VI The Tasks Ahead
- Sergei Alexashenko, and Augusto López-Claros
- Published Date:
- April 1998
Russia has made remarkable progress during the 1990s in laying out the foundations of a market economy and in defining the role of the state within it, both in its capacity as intermediator of a large share of resources and as the primary agent for the establishment of the institutions and rules that govern economic relationships. It is beyond the scope of this chapter to make a listing of the many enduring changes that have characterized this period and that have taken the Russian economy from the days of the Soviet plans, when the state “sought to control all activity in society,” 72 to the first days of economic liberalization, when initial tentative steps were taken aimed at creating the basic elements of a functioning market economy, to the present when the bulk of economic activity is generated within an expanding private sector and in the context of a system of flexible prices reflecting relative scarcities in the marketplace.
Some of the positive developments underlying this process of change have taken place in those areas most closely linked with the fiscal functions of the government and have involved, for instance, moves toward the establishment of a tax system freer of some of the distortions of the past, which has enhanced the transparency and efficiency of existing taxes and is closer in its chief characteristics to inter-nationally accepted norms. In practice, this involved the introduction of a VAT and excise taxes, schedular personal income taxes, a profit tax to replace confiscatory profit taking from the enterprise sector, and the conversion of nontariff trade barriers to ad valorem duties. Together with the liberalization of prices and the gradual introduction of a modern tax system, there has also been a retrenchment in the scope of activities traditionally financed by the state affecting, mainly, a broad range of consumer and producer subsidies, a process that has contributed to reduce distortions in the economy and has laid the basis for a more stable macroeconomy.
Nevertheless, much remains to be done in the period ahead. This paper has tried to identify some of the key challenges facing decision makers over the medium term, with particular reference to the policy choices and institutional developments that must underpin the implementation of fiscal policy.
Key elements of the unfinished agenda on the revenue side include the following.
- The basic legal tax provisions remain embodied in a collection of legislative acts, presidential decrees, and government resolutions put together with no attempt at consistency or administrative simplicity. Furthermore, these are subject to frequent and unpredictable changes; for example, 24 different amended versions of the VAT and profit tax laws were promulgated in 1992–95. While the prospective adoption of a tax code should go a long way toward coherence and predictability in Russia’s tax legislation, it will not, in and of itself, be effective without parallel improvements in other areas.
- The fiscal relationship between the federal government and the subjects of the federation needs to be clarified. Lack of clarity in this area has allowed the regional and local authorities to introduce many new taxes not envisaged in the tax legislation and has contributed to the general weakening of the tax-compliance environment. In the process, the system of intergovernmental fiscal relations has been undermined, as evidenced by the growing number of regions entering into “special” fiscal regimes with the federal government (involving, for instance, the remittance to the federal budget of a smaller VAT share from the region than called for in the law) or “single channel” agreements (which bypass revenue-sharing formulas altogether), thus introducing an element of arbitrariness in the intergovernmental relations that the system of fiscal federalism was initially intended to prevent.
- The widespread use of tax exemptions, often with the declared aim of “supporting key sectors of the economy” or “boosting economic activity,” but more often reflecting lobbying efforts by key constituencies representing various vested interests, has been one of the main reasons for the decline in revenues. No attempts have been made to keep track of all exemptions in place or, in the context of preparation of the budget, to estimate the implied revenue loss and to examine their macroeconomic impact. There is no tax for which there is not some form of exemption, no sector of the economy that has not sought and obtained some form of tax relief; thus tax privileges have become the rule rather than the exception. In the context of tight budgets brought about by the need to bring inflation under control, discretionary recourse to exemptions has made the task of fiscal adjustment more difficult than would otherwise have been necessary, imposing severe constraints on the permissible level of government expenditures and, more generally, undermining public support for economic reform.
- The large increase in the number of taxpayers and the shift in economic activity from the enterprise sector to the emerging private economy (registered or otherwise) has imposed a heavy burden on the administrative capacities of the authorities and complicated tax collection more generally. Tax administration needs to move away from the present system—characterized by large-scale involvement of tax officials in routine functions associated with reporting by taxpayers—to a system guided by the application of internationally accepted principles, such as self-assessment and voluntary compliance. This needs to be supported by a credible system of penalties and fines to discourage noncompliance, efforts to improve coordination between the center and the regional tax authorities, closer monitoring of tax exemptions, the creation of a master file of registered taxpayers that would facilitate the tasks of audit and control, and the creation of a streamlined accounting framework with simpler forms and procedures to encourage taxpayers to fulfill tax obligations. Of critical importance in all of this is the need for the state to earn the confidence of the population that it will use these resources well and in the interests of the public at large and not to preserve the privileges of lobby or interest groups. Without this, tax evasion and noncompliance could become a permanent feature of Russia’s fiscal environment, with disturbing implications for market reforms in general, popular support for them, and, ultimately, the prospects for a recovery of economic growth.
