With COVID-19 cases rising in Russia, President Vladimir Putin addressed went on TV to announce measures he said were aimed at lending young families, workers, and small business owners financial support as the coronavirus upends daily life on a mass scale.
And toward the end of his surprise 17-minute speech on March 25, announced just a few hours beforehand, Putin laid out how this support would be financed, in whole or in part: taxes on the well-to-do.
Despite having access to hundreds of billions of dollars meticulously stored away for just such an economic crisis, Putin unexpectedly called for long-term changes to the nation’s Tax Code to target its richest individuals – as well as, to a much lesser extent, the middle class.
Putin said he would hike taxes on dividend and interest payments that Russian companies make to their owners’ offshore bank accounts. He also said he would tax interest on Russian bank deposits and bonds exceeding one million rubles ($12,500).
“All the additional money coming into the budget from these two measures, I recommend spending in a targeted way to support families with children, to help people who have lost their jobs or are sick,” he said.
While the temporary spending measures were recently conceived to deal with the coronavirus spread, the tax changes may be a separate policy developed some time ago, analysts said.
The crisis atmosphere swept in by the coronavirus may have simply presented an opportune time to impose potentially risky tax hikes that rich Russians — whose cash can translate into political clout — had so far managed to resist.
“They have been preparing this new stage of tax reform for a while. I don’t think it was an impromptu [decision] from Putin. But he decided to use the crisis as an excuse to push forward with non-crisis-related tax increases,” said Vladimir Tikhomirov, chief economist at the Moscow-based BCS Brokerage.
Putin said Russia would tax dividends and interest payments made by local companies to offshore entities at 15 percent, closing a loophole much abused by the nation’s elite.
Many of Russia’s wealthiest individuals own their domestic businesses through entities registered in low-tax offshore jurisdictions like Cyprus and the British Virgin Islands. The Russian businesses then typically distribute their profit as a dividend to the offshore entities.
Putin claimed that two-thirds of those payments are taxed at only 2 percent, rather than at Russia’s 13 percent flat tax rate, due to the international agreements it has with such offshore destinations.
“That is, to put it mildly, not fair,” Putin said in his March 25 address.
He also said that individuals with large bank deposits or bond holdings would be taxed 13 percent on the interest they earned.
Many Russians put their savings in bank deposits rather than securities because — unlike in the West — they pay high interest rates.
Putin highlighted that most nations tax such interest and claimed that Russian bank deposits “will still remain attractive” even after the change. His assertion that it would only affect 1 percent of deposit holders — a contentious number as many citizens split their deposits among multiple accounts — did not soothe critics who contended that the middle class would take a substantial hit.
“Additional milking of the disappearing middle class,” Leonid Volkov, an opposition politician allied with Kremlin foe Aleksei Navalny, wrote of the bank-interest taxation in a Telegram post. “And, importantly, what connection does this have at all to the coronavirus?”
Tikhomirov said that the government may have been cautious about carrying out a major tax move following a hike in the value-added tax (VAT), which hurt economic growth, and a retirement-age increase that knocked Putin‘s popularity ratings lower.
Russia raised VAT to 20 percent from 18 percent at the start of 2019, and in 2018 passed legislation that would gradually raise the pension age by five years. The unpopular pension reform was submitted to parliament in June of that year just as Russia began hosting the monthlong soccer World Cup.
Economists said it is unclear how much the new spending measures to fight the coronavirus will cost the Russian budget.
The crisis spending means Russia will likely face a budget deficit this year if global oil prices stay below $40 a barrel, said Elina Ribakova, deputy chief economist at the Washington-based Institute for International Finance. Benchmark Brent crude is currently under $30 a barrel.
Russia could easily tap the $120 billion in a so-called “rainy day” fund to cover budget deficits not just for this year but for years to come, officials said earlier this month. The fund is part of the nation’s total reserve war chest of $570 billion, the fourth-highest in the world.
“The whole point here is not to spend the money from the reserves but to try to keep the budget balanced,” Tikhomirov said of the taxes. “If they are going to spend money from the rainy [day] fund, they are going to do so gradually.”
The budget could receive at least $8 billion from the new tax based on one analyst’s estimate that Russians paid $93 billion last year in dividends and interest payments to their offshores.
