Russia's Fiscal Crisis
Alexander Battles
Garik works five to six days a week on the renovation
of St. Petersburg's
Russian Museum, but he never gets paid. Garik
faces the threat of not
being able to afford the rent on his apartment
and buy basic necessities
for his wife and two teenage daughters. Although
he works over 40
hours a week, he received his last paycheck nearly
two years ago. His
family depends on the income they receive from
housing foreign students
in their three-room apartment to supplement the
money his wife earns
working three days a week at a private educational
institution. Still he
continues to go to work each day because he believes
that some day the
government will pay him all he is owed.
Garik is just one of over 20 million Russians
who work for the federal
government or a government-owned business, most
of whom go months
on end without pay. The Russian Federation suffers
massive financial
debt.1 Without the ability to raise sufficient
revenue, the government must
choose each month who will receive his due and
who will not. Of the
state-employed, which comprises over 36 million
pensioners and other
transfer recipients, the government had lagged
in payments to about 67
million of them at the end of 1996.2 There is
no immediate end in sight.
Soviet Legacy
Russia inherited a dire financial situation from
the Soviet Union and
improvements have come slowly. Initially the
government attempted to
pay its debts and provide funds for recently
privatized businesses by
printing money. This tactic combined with the
decision to release the
ruble from its dollar peg created run-away inflation.
Ruinous rates of
inflation2,500% in 1992, 950% in 1993, 315% in
1994swept the nation
clean of its savings.3 Russians saw thousands
of rubles turn into pocket
change overnight. With inflation continuing at
such rates since the early
1990s people have been unable to replenish their
depleted savings and
must rely on each month's paycheck to meet their
needs.
In the past year, inflation has been held to acceptable
levels. The Deputy
Head of the Presidential Administration, Alexander
Livshits, predicts
inflation will certainly fall below 10% by 1998.4
The ruble
held stable at 5,782 rubles to the dollar for
the entire summer, its longest
period without depreciating in several years.5
This stability is due in large
part to the $14 billion the International Monetary
Fund granted Russia
last spring.6 Eduard Brau, the former IMF Deputy
Director of Europe
says, "The IMF's help for Russia's 10% macrostabilization
problem is no
longer needed; the IMF has done its job." He
noted that the Russian
Central Bank accumulated more than $20 billion
in gold and foreign
reserves during the last few years to stabilize
the ruble.7
IMF Bailout
The loans from the IMF, however, were granted
with stipulations. The
IMF set several conditions which included small
budget deficits, limited
monetary growth and high currency reserves. If
Russia failed to meet the
IMF's goals, the government would not receive
IMF funds. In order to
meet these standards the Finance Ministry cut
planned expenditures.
From 1993 to 1995, Russia cut real expenditures
almost in half. Much of
this reduction was accomplished by trimming military
spending, but funds
for salaries and transfers were also affected.
Many Russians believe the
IMF handcuffed the Russian government and prevented
it from paying
salaries and pensions it could have otherwise
afforded. While this theory
may have some validity, Russia used the money
it received from the IMF
and the World Bank very inefficiently. None of
$210 million the World
Bank allocated for agricultural reform has been
spent.8 Furthermore, the
IMF succeeded in stopping inflation so that Russia
could end its
dependence on IMF funding. Professor Peter Rutland
of Wesleyan
College, a leading scholar on business and government
in Russia says,
"Russia has maintained the view that it is a
great power, and being able to
borrow with good credit from private sources
supports this view and
prevents them from having [to continue] to meet
the demands of the
IMF."9
A leading cause of Russia's crisis is the government's
inability to collect
sufficient tax revenue. During the first nine
months of 1997 the
government collected only 52% of its anticipated
revenue.10 There are
three reasons for this phenomenon. First, the
Russian tax code is so
complex and ambiguous that it is too burdensome
for any business or
even government auditor to determine amounts
owed to the government.
Second, for political reasons, the government
granted tax concessions to
some of Russia's largest firms, foregoing billions
of dollars in potential
revenue. Perhaps the most important factor however,
is the floundering
economic situation. Without a stable economy
in which businesses thrive,
few firms produce enough revenue to bear their
tax burden and turn a
substantial profit.
A New Tax Code
One of the conditions for securing IMF loans last
spring was that the
State Duma begin reviewing new tax legislation.
Under the current system
a business can face up to 180 different taxes
from federal and local
authorities. The taxes on labor alone can cost
a firm nearly double a
worker's wage. If an enterprise were to obey
all the tax laws, it could
expect to lose up to 90% of its revenue.11 There
is no practical way any
business can both comply with the myriad tax
laws and operate
profitably. Therefore, the only way a company
can remain in business is
to operate illegally.
