Russia's Virtual Economy Part 2 - U.S.-Russian Business

The nonmonetary means of payment that characterized the virtual economy spanned a wide range. They included direct exchanges of goods (true barter), either bilaterally or through “chains” with multiple participants, offsets (where debts accrued by one party were later paid off not in money but in goods), and promissory notes called veksels. Veksels — the name for which is derived from the German Wechsel — were a widespread non-monetary payment mechanism that ranged from being a substitute for money to essentially a form of barter.

There were several key nodes in the barter chains, above all the major natural monopolies known popularly as the “Three Fat Boys” (tri tolstyaka) — Gazprom (the natural gas monopoly), RAO UES (the electricity monopoly), and MPS (the state railways). All three frequently complained that they collected as little as 10 percent of their revenues in cash. Almost all enterprises in Russia were consumers of the output of these three companies: rail freight transport, gas, and electricity. The three monopolies also accounted for about 25 percent of taxes due to the federal budget. The fact that everyone needed to purchase services from the “fat boys” meant that there was a ready demand for the veksels (IOU’s) of these companies. It was this special position that put them at the core of the non-payments system in Russia.

The other key player in the barter economy was the government, or rather, governments at all levels. Here again was an agent to whom nearly everyone had an obligation. The volume of accrued unpaid taxes, plus the huge fines and penalties levied for nonpayment, presented governments with an almost inexhaustible supply of debts. And, in turn, governments themselves owed many others. They were, like the natural monopolies, a key node for barter.


	Enterprises frequently colluded with regional and local officials to hide income and hence keep revenues away from the federal government for taxes whose revenues were split between local and national authorities.

One particularly important phenomenon was tax offsets. An enterprise owed taxes to the government, and concluded an agreement whereby those tax obligations were settled by delivering goods or performing services for the government. Of all the forms of nonmonetary transactions observed in Russia in the 1990s, the mechanism of tax offsets was the most characteristic of the virtual economy. Russian governments at all levels grew increasingly willing to offset enterprises’ tax obligations against goods or services delivered to the government. By the end of 1997, the accumulated tax debt was enormous. Industrial enterprises were particularly egregious delinquents. The sum owed by the enterprises at the end of 1997 was equal to 46 percent of the amount they actually remitted in taxes for all of 1997. These enormous debts gave impetus to the practice of tax offsets.

Consider, for example, an enterprise that was able to supply the local government with services in lieu of taxes. The enterprise could have paid its tax liability in money, but that would have required selling its output for cash. Alternatively, the enterprise could negotiate with the government to supply some service as an offset for taxes. If the enterprise had resources that were not fully utilized, the latter alternative was likely to reduce the effective tax burden on the enterprise. Moreover, once the government showed itself to be willing to engage in tax offsets, the options open to enterprises expanded. Now the enterprise could potentially pay its taxes not only with its own products but also with products it received in barter deals from other enterprises. This greatly reduced the cost to the seller of accepting goods rather than cash.

The motivation for governments to join in the barter economy was simple. They reasoned that if they could not get cash, it was better to reach some sort of settlement than receive nothing at all. In some cases, especially at the local level, an enterprise could offer to deliver goods or services to the city or regional government in lieu of taxes. At the federal level, it was more common for the government to cancel tax arrears or taxes due by writing off the government’s own debt to the enterprise in question for state orders. Once the practice was established with respect to past arrears, there was an anticipatory factor: enterprises began to feel confident that they could henceforth ship off products to the government, knowing that later they would be allowed to offset their taxes in an equivalent amount. Less than 60 percent of all federal taxes collected in 1997 were paid in cash; the rest were in the form of offsets.

The federal government was particularly victimized by these schemes. Enterprises frequently colluded with regional and local officials to hide income and hence keep revenues away from the federal government for taxes whose revenues were split between local and national authorities. In other cases, local governments demanded that enterprises pay their taxes in the form of goods and services that could only be used locally and not be shared with the federal government (for instance, by providing road construction or repairs of buildings). Often, if the federal government received anything at all in these schemes, it was only what the regional governments did not want.

In one notorious case reported in the Russian press in the spring of 1998, the oblast (province) government of Samara had permitted enterprises to pay their regional taxes in the form of goods. One of the items offered turned out to be ten tons of toxic chemicals from a local chemical plant. Although the plant claimed (and was given) credit for 400 million rubles [$80,000] in taxes, auditors later determined that the chemicals were worthless (and indeed dangerous). The Samara government never suffered from this curious deal, however, since it had previously sought and received permission from the federal ministry of labor to fulfill its obligations to the federal unemployment compensation fund by delivering goods instead of money. Among the goods it offered were ... the ten tons of toxic chemicals. (Gaddy and Ickes, 2002, p. 176)

As a result of these practices, the Russian budget ran massive deficits. Even using the inflated prices used in the offset deals, federal revenues plummeted — from 16.2 percent of GDP in 1995 to 12.4 percent in 1998. To finance its deficits, the government had resorted to extensive borrowing outside and inside Russia at increasing and unsustainably high costs, thus digging itself even deeper in debt. Finally, on August 17, 1998, the government defaulted on about $40 billion worth of its own ruble-denominated debt instruments (so-called GKOs), some $17 billion of which were held by foreigners.