On the expenditure side, key elements of the unfinished agenda include the following.
- The chief priority on the expenditure side is to move away from the pervasive system of expenditure sequestration used in the execution of the budget when faced with revenue shortfalls. As presently applied in Russia, sequestration has introduced a high degree of arbitrariness in the spending process. The spending authorizations included in the budget have become no more than a loose framework providing spending units a rough indication of the maximum level of resources that could potentially become available in the course of the fiscal year. This, inevitably, has introduced considerable uncertainty in their operations, making it difficult to plan and prioritize and focusing the attention of managers in these units on finding ways to lobby the government to maintain a certain flow of financing, at least large enough to pay wages. Sequestration has given rise to situations where individual spending units have unilaterally implemented decisions (for example, wage increases in the military) not contemplated in the budget that, after the event, the government has had to validate on the margins of the budget law—for instance, by granting guarantees to the spending units for short-term borrowing from the banking system. Sequestration has also contributed to the growth of arrears, including in the payment of taxes to the budget. It has thus severely undermined the credibility of the budget as an instrument of fiscal policy and of the government as the architect of that policy.Sequestration has also often shielded the government and parliament from making difficult policy choices in a number of areas. It has sharply limited the ability of the government to monitor the structure of expenditure over time and hence to prevent abuses and the misallocation of scarce resources by individual spending units. There is no alternative, over the medium term, to the elaboration and execution of a budget that is based on realistic macroeconomic assumptions and that economic agents come to recognize as the legal framework within which the state will carry out its responsibilities as the economy’s main intermediator of financial resources.
- A credible budget becomes an urgent priority in the context of a country where the scope for an additional compression of expenditures has probably been exhausted and where there are a number of identified areas where spending pressures will remain over the medium term. These include
- — interest payments, given the rapid accumulation of public debt and the use of market-based debt instruments to finance fiscal deficits;
- — wages, to narrow the gap with respect to the private sector and as various hidden subsidies at the enterprise level continue to be eliminated;
- — capital spending, to stem further deterioration of the country’s physical infrastructure and of the health and education systems;
- — environmental cleanup; and, more generally,
- — institution-building, including support for improvements in the judicial area and institutions created in the context of a market economy.
Priority reforms in the area of social protection include the following.
- The link between the value of pensions and increases in the cost of living needs to be strengthened. This would involve a closer correlation between regional pension levels and the regional cost of living and, in particular, a shift of the minimum pension to the level of the minimum subsistence level.
- The Pension Fund’s revenue base should be improved by including in-kind benefits in the wage base and eliminating a number of exemptions that, with growing arrears in the payment of contributions, have contributed to significantly reduce the effective contribution rate.
- The burden of financing pensions should be distributed more equitably between employers and employees by increasing the contribution rate of the latter while reducing that of the former.
- The functions of the Pension Fund and the Ministry of Labor and Social Development in administering the pension system should be integrated and the jurisdiction over the various social funds clarified. These reforms should also unify the collection of contributions by the various funds.
- The value of benefits should be delinked from the level of the minimum wage, moving to a system involving a greater degree of targeting than at present.
Concerted government action in addressing these challenges should go a long way toward creating a stable macroeconomic environment in Russia, characterized by the rule of law and broad acceptance by the government and the public of the patterns of governance and economic behavior increasingly evident in the developed world. In the absence of such actions, public support for market reforms in general is likely to remain weak or weaken further, confidence in the future is likely to be undermined, the achievement of political stability is likely to remain a distant goal, and an environment conducive to growth is unlikely to emerge. In the absence of growth, a significant improvement in the standard of living of the population is also likely to be postponed. This would be a loss not only for Russia, a country that is so richly endowed with natural and human capital resources, but also for the international community, given the ongoing processes of global integration and the potential contributions that Russia could make to the world economy.