Paying up: The Kremlin is sacrificing regional development, business, healthcare, and education to fund the war in Ukraine

A new tax reform approved by the Russian parliament in mid-November is intended to squeeze enough money out of the economy to keep the war going. The change provides for an increase in the VAT rate and tighter conditions for small and medium-sized businesses. The updated regime will create serious problems for Russia's regions: with more money flowing to the capital, prices will rise, especially in remote areas. Businesses will shut down due to reduced benefits, and profitability and job numbers will plummet. Labor-intensive industries and retail will be the first to take the hit. Several regions have already drafted their 2026 budgets so as to include strict austerity and cuts to education and healthcare spending. Economists forecast a “gradual degradation of human capital.”

• 1.New conditions for survival
• 2.Caution: businesses are closing
• 3.Regional repercussions
• 4.Higher prices, harder life

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New conditions for survival

The Russian government’s tax initiatives are part of broader budget reforms proposed for 2026–2028. The new federal budget places the burden of military spending on the public and businesses — and the war will cost them dearly.

Starting Jan. 1, 2026, Russian authorities will introduce a package of tax changes. The key shift involves an increase in the value-added tax (VAT) rate from the current 20% up to 22%. This is the first major VAT raise in the past 20 years.

For entrepreneurs using the simplified taxation system, the income threshold for paying VAT will be significantly reduced — from the previous 60 million rubles down to 20 million rubles per year (from $780,000 to $260,000). Up until a year ago, users of the simplified taxation system could avoid paying VAT altogether. To ease market concerns, authorities claimed the new rule, which was presented as a measure intended to combat business splitting, would affect only 4% of small and medium-sized companies.

But now the authorities have decided to tax simplified-system businesses to the fullest. An income of 20 million rubles ($260,000) is not mid-tier — almost any active sole proprietor or small company could exceed that threshold in a single successful quarter or after securing a promising new client. Once they do, they automatically become VAT payers. Even a gradual reduction of the threshold will push tens of thousands of Russian companies out of the “tax-free zone.”

The authorities had promised that the tax increase would affect only 4% of small and mid-sized businesses, but now they have decided to squeeze small enterprises to the fullest

Including these businesses in the VAT chain will entail complex accounting, which means additional costs of hiring an accountant or purchasing specialized software. For most small companies, this will mean added expenses in the vicinity of 200,000–300,000 rubles ($2,600-$3,900) per year. This will affect hair salons, small auto repair shops, and consulting firms. Combined with the VAT rate increase, these expenses will drive up the cost of their goods and services.

The government is also set to abolish the reduced social insurance contribution rate for SMEs. Such an increase in the tax burden of small companies will wipe out profits that were previously earned within the range of 10–12% of revenue. This measure will hit labor-intensive industries first — retail, catering, and construction — where payroll makes up a significant portion of expenses.

The tax authorities are also gaining powers to tighten oversight. They will be authorized to increase fines, write off taxpayers’ debts from bank cards without a court order, and bring in inspectors from other regions to conduct major tax audits.

Deadlines for paying taxes have also been tightened. Under the new regulations, if a payment deadline falls on a weekend or public holiday, the obligation must be fulfilled in advance, requiring businesses to plan more precisely if they are to avoid facing penalties for noncompliance.

Deadlines for paying taxes have also been tightened, requiring businesses to plan more precisely — or face penalties for noncompliance

Additionally, in some regions, corporate property taxes and vehicle fees are set to increase, and the number of preferential taxpayer categories will be reduced, further adding to the burden on businesses and households.

The Ministry of Finance insists that, in the medium term, the economy will benefit from these measures: additional revenues will strengthen the budget and financial system, acting to lower inflation and to allow for a reduced central bank rate. However, economists disagree, warning that a large share of low-margin companies could move into the shadow economy, as the extra taxes would eat up essentially all profit in the trade, real estate, and private education sectors.

Caution: businesses are closing

“If I have to start paying VAT, costs will skyrocket,” entrepreneur Vyacheslav Kopylov complained on Business FM. Kopylov runs a small grocery store in Krasnodar, operating under a patent system. He expects that next year could be the last for his business. Meanwhile, the trade sector accounts for the largest share of the gross regional product (GRP) in Krasnodar Krai. Even nationwide, it ranks just behind Moscow, St. Petersburg, and the Moscow Region. In other words, Krasnodar Krai is set to suffer the most from the tax hit.

While it is commonly acknowledged that laws are only as strong as the state’s ability to enforce them, Russia's tax authorities have found a workaround for understaffed regions: VAT field audits in Moscow and St. Petersburg are now conducted by Federal Tax Service inspectors from other parts of the country.

