”Dear citizens of Russia!” declared President Vladimir Putin in his first address to the Federal Assembly on July 8, 2000. It was Russia’s equivalent of the State of the Union, a chance to set priorities and explain his goals to Russians, who knew little about him. Putin began his address not with grand claims or promises of prosperity, but with tax policy. From income tax rates to deductions, from the total tax burden to its effect on the shadow economy. It was a technocratic start to a speech that, many expected, would be used to set out broader goals.
Putin could see no greater priority. The tax issue, he explained, was the country’s most pressing problem. The introduction of tax reforms, he promised, “will become a reference point of a new era in building the state, and in the rules of behavior in the economy.” The entire state and social structure depended on a new set of economic rules, which would bring in more revenue and stabilize the country’s budget. “We must ensure that all of us—entrepreneurs, authorities, citizens—strongly feel our responsibility to the country, so that strict fulfillment of the law becomes the deliberate choice of all citizens of Russia. Policies built on open and honest relations of the state with society will protect us from repeating past mistakes. They are the basic conditions of a new social contract.” The key to economic stabilization, he asserted, was a stronger, functioning, capable government. Putin promised that stronger government finances would boost the economy. The word Putin used most frequently in his address, however, was not economy but state.1
American political scientist Mancur Olson famously argued that government by bandits is tolerable only if the bandits stay in one place. Roving bandits simply seek to pillage, Olson explained. After seizing resources from one town, they pillage the town down the road. Stationary bandits, however, face different incentives. Thuggish though they may be, such bandits can even act responsibly, enacting policies that foster economic growth. The reason, Olson explained, is that rather than killing chickens, stationary bandits prefer to take eggs. A smart stationary bandit will encourage economic growth, to pillage (tax) even more in the future. In the end, Olson believed, the policies adopted by a stationary bandit could improve the lives of bandit and populace alike.2
After the corruption and violence of the 1990s, few Russians at the turn of the millennium would have objected to describing their political leaders as bandits. More often they used cruder language. Olson’s notion—that rule by a single strong power was better than diffuse local mafias—made sense to many Russians. The idea that Russia needed a stronger central government was embraced by both market liberals and statist conservatives alike.
Market liberals saw a stronger state, which would effectively collect taxes, enforce the rule of law, and defend property rights, as crucial to economic growth. Statist conservatives appreciated the focus on law and order. Russia’s new president understood the logic. The link between rebuilding state authority and economic growth was a central plank in Vladimir Putin’s political campaigns. It let Putin assemble a new coalition between business and security elites that continues to undergird his power today. Russia’s oligarchs and its business class backed Putin’s efforts to strengthen state authority because they believed this would facilitate economic growth. Conservative, law-and-order nationalists cheered the restoration of centralized power and found Putin’s orderly capitalism far more appealing than the chaotic capitalism of the Yeltsin era. Influential Russian economists argued that “macroeconomic stabilization hinges on a strengthening of political institutions.”3
Reforging Russia’s state and rebuilding its economy were two sides of the same coin, many believed. In many countries, business leaders want less government intrusion. After the chaotic 1990s, Russia’s business classes generally believed that the key to stability was a stronger state. This provided the basis for a sturdy coalition between business and security services, whom Putin satisfied both by strengthening the government and providing stable macroeconomic management.
The first step toward rebuilding the government’s authority, Putin concluded, was to strengthen Moscow’s power over the provinces. After moving to Moscow, Vladimir Putin had initially served as first deputy to the chief of staff of Yeltsin’s presidential administration. He was put in charge of supervising contacts with the governors of Russia’s far-flung regions, a job he says was the most interesting work he ever had.4 Managing relations between Moscow and the regions was key to resolving many of Russia’s problems: the Kremlin clashed repeatedly with regional elites. After the Soviet Union collapsed, Russia became a federation, with each province granted its own elected leader and tax system. Yeltsin famously told regional elites in 1990 to “take as much sovereignty as you can swallow.” They happily obliged. The collapse of central authority during the final months of the Soviet Union gave regional powerbrokers a chance to seize power. The Kremlin decided there was little point in trying to control everything in the provinces given how little authority the government exercised even in Moscow. The provinces got a free ride for most of the 1990s, with little central supervision.
