Russia's economy is creaking — and the Kremlin wants Russians to pay more for the war

Russia's finance ministry plans significant tax hikes, including raising VAT from 20% to 22% and lowering the VAT threshold for small businesses, to fund military spending and manage a projected 1.6% GDP budget deficit in 2026. This fiscal strategy aims to avoid increased borrowing and curb inflation, despite a nominal decrease in defense spending, as overall security expenditures rise and economic growth is forecast to slow sharply to 1.3% in 2026. Analysts view these measures as effectively shifting the cost of the war to the Russian public and businesses, indicating a constrained economic outlook and potential long-term stagnation for the civilian economy.

Analysis

Russia is preparing for a period of fiscal tightening and economic stagnation to sustain its war effort, as detailed in the 2026 draft budget. The finance ministry plans to increase the value-added tax (VAT) from 20% to 22% and drastically lower the VAT payment threshold for small businesses from 60 million to 10 million rubles, effectively shifting the war's financial burden onto consumers and the private sector. This strategy is designed to finance security spending and manage a projected budget deficit of 1.6% of GDP without increasing public debt, which the finance minister argues would fuel inflation. These tax hikes are set against a sharply deteriorating economic forecast, with projected GDP growth slowing to just 1.3% in 2026, a significant downgrade from the 4.1% expansion in 2024 and previous forecasts. While nominal "national defense" spending is set for a slight decrease to 13 trillion rubles, this is offset by a 13% increase in spending on "national security and law enforcement" to 3.91 trillion rubles, indicating a re-prioritization of security expenditures rather than a de-escalation. The policy mix of fiscal austerity, high inflation (8.1% as of August), and a restrictive central bank policy rate (17%) points towards a deliberate suppression of the civilian economy to support the state's military and security objectives.

Key Decisions for Investors

• Investors should view the proposed tax hikes and downgraded growth forecast of 1.3% as strong confirmation of a stagflationary outlook for Russia, warranting an underweight or deeply cautious stance on any assets exposed to the domestic consumer and non-military industrial sectors.
• The budget's pivot from direct defense spending to a 13% increase in 'national security and law enforcement' highlights that state-supported growth is exclusively concentrated in sectors tied to the war and internal security, reinforcing the negative outlook for the broader civilian economy.
• Monitor for signs of social or political stress as the increased tax burden is passed directly to the Russian populace and small businesses, which represents a significant tail risk in an already constrained economic environment.
• The conflicting pressures of high inflation (8.1%), high interest rates (17%), and new austerity measures create significant uncertainty for monetary policy, and investors should not expect a near-term easing cycle despite the finance ministry's rationale.