The Russian Tax Man: Return to the Bad Old Days?

November 26, 2013

Recently, Russian President Vladimir Putin attracted international attention when he appeared to publicly rebuke his Prime Minister Dmitry Medvedev. For all the attention the incident received, the reason for the dispute between Medvedev and Putin has been largely ignored by the media. The Interpreter’s Andrew Bowen examines the new tax fraud laws, backed by Putin, that harken back to “the bad old days” of early post-Soviet Russia. – Ed.

The fall of the USSR brought with it the hope of democracy, free elections and capitalism. Yet the transition from centrally planned and authoritarian political and economic systems led to a period of considerable anarchy, where a majority of the population was left to struggle in a new society that was searching for stability and a sense of identity. The international business community was also initially very excited at the prospect of gaining access to a previously untapped market. However, the exuberance soon gave way to hesitance as investors experienced the difficulty of working in a transitioning economy. One of the biggest obstacles investors found was the uncertain legal requirements and protections of business. Investors soon realized that due to corruption the legal system was an undesirable recourse to solve disputes, as were the law enforcement authorities.

The same struggles that Russia went through to find a new political system of participatory democracy were experienced by the business and economic environment. The plan to transition the old Soviet planned economy to a market/capitalist based one was to be conducted by a method known as “shock therapy.” This method called for the rapid introduction of market measures to an economy, such as the selling of state owned assets and the liberalization of price and currency controls. This method had been applied to other post-communist countries such as Poland and the Czech Republic with great success, but the results in Russia were far from ideal. The process was soon found to be forced too quickly, and that without the necessary legal and institutional foundations to control the rapid process, anarchy quickly ensued. Connected businessmen and former Communist party officials were able to buy state owned enterprises for next to nothing, and law enforcement became known for its corruption and co-optation by organized crime. The result was a weakly regulated open market that allowed for the black and grey sectors of the economy to grow. The government was also facing problems of asserting its authority in an essentially free-for-all economic environment. This led to the creation of the Russian Federal Tax Police whose remit was to do exactly what their name implies: to fight tax crime and be the government’s armed collection agency. The only problem was that the Tax Police became extremely aggressive and received a portion of the money that it collected (the only limitation on their equipment was that they were not allowed to use police dogs, armored vehicles or water cannons). In the anarchic environment of the 1990s, almost every business, to some degree, was not up to date on its tax or legal compliance. The Tax Police were known to simply show up at a business and threaten the owner with investigation unless they paid a percentage of their assumed tax bill (the Tax Police were able to roughly estimate what businesses owed as they were actually semi-competent in their abilities and could shut down a business for up to one month.) Additionally, the Tax Police, MVD, and FSB investigations resulted in considerable jurisdictional overlap and confusion.

Understandably, this caused considerable discomfort to the business community and the Tax Police were dissolved in 2003.

The dissolution of the Tax Police did not end the unease of the business community over the use of legal mechanisms by the government to institute its policy preferences and as mechanisms of control. The death of Sergei Magnitsky, the ousting of Bill Browder from the country, and even the difficulties of Shell, are all emblematic of a continued capricious exertion of power by the government on the business community. The convictions of Mikhail Khodorkovsky and the legal challenges to some of the most powerful businessmen in Russia, like Vladimir Gusinsky and Boris Berezovsky, showed that Putin would not tolerate any challenges to his rule and would not hesitate to use legal charges of financial malfeasance to subdue any potential challengers. The recent conviction of Navalny on trumped up charges in Kirov, and his recent indictment, along with his brother, on money laundering charges show how the regime uses legal structures and accusations of financial impropriety as an expedient cover for jailing dissent.

Realizing the need for reform in both the law enforcement and legal sphere to induce economic growth and modernization, Medvedev sought about to reform the police—including changing the name from militsiya to politsiya—with his 2011 Law on the Police. In addition to attempting to professionalize the police forces, it also sought to allay the concerns of the business community by only allowing the Tax Service the right to open investigations on taxes and took away the power from individual investigators in the other law enforcement departments. Thus limiting the enforcement uncertainty and helping to professionalize the enforcement of Russia’s business environment. The 2011 Law on the Police was also the one major reform of the Medvedev presidency that had not been rolled back or changed with the return of Putin to the Kremlin.