But however many thousands of miles separated Russia’s far-flung settlements from the Kremlin, many Russians wished that their new tsar—President Yeltsin—would do more to establish order. The reality was that decentralization caused as many problems as it solved. Russia was not the only territory to declare its sovereignty as the Soviet Union dissolved. So too did Tatarstan, Karelia, and other provinces within Russia that had large non-Russian ethnic groups.5 In Chechnya, the province in Russia’s southern Caucasus border region, disputes about sovereignty led local leaders to declare independence, launching a brutal civil war that still smolders today. By contrast, Yeltsin resolved conflicts with oil-rich Tatarstan and other provinces peacefully, preventing them from leaving the Russian Federation. The cost, however, was formal recognition of these provinces’ special rights, and the surrender of further power to local elites.
Well-devised federalism is no bad thing, as residents of Canada, Germany, the United States, or any other federal state can attest. Yet newly independent Russia suffered the downsides of federalism with few of the benefits. In many countries, federalism is justified by the notion that smaller units of government are more responsive to their peoples’ interests and more accommodating of local differences. On certain issues, such as Tatarstan’s support of the Tatar language, this may have happened in Russia during the 1990s. On balance, however, Russian-style federalism made the country worse off. Regional governments were no more effective than the Kremlin, but they used their power to obstruct the central authorities.
Russian federalism’s most serious fault during the 1990s was that it obstructed tax collection at a time when the central government was desperately short of cash. During the 1990s, the revenue from Russia’s taxes was shared between central and regional governments. The Kremlin’s inability to enforce rules meant that regions regularly confiscated revenue that was owed to the center. Regional authorities helped businesses hide from tax collectors. Firms benefited from a lower net tax bill, while regional leaders acquired political capital. The federal government, which was struggling with massive budget deficit, lost out.6
Vladimir Putin was not the only Russian to conclude that the government needed to strengthen central authority, but he had a clearer plan than most Russians of how the problem should be fixed. In his work as Yeltsin’s aide responsible for relations with the regions, Putin recounted, he “developed relationships with many of the governors.” It was clear, he came to realize, “that work with the regional leaders was one of the most important lines of work in the country.” His diagnosis of the problem was straightforward as his solution. “The vertikal, the vertical chain of government had been destroyed,” Putin concluded. “It had to be restored.”7
In an interview in 2000, Putin suggested that restoring a vertical power—a hierarchical system in which each level of government followed instructions from the level above it—would be a straightforward task. “After all,” Putin explained, “the governors are part of the country, and they also suffer from management weakness,” so they would benefit from more efficient government. “You can’t please everybody, but you can find common approaches,” Putin insisted. He was right that the country’s broken system of dividing power made both center and regions worse off. But Putin’s vision of fixing Russia’s broken federalist system by replacing it with a vertical hierarchy not only contradicted Russia’s constitution but also challenged the authority of the regional elites whose clout undergirded Russia’s federal system.
To rebuild central authority—to enforce tax laws, create a regulated market, and provide the sort of public goods that are a precondition of economic growth—Putin spent his early years in power appointing new officials to key positions. He chose people he could trust, either because he knew them personally or because their backgrounds were like his. As it happened, Putin’s own background made him well-suited for reestablishing a “vertical of power” in Russia. His former employer—the KGB—was the institution that had enforced order during the Soviet period. Most of the KGB’s alumni were keen to see such order restored.
Putin began by creating seven new federal districts, which were tasked with mediating between the regions and the Kremlin. Of the seven officials initially appointed to head these new federal districts, two were former KGB officers, two were army generals, and one was a police general. Only two of the seven were civilians, and one of these civilians was alleged to have KGB ties.8 This was the first step in a vast expansion of the role played by security officials in Russian politics. Each of the seven heads of the federal districts was also appointed to Russia’s Security Council. The territory of the new federal districts corresponded precisely with the territorial division of the Interior Ministry’s troops. Several other security agencies soon created their own divisions based on the federal districts.9 Many governors concluded that the new federal districts were less about coordinating policy and more about enforcing the Kremlin’s writ. They sensibly kept their heads down in response.
