On March 30, 2011, President Medvedev gave a speech in Magnitogorsk, where he announced a series of executive orders aimed at improving Russia’s miserable, “bad, very bad” investment climate. In an apparent effort to reach out to business interests, Medvedev declared that social insurance payroll taxes (strakhovye vznosy) were too high, and he ordered the government to work out a tax reduction plan, due on his desk by June 1, 2011. That deadline came and went, as officials brushed off Medvedev’s directive and loosely advised a return to the subject perhaps in a year. Vladimir Putin dragged his feet and Finance Minister Aleksei Kudrin openly criticized as fiscally irresponsible the idea of lowering the social tax (the main revenue source supporting Russia’s pensions system). Commentators speculated that this was a standoff, between either Putin and Medvedev or between Medvedev and cabinet members like Kudrin. As talk turned to tax cuts favoring just small businesses, many wondered if the President would backtrack on his effort to reduce taxes for all and settle instead for reductions affecting only some employers. (In his March speech, he never singled out different-sized businesses.)

Springing up everywhere.

On June 8th, Presidential Aide Arkady Dvorkovich told the press that the government would spend two weeks debating two possible tax cut ideas: one plan in which reductions would be made only for medium and small businesses, and another plan that would lower payroll taxes for everyone, marginally more so for small businesses. Dvorkovich signaled that the Administration preferred the first option (given the greater priority of alleviating smaller entrepreneurs), but added, “If such a business-friendly scheme cannot be reached, then we are left with only the second option. There simply won’t be another way.” On June 14, 2011, Deputy Finance Minister Sergei Shatalov revealed to the media that the first tax cut plan had “no chance” of becoming a reality, as dividing taxes into three tiers would be “technologically” unfeasible.

It’s worth noting that members of the business community have long warned that increased rate differentiation and favored categories will simply increase evasion and push entrepreneurs to either break up their businesses or pay more employees under the table. For decades, the Russian economy has been plagued by massive tax evasion. Salaries ‘in envelopes,’ also known as ‘grey pay,’ is an unfortunate reality of Russia’s tax collection situation, and has been a major feature of the social tax debate. Officials like Shatalov have proposed levying a small tariff on higher income brackets (currently untaxed), in order to recover some of the revenue lost by Medvedev’s tax cut. Yet, just as officials have highlighted the difficultly of determining ‘business size tiers,’ any effort to collect money from higher earners will undoubtedly lead to new schemes aimed at hiding or dividing income. This is a problem Russia has and will continue to face.

After Dvorkovich’s press conference, it seemed Russians would have to wait until June 22nd, before the government would announce its recommendation to the President, who in turn would approve or reject the final tax cut plan.

The President has his own timetable.

Then, on June 16th at the Petersburg International Economic Forum, President Medvedev announced — before Dvorkovich’s ‘two weeks’ timetable was up and apparently without the government’s formal recommendation — that the state would implement the second tax cut scheme: social insurance taxes would fall from 34 to 30 percent for salaries paid at most businesses, dropping to as low as 20 percent for small businesses. The ‘compromise’ was a belated and partial, but still surprising, fulfillment of Medvedev’s Magnitogorsk speech, when he ordered his cabinet to try to return tax rates across the board to what they were before new changes took effect this past January. Before 2011′s social tax reforms, the federal pension fund was financed mostly by the United Social Tax (the ESN). This year, the ESN was eliminated and replaced with increased social insurance taxes, raising the total payroll burden from 26 percent to 34 percent. The amount of state revenue flowing specifically to the Pension Fund was 20 percent of salaries under the ESN and rose to 26 percent under expanded social insurance taxes. (The remainder of the tax money finances the Social Insurance Fund, Mandatory Medical Insurance Fund, and Territorial Health Insurance Fund.)

Aleksei Kudrin, Russia’s indefatigable fiscal conservative, opposed the tax cuts publicly, warning in April that other taxes would have to rise as a result. Before Medvedev’s official order (while the Kremlin and the ministries of Economic Development and Public Health were still just kicking around the idea), Kudrin warned that cutting the social insurance tax for small and medium businesses down to 14 percent would result in the loss of 120 billion rubles.

