an interview in March, Putin said he planned to introduce a new progressive tax scale in part to alleviate poverty — a popular message among many Russians who support increasing taxes on the country’s rich, which have historically been low.

A tax that largely spares lower income earners could also help mute discontent over the war among poorer Russians, who are providing much of the manpower for the army and bearing the brunt of the casualties. Putin has signaled that the tax overhaul will include special incentives for certain groups, which could include Russians directly involved in the war effort or families with three or more children.

In internal discussions, Russian officials have considered raising the personal income tax for earnings over 1 million rubles ($10,860) a year to 15 per cent from 13 per cent, and increasing the rate for earnings above 5 million rubles a year to 20 per cent from 15 per cent, according to a report by the independent Russian investigative outlet Important Stories, which cited unnamed government officials and was confirmed by Bloomberg News.

The change is likely to hit particularly hard in Moscow, whose residents earn some of the country’s highest salaries. The average Russian salary last year was about 884,500 rubles, according to the state statistics agency, Rosstat. In Moscow, it was nearly double, or about 1,636,800 rubles.

The government is also considering raising the tax on corporate profits to 25 per cent from 20 per cent, Important Stories reported. The change in corporate taxation is considered one of the key ways to increase the share of revenue from sources other than the oil and gas sector.

About one-third of the Russian federal budget comes from oil and gas, meaning a substantive drop in prices in that industry could impede Moscow’s ability to fund the war, said Heli Simola, a senior economist at the Bank of Finland.

“They are not thinking about whether the companies are happy or not,” Simola said. “They want to get the money, and they also need it, and they want to show the companies they have to do their part in financing the war and the common cause.”

The planned new tax policies demonstrate how the whole of Russian society, from business executives down to mobilized soldiers, is being pulled into the war effort, which has become the defining principle of Russian public life. Still, apart from high earners, many Russians would not pay significantly more in income taxes under the proposals being discussed, limiting the potential political backlash for Putin.

Moscow’s defense expenditures have skyrocketed on account of the war. Compared with the year before the full-scale invasion of Ukraine, the government’s spending on national defense has more than tripled. Russia’s financial technocrats are taking advantage of the current economic moment to raise funds for future war expenditures.

“No one knows Putin’s projections” for the war, said Alexandra Prokopenko, a fellow at the Carnegie Russia Eurasia Center. “There are rumors and anticipation of an upcoming Russian escalation. They don’t have a crystal ball, that’s why they want to have this money now.”

For much of the 1990s, Russia operated under a complicated tax code with limited enforcement, allowing many Russians to avoid paying taxes altogether.

But in the nearly quarter century since Putin came to power, the nation underwent a tax revolution. The introduction of the 13 per cent flat tax on personal income encouraged compliance, drastically increasing income tax revenue but raising questions of fairness in a society with significant income inequality.

Russia technically departed from the flat tax in 2021, requiring residents earning over 5 million rubles per year to pay 15 per cent. A report in the Russian business newspaper RBK found that excess revenues derived from the increase came overwhelmingly from Moscow.

Beyond running a deficit, Russian finance officials have found creative ways to raise more money to fund the war since Putin launched the invasion in early 2022.

Russia changed the way it calculates taxes on oil companies last year to fill government coffers. It taxed exits by foreign companies leaving Russia and introduced new export duties on goods including oil, timber and machinery. And Putin placed a “windfall” tax on companies’ excess profits.

Many businesses in Russia are happy to pay higher corporate tax rates so long as the surprise windfall taxes and payments end, but that isn’t guaranteed.

“You increase the corporation tax now, then say you will try your best to refuse windfall taxes, but then if the war carries on, these things are likely to continue,” said Connolly, who predicted that higher Russian expenditures on defense would persist for a long time.

Prokopenko, a former official at the Russian central bank, said authorities, having initially tapped more oil- and gas-related revenue to fund the war, would now go after all corporate profits.

“They need to do what’s called income mobilization,” she said. “And increasing taxation is part of this.”