Putin Urged to Shine Light on ‘Shadow Economy’

Sergei Kardanovsky, who owns one of the biggest chains of dental clinics in Moscow, doesn’t question the law that says he has to have fire extinguishers in his clinics. He also doesn’t question the local fire official’s recommendation that he buy the $5 extinguishers at a nearby shop that sells them for $10.

In the old days, he said, graft was more straightforward: “You come to an official. He says, ‘OK, here’s the account number. Put some money in it and we’ll start talking about how to resolve your problem.’ ”

“It was insolent extortion,” he said of the bureaucrats’ greed. “Now, they know their business quite perfectly, and it’s called ‘friendship.’ It ranges from buying a car as a gift to paying for a trip to the Canary Islands. And it’s worth it.”

As Russian President Vladimir V. Putin begins his second term, one of his biggest tasks -- arguably, one on which the success of his economic reform program rests -- will be slashing the bureaucracy that ensnares business and staunching the billions of dollars that flow out of the legal economy each year in bribes and evaded taxes.

Much of the attention in the run-up to the March 14 elections focused on Putin’s battles with wealthy oil barons and his plans to levy as much as $3 billion a year in new taxes on the oil industry.

But many analysts say what Putin does to attack the massive “shadow economy” and spur small entrepreneurs will prove much more significant. In fact, the outcome could determine whether Russia ends its heavy reliance on oil, lifts millions of citizens out of poverty and creates the kind of democracy that is nurtured only by a prosperous middle class.

Oil and gas have been the real drivers of the economy, and so far, with near-record-high oil prices, it has been a successful strategy. GDP growth last year was 7.3% -- one of the strongest in the world -- and the government racked up a 2003 budget surplus of $7.9 billion.

But economists are growing increasingly worried about what will happen when oil prices drop -- as they almost surely will. “After oil prices drop below $22 a barrel, we’ve got about two to three years to go. And then we’re looking at a devaluation of the currency and a systemic political crisis,” Mikhail G. Deliagin, head of the Globalization Problems Institute in Moscow, said in an interview this month.

Putin and his reform-minded ministers have vowed to encourage new business development, close loopholes on tax evaders and attack the complicated tax laws and crippling bureaucracy that small-business people say is one of the biggest impediments to growth.

An independent think tank, Information for Democracy, estimated that $40 billion in bribes were paid to government officials last year. The federal prosecutor general’s office announced recently that as many as 20,000 public officials in one recent year “used their official positions to commit 55,000 crimes.... And this is only what we have been able to uncover.”

“State officials continue to carry out various functions -- granting all manner of permissions and licenses, performing inspections and supervisory functions -- that taxpayers do not need and did not request,” Putin said last month. “The result is stifled business initiative, corruption and abuse of power.”

Vladislav Korolev, who owns a successful beverage-distribution company and lumber mill in the Siberian city of Krasnoyarsk, said he was lucky enough to be able to buy his building. But the large majority of businesses in town are forced to rent city property on annual leases, he said.

“The local officials sit in their offices and know that, once a year, the businessman will come in to extend the lease and pay a bribe,” he said. “And these city officials who are making no more than 10,000 rubles [about $350] a month are driving around in $120,000 foreign cars. Where did they get the money? That’s our money.”

Despite years of talk of economic reforms, Korolev said, “we entrepreneurs haven’t seen any reforms, any willingness on the part of the Putin administration to help business.”

If the government were serious, he said, it would rein in the bureaucracy, make credit more readily available and allow business people to buy publicly owned land at market prices.

Jamison Firestone, a U.S. lawyer and Moscow business owner who heads a committee on small business for the American Chamber of Commerce in Russia, said the country recently made concessions on its hideously complicated tax laws by adopting a sharply simplified code for small business. The problem, Firestone said, was that the new law applied only to firms with sales of less than $526,000 a year -- a tiny proportion of the companies that need it.

“The first thing the Russians have to understand is that economies like Europe and America are not kiosk economies,” he said. “When we talk about small business, we’re talking about businesses that are typically in the tens of millions of dollars in turnover, and those are the businesses that really need help.”

Many companies simply avoid paying taxes. Large energy companies, government investigators say, run entire oil wells off the books, or create offshore companies to which profit is sent. Small companies pay their employees in cash that is never reported and keep a set of “black books” to conceal corporate profit.

“I avoid paying taxes. And about 80% of the companies I know do the same thing,” said the owner of a Moscow information technology company who spoke on condition of anonymity. He said the 35.6% tax for pensions and other social benefits collected from employers on salaries (on top of the recently reduced 13% flat tax on income) was too high and would never be seen by employees in future pensions.

“This money just disappears without any reasonable use,” he said. “That is why instead of $1,000, I will declare $300 and I will get away with it, because there is no way to check it out.”

The shadow economy created by these schemes has become so huge that economists believe it is draining billions of potential revenue from the budget.

“After the beginning of privatization, about 40% to 50% of the economy went into the shadows. I am talking about half the economy going underground,” said Dmitry Mikheyev, lecturer at the Academy of National Economy’s school of corporate governance. In dollar terms, he said, that could amount to as much as $235 billion that slips below the government’s radar without being taxed.

Even conservative estimates put the figure at $90 billion a year.

An economic analyst who studies the shadow economy for the Interior Ministry said he estimates it reaches 40% to 60% of the GDP.

And he charged that big business, with its lawyers and influence in recent parliaments, was responsible for most of it.

“The borderlines between the legal and the shadow sectors of our economy have been so indiscernible that, in some cases, it has become difficult even for specialists to distinguish between the two and establish convincingly what is legal and what is acceptable,” said the analyst, who would not agree to have his name disclosed.

“This situation with our complicated and confusing tax legislation plays into the hands of both dishonest businessmen and corrupt government officials,” he added.

Kardanovsky said most business people have worked for years in the Russian system and have simply added the cost of bureaucracy to their budgets.

“You put a sign on the wall of the building, and 10 agencies come to you which are dealing with signs,” he said. What to do? “I call my friends: ‘Do you remember last year in the Canaries?’ ”

Vladimir Pavlov and Maxim Likhvintsev, who run a high-end furniture company in Moscow, say business people all over the world fight bureaucracies. It is not reasonable, they say, to expect Russian business to mature to Western standards overnight.

“Democracy and capitalism have been around in the U.S. for 200 years,” Likhvintsev said. “Here we have no democracy, only capitalism. And we are only 10 years old.”

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Times staff writer Sergei L. Loiko contributed to this report. Moscow bureau chief Murphy is currently on assignment in Iraq.