Breaking down the social insurance taxes.

Despite Kudrin’s call for alarm, it has been difficult to tell in the tax debate who exactly is warring with whom. Economist Maksim Blant, a columnist for Newsru.com and contributor to EZh, initially interpreted the battle to be between Medvedev and Kudrin. In April, Blant authored an interesting piece about the divide between the country’s elite, splitting the camps into proponents of (a) deficit spending and (b) surplus accumulation. Blant argued that Medvedev’s Magnitogorsk initiative was a pre-election populist stunt: cutting taxes without cutting state spending (that is, running a deficit). “When [Putin] was president,” Blant claimed, “he, as a rule, did not encroach on the MinFin’s domain, requiring only a bit of extra financing before elections to raise pensions and state employee salaries.” With Medvedev, Blant continued, things are different: he can’t trust Kudrin to simply handle the budget and secure his reelection. (Gazeta.ru was also cynical about Medvedev’s motives, concluding in a June 7th editorial, “Everything will end in a political compromise: they will lower taxes on businesses before the elections, and reduce social spending immediately afterward.”)

On June 8, 2011, after the government failed to meet the President’s deadline for a tax cut plan, Blant announced a total victory for Kudrin over Medvedev. “It is no secret,” he wrote, “that the main opponent of lowing the social insurance taxes is Finance Minister Aleksei Kudrin, and he became the main victor.” Blant was so convinced of Medvedev’s defeat that he went so far as to proclaim the death of his entire reelection campaign, titling the article “A Farewell to Modernization.”

Now skip ahead to June 17th, the day after Medvedev’s Petersburg speech (where he announced the social insurance tax compromise). In his Newsru.com column, Blant writes the following:

Having integrated into his own platform key theses expressed in recent months by Finance Minister Kudrin (except perhaps for the unpopular idea of raising the retirement age), Medvedev is obviously trying either to enlist the support of a key member of the current cabinet in the battle with his potential rival, Vladimir Putin, or (more likely) trying to attract to his side forces dissatisfied with Putin’s authoritarianism but in favor of Kudrin’s liberal ideas.

As Blant’s change of heart about the relationship between Medvedev and Kudrin indicates, social insurance taxation is part of an issue convoluted and important enough to inspire serious intrigue: the future of the pensions system.

This is the photo Kommersant used for his interview. (Seriously.)

Earlier this month, as Medvedev’s deadline was sailing by, it was apparent that some in the government wished to postpone social tax reforms until next year, given the impending need for a massive overhaul of the pensions system itself. This redesign would rival changes made at the outset of Putin’s presidency, occurring early in the next President’s administration in order to provide maximum ‘breathing room’ between inevitably unpopular cutbacks and the next election in 2018. The biggest changes to come will likely include: (1) raising the number of work years necessary to qualify for a full pension, (2) returning pension funding to a pay-as-you-go system, and (3) introducing “demographic” and “macroeconomic” benefit-determination powers for the state.

The first reform is widely popular with market liberals, craftily allowing the government to pressure people to work longer, without formally raising the retirement age. (The numbers often floated are 15 years for a minimum pension and 30 years for a full pension.)

The second idea means scaling down the individually-owned pension investment accounts funded by the nakopitel’naia portion of pension benefits, which is funded by a 6 percent payroll tax. Currently, the rest of social insurance taxes (amounting to a 20 percent payroll tax) funds the strakhovaia chast’, which feeds the Pension Fund. Half of this money goes to pay current pensioners. For more than two years, Deputy Minister of Healthcare Yuri Voronin has raised concerns about the shortcomings of the pension investment accounts (the nakopitel’naia chast’), arguing that its gains fail to overcome inflation.

According to Vnesheconombank, the yield (between 2006 and 2008) of pension investment accounts owned by low earners was 3.71 percent annually, and the average profits of private pension management companies was negative 2.8 percent annually. During that same period, the annual inflation average was 11.4 percent.

