Chapter

28 Russian Federation

Editor(s):
Teresa Ter-Minassian
Published Date:
September 1997
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Author(s)
Jon Craig John Norregaard and George Tsibouris

The Russian Federation has a system of fiscal federalism that has been undergoing rapid and substantial changes since it became a sovereign country at the end of 1991. Centrifugal forces have played an important role in easing the grip of centralized control that marked the former communist system. These forces have in some cases been driven by ethnic and historic regional differences, but significant discrepancies in the fiscal capacities between different regions, as well as regional resource concentration, have also been important.

Overall, the reforms of intergovernmental fiscal relations carried out so far have not been governed by a clear strategy, but have been introduced in a trial and error manner, reflecting in part the ongoing political struggles between the federal government and the regions.1 While legislation has been put in place that assigns revenue powers to different levels of government, such a system has not taken into account sufficiently the revenue-raising capacity and expenditure assignments of the regions. Furthermore, several regions have entered into special fiscal regimes with the federal government. At the same time, there has been a shift of expenditure assignments, relating mainly to social and capital outlays, toward subnational levels of government. Given the limited ability of subnational governments to borrow, the system of equalization transfers was to play a crucial role in addressing the mismatch between assigned revenues and expenditures. However, there are still significant technical shortcomings in the equalization formula, and the redistribution of resources it affords remains insufficient when judged against the goal of greater equalization of per capita outlays for the social safety net, education, health, infrastructure, and administration.

Intergovernmental fiscal relations are still in a state of flux in Russia. Issues discussed in the following sections may quickly be superseded by ongoing developments. However, it is evident that continuing reform of the system of fiscal federalism in Russia is an important priority.

Structure of Government

Russia is a three-tiered federal state. The central government forms the first tier. The second tier comprises 89 geographic administrative units that carry varying descriptions, largely reflecting differences in the relative degree of autonomy from the center and in the ethnic mix of the population of the region concerned. The status of these units has been changing substantially as pressures for greater independence have emerged. In early 1993, there were 20 ethnic republics, 2 soviet republics, 2 soviet socialist republics, 1 autonomous soviet republic, 49 oblasts, 3 autonomous oblasts, 4 autonomous okrugs, 6 krays, and 2 metropolitan cities with oblast status (Moscow and Leningrad, now called St. Petersburg). There is also a third tier of administration covering, within the urban areas, the major municipalities (except Moscow and St. Petersburg, which have oblast status), and their cities and urban districts and, within the nonurban areas, the rayons.

The basis for distinction between the various 89 second-tier administrative units (see Table 1 for a full listing) came originally from the former constitution adopted in 1977 that adopted a nationality-based logic for distinguishing between units. Thus, ethnic republics were seen as having the greatest autonomy from the center in terms of, inter alia, trade and foreign policy and, importantly for fiscal policy, control over the land and resources within their boundaries. One step below in terms of autonomy were the other forms of republics, oblasts, the metropolitan cities, autonomous oblasts, and autonomous okrugs. The nonethnic republics did not have a sufficiently large proportion of a non-Russian nationality group to be called an ethnic republic, but nevertheless had boundaries that recognized some nationality groups. They also shared the privilege of having their own governments (supreme soviets) with at least some autonomy. An oblast is an administrative unit that contains no significant non-Russian group. A kray, like an oblast, has purely administrative boundaries, but contains within its borders autonomous oblasts or autonomous okrugs that themselves are based on nationality groups.

