4.14 At the same time, it is worth noting that in the short term the broader demographic structure of the Russian population has a less unfavorable impact on pension financing. This is because the recent increase of older people’s share in the population was accompanied by a drop in the birth rate, and therefore the overall share of people of non-labor age (children and retirees combined) in the total population did not increase. According to the Roskomstat, in 2002 60.8 percent of Russians were of labor age, while this share was 57.0 percent in and 57.3 percent in 1997. This means that in the short term sustaining a pension system in Russia may not necessarily require an immediate increase in the overall tax burden on the De Castello-Branco (1998) provides a general overview of the main features of pension systems in the FSU economies as they were inherited from the planned economies.
In Romania, for instance, the number of contributors to the pension system declined from 8.2 million in to 4.4 million in 2003 (Plevko 2004).
The new draft Law on professional pension schemes is currently under consideration in the Duma.
It should be noted, however, that despite the growing pressures, the Russian pension system is still in a more favorable position relative to one e.g., in Ukraine, where the ratio of pensioners to employees reached 0.92 and overall pension spending have been approaching 10 percent of GDP (Anusic and Petrina, 2003).
working population. However, some restructuring of the overall public taxation and spending may be needed to reflect the ongoing demographic changes. Still, in the longer run Russia’s pension system will have to deal with the same set of fiscal problems associated with the ageing population as most developed and middle income countries.
Table 4.1: Basic Parameters of the Russian Pension System, 1995 - 1995 2000 2001 Number of pensioners (end year), million 37.08 38.41 38.63 38. o/w: old-age pensioners 29.01 28.81 28.99 29.Share of pensioners in population, % 25.1 26.5 26.8 26.Pension system load (ratio of pensioners and employed) 0.56 0.60 0.60 0.Average monthly pension, including compensations (1995 - 188.1 694.3 1,024.1 1,378.‘000 rubles; after 1998 – rubles) O/w: old-age pension 258.5 894.0 1,254.Minimum pension, rubles 89.6 427.8 474.1 522.4 (*) Replacement rate (ratio of average pension to average 40 31 32 monthly salary), % Ratio of average pension to the pensioner’s living 101 76 90 subsistence minimum, % Ratio of average pension to the minimum pension, % 210 162 216 Employed in the economy, million 66.44 64.33 64.70 65.Economically active, million 70.86 71.46 70.97 71.Economic activity rate, % 48.0 49.4 49.3 50.Average (reported) monthly salary (1995 - ‘000 rubles; after 472.4 2,223 3,240 4,1998 - rubles) Taxable payroll amount, estimated (billion rubles) 377 1,716 2,516 3, - taxable payroll amount, as % of GDP 24.5 23.5 28.1 31.Total payroll amount, incl. informal wages but excluding n.a. 2,304 3,141 n.a.
payroll taxes (billion rubles) - total payroll amount, as % of GDP n.a. 31.5 35.1 n.a.
Total collections by the Pension Fund, as % of taxable 19.6 22.1 19.7 18.payroll - collections as % of GDP 4.8 5.2 5.5 5.Pension expenditure by the Pension Fund, as % of GDP 4.4 5.2 5.Pension Fund balance, as % of GDP -0.03 1.24 0.19 -0.Memo: Total population (end year), million 147.60 144.80 144.00 143. GDP, billion rubles 1,541 7,306 8,944 10,(*) – Base component of the old age benefit.
Source: Roskomstat, Pension Fund.
4.15 The current pension system provides for a relatively high nominal replacement rate of about 32 percent66. However, the purchasing power of the average pension is low, because it merely exceeds the pensioner’s living subsistence minimum. According to the Pension Fund, due to a real growth in pensions in 2002-03, by August of 2003 the average pension reached 108 percent of the subsistence minimum67. This contradiction between the high replacement Here and everywhere in this Chapter the replacement rate is estimated (according to the established tradition) on the basis of the average gross wage. A more accurate way to estimate the replacement rate would be based on the net wages (wages after personal income tax). This would result in the replacement rate estimates that are percent higher.