However, it seems that Putin, after realizing that charging opponents with hooliganism leads to a far greater outcry than money laundering (just ask Khodorkovsky as opposed to the recently arrested Greenpeace activists or Nadezhda Tolokonnikova), has sought to give his personal praetorian guard, Alexander Bastrykin and the Investigative Committee, the authority to open tax cases on their own. In February, Bastrykin continued his ever increasing attempts to expand the Investigative Committee’s purview by calling for the creation of a financial police force under the auspices of the Investigative Committee. It seems as though his calls are one step closer to reality. A recently submitted bill to the Duma would allow other law enforcement agencies (primarily the Investigative Committee), besides the Tax Service, the ability to open cases at their discretion. The public logic is that with investigators losing the ability to open criminal cases, the authorities have been less successful at discovering instances of tax fraud — despite the fact that criminal conviction rates from tax fraud have increased from 25% in 2009 to 47% in 2012. This has caused a backlash among the business community, with a recent appeal to Putin stating that the amendments: “will lead to a renewal in the use of criminal prosecution for tax crimes as an instrument of pressuring business, which will be seen as a highly negative signal and will lead to a decrease in business activity while intensifying the outflow of capital from Russia.” Business ombudsman Boris Titov signed the appeal along with Sergei Katyrin of the Russian Chamber of Industry and Commerce and Alexander Shokhin of the Russian Union of Industrialists and Entrepreneurs. Igor Yurgens, the vice-president of the Russian Union of Industrialists and Entrepreneurs, expressed concern that the Investigative Committee would be given such broad powers: “The Investigations Committee does not enjoy the reputation of a smooth and cultured agency with the business community.” Oligarch and Civil Platform party leader Mikhail Prokhorov has also voiced his opposition and started a campaign to get 100,000 signatures to oppose the amendments. Even the Foreign Investment Advisory Council was so concerned it asked Prime Minister Dmitry Medvedev to look into the proposed amendments, indicating that the proposal could affect the willingness of foreign businesses to invest in the country.

On November 12, Medvedev publicly spoke out against the bill saying: “You can launch as many inquiries as you want, especially so if you are paid to do that, as was unfortunately quite often the case when one [business] structure was fighting another [back in the 1990s in Russia].” The fact that Medvedev spoke out publicly against the proposal seems to have riled Putin. He responded to questions about members of his government questioning the bill by saying, assumedly at Medvedev: “I will be forced to remind them that there is a set practice for resolving issues before appearing in the mass media. It is well known … if someone doesn’t agree with something, as Kudrin did in his time — he left [the government] to join the expert community.”

The public spat shows not only the continued infighting among the elite in the Kremlin, but also the diverging attitudes on how to stimulate Russia’s lackluster and anemic growth rates. The economic projections for Russia are not promising, with everyone from the IMF and the OECD to Russia’s own Economic Development Ministry projecting worrying growth rates. Medvedev and a large segment of the economic advisors are realizing that reforms must be made to the institutional and structural makeup of Russia’s legal and economic environment. However, the changes necessary would threaten the interests of much of the elite that the Kremlin draws its support from. It is also worried the possibility of protests and challenges that the reforms would bring; the kind of situation that Putin blamed on Medvedev for the riots that were blamed on his attempts at liberalization.

Whatever the internal political jockeying and power battles portend for Russia remain to be seen, but the immediate future for investment and business in Russia is not promising. The proposal on tax investigations along with the attempts at combining the Supreme and Arbitrazhniy Courts have caused unease among the business community and will most decidedly not contribute to increasing Russia’s abysmal growth rates. Whether Russia will be able to break free from its reliance on commodities and access its economic potential is unclear, but the recent legal proposals do not endear much confidence.