Table 1.Russia: Regional Budgets, 1992
RegionPopulation

(In thousands)
Own Revenue Total

(In thousands of rubles)
Own Revenue Per Capita

(In rubles)
Own Expenditure

(In thousands of rubles)
Expenditure Per Capita

(In rubles)
North6,136108,94017,754114,96518,736
Arkhangel Oblast1,51718,78912,38619,35912,761
Nenets Aut. Rep.5464211,8842,65649,188
Vologda Oblast1,36220,62015,14020,46415,025
Murmansk Oblast1,14826,35922,96124,93321,719
Katelian Republic80015,28619,10821,15026,438
Komi SSR1,25527,24421,70826,40321,038
Northwest8,27099,36412.015106,41512,868
St. Petersburg City5,00462,06812,40462,95312,581
Leningrad Oblast1,67320,99712,55119,93411,915
Novgorod Oblast7528,90911,84811,56015,372
Pskov Oblast8417,3898,78611,96714,230
Central30,383436,79714,376401,27713,207
Bryansk Oblast1,46412,4968,53513,5299,241
Vladimir Oblast1,65622,28913,46017,93310,829
Ivanovo Oblast1,31214,71611,21714,13110,771
Tverskaya Oblast1,66816,69110,00715,1859,104
Kaluga Oblast1,0819,1428,4579,9059,163
Kostroma Oblast8129,09111,19510,33912,732
Moscow City8,957187,46420,929178,16519,891
Moscow Oblast6,70776,46411,40161,2069,126
Orel Oblast9039,57710,60511,34912,568
Ryazan Oblast1,34416,00211,90614,39310,709
Smolensk Oblast1,16313,43611,55312,69410,914
Tula Oblast1,84422,44412,17119,05010,331
Yaroslavl Oblast1,47226,98618,33323,39815,895
Volga-Vyatka8,483101,00211,906107,84712,713
Nizhegorod Oblast3,70457,71415,58249,33913.321
Kirov Oblast1,70019,22411,30919,08811,228
Mari Republic7625,1916,81210,25013,452
Mordovian Sov. Soc. Rep9647,8088,10013,28013,776
Chuvash Oblast1,35311,0658,17815,88911,743
Central Chernozem776293603120598886711449
Belgorod Oblast140821499152692067514684
Voroneszh Oblast2475235369509230469311
Kursk Oblast133517993134781522511405
Lipetsk Oblast123418669151291640313293
Tambov Oblast13101190590881351810319
Volga16,641280,72016,869247,73914,887
Astrakhan Oblast1,0108,1278,04610,76210,655
Volgograd Oblast2,64336,83013,93533,09912,523
Samara Oblast3,29670,31021,33258,66817,800
Penza Oblast1.51411,7277,74612,9028,522
Saratov Oblast2,71128,50910,51626,5649,799
Ulyanovsk Oblast1,44418,59012,87417,93812,423
Kalmyk Oblast3271,9686,0185,61917,184
Tatar Republic3,696104,65928,31782,18722,2.37
North Caucasus17,246142,3918,256162,3779,415
Krasnodar Kray4,79748,50610,11245,6269,511
Adygey Republic4423,5998,1424,82810,924
Stavropol Kray2,53619,3797,64218,4687,282
Karachay-Cherkess SSR4312,9736,8974,2179,785
Rostov Ob last4,36348,37211,08743,87810,057
Daghestan Oblast1,8904,8012,54021,23911,238
Karardino-Balkar SSR7844,6175,8897,7909,936
North Ossetin SSR6955,1607,4259,69013,942
Ingush-Checken Republic1,3084,9843,8106,6405,077
Urals20,430393,86619,279331,65316,234
Kurgan Region1,11510,9149,78812,75911,443
Orenburg Oblast2,20429,12813,21625,88511,745
Perm Oblast2,94947,00715,94043,69114,816
Komi-Perm Aut. Okrug1603145,0881,90711,919
Ekatermburg Okrug4,71980,47517,05373,91115.662
Chelyabinsk Oblast3,63861,52516,91266,56118,296
Bashkortostan Republic4,008142,76435,62086,17821,502
Udmurt Republic1,63721,23912,97520,76212,683
Western Siberia15,167304,16320,054296,07619,521
Altai Kray2,66624,1349,05330,60711.481
Altai Republic1981,0225,1601,05515,431
Kemerov Oblast3,18162,72819,72063,71920,031
Novosibirsk Oblast2,80327,2599,72528,95010,328
Omsk Oblast2,17029,41113,55331,52914,529
Tomsk Oblast1,01214,11413,94713,97013,804
Tyumen Oblast1,35324,32417,97827,76120,518
Khanti-Mansi Aut. Okrug1,30588,20667,59166,78851,179
Yamal-Nenets Republic47932,96568,82129,69761,998
Eastern Siberia9,260143,72815,521156,52016,903
Kransnoyarsk Kray2,97359,99820,18153,00017,827
Khakasia Aut. Okrug5817,99713,7647,46012,841
Taymyr Okrug Aut. Oblast531,17522,1731,97137,186
Evenk Autonomous Oblast2536114,4261,01840,738
Irkustsk Oblast2,73250,82018,60250,41818,455
Ust-Orda Buryat Aut. Okrug1405133,6632,02914,494
Chita Oblast1,31212,4329,47516,16912,324
Aga-Buryat Aut. Oblast792132,6991,68021,264
Buryatt SSR1,0599,1238,61516,19915,296
Tuva SSR3061,0973,5866,57521,487
Far east8,032209,24126,051229,51728,575
Primoskiv Kray2,30930,90713,38531,79013,768
Kabarovsk Oblast1,6342,90517,78030,29618,541
Jewish Aut, Okrug2211,8978,5863,30014,931
Amur Oblast1,07512,75911,86914,47113,462
Kamchatka Oblast4336,79815,70011,56626,711
Koriak Oblast3943911,2543,15780,948
Magadan Okrug36312,99735,80514,37839,609
Chukchi SAR1464,47310,6369,95568,182
Sakhalin Oblast71913,18318,33519,15726,644
Sakha Republic (Yakutiya)1,09396,73588,50491,44683,665
Kaliningrad Oblast8949,90111,07510,13011,331
Total all regions148,7042,323,717185,2172,253,382185,840

The territory of administrative units created on the basis of nationality groups (namely all republics, autonomous oblasts, and autonomous okrugs) covers 53 percent of the territorial area of Russia and includes 20 percent of the total population. Forty-nine oblasts, 2 metropolitan cities, and 6 krays (excluding the territory and population of the administrative units within their borders) constitute the remaining 47 percent of the territory and 80 percent of the population. The territory and population of the three resource-rich republics—Yakutia, Tatarstan, Bashkorostan—that have demonstrated a strong desire for greater autonomy, and particularly control over revenue from their own resources, account for about 20 percent of the territory and 6 percent of the population.