This summer the Duma began considering a new tax
code to replace the
current one which is so long and convoluted that
it is open to
interpretation and manipulation. Although the
new tax law decreases the
number of corporate taxes to thirty, it does
not simplify matters
satisfactorily. Many believe it is still too
complicated and difficult to
understand. The first two sections of the new
code alone contain 416
articles requiring over 100 pages of text.12
For example, Boris
Berezovsky, a businessman and presidential cabinet
member who is
listed as one of Forbes Magazine 100 wealthiest
people in the world with
an estimated net worth of $3 billion, was able
to claim only $38,500 in
taxable income last year.13 The new code must
be clearly defined to
remedy such abuses.
The tax system is still based on profit taxes
and value-added taxes and
not on income taxes. The new rich, like most
wage earners, pay virtually
no taxes. Most tax revenue comes from excise
duties on oil, gas and
metals.14 In contrast to other developed nations,
only 8% of the tax
revenue in 1995 came from individuals while 26%
came from profit
taxes.15 This system forces businesses, particularly
the small and
medium-sized companies, to either give most of
what they earn to the
government or illegally evade tax payments. Meanwhile,
Russia exempts
the country's richest men from paying more than
a very small percentage
of their incomes to the government.
Russia loses billions more in revenue from tax
breaks the government
grants to certain major corporations. Privileges
granted to Norilsk Nickel
spared the company over $1 billion. The National
Sports Fund has also
saved an estimated $2 billion from exemptions
on import duties.65 The
most notable example, however, is the case of
Gazprom, the oil
monopoly. The company lobbied the government
and received a
"stabilization fund" which enabled Gazprom to
place an enormous amount
of its export revenue into a tax-free fund. Therefore
Russia's richest and
most powerful company has paid almost no taxes
for years. When the
government finally forced Gazprom to pay its
$2 billion tax debt last
June, the government was able to pay its several
billion dollar debt to the
pensioners.17 Russians began to hope that tax
revenue would enable the
government to pay its debts. However, there has
been no savior to cover
the balance of the unpaid tax revenue and the
government's debts
continue to accrue.
While pressure from both the West and certain
internal groups within
Russia to change the tax code mounts, the government
faces strong
opposition to the new code from within. The new
elite do not look
favorably upon proposals that shift the tax burden
from businesses to
individuals. Their current earnings are nearly
untouched by taxes, and
they are not prepared to sacrifice this luxury.
President Yeltsin and the
Finance Ministry also encounter pressure from
the Communist party
which holds a majority of the seats in the Duma.
The Communists resist
implementing a code focused on income taxes that
would shift the
financial burden to individuals. However, the
greatest threat to the new
code comes from the other chamber of the government,
the Federation
Council, which is comprised of elected governors
from each of Russia's
regions. The governors fear that the new tax
code and the accompanying
budget will severely limit the monetary resources
of the regions by
restricting local authorities' ability to tax
and by decreasing transfer
payments from the federal government. Estimates
predict the new code
will reduce local administrations' revenue by
13.4% in 1998. Combined,
they could lose $6-6.8 billion next year.18
Despite these concerns, new tax legislation must
be passed in order for
the government to embark on its most important
task, creating a stable
economic environment. Without a stable economy,
Russia will not attract
the investment necessary to raise GDP. Last year
GDP fell 6% and over
the past six years it has fallen a full 50%.19
This overstates the problem
somewhat. As Mr. Brau explains, "Consumption
hasn't dropped so much
but GDP has fallen due to unwanted output."20
He referred to the military
production which was once instrumental to the
Soviet economy but is
now being phased out.
Economic Future
The outlook for Russia's immediate economic future
is not particularly
hopeful. Russian industry is hopelessly outdated
and outmoded. In
addition, a lack of long-term investment prevents
the Russian economy
from growing at the 6-7% per year pace Mr. Brau
believes is possible.
With the right policies, Russia's potential for
growth coupled with its
enormous natural and human resources could put
it in contention to rival
the economic expansion experienced by China during
the last decade.
The goal for the Russian government is to create
a situation where
investors are confident enough to wait five years
for a return on their
investment. At the moment, nearly all investment
is short-term. Few have
the faith to start businesses in Russia because
of the uncertain economic
situation. President Yelsin's reelection in 1996
is a reason for greater
confidence in future stability because it reaffirmed
the Russian people's
faith in democracy and capitalism. Now the government
must take
responsibility and justify this confidence. Developing
the new tax code is
the first step.
The government must also eliminate organized crime.
Contrary to popular
media reports, street crime in Moscow is not
particularly different from
that found in New York or any other big city.
A more significant
problem, however, is the black economy which
officials estimate
comprises 22% of the nation's economic revenue
with some estimates
going as high as 40%.21 Most businesses in Russia
pay 10-20% of their
profits to the local Mafia. In addition, the
number of contract killings rises
every year. With the slaying of the first American
businessman in
Moscow two years ago and the recent murder of
St. Petersburg's deputy
governor in daylight on the city's main street,
it is evident that no one is
safe from the Mafia's violence. The federal government
claims to be
cracking down on racketeering but until its efforts
are apparent, crime
will continue to deter investors and impede economic
growth. Russia
must establish a lawful business environment
in which courts and
contracts are the authority, not the Mafioso.
While simplifying taxes and regulations and tackling
crime are the most
important steps toward making Russia attractive
to investors, the country
must also contend with the resistance to reform
by powerful elites. The
elite classes recognize a need for foreign money
but col
lectively reject foreign ownership and management
in Russia. However,
Russian business managers have had little exposure
to more efficient
Western management practices or training. Businesses
continue to use
obsolete methods of organization and operation
that were created for a
communist economy and not for efficient profitable
businesses. They
need foreign business leadership to demonstrate
modern practices, set
new precedents for production and create stronger
competition, thereby
propelling the economy forward. The government
must overcome the
biases of Russia's most powerful citizens to
entice foreign investors to
Russia.
Until Russia can rectify its economic situation,
it remains trapped in a
circle in which the people are dependent upon
salaries and transfers from
the government, but poor tax polices and business
practices do
not provide sufficient government revenue to
pay them. Some quick fixes
have been proposed. The government intends to
sell off companies next
year which should bring a sizable amount of revenue.
This is another step
toward economic efficiency. But without economic
growth Russia is
locked in this cycle. The foundation upon which
the economy can grow is
being laid, inflation is in check, a new tax
code is being created and
promises to curb crime and corruption have been
made. Because these
processes are inherently slow, the road to prosperity
is long.
Undoubtedly, Russians will wait many more months
for their pay.
Russians expressed faith in the democratic process
in the 1996 elections
and are aware of improvements since communism
fell. The long lines for
bread and the empty grocery stores, so long an
image of Russian cities,
are no longer part of their lives. Stores with
the most modern products
line city streets showing people the possibilities
of a thriving economy.
Hopefully, as Russians rely less on the government
and more on private
business and the government creates a stable
business society, people
will be able to afford the standard of living
they see in store windows.
Note: Subsequent to the writing of this article
President Yeltsin pledged
to allow full foreign ownership of firms located
in Russia and relieved
billionaire Boris Berezovsky of his position
in the cabinet.
Notes:
1 Professor Peter Rutland,Wesleyan College, interview, October 1997.
2 The Makings of a Molotov Cocktail, The Economist,
July 12, 1997,
p. 5.
3 Joerg Eigendorf. "Does the IMF know the right
cure for Russia's ills?,"
St. Petersburg Times, March 24, 1997.
4 Stephanie Baker-Said. "Budget gets early nod
from Yeltsin," St.
Petersburg Times, August 25, 1997.
5 Stephanie Baker-Said. "Once-sickly ruble suddenly
strong," St.
Petersburg Times, July 7, 1997.
6 Eigendorf.
7 Mr. Eduard Brau, former IMF Deputy Director
of Europe, interview,
October 1997.
8 Irina Yasina. "Helping Russia is worth the hassle,"
St. Petersburg
Times, May 19, 1997.
9 Rutland.
10 "Stephanie Baker-Said. "Paltry tax collection
endangers IMF loan,"
St. Petersburg Times, October 27, 1997.
11 Jim Kennett. "The tax man cometh," St. Petersburg
Times, July 28,
1997.
12 Christopher Lowe. "Income law backed despite
loopholes," St.
Petersburg Times, July 8, 1997.
13 Ibid.
14 Rutland.
15 Kennett.
16 Ibid.
17 Irina Yasin. "This summer's forecast looking
sunnier," St. Petersburg
Times, July 21, 1997.
18 Christopher Lowe. "'98 budget provokes rebellious
governors," St.
Petersburg Times, September 29, s1997.
19 Rutland.
20 Brau.
21 Rutland.
