#10
Russia's Shadow Economy Examined
Trud
10 January 2002
[translation for personal use only]
Article by Vitaliy Golovachev, Trud political observer:
"Invisible Octopus. Scope of Shadow Economy in Russia Estimated at $90-$110 Billion"

Parallel to the official economy in Russia, there is also a shadow economy, which greatly affects practically all sectors. Specialists subdivide it into the "gray" [semi-legal] economy (legal enterprises which conceal income or engage in false export and other machinations) and the criminal economy (trade in narcotics, arms, racketeering, prostitution). In 2001, the volume of the "gray" segment of the economy was estimated by government experts at $50 billion, or 18 percent of the gross domestic product (GDP). For comparison: $50 billion was the income portion of the entire federal budget of Russia last year. Furthermore, $40-$60 billion circulates within criminal business. According to the latest data of the General Prosecutor's Office, up to 60 percent of Russian enterprises and organizations are controlled by organized crime groups. Altogether, the shadow economy has reached fantastic proportions--from $90 to $110 billion.

Public officials take a big bite

Many public officials, politicians and entrepreneurs are involved in the shadow sphere. Lobbyists act almost openly, and bribery is practically the norm in our life. There are even tariffs for obtaining permits and licenses in various organizations. And, for example, when graduate students enroll in many medical schools, they must "give" $15,000-$20,000, and in law and economic faculties of universities--$10,000-$20,000.

In small and medium business, one cannot take a step without an "envelope" or expensive gift. State Duma Deputy and leader of the Development of Enterprise Party, Ivan Grachev, cited a shocking figure: Entrepreneurs in our country spend around $10 billion a year on bribes to public officials of all levels. Another fact: According to the data of the MVD [Ministry of Internal Affairs], in one year, the sum of $1.5 million was handed over to the "right" people for what would seem to be a routine procedure--granting of licenses for production of alcoholic products.

Shadow money is laundered and placed into circulation, and a large part of it goes abroad. In one of his interviews, former General Prosecutor of Russia Yuriy Skuratov stated that, several years ago, high ranking Russian public officials had millions of dollars in accounts in foreign banks. In his words, "in only one of them, in Lugano (Switzerland), individual deposits by dozens of Russian public officials were reported." Similar accounts were also discovered in banks in Greece, Cyprus, the USA and France... Has this situation changed in recent years? In the opinion of the Russian Federation Presidential Advisor on Economic Questions, Andrey Illarionov, "the scope of corruption today is even higher than before. Previously, this was done in somewhat of an amateurish manner, but now corruption is becoming institutionalized."

Of course, there are similar phenomena in the developed countries as well. However, while in the countries of the European Union the relative share of the shadow economy fluctuates from 7 to 16 percent, here, in the opinion of Director of the Federal Tax Police Service Mikhail Fradkov, it takes up around 40 percent (taking into consideration the criminal segment). Economic crime and corruption have taken on menacing proportions. "In a year, 20,000 public officials used their official positions to commit 55,000 crimes. And within the complement of organized groups there were 1,405 crimes reported," Russian Federation First Deputy General Prosecutor Yuriy Biryukov announced recently. And this is only what we have been able to uncover. Much more still remains "outside the picture." For example, in half a year, there were 6,980 cases of bribery uncovered. It is unlikely that anyone would argue the fact that for Russia this is a mere drop in the bucket.

One of the leading analysts of the Federal Tax Police Service, Dmitriy Makarov, tells about how the struggle against the shadow economy is proceeding.

[Correspondent] Dmitriy Gennadyevich, what are the most typical schemes of obtaining shadow income?

[Makarov] There are very many of them. For example, the so-called one-day firms--or, in our terminology, anonymous structures--are widely used in the shadow economy. These firms are registered under lost or stolen passports (often hundreds of fictitious structures are "housed" in one apartment, whose owner does not even suspect this), as well as to non-existent persons or at non-existent addresses. One-day firms are used for all sorts of machinations!

Here is one of the schemes: Firm "A" makes a verbal agreement with company "B" for performance of certain work or provision of services. However, the written agreement with "B" is concluded not by "A", but by fictitious firm "C." When the work is fulfilled, the money is transferred to the account of "C", generally in non-cash form. Then it is cashed and handed over in a suitcase to firm "A," and firm "C" simply disappears. Naturally, no taxes are paid. When the tax inspectors come to the registration address of "C," it turns out that this is a residential apartment whose owner had at one time lost his passport, or else a pensioner who had given his documents to someone for a time.

