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A Top-to-Bottom Review of the Russian Economy

Nov. 30, 2017 With low oil prices, Moscow has had to get creative with the way it raises money.

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It’s no secret that we at GPF believe Russia, as a global power, is on the decline. And it’s no secret that Russia owes its decline partly to the fall of the price of hydrocarbons, which drive its economy and account for much of its tax revenue. But resources such as oil and natural gas are only one of the three legs that prop up the Russian economy, which would falter without the other two: resource distribution and social spending. The former is structured to prevent the oligarchy from challenging Moscow’s power; the latter is structured to prevent the people from usurping it.

The economic framework that underpins Russia has been in place for decades – even during the Cold War. When the Soviet Union collapsed in the early 1990s, money was transferred to the oligarchs in the hopes of maintaining political stability. But instead of reinvesting the money into Russia, the oligarchs sent it abroad, squandering an opportunity to create a long-term capital base for the new economy. For Vladimir Putin, who was elected president in 2000 and would eventually stabilize the country, taking money from the oligarchs meant taking money from his support base. He couldn’t do it lightly, and he couldn’t do it without also considering the needs of Russia’s intelligence agency, the FSB, one of the few institutions that remained coherent during and after the fall of the Soviet Union. Put simply, political considerations complicated what would otherwise have been rational investment decisions. 

High oil and gas prices bought Russia time, but those prices were unsustainable, and now that they are falling, Russia’s budget deficit is rising. Oil prices are unlikely to rise, given the state of U.S. production, but even if they did it wouldn’t really matter – when oil was $100 per barrel, Russia still failed to create a more mature, diverse and advanced economy. This is because contemporary Russia is structurally similar to the Soviet Union, which fell because the system it supported was paralyzed by political forces that made economic development impossible. In Russia, as in the Soviet Union, a capital base dictated by rational investment decisions can’t really coexist with an economic elite to whom political decision-makers must pay fealty. And so the economy, we believe, will stagnate. It might grow a little, but it will not grow enough to solve Russia’s political problems.

Still, we are in the business of constantly challenging our own beliefs. The following report, then, stems from one question: Are our assumptions about Russia’s economy correct, or have we missed anything? Answering this question requires a top-to-bottom review of the Russian economy.

Boom to Bust

After the oil crisis of 1973, the Soviet Union became a global oil exporter, including to Europe. The receipt of oil rents and revenues became an effective way to replenish the state treasury. Oil and gas, moreover, gave Moscow leverage over countries that had come to rely on the Soviet Union for imports. As infrastructure to transport oil and gas from the Soviet Union to Europe was built, the cost to find alternative suppliers reinforced this dependency.

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But when the Soviet Union collapsed, the economy collapsed with it. The wealth that had not been distributed to the oligarchs lay in its natural resources, making this sector all the more important to the government in the following years. From roughly 2003 to 2014, when oil prices more than doubled, the Russian economy boomed. The revenues generated by these exports enabled Russia to pay off the remaining foreign debt owed by the Soviet Union. They also enabled Moscow to run a budget surplus and allocate resources to social initiatives and national defense. In 2009, Russia saw a surplus of both the federal budget and the current account balance.

Things changed in 2014, when oil prices so famously fell. Unsurprisingly, Moscow’s oil and gas revenue fell too, forcing the government to find new ways to generate revenue.


Understanding the options available to Russia in that regard requires an understanding of the country’s peculiar budgets. Russia boasts both a consolidated budget and a federal budget. The consolidated budget is a combination of the federal budget, which is controlled by Moscow, and Russia’s regional budgets. The federal budget, which is only one part of the consolidated budget, is developed, approved and spent by the central government.

Each budget, both the consolidated and federal, is constituted by tax revenues such as VAT, excises for gasoline, cars, fuel and tax mineral extraction, and non-tax revenues such as fees and payments. Export custom duties go to the federal budget. Personal income taxes, property taxes, resort fees and land taxes are directed to the consolidated budget. Some taxes – for example, corporate income tax – are divided and flow into both budgets. However, all taxes and revenues associated with oil and gas activities are fed into the federal budget and so are also included on the consolidated budget.

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Two trends are apparent in the federal budget – the one controlled only by Moscow. The first is a decline in tax revenue from oil and gas activities. It fell from 51.3 percent of the budget in 2014 to 36 percent in 2016. The second is a steady increase in non-oil and gas incomes as a percentage of the total budget through the same period. In absolute terms, oil and gas income also fell from 2014 to 2016, and non-oil and gas income has increased steadily since 2009.