The federal districts were the first of many changes that strengthened the Kremlin’s authority by expanding the remit of the security services. Chief federal inspectors in each region, for example, were drawn from the ranks of the siloviki—former employees of the KGB or army who had transitioned into politics.10 Putin also solidified his personal control over the security services, firing the ministers of defense and interior, both holdovers from the Yeltsin era, and nominating Sergei Ivanov and Boris Gryzlov in their places. Meanwhile, Mikhail Fradkov was put in charge of the tax police. Both Ivanov and Fradkov are believed to have a background in the KGB, while Gryzlov was a St. Petersburg politician and a former classmate of FSB director Nikolai Patrushev.11
Putin’s strategic appointments—and his willingness to tap long-standing KGB networks to buttress his formal authority with informal networks—facilitated the consolidation of power. He continued to trim gubernatorial authority, refashioning the balance of power in favor of the Kremlin. In 2001, the rules governing the appointment and dismissal of judges were rewritten, strengthening the Kremlin’s ability to interfere in court decisions while decreasing local elites’ influence on the judiciary.12 Putin also gained new powers that let him remove governors and dissolve regional legislatures.13
These changes drove a remarkable reversal of fortune in Russian politics. Regional elites, who had been the greatest beneficiaries of the fragmentation of the 1990s, struggled to respond to Putin’s aggressive recentralization of power. Gubernatorial elections were replaced by presidential appointment. The new federal districts chipped away at gubernatorial authority by shifting power to officials dependent on the Kremlin.14 The shake-up of the security forces and the appointment of Putin allies to leading positions broke the bonds between regional elites and the police, prosecutors, and the Interior Ministry—bonds that, under Yeltsin, had undermined the central government’s monopoly on violence and diluted presidential authority.15 Now, the security forces answered solely to the Kremlin. And at the top of the new vertical power sat Vladimir Putin.
Even as Putin centralized power by appointing KGB allies to key posts, he also sought to make the government more effective. Here, too, Putin’s goals appealed both to law-and-order conservatives, who feared that the government was incompetent, and to business-oriented economic liberals, who wanted to cut red tape. German Gref, who, like Putin, had served in the St. Petersburg city government before moving to Moscow in 1998, was tasked with devising a strategy to make the Russian state work better. Gref assembled many of Russia’s leading economists and public policy experts to provide advice to the new government. The goal, Gref declared, was to boost GDP growth to 8 percent per year.16
Gref’s recommendations, which were presented in a major report, touched nearly every aspect of Russian life, from education to employment, infrastructure to industry. The report’s broad conclusion—driven by the liberal-minded economists who served as Gref’s expert advisers—was that Russia’s government should do less but do it more effectively. In the social sphere, for example, Gref’s team recommended moving away from universal government-provided benefits. Instead, they argued that the government should target financial assistance at the poorest Russians, while fostering a system of retirement savings accounts and health insurance to provide for the middle class. Monopolies should be subject to competition. The government’s main task in the industrial sphere was to provide a stable investment climate by securing property rights and establishing an effective judicial system. Subsidies to industry should be phased out, the report argued, to reduce the budget deficit and inflation.
Gref’s proposals were as controversial as they were ambitious. They amounted to a full restructuring of the Russian government, as many commentators realized.17 Gref supported many of the least popular policies from the Yeltsin era, including cutting social programs, ending industrial subsidies, and withdrawing the state from economic life. Gref promised that his proposals would increase efficiency. But many people benefited from programs that Gref thought were holding the country back.
