Incomprehensible progression: what income tax should not be in Russia

The idea of ​​progressive wealth taxation is very old, and the range of concepts that explain it is wide. However, all of them are only an ideological basis for progression, since they do not reveal how to accurately set tax rates. Let’s say, what can be the maximum bet? At what level does capitalism end and egalitarian socialism begin? But these concepts set two semantic vectors: “let it be easier for the poor” or “let it be worse for the rich.”

Due to the lack of a strict scientific justification for the size of withdrawals, all disputes about progressive taxation are ideological, almost religious in nature, and any scale of rates is inevitably arbitrary, based on a rather crude approach to determining solvency.

The practice of foreign countries is rich in different approaches to establishing key parameters of progression: the non-taxable minimum, the number of steps, the rate corridor, the level of income of the highest category. Therefore, it is impossible to say what the progression should be. But it is possible to highlight what should not be: which approaches do not correspond to the general principles of law and taxation and, therefore, are unacceptable.

Here is an overview of such pain points.

Equalization taxation

The public debate about progression is driven by social populism. Since other people’s wealth is visible, progressive taxation acts as a kind of “pacifying agent.” Progression mystifies broad sections of society, but does not at all guarantee a reduction in social inequality. For example, the highest level of income inequality is in South Africa, despite the fact that the country has a progressive scale: the minimum tax rate is 18% and the maximum is 45%. Taxation is not the cause of inequality, and taxes are not the cure for it. And here it’s time to remember the fairy tale about the fox who made peace with the bear cubs: one piece turned out to be larger, and the fox equalized the pieces, taking alternate bites from both. As a result, the debaters became equal.

Taxes cannot be justified on the basis of redistribution objectives. To do this, their legal mechanisms must take into account the reasons for the discrepancy in income and property, and this they cannot do. One can take into account why an individual does not participate at all or does not participate actively enough in economic life: unemployment, illness, low education or lack of start-up capital. But this is not about increased tax rates, but on the contrary – about their reduction and social benefits.

Taxes can be an obstacle to conspicuous consumption, which is characteristic of wealthy citizens and irritates society. But for this purpose, it is not progressive personal income tax rates that are being introduced, but luxury taxes in various forms.

Cumulative Progressivity

When establishing progressive income taxation, it is necessary to evaluate the consequences of taxation of a person in the aggregate. For example, high taxes on powerful cars or expensive housing were introduced relatively recently as a form of luxury taxation. The goal was to approach high incomes from the rear, which the personal income tax does not directly reach. So we cannot say that there is no progressive taxation in Russia.

It is also very important that in most situations, it is not net income, that is, everything received minus business expenses, that is taxed, but the revenue in full. For example, in the tax return there is simply no line where a citizen renting out an apartment can indicate the amounts of utility and other payments he has paid. As a result, the rent is taxed in full, even though the income from the transaction is less.

This is a legacy of the Soviet era, when there was practically no other economy outside the public sector and there was no task to accurately determine the income of the payer. This could somehow be tolerated at a rate of 13%, but with a significant increase in tax, income should not be determined by eye.

Budget allocation

Personal income tax is mainly credited to the regional budgets, and in part of the additional 2% introduced from 2023 on high incomes – to the federal budget. The vast majority of Russian regions will not gain anything from raising rates. Millionaires are not spread thinly across the country. An increase in regional budget revenues is possible only in a narrow circle of subjects.

This was confirmed by the practice of charging a two percent surcharge. In 2023, the federal budget received an additional 160 billion rubles in taxes. Almost 70% of the revenue came from four regions – Moscow and the Moscow region, St. Petersburg and the Krasnodar Territory.

True, it is planned to change the system so that a higher portion of personal income tax is credited to the federal budget and from there, possibly, redistributed among the regions, but this will only be a new blow to the already frail Russian federalism.

Family taxation

Progression is extremely unfair for families where there is only one breadwinner. The earnings of one parent are consumed by the entire family and belong to it as a unit of society. So, is it fair that a person who strives to earn—often from several jobs—a high income to adequately support a large family finds himself in a high-tax zone?

To tax true income, many countries use joint declaration of income by spouses, and in some cases by other family members. Spouses can file a joint return and are subject to special deductions and a special rate scale applied to their combined income. There are many options, but none of them were used either in Soviet times or in post-reform Russia. Meanwhile, fair progression without this tool is unattainable.

The existing or proposed approaches to promoting equity for large families do not actually achieve this goal. The standard tax deduction for the first and second child is 1,400 rubles per month, and for subsequent children – 3,000 rubles. From the moment the parent’s annual income reaches 350,000 rubles, there is no longer a deduction (subclause 4 of clause 1 of Article 218 of the Tax Code of the Russian Federation). It is now proposed to increase the deduction for the second child to 2,800 rubles, for subsequent children to 6,000 rubles, and to raise the maximum level of preferential annual income to 450,000 rubles.

