We perform some of these policy experiments using RUSMOD and find that the Russian tax-benefit system reduces poverty by half and inequality by a third if direct and indirect taxes and cash transfers are taken into account. There are however two caveats to this statement. First, this performance, while commendable, is moderate for international standards. In particular, the system of direct taxes and transfers could be more effective in reducing inequality—in fact, it is the least redistributive among the EU countries. Second, it is not clear that this performance is being achieved in the most efficient or effective way. Almost the entire equalization in Russia happens though pensions, and—unlike in many other countries—the role of direct taxes and direct benefit, particularly means-tested benefits, is minor. We also find that fiscal policy changes between 2010 and 2017 benefited mostly the middle of the income distribution. Despite large sums spent on social protection, the system did not prevent people from falling into poverty during the 2014-16 recession.

This paper also assessed the role of changes in the tax-benefit system in explaining the incidence of informal employment in Russia. In particular, we investigate whether the existing system creates disincentives for formalization in terms of reducing household income, increasing poverty and inequality; and whether the hypothetical ‘tax maneuver 22/22’ could help reduce the opportunity costs of formalization for informal workers, improve distributional outcomes and increase fiscal revenues. We simulate a number of hypothetical scenarios assuming random formalization of some (or all) informal workers, the tax maneuver without formalization and the tax maneuver followed by formalization. In addition, we also attempt to simulate behavioral responses to the tax maneuver through a probabilistic model.

The main conclusion from that analysis is that formalization without any changes in tax policy would result in significant gains for the budget but would have negative impact on the current income of the population in general and on current incomes of the target group. Assuming zero changes in informality, we find that the tax maneuver will result in additional budget deficit of up to 1 percent of the GDP but will be beneficial for the population under the assumption that economic incidence of all taxes falls on workers. The fiscal losses due to the tax maneuver could be fully compensated if at least 50 percent of workers would formalize. But then workers who formalize would see a fall in current incomes and poverty rates for them and the society in general would increase; the tax maneuver is not able to compensate for the losses in the population income under any scenario. The results of behavioral model show that the share of the formalized is not very sensitive to changes in net wages due to the tax maneuver: at most 6 percent of informal workers would become formal, leading to small increase in poverty and a decline in fiscal revenues.

From a policy perspective our research implies that informality in Russia is a more complex phenomenon and could hardly be addressed by a single intervention, such as the shift from direct to consumption taxes. However, there are certain conclusions that could be done based on this analysis as well as another paper in this project. The evidence compiled by this research points to three main messages.

First, the tax reforms such as a reduction of SIC or other direct taxes could have very limited effect in terms of reducing informality in Russia. According to our model, the 8-percentage point reduction in SIC rates seems to elicit a too small formalization. A larger SIC reduction could do better but, given its fiscal cost if generalized to all income groups, perhaps it should be focused on a few selected types of workers (e.g. the youth, rural workers, self-employed). Moreover, incentives upon firms, which we do not include in our analysis, should be better studied and considered as part of formalization policy.

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