Maturing Russia. Rule of Law; Transforming Russia Into a More Predictable Place
This is the first of three articles about “Maturing Russia”.
It has been a significant time since the changeover from Communism to Russia’s own interpretation of Capitalism and if one could sum up the changes they clearly have been quite dramatic as they have touched almost every aspect of life, from the Rule of Law to consumerism. For those of us who have lived here for many years the evolution of life in Russia, day by day, has been taken in stride. It sometimes needs someone who was last here five or even ten years ago to wake us up by saying, “Hey, this place is unrecognizable.”
This first article describes some of the positive changes with respect to the Rule of Law, with a special focus on taxation and the working world.
By James Logan and John Bonar
It is well understood that a country without a rule of law is a country that is not investor friendly. In the 90’s there was hardly a rule of law in Russia, but all that is slowly changing. More and more foreign companies are coming into Russia to invest in all aspects of the economy with more predictable results. At the start of Russia’s capitalism, companies were generally nervous to invest and often brought their products in only through agents and distributors; as if hesitant to get any closer than from a safe distance. With more predictable laws and less boardroom violence, the name of the game today is to build local production to sell to Russians and often to export into Europe or other markets, which can be profitable due to relatively cheap labor, as compared to Western Europe. Western investment companies feel more confident that they can purchase property, develop production facilities and rely on the rule of law to protect their investments and agreements in Russia.
Paul Melling, founding partner of the Moscow and Almaty offices of the leading international law firm Baker & Mackenzie says that the progress in the civil judicial system is marked. “If you were to compare Russian Courts to the High Court in London’s Strand, then Russia would still fall short,” he cautioned. “But the legal system here is speedier, cheaper and becoming more reliable,” he told Passport. Most disputes, according to Melling, who has practiced law here for 20 years, are resolved in 30 days. “Even the most drawn out commercial litigations are finished within 18 months to two years,” he asserts.
“Even five years ago only the incredibly stupid or brave would litigate here. Now commercial courts here are the favored place for dispute resolution.”
In conjunction with various Western experts and the likes of the World Bank, Russia embarked upon a multi-faceted effort to become more independent and less reliant on Western funding from sources like the IMF. According to the mid-90’s strategy, if the government could increase tax revenues and reduce governmental corruption, Russia could change from a dependent (on Western IMF money) country to an independent self-sustaining economy. The first prong of this approach was to provide a user friendly tax system with low taxes and easy or no-filing requirement (which applies to most taxpayers). In conjunction, by increasing the number of “white” employees, and requiring all employees to acquire bank accounts and have their salaries only paid through these accounts, it decreases the reliance on cash. It was only in President Putin’s fi rst term of 2000-2004 that income and corporation tax were slashed to their present business-friendly levels.
In parallel with these efforts the World Bank and EBRD have been investing in consumer fi nance companies, credit card companies, transaction technology companies, and retailers and shopping centers to move consumerism from the often gray economy of openair markets to malls. The cash that was once used by consumers in the markets to feed a completely black, underground and illegal (money laundering) economy is being replaced by recordable and auditable cash transactions and sometimes plastic card transactions. As traceability increases, shop employees and all other staff in the retail system are being paid legally, and the products are being purchased with recorded invoices instead of with cash. This has resulted in an increase in all categories of taxes, from VAT, to Employer and Employee taxes, to corporate and other taxes. Employees who once preferred being paid ‘under the table’ now often prefer their bosses to pay all the necessary taxes so that they can show their ‘white salary’ when applying for consumer credit. According to Luc Jones at Antal Recruitment Company, “we have witnessed a strong tendency towards companies paying salaries in accordance with Russian labor law over the past several years.” Jones has also confi rmed the candidate-led trend to insist on white salaries for purposes of applying for consumer credit; i.e. consumers refusing jobs where payments are not made in accordance with the law. This has been confi rmed by Avenir Recruitment President Maxim Stepanov who added that: “Candidates today, now frankly refuse to work for companies that use non-transparent salary schemes, pay salaries late or refuse to pay into state Pension or Social Security Systems.” In the recent past companies would declare only a small percent of real wages as offi cial salary, in order to reduce taxes. Now the trend (even with the most egregious violators) is to declare a higher and higher percent as official salary.
