On The Eve of a Budget Freeze: in Russia’s regions, the era of military dividends is giving way to an era of military costs
At first glance, the militarisation of the Russian economy appeared to benefit the regions. Military spending supported those with a high concentration of defence industries, while strong demand for labour increased the share of wages in GDP. This should have benefited regional budgets, which are heavily funded by personal income tax.
However, the regions were only able to capitalise on these advantages in 2023, when wages had already risen but corporate profits, and therefore regional corporate profit tax revenues, had not yet begun to decline. The sharp, almost 10%, fall in corporate profit tax receipts in 2025 led to a significant divergence between the expenditure and revenue trajectories of regional budgets. As a result, the underlying consolidated regional budget deficit, excluding federal transfers and Moscow, reached 5.5 trillion roubles, or 2.7% of GDP.
Based on the results for the first five months of 2026, the regions have adopted an extremely restrained approach to spending and are, for now, broadly following the pattern seen in 2025, when the underlying deficit, before federal transfers, remained relatively moderate until October. The key determinant of regional finances will continue to be corporate profit tax receipts, which, after a temporary improvement, are likely to weaken again in the second half of the year. One contributing factor will be the more gradual pace of reductions in the key policy rate.
The structural deterioration in regional public finances has two dimensions. First, the number of deficit regions has almost quadrupled, from 19 in 2021 to 73 in 2025. Many of these are regions that were previously fiscally healthy and possess substantial export potential. Second, the structure of federal transfers has changed during the war. In real terms, equalisation grants have not increased, while subsidies requiring co-financing of military expenditure by both regional and federal governments have expanded. As a consequence, spending on a range of standard, non-military functions has been reduced, most notably in healthcare.
Thus, the regions’ war-related costs have risen, but during 2023 and 2024 these were offset by growth in regions' own-source revenues. Those additional expenditures now either crowd out funding for regions' own priorities or increase pressure on the federal budget, which will have to bridge the widening gap between revenues and expenditures. This trade-off makes it highly likely that the fiscal and social situation across the regions will deteriorate by the end of the year, unless another war and a surge in oil prices once again come to the rescue of Russia's wartime finances.
Military Keynesianism has not helped the regions
At first glance, the militarisation of the Russian economy over the past five years appeared to benefit the regions in a number of respects. In addition to the fact that Russia's defence industries, which have received substantial state funding, are traditionally located outside Moscow, several structural changes in the economy also appeared favourable for regional finances. In particular, the acute labour shortage caused by the expansion of defence production, the wave of emigration in 2022, and the diversion of workers to the front triggered rapid wage growth, leading to a marked increase in labour's share of GDP. This mattered because one of the principal sources of regional budget revenue is personal income tax. Indeed, between 2016 and 2019, and again in 2021, personal income tax revenues amounted to the equivalent of 3.6% of GDP. By 2024 and 2025, this figure had risen to 4.1%.
Even so, the regions were only able to benefit fully from this development in 2023, when wages had already increased but revenues from another key source of income, corporate profit tax, had not yet begun to decline. Corporate profit tax receipts amounted to 2.9% of GDP in 2017 to 2019, rose to 3.4% in 2023, then fell back to 2.9% in 2024 and declined further to 2.5% in 2025. This was the lowest level since 2014 and 2015.
Furthermore, regional public finances were also undermined by expenditure persistently growing faster than revenues throughout the war period. Between 2022 and 2024 the gap remained relatively modest, with revenues increasing by an average of 12% a year and expenditures by 14%. By 2025, however, the divergence had doubled, with expenditure rising by 9.9% compared with revenue growth of just 5%. The main reason was that, despite broadly normal expenditure growth, corporate profit tax revenues fell by 4.5% in 2024 and by a further 9% in 2025, both in nominal terms. As a result, regional budgets recorded their largest deficit in more than a decade in 2025, amounting to 1.5 trillion roubles, or 0.7% of GDP. Looking instead at the more meaningful measure of the underlying regional budget deficit, excluding federal transfers, which are specifically intended to balance regional finances, the deficit reached 5.5 trillion roubles, or 2.7% of GDP, in 2025. As a result, the fiscal position of the regions has deteriorated to levels last seen in the early 2010s.
Figure 1. Structure of regional budget revenues, expenditure and underlying deficit, 2011–2025, % of GDP
At the end of the first five months of 2026, Russia's consolidated regional budgets, including federal transfers, recorded a modest nominal surplus of 277 billion roubles. This reflects exceptionally restrained spending. Expenditure was only 6% higher than a year earlier, while revenues increased by 5%, meaning that, after adjusting for inflation, both revenues and expenditure remained broadly unchanged in real terms. However, a more accurate picture of regional public finances requires excluding Moscow, which occupies a unique fiscal position and typically accounts for 20 to 23% of all regional budget revenues. On this basis, the small surplus becomes a modest deficit of 80 billion roubles. Comparing regions' own-source revenues, excluding federal transfers, with their expenditure produces an underlying deficit of 1.49 trillion roubles.
