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)

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SUMMARY
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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.

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Higher Taxes to Prop Pensions
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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).

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Negative Business Reaction
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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.

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Mixed Reviews From the Financial Community
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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.

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Comment
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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