Voronin has said that the Healthcare Ministry would like to make the investment accounts optional for workers, allowing Russians the choice between nakopitel’naia or strakhovaia deposits for that 6 percent bit of their payrolls. Voronin says the only thing undecided is which option should be the default.

In May earlier this year, Anatoly Puzyna (president of ‘Sotsium,’ a private pension fund) went on Ekho Moskvy and defended his organization’s record on inflation, when asked why the government shouldn’t simply liquidate the nakopitel’naia system. Puznya claimed to have earned almost 10 percent for investment accounts in 2010 (which is slightly above the current inflation rate of 9.6 percent and higher still above the year’s average).

The third major potential pension reform has experts most worried. Voronin describes it in the following deliciously Orwellian terms:

It is a complicated integrated coefficient that will take into account the demographic and macroeconomic burden. It will be calculated annually from an actuarial perspective. [...] Our proposed formula is complicated, but it corrects liabilities subject to a changing macroeconomic and demographic situation, forbidding the acceptance of unfounded liabilities that are not covered by social insurance taxes, and simplifying for citizens the calculation of their pensions. Above all, the new formula will allow [us] to take social taxes from all income, lower the rate, and eventually balance the pension system’s revenue and expenditures. Ideologically, we have come to the point of no other alternatives.

After Voronin made those remarks on June 9th, INSOR’s Evgeny Gontmakher visited Ekho Moskvy the same day to review what such reforms would mean for the pensions system. Regarding the ‘demographic and macroeconomic’ coefficient, Gontmakher had this to say:

It’s an absolutely Soviet mechanism. It’s like in Soviet times, when there wasn’t any insurance scheme at all. [...] Then everything was determined by the decision of the state. Then very little depended on the pensioner himself. [...] Here it’s the exact same thing: it’s not the person who will decide what kind of pension he’ll have, striving to earn [the maximum] — and this ideology by the way was introduced back in 2002. And now once again the state is going to decide for you. People, what have we come to?

Gontmakher's vision of Russia's future. (Gypsies?)

The following week, on June 16th, EZh published a Gontmakher article exploring the long-term meaning of the proposed pension reforms. According to the INSOR insider, the nature of cutbacks to the pension system reveals the profound “catastrophe” facing Russia. “Our economy,” Gontmakher writes, “frozen in its own archaism, is already in the near future (the next 3-5 years) unable to provide even the low living standards that are today characteristic for the majority of the population.” He concludes with a dire warning that the authorities’ dwindling ability to develop the country could empower “some kind of underground charismatic” leader, perhaps leading to “a new Manezh” — that is, a new wave of populist violence.

Are Gontmakher’s concerns more than alarmism? If Medvedev’s tax cuts were a pre-election giveaway to ingratiate himself to businesses and tax-payers, will the state follow up (after 2012) with budget-balancing cutbacks to the pensions system? Or will a struggling economic situation derail liberals’ goals of reducing the government’s economic presence, requiring continued deficit-spending to prevent the kind of immiseration and unrest foretold by Gontmakher?

Whatever his fiscal plans for the future, Medvedev’s maneuvers throughout the social tax debate fill another chapter in the book of ‘Looks Like He’s Running For President’: issuing unambiguous executive orders in front of TV cameras, refusing to wait two weeks for the government’s late recommendation, and sticking with the tax cut plan that more closely fulfilled his original initiative. Medvedev appears to have overcome officials who sought to deny him this populist opportunity. Were his opponents the liberals, worried he would bankrupt the pension fund? Or maybe it was the siloviki, convinced the state would later raise taxes on their pets, the oil and gas industries, in order to balance the budget? The obstructionism that washed up against Medvedev’s tax cuts might also have been entirely political: certain people in the government could simply have wanted to deny the President a chance to appease the business community. Mostly likely, all of these groups made some effort to interfere with Medvedev’s plan. In the end, the President accepted a compromise, but in the process scored an unmistakable political victory.