Over time, however, administrative units without nationality-based distinctions have also been seeking greater autonomy. This is evidenced by the number of oblasts and krays—including St. Petersburg City, Rostov Oblast, Krasnodar Kray, and Stavropol Kray—that have demanded republic status, as well as by the demands of lower-level administrative units, such as okrugs, to gain a higher status.

Expenditure Assignment

Although the expenditure assignments to different levels of governments inherited by Russia after the breakdown of the U.S.S.R. had a sound conceptual base, subsequent developments have been marked by discretionary changes that do not appear to fit into a consistent long-term strategy.

The theoretical assignment of recurrent expenditure responsibilities under the U.S.S.R. was broadly consistent with that which might have been expected from application of the “subsidiarity principle” (see Chapter 2). The central budget included activities and enterprises that were considered to be of national importance (such as transport, heavy industry, and defense) including, importantly, subsidies to large state-owned enterprises. The center was also responsible for foreign affairs, national law enforcement, debt servicing, university education, technical and vocational education, medical and pure research, national parks, and cultural services. Subnational administrative units were responsible for small and light industry (including consumer goods), public services, and regional roads. Rayons and cities had responsibility for housing, utilities, trade, and public services such as health care and pre-university education.

However, in practice, subnational governments never had the autonomy to determine either the level or the composition of their services. All substantive decisions were taken at the central level of government, and only the execution was left to the subnational governments. The decision-making process with regard to capital expenditures was highly centralized both in form and practice. All investments were financed and implemented by the former Gosplan with the exception of those funded directly by the Ministry of Finance or by specific public enterprises.

Since the breakdown of the U.S.S.R., expenditure responsibilities have become more blurred, with particular responsibilities and projects often being assigned on a case-by-case basis. As a result, while the basic structure of assignments (Table 2) still follows the logic of the former U.S.S.R. system, there is now greater variance of subnational responsibilities across regions.

Table 2.Russian Federation: Expenditure Assignment in the Russian Federation
ExpenditureFederalOblastsRayonsVillage Soviets
Defense100 percent except military housingMilitary housing
Justice and internal security100 percent
Foreign economic relations100 percent
Education1All university and research institute expenditures All technical and vocational school expendituresSeveral special vocational schoolsWages, operations construction, and maintenance of all primary and secondary schools
Culture and parks2National museums National theaterSome museums with oblast significanceSome museums All recurrent expenditures of all sport and park facilities and all other cultural facilities
Health3Medical research institutesTertiary hospitals, psychiatric hospitals, veteran hospitals, diagnostic centers, and special service hospitals (cardiology, etc.)Secondary hospitals Primary health clinics MedicinesParamedics
Roads4Construction of all roads Maintenance of federal roadsMaintenance of oblast roadsMaintenance of rayon and city roadsMaintenance of commercial roads
Public transportation(Previously interjurisdictional highways, air, and rail)Most public transportation facilities (earlier assigned to federal government)Some transportation facilities including subway systems
File protectionMost fire protection servicesVoluntary, military and enterprise services possible at this level
LibrariesSpecial libraries, e.g., Lenin LibrarySpecial library servicesMost local library services
Police servicesNational militiaRoad (traffic) policeLocal security policy (since 1991)
Sanitation6 (garbage collection)Part of garbage collectionPart of garbage collection
Sewerage7Infrastructure capital investmentMost of the operational expendituresSome operational expenditures
Public utilities (gas, electricity, and water)Subsidies to households (not enterprises)
Housing8Building and developmentMaintenance and small-scale building
Price subsidiesFuels Mass transport Food: bread, milk Medicines
Welfare compensationPart central government responsibilityPart oblast government responsibilityManaging programs funded by upper level governments
Public enterprises (productive sectors)Capacity to invest in joint ventures (keeps 50 percent of privatization proceeds if rayon subordination)Capacity to invest in joint ventures (keeps 50 percent of privatization proceeds if rayon subordination and 10 percent of any other subordination)
EnvironmentResponsible for national environmental issuesResponsible for local environmental problems, e.g., preservation of forestsIf transferred to local level
Enterprises“Group A” enterprises, e.g., transport and heavy industry “Group P” enterprises, e.g., light industry, transport, and agriculture“Group C” enterprises, e.g., local light industry, housing construction, and food industry

Public enterprises also build schools but typically do not operate them. They frequently operate kindergarten services.

Some enterprises build sport facilities.

Some enterprises build hospitals and in some cases also operate them. Social insurance mostly financed by enterprises pays for health services of those covered.

There is a “special extrabudgetary fund” financed by an excise tax on oil consumption.

There are special fire protection services provided by enterprises, but on the decrease.

Usually there are no separate user charges for garbage collection.

There are separate user charges for sewerage.

Enterprises have been important builders of housing and own close to half of the housing stock in Russia. The central government has transferred housing to local governments; maintenance is the responsibility of the level of government or enterprises owning it. Capital expenditures are included unless otherwise noted.

Public enterprises also build schools but typically do not operate them. They frequently operate kindergarten services.

Some enterprises build sport facilities.

Some enterprises build hospitals and in some cases also operate them. Social insurance mostly financed by enterprises pays for health services of those covered.

There is a “special extrabudgetary fund” financed by an excise tax on oil consumption.

There are special fire protection services provided by enterprises, but on the decrease.

Usually there are no separate user charges for garbage collection.

