Within the project “Empowering Civil Society Networks in an Unequal Multipolar World – BRICSAM”
THE IMPACT OF THE RUSSIAN FEDERATION’S TAX POLICY ON
SOCIOECONOMIC INEQUALITY. POLICY ANALYSIS
By Lyudmila Kostyleva for GCAP Russia
This project is funded by
The European Union
This project implemented by
Global Call Against Poverty
Russia (GCAP Russia)
This publication has been produced with the assistance of the European Union. The contents of this
publication are the sole responsibility of GCAP Russia and its partners and can in no way be taken to
reflect
views of the European Union.
1.theINTRODUCTION
1. INTRODUCTION
In contemporary Russian society, there are high levels of socioeconomic inequality, largely caused by the
inadequacy of existing tax policy. Since 2001, a flat personal income tax rate has been in force in the
Russian Federation, and the role of the income tax in budgeting has been quite small compared with other
countries. The flat tax rate schedule fails to create proportional taxation due to the existence of multiple tax
credits and deductions as well as differentiated tax rates for different income types. This situation can be
regulated by reintroducing a progressive personal income tax rate, increasing tax rates on dividends, and
introducing a wealth tax.
Today’s Russian society is characterized by high levels of stratification between the rich and the poor,
which is officially recognized as one of the most urgent social issues. According to the Federal State
Statistics Service data, in 2012, the R/P 10% ratio, i.e. the ratio of the average income of the richest 10% to
the poorest 10%, was 16.4. But some experts argue that the actual income gap is much bigger and lies
between 25 and 30. Besides Russia, similar levels of inequality characterize some Latin American
countries, while in European countries this measure does not exceed 10.
Unequal income distribution among the country’s population limits the consumption of products and
services by a considerable part of the population, which leads to economic and demographic losses and
degrades human capital assets. Due to excessive inequality, Russian regions lose around 14% of gross
regional product.
2. HOW CURRENT STATE OF RUSSIAN TAXATION SYSTEM IMPACTS INEQUALITY
Income inequality originates in the process of wage distribution among enterprise and organization
employees. Having started with income distribution, this differentiation of the population increases at the
redistribution stage. To identify the aspects of tax policy that impact the population’s socioeconomic
inequality, we will start by analyzing the Russian tax system since 1991, the moment when the USSR
collapsed and a radical economic reform was launched.
While the Western tax system functioned in a context of normal economic development, the tax system in
Russia has long been influenced by a profound socioeconomic crisis. This is why the Russian taxation
system is largely geared towards fiscal goals, i.e. to the pumping up of state budget revenues. All other
goals common to the modern Western tax system, particularly those of production stimulation and
advancing social justice, remain secondary (In 1991, the official US dollar to ruble exchange rate was 60.7
kopecks).
The creation of a new tax system in Russia in 1991–92 was based on the need to apply progressive
taxation to citizens’ incomes. The RSFSR Law of July 12, 1991 N. 1998-I "On the Personal Income Tax"
provided for three income tax rates: 12% for the total taxable income until 10 million rubles ($16 4741) in
the calendar year, 20% from 10 to 50 million rubles (from $16 474 to $82 372), 30% for more than
50 million rubles ($82 372). Employees also paid pension taxes (1%) and employers paid the following
payroll taxes: 28% to the Pension Fund, 5.4% to the Social Insurance Fund, 3.6% to the Compulsory
Medical Insurance Fund, 1.5% to the Unemployment Fund. During 10 years only minor changes were
introduced in the progessive taxation system, concerning inflation and currency valuation.
The role of the income tax in the tax system of that period was quite small compared with developed
industrialized countries and the most successful transitioning economic systems. In the vast majority of
countries, the income tax's share of the total amount of tax revenue was 25% to 30%, while the role played
by the income tax in Russia was considerably lower even than in outlier countries: Greece and the Czech
Republic (around 13%).
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The fact that the income tax was not an important tool of tax policy in the early stages of the transition
period can be explained by several factors, including:
1.
Low levels of income among a considerable part of the population, primarily from low wages
(wages being the principle component of the tax base). It is important to note that the tax administration’s
inability to adapt to the new economic situation prevented efficient collection of taxes on income other than
wages, and such income largely fell outside of the taxable base, while constituting a substantial part of total
income.
2.
Legal confusion and multiple income tax privileges. The implementation of populist theories
about taxes’ ‛stimulating role’ in supporting certain economic sectors, business branches, or particular
groups of taxpayers in Russia led to several deformations of the tax system and made it unfair towards the
ordinary law-abiding taxpayer who had no special tax privileges. The state put an extremely high burden on
such taxpayers. At the same time, tax privileges almost never achieved the goals they were introduced for,
violating the principle of equitable competition of economic actors and promoting corruption.