Kakwani and Sajaia (2004) argue, however, that the current official subsistence minimum in Russia is inflated and in the case of pensioners exceeds by about 25 percent the true cost of the consumer basket that covers both minimum calorie requirements and basic non-food needs.
rate and low pension purchasing power is explained by a large proportion of informal wages in the economy that are not taken into account in calculations of the average reported salary size. Informal wages are not reflected in the conventional estimates of the current replacement rate that are significantly upwards biased and somewhat misleading (especially for those in higher income brackets).
4.16 Under the circumstances, in addition to the values of a nominal replacement rate, it is worth looking at the estimates of a real replacement rate (ratio of the average pension to average real salary, i.e., salary that includes both formal and informal nontaxable wages).
Based on the Roskomstat publications of national accounts, we estimated that the share of informal wages in 2001-02 amounted to about one-third68 of the total labor earnings and to about a half of the taxable payroll amount (Table 4.2). Respectively, the real average replacement rate was one-third lower than the nominal one and amounted to only 22 percent.
Table 4.2: Structure of the total payroll, as % of GDP 1997 1998 1999 2000 2001 Total payroll, as % of GDP 50.0 47.2 40.6 40.2 43. - payroll taxes 11.0 10.6 8.3 8.7 8.1 8. - all wages 39.0 36.5 32.2 31.5 35. o/w: taxable wages 27.3 26.4 21.2 20.4 23.9 24. hidden wages 11.7 10.1 11.0 11.1 11.Share of taxable wages in all wages, % 70.0 72.3 65.8 64.8 68.Other non-transfer incomes, as % of GDP 14.8 14.9 14.8 12.6 12.Source: Staff estimates based on Roskomstat’s publications on National Accounts.
4.17 The prevailing statutory contribution rate is 28 percent, which is high relative to most OECD countries but much lower than in the transition economies of Central Europe (IMF, 2002). The 2002 effective UST rate has been 18.7 percent of the reported (i.e., without informal wages) payroll amount, and it shows a steep decline relative to 22.1 percent in 2000.
This is owing to two primary factors: (i) the introduction of lower UST rates for higher wages in 200169; and (ii) the growing incidence of UST benefits for those employed by SMEs.
4.18 The high UST rates are usually considered among the primary reasons for a high incidence of informal wages in the economy. Indeed, World Bank experience indicates that mandated contributions in excess of 20 percent are likely to be quite detrimental for compliance in middle and high-income countries (Holtzmann, 2004, p. 34).
4.19 Since the introduction of the flat PIT rate of 13 percent in Russia in 2001, there has been a striking difference in trends between UST and PIT tax bases. Nominal growth in the PIT tax base was twice as high in 2000-03 than the one for UST – 106 versus 59 percent (Figure 1). The response to a cut in average income tax rate was quite strong, and a noticeable share of personal incomes was legalized, especially in 2002-03. While the marginal UST rates were also reduced in 2001, this cut was much smaller and apparently had a weaker incentive effect. As a result, the growth in the PIT tax base occurred primarily due to the legalization of It is worth noting, however, that the share of informal wages declined somewhat since the middle of the 90s as a result of the post-1998 fiscal stabilization and phasing out non-cash settlements in the economy.
Since the beginning of 2001 the portions of the wages that exceed 100,000 Rbl a year (about $3,500) have been taxed at lower (steeply declining) rates. See also Annex 4.4.
non-wage incomes, especially among those in top income deciles for whom a substantial share of total income comes from non-wage sources (Sinelnikov et al., 2003). This observation provides indirect support in favor of further cutting the existing UST rates, and may give additional backing for an assumption that future cuts in UST rates could be accompanied by some expansion in the tax base.
4.20 One of the problems with the existing UST regime relates to its fragmentation, with a considerable proportion of the labor force being eligible for significantly reduced UST rates.
As can be observed from Table 4.3, in 2003 the share of such employees amounted to at least 16 percent of the total number of UST taxpayers, and on average they paid three times less in their pension contributions than the “regular” employees. The actual number of beneficiaries of the special UST regimes is even higher, in particular because the data in Table 4.3 do not cover those who are eligible for a single agricultural tax. The Pension Fund staff estimates that the overall share of those who benefit from preferential UST rates amounts to 19 percent.
The main beneficiaries of these tax privileges are farmers and employees in small firms, who are eligible for a 50 percent reduced UST rate (Box 4.1). These employment groups do not make any contribution to their base pension, and therefore they are implicitly cross-subsidized by regular UST payers.