A simple calculation shows that for a family with three children and one working parent, the benefit will allow them to save at least 1,326 rubles in the family budget if their income in January is already 450,000 rubles, and a maximum of 15,912 rubles if the maximum income is received only by the end of the year. With two breadwinners, the effect is twice as high. With a maximum family saving of about 32,000 rubles per year, one child accounts for 884 rubles per month, while per capita family income is 15,000 rubles per month. You won’t go wild.

For families with five children, the maximum amount saved will be just under 70,000 rubles per year, that is, 1,154 rubles per month per child. The effect of a large family is an additional monthly 270 rubles per child in the context of a decrease in the average per capita income of such a family to 10,714 rubles per month.

We cannot agree with the proposed version of family benefits, because their general message is this: either receive the maximum benefit, but remain in deep poverty, or earn enough to support your children yourself and do not count on tax “indulgences.”

Non-taxable minimum

We are talking about a person’s constitutional right to life: taxes cannot take away that part of income that is absolutely necessary to cover minimum needs. The miserable non-taxable minimum does not in any way correspond to the idea of ​​fair taxation. On the contrary, raising non-taxable income to a real social and hygienic level leads to actual progressive taxation without any increase in tax rates: the income of low-income citizens would ultimately be taxed only in a small part. But the Ministry of Finance is opposed: significant revenues will fall out of the budget.

Inflation tax

A progressive scale should not be introduced in conditions of persistently high inflation. If rate thresholds are not regularly reviewed, the depreciation of money will lead to the payment of an inflation tax: taxation intended for the middle strata of the population will gradually spread to low-income citizens, intended for the very rich to the middle strata. The rate scale must be periodically reviewed and deflator coefficients introduced. Such adaptation to inflation will be constantly delayed, as the experience of the 1990s has already shown. Therefore, progression can only be introduced in conditions of economic and monetary stability, which is no different in our time.

Let’s take the fees again at the increased personal income tax rate. In 2022, they amounted to 149 billion rubles, in 2023 they grew to 160 billion rubles, and for 2024 an increase to 280 billion rubles is planned – by 75%. Why is there such a jump, since citizens’ incomes are not growing so quickly? Simply because of inflation, leading to salary adjustments, average incomes exceed 5 million rubles abroad and begin to be taxed at an increased rate, although the purchasing power of taxpayers has remained the same or decreased.

Budget efficiency

The effect of introducing flat taxation is convincingly proven by numbers. The Ministry of Finance, which now vigorously supports progression, notes in official reports that from 2006 to 2023, personal income tax collections increased sevenfold.

And back in 2009, then Prime Minister Vladimir Putin informed the State Duma that in the first eight years of applying the flat tax scale, tax revenues to the budget increased 12 times. In 2001 alone, payments increased by 28%. The flat scale has been named one of the main competitive advantages of the domestic economic system.

Foreign economists recognized the success of the reform. About 30 states have switched from progressive taxation to proportional taxation. And these are not only countries that are solving the problem of accelerating economic growth, but also developed ones. Proportional taxation is not alien, for example, to the Canadian province of Alberta and US states such as Illinois, Indiana, Massachusetts, Michigan and Pennsylvania.

Russia is making another zigzag and it is not at all obvious that it is successful. The introduction of a flat scale sharply reduced incentives for tax evasion, which was responsible for the surge in collections. The return of progressiveness will revive them again, and will also reduce the desire to work: why earn more if a significant part of the extra income goes to tax? Therefore, depending on the scenario of a progressive increase in personal income tax rates, we can expect a reduction in GDP from 0.3% to 1.3% per year. Businesses will be forced to increase wages in order to maintain the same level of income for employees. And this, naturally, will increase the cost of production and, as a result, prices.

Social perception of progression

In the fall of 2023, Russian Finance Minister Anton Siluanov promised that personal income tax rates would not change in the next three years, and the authorities intend to return to this issue in the next budget cycle. The actual development of events turned out to be completely different, which undermines any confidence in the strategic statements of those whose direct area of ​​responsibility is taxation. And trust is an important economic factor, especially when making investment decisions.

If the reform is not accompanied by tangible benefits for low-income and family citizens, then social support and approval of the event will be, to put it mildly, restrained, despite all today’s opinion polls demonstrating public support for the initiative. It’s one thing to answer in the abstract; it’s another to face reality.

And among the economically active part, the mood will completely deteriorate. And here it is very important what will happen to the tax on professional income and to the main tax planning tool for the middle class – a simplified taxation system, to which progression is contraindicated. Tax rates under the simplified tax system are quite low, which makes this regime attractive. But there is already talk that employees, self-employed, individual entrepreneurs pay taxes at different rates, and this “has a negative impact on the labor market and contributes to obtaining tax benefits without any business purpose. This disproportion also needs to be worked out.” So, special regimes that stimulate exit from the gray non-taxable zone and simplify the tax bureaucracy are at risk.

The editors’ opinion may not coincide with the author’s point of view