At the heart of the reforms lies the classic liberal tax theory according to which lower taxes translates into increased tax revenues. The best known theorist behind this idea was the late Arthur Laffer, but the person whose name it is most associated with is U.S. President Ronald Reagan. Therefore, it is an interesting historic irony that Russia, a country where the socialist creed reigned strong until very recently, has now been converted into an international showcase of economic liberalism. In America, President Reagan and his supporters were known for campaigning for such tax policies, but it is Putin’s Russia that has actually implemented them. Reagan could never have dreamed of pushing such measures as Putin’s 13% fl at income tax rate through Congress. It would be fair to say that never before has there been such a dramatic and speedy shift from socialist tax policies to classical liberalism, and the results could hardly have been more impressive.
According to Dr. Frank Schauff, Chief Executive Officer, Association of European Businesses in the Russian Federation: “Over the past eight years or so, we have seen the Russian economy, and indeed Russian society as whole, become more transparent and subject to the Rule of Law. Recent surveys among AEB members have revealed that they consistently judge Russia’s economic and political situation to be stable. Bureaucracy and corruption are still quoted as the main barriers to business in Russia, but clear progress on this issue is evident – in the very active customs reforms currently underway and the tightening of the legislative framework.
Certainly on the economic front, there is no shortage of evidence that Russia is here to stay. With WTO membership now being a realistic possibility firmly on the agenda, the hosting of the Winter Olympics in 2014, and swelling foreign direct investment, Western companies and investors are lining up to benefi t and take part in Russia’s seemingly unstoppable growth.
According to Jon Hellevig, a tax book author and partner at the law firm Hellevig, Klein & Usov: “The tax reform as a model for farsighted and well-thought out legislation also had the side-effect of helping to improve the overall lawmaking process and stabilizing the task of state administration. It has also improved the judiciary, which is showing encouraging signs of moving towards a system where court precedents are awarded a significant role that would more closely resemble the Anglo-American system than the more rigid Continental European practices. One way to reduce judiciary and other public service corruption is to raise salaries and on that note, the salaries of judges alone have gone from a few hundred dollars a month to over $4,000.”
Hellevig further noted that: “Having consolidated these achievements in tax administration and the judiciary, the government has concentrated its recent efforts on reigning in notorious abuses in the field of customs as well. The effects of this crack down on customs corruption and gray import schemes began to be felt last year among the foreign suppliers that have relied on such thievery for their profits. Currently many importers are panicking to change their business model to refl ect the new realities of importing in a legal and transparent manner.”
The Russian Economic Miracle
According to statistics provided by the Avenir Group; in dollar terms, Russian GDP has increased fivefold from 2000 to 2006. According to our source, Deutsche Bank, the total growth will be six fold by the end of 2007. At end of 1999, per capita Russian GDP was just $1,334 (the dollar to ruble exchange rate being 27.0). By the end of 2005 per capita GDP had risen to $5,346 annually, for the year 2006 it was $6,879 and by the end of 2007 it is expected to reach $8,350. This is more than 600% growth in 7 years.
The currency and gold reserves of the Russian Central Bank were a mere $36,6 billion in 2001, but today they have ballooned to a staggering $315 billion (Source: www.minfin.ru). Russia’s cash reserves today are the third largest in the world, trailing only China and Japan. So Russia has transformed itself from an economically dependent country to an independent one. It cannot be denied that a lot of these reserves are a dividend from high oil prices, but perhaps a lot of these funds under less transparent circumstances would have fallen into private hands instead of into government coffers.
In 2001 the World Bank estimated that 27.3% of Russians or 40 million people lived below the poverty line. By the end of 2005 the number of people living in such dire poverty had been halved down to 15.8% of the population or 22.6 million. According to recent EU statistics this fi gure corresponds with the EU average which is the same unfortunate 16% (Business Week, February 2007).
So by Passport Magazine accounts, it looks as if Russia is becoming more and more mature in many respects and looks to continue in that direction.
Next month: Infrastracture: Transforming