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Since all oil and gas income that flows to the consolidated budget is already captured by the federal budget, income trends in the consolidated budget mirror those in the federal budget. Oil and gas income as a percentage of the total budget declined from 27.8 percent of the consolidated budget in 2014 to 17.2 percent in 2016, and non-oil and gas incomes have increased as a percentage of the budget and in absolute terms.

Given the decline in global oil and gas prices, decreased oil and gas revenue was expected. What is surprising is the continued increase, in absolute terms, of non-oil and gas incomes. Had Russia, in the past few years, developed an industrial base capable of offsetting its losses from oil and gas?

Different industries’ contributions to the gross domestic product reveal that that is not exactly the case. Though manufacturing has grown in absolute terms over the past decade or so, its contribution to GDP has grown only slightly. In real terms, this suggests that the increase in non-oil and gas incomes is due instead to a more efficient tax collection system. In fact, over the past few years, the Kremlin has implemented a number of tax reforms to do just that.

It’s instructive to look at the composition of Russia’s GDP, which has changed only a little in the past 10 years. Manufacturing has the largest share in three of the eight federal districts – the Northwest Federal District, the Volga Federal District and the Siberian Federal District. Though the share of manufactured goods in GDP increased in 2016 compared with 2011, it has not been by much (approximately 0.3 percent). The share of mining as a percentage of GDP is a little over 9 percent. Oil and gas accounts for approximately 8 percent of this 9 percent.

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The largest component of GDP is wholesale and retail trade and motor vehicle repair. In 2016, manufacturing accounted for about 14 percent of GDP, while mining constituted a little more than 9 percent. Subcategories with the largest increase in contribution to GDP include the share of manufacture of ships, aircraft, spacecraft and other vehicles, which increased from 0.8 percent of GDP in 2011 to 1.4 percent in 2016; chemical production (excluding the production of gunpowder and explosives), which increased from 0.9 percent of GDP in 2011 to 1.2 percent in 2016; and food production, which grew by 66 percent in 2016 compared with 2011, now accounting for 1.8 percent of GDP.

Within manufacturing, the biggest contributors were metallurgical producers, food product manufacturers, petroleum product manufacturers, vehicle manufacturers, and materials and chemical producers. From 2006 to 2016, the production of ships, aircraft and spacecraft more than doubled, chemicals production nearly doubled, and metallurgy production grew by roughly 150 percent. The share of metal and machinery production in exports also increased, albeit modestly (1-2 percent).

To summarize: Though the composition of taxes has changed fairly substantially over the past five years, the composition of Russia’s GDP has remained fairly constant since 2011. The fundamentals of the economy, then, remain intact.


Exports account for approximately 26 percent of Russia’s GDP. Though oil and gas as a percentage of total exports have decreased over the past two years from 70 percent to 47 percent, they are still Russia’s largest export category by far. Despite smaller levels in income generated from its oil and gas industries, Russia continues to increase its production in terms of volume. Adding in other commodities such as iron, steel, aluminum and copper, more than 75 percent of Russia’s total exports are natural resources.

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The State Duma of the Russian Federation passed a law on the federal budget for 2018 and the planning period of 2019-2020. These budgets anticipate a continuation of the current deficit. It is constructed with the expectation that the price of oil remains at $40 per barrel, which will be subject to an annual indexation of 2 percent starting in 2018.

However, the new budget has some differences. First, Moscow expects budget revenues in the next three years to grow in nominal terms but decrease as a percentage of GDP. In 2018, the volume will amount to 15.3 trillion rubles ($262 billion), or 15.7 percent of GDP. In 2020, it will amount to 16.3 trillion rubles, or 14.8 percent of GDP. The new budget therefore reflects an expectation of further declines on the revenue side due to assumed low prices and a substantial cut in expenditures relative to GDP.

Second, the budget law also includes the transition to a new budget rule, which implies that the additional oil and gas revenues received from the price of oil above the amount budgeted will be directed not to expenses but to reserves. The reserve fund, which Moscow dips into when it is running short on cash, declined from $140 billion in the beginning of 2008 to about $16 billion in the beginning of 2017. At that time, Russian officials said they expected to exhaust the reserve sometime in 2017. Moscow expects that the main sources of financing the budget deficit will be domestic loans.

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To summarize: Moscow is attempting to plan around the expected continuation of low oil prices by seeking tax revenues in other sectors. Though non-oil and gas revenue today makes up around 36 percent of the federal budget, oil and gas remains the largest single category of tax revenue for Moscow. However, since other sectors are growing only modestly, there is a limit to the amount of additional taxes that can be levied.

