PUTIN'S PENSION REFORMS: BUSINESS BURDEN OR

C O N F I D E N T I A L MOSCOW 002970 SIPDIS E.O. 12958: DECL: 10/07/2018 TAGS: ECON EFIN ELAB SOCI RU SUBJECT: PUTIN'S PENSION REFORMS: BUSINESS BURDEN OR MARKET BOON? Classified By: ECON MINCOUNS ESCHULTZ, REASONS 1.4 (B/D) -------------- SUMMARY -------------- ¶1. (C) Prime Minister Putin's recent announcement that social security taxes paid by businesses will increase eight percent over the next two years has alarmed segments of the business community, particularly the cash-starved small and medium sized enterprises. On the other hand, market analysts view a solvent pension system as an important source of domestic investment capital, and some advocate government co-financing of private pensions. There is overall agreement that given negative demographic trends, the present pension system is a financial liability. Short of raising the retirement age or privatizing pensions, contributions to the pension fund will decrease steadily while payouts increase and the government will be forced to continue to make up the difference through increased taxes or other revenue sources. End Summary. -------------- Higher Taxes to Prop Pensions -------------- ¶2. (U) On October 1, Prime Minister Putin announced that in an effort to support the solvency of the Russian pension system, the Unified Social Tax (UST) or social security taxes paid by businesses will rise by up to eight percent. The current UST of up to 26 percent paid by employers will be replaced by three insurance payments, not exceeding 34 percent of salaries, by 2010. These include pension insurance (26 percent); medical insurance (5.1 percent) and payments to the social insurance fund (2.9 percent). The payments will be levied on employee salaries up to 415,000 rubles (roughly $17,000) per year. Minister of Health and Social Development Tatiana Golikova explained on the evening news programs that if payroll taxes were not increased, the country's pension fund would run a deficit by 2050 with 86 percent of its budget financed by federal funds. ¶3. (U) Putin acknowledged that the tax measures would entail added expenses for businesses, but suggested that the government would compensate losses by tapping into the National Welfare Fund. The mechanisms for compensation would be developed jointly by the Ministries of Economic Development and Finance. Putin also stated that the base pension would increase by 37.1 percent next year, and the insurance portion of the pension will rise by 15.6 percent. Currently, the average pension is 4,188 rubles ($163.60) per month. (Note: Pension increases projected for 2009 will place the average pensioner just above the subsistence level, by Putin's own admission). -------------- Negative Business Reaction -------------- ¶4. (C) Boris Titov, Chairman of "Delovaya Rossia", a lobby group for small and medium sized enterprises (SMEs) told us he had appealed to the government to re-consider the tax increases, maintaining that most of the burden of the changes would fall on the SMEs. Mikhail Orlov, head of the tax committee for the pro-business "Opora Rossii", maintained that the new taxes would force wages back into the "gray area", i.e., compel many smaller companies to understate wages - paying part of their employees' wages on the side. In a September meeting with the Ambassador, the Chairman of the Russian Union of Industrialists and Entrepreneurs, Aleksandr Shokhin - spokesman for the larger enterprises - was also critical of any payroll tax hikes, arguing that the increased financial burdens on business would hamper economic development and the government's overall stabilization polices. -------------- Mixed Reviews From the Financial Community -------------- ¶5. (C) Market analysts, on the other hand, tended to applaud Putin's move, arguing that pension reform was needed to create a long-term capital base in the country. Chris Weaver, Chief strategist for Uralsib, wrote in his morning note of October 2 that pension reform should be seen as a positive reaction to the global liquidity squeeze, noting that pension funds could eventually form one of the biggest sources of domestically available investment capital. Alesxander Popov, head of the trust management Department of Vneshekonombank, told us he had urged the government to also move ahead with plans to co-finance accumulated pension accounts for individuals, thereby encouraging Russians to independently save for their retirements. ¶6. (SBU) However, there were discordant notes. Nina Orlova, senior analyst for the Alfa Bank, took a more jaded view of the insurance tax hikes, arguing in her October 2 morning brief they were a reaction to mounting inflationary concerns and the likelihood of an economic slowdown. She stated that the increases would be a burden to the corporate sector and the middle class - now forced to pay the "social costs" of increasing inflationary pressure. -------------- Comment -------------- ¶7. (C) Putin probably had little choice but to raise taxes given that with Russia's current demographic trends, contributions to the pension system will decline notably (with an increasing share of the population above the retirement age),while payouts continue to increase. The pension system is unsustainable under existing conditions and is a major fiscal liability in a time of slowing economic growth and declining oil and gas revenues. Moreover, while moves towards private pensions might make sense, they are unlikely to be successful. The average Russian has been weaned on state providence from cradle to grave, there are no real incentives to save in an economy with very negative real interest rates, and most Russians deeply distrust the financial system. In the final analysis, only a small share of the population can be expected to save for their retirement and the pension burden will therefore fall on the government. End Comment. RUBIN