'i'5 lDI
POLICY RESEARCH WORKING PAPER 28 07
The Role of Natural Resources
in Fundamental Tax Reform
in the Russian Federation
Benoit Bosquet
The World Bank M
Europe and Central Asia Region k
Poverty Reduction and Economic Management Sector Unit
March 2002
I POLICY RESEARCH WORKING PAPER 2807
Abstract
The Russian Federation has one of the richest natural owns most of the natural resources, which theoretically
resource endowments in the world. Despite their facilitates change in resource pricing and taxation.
importance in the Russian economy, natural resources do Second, the cost of adjusting the tax system is relatively
not contribute as much as they could to public revenues. low at this time since Russian tax policy is undergoing
Large resource rents (excess payments, or above-normal thorough reform.
profits generated by natural resources in scarce supply) Increasing rent taxation should be relatively
are dissipated through subsidies and wastage, or straightforward since the system already exists. What
appropriated by private interests. Failure to tax this rent mainly needs to be done is to differentiate the fees to
means that taxes must be levied elsewhere (on capital reflect objective rent-generating conditions by
and labor) to sustain revenues, thereby depressing withdrawing the rent and imposing higher taxes on
investment and employment, or that potential revenues profitable resource deposits. A seemingly desirable
are foregone. Failure to reinvest rent means that Russia instrument-true differentiation of rental payments-
perpetuates the tradition of exporting low value-added does not exist in Russia despite legislative provisions that
raw materials and excessive capital outflows, and retards it should. Several natural resource taxes are specific taxes
its transition to sustainable economic development. (set per volume), regardless of the market price or
Bosquet provides estimates of the average and total production cost. Such taxes favor profitable deposits anld
current rent on crude oil, natural gas, and round wood in penalize marginal ones.
Russia. The sum of appropriated rent on oil and gas was The author's study should be given serious
estimated at US$9 billion in 1999 (in excess of $15 consideration in the renewed debate on tax reform and
billion in 2000), or about 18 percent of consolidated tax in the context of Russia's structural reform program. It is
revenues. The appropriated rent on round wood was in line with the proposals of the new governmental
estimated at US$191-1,032 million. economic strategy, particularly with boosting the share
A more appropriate natural resource taxation system of natural resources in generating revenue and reducing
would enhance the fiscal role of natural resources as well income tax rates. The extra advantage to rent taxation
as create better incentives for resource conservation and and revenue recycling is that it would allow the
environmental protection. Two conditions further government to lower the tax burden without leading to a
reinforce the appeal of such a reform. First, the state still budget deficit.
This paper-a product of the Poverty Reduction and Economic Management Sector Unit, Europe and Central Asia
Region-is part of a larger effort in the Bank to understand the quality of fiscal adjustment in Central and Eastern Europe.
Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact
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Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted
at bbosquet@ worldbank.org. March 2002. (66 pages)
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papers carry the nampies of the authors and should be cited accordintgly. The findings, interpretations, and conclusiots expressed in this
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countries they represent.
