Protection Racket

Many people wonder why Putin is willing to engage in activities that seem inimical to Russia's economic interests. These comments tend to miss the point of what Putin cares about. Cliff Gaddy sends in this comment that has it exactly right:

People ask, Why would Putin allow this to happen? It is not in Russia’s or his own interest. Foreign investors will be discouraged, oil production will suffer, and so on. It doesn’t make sense.

Thinking in these terms confuses efficiency as seen from the economic point of view and what might be termed political efficiency. Putin does indeed desire economic efficiency, that is, continued production of resource rents. But his first priority is control of the use of those rents – political efficiency. And here, informal taxes have two big advantages for Putin. First, informal taxes can be collected and redistributed much more flexibly than formal taxes. He and his inner circle need to be able to channel resources to precisely the people and purposes they choose, when they choose. One might object that they can do that anyway with the budgetary flows (the formal taxes) at their disposal. But those flows are not nearly as flexible. Putin is very concerned about his ability to react flexibly to changing circumstances. He needs to call on key actors to channel resources quickly.

The second advantage of informal taxes is even more important. Informal taxation is a key component of the property rights protection racket – Putin’s mechanism for manipulating the behavior of the resource owners. The world of informal taxes is a world of quasi-legality at best. Keeping companies in that world gives Putin leverage. It is absolutely a good thing for Putin that companies engage to a controlled extent in various forms of illegal payments such as bribes, kickbacks, padded contracts, and the like. Precisely because the actions are illegal, they make the companies vulnerable to the tax authorities and the police. Paying informal taxes forces companies to violate laws. And that is the point. The evidence of their financial crimes is collected at the same time that their money or favors are collected. The individual chiefly responsible for this branch of “Russia, Inc.” is Putin’s no. 2, Viktor Zubkov. Since his days as founder of Putin’s Financial Monitoring Agency (a “financial intelligence service”, as Putin once described it), Zubkov has been the personal repository of information that can destroy any major company and any wealthy individual in Russia. He can see to it that real – not fake – charges are brought against anyone, at any time. This is the way the Protection Racket works. Informal taxation is at its heart.

In a ruling handed down by the United States Supreme Court in 1819 (“McCulloch v. Maryland”), Chief Justice John Marshall wrote the famous words that apply to any society: “The power to tax involves the power to destroy.” In today’s Russia, the discretionary power to informally tax is an equally potent instrument of destruction and, more important, of control.