There are separate user charges for sewerage.

Enterprises have been important builders of housing and own close to half of the housing stock in Russia. The central government has transferred housing to local governments; maintenance is the responsibility of the level of government or enterprises owning it. Capital expenditures are included unless otherwise noted.

Despite the greater diversity in subnational responsibilities, it is possible to delineate some important trends since 1991. First, the central government shifted responsibility to subnational governments for funding and administration of most price subsidies (milk, bread, baby food, and so on), and some cash subsidies for vulnerable groups, some welfare programs for pensioners, family allowances and child compensation, and support for the homeless. These outlays were quite substantial at the outset; for example, aggregate price subsidies accounted for about 4 percent of GDP when they were transferred in the first quarter of 1992. However, over time these expenditures have declined in magnitude, particularly as the majority of price subsidies were phased out. It should be noted that most subnational governments received only partial compensation for the tasks they took over.2

Second, regional and local governments have been taking over the social safety net provisions previously carried out and financed by state-owned enterprises. The total social spending by enterprises has been estimated to constitute more then 3 percent of GDP in 1993, equal to 14 percent of the wage bill, or about a quarter of total budget spending on social purposes. About 40 percent of these expenditures are used for housing maintenance. Although enterprises’ social spending has declined in real terms during the last couple of years, this burden is still a key constraint on enterprise restructuring and privatization, and a successful completion of this transition is important for the establishment of a well-functioning private sector.

It is an unresolved empirical question whether such divestiture of social assets imposes a net burden on local governments. A part of the increase in budgetary expenditures would be compensated by higher profit taxes because the costs for the enterprises have been deductible for tax purposes, and the federal government partly compensates local governments for the increased expenditure burden through increased specific transfers. In addition, a local government turnover tax of 1.5 percent was introduced in 1993 to help finance the extra expenditures. The increased local expenditures would be partly neutralized by reductions in subsidies previously extended to enterprises maintaining large stocks of social assets.

Third, responsibility for funding many capital projects was also shifted to subnational governments. The projects in question appear to include some that might be considered national projects usually undertaken by central governments, such as airports, inter-oblast highways, and housing for military personnel.

Revenue Assignment

Russia took over the revenue and expenditure responsibilities for its regions from the former Soviet Union at the end of 1991 and began to pursue “sovereign” tax policies. Many of the tax-sharing arrangements between the central and subnational governments initially remained in place. This situation began to change in late 1991, however, as new market-oriented taxes were introduced to replace the former system of state financing, which relied heavily on profit remittances from state enterprises.

Russia introduced its own budget toward the end of 1991 and, by mid-1992, a wide range of new tax laws were in place, including those for the value-added tax (VAT), the corporate income tax, excise taxes, and a revised personal income tax. This reform package was spelled out in the Law on the Basic Principles of Taxation and a series of laws on particular taxes. The Law on the Basic Principles of Taxation set down a unified structure together with accompanying rules, penalties, tax administration powers, and maximum rates for some taxes.

Under the law, the following taxes accrued fully to the federal level, with the central government having control over the rate and the tax base: VAT, export taxes (abolished in 1996), excises on motor vehicles and alcohol, taxes on bank and insurance profits, taxes on “exchange activities” and securities operations, and customs duties. Natural resource taxes are to be shared with subnational governments.

The revenues assigned to subnational governments, where the central government would retain control over the base and the rates of tax, include revenues from personal income tax, corporate income tax, and all excises except motor vehicle excise and alcohol. In addition, the subnational governments were to set their own rates on taxes imposed on the following tax bases to be defined by the central government: property and asset taxes on enterprises, forestry taxes, and payment for water use. The subnational governments were also to receive all revenues, at rates established by them, from road fund taxes, stamp duty, estate duty, gift tax, and inheritance taxes.

Rayons were to be permitted to set both the rate and base on 21 taxes and fees: property tax on natural persons including the land tax; business registration fees; construction in resort areas; resort fees; tax on the right to trade; special purpose taxes for maintenance of militia; taxes on advertising, resale of cars, computers, and ownership of dogs; license fees for sale of wine and liquor; conduct of auctions; occupancy of apartments; car parking; trademarks; participation in horse racing, winnings at horse races, and totalizer games at races; commodity exchange transactions; and cinema and television film production.

The Law on the Basic Principles of Taxation, however, has never been fully implemented. In practice, the corporate income tax has been shared between the federal and oblast levels, and personal income tax revenues have flowed to the subnational levels, including some allocation by oblasts to rayons (up to 1996, the personal income tax was a shared tax). In 1994, the corporate income tax (including the excess wage tax) was shared in accordance with tax rates of 13 percent for the federal government and a maximum of 25 percent in each of the regions. This system continued through 1996, but with a maximum for the regional rate of 22 percent. The personal income tax, which previously had accrued solely to the local level, was shared in 1995–96, with 10 percent of total revenues accruing to the federal level, but apparently was earmarked to finance special local expenditure programs. The 1997 budget envisages a return to this tax accruing exclusively to the local level.