Regional elites were particularly opposed. Yegor Stroyev, the chairman of the Federation Council, the upper house of Russia’s parliament, attacked Gref’s plan at the annual St. Petersburg Economic Forum in June 2000. Stroyev argued that Gref’s proposals lacked mechanisms to “stimulate domestic production, without which serious economic growth is impossible.” Stroyev emphasized that “the government needs to understand: if regions don’t work in this direction, there won’t be any economic development.”18 Stroyev’s criticism was echoed by many other regional leaders. Kursk Oblast governor Aleksandr Rutskoi growled that Gref’s program is “rubbish that cannot be implemented.”19 Journalist Mikhail Delyagin, meanwhile, argued that the plan’s “main instrument of transformation is social default” through cuts to welfare programs.20 Delyagin suggested that Putin “is increasingly reminiscent of Gorbachev” in his inability to cope with the contradictory forces that buffeted the Kremlin.
To counter Gref’s plan, a committee of regional leaders and economists was assembled under the leadership of Viktor Ishaev. The economic advisers who worked with Ishaev were sharp critics of the Gref proposals. Abel Aganbegyan and Leonid Abalkin had been prominent economists in the USSR and had advised Soviet leaders such as Mikhail Gorbachev. None believed that Gref’s recommendations would benefit Russia.
Abalkin, for example, alleged in a leading newspaper that the Gref report contained false claims and dubious calculations. More important, Abalkin argued, it misunderstood the mechanism by which Russia’s economy could return to growth. The eminent academic slammed Gref’s “questionable conclusion that in the long run only private investment could drive production.”21 The government also needed to invest, he argued, echoing a common criticism of Yeltsin-era investment cuts. Indeed, almost all Ishaev’s colleagues had been critics of Yeltsin during the 1990s. As Ishaev explained in an interview, Russia during the 1990s, “implemented the IMF’s strategy, but it was not beneficial for us.”22
The general trend under Yeltsin—encouraged by the IMF but driven primarily by Russian economists and political leaders—was to shift away from the Soviet style of managing the economy by government decree and toward a system in which the government focused on a small number of macroeconomic indicators such as inflation and GDP growth, while leaving most other decisions to private actors. Ishaev rejected that approach. “The regulation of the economy on the level of macro-indicators has no effect,” he argued. “The most effective is micro-regulation on the level of the regions, regional politics.” Ishaev and his coauthors advised that government play a more active role in allocating and funding investment. This had been a constant debate throughout the 1990s, as economic liberals sought to unwind the Soviet-era connections between industries and the central bank, while their opponents argued that ending the flow of cheap credit to Russian firms would cause mass bankruptcies and unemployment. Under Yeltsin, the government had steadily reduced financing for industrial investment. But the adjustment happened slowly, over the course of a decade, giving businesses time to adjust.
Putin’s arrival to power, however, offered an opportunity to reverse this trend by reinstating the government’s role in subsidizing and directing investment. Ishaev argued that the government should embrace its role as a guiding hand for the industry, without which, he believed, Russia was unlikely to achieve the economic growth needed to alleviate social challenges. “We need to set strict requirements for economic growth rates. The tempo should be no lower than 5–6 percent per year,” Ishaev advised—a bold change for an economy that had shrunk for much of the previous decade. The only way to guarantee such growth rates, Ishaev posited, was through an “investment breakthrough” that saw investment levels increase on average by 8–9 percent per year over the subsequent decade. This was possible, Ishaev argued, only by expanding government investment.23
How could he be sure that government-backed investments would make money and not be siphoned off into Cypriot bank accounts? Ishaev downplayed the threat of corruption, arguing that Russia had sectors that could become competitive exporters, such as agriculture and electricity. There were many reasons why an increase in capital investment would unlock broad-based economic growth, Ishaev argued. Existing built capital—infrastructure and buildings—were being underutilized, he believed, due to the economic crash of the 1990s. A burst of investment could put these resources back to productive use—”a practically free source of economic growth.” Second, the crisis of the 1990s made production within Russia relatively inexpensive compared with other centers of global manufacturing, giving Russia a cost advantage, at least when compared to Western Europe or the United States.