Produced by the Research Advisory Staff
THE ROLE OF NATURAL RESOURCES
IN FUNDAMENTAL TAX REFORM
IN THE RUSSIAN FEDERATION
Benoit Bosquet
March 2002
TABLE OF CONTENTS
EXECUTIVE SUMMARY ...........................................................i
I. INTRODUCTION ...........................................................1
Overview of Current Tax Structure ...........................................................1
Natural Resource Rent and Its Measurement ...........................................................4
The Taxation of Rent ...........................................................6
II. NATURAL RESOURCE TAXATION IN RUSSIA: CURRENT SYSTEM AND
RECOMMENDATIONS ...........................................................9
Overview ...........................................................9
Oil and Natural Gas .......................................................... 11
Oil and Natural Gas in the Russian Economy ................................................... 11
Tax Regime in the Upstream Oil Sector .......................................................... 11
Licensed oil .......................................................... 12
Proposed Changes in Licensed Oil Taxation ............................................... 13
Production Sharing Agreements .......................................................... 15
Estimation of Oil Rents .......................................................... 16
Estimation of Gas Rents .......................................................... 19
Timber .......................................................... 21
The Russian Forest Revenue System .......................................................... 21
The Forestry Sector in the Russian Economy ................................................... 23
Low Rent Capture .......................................................... 24
Low Stumpage Fees .......................................................... 24
Illegal Logging and Exports .......................................................... 27
Estimation of Timber Rents .......................................................... 28
Equity Technique .......................................................... 29
Costs Technique .......................................................... 32
Enhancing Timber Rent Capture .......................................................... 33
III. RECENT NATURAL RESOURCES TAX REFORM INITIATIVES ............... 34
Komi Republic .......................................................... 35
Northern Territories .......................................................... 36
Samara Oblast .......................................................... 37
A Practical Experiment: Novgorod Oblast .......................................................... 37
IV. SOME POLITICAL ECONOMY DIMENSIONS OF NATURAL RESOURCE
RENT TAXATION IN RUSSIA ............................................................ 39
Natural Resource Taxation and the Non-Payments Problem ................................ 39
Fiscal Federalism ............................................................ 40
A Hypothetical Example: Timber Rent Tax Reform ............................................. 43
Volatility of Commodity Prices ............................................................ 46
V. CONCLUSION ............................................................ 47
ANNEXES ............................................................ 50
Prices and Costs in the Oil Extracting Industry ..................................................... 50
Estimation of Rent in Natural Gas Production ....................................................... 51
Oil Extraction in Russia ............................................................ 52
Natural Gas Production in Russia ............................................................ 53
Timber Harvest in Russia ............................................................ 54
Estimates of Timber Rent in Selected Russian Regions - Equity Technique ...... 55
Estimates of Timber Rent in Selected Russian Regions - Costs Technique ......... 56
REFERENCES .................................................................................................................57
LIST OF FIGURES
Figure 1: From potential to appropriated forest rent ....................................................8
LIST OF TABLES
Table 1. Russia's 1999 Budget Revenues ............................................................
Table 2. Natural Resources and the Environment in Russia's 1999 Budget ..............2
Table 3. Estimated tax collections by the Ministry of Taxation in 1999 .....................3
Table 4. The Russian System of Natural Resource and Environmental Taxes ..........9
Table 5. Oil Export Duty and Oil Prices ............................................................ 12
Table 6. Proposed Tax on Additional Profits from Fossil Fuel Extraction .............. 14
Table 7. Financial Breakdown of Russia's Oil Exports .............................................. 16
Table 8. Average Current Appropriated Oil Rent ...................................................... 17
Table 9. Appropriated Rent on Licensed Oil - Sensitivity Analysis ......................... 19
Table 10. Total Current Oil Rent in 1999 .......................................... 19
Table 11. Average Appropriated Natural Gas Rent ..................................................... 20
Table 12. Appropriated Natural Gas Rent - Sensitivity Analysis . . 21
Table 13. Total Current Rent on Natural Gas in 1999 . ................................................ 21
Table 14. Profitability of the Russian Forest Industry . ................................................ 23
Table 15. Average Current Timber Rent - Equity Technique . . 31
Table 16. Total Timber Rent in Russia - Equity Technique ....................................... 31
Table 17. Timber Rent in Russia - Costs Technique .................................................... 32
Table 18. Total Timber Rent in Russia - Costs Technique ......................................... 32
Table 19. Statutory Assignment of Selected Natural Resource Revenues in Russia.41
Table 20. Actual Revenue Sharing Among Levels of Government (1998) ................. 42
Table 21. Predicted Initial Responses to Timber Rent Tax Reform ........................... 44
EXECUTIVE SUMMARY
1. Russia has one of the richest natural resource endowments in the world. It is the
largest producer of natural gas, the third largest producer of crude oil and one of the principal
sources of many minerals, such as coal, gold, diamonds and ferrous metals, as well as
biological resources such as timber and fish. Despite their importance in the Russian
economy, natural resources do not contribute as much as they could to public revenues.
