According to current projections, Russia’s pension system faces annual deficits of more than $50 billion in the coming years, while the number of retirees is on the rise. The government has tinkered with the system in an attempt to fill the gap, but some experts insist that the changes have only made things worse. In part one of a two-part story, IMR analyst Ezekiel Pfeifer examines the origins of the pension system’s acute and chronic ailments.

On a chilly March evening last year, economist Mikhail Dmitriyev was walking home from a suburban train station in the town of Lobnya, a quiet, tree-lined Moscow suburb dominated by high-rise apartment blocks. Despite his status as one of the nation’s top economists—he led the Kremlin-linked think tank Center for Strategic Research for eight years, having succeeded current Central Bank Governor Elvira Nabiullina in the role—Dmitryev took the run-down elektrichka to work every day, alongside thousands of other commuters. (He apparently enjoyed the freedom of not being stuck in Moscow’s infamous traffic.) As Dmitriyev approached the entrance to his building, a group of hooligans suddenly attacked him, beating him up and stealing his briefcase that contained his computer. He suffered a concussion and minor contusions, although the attackers did not take his wallet.

Some immediately linked the beating and theft to Dmitriyev’s increasingly unvarnished views about the problems facing Russia’s government. The economist became well-known after the mass protests in the winter of 2011-2012, since he predicted such social unrest back in March 2011. Then in October 2013, he opened a new front: he began sharply criticizing a major change to the pension system. “It’s confiscation,” Dmitriyev said, referring to the Kremlin’s decision to freeze the so-called accumulative portion of Russians’ pensions and put the money—a whopping $7.2 billion—into state coffers instead. He called the move illegal. A few months later, in January 2014, it was announced that Dmitriyev had been fired as head of the Center for Strategic Research, apparently due to his criticism of the decision regarding the pension money.

When Dmitriyev was beaten up two months later, in March 2014, without having his wallet stolen, many observers linked it to his openly critical views. Considering the track record of Kremlin detractors being assaulted, this seemed like a realistic assumption to make. But could the authorities really have become so incensed by criticism of an abstruse topic like pension reform? Given the massive influence of the pension system on Vladimir Putin’s ability to spend money as he sees fit on things like the military and sprawling state companies, the answer is an unequivocal yes.

To be fair, Dmitriyev was not alone in panning the move to stop payments to the accumulative pension system. The accumulative system consists of individual accounts that Russians can either allow the state to invest or can move to private pension funds, which often achieve higher returns than the government. Former Finance Minister Alexei Kudrin, who was involved in creating the system in 2002, has led a chorus of criticism over the decision to halt transfers to it, arguing that the approximately 3.2 trillion rubles ($47.7 billion) currently present in the system represents a rare and valuable source of long-term investment capital, something that Russia lacks but desperately needs.

Even permanently eliminating the accumulative system—which the government promised not to do in April 2015—could not fix the country’s pension problems, however. They run deeper, and represent perhaps the biggest threat to Russia’s financial wellbeing in the coming months and years.

How the 22% Pie Gets Split

Like many national pension systems, Russia’s system is mostly “pay as you go,” meaning that working people pay for the pensions of retired people. But, unlike some systems (such as that in the U.S.), Russia also has the so-called accumulative portion. Pension contributions come from a 22 percent tax on people’s incomes, although employees don’t pay a single kopeck from their paychecks—instead it is all paid by the employer. Of this 22 percent tax, 16 percent goes into the pay-as-you-go system—meaning to current pensioners—while the other 6 percent goes into the accumulative system, or at least it did until 2013, when the moratorium was announced.

The NWF doesn’t have enough money to feed the zombie pension system. Just as a bank is called a “zombie” if it has zero net worth but keeps functioning thanks to state bailouts, Russia’s pension system is an economic walking corpse.

Russia’s 22 percent pension tax is near the median worldwide—it’s higher than the United States’ 12.4 percent and Germany’s 19.6 percent, but lower than Spain’s 28.3 percent or Hungary’s 34 percent. Over the last decade, the Russian government has raised payouts to pensioners significantly, spending about 8-9 percent of GDP each year from 2010 to 2014, up from 5-6 percent from 2001 to 2008. This makes sense—the economy grew significantly over the last 15 years and the government, flush with cash from energy exports, decided it would be politically expedient to redistribute some of its earnings, especially after pensioners revolted over changes made in 2005. The spending increase is also due to a rise in the pensioner population: after the number of retired people held steady at about 38.5 million from 2001-2008, it gradually increased to almost 41.5 million today.

The Russian government, and former Finance Minister Kudrin in particular, planned for these changes in the 2000s, knowing that the state would need a source of money to pay for pensions in the years when the price of oil fell. This source became the National Wealth Fund (NWF), created in 2008 along with the Reserve Fund, both of which were successors to the Stabilization Fund formed in 2004. The NWF grew to over $93 billion in early 2009 and held steady above $80 billion until 2014.

A Gaping Hole

At the moment, the NWF has about $74 billion left, or 4.9 trillion rubles—but its stated purpose has changed. After being opened up to infrastructure projects in 2012, the fund has become a piggy bank for state companies to raid for investment money. In the midst of Russia’s current recession, the total value of requests from the fund has exceeded the amount of cash it possesses, and new appeals from the likes of Gazprom and Rosneft roll in every month. This is despite the fact that in recent years, Gazprom has massively overinvested in new capacity, to the point that it can produce 617 billion cubic meters of gas while it has only needed 400-450 b.c.m. annually in recent years, due to a worldwide glut of hydrocarbons. In other words: state companies, led by the likes of Putin pals Alexei Miller and Igor Sechin, want money that was originally promised to pensioners in order to invest in capacity they probably don’t even need.

The bigger problem, however, is that the NWF doesn’t have enough money to feed the zombie pension system. Just as a bank is called a “zombie” if it has zero net worth but keeps functioning thanks to state bailouts, Russia’s pension system is an economic walking corpse. Russia’s 2015 budget projects pension expenditures of 7.77 trillion rubles, or well over $100 billion, and revenue of only 4.14 trillion rubles. The government has to make up that difference of 3.63 trillion rubles ($54 billion) with money from the budget, which itself is expected to have a deficit of 2.68 trillion rubles this year. The current draft budget for 2016-2018 predicts annual pension system shortfalls of about 3.7 trillion rubles, to be compensated from the budget. If the National Wealth Fund were used to pay for these shortfalls instead, it would be gone in 16 months.

How did this happen? A confluence of factors acted to expand the hole in the system. As Russia’s population has aged, the size of the workforce has been flat—while the number of pensioners has increased by 3 million in recent years to 41.5 million, the labor pool has held steady for the last decade at just over 75 million people. This means that while the same number of people are being taxed, many more people are collecting pensions. At the same time, pension payments have gone up as a percentage of GDP, even as the economic bloc in Russia’s government warned that the increases were unsustainable without structural changes that would increase worker productivity and, therefore, per capita tax revenue. The government also did not stash away enough of the proceeds from energy sales to be able to plug the hole using the NWF. From 2011 to 2014, as the price of oil shot to above $100 per barrel, the government nonetheless ran an average of a 0.1 percent annual budget deficit, instead of running a surplus that could have been put into its rainy day funds.

Read part two of this story, which examines possible solutions to the problems in the Russian pension system.