On top of funding investment, Ishaev believed the state should manage firms. “The government has to be an effective owner in certain industries,” he argued. Privatization is not necessarily better than state control. “Russian economics research of the past century has shown that a change of ownership does not adequately improve production efficiency. . . . The government has management, the defense industry, part of the credit system, licensing, and finally, the law enforcement system. . . . In short, there are plenty of levers for managing the economy.”24 Perhaps most important, Ishaev’s report suggested, was to use the central bank’s monetary reserves to make direct loans to businesses, a policy that offered theoretically endless funds but risked reigniting inflation.25
Ishaev’s proposals seemed perfectly pitched for a young president seeking to bolster his government’s authority, and for a society that believed that Yeltsin-era capitalism had failed ordinary Russians. The government, Ishaev argued, should seek to “strengthen and expand the middle class,” as the country’s “deeply divided society remains a key impediment to the strengthening of Russian statehood.” And Ishaev’s recommended methods corresponded with those that many Russians—including many in the Duma—supported. “One of the illusions of the 1990s,” Ishaev argued, “is the belief that liberalization and privatization are themselves sufficient prerequisites for the development of a market economy.” The reality was the opposite. The key task, Ishaev believed, was “to form a strong and effective state.”26
U.S. president Franklin Delano Roosevelt was once given two contradictory proposals, one to raise tariffs on imports, the other to lower them. “Weave the two together,” Roosevelt asked, leaving his aides stupefied.27 But daft policy can be deft politics. Roosevelt sought to chart a middle path, keeping even his aides guessing about his intentions. Putin took a similar approach with the Ishaev and Gref plans. Presented with two opposing viewpoints about how Russia’s government and economy should be organized, the president asked his aides to weave them together.
There were significant overlaps between the Gref and Ishaev proposals—and between the political groups that they represented. This made “weaving together” a not completely unrealistic goal.28 Despite the political conflict of the 1990s, Russia’s governing class agreed on several key principles. The possession of private property by individuals and businesses was legitimate. The accumulation of vast fortunes was acceptable in theory, so long as the fortunes were acquired at least somewhat legally. Markets must be competitive in order to be fair and effective. The government had an obligation to provide pensions and health care, but it would do so only at a very low level and would not welcome labor unions’ participation in the political process. These basic principles were accepted across the Russian political spectrum in the early 2000s, from the Union of Right Forces party to the ostensibly left-wing Communists.
Political disagreement focused on several questions. What should be done with fortunes that were not acquired legally or were built up in legal grey zones? How should government address monopolies, particular in instances in which market competition was not feasible? The most important dispute, though, was how the government should bolster economic growth. Should it invest directly in Russian firms? Could the central bank directly fund investment? Are budget deficits justified when caused by investment spending? Putin might have asked that his aides find the best of all approaches—but on some issues decisions had to be made.
Indeed, from the very beginning of the process of weaving together the Gref and Ishaev plans, there was a twist. The person charged with combining the two proposals was German Gref. In the spring of 2001, the “Strategy for the Development of Russia through 2010” was formally adopted by the government. In theory it was a mix of the Gref and Ishaev plans. In reality, one of Gref’s aides told a newspaper, only 10 percent of Gref’s initial proposals were adjusted to take into account Ishaev’s criticisms. A section was added on science, and proposals for the government’s role in regional politics was reworked.29 But most of Ishaev’s main differences with Gref—above all, his demand for more direct government financing of industry—was ignored. Government staffers referred to Ishaev’s plan as a backward “state-Soviet” proposal and joked that when asked to combine the two proposals, all they did was add a meaningless line taken from Ishaev’s introduction: “The most important function of the supreme power of the country is strategic goal setting.”30 Whatever that means.