It is also worth noting that regional expenditure is traditionally back-loaded, with only 33 to 35% of annual spending typically executed by the end of May. This year spending may have been even more restrained. In Moscow, for example, expenditure during the first five months amounted to only 30% of the annual budget, while revenues had already reached 39%. This suggests that regions, including the fiscally strongest, are deliberately holding back expenditure in anticipation of a possible deterioration in budget conditions later in the year. Last year regional budgets remained within the limits of expected federal transfers until October, allowing them to avoid post-transfer deficits. However, 25% of annual expenditure was concentrated in November and December, causing the underlying regional deficit, excluding transfers, to almost double from 2.9 trillion to 5.5 trillion roubles. For now, regional budgets continue to follow last year's trajectory, with an underlying deficit of 1.1 trillion roubles, or 1.5 trillion roubles excluding Moscow.
The evolution of regional finances over the remainder of 2026 will depend largely on corporate profit tax revenues. Receipts fell by 12% year on year in the first quarter but recovered significantly by May. Nevertheless, another deterioration is likely towards the end of the year, reflecting, among other factors, the delayed path of policy rate cuts following renewed inflationary pressures driven by fuel prices. This is likely to weaken GDP growth and further worsen the situation for companies.
At the same time, despite a broader slowdown in wage growth, regional finances have been supported by the 20% increase in Russia's statutory minimum wage from 1 January and by an average 7.8% indexation of public-sector wages. These measures automatically boosted personal income tax receipts. Collections rose by 28% year on year in February 2026 before stabilising at around 15% growth in subsequent months. Finally, regional finances will also be shaped by pressure from Moscow for fiscal restraint, particularly after the September elections. The federal government has strong incentives to preserve room for its own spending priorities and will therefore seek to shift part of the political cost of expenditure restraint onto the regions, whose deficits ultimately become a burden for the federal budget.
The hidden burden of war
Thus, overall, the fiscal position of Russia's regions has deteriorated during the war, despite structural economic changes that appeared, at first glance, to favour them. This is hardly surprising. Over the four years of the war, regional budget revenues increased by 47%, while expenditure rose by 62%. The deterioration in regional public finances has two important structural dimensions.
First, the number of regions running budget deficits quadrupled during the four years of the war against Ukraine, rising from 19 in 2021 to 73 in 2025. These figures refer to nominal deficits after federal transfers. According to a report by the Accounts Chamber (covering Russia's 83 regions as well as the federal territory of Sirius, annexed Crimea and Sevastopol, and the territories of four partially occupied Ukrainian regions), the number of regions recording surpluses fell from 66 to just 17. The sharpest deterioration occurred last year, when the number of deficit regions increased by almost 50%, from 49 to 73. During the first quarter of 2026 this figure fell slightly to 56, according to the latest operational report from the Accounts Chamber, but this is most likely a temporary phenomenon.
The combined deficit of the 73 deficit regions increased by a factor of 2.5, from 638 billion to 1.61 trillion roubles, while the aggregate surplus of the remaining regions declined fivefold, from 341 billion to just 70 billion roubles. Notably, regions also responded to growing fiscal imbalances by sharply increasing commercial borrowing. Outstanding commercial loans rose from 323 billion roubles in 2024 to 676 billion roubles in 2025.
The deterioration in regional fiscal capacity has been driven primarily by declining corporate profit tax revenues. In 2024 and 2025 this also produced a marked geographical shift in regional finances. Previously prosperous resource-rich and export-oriented regions experienced a pronounced deterioration. These included the Orenburg, Sakhalin and Tyumen regions, the Nenets and Yamalo-Nenets autonomous districts, which are rich in oil and gas reserves, as well as the Komi Republic, the Arkhangelsk and Irkutsk regions, where the timber industry is concentrated, and the Kemerovo region (Kuzbass), home to Russia's largest coal producers. Sanctions, lower global commodity prices, more costly logistics following the reorientation of trade flows, the appreciation of the rouble, which placed considerable pressure on exporters, and rising debt servicing costs have together severely weakened what had previously been Russia's belt of relatively prosperous regions.
Corporate profit tax revenues increased in 2025 only in parts of the Far East, including the Magadan region and Zabaykalsky Krai, which benefit from better transport links and stronger integration with Asia-Pacific markets, as well as in regions heavily dependent on the defence industry (such as Chuvashia). In total, there are 18 such regions where defence contracts have enabled an increase in tax revenue despite an all-Russian decline in corporate income tax receipts. These are concentrated mainly around military-industrial plants built during the Soviet era, according to a review by the research institute attached to the Bank of Finland (BOFIT).
