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28 September 2016

On the Great Compromise

“Great Compromise” regarding the development of fiscal and budgetary systems should be sought in Russia

Although the Russian authorities routinely speak of overcoming Russia’s economic crisis, reports which indicate that just the opposite is occurring appear on an annoyingly regular basis and more often than not, these reports concern public finance.

The Ministry of Finance announced just a month ago that the government had decided to abandon the drafting and adaptation of the three-year budget and to submit only the 2017 budget to the State Duma. Many experts interpreted this development as a sign that we could see an increase in taxes as early as 2018, that is before the next presidential election. The announcement was followed by new initiatives of the same ministry containing indications regarding the specific taxes which could be raised. Finally, news followed that long-term budgetary estimates suggest a dramatic slump in tax revenues is afoot (it is thought that tax revenue may account for as little as 13.3% of GDP in 2019, the lowest ever during Putin’s rule). Under such circumstances, the authorities cannot afford to rest on their laurels - as they traditionally have - convinced that economic problems will disappear all by themselves.

13.3% of GDP is very low by Russian standards. Such meager tax revenues were not observed even during the first year after Russia’s 1998 debt default. The problem is that such financial indicators do not require a tightening of authoritarian rule, but rather a dialogue with society. Dialogue was extremely intensive in the late 1990s but it currently has no place on the agenda and is absent from the behavioral patterns of today’s power elite. Authoritarianism is accepted both by the people and the elite when problems can be solved with money. In other cases, however, democratic institutions are required – a system of checks and balances – while a division of power between the regions and the center in order to mitigate problems and disperse responsibility is inevitable in some circumstances.

Obviously, the incumbent Russian authorities will not agree to a change of the regime. Political systems like this one do not undergo modernization but are rather destroyed in the aftermath of a fatal clash with reality. However, I have no doubt that the authorities will have to establish some sort of dialogue: a dialogue with both taxpayers (citizens and entrepreneurs) and bureaucrats as well as the departments which expend treasury funds. Now is the time to start thinking about how this will take shape.

A dispute which could have destroyed a young federation broke out in the early days of the United States of America in 1787. This dispute concerned larger and smaller states’ respective representation in Congress. In line with a proposal by Roger Sherman of Connecticut, a system was approved whereby a House of Representatives was established which took into account the size of each state’s population, and whereby each state delegated two senators to the Senate. The proposal adopted on July 23, 1787 went down in history as “the Great Compromise” and continues to serve as the basis for parliamentary democracy in the U.S. today.

In my opinion, an equally significant “Great Compromise” regarding the development of fiscal and budgetary systems should be sought in Russia. They assumed their current form during a period of high and ultra-high oil prices in which the state met its needs primarily thanks to oil and gas rent (its share i.e. the share of the so-called “oil and gas revenues” averaged 50% of total federal budget revenues from 2011-2013). It has slumped to as low as 35-38% today and a recovery is not expected in the nearest future. In such a case, an increase in taxes on oil and gas revenues would deal a crushing blow to extractive industries, still trying to ramp up production, and could lead to an all-out recession.

Therefore, certain compromises are inevitable. In my opinion, compromises could become integral to what is referred to as a “social contract” by many liberal experts (see: Auzan, Alexander “A social contract and civil society”/ Mir Rossii (the Universe of Russia), 2005, No. 3; Gontmakher, Yevgeny “A scenario: 2012 Moncloa Pact”). This contract is seen as vital for the country and could be built around the principles of tax collection and State Treasury expenditure.

The federal budget deficit is forecasted to approximate 3.5 trillion rubles by the end of the year. It cannot be repaid through the sale of large stakes in state-owned enterprises (they are simply not worth that much at the moment), by increasing government borrowing (external debt would have to be more than double its current level) or at the expense of the reserve fund (as the fund would be depleted in the lead up to the presidential election). The government is trying to increase revenues by expropriating the pro-rata component of pensions and limiting expenses by freezing public sector pay. However, not only are these measures unpopular but they are also unlikely to help counterbalance income and liabilities.

Given this situation, I would suggest that a mid-way compromise is reached over the budgetary gap as an optimal measure. In other words, I would suggest simultaneous increases of budgetary revenues by 1.75 trillion rubles and a reduction of expenses by the same amount (figures could differ should part of the deficit be covered using the reserve fund). A broad expert discussion should also take place accompanied by a large-scale agitation and educational campaign in order to determine which expenses are to be cut and which taxes raised. (Let me remind you that the then Finance Minister Fernando Henrique Cardoso spent more than five months travelling throughout Brazil in 1992 explaining the specifics and advantages of the proposed, unpopular austerity plan for curbing inflation and the introduction of a new currency. When it had gained over 50% of public support, the plan was successfully implemented.) On the one hand, this initiative in a sense helped overcome the democratic deficit which was very visible in society and was no less dangerous than the budgetary deficit. On the other hand, it filled vapid and scholastic economic debate, typical of that time, with meaning.

Naturally, issues painful for the authorities would be raised, among many others, during the debate: the appropriateness of the expenditure on the Ministry of the Interior and Ministry of Defense; the salaries of officials and potential savings on the state apparatus; the scope of confidential budget items. However, in my opinion, the dangers usually associated with such debates are not so great right now given the popularity enjoyed by both the president and the government. They can help cut low-priority (or rather unnecessary) expenditure, which in turn will help garner the consent of the people to a tax hike (and perhaps an even sharper increase in taxes than that currently being proposed by the Ministry of Finance) and will thereby ensure the increased stability of the financial system.

Unlike many Russian liberals, I do not think that taxes are too high in Russia. Indeed, some are excessive but, on the whole, problems stem from the fact that taxes are set in the absence of any public consultations and are also reviewed practically without any consultations (the puppet State Duma cannot be considered a forum for consultation). Meanwhile, taxes (and the way they are expended) are key to economic relations between the people and the authorities and remain crucial even in a situation where the majority of the population supports annexations and shows no interest in the fates of arrested opposition members. The government is unlikely to enjoy steadfast public support if it chooses to disregard or rather openly ignore the economic interests of the masses.

By all accounts, the days of the oil glut in Russia are history and the country is doomed to change. The above-mentioned proposal is perhaps the least radical of those capable of bringing about significant change. It will not be accepted, of course, which will serve as proof that the authorities do perhaps need a great Russia but are most probably only heading towards great upheavals. 

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