Regions and Their Tax Contributions

Over the past 10 years, consolidated budget revenues from excise taxes quintupled, VAT tripled and social contributions (which includes payments made by employers for medical insurance and pensions) quadrupled. When inflation drives up the prices of goods, the cost, from which VAT is calculated, increases. Indeed, most of the increases in total revenues of the consolidated budget comes not to greater corporate taxes (which might imply the development of more robust industry), but VAT, personal income tax and social contributions – all forms of taxes that suppress consumption and investment.

In addition to a breakout by industry, the geographic component of Russia’s economic health can be analyzed by looking at regional contribution to GDP. One notable observation is that, despite the oil and gas that constitutes a large portion of Russia’s GDP and budgets, the composition of regional GDP varies significantly. Resource distribution remains an issue politically in part because of these geographic disparities.

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The region that generates the most income from tax collections to the budget, the Central Federal District, which is home to Moscow, is not a major oil-producing region. The district, which has a larger population than all other areas, plays a key role in tax revenues. About 30 percent of all taxes come from the central district, which generates more economic productivity from services than resources. Almost half of all the personal income tax collected comes from the Central Federal District. Meanwhile, the central district accounts for 34 percent of Russia’s GDP.

The Ural Federal District takes second place. It pays heavy taxes and fees for its natural resources. The Volga Federal District accounts for 15 percent of Russia’s tax revenue due to mineral extraction activities and its excisable goods.

Russia’s budget receives a quarter of all taxes on excisable goods from the Northwest Federal District. By comparison, the city of Moscow collects more than twice the amount of tax revenue that the Northwest Federal District does. Right behind Moscow is the Khanty-Mansiysk region, which is located in the Ural Federal District.

The majority of tax revenue collected comes either from regions that consume or trade a lot or from regions where resource extraction occurs. Thus, not all districts of the Russian Federation depend on oil. In fact, the extraction of mineral resources is the largest share of regional GDP in only two regions. In the Far Eastern Federal District, the share of mining almost doubled compared with 2004 figures and reached almost a third of regional GDP. Roughly 37 percent of the total regional GDP of the Ural Federal District also goes to the extraction of minerals. The share of mining in the Siberian district has grown from 7 percent in 2004 to 14 percent in 2015.

The Tax Maneuver

Russia may not be generating as much revenue from oil and gas as it once was, but it is earning more money by taxing its extractive industries. This, however, represents a change in how oil and gas is taxed, not a decreased reliance on taxes generated from oil and gas activities. There is a significant decrease in the share that previously provided large profits – namely, revenues from foreign economic activity and a turn to taxes that are not so dependent on foreign markets but on overall output. The share of oil and gas budget revenue was slightly above 50 percent in 2012 and reached a high of 51.3 percent in 2014. The nominal oil and gas revenues of the budget grew by 1.6 times in 2016 as compared to 2006. The tax on the extraction forms 17 percent of the federal budget revenues, and the revenues from export duties decreased to 7.6 percent in 2016 compared to the 2012 index (nearly a 20 percent change).

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In the past few years, Russia has been reforming the way it taxes the oil sector. The main medium-term objective of the reform is to reduce the rates of export duty on oil and to raise the rates of the mineral extraction tax. The implementation of this reform, adopted in 2013-14, was called the tax maneuver. The tax maneuver in the oil and gas industry provides for the reduction of export duties on oil to 30 percent in 2017 from 42 percent, with a separate increase in the rate of mineral extraction tax for oil to 919 rubles per ton in 2017 (up from 857 rubles per ton in 2016). As a result of this reform, tax revenues from the mineral extraction tax increased significantly. From January to July 2017, revenues from the mineral extraction tax grew by 44 percent compared to the previous year.

Moscow is trying to squeeze whatever it can from its oil and gas industries without further depressing exports, which have already declined significantly in dollar terms because of falling energy prices. Additional taxation is tolerable to the oligarchy to a degree, but Putin knows that they must still be appeased and is therefore constrained from imposing further taxes.


The Soviet Union was pushed to its spending limits when U.S. President Ronald Reagan forced it to increase military expenditures to unsustainable levels. Contemporary Russia’s spending on defense is much lower than it was during the late 1980s – at least according to official statistics, which were also underrepresented during the Cold War – but it nevertheless faces tradeoffs. It can increase spending to continue modernizing its military, or it can sustain social programs that keep the public from becoming angry at the central government. Putin is familiar with Russian history – disenchanted oligarchs may have brought down the Soviet Union, but it was mass revolution that ended the czars. There is only so much money to go around, and the details tell a story of a country caught between a set of bad choices, each of which will result in one of the legs of the proverbial stool growing weaker and struggling to support the weight of Russia’s challenges.