Initially, the VAT was shared with oblasts according to a formula that varied the share across regions, in line with some unspecific assessment of revenue capacity (for example, oblasts with large VAT collections often retained a smaller portion of collections in that region than oblasts that had relatively lower collections). However, starting in April 1994, the federal VAT statutory share has been a uniform 75 percent. The main reason why the recorded federal share of the domestic VAT revenues in 1994–96 has been well below the statutory 75 percent was a set of negotiated settlements with individual regions according to which the regions were allowed to keep part of the federal VAT proceeds against offsetting reductions in the federal transfers to the regions in question. This system was allegedly implemented to simplify the flow of funds between the two levels of government. In addition, there are indications that some regions did not fully comply with their legal obligations to remit a share of VAT revenues (and other tax revenues) to the federal government, albeit little is known about the precise nature and magnitude of this phenomenon.

In common with duties and other taxes on foreign trade, the VAT on imports, which was gradually introduced during 1993, accrues solely to the federal government. The special 3 percent VAT surcharge, in force in 1994, was maintained through March 1996, but with a lower rate of 1½ percent. Proceeds were earmarked for special sectors, in particular agriculture. The special surcharge was eliminated after March 1, 1996. The excise on vodka was shared equally with the oblasts.

Table 3 shows the outcome of the tax-assignment and tax-sharing systems (all of which are based on the derivation principle) that occurred during 1992–95.

Table 3.Russia: Revenue-Sharing Arrangements(In percent of total)
Initial Plan in 1992: Basic Principles1992 Actual1993 Actual1994 Actual1995 Actual
FederalLocalFederalLocalFederalLocalFederalLocalFederalLocal
Value-added tax (VAT)10007525643673277426
Of which:
Domestic VAT7129
Import VAT1000
3% (1.5%) VAT6733
Profit tax01004159336735653565
Personal income tax01000100010001001090
Excise on alcohol10005050505050505050
License fee on alcohol1000
Other nonenergy excises40604258
Energy excises1000100010001000
Natural resource taxes5248485222783565
Property tax01000100010001000100
Land tax01000100010001000100
Foreign trade taxes100098298210001000
Total revenue, excluding transfers5743485246544951
(In percent of GDP)16.412.613.714.811.813.910.611.1
Sources: Ministry of Finance; World Bank; and IMF staff estimates.
Sources: Ministry of Finance; World Bank; and IMF staff estimates.

To alleviate uncertainties at a time of presidential, regional, and local elections, the Law on the 1996 Federal Budget committed the government to maintain existing revenue-sharing proportions for three years. This feature has been maintained in large part in the 1997 budget. The tax code, which is in the process of being drafted and could be approved by the parliament in 1997, aims to consolidate existing legal tax provisions into a comprehensive, consistent, and transparent legal basis for the future tax system, including arrangements for tax assignment and tax sharing.

Regional Expenditure and Revenue Budgets

Table 1 shows the considerable disparities between administrative regions in per capita revenues and expenditures in 1992. These regional disparities largely reflect differences in economic wealth and activity between regions. As the main regional tax revenues come from the profit tax, the VAT, and the personal income tax in regional budgets, regions with strong industries or natural resources, particularly oil and precious metals, tend to have higher per capita revenues. Regions with large rural communities generally fare poorly, and this situation is exacerbated by the tax exemptions available to agriculture, which erode the tax bases.

Since few regions have the capacity to finance substantial ongoing deficits, per capita expenditures are governed by available own account revenues, loans, and subventions from the center. Almost 80 percent of expenditure is made in two functional areas, the national economy (including, in particular, subsidies to housing, enterprises, and agriculture) and sociocultural activities (mainly health and education outlays). Sociocultural expenditures have tended to be more equal across regions, while national economy outlays and other more discretionary expenditures are considerably higher in the richer regions.

Despite the inability of most regions to run substantial deficits on a sustained basis, the aggregate position of regional budgets has deteriorated over the years. While subnational governments had a fiscal surplus of 1.5 percent of GDP in 1992, this position weakened to a surplus of 0.5 percent in 1994 and estimated deficits of 0.2–0.3 percent in 1995 and 1996 (Table 4). These deficits were largely financed by the issuance of local debt instruments, such as veksels, and privatization proceeds.

Table 4.Russia: Summary Operations of the Enlarged Government(In percent of GDP unless otherwise indicated)
1992199319941995Est. 1996
Enlarged government balance (deficit −)−18.4−7.4−10.4−5.1−6.6
Revenues39.336.234.627.924.5
Expenditures57.743.645.033.031.1
Federal government balance1−10.4−6.5−11.4−4.8−6.3
Revenues16.613.711.810.69.5
Expenditures27.020.223.215.415.8
Interest0.72.02.02.94.5
Transfers to local government1 72.64.11.32.1
Local government balance11.50.60.5−0.3−0.2
Revenues13.516.718.012.411.6
Of which; federal transfers1.72.64.11.32.1
Expenditures12.016.117.512.711.8
Extrabudgetary funds balance12.50.60.50.0−0.1
Revenues10.98.69.06.65.6
Of which: federal transfers0.20.10.40.0
Expenditures8.48.08.66.65.7
Unbudgeted import subsidies11.92.10.00.0
GDP (in trillions of rubles)19.2171.5611.01,862.12,823
Sources: Ministry of Finance; Central Bank of Russia; Goskomstat; and IMF staff calculations.

