NCPA - National Center for Policy Analysis

Russia's Challenge

June 26, 2015

Currently, 17.1 percent of Russia's Gross Domestic Product (GDP) and 30.4 percent of government revenue comes from comes from the sale of fossil fuels.

According to a study by economist Laurence J. Kotlikoff of Boston University and colleagues, a 50 percent decline in fossil fuel prices from 2013 prices would put Russia under great fiscal stress. If Russia chooses not to make cuts to spending, then it will need to increase taxes, institute growth-enhancing reforms, or resort to debt finance. Without tax hikes or spending cuts, the government will run deficits of about 6.1 percent of GDP immediately after the economic shock and later deficits of 10.8 percent of GDP. By 2024, debt reaches 99.3 percent of GDP and entails perpetually higher government spending.

However, Russia is not without policy options. It could:

  • Gradually phase out its pay-as-you-go state run pension system and its associated very high payroll tax and replace it with a personalized account system.
  • Eliminate corporate income tax and make up lost revenue by raising consumption and wage taxes.
  • Raise Russia's fertility rate significantly (a 25 percent increase).

Raising Russia's fertility rate has a pronounced impact on the country's future GDP. The lesson here is that the size of the Russian work force, not improved work incentives facing Russian workers (via lower marginal tax rates or higher pre-tax wages), is of paramount importance in determining Russia's production of goods and services. Without a change in fertility rate, Russia could face a population of 98.8 million by 2100, a shrink of over 30 percent relative to its current size.

Fossil-fuel depletion and the potential for permanently lower fossil fuel prices make Russia's fiscal finances particularly precarious. With no change in policy, average tax rates in Russia will close to double over the century. Marginal effective wage-taxation will rise to levels that provide greater incentives for tax evasion. This points calls into question the sustainability of long-term fiscal policy.

Source: Seth G Benzell, Eugene Goryunov, Maria Kazakova, Laurence J. Kotlikoff, Guileermo LaGarda, Kristina Nesterova, and Andrey Zubarev, "Simulating Russia's Challenging Transition," National Bureau of Economic Research, Working Paper No. 21269, June 2015. 

 

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