12.10.08

The current financial crisis combined with the necessity of increasing the standard of living for pensioners has forced the government to make an unpopular decision. Prime Minister Vladimir Putin declared that the Unified Social Tax will be abolished in 2010, to be replaced by insurance premium payments. Employers will pay in essence a new social tax of 34%. The maximum rate of the current Unified Social Tax is 26%. In order to prevent financial hardships for businesses, Putin has promised to decrease other taxes. It is not yet clear which taxes will be decreased or when this will occur.

Businesses are skeptical of this new policy. The government explains that the pension system might collapse by 2010 if taxes are not increased. Even large transfers from the federal budget, which amounted to 1.2 trillion rubles this year alone, would not save it from collapsing. 

Finding a Solution for Pensioners

The financial crisis, which will require Russia to carefully review its budget, is not the only difficulty facing the government when working out a plan for pensioners. Another problem is that last year there were more pensioners than workers. According to the Ministry of Finance and the Ministry of Health and Social Development, the number of retired versus employed persons will continue to rise through the next decade.

There were two rescue plans for the retirement system. The first plan, developed by the Ministry of Finance, involved increasing the Unified Social Tax from 26 to 29 percent starting from 2020. The plan held that the amount paid by those on reduced social tax rates be increased from 280,000 rubles to 1,100,000 rubles starting from 2010. Starting from 2013, Kudrin also suggested that citizens younger than 40 pay an additional 3% social tax.

The government approved the more drastic plan offered by the Ministry of Health and Social Development.

Finishing Touches for the 2020 Strategy

The government approved the “Strategy for the Social and Economic Development of Russia until the year 2020.” However, the Minister of Economic Development, Elvira Nabiullina informed the press that the plan is actually still being finalized, with the main topics currently in question revolving around retirement and sports.

The government's finalized plan will govern Russia’s course until the year 2012 and include specific mechanisms and deadlines for implementing the provisions of the new strategy. Russia’s purpose for the 2020 Strategy is to achieve a level of economic and social development that will place Russia as a leading world power. In order to reach this goal, from 2015-2020, Russia must have one of the five highest GDPs in the world. Russia’s middle class should be a make up a majority of Russia's population by 2020, and Russia must take an important place (5-10%) in the global technology markets. Transforming the Russian economy from mainly an exporter of raw materials to an innovative, society-orientated country will be the main challenge.

Tax Magic

The Unified Social Tax is currently 26% and is regressive: the higher one’s salary, the less tax one pays. Employers pay the tax directly and average an actual tax rate of about 22% tax under the regressive system.

If the employee’s salary is 280,000 rubles a year, then the employer pays 26%. If the employee’s salary is between 280,000 and 600,000 rubles, then the employer must pay 72,800 rubles and additional 10% of the amount that exceeds 280,000 rubles. If an employee receives more than 600 thousand rubles a year, the company pays 104,800 rubles plus 2% of the amount that exceeds 600,000 rubles. 6% of the tax is deposited in the Extra Budgetary Fund, another 6% in the Federal Budget and 14% in the Pension Fund. Moreover, citizens who were born in 1967 or earlier, pay the entire 14% to the general insurance portion of the pension. Citizens born after 1967 deposit the 6% into a "personal saving account" with the fund and the remaining 8% they deposit to the general fund.

The system will change slightly when the Unified Social Tax is replaced: most of the tax will be paid to the Federal Insurance Funds, according to a regressive scale. For employees who earn 415,000 rubles a year, companies must pay into the Obligatory Pension Insurance Fund at a rate of 26% in addition to payments made for medical and social insurance. Yesterday, Prime Minister Vladimir Putin stated that “medical and social insurance fee rates will not exceed 34% of the payroll.” Moreover, the Ministry of Health and Social Development has argued that, when indexed against economic variables, a wage today of 415,000 rubles is essentially the equivalent of 280,000 rubles from 2005 (this is the current benchmark for the tax). Salaries above 415,000 rubles will not be taxed heavier under this plan. This will not only affect the future pensions of highly-paid employees, but will also increase the tax burden on businesses (see the table on this page, prepared by “Gazeta” in cooperation with the Chief Tax Consultant for the Grant Thornton company, Nadezhda Zubkova).

Easing the Budget Burden

According to the Minister of Health and Social Development, Tatiana Golikova, increases in the Social Tax will decrease the burden on the federal budget for providing pensions. According to the Minister, pension fund revenue starting from 2010 will reach 4.2 trillion rubles. The federal budget, instead of spending 2 trillion rubles on the continuing to subsidize pensions, will only spend 569 million rubles. At the same time, the pension fund’s deficit will decrease.

The government will continue to index pensions. The Prime Minister stated that the pension’s base will be increased by 37.1% and the pension’s insurance will increase by 15.6% in 2009. These measures along with increases in the Social Tax, according to Golikova, will double the average size of labor pensions by the end of 2010. By 2020 it will reach three times the "living wage" as calculated for pensioners. Moreover, citizens will be guaranteed that they will receive no less than 40% of their wages after retirement, which will come for the insurance fees paid into the pension system. “However, in order to do that, they have to pay fees for at least 30 years” – clarifies Golikova. Starting from 2015 the government promises to annually index the 6% of pension fund coming from workers with more than 30 years of work history, which currently amount to 30.5 million people throughout the country, states the RusStat, the Russian Statistics Agency.

Opposition to the 2020 Strategy

In order to calm down the business world, the government promises to compensate for the increases in these taxes by decreasing other taxes. The National Welfare Fund will also pay into the budget. In addition, the government promises that during the first five years after switch, it will provide a federal subsidy to small companies producing technical and agricultural products. Other companies will not have this privilege.

Entrepreneurs do not approve of this action. “In combination with the VAT’s continuing rate, increasing the Social Tax to 34% increases the expenses of companies,” notes the chairman of “Delovaya Rossia”, Boris Titov. According to him, the Social Tax and VAT are withdrawn at the manufacturing stage, when the funds are most crucial. “Therefore, even increasing taxes on profits to 90% would hurt companies less, because not everyone earns a profit,” states Titov. The Head of Russia’s Union of Industrialists and Entrepreneurs, Aleksandr Shohin, notes that new companies are likely to hirer fewer staff or not offer employee benefits to compensate for the higher taxes. “However, I welcome the idea of switching from Unified Social Tax to insurance fees. Currently, the tax is unclear, and the tax and insurance fees are combined” Shohin states. The business world’s position is strengthened by the fact that many countries are decreasing taxes despite the financial crisis. Both America and Kazakhstan plan to decrease taxes.

New Social Tax Rates

Wage per month, in thousands of rubles	Wage per year, in thousands of  rubles		The Amount that the Employer pays, in thousands of rubles	Actual Rate, %
20	240	Unified Social Tax (UST)	62,4	26
		New Social Tax (New ST)	81,6	34
50	600	UST	104,8	17,5
		New ST	141,1	23,5
100	1200	UST	116,8	9,7
		New ST	141,1	11,8
150	1800	UST	128,8	7,2
		New ST	141,1	7,8

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Source: "Газета", Grant Thornton