Unconsolidated revenues and expenditures (inclusive of intragovernmental transfers).

Sources: Ministry of Finance; Central Bank of Russia; Goskomstat; and IMF staff calculations.

Unconsolidated revenues and expenditures (inclusive of intragovernmental transfers).

New System of Transfers

The Law on Basic Principles and other relevant legislation established no explicit arrangements for transfers and grants to lower-level governments. This situation appears to reflect experience in the U.S.S.R., where transfers and grants were supplanted by the complex tax-sharing arrangements, which largely negated the need for such payments. Where such payments were made—usually to fill temporary gaps—they tended to be negotiated on an ad hoc basis with no explicit rules or formula for their determination. Thus, there was no concerted attempt to “equalize” the fiscal capacities of the various regions to sustain the provision of public services of similar standard.

Intergovernmental fiscal relations during the 1991–93 period of transition were based on three main pillars: (1) a quasi-equalizing tax (VAT), with local shares differentiated according to the supplementary revenue needs of local budgets in relatively weaker financial positions; (2) transfers from the federal government to the regions, which took the form of grants or budget loans;3 and (3) special treatment granted to selected regions on a case-by-case basis, often involving exemptions from paying export taxes or import duties, as well as exemptions from transferring federal taxes to Moscow.

Although several attempts were made to place the system on a transparent and permanent basis, bargaining remained the centerpiece of intergovernmental fiscal relations in the first two years of reform. Recognition of these shortcomings led to a redesigned system of fiscal relations, which came into effect in April 1994.

Under the new system, the Fund for Regional Support was instituted and was financed by 22 percent (27 percent since 1995) of total VAT receipts out of the federal government’s 75 percent share (see above). These resources, determined on the basis of formulas, were intended to serve as the sole source of federal transfers to local governments and largely replace subventions, but shortfalls in actual VAT collections relative to budget projections resulted in the continuation of other types of discretionary transfers (that is, regions being allowed to withhold a larger proportion of VAT, discretionary lending, and other ad hoc transfers with an important subsidy element).

Federal transfers were provided from the Fund for Regional Support according to two formulas, depending upon whether a region was deemed “in need of support” or “very much in need of support.” For each subsequent year, while the size of the fund was set by that year’s VAT revenues, each region’s share in the fund4 was determined on the basis of 1993 data.

Regions were classified as in need of support if their per capita revenues fell below a threshold equal to the average for Russia.5 This determined the unadjusted size of a region’s notional transfer. In order to scale the transfer up or down to reflect different cost structures in different sections of the country, the unadjusted transfers were adjusted according to average expenditure patterns in each of Russia’s 12 economic districts.6 To determine the adjustment, average per capita expenditures (net of investment) were multiplied by 0.95,7 yielding a per capita expenditure norm for each region, denominated in 1993 rubles.

Regions were considered very much in need of support if their own revenues plus the adjusted notional transfer would not have been sufficient to cover their current expenditures. In this case, an additional transfer would be required.

A large and increasing number of regions have been classified as both “needy” and “very needy.” The number of needy regions increased from 59 (of the 89) in 1993 to 64 and 78 in 1994 and 1995, respectively. Very needy regions increased from 23 in 1993 to 53 in 1995. For the most part, the very needy regions are located in the southern part of European Russia (such as the Republics of Dagestan and Kalmykia), Western Siberia (such as Kemerova and Omsk oblasts), Eastern Siberia (such as the Buriat and Tuvinian Republics), and the Far East (such as Kamchatka and Sakhalin oblasts). Regions that are not needy at all tend to be either large cities (such as Moscow, Moscow oblast, St. Petersburg, and Nizhnyi Novgorod oblast) or located in the northern or central part of European Russia, the Urals, or—in the case of energy-producing regions like Tuymen oblast—Western Siberia.

Despite a move toward greater transparency and reliance on rules rather than discretion with this system of transfers, a series of problems have arisen. First, the transfer mechanism is based on actual expenditure and revenue data for each region rather than underlying objective measures of revenue capacity and expenditure needs. This implies that, to some extent, regions may be able to manipulate the formula to their advantage. For instance, regions will continue to have a strong incentive to place resources in local extrabudgetary funds, whose revenues and expenditures are not included in the formula. The hoarding of resources in such extrabudgetary funds would alter the amount of transfers due to them. Such strategic budgetary accounting explains in part the significant increase in eligible regions. With regard to transfers to the very needy regions, the mechanism provides incentives for regions to overspend with the transfer being relegated to gap filling rather than equalization of needs and fiscal capacity. Finally, the degree of equalization that is possible to achieve in the present system is constrained by the financing limit of 22 percent (27 percent since 1995) of the total VAT revenues. In other words, the degree of equalization, which in any case is fairly modest owing to the limited size of the transfers relative to total regional budget expenditures, will vary over time in accordance with the revenue buoyancy of the VAT.

The Russian authorities are currently discussing ways of further improving the system of transfers, and parliamentary hearings on this issue have been initiated. Already for 1997, it is intended that the criteria for eligibility to the Fund for Regional Support be tightened so as to include only remote regions, regions with an extended heating season, and regions with a limited period in the year in which they can receive commodity supplies (mainly in the far North). Further work in modifying the transfer arrangements is planned in 1997, including the possible introduction of conditional transfers that reward regions that implement local policies in accordance with federal guidelines.