Large resource rents (excess payments, i.e. above-normal profits generated by natural
resources in scarce supply) are dissipated through subsidies and wastage and/or appropriated
by private interests. Failure to tax this rent means either that taxes must be levied elsewhere
(i.e., on capital and labor) to sustain revenues thereby depressing investment and
employment, or that potential revenues are foregone. Failure to reinvest rent means that
Russia perpetuates the traditions of exporting low value-added raw materials and excessive
capital outflows, and retards the transition to sustainable economic development.
2. A more appropriate natural resource taxation system would enhance the fiscal role of
natural resources as well as create better incentives for resource conservation and
environmental protection. Two conditions further reinforce the appeal of such a reform. First,
the state still owns most natural resources, which theoretically facilitates changes in resource
pricing and taxation. Second, the cost of adjusting the tax system is relatively low at this time
since Russian tax policy is undergoing a thorough reform.
3. Technically, increasing rent taxation should be relatively straightforward since the
system already exists.What mainly needs to be done is to differentiate the fees to reflect
objective rent-generating conditions.
4. It should be given very serious consideration in the renewed debate on tax reform and
in the context of Russia's structural reform program. Indeed, it is in line with the proposals of
the new governmental economic strategy, in particular with respect to boosting the share of
natural resources in revenue generation and reducing income tax rates. The extra advantage
of rent taxation and revenue recycling is that they would allow the government to lower the
tax burden without affecting the budget deficit.
5. Recent regional experiments may show the way forward. In the Komi Republic,
forest stumpage fees have been raised to better reflect and capture the timber rent. Samara
Oblast has differentiated natural resource user fees to capture part of rental incomes on
mineral resources. Following in Komi's footsteps, the Northern territories have declared their
intention to differentiate all natural resource payments. Finally, Yaroslavl Oblast is
developing a cadaster of its resource base designed to value and price resources more
adequately. A similar experiment is taking place in the Vologda region.
6. The Government is aware that natural resources are inadequately taxed and has
proposed that the public finance role of rental payments should be enhanced and these
payments should be differentiated according to the amount of potential rent.
7. This report provides estimates of the average and total current rent on crude oil,
natural gas and round wood. For each of these resources, a large fraction of the rent is
unrealized, meaning it is dissipated through economic inefficiencies (subsidies and waste).
The remainder of the rent, which is realized, consists of normal profit (the entrepreneurial
rent), rent captured by taxes, and excess profit (the appropriated rent).
8. Regarding crude oil, the average current rent was estimated at US$ 95 per ton in
1999, which broke down into 42% unrealized rent (subsidies to the Russian and other
Commonwealth of Independent States economies), 17% normal profit (assuming a 20%
return on equity), 25% tax take, and 15% appropriated rent (assuming transfer pricing). This
amounts to an annual total appropriated rent on crude oil of US$ 4.5 billion in 1999 (US$ 12
billion in 2000).
9. Regarding natural gas, the average current rent in 1999 was estimated at US$ 55 per
thousand cubic meters, breaking down into 66% unrealized rent (subsidies to the Russian and
CIS economies), 4% normal profit (assuming a 15% return on equity), 16% tax take, and
14% excess profit. This amounts to a total appropriated rent on natural gas of US$ 4.6
billion per year.
10. The sum of appropriated rent on oil and gas was estimated at US$ 9 billion in 1999
(in excess of $15 billion in 2000), i.e. about 18% of consolidated tax revenues.
11. Regarding round wood, the average rent in 1999 was estimated at US$ 17-24 per
cubic meter (depending on the data set used), which is made up of 41-57% unrealized rent
(subsidies to the Russian economy), 7-10% normal profit (assuming a 20% return on equity),
20-23% tax take, and 11-33% excess profit. This would mean a total appropriated rent on
round wood of US$ 191-1,032 million per year.
12. Unrealized rent, inadequate withdrawal of rent and misuse of the rent that