Sergei Aleksashenko, a former deputy central bank chairman and vocal critic of Putin, indicated that the president had other motives for raising taxes on the wealthy.
“Putin wants to extend his personal control over Russian business and its resources,” Aleksashenko said, adding that the taxes will provide a “minuscule” result for the budget.
If so, this would not be the first time that Putin leveraged a crisis to push through unrelated policy that enhances his power.
In 2004, a series of terror attacks culminated in the hostage-taking assault on a school in the southern town of Beslan that left 334 people dead, more than half of them children, after what critics say was a bungled rescue operation.
Part of Putin‘s response was a package of electoral changes including ending elections of governors, a move that strengthened his power over Russia’s far-flung regions but drew accusations of a rollback of democracy.
Putin has previously announced measures to get more state control over offshores and subsequently the nation’s elite.
He laid out his idea of “de-offshorization” of the Russian economy in a December 2012 state-of-the-nation speech and soon banned government officials from owning assets abroad.
He later required all resident taxpayers to declare their offshore accounts and pay 13 percent on that income, a policy in line with many Western nations, but one that rattled his elite.
According to a study of around 300 high-net-worth Russians carried out by the Moscow-based law firm Yegorov, Puginsky, Afanasiev and Partners, nearly half of the nation’s wealthy individuals gave up Russian tax residency or transferred assets to relatives with foreign residency rather than turn over information about their offshore assets to the nation’s tax authorities.
Russian citizens can avoid being local tax residents by spending less than 183 days inside the country. In an attempt to fight this practice, the Finance Ministry late last year submitted a bill to the lower house of parliament, the State Duma, that would make a person a tax resident if they spend just half that time in Russia, 91 days.
Separately, a bill to end the flat tax and raise the burden on those Russians earning 24 million rubles a year ($300,000) to 18 percent was swiftly shot down in parliament in December after nearly two years of discussion.
Russia’s wealthy have a strong lobby wing in the Duma that has blocked similar bills at an early stage, analysts have said.
Putin‘s public address means the Duma — in which the Kremlin-controlled United Russia party holds a big majority — is almost certain to pass the tax increase on offshore payments.
Isaak Bekker, a financial consultant for FCP Financial Management and a Forbes Russia contributing columnist, wrote in November that taxes on the nation’s wealthy “may very soon dramatically change,” pointing out that Russia had the second-highest concentration of wealth after Thailand, according to a 2018 report by Credit Suisse. It said 10 percent of Russia’s population owned 82 percent of its wealth.
Political Risk — Or Reward?
Bekker predicted domestic politics, rather than budgetary needs, would be the main driver for imposing a greater tax burden on the wealthy. Higher taxes on the rich could play the role of a “national idea,” he said, as Russia heads into parliamentary elections in 2021 and a presidential vote in 2024, in which Putin is likely to be able to seek a fifth term due to constitutional amendments he is pushing through.
However, he said, to be effective in that regard, this tax revenue should be spent in a “visible” way for the public and not fall into the general budget, which is what Putin recommended.
Evghenia Sleptsova, an economist at Oxford Economics in London, said Putin may be using the coronavirus crisis to further the process of de-offshorization he started years ago.
And though Putin is now making it more attractive for the wealthy to keep their money inside Russia with a higher tax on offshore payments, Sleptsova said it won’t be an easy sell due to the nation’s weak rule of law.
“My sense is that tax rates are not the only reason why Russian businessmen would take money offshore. It’s a risk of losing all or part of it if left in Russia in case your business gets expropriated,” she said.
Russia’s nationalization of Yukos, once the nation’s largest oil company by market value, is the most vivid example of business expropriation since Putin came to power. However, many smaller businesses have been seized from rightful owners over the years with the help of the nation’s law enforcement.
New Russian Prime Minister Mikhail Mishustin could be well suited to oversee implementation of the new taxes. He ran Russia’s tax service from 2010 until Putin made him cabinet chief in January 2020, and has been credited with modernizing the agency and improving collection.
Nonetheless, it may not be an easy task.
“When you are trying to go after the wealthy, you could potentially hit special interests and then it gets very tricky. How much they will be able to collect is unclear,” said Ribakova.
Even so, she said, the mere proposal will sit well with most citizens, who have a critical opinion of the wealthy.
“It works beautifully for political messaging,” Ribakova said.