Replenish All: Why does the Ministry of Finance save the budget at the cost of economic growth

President of the Institute, Marcel Salikhov published the author’s column in Novaya Gazeta on  the current budgetary policy of Russia.

The beginning of autumn is a traditional time to discuss budgetary policy. On September 19, the government considered and approved the draft budget for the next three years. The budget must be submitted to the State Duma by the end of September. As practice shows, the main parameters of the federal budget do not change during the Duma consideration. Therefore, the figures already approved by the government can be considered as well-established.

Cut and conquer

Back in the summer, the Ministry of Finance outlined its position — the need for budgetary consolidation, that is, cutting expenses since next year. Many economists have expressed fears that excessively rapid spending cuts could be the main threat to economic recovery next year. The Ministry of Finance has partially taken into account this criticism — the submitted draft budget for 2021 has become less radical in terms of budget consolidation compared to previous designs.

The Finance Ministry expects federal budget spending this year to reach RUB 22.6 trillion, up from RUB 18.2 trillion last year. When using the carried over residues of the last year — even more. This is an increase in the expenditure side by at least 4.5 trillion rubles — almost 4% of the GDP of the budgetary «stimulus» this year.
Such an extraordinary increase in spending is associated with the fight against coronavirus and anti-crisis measures — this level of spending will not be possible to maintain in the future. Therefore, the draft budget assumes that spending in 2021 will be reduced by about 1 trillion rubles, to 21.5 trillion, and will grow by 400 billion rubles, to 21.9 trillion, in 2022.

This is the principled plan for budgetary consolidation from the government: the authorities provided serious support to the economy at the expense of the budget in 2020, starting next year it should be reduced and return to «normal» by 2022.

Another problem for the government is that if it is necessary to increase spending, the revenue side is greatly reduced. The Ministry of Finance expects federal budget revenues to amount to 17.8 trillion rubles. This is minus 2.2 trillion rubles compared to 2019.

This ratio of income and expenditure will lead to a deficit of almost 5 trillion rubles (4.4% of GDP) this year.
Revenues are projected to rise to 1 trillion rubles next year, mainly driven by GDP growth of 3%. Together with the expected spending cuts, this will reduce the deficit to 2.4% of GDP in 2021 and reach 1% of GDP by 2022. Thus, the Ministry of Finance maintains a conservative vector of budgetary policy, considering the coronavirus epidemic as a temporary deviation from long-term levels, to which it will be possible to return in two years.

Not the worst scenario

However, such a seemingly logical picture does not really «beat» the actual results of 2020. For example, in January-August, the federal budget expenditures increased by 2.8 trillion rubles. To increase expenditures to the expected 4.5 trillion rubles for the entire year, expenditures over the remaining four months should be increased by 1.7 trillion rubles, compared with quite active spending on national projects last year.

Last year, the government, even in stable conditions, was unable to ensure the spending of about 1 trillion rubles of the planned spending budgets. This year, the authorities are trying to prevent a repetition of this situation, however, apparently, increasing expenditures will be less and will be in the range of 3.5–4 trillion rubles per year, the total amount of budget expenditures will be about 22 trillion rubles.

The decline in the federal budget revenues hides various trends. The revenues fell primarily due to a decrease in oil and gas revenues — a fall in oil prices and a reducing production under the OPEC + deal.

Oil and gas revenues are expected to be around RUB 5.8 trillion this year, up from RUB 8.3 trillion last year.
However, the fiscal rule means that in terms of spending oil and gas revenues, it is only important whether they exceed the «base» amount — that is, revenues calculated based on the base oil price ($ 42.4 / bbl in 2020). If the actual Urals price is below the «baseline», then the difference should be compensated by the National Wealth Fund (NWF).

Taking into account that oil production this year will decrease by 9–10%, the effective base price for Urals is in the range of $ 45–46. In June-August, the average Urals price was $ 43.9 per barrel, slightly falling short of this figure.
This situation allows to spend the generated oil and gas revenues and means that the current amount of oil and gas revenues is neutral for fiscal policy. If oil price remains within the range of recent months, this will mean that this year there will be no need to use the funds of the NWF to finance the deficit at all.

The situation with non-oil and gas revenues is also not as bad as one would expect in the current environment.
These revenues grew by 5% for the first 8 months of 2020. Of course, this dynamic also includes the pre-coronavirus first months of the year, as well as «schematic» 1.1 trillion rubles due to the transfer of Sberbank’s stake from the Central Bank to the government. Nevertheless, in June-August, non-oil and gas revenues were 14% less than last year.

However, an important part of the government’s anti-crisis measures was provision of deferrals for paying taxes in the affected industries in the first half of the year — for the most part, these funds should be paid to the budget this year, the rest — next one. This means that the current decrease in budget revenues is associated with this factor, which is temporary in nature.

The economic downturn is also likely to be less than the forecasts that the authorities were expecting a few months ago. Back in May, the Ministry of Economic Development predicted a decline in GDP by 5%, now it is expected to decline by only 3.9%.

Is Consolidation Needed?

All this means that the «critical» 2020 presented by the Ministry of Finance will not be so terrible for the budget. Most likely, the increase in expenditures will be less, and revenues — more than the current official forecasts. The federal budget deficit will be in the range of 3.4–3.7% of GDP, compared with the official forecast of 4.4% GDP.
This raises the question of the rationality of the fiscal consolidation next year and the need to increase the tax burden.

The presented plan of «tax mobilization» should provide 500–600 billion rubles in additional income annually, starting next year. It provides for raising taxes for the oil industry by revising the mineral extraction tax (MET) and additional income tax (AIT) mechanisms, increasing MET rates for metallurgists and chemists, as well as a progressive personal income tax scale and taxation of interest and coupon income.

We can assume that wealthy Russians and the resource sectors will finance another anti-crisis measure — a reduction in the rate of social contributions from 30 to 15% for small and medium-sized businesses. The cost of this indefinite measure is also estimated at about 500 billion rubles for the PFR budget and, accordingly, will require additional expenses from the federal budget.

If we believe that 2020 will be a «terrible» year for the federal budget, then such measures are necessary. However, this is not so — the current situation is much more stable than the Ministry of Finance shows it. There is no urgent need for an immediate tax increase from next year.

Rather, on the contrary, unexpected and dramatic changes in the tax system increase uncertainty and may discourage economic activity. The three percent GDP growth that the Ministry of Economic Development regularly expects may turn out to be a pipe dream under these conditions.