Threat to economic security

These one-day firms also inflict great detriment upon the state by using another scheme: They unlawfully receive from the budget the sum of value-added tax (VAT), which, as proscribed by law, is refunded to exporter enterprises when the products are shipped abroad. The swindling in this case consists of the fact that either there was no exported product at all, or that its volume had been greatly overstated. In 2000, machinations with VAT took on mass proportions and encompassed practically all regions of Russia. An analysis of the monetary flows in the foreign economic sphere showed that the rates of increasing payments by exporter enterprises significantly surpassed the growth in volumes of export itself. The overpayments "for air" comprised almost 12 billion rubles (R). Huge sums were lost from the budget. In this case, not only one-day firms were used, but also fictitious accounts in banks, overstated export value of goods, and forged customs declarations.

The situation was so serious that a special report had to be sent to the President's Administration of Russia. The discussion, in essence, centered around a threat to the country's economic security. The FSNP [Federal Tax Police Service] developed a secret operation, "Zachet," ["mutual offset"], in which associates of the tax police, the tax services, the internal affairs agencies, the FSB [Federal Security Service], and customs officials participated. They tossed a huge dragnet over criminals, so to speak, which encompassed the entire country.

Another operation under the code name, "Podsnezhniki" ["snowdrops"], was aimed at identifying one-day firms and suppressing their activity. Today, we may summarize certain results. During 9 months of 2001, losses from replacement of VAT "for air" in the sum of over R6.9 billion were uncovered. Over R2.2 billion were returned to the budget. VAT refunds in the amount of over R4 billion were prevented. Hundreds of attempts at certifying false export under falsified documents were suppressed.

In the course of Operation Snowdrop, 115,258 anonymous structures were exposed, through which considerable sums had passed (R8.9 billion were recorded). Operations were halted on 1,956 accounts. Thousands of materials were sent to the tax agencies for the purpose of initiating lawsuits on recognizing the unlawful registration of one-day firms.

[Correspondent] Was money transferred abroad through such fictitious firms?

[Makarov] Of course. I will cite only that sum which we were able to determine in the course of the operation--over $33 million. But, naturally, it is already impossible to investigate those anonymous structures which have "evaporated." I will only say that, according to data of the Central bank of the Russian Federation, the drain of capital from our country in 1999-2000 surpassed $40 billion. Obviously, not all of these transfers were performed in violation of the law, but those enterprises which used the services of one-day firms in most cases consciously opted for serious violations. Over 660 criminal cases were filed in the course of the operation.

[Correspondent] Were you able to identify those who organized the fictitious firms?

[Makarov] Our "dragnet" netted over 500 people.

[Correspondent] Could you cite at least a few examples?

[Makarov] In the Khanty-Mansi Autonomous Okrug, we audited the closed joint-stock company Asta. It turned out that the director had organized a well-concealed criminal group for registering firms and entrepreneurs to fictitious persons. Various accounts were used for cashing monetary means and transferring bank notes to enterprises in Nizhnevartovsk, as well as to private individuals who were concealing their entrepreneurial activity. The complement of the crime syndicate included not only associates of Asta, but also of the closed joint-stock company Yuridicheskoye Byuro, NGAB Yermak, the Tyumen branch of Vneshtorgbank, as well as middlemen who gave the cash money to clients. Enterprise managers and shadow entrepreneurs employed the services of Asta. As a result, the budget lost R55 million due to unpaid taxes and unlawful refund of VAT. Thirty-one criminal cases were filed against all the participants. The directors of Asta and Yuridicheskoye Byuro were taken into custody. Their current accounts were seized, and cash money in the sum of R1.9 billion was confiscated.

Here is another case. In Maritime Kray, two Russians and a citizen of South Korea organized but did not register a firm. They had falsified paperwork, and they were supposedly acting under power of attorney from entrepreneur Pak Ok Sun, who had in fact died back in 2000.

The trio did business on the sale of a large amount of fish through illegal channels. Their gross income for 2000 comprised $1.3 million. Their net income was R1.7 million. Two of the participants in the crime group were arrested, and one--O. V. Lepeshkin--managed to flee and is currently being sought.

