Russia’s first major tax overhaul in 20 years

Hello! Welcome to your weekly guide to the Russian economy — written by Alexander Kolyandr and Alexandra Prokopenko and brought to you by The Bell. Our top story this week is analysis of big changes to the tax system. We also look at the possibility of sanctions on Russian insurer Ingosstrakh.

Russia’s landmark tax reforms to raise revenue, change economy 

Russian officials this week announced a long-expected tax reform plan, which puts an emphatic end to a status quo that has lasted two decades. On Tuesday, the Finance Ministry announced the changes it was seeking to implement, and the government approved the necessary legislation two days later. Formal approval from parliament should be received by the end of the summer, and the changes will come into force early next year.

What are the changes?

• Russia’s flat income tax rate of 13% (the only exception, introduced in 2020, was a 15% rate on salaries over 5 million rubles ($55,300) a year) will be replaced by a progressive system. For salaries up to 2.4 million rubles, income tax will remain at 13%. All earnings above that threshold will be taxed at incrementally higher rates, ranging from 15% to 22%.
• Income from dividends, deposits, or transactions involving securities and real estate will not be affected by the new rules (the maximum tax on them remains at 15%).
• Corporate income tax will increase from 20% to 25%. From a revenue point of view, this is the most important change (it is predicted to generate 1.6 trillion rubles next year).
• Small and medium-sized businesses will be able to access tax breaks, but will also have to pay VAT on revenues over 60 million rubles ($670,000). 

How will they work?

The Finance Ministry promises that the changes will only increase taxes for 3% of the population. In reality, though, this group is likely to be bigger. First, because of inflation. There is no plan to index tax thresholds, which means that the number of individuals facing higher tax bills will increase even if real incomes remain the same, never mind if they continue to rise by 8% a year as at present. Secondly, high inflation (and with it, high interest rates) will push up unearned incomes.

There will be no personal tax-free threshold (like, for example, France or Germany). And initial proposals to cut taxes on the poor were dropped. Instead, the government is pushing ahead with a system of support for large, low-income families, and is planning to offer a rebate on taxes paid by low-income families with two or more children. These individuals will pay income tax at a rate of 6% instead of 13%. According to the Finance Ministry, this will help almost half of Russian families with 2 or more children. 

Increasing corporate income tax will reduce company profits by an average of 6.3%. Although tax breaks are available when money is spent on scientific research and Russian technologies, these – by definition – apply to only a small number of companies. The trade and service sector – the bulk of medium-sized business in Russia – is unlikely to benefit.

How much money will it raise?

The Finance Ministry expects the changes to provide an additional 2.6 trillion rubles. That’s one trillion more than the projected budget deficit for 2024. If current growth estimates hold up, the additional revenue would be about 1.4% of GDP.

However, the bond market did not react to this potentially significant boost to state finances. Apparently, the market expects the government to increase its spending at a similar rate, which means the need for borrowing will remain. 

Why the world should care

As we’ve explored many times in this newsletter, state spending is the basis of Russia’s current economic growth. And the new tax system is designed to allow the Kremlin to continue spending for longer. However, this is not the only goal. It looks like the government hopes the tax changes will tilt the economy’s focus toward the development of domestic manufacturing – in particular military production – at the expense of trade, services and other bourgeois pleasures.

Europe poised to target Russian oil export insurers

The EU is again considering sanctioning Russian insurance company Ingosstrakh, Bloomberg reported Wednesday. Such a step would be significant because Ingosstrakh is one of the largest insurance providers for Russian oil transportation. 

• Since 2022, the G7’s price cap on Russian oil exports has prevented international insurers – who make up 95% of the market – from insuring transit for Russian oil traded at more than $60 a barrel. Russian oil sold above this price is ferried by a “shadow fleet” of tankers that can only be insured by Russian companies. Ingosstrakh is one of the leading insurers of this shadow fleet.
• The proposal reported by Bloomberg to target Ingosstrakh comes from an unidentified European Union country. However, the insurer was not mentioned in the EU’s discussions around the next round of sanctions on Russia (which must be approved by all member states). There was a previous attempt to sanction Ingosstrakh in Feb. 2023, but this was opposed by some member states. Further sanctions against Russian oil tankers are opposed by countries such as Hungary and Austria, which are seen as more “pro-Russian,” as well as countries with a large maritime sector (particularly Greece). 
• The Financial Times reported in March that Ingosstrakh’s insurance for Russia’s shadow fleet does not cover possible oil spills, and therefore poses a threat. A similar study in Denmark has highlighted environmental risks.

Why the world should care

Sanctions against Russian insurers would be in line with an apparent pivot in Western tactics toward targeting the profits Russia makes from oil exports (by increasing costs). However, restrictions on Ingosstrakh, one of Russia’s leading insurance companies, may affect more than just shipping: they could also impact passenger aviation within Russia and beyond.

Figures of the week

Between May 17 and 21, inflation in Russia was 0.1% compared with 0.11% the preceding week. According to the Central Bank, year-on-year inflation on May 27 was 8.15% (compared to 7.84% at the end of the previous month). These numbers increase the likelihood that the Central Bank will raise interest rates at its next board meeting on June 7.

A total of 110 billion rubles were loaned under Russia preferential mortgage schemes for new-build apartments in April, according to the Central Bank. That’s up 15% from March.

In the first four months of this year, a total of 22,000 foreigners were deported after breaking the law in Russia. That’s almost twice the number from the equivalent period in 2023, according to a report from the Interior Ministry.