After two years of substantial growth driven by military expenditures related to the war in Ukraine, Russia's economy is now experiencing a slowdown. Recent reports indicate that oil revenues have declined, the budget deficit has increased, and defense spending has plateaued.
In response to these economic challenges, President Vladimir Putin is looking towards ordinary citizens and small businesses to bolster state finances. An increase in the value-added tax (VAT) from 20% to 22% is anticipated to generate approximately 1 trillion rubles, equivalent to around $12.3 billion, for the state budget. This VAT hike is included in legislation progressing through Russia's parliament and is scheduled to take effect on January 1.
Additionally, the new legislation will reduce the revenue threshold for businesses required to collect VAT from 60 million rubles (approximately $739,000) to just 10 million rubles (about $123,000) by 2028. This change aims to tackle tax avoidance strategies, but it may also adversely affect small businesses such as corner stores and beauty salons.
The government's proposed tax increases extend to liquor, wine, beer, cigarettes, and vapes. For example, the tax on stronger spirits like vodka will rise by 84 rubles per liter of pure alcohol, translating to an increase of roughly 20 U.S. cents for a half-liter bottle, which represents about 5% of the minimum price of 349 rubles ($4.31). Other fee increases include costs for renewing driver's licenses and international licenses, alongside the elimination of a significant tax break on imported vehicles.
Public sentiment regarding the impending tax hikes is mixed, with many Muscovites expressing a sense of resignation. Pensioner Svetlana Martynova remarked that the requirement for small businesses to collect VAT could lead to business closures, ultimately resulting in decreased budget revenue rather than increases.
Further complicating matters, an increase in the recycling fee for registering cars is set to impact the ownership of higher-priced imported vehicles. Beginning December 1, individuals will no longer be able to register cars with more than 160 horsepower at the concessionary rate of 3,400 rubles ($42) but will instead have to pay commercial rates, which could amount to hundreds of thousands of rubles or several thousand dollars per vehicle. Despite these challenges, some experts, like Andrei Olkhovsky, general director of Avtodom, believe that sales will rebound within six months.
The Russian economy has contracted since early 2025 and is projected to grow by only around 1% this year, a sharp decline from above 4% growth in the previous two years. Factors contributing to this stagnation include high central bank interest rates, currently at 16.5%, which aim to control inflation that stands at 8% partly due to vast military spending. Oil revenues have decreased by about 20% this year primarily due to lower global prices, while Western sanctions have consistently hindered growth by raising costs and deterring potential investments.
This year's budget deficit has been upwardly revised to 2.6%, compared to last year's 1.7%. While this may not appear significant in comparison to other countries, Russia's unique position prevents it from borrowing in international bond markets, forcing reliance on domestic banks for credit. Finance Minister Anton Siluanov expressed that increasing revenue is preferable to borrowing, which could lead to inflationary pressures and compel a rise in the central bank's key interest rate, negatively impacting investment and growth.
While the VAT increase may initially spur inflation as merchants adjust their prices, it could help stabilize prices over the long run by dampening demand for goods. The Russian government is poised to confront difficult economic choices moving forward, balancing military expenditures against consumer welfare due to the ongoing conflict in Ukraine.
In light of these developments, it appears that although the Kremlin has enough revenue for the immediate future, tough decisions will inevitably arise regarding resource allocation between military and domestic welfare. Analysts like Alexandra Prokopenko from the Carnegie Russia Eurasia Center suggest that while economic growth is slowing, the current fiscal structure allows for the maintenance of military efforts and expenditures temporarily.