The debate over the government’s economic strategy took over a year. It was ostensibly marked by ups and downs as different perspectives and political groups vied for the president’s ear. At times, it looked as if Gref’s liberal vision might lose out. At one point, the Gref plan’s fate looked so dim that Kommersant, a leading business newspaper, ran an article titled “The Life and Death of the Gref Plan.”31 But in retrospect, the entire debate seems to have been determined from the start. “In economics,” wrote Yevgeny Yasin, a leading economist and liberal intellectual, “President Putin has been a stealthy reformer yearning for consensus.”32
But even if the government formally adopted a policy of liberal reforms, did this affect bureaucratic practice? Many Russian journalists were skeptical. Many people “still haven’t realized that approval of the Gref Program does not mean readiness to implement it,” wrote one columnist, who saw the program’s approval not as evidence of real intent to reshape government but rather as a “wave from deep-water clashes of several elite clans.”33 Economic policy in the early 2000s may well have been shaped by elite groups—what political question is not?—but many of the policies had real effects. On the tenth anniversary of the report’s release, one of Gref’s former top aides issued a report card that found that about one-third of Gref’s initial recommendations had been implemented.34 In several spheres, especially during the early 2000s, the government rapidly adopted many of Gref’s key recommendations, above all in the sphere of regulation and tax.
Few in Moscow doubted that the Russian bureaucracy imposed too many rules and enforced them too capriciously. Many branches of the government, from health inspectors to traffic police, seemed to exist primarily to collect bribes. In a 1999 survey, for example, 70 percent of Russian firms said it was a rarely possible to appeal a regulatory decision without a bribe.35 Inspectors visited businesses less to examine their operations than to threaten and collect payments in exchange for leaving the targeted firm alone. Industrial inspections varied drastically by region, with an average of 6.5 inspections per month in Krasnoyarsk but only 1.1 per month in Tver. There was no evidence that Krasnoyarsk factories were safer than Tver’s. The difference between the two provinces had less to do with factories than with inspectors, who were apparently more venal in Krasnoyarsk.36
Rates of inspection varied between Russian provinces, but there was little doubt that the whole country suffered from an infestation of bribe-extorting officials. In 2000, a typical small company received dozens of inspector visits each year, many of which required a bribe after the official identified violations real or imaged.37 One study found six times as many inspections in Moscow than in Warsaw, Poland, a city with a comparable level of economic development and that, like Moscow, also previously had a centrally planned economy.38
To cut the burden that bribes and regulatory compliance placed on Russian firms, the Gref reforms sought to slash business regulation. Legislation passed in the early 2000s restricted the number of activities requiring a license, for example.39 Registering a business was made simpler, and the time required was reduced from a month to just five days.40 License requirements for certain professions were removed.41 Foreign exchange rules were liberalized.42 Certain product markets were deregulated.43 Laws governing land sales were loosened. The government began efforts to join the World Trade Organization (WTO), which would simplify trade procedures and lower tariffs.44 Putin was personally involved in some of these reforms.45 As political analyst Nikolai Petrov noted at the time, “President Putin is serious about civil service reform. . . . He is offering the Russian people more than philippics.”46 Yet Russia’s bureaucracy remained difficult and costly to navigate. Surveys conducted by the World Bank found that the investment climate improved during the early 2000s, but the rate of change was slow, and problems remained widespread.47
The most successful reform, in the eyes of many Russian leaders, was taxation. Collecting tax revenue had been an insoluble problem throughout the 1990s. The main problem was getting Russians to pay the taxes they owed. Tax collectors faced a nearly hopeless task. They were resisted violently at the regional level. In 1996, one study reported, “26 tax collectors were killed, 74 were injured in the course of their work, 6 were kidnapped, and 41 had their homes burnt down.”48 Only 8 percent of large businesses paid taxes in cash, while the rest paid in kind or not at all.49
Because of this, IMF estimates suggest, during the late 1990s government coffers received only half of the taxes due.50 The structure of the tax system did not help. The tax code was a jungle of different levies that individuals and businesses struggled to understand. Official tax rates were high, encouraging laborers and businesses to stay in the shadow economy and pay no tax at all. But even though headline rates were high, average tax rates were low, due to an array of credits and deductions. The result was a system that simultaneously raised little revenue while discouraging legal work and business activity.
