Tax the Oligarchs

Around the world, there is concern about the arrest of Russian oil billionaire Mikhail Khodorkovsky. The worry is that Russia may be backtracking from democracy and the rule of law.

Russia faces numerous problems posed by the legacy of Communism and the way the transition from Communism to a market economy was handled. One set of problems concerns politics and the difficulties of creating democracy and the rule of law after decades of totalitarianism. Another relates to economics.

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Two grievous economic policy errors were committed during Yeltsin's presidency. The first, as I argue in my book Globalization and its Discontents , was to create incentives that led to asset stripping rather than wealth creation. The other was to squander the few positive legacies left from the Communist era.

One such legacy was a high level of human capital, especially in technical and scientific areas, much of which was lost, as many of the country's most talented people emigrated. Another squandered legacy -- with serious political consequences -- was the relative equality bequeathed by Communism.

Politics and economics are in fact inextricably linked here: the erosion of the middle classes, which accompanied the rise of a few enormously wealthy oligarchs, and the descent of millions into poverty, made creation of a democratic society and the rule of law much more difficult.

The reason is simple. It is not the Rockefellers and the Gateses of this world that are the strongest advocates of a "level playing field" and respect for law (including the law of competition). Historically, it is the middle classes that have an inherent stake in fairness and equality, thus playing an instrumental role in instituting the rule of law.

For this reason, coming to terms with the illegitimate privatizations of the 1990's, which are at the root of wealth inequality in Russia, is something that still needs to be done -- and not only as a matter of justice; it is important for the long-term performance of Russia's economy.

Ultimately, security of property rights -- and the growth it enables -- depends primarily on the legitimacy with which those rights are viewed by society. If those who hold wealth are seen as having obtained it in ways that lack legitimacy, no legal system can make property secure. If property is not secure -- or even is not perceived as secure -- incentives are distorted. Those in control of Russian businesses will thus continue to strip assets and convert them into forms of wealth that can be easily taken out of the country.

Worse, if the legacy of illegitimate privatizations is not addressed, the economic oligarchy will likely be transformed into a political one as well. It is in light of this that Putin's moves against Khodorkovsky should be seen. For if the oligarchs succeed in keeping their ill-gotten gains, it is not hard to imagine someone like Khodorkovsky -- who was already starting to build a political machine alongside his business empire -- cashing in his Yukos shares, parking his wealth in a safe haven offshore, and using it to manipulate Russian politics.

What is to be done, then, with the tainted property gained during the wild privatizations of the 1990's? It probably would have been easier for Russia's government to recapture some of the oligarchs' ill-gotten gains earlier, say, after the ruble crisis of 1998, when many of them fell into arrears on their loans.

Although that opportunity has passed, I still think that it will be far easier to address this problem now than, say, in another decade. Once Khodorkovsky and his ilk sell their stakes to foreign interests and take their money out of Russia, there will be little that can be done.

But wouldn't a reversal of the illegitimate privatizations of the 1990's create new problems and undermine Russia's attempt to establish secure property rights? I believe some of the inequities of the past can be addressed without any direct attack on "property rights," no matter how dubiously acquired. Russia could impose an "excess capital gains tax," analogous in spirit to the tax imposed on US oil companies when their profits soared, through no effort of their own, from high oil prices in the 1970's.

A tax could be imposed, say, at the rate of 90%, on the "excess" gains from the acquisition of state assets--e.g., on gains in excess of 10% cumulative returns on original equity investments. The tax would be payable either when the company is listed on a stock market or when the assets are sold. Such a tax would leave the oligarchs with plenty, and could even compensate them for their efforts at restructuring enterprises.

To encourage domestic investment, and recognizing that it is difficult to tax assets held abroad, an "exit" tax could also be imposed on capital taken out of the country. It would be a move somewhat similar to that contemplated in the US by the Clinton administration, which proposed a tax on billionaires who surrendered their citizenship in order to avoid taxation.

The money raised by the new tax could help restore, for instance, Russia's ailing health and educational systems. To be sure, the tax would not solve all of Russia's problems. It would not eliminate huge inequalities. It would not create a new middle class.

It would, however, go some way towards rectifying the consequences of the "wealth grabs" of the Yeltsin era. Most importantly, while it would not ensure the creation of a viable democracy, it would at least reduce the threat to democracy posed by the increasingly poisonous role played by money in Russian politics.