Pension reform has pushed Russian business into the shadows

13.05.2011 — Analysis

Russian small businesses now find themselves in a semi-legal position, and the increase in mandatory insurance payments to state extra-budgetary funds was the push that sent them into the shadows. A year ago experts were already warning the Russian government that increasing the tax burden on payrolls would result in a business slowdown and a return to the practice of slipping employees their wages in envelopes. This columnist for "RusBusinessNews" shows that these predictions have borne themselves out, and high-value-added businesses have felt the brunt of this fiscal policy.

Russian businesses carried a heavy social burden in the 1990's - insurance contributions paid into the Pension Fund of the Russian Federation, the social security system, and the obligatory medical insurance fund made up 38% of payroll costs. In 2001, a single 35.6% social tax replaced these payments to extra-budgetary funds. Later it dropped to 26%, which, along with a flat-rate income tax, helped convince employers to stop paying their workers under the table and increased state budget revenues.

By 2009, the Russian government realized that pension reform had failed, and they needed to tap other sources to cover the deficit in the Pension Fund - the destination for most insurance payments. The decision was made to return to the practice of making contributions to extra-budgetary funds, and their volume increased to 34%.

This move drew sharp criticism from the business community. Boris Titov, chairman of the Delovaya Russia social organization, suggested that the increase in insurance payments would result in a country where only very profitable businesses specializing in raw materials could survive. He felt that agricultural businesses and machinery manufacturers would be unable to bear the increased burden and would be forced to either operate in the shadows or shut down. The RUSSOFT non-commercial partnership had somewhat earlier claimed that the reform of the social system would be a palpable blow to innovative businesses, where labor costs are proportionally much higher than in the mining industry. The Russian Union of Industrialists and Entrepreneurs warned the government that it was too risky to raise taxes in a time of financial crisis - that it would lead to a decrease in investment programs, job losses, and slowed economic development.

Aleksandr Shokhin, president of the Russian Union of Industrialists and Entrepreneurs, noted that there was an alternative to increasing the burden on businesses. For example, most of the Pension Fund could be financed by the federal budget, or the Pension Fund could be given control of assets currently at the disposal of state-owned corporations. Entrepreneurs remain convinced that insurance contributions alone aren't going to solve the Pension Fund's problems. In the next few decades 800,000 more people will retire each year in Russia than will start working.

Russian Prime Minister Vladimir Putin, however, brushed off the pleas of the business community and increased the tax burden on payrolls. The results were soon apparent and a business slowdown began in the fourth quarter of 2010. The noncommercial organization National Institute for Systematic Research on Entrepreneurship examined the statistics on small businesses and presented a report in April of 2011, showing that the number of small businesses in Russia decreased by 3.6%. An increase was seen in only three of the seven federal districts: the Far East, Urals, and Volga regions. But this uptick does not change the larger picture. Small businesses in the Urals district also had 5% lower sales and investment in fixed assets fell by 35%.

The increase in the number of small businesses coupled with a decrease in overall business activity can be easily explained. Evgeny Artyukh, director of the Sverdlovsk branch of OPORA RUSSIA, the NGO for small and medium business, told "RusBusinessNews" that in the Sverdlovsk region, where the number of small businesses declined by 16.5%, a program called Start Your Business had been introduced. This program provides grants and step-by-step business advice to the unemployed. Naturally, this government support helped to increase the number of small businesses that were registered, but it had no impact on the gross regional product. According to Evgeny Artyukh, many Urals residents who opened businesses ran into problems and gave up.

An increase in land-use taxes also affected the business slowdown. These taxes increased tenfold or more after an attempt was made to link them to the market value of the land used by a company. Businesses began to lobby for a review of the rates, and as a result, a new method of calculating the tax was developed, which did not take the land's market value into account. But in 2011 this new method was rejected, because the government decided that the budget would be deprived of significant amounts of money. It can be fairly argued that a high tax burden leads to lower rates of investment in fixed assets, because businesses simply have no money to expand production and they are reduced to focusing on day-to-day survival. Businesses began to operate in the shadows, as Boris Titov had warned.

What's truly odd is that Prime Minister Vladimir Putin, while increasing the tax burden at the height of the financial crisis, at the same time was arguing for greater transparency in business, and called upon trade unions to fight the practice of employees being paid under the table, which he claimed was nothing less than "theft from the budget and a violation of citizens' labor and pension rights". It's hard to argue with this last statement, but it's also clear that forced transparency, coupled with an increase in mandatory payments, is a sure way to wreak havoc on businesses.

Boris Zyryanov, chairman of the Innovatsionnye Tekhnolgii regional social fund and president of the Mikron holding company, suggests that reduced investment in fixed assets shows how uncertain businesses are about the future. Foreign companies have stopped buying real estate in Russia in order to minimize their risks, while Russian companies are afraid to make long-term investments and are limiting themselves to current payments. He claims that no one wants to invest major sums during periods of instability.

Whether there will be a change in business activity in Russia will largely depend on the government's relationship to business. Right now the nature of the relationship between the state and small and medium business is clearly evident in the increase in utility rates and social security payments and the preservation of value-added tax. Wittingly or unwittingly, the state is forcing business into a fiscal impasse.

Vladimir Terletsky