Putin’s first government tackled taxes immediately. Corporate taxes, which on certain industries had been as high as 43 percent, were reduced to 24 percent, with no exceptions. Other inefficient taxes, like the Soviet-legacy turnover tax, were phased out entirely. A system that had previously relied on a total of fifty-two taxes now collected only fifteen types of tax. The change was most drastic at the local government level, where a patchwork of twenty-three taxes was replaced by two, on land and on personal property. Provinces were limited to collecting three taxes, on corporate property, transport, and gaming. The most significant change, however, was to personal income taxes. Prior to 2001, the top marginal tax rate was 30 percent, but the average effective tax rate was 13.5 percent. Many people avoided tax by receiving their salary in an envelope of cash at the end of every month. To push employment out of the shadow economy, the individual income tax system was replaced with a single flat tax of 13 percent—roughly the same average rate as before, but with less incentive to cheat.51
In terms of its stated aims of capturing revenue and cutting the cost of compliance, the new tax policy worked. Central government revenue increased by 3 percent of GDP between 1998 and 2002, a third of which came from personal income taxes.52 There was much, of course, that the tax reform did not do. The government made no attempt to raise the magnitude of revenues that would have been necessary to rebuild a welfare state, for example, or to hike investment in health and education. In 2000, Russia’s government spent only 2.9 percent of GDP on education, compared with the European Union average of 4.8 percent. Health spending was 5.4 percent of GDP, compared to 8.4 percent in the European Union. As Russia’s economy grew in the 2000s, public and private investment in health and education increased, but it remains below the European average. The tax hikes of Putin’s early years in office made no effort to raise the magnitude of revenue that would have been necessary to meet European average spending on health and education.
Indeed, in the medium term, the flat tax functioned as a cap on the government’s revenue-raising capabilities. Hiking the personal income tax rate has thus far proven politically impossible, because urban upper middle classes have become accustomed to relatively low taxes, and the government is wary of angering them. Yet as a solution to the problems of the 1990s, the tax reforms of the early 2000s worked reasonably well. The budget was balanced.53 The government sorted out its relations with 99 percent of taxpayers. But the oligarchs at the top also represented a lucrative source of revenue. Ordinary taxpayers might burn down the tax collector’s house. In their pursuit of lower tax rates, the oligarchs had far more powerful, and more damaging, cards to play.
On July 28, 2000, in the Kremlin’s ornate Ekaterininsky Hall, President Putin met with twenty-one leading Russian businessmen. Kremlin officials told some journalists that the meeting was intended to calm the country’s nervous oligarchs, who looked worriedly at the legal proceedings that threatened some of their peers with fines, jail time, or worse.54 One suspects that the businessmen—from banker Vladimir Potanin to oilman Mikhail Khodorkovsky to industrialist Kakha Bendukidze—did not leave feeling reassured. “No clan, no oligarch, should come close to regional or federal authorities,” Putin declared. “They should be kept equally far from politics.”55
The need for oligarchs to stay out of politics was a frequent theme of Putin’s. “I don’t really like the world ‘oligarch,’” he explained. “An oligarch is a person with stolen money, who continues to plunder the national wealth using his special access to bodies of power and administration. I am doing everything to make sure this situation never repeats in Russia.”56 The oligarchs, many of whom feared that their businesses would be “de-privatized”—that is, seized by the state—sought assurances from Putin that no such confiscation would occur. Potanin, whose nickel firm was being harassed by prosecutors, asked Putin about the security of his property. “Are you sure you will be able to prove your case in court?” asked Putin. When Potanin answered affirmatively, Putin said, “So prove it. What do you have to fear?”57
Other oligarchs faced pressure from Putin over their tax payments. After Lukoil head Vagit Alekperov told Putin that the existence of large vertically integrated companies strengthens the state, Putin attacked him for paying insufficient tax. Lukoil pumped more oil than any company in Russia, Putin said, but its tax payments per ton of oil were only the seventh highest. Sibneft president Evgeny Svidler also received a personal rebuke from the president. Both oligarchs meekly claimed that the data Putin cited were inaccurate. “The main goal of the meeting was to put the oligarchs in their place,” explained one presidential aide.58 Mission accomplished.
