Russia is launching a major tax overhaul next year. Invest Foresight asked Nikita Maslennikov, Director of Economics and Finance at the Institute of Modern Development, why this needs to be done and what pitfalls might be encountered on the way to change.
– Is this tax reform really necessary?
– I would not describe the announced initiatives as a fully-fledged tax reform, since the amendments are not going to affect the entire system of taxes, insurance premiums and other levies. It is more likely to be an adjustment, or ‘modernising the fiscal system,’ as Vladimir Putin said in his Address to the Federal Assembly.
– Actually, several amendments have been announced.
– Yes, the initiative will cover two major aspects – one is personal income tax (PIT), and the other is corporate tax. And in fact, there are a few hard factors that make reforming these two components an unavoidable necessity. When it comes to PIT, the policy needs to be weighed extremely carefully.
– Why?
– There is a certain trend today, which negatively affects the coefficient of social inequality. Even though the number of poor people is declining, in both relative and absolute terms, the government is providing social assistance to families with children on an unprecedented scale. This has already pushed the inequality coefficient up to 0.403 from 0.395 last year.
The situation is slightly worse than in China and much worse than in many European countries; it is somewhere similar to the dynamics observed in the United States.
– But personal income tax can’t be left as it is either, can it?
– The flat PIT rate could not remain in place indefinitely. The most likely reason for changing it now is the result of introducing the 15% rate for higher earners earlier. Apparently, the Finance Ministry believes the initiative was a success.
– What about corporate profit tax?
– The situation is quite obvious here. We can endlessly repeat that low inflation is one of the main drivers of investment. And this is indeed true – private investment on a mass scale is never observed with inflation above 6%. And all the triumphant reports about massive investment could actually stem from the growing defense production.
– How so?
– The manufactured military equipment is always counted as investment. But the real level of investment, let’s say, for civilian purposes, is lower.
It is clear from the above that, if we were serious about fighting inflation, we would need to balance supply and demand, and supply won’t grow without investment. However, the recent corporate profit tax developments have been doing anything but stimulating investment – a ridiculous situation, to put it mildly.
– Why did that happen?
– Because no incentive – there is a range of stimulating regimes currently in place such as capital investment protection agreements, special investment contracts, territories of priority development and special economic zones – none of these tools will work if medium-term prospects remain unclear. The applicable tax deductions and benefits need to be predictable at least until 2030.
– What was the actual situation?
– All through 2022 and 2023, we saw one-off levies. According to estimates of the Russian Union of Industrialists and Entrepreneurs, export duties alone have effectively increased the tax burden on the companies that have been taxed. With the rate at 20% (3% to the federal coffers and 17% to the region), a 40% tax burden on leading exporters is a bit too much. Therefore, it is absolutely imperative to modernize the profit tax to stimulate investment; the question is how it will be done.
– Is there no answer to this question? A tentative one perhaps?
– At this point, the two rounds of hearings at the State Duma have only confirmed the underlying idea: the government wants to stimulate investment, on the one hand, but on the other, it also wants to alleviate social inequality and, above all, inequality between Russian regions. The whole reform business is not about some abstract coefficients; the purpose is for the regions to be more or less equal in terms of fiscal capacity and other aspects.
The guiding principles are clear, but the details aren’t. In fact, the progressive personal income tax plan the media have been citing (a 13% tax on annual incomes under 1 mln rubles ($11.4K), 15% on 1 to 5 mln rubles, and 20% for people earning more than 5 mln rubles ($56.8K)), also raises questions.
– How many people will the tax changes affect?
– The important thing is that they will affect the entire middle class. But one of the recommendations made at the State Duma hearings was just the opposite: let’s not harm the medium earners, who have just got on their feet, let’s leave them alone. It turns out that this plan is not too feasible now.
– Let’s go back to corporate tax again.
– Well, Finance Minister Anton Siluanov made it clear that the rate will be about 25%, because he has discussed competitiveness with our closest neighbors, and Iran and China have corporate profit tax at just 25%. But then, there are also tax benefits and tax deductions, and most importantly, how will intensive investment help a company optimize taxes?
– Is there no clear understanding at the moment?
– The question is still open. The guiding principle is clear: companies making considerable investments pay less taxes. But this raises the question of criteria: the employers’ union proposed developing and legislatively approving a set of criteria for an ‘actively investing company.’ The Ministry of Finance has taken note of this, but they still need to decide what these criteria will include: the company that invests, the projects it invests in, the amount invested, etc.
Everyone agrees about investing in production assets. But what if a company is building an infrastructure facility? Will this count? And what about investment in human capital?
– This will be even more difficult to take into account.
– The government and the Central Bank are telling us that we need to stimulate long-term savings, and to do that, corporations can create their own corporate pension programs. This is all good, but what about the rules for co-financing pensions? They seem to exist, but clarifications are needed. If I am allowed to do this, can I move the incoming funds from profits to tax-free revenues? If so, this will definitely spur stock market development, because where else will these new savings be invested? There is no answer to this question.
– As far as I remember, there were recommendations.
– Yes. The recommendations said the government should incentivize investment in social policy programs. Does this apply to corporate pensions? A lot of questions remain unanswered. The experts raised them at the hearings, but they haven’t made any significant progress.
– Perhaps you could summarize what’s more or less clear?
– There will be a reasonable scale of personal income tax brackets. The corporate tax rate will be increased. However, it will be lower for companies making significant investments – at 20% or, say, 17.5% – but it remains unclear which companies will be eligible to take advantage of the rebate.
– But inequalities between the regions remain?
– Yes, both personal income tax and corporate profit tax contribute to regional budgets. How do we ensure the redistribution of funds? The State Duma Budget Committee actually mentioned this in its recommendations following the hearings.
A simple linear increase in corporate tax and personal income tax revenues will not solve the problem of regional inequality. The new levels will be recorded in some new quantitative parameters, but the gaps will remain. Therefore, proposals are needed on how to change the redistribution mechanism and create a new architecture of inter-budgetary settlements and transfers.
The new Defense Minister, Andrei Belousov, promoted a regional investment standard initiative when he was Economics Minister, and that standard was approved in most regions. But they established regional benefits, which are not as effective as they should.
What we see now, again, is limited effectiveness of all these investment stimulating decisions.
– But the tax reform – or modernization – will happen anyway.
– Yes, it will happen no matter what. But it is still unclear what form it will take and what criteria will be used.