As noted above, personal income tax has acted as the principal stabiliser of regional revenues. BOFIT researchers find that, despite the nationwide slowdown in wage growth, the boom in personal income tax receipts continued throughout 2025 in regions dominated by the defence industry. In almost all of these regions, personal income tax collections increased by between 10 and 22%. It should be noted, however, that the introduction of a progressive income tax scale did not generate additional revenues for regional budgets, since the extra proceeds accrued to the federal budget. At the same time, the significance of this trend should not be overstated. According to the Accounts Chamber, 35% of the total increase in personal income tax receipts in 2025, and again in early 2026, came from Moscow, which accounted for 200 billion roubles or 21% of the national increase, the Moscow region with 75 billion roubles or 8%, and St Petersburg with 56 billion roubles or 6%. This suggests that personal incomes in most regions remain substantially lower than in Russia's largest metropolitan areas, meaning that even smaller percentage increases in wealthier urban agglomerations translate into much larger gains in absolute revenue terms.
The second structural issue concerns federal transfers, which are intended to balance the budgets of fiscally weaker regions. These transfers have become increasingly volatile. They amounted to 1.9% of GDP during the 2015 to 2016 crisis, rose to 2% in 2018 and 2019, surged to 3.5% during the Covid-19 crisis, then declined steadily to a low of 1.85% of GDP in 2024 and 2025. In 2024 this decline largely reflected favourable economic conditions and stronger own-source revenues in the regions. By contrast, the reduction in 2025 primarily reflected growing pressure on the federal budget.
BOFIT also notes that the composition of federal transfers has changed during the war. Equalisation grants increased by only 30% over the period, from 718 billion to 932 billion roubles, well below cumulative inflation of approximately 39%. By contrast, subsidies requiring regional co-financing increased by almost 50%, (from 1,194 billion to 1,746 billion). As a result, relations between the federal centre and the regions are shifting from a model of fiscal support towards one of fiscal extraction, according to BOFIT. Rather than acting as net beneficiaries of fiscal redistribution, the regions are increasingly being drawn into financing Moscow's war effort. Governors have been instructed to pay recruitment bonuses and benefits to soldiers' families, finance the reconstruction of occupied territories, and co-finance infrastructure investment linked to the war.
An analysis by the Accounts Chamber shows that the overall composition of regional expenditure in 2025 changed relatively little compared with 2021. The principal exception was healthcare, whose share of regional spending declined from 12% to 8.5%. In nominal terms, healthcare expenditure increased by only 15% over four years, from 2 trillion to 2.3 trillion roubles, representing a substantial real-terms reduction against cumulative inflation of almost 40%. This trend has continued into 2026. According to the Accounts Chamber, regional healthcare expenditure during January to March declined by 6.4% year on year even in nominal terms. Although Russia's federal compulsory health insurance system has probably mitigated some of the reduction, the 2026 federal budget envisages no further growth in transfers through that system, making the outlook for regional healthcare even bleaker, according to BOFIT.
Figure 2. Main categories of regional budget expenditure in 2021 and 2025, %
According to BOFIT's estimates, the sectoral composition of regional expenditure changed substantially during the war years, with most of the increase concentrated in military and war-related spending. In addition to the obvious budget categories of ‘National Defence’ and ‘Other matters relating to national security and law enforcement’, 23% of social welfare expenditure was identified as being war-related. This share was estimated by Janis Kluge, an expert at the German Institute for International and Security Affairs (SWP), and includes benefits paid to the families of deceased soldiers as well as disability payments to service personnel. On BOFIT's conservative estimate, regional military expenditure reached almost 1 trillion roubles in 2025, roughly double its 2021 level. Military-related expenditure also extends beyond these categories. It includes spending on the reconstruction of border regions and compensation for damage caused by Ukrainian drone strikes, which are formally recorded in budget accounts under infrastructure and national economy programmes. Under BOFIT's broader methodology, which includes all social welfare spending affected directly or indirectly by the war against Ukraine, regional military expenditure increased from 1.9 trillion roubles in 2022 to 3.5 trillion roubles in 2025, accounting for 13.2% of total regional expenditure.
Table 1. Regional military expenditure in 2021 and 2025, in billions of roubles
Thus, regional war-related costs have increased significantly in recent years. During 2023 and 2024, however, these additional burdens were offset by growth in regions' own-source revenues. That revenue base is now contracting. As a result, additional spending on military needs is increasingly leading either to the underfunding of regions' own priorities, most notably healthcare, or to greater pressure on the federal budget, which will ultimately have to bridge the resulting funding gap. This makes it highly likely that the fiscal and social situation across Russia's regions will deteriorate by the end of the year, unless another war and a surge in oil prices once again come to the rescue of Russia's wartime finances.