Natural Resource Taxation

The uncertainties created by political and economic events in Russia suggest that further changes to revenue assignments will evolve over time, particularly in natural resource taxation. Russia has vast untapped natural resources, many of which are located in ethnic regions. At present, the natural resource taxes are directed mainly at oil and gas extraction where a combination of royalties, export taxes, and fees are imposed. Under the present system, certain of these taxes are assigned to the center and some are shared according to either negotiated or fixed sharing systems.

Recent events have indicated that this situation could change. The Law on Ethnic Minorities has given indigenous populations an effective veto power over the development of natural resources in their traditional lands. The native peoples of Khanti Manisk already have such veto power under a presidential decree. Contracts formed between development enterprises and the tribe will define compensation and govern the resource exploitation process. Similar arrangements now apply in other republics. For example, the Republic of Sakha has secured significant concessions to sell directly substantial portions of the mineral resources in the republic, including 20 percent of diamonds produced there.

These pressures for local control are accentuated by past experience that has seen regional poverty and environmental problems coexist with considerable natural resource wealth. Although the pressures now emerging run the risk of going to the other extreme—preserving huge amounts of wealth for a very small proportion of the total population—some populations in oil-rich areas see their claims as a form of indemnification for past neglect under the Soviet system.

Special Treaties

In the absence of clear assignments for each level of government, the central government has found itself agreeing to a number of de facto relationships with various regional governments under which it has negotiated some share of overall regional revenues in return for the provision of a range of services such as defense and foreign affairs. Under these special treaties, the regional governments concerned seek to become largely independent, taking responsibility for the bulk of their own affairs in return for a single payment to the central government. The region of Bashkiria is one such case. The oblast government has established a “single channel” agreement with the federal government, retaining all revenue from all taxes collected in its territory and transferring a fixed amount each month to the federal budget.

Borrowing

Laws passed in 19928 give oblasts, cities, and rayons the right, in principle unlimited, to borrow. However, in practice, different factors, including the building up of substantial payment arrears, have prevented a surge in subnational borrowing. Although some subnational governments may be able to borrow against natural resource developments and other assets, most have limited assets or income that could be used as collateral for loans. Moreover, institutional factors, such as lack of commercial bank facilities and financial markets capable of absorbing market-style debt instruments, inhibit subnational borrowing. Nevertheless, there are indications that these obstacles are slowly being overcome, and that some subnational governments have issued or are in the process of preparing issues of securities (there is even some talk of regions borrowing abroad). This is a worrisome trend in a still underdeveloped and nontransparent capital market, in the absence of clearly specified and firmly enforced rules limiting such borrowing to levels that can be serviced in the future, and due to the fact that such borrowing could carry an implicit guarantee that the federal government would bail out the subnational government in case of default.

Administration of Subnational Governments

Tax Administration

Until 1990, the tax administration was highly decentralized. Regional and local offices were supervised by their respective Offices of Finance. However, in November 1991, the State Tax Service was separated from the Ministry of Finance and made an autonomous agency with ministerial ranking. It is now in charge of administering all taxes in Russia, including taxes imposed by the regional and local governments. Tax policy remains the responsibility of the Ministry of Finance. These arrangements were endorsed by the Law on the Basic Principles of Taxation.

The new arrangements have substantially reduced the dual leadership problems of the former decentralized administration, which raised potential conflicts in setting priority in collection of national versus local taxes. This issue has not been entirely overcome, however, since local administrations are still responsible for allocating and providing housing to State Tax Service staff and for paying their fringe benefits (only their wages are paid from the central budget). Furthermore, the increased frequency of payments of shared taxes to local tax offices in the form of local debt instruments or in kind has further complicated the relationship between the center and the local tax administrations.

Budget Formulation and Implementation

If the planned devolution of fiscal policy is to have its maximum impact, it is important that local officials be responsive to local needs.

That, in turn, requires local officials to have more discretion to decide on the planning and implementation of local expenditure. As noted earlier, the recently passed Laws on the Rights of Local Self-Government and Basic Principles of the Budget System and Budgetary Process purport to grant full autonomy to subnational governments in the formulation and implementation of their budgets.

In practice, this autonomy appears heavily constrained. For example, the central government still determines the salary levels of all employees and sets ceilings on public enterprise prices and rents. Most important, the central government still determines the tax-sharing arrangements vital to subnational budget financing. Local governments are also constrained by the process of norm setting by the central government, which prescribes the level of specific services that local governments are expected to provide. These features render the system of local governance nontransparent and question the degree of accountability of regional and local governments.

The technical basis for subnational governments’ ability to perform the tasks of budget execution, expenditure control, and revenue collection also needs to be improved, and ought to be developed in parallel with the ongoing program for setting up a new federal treasury system with regional and local offices. In addition to serving as a model of financial management by the subnational governments, that project could also have positive spillover effects for local governments, to the extent that it achieves the expected improvements in revenue collections for taxes, including shared taxes.