VAT field audits in Moscow and St. Petersburg shall be conducted by tax inspectors from other regions

“Business owners tend to operate under old assumptions: if bribes could solve their problems a few years ago, they think it would work now. But it won't!” tax consultant Mikhail Zhukhovitsky explains. “Historically, businesses across the country hide within the large turnovers of the capital. In Moscow, you stay ‘under the radar’ with amounts tens of times higher than in the regions. The number of legal entities per tax inspector in Moscow is hundreds of times as high as in, say, Khanty-Mansiysk. In Moscow, if you have a VAT gap of 50 million over three years, no one will bat an eye. But in the regions, they’ll squeeze everything out of you, seize offices, and get local law enforcement involved. The audit will be conducted by inspectors from distant regions. How are you supposed to strike a deal with officials sitting in Buryatia? The procedures and results will be monitored in two regions: yours and Buryatia. Officials are cautious people. They won’t take any risks.”

Regional repercussions

Importantly, while VAT goes entirely to the federal budget, 100% of revenues from the simplified tax system go to the regional budget. Therefore, small businesses that survive the tax hike will be paying into the federal budget instead of contributing money for use closer to home. Regional budgets will lose revenue and, by rough estimates, face a combined deficit of around half a trillion rubles ($6.5 billion). Only the budgets of Moscow and St. Petersburg will remain in surplus.

Under the new rules, regional authorities will no longer be able to set reduced simplified taxation rates or grant tax benefits. The list of preferential sectors will now be approved on the federal level. This loss of autonomy in granting benefits will deprive regions of tools that were previously used to stimulate business, reducing their budgetary flexibility. For some regions, especially those with many beneficiaries, this could lead to financial instability. Additionally, without tax incentives, businesses may leave, further reducing regional budget revenues.

The consolidated budget features a deficit of 170 billion rubles ($2.2 billion) after nine months, and more than half of Russia's regions are facing budget shortfalls. As a result, following the announcement of the tax reform, regions have begun prematurely canceling tax benefits and adjusting their budgets for the next year.

The Yaroslavl Region governor ordered the land tax and personal property tax to be “raised to the maximum.” Authorities in the Ulyanovsk Region plan to reduce the number of preferential taxpayer categories. Tax increases are expected in Dagestan and the Voronezh Region. Krasnoyarsk Krai and Orenburg Region are raising vehicle taxes, with the rate on the domestic make Lada Granta set to surge by another 10%. Novosibirsk Region is also driving up vehicle taxes and the corporate property tax rate.

Authorities in Bashkortostan have already estimated their 2026 budget. Spending cuts will affect education (down 10.5%) and healthcare (down 15.9%). Radiy Khabirov, head of Bashkortostan, stated that 2026 will be the region’s worst-ever year financially. With such a budget, the degradation of both human capital (through underfunding of education and healthcare) and physical capital (due to insufficient funds for utilities and road maintenance) is inevitable, warns economist Vsevolod Spivak.

Bashkortostan has taken an axe to education and healthcare spending, at the risk of facing inevitable degradation of human capital

The Ministry of Finance of Nizhny Novgorod Region has also drafted the 2026 budget with strict austerity: it anticipates a 2.9% increase in simplified taxation system revenues, which, accounting for inflation, actually implies a decrease. Local businesses are projected to see profits drop by 25% in 2026. To make up for the slump in revenues, local authorities are targeting individuals in precarious employment and companies that reduce tax payments by hiring their staff as self-employed. The government has identified over 400,000 such cases and plans to bring them out of the shadows.

The construction sector, considered a multiplier for economic growth, deserves special attention. Construction activity is highest in Moscow, with the value of construction works completed in 2025 amounting to 1.9 trillion rubles ($24.7 billion). The runners-up are Tyumen Region (1.2 trillion rubles, or $15.6 billion) and Tatarstan (0.9 trillion rubles, or $11.7 billion). While Moscow has a safety net, Tyumen Region and Tatarstan are truly “middle-tier” regions, with much more limited reserves.

Higher prices, harder life

The tax increase will also lead to rising costs throughout the supply chain, with each participant adding their share of the tax and their markup to maintain profit. The manufacturer includes 22% in the ex-factory price, the wholesaler adds a markup on that amount and applies VAT again, and the retailer repeats the process.

As a result, a seemingly modest two-percentage-point increase in the VAT rate leads to a 10–15% surge in store prices. Consumers’ purchasing power declines, affecting not only people but also the stores themselves.

A two-percentage-point increase in the VAT rate leads to a 10–15% surge in store prices

The blow will be especially hard on regions with large populations and developed retail markets — Moscow, St. Petersburg, Krasnodar Krai, and Moscow Region. In these areas, a combination of intense competition and low margins could drive down turnover in multiple sectors, most notably in food retail and services (catering, beauty salons, dry cleaners). Any increase in the tax burden presents a critical threat to such businesses.

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