It was easy to see why the government wanted to pressure the oligarchs. New tax laws and better tax collectors would only make a difference if businesses paid taxes. Small and medium-sized firms had little choice. But Russia’s biggest enterprises, controlled by its class of unaccountable oligarchs, had a history of not paying taxes or of rewriting tax laws to suit their own purposes. Putin’s government set out to change that—and to send a message that oligarchs no less than average citizens were responsible for following the government’s orders. Just months after Putin took power, Vladimir Gusinsky, a banker-turned-media magnate, was arrested in a takedown widely presumed to be linked to Gusinsky’s NTV television channel, which had been critical of Putin. Gusinsky was later released on the condition that he sell the TV station and leave Russia. He has not returned.
Four months later, a second oligarch fell. Boris Berezovsky, whose businesses spanned automobiles to airlines, announced while traveling abroad that he would not return to Russia, fearing that the government would press charges against him, too. The exile of Gusinsky and Berezovsky was a devastating blow for Russian media, as the oligarchs had each invested heavily in newspapers and TV stations which, though far from independent (they usually parroted their owners’ opinions), at least provided a point of view different from the government’s. From a business perspective, however, the exile of Gusinsky and Berezovsky did not appear to be a turning point. Both oligarchs were extensively involved in politics, making many enemies and few friends. Berezovsky had a knack for insulting Russians by insisting that his self-interested lobbying was the only thing preventing Communists from returning to power.59 By 2000, most Russians—whether in the security services, the business elite, or the public at large—saw him as a problem rather than as a solution. Few were sad to see him go.
Both Berezovsky and Gusinsky had played fast and loose with the law, and when the government described their exile as part of an attempt to rebuild the rule of law, many Russians found that explanation compelling. The Russian public wanted to see the oligarchs cut down to size and their political influence reduced. That was a tall order—but the oligarchs as a class were indeed changing. Those who had acquired assets in the 1990s wanted to see those assets defended, so they tended to support efforts to reduce the power of mafias and criminal organizations—groups that use their power to seize others’ businesses.
The oligarchs’ business model was changing, too. In the early 1990s, most of the great fortunes were made in banking, by taking advantage of high inflation or otherwise stealing from the state. But the 1998 crash had driven many of the oligarchs’ banks out of business. Some owners lost their fortunes, while others survived only by abandoning finance and turning to other lines of business instead. The greatest change was the increasing importance of commodities to Russia’s leading businessmen, not only oil but also aluminum, nickel, and steel.60
The oligarchs’ shift toward physical assets, the government hoped, would make their businesses easier to tax. The government made no secret of its desire to collect more revenue from business. “The state has the right to expect entrepreneurs to observe the rules of the game,” Putin explained in July 1999. “The state announced that it would act more vigorously towards the environment in which business operates. I am referring first and foremost to the tax sphere and the restoration of order in the economy.”61 Levying heavier taxes on big business was a popular policy among most Russians. Though the oligarchs were understandably opposed, cracking down on oligarch-owned businesses also fit the preferences of Putin’s political coalition. Statists appreciated the focus on law and order and the boost to government revenues. Liberal officials in the Finance and the Economy Ministries saw potential benefits from more stable public finances and a reduction in oligarchs’ ability to rig markets. Many average Russians were happy to see the country’s billionaires brought down a notch.
Putin was not unsympathetic to the needs of business, but he saw higher tax revenue as key to restoring central authority and announced that he would brook no opposition to his campaign to raise revenue. “These people who fuse power and capital: there will be no oligarchs of this kind as a class,” Putin threatened, alluding to Stalin’s promise to eliminate kulaks—rich peasants—as a class. Stalin’s antikulak campaign caused many thousands of violent deaths. Putin wanted the oligarchs to understand: he was tough, too. “The state has a club, the kind that you only need to use once: over the head,” Putin explained. “We haven’t used the club yet. But when we get seriously angry, we will use this club without hesitation.”62 The oligarchs had been warned.