Policy Implications

It is only quite recently that Russia has made significant inroads toward financial stabilization. The general government deficit amounted to about 4.8 percent of GDP in 1995, compared with about 20.5 percent in 1992, and is provisionally estimated to have reached 6.3 percent of GDP in 1996. The combination of further efforts aimed at consolidating stabilization, the fundamental structural changes in the economy, and strong centrifugal forces and regional conflicts have created an extremely complex setting for the reform of intergovernmental fiscal relations.

Faced with intense pressure on the state budget, the central government has reacted in two ways during the transition. First, it has sought to divest a substantial portion of its social and new capital spending to subnational levels of government. Second, it has sought in different ways to boost its revenues by increased taxation and other charges, although these attempts so far have not been sufficient to reverse a major decline in revenue collections. More seriously, while these short-term reactions may be understandable, they do not necessarily present longer-term solutions for two reasons.

First, notwithstanding recent progress in reducing the fiscal deficit, the central budget appears vulnerable. Unlike a number of other federations reviewed in this book, the central government in Russia has financed an overwhelming majority of the national fiscal deficit. Further devolution of revenue powers to the subnational governments, therefore, threatens to leave the central government (and to some extent also the social funds) without sufficient revenue resources to meet the many national expenditure needs, including the maintenance and further development of a social safety net, clean-up expenditures for the environment, and basic infrastructure development. This situation could be exacerbated if the emergence of special treaties with regional governments leaves the federal government unable to tax prospective resource developments effectively, or to benefit fully from the movement of oil and other resource prices to world levels.

Second, while the attempt to push expenditure responsibilities down the line to subnational governments may be a natural reaction in current circumstances, not all these governments will have the capacity to fund such added responsibilities. One of four choices will therefore face these governments: (1) important expenditures will not be made, (2) new and possibly less efficient revenue sources will have to be tapped, (3) some regional governments will try to exploit their borrowing powers and capacities, or (4) the regional government can seek to become independent via the creation of a special treaty with the central government. The choice will largely be determined by the revenue sources available to the regions concerned. Those regions with access to natural resource revenues will face a strong temptation to tap these resources, either directly or indirectly through the added borrowing capacity that such revenue bases may generate, and to establish special treaties with the central government. As noted earlier, however, widespread implementation of special treaties would weaken the revenue capacity of the central government.

In some sense, the mounting fiscal pressure may force local governments to implement policies supportive of a transition to a market economy, including speeding up privatization of municipal property, which may constitute a drain on local budgets, issuing local government securities (municipal bonds), which may assist in developing regional capital markets, and decontrolling prices and improving cost-recovery for utilities and local service provision, which will improve economic efficiency as well as the local budget position.

A potentially detrimental side effect of the above-mentioned budget devolution is the scope for further divergence in the already wide regional disparities in the provision of public services. Such regional disparities may ultimately set in train added strains on the federation, including demands on the central government to make equalizing grants to regions that find themselves incapable of meeting acceptable nationwide standards in the provision of public services. Added pressure may fall on the central government to maintain and improve social safety net mechanisms in the poorer provinces.

Against this background, an intergovernmental fiscal program with a medium-term time perspective is urgently called for. Such a program should encompass the following elements.

  • Clarification of, and adjustments to, present expenditure assignments. Ultimately, the goal must be implementation of a comprehensive, transparent, and stable system of expenditure assignments, which allocates clear responsibilities for the different tasks to each level of government, including the social responsibilities now borne by enterprises. The system must leave room for subnational governments to vary service levels in accordance with local needs, but must also set strict limits for local government price regulation powers and for the possibility of providing subsidies to local enterprises and households.

  • A comprehensive, consistent, and transparent legal basis for the tax system, including arrangements for tax assignment and tax sharing. Over the medium term, regional and local governments should be assigned at least one major source of revenue, for which they could determine the rate, to enhance their accountability and responsibility. The sharing of other sources of revenue should be adequate to cover the gap between revenue powers and expenditure responsibilities. Revenue sharing based on derivation principles should be complemented by vertical or horizontal transfers designed to achieve a desired degree of equalization of revenue capacities and expenditure needs across regions.

  • To the extent that borrowing by subnational governments is allowed, it should be limited in accordance with clear and transparent principles that take into account the debt-servicing capacity of each government.

Finally, concerning most of the areas referred to above, there is a clear need to improve the scope and quality of statistical reporting covering the operations of the subnational levels of government in Russia, with the aim of enhancing the transparency of these operations and thereby improving the basis of economic analysis and future policymaking.

Although a recent presidential decree mandates full cost recovery in the housing sector to be achieved by 1998.

These were short-term, interest-free loans from the federal budget, which, in theory, were to be repaid within the fiscal year, although typically they were not repaid.

This relates to the last nine months of 1994 only, as the old system was still in operation during the first quarter.

The average per capita local government revenue for Russia as a whole, multiplied by 0.95, which serves to leave some regions (in 1994, three in European Russia) otherwise eligible out of the transfer system. Certain regions, notably those administered by the Ministry of Defense and the city of Sochi, will be excluded from this scheme and will be subject to a special financial regime.

Including Kaliningrad oblast. There is some evidence that the average for Russia as a whole has been used so far, instead of that for each economic district.

According to the authorities, the intent of this step is to stimulate additional own revenue generation by the regions.

Law on the Rights of Local Self-Government and Law on Budgetary Rights of Local Self-Governments.

References

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