A slowing wartime economy pushes the Kremlin to tap consumers for revenue

Russia’s Economy Slows as Putin Turns to Tax Hikes to Fund War Effort

After enjoying two years of robust growth fueled by military spending on the war in Ukraine, Russia’s economy is now showing signs of deceleration. Oil revenues have declined, the budget deficit is widening, and defense spending has plateaued, creating fiscal challenges for the Kremlin.

President Vladimir Putin’s solution is becoming increasingly clear: tap ordinary Russians and small businesses for additional revenue. The centerpiece of this strategy is an increase in the value-added tax (VAT) from 20% to 22%, expected to generate approximately 1 trillion rubles ($12.3 billion) for state coffers. The tax hike, already advancing through Russia’s parliament, will take effect January 1.

Beyond the rate increase, the government is significantly lowering the threshold at which businesses must collect VAT. The current threshold of 60 million rubles ($739,000) in annual sales will drop dramatically to just 10 million rubles ($123,000) by 2028. While partly aimed at preventing tax avoidance schemes where companies split operations to stay below collection requirements, the change will heavily impact previously exempt small enterprises like convenience stores and beauty salons.

The revenue-raising campaign extends well beyond VAT. Tax increases on spirits, wine, beer, cigarettes, and vapes are in the pipeline. The tax on stronger spirits such as vodka will rise by about 20 U.S. cents per half-liter bottle, representing roughly 5% of the minimum price. Administrative fees for driver’s license renewals and international permits are increasing, while a key tax break on imported cars is being eliminated.

Russian media outlet Kommersant reports the government is also considering a new technology tax of up to 5,000 rubles ($61.50) on digital devices including smartphones and notebooks, with higher rates applying to premium products.

These economic pressures signal that Putin and ordinary Russians face increasingly difficult choices between military spending and consumer welfare after 3½ years of war against Ukraine.

On the streets of Moscow, citizens interviewed by The Associated Press expressed a mixture of dismay and resignation about the coming tax increases. Many worry about the impact on food prices, particularly in economically disadvantaged regions and among low-income households.

“I think that small and medium businesses will fold,” said Svetlana Martynova, a pensioner. “The budget will get less, not more.”

The automotive sector faces additional challenges. From December 1, the government is eliminating the concessionary registration fee of 3,400 rubles ($42) on cars with more than 160 horsepower. Instead, individuals must pay the commercial rate, which can amount to thousands of dollars per vehicle.

According to Andrei Olkhovsky, general director of major auto dealer group Avtodom, this change is unlikely to boost domestic manufacturing given high interest rates and Russia’s smaller market compared to neighboring China, which now supplies most imported vehicles to Russia.

“Increased taxes and fees will influence prices for the end consumer,” Olkhovsky noted. “Consumers in turn will factor this into their lifestyle and demand higher wages from their employers. This will increase the cost of everything around us.”

The economic slowdown is stark. After expanding by more than 4% annually in 2023 and 2024, Russia’s economy contracted at the start of 2025 and is now projected to grow by only about 1% this year, according to government estimates. The Central Bank’s high interest rate of 16.5%, aimed at controlling 8% inflation fueled by massive military spending, has dampened economic activity.

Oil revenues, a critical source of government funding, have fallen approximately 20% this year, primarily due to lower global prices, according to the Kyiv School of Economics Institute. Western sanctions imposed in response to the Ukraine invasion continue to increase costs and deter investment that could expand productive capacity.

As a result, Russia’s budget deficit has been revised upward from an initial projection of 0.5% to 2.6%, compared to 1.7% last year. While this figure might seem manageable by international standards, Russia faces a unique challenge: Western sanctions block access to international bond markets, forcing reliance on domestic banks for credit.

Finance Minister Anton Siluanov defended the tax increases, arguing that raising revenue is preferable to increasing borrowing, which “would lead to a speeding up of inflation, and as a result, to an increase in the key rate” that would further harm investment and growth.

The VAT increase may initially boost inflation as businesses update their prices, but economists suggest it could eventually help control inflation by dampening consumer demand – potentially aiding the Central Bank in its battle against rising prices.

These fiscal adjustments mark a significant shift from Russia’s wartime economic approach of the previous two years, when higher oil export prices filled state coffers and military spending boosted employment. Factory workers’ wages generally kept pace with inflation, while recruitment and death bonuses injected cash into poorer regions.

Alexandra Prokopenko, fellow at the Carnegie Russia Eurasia Center in Berlin, believes Putin isn’t facing an immediate financial crisis. “Growth is slowing down, but corporates are paying taxes, people are consuming and getting salaries, and paying taxes from this,” she explained. “For the coming 12 or 14 months, Putin has enough money to maintain the current war effort and the current level of expenditures.”

However, the longer-term outlook presents challenges. After that initial period, Prokopenko notes, “he will need to make tough choices, trade-offs between maintaining military effort or, for example, maintaining consumer abundance so people won’t feel 100% that the war is going on.”