3.
Poor administration of tax collection and, consequently, mass tax evasion. As a result, full
taxes were not paid by all enterprises and citizens, but only by prompt taxpayers who observed tax law and
had no tax privileges. At the same time, although tax management and tax administration were gradually
improved every year, many potential taxpayers either paid no taxes at all or paid considerably less tax than
dictated by the law. This made the tax system unfair and undermined its neutrality.
4.
High tax levels. An important factor in discouraging full tax payments was the fact that in the
eyes of the taxpayers, the nominal tax levels were high. The marginal tax rate for incomes in the lower
brackets of the tax rate schedule (i.e. those suffering the 12% income tax rate), including provisions to
social non-budgetary funds, amounted to 37.18%, and the marginal tax rate for incomes subject to the
maximal tax rate, including all provisions to non-budgetary funds, was 50.2%.i
This tax rate not only surpassed the 30% profit tax rate which was in place at the moment when income tax
reform was implemented, but also the income tax rates for other personal income types: 38.4% on jointstock companies’ dividend distributable profits (including double taxation of income at the 12% marginal
income tax rate), 0% on imputed rent for use of durables, 0% on government stocks yield, 0% on interest
income on bank deposits, 15% on profits realized on the difference between two thirds of the central
bank's refinancing rate and bank deposit interest rates, etc. This also created a lack of neutrality of the
income tax towards the type of income and led to the transformation of wages into other income types.
Another problem in Russia at that time was the extremely large scale of the informal economy: according to
the Federal State Statistics Service, it was estimated at 20% of the GDP in 1995, 23% in 1996, 40% in
2000. The informal economy generated undisclosed earnings for the population. The percentage of hidden
wages reached its peak in 1999 (38.4%), and in the year before the reform the share of hidden wages was
31.0%. As such, the main reason for introducing a flat tax rate schedule was the need to drive capital out of
the shadows, i.e. to legalize citizens’ incomes.
In 2001 Russia became the first of the larger countries to introduce a flat income tax rate schedule, and
moreover at a relatively low rate of 13%. Both progressive tax rates (20% and 30%) for people with large
incomes, as well as the 1% pension contribution, were abolished.
A certain increase in the rate at which the budget was filled from income tax resources did indeed occur in
2001 (Table 1), but this could have been caused by tax-related as well as tax-unrelated factors: it was at
that same time, since 2000, that the economy started to develop rapidly, oil prices and loan markets grew. ii
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Table 1
Return of personal income taxes in the Russian Federation’s consolidated budget, 1999 – 2006
Indexes
199
9
2000
200
1
2002
200
3
2004
200
5
200
6
1. Rate of increase of the
personal income tax volume
in analogous estimations, %
120
125
127
124
113
113
110
120
123
105
2. Share of the personal
income taxes in the returns
of the consolidated budget,
%
9,7
8,3
9,5
10,2
11,0
10,6
8,2
8,8
9,6
9,7
As to tax-related factors, it should be noted that along with switching from a progressive to a flat tax rate,
standard tax deduction rates were also changed, several privileges abolished, new tax deductions
introduced, and a new index of taxable incomes established. Moreover, the changes affected tax
assessment and withholding regulations, the dates of income receipt, the procedure for property tax
deductions, etc.
In the press, the increase in the volume of tax revenues has often been linked to taxpayer growth due to
the inclusion of the Ministry of Defence service personnel and staff of the Ministry of Internal Affairs, the
Federal Tax Police Service, the Prosecution Service and other defence and law enforcement agencies.
According to estimations made by the Economic Expert Group, the effect of introducing the flat income tax
was insignificant: only 0.1% of GDP. The wages’ coming out of the shadows could be related to the
recovery after the 1998 crisis.
The current Russian personal income tax system presumes the taxation of resident private persons at a
13% unified tax rate and the taxation of non-resident private persons at a 30% rate. At the same time, a
distinction is maintained for two groups of incomes taxable at special tax rates and special assessments of
taxable income: regular ‛passive’ incomes (dividends) fall under a 9% tax rate and irregular ones (including
winnings and insurance payments) a 35% rate. Returns from income taxes are sent into the federal (30%)
and regional (70%) budgets.
Having described the taxation system, we will consider the level of the population’s income inequality
during this period, which can be demonstrated through changes in the Gini coefficient (Figure 1) and the
indexes of total income distribution among population quintiles.