Figure 4.1: Trends in tax bases for unified social and personal incomes taxes, 2000-03, trillion rubles SST and PIT tax bases, trln rbl SST PIT 2000 2001 2002 Box 4.1: Preferential UST regimes for employees of small business According to the Russian Tax Code (Article 18), there are three specific tax regimes that de facto provide considerable tax benefits for specific employment categories:
• Simplified taxation for SMEs • Single tax on imputed incomes for businesses engaged in specific types of economic activities • Single agricultural tax for agricultural producers In all these cases, the eligible businesses benefit from the overall lower taxation rate and simplified taxation structure, under which several major taxes are replaced by a single tax on revenues or imputed incomes. As a part of this benefit package, SMEs are eligible for lower UST rates, which include: (i) a 50 percent discount on UST tax on employee earnings (full exemption for contributions to the base pension benefit); and (ii) a very low fixed payment of 150 ruble a month for employers and self-employed. In addition, agricultural producers benefit from further reduced UST rates (10.3 percent versus 14 percent for other SMEs and 28 percent for the rest of the enterprise sector).
Source: Bolshakova (2004).
4.21 Another peculiar feature of the pension system relates to the currently effective indexation rules for both the base and NDC parts of the pension benefit. Currently, the indexation rules are broadly linked to the actual inflation rate, but the rules are insufficiently formal and provide the government with considerable discretion powers with respect to both timing and scale of indexation. In addition, the pension legislation (Federal Law No. 173, Article 17) envisions complementary indexation of NDC components in cases when growth in wages exceeds the size of basic pension indexation. However, the scale of such additional indexation can not exceed the growth rate of actual Pension Fund revenues per one current beneficiary70. This de facto makes the NDC component partially based on wage growth indexation, adjusted for real growth in collection rate and growth in a number of beneficiaries.
4.22 As of January 1, 2002, when the Russia’s pension reform was launched, the size of the monthly base pension was 450 rubles, the minimum pension – 600 rubles, and the overall average labor pension amounted to 1241 rubles. Subsequent indexation to compensate for the inflation so far has been broadly in line with the provisions of the law. Moreover, indexation in both 2002 and 2003 of the average pension exceeded the inflation rate. The latest indexation took place in April 2004. According to the Pension Fund, at that time the base pension reached 621 rubles, the minimum pension reached 944 rubles, and the average pension - 1892 rubles per month.
Table 4.3: Main preferential regimes for social insurance contributions, 9 months of Number of contributors Number of Average monthly to the Pension Fund firms contribution, ruble 1. Reduced UST tax for particular employment groups -- agriculture 4,052,947 154. -- individual entrepreneurs 2,030,569 141.2. Simplified tax regime for small business (*) -- firms 1,088,541 120,949 347. -- individual entrepreneurs 475,706 317,137 109.3. Presumptive tax on small business (*) -- firms 1,485,162 165,018 174. -- individual entrepreneurs 2,373,903 1,582,602 89.Total for taxpayers under the preferential schemes (**) 11,506,828 158. -- share in the total number of UST taxpayers 16.3% -- average ratio between a preferential and regular contribution 32.3% Memo: regular UST taxation 59,270,991 489.(*) – Number of employees is estimated based on the average size of respective businesses.
(**) – Total does not include the number of taxpayers that pay single agricultural tax, for which no data are available.
Source: Estimates by the IET based on the data from the Taxation Ministry.
The inflation-based indexation rules provide for the real values of pensions for current pensioners to be maintained at their end-2001 levels. However, historically this was a period with rather low real pensions. The real value of average old age pensions in Russia declined dramatically as a result of the 1998 crisis, and at the end of 2001 it still was below the 1997 level (Smirnov and Isaev, 2003, p.19).
4.23 The earlier World Bank Report (2003) “Pension Reform in Russia: Structure and Implementation” undertook a comprehensive review of the Russian pension reform strategy.
The report identified major risks that the strategy has been facing and which relate to the following issues: (i) fiscal sustainability, (ii) deficiency in the system’s design that may weaken workers’ incentives to contribute to the system and work longer, (iii) weakness of the financial sector that may constrain the development of the funded pillar, and (iv) limited implementation capacity in the government.
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