There are many machinations in the timber industry complex. In the course of a search of the offices of OOO [limited liability company] Vityaz (Maritime Kray) and at the residence of its director, falsified documents on five one-day firms were found. By sending saw-timber abroad, the director had concealed R2.3 million from taxation. Serious violations were discovered also in the organizations of the Ministry of Defense. Specifically, the enterprises belonging to the Main Rocket-Artillery Administration had engaged in the procurement, processing and sale of non-ferrous metal scrap without having a license and without showing the obtained income in the bookkeeping documents. Over R30 million were returned to budgets of all levels.

There are thousands of such cases. For some firms, the investigation continues, while others still await an in-depth audit. We were interested, for example, in the fact that over 1.5 million organizations had presented to the tax organs either "zero balances," or had not filed tax declarations at all. A significant part of these firms is "anonymous," as practical experience shows. Be assured: We will sift through our sieve everyone who evokes suspicion.

Illegal income of oil companies

[Correspondent] In the USA and a number of other countries, many secret agents are planted in illegal business, who transmit most valuable information. Does the tax police make use of this experience?

[Makarov] Not a single structure which engages in exposing secret operations can successfully operate without a network of agents. Of course, we too have such a network. But this is only one of the channels of obtaining information.

[Correspondent] In the shadow economy, as in the criminal world, there are harsh customs. If a secret agent is exposed, he has few chances of saving himself. Have you lost many of your agents?

[Makarov] Thank God, we have not had any failures. However, there have been some casualties among the officers of the tax police--around 20 associates have perished. There is an ongoing fierce struggle with underground business, in which tens of billions of dollars circulate. Wherever there is big "shadow" money, there is always a very high risk for operative workers. After all, war is war.

[Correspondent] Do large Russian companies engage in shadow machinations?

[Makarov] Investigations have either already been conducted on some of them, or there are signals which require investigation. I will not repeat what has been published in the press. I will tell about Operation Stakhanovtsy, which began around a year-and-a-half ago. Specifically, the oil companies were investigated in the course of this operation. Some of them had used exploratory and survey wells in the regimen of industrial exploitation, but did not show the profits in their documents. Also, wells were exploited which were not even listed on the balance sheets. The oil companies received (and I believe, still receive) huge amounts of money through "unlawful" channels, so to speak. For example, at the time of the audit, the Belyye Nochi Oil Company had been performing industrial exploitation of wells which were not listed on the balance sheet. We can imagine what kind of shadow funds the managers of Belyye Nochi had at their disposal if the supplemental payments to the budget alone comprised R33.8 million. On the whole, 146 crimes were exposed. Losses in the amount of R2 billion 181 million were recovered.

[Correspondent] Is it generally possible to conquer the "shadow octopus?" You expose a thousand one-day firms, and 10,000 new ones crop up in their place. You expose the machinations of the oil generals, and when the tax policemen leave they begin industrial exploitation of new wells which are not listed on the balance sheets. Is this not reminiscent of tilting windmills?

[Makarov] No, because we must judge the effectiveness of our work by objective indicators. And they are such: In January-November of 2001, the Federal Tax Police Service returned R97.2 billion to the state.

Re-computed, this is over $3 billion. Around 35,000 criminal cases were filed, and 132,000 people were brought to administrative responsibility (with fines totaling R455 million). And the relative share of the "gray" segment of the shadow economy, I would like to stress, has declined. In 1999, it comprised 25 percent of the GDP, and today it is 18 percent. Although there will always be unscrupulous dealers who want to circumvent the law in order to get rich at the expense of the state. And we will always need the tax police.

It is another matter that we must improve the legislation and eliminate the "gaps" which exist in it. In my opinion, we should significantly tighten sanctions for machinations and deceit of the state.

[Correspondent] In recent years, there has been an energetic merging of criminal business with the "gray" economy. Legally operating enterprises are financing criminal groups. Are the tax police able to expose these ties? Including the channels of transfer of monetary means to bandit formations in Chechnya?

[Makarov] Obviously. The FSNP Main Administration on the Central Federal District has sent to the FSB and MVD [Ministry of Internal Affairs] materials on 65 commercial structures which are suspected of financing bandit formations on the territory of Chechnya. Fifty-four criminal cases have already been filed. Such firms have been exposed, specifically, in Kostroma. Many of the aforementioned 65 structures engaged in the unlawful production and sale of alcohol, and the money received went to Chechnya.

Altogether, the Federal Tax Police Service is currently studying the activity of around 3,000 legal entities and individuals suspected of involvement in financing of organized crime groups.