4
0,45
0,4
0,35
0,3
0,25
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
0,2
Figure 1. Change in Gini coefficient in the Russian Federation, 1991 – 2012. [4, 5]
The 1991–92 price liberalization was accompanied by a high rate of inflation and a manifold growth of
nominal incomes, while actual incomes shrank by almost half as a result of ‛shock therapy.’ The collapse of
average income levels happened simultaneously with drastic changes in the distribution of the total income
volume in Russian society: by 1994, the value of the Gini coefficient grew more than by half and did not
change significantly in the following years. Having emerged like the kind of temporary phonomenon that
usually accompanies reform processes, income inequality in Russia has calcified. Furthermore, in 2000 a
reduction of the coefficient could be observed, which has been explained by the aftermath of the 1998
crisis, but later on it began increasing again, reaching 0.420 in 2012.
The average income of the most well-off 20% of the population (the 5th income group) exceeds the
subsistence minimum by almost 8 times, while the average income of the lowest income group amounts
only to around 84% of that index. Only the richest 20% have benefited considerably from reforms in Russia.
It could be said that the 4th and 3rd groups have retained their standards of living. As to the lowest two
income groups, their income levels and, consequently, their quality of life have decreased significantly.
Moreover, more than half of the 1st income group lives below the abject poverty line (Figure 2.)
5
Кратность к ПМ, раз
9
8
7
6
5
4
3
2
1
0
1990г. 1995г. 1998г. 2000г. 2003г. 2005г. 2007г. 2008 г. 2009 г. 2010г.
Первая (нижняя)
Вторая
Четвертая
Пятая (верхняя)
Третья
Figure. 2. The relationship of average monetary income to subsistence rate in quintile groups of the
Russian Federation’s population in 1990–2010.
As such, Russian tax policy can hardly be qualified as successful in terms of fulfilling its fiscal task or
solving social problems. Among the external factors which have led to its failure the following should be
noted, some of which have already been mentioned above:




low income levels for the bulk of the population;
financial and economic crises;
the Russian law’s inadequacy;
the population’s low cultural standards, contributing inter alia to mass tax evasion.
However, the main reasons for tax policy failure are not external factors, but rather components of the
policy itself. Let us identify the aspects of the Russian Federation’s tax policy which affect income
and, consequently, socioeconomic inequality. The flat schedule introduced in 2001 has not facilitated
proportional taxation primarily due to the following reasons:
1. The existence of tax credits and deductions.
There are several types of deductions in the Russian taxation system, namely standard, social, propertyrelated and professional deductions. Standard and professional deductions reduce an employee’s income
within the organization he/she works for, while social and property-related deductions can be obtained by
an employee in the tax office when filing a tax return for the previous year.
The use of deductions combined with the existence of several tax rates results in a tax system that is mildly
progressive for those at lower income levels, while for those at higher ones taxation is in fact proportional.
For the highest income levels, taxation can become regressive depending on the scale of tax deductions
used, income structure, and other conditions.
2. Tax rate levels for different income types.
Introducing differentiated tax rates for different income categories leads to an effective tax rate
differentiation at a fixed income, depending on income structure. On average, the income of wealthy people
in Russia is 2/3 composed of ‛other’ monetary incomes, which include incomes from diverse types of
property, dividends, interest, and other returns from the financial system. At the same time, the withholding,
interest, and rent tax rates (equaling respectively to 0%, 6% and 13%) are considerably lower than the
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double wage tax rate (working people give away almost 40% of their income by paying the 26.2% unified
social payroll tax and the 13% wage income tax). As such, earned incomes turn out to lose to rental ones.
3. The scale of the shadow economy.
The scope of tax evasion in Russia is huge: it is estimated at 35 to 40%, which is 2 to 3 times higher than
similar indexes in Western countries.
4. The lack of a wealth tax.
The main tax burden in Russia is carried by the population group whose incomes correspond to the
national average wage (3rd to 7th decile income groups). Moreover, the tax burden of the richest
population group is even smaller than that of the most disadvantaged. The introduction of a wealth tax
would bear on the 10th decile group, which would ensure a more equitable income distribution.
3. RECOMMENDATIONS FOR STATE POLICY
The taxation system at work in today’s Russia is only fiscal and fails to fulfil urgent social functions:
equalizing incomes, leveling economic inequality, regulating the structure of personal consumption, and
supporting disadvantaged groups. The primary avenues for regulation in the current situation could be
the following:
1. Reintroducing a progressive personal income tax rate.
Three facts point to the necessity of introducing a progressive tax rate in Russia.
Firstly, global practice proves that flat tax rates are the refuge of backward countries with a weak
economies which are unable to efficiently administrate and collect taxes. Besides, personal income tax
levies still constitute a negligibly small share of the GDP, namely less than 4%. International comparisons
indicate that Russia’s success in legalizing incomes has been extremely limited.
The country’s seminal budgeting document, the Budget Strategy of the Russian Federation Until 2023,
states that “the considerable reduction of all basic tax rates during the tax reform has generally not led to
an increase in their fiscal performance. There is no conclusive evidence of a causality between the
increase of tax returns and the decrease of tax evasion as a consequence of reducing tax rates.”
The second reason for introducing a progressive tax rate schedule is the drastic decline in the budget
incomes of the Russian Federation’s subnational entities, which jeopardizes their financial stability. During
the last 10 years, the regions’ dependency on financial transfers from the federal center has grown.
The third reason is the precipitous growth of Russian society’s income inequality. According to Federal Tax
Service data, in 2005–07 the number of extremely wealthy Russian citizens, those whose yearly income is
10 to 1000 million rubles or more, grew several times faster than nominal GDP.
In the media, there are three prevailing versions of how introducing a progressive tax would impact the
Russian economy:
A. It would affect the economy negatively. Proponents of this version argue that introducing the
flat income tax was reasonable and efficient and going back to the old differentiated system
would push the country seven years back. A. Kudrin, a supporter of this idea, believes that
“at the current historical moment the unified rate is justified.” According to him, in the first
year after the introduction of the flat rate “incomes were massively legalized,” while
previously the majority of incomes had been hidden. Those who hold this view expect that if
a progressive tax rate were to return, capital outflow would increase considerably. The
probability of this version is estimated at 35%.
B. It would generate a positive dynamic. This version is based on the experience of Western
countries where the progressive tax has proven to be a highly efficient tool for alleviating
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social inequality. Modern economists advocating for the reintroduction of the progressive
income tax have considered the Russian experience of applying the progressive tax before
2001, when even the lowest wages were taxed. Most initiatives therefore include introducing
a minimal threshold. Moreover, modern proposals for a differentiated tax rate are rather
liberal: the proposed tax rate for higher incomes is usually 20 to 30%. The probability of this
scenario is 15%.
C. It would not fundamentally affect the country’s development. A number of experts believe
that the adoption of a progressive tax rate would not instigate any significant changes in the
Russian economy. The abolition of taxes for poor people would not significantly improve
their condition. The middle class would continue to pay taxes at a similar rate. The
probability of this scenario is 50%.
Opponents of progressive taxation often cite the following arguments (see Table 2), the so-called
‛indefensible myths.’
Table 2
Progressive tax myths debunked
Myths
Debunking
1. The flat tax is Russia’s advantage over other
countries and it attracts foreign investors.
1. There has been no considerable growth in
foreign investments since the tax reform in
2001.
2. Applying a progressive personal income tax
rate will increase the burden on tax enforcement
agencies and will require updating tax
administration.
2. According to preliminary estimates, only
around 420,000 people are the recipients of
‛excess incomes’ (more than 1800 thousand
rubles per year) in Russia. Monitoring the
finances of this number of people should not be
overly difficult.
3. Introducing a progressive tax will lead to
wage hiding in such high yielding spheres as
finance and banking, oil and gas extraction,
petroleum processing, energy industry etc.
3. Electronic databases on all taxpayers are
already in place in the tax system that enable
accounting for these tax returns in the federal
budget.
4. The progressive tax will hit hardest on the
pockets of the middle class: highly-paid
professionals and businesspeople.
4, 5. The proposals are to introduce such
taxation rates and income group limits that high
rates will only concern those with ‛excess
incomes’ and not middle class representatives.
5. Motivation and, consequently, work
performance will decrease.
However, the main reason why the State Duma of the Russian Federation does not adopt a progressive tax
rate is the opposition work of the numerous lobbyists who have no interest in increasing tax rates.
Representatives of the financial and economic block in the Russian Government have suggested instead
another mechanism of collecting incomes from the wealthiest part of the population, namely by updating
net worth taxes. Undoubtedly, improving the net worth tax system can be considered one way to level
inequality; however, its efficiency is not comparable with the effect of introducing a progressive tax rate.
2. Increasing withholding tax rates.
The current withholding tax rate is 9%, which is considerably less than the earned income tax rate.
Because it is more typical for those in higher income groups to have property income, of which dividends
are a part, as the biggest share of total income structure, a relatively low withholding tax rate further
deepens inequality.
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3. Introducing a wealth tax.
Introducing a wealth tax could also encourage a more equitable income distribution. Taxable luxury items
are art objects, jewelry, luxury cars, yachts, private jets, helicopters etc. In this case the law should define
which items of which value are to be considered luxury ones. Moreover, this list should be periodically
revised.
All these measures should result in the decrease of the R/P 10% ratio to 7–9 values, which is exactly the
optimal level in terms of economy and strategic development. At such parameters of income distribution,
the majority of the population will be able to fulfil their expectations in economic and reproductive behavior,
preserving their health and increasing their human capital assets.
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