Greasing the public’s hands: how oil and gas taxes financed the Kremlin’s social contract

Guest contribution by Miranda Lupion


Photo: Rambler

This past month, Russian news outlet RBC published a detailed report breaking down the revenue sources that funded the Kremlin’s 2016 federal budget. While the headline, “50 Companies Furnished Half of the Russian Budget’s Tax Revenue,” may come as no surprise to those familiar with the country’s business landscape, the fine print is worth a double take.  In 2016, revenue from nine oil and gas firms funded more than 35 percent of the total consolidated budget. Rosneft paid the most in taxes (1.36 trillion rubles/US$22.7 billion), followed by Gazprom (1.17 trillion rubles/US$19.5 billion) and then Lukoil (565 million rubles/US$9.4 billion). For a rough reference, in 2011, ExxonMobil, Chevron, and ConocoPhillips – then the US’s largest oil companies – paid a combined $54.9 billion in income taxes or 2.4 percent of the federal government’s tax receipts that year. Additionally, US oil companies frequently defer their tax payments and receive substantial breaks. In 2016, Chevron recorded a federal tax benefit of $0.623 billion, while deferring $1.558 billion in payments.

So why, when compared to their US counterparts, do Russia’s giants pay a disproportionate share of the country’s federal tax revenue? They’re not significantly larger than their Atlantic peers. Gazprom and Rosneft bring in less than half of what ExxonMobil grosses. The Economics 101 answer might point to the relative diversity of the American economy, which has tech behemoths such as Apple and Microsoft to bear more of the load. However, even in the late 1990s, when oil reigned supreme over the emerging Russian economy, tax rates on this industry were substantially lower. Diversification is, at best, only a small part of the answer.

The real key to the tax conundrum is political. In the early 2000s, President Vladimir Putin oversaw an effort to increase government revenues from oil and gas sales, beginning his first term with a series of tax reforms in the energy sector. The Ministry of Finance tied export duties more tightly to oil prices. For instance, if the price per barrel were to jump to $25, the duty would increase accordingly. As a result of the reforms and a fairly steady increase in oil prices, between 1999 and 2005 the government increased its share of oil companies’ profits from 45 percent to 83 percent. Even after the global financial crisis caused prices to fall, by 2011 oil and gas accounted for 64 percent of Russia’s export revenues and 49 percent of its federal tax revenues.

These changes enabled the government to lower individual tax rates and provide generous benefit packages to citizens, improving the standard of living for ordinary Russians. In 2001, the Duma voted for a unified 13 percent flat tax on personal income. This replaced a progressive tax, which had maximum rates of 35 percent. Led by Putin, in 2004 the Duma also lowered the VAT and abolished the 5 percent national sales tax. These reforms simplified the Russian tax system and were accompanied by a mandate to eliminate over 200 regional and local taxes – relics of the chaotic 1990s. Even in the wake of these tax breaks, revenue from oil and gas allowed Moscow to provide Russians with additional benefits: gas at subsidized prices (which would otherwise be unaffordable for the average Russian), higher wages for teachers and doctors, and more generous pensions for retirees and veterans.

In short, oil and gas revenues fuelled the Russian social contract, or “bargain”, in which citizens implicitly exchanged claims to political pluralism for a more comfortable standard of living. While Russian incomes increased, Putin reestablished the supremacy of the central government over the regions, passing legislation that prevented governors from serving as representatives in the Federation Council. Governors no longer enjoyed the legal immunity previously afforded to them as representatives, and the Kremlin could easily unseat uncooperative governors. While a burgeoning Russian middle class began to vacation abroad in Egypt, Tunisia, and Turkey, Putin’s 2005 reform on the Law of Political Parties cut the number of parties in Russia from 37 in 2005 to six in 2006, giving voters fewer options at the polls, eliminating the need for power-sharing arrangements in the Duma.

Today, Russia’s budget continues to rely on revenue from oil and gas companies, but sanctions and lower oil prices have hindered the Kremlin’s ability to keep the benefits flowing. In fact, during a May 2016 visit to Crimea, Prime Minister Dmitry Medvedev confronted what may be the first sign of the contract’s eventual implosion. As exasperated locals demanded to know when their pensions would be indexed to Russia’s higher cost of living, Medvedev hastily retreated, telling his accosters to “hang in there”. The gains in living standards that Moscow’s social contract engendered may eventually sabotage the bargain itself.

Miranda is a recent graduate of the University of Pennsylvania, where she majored in International Relations and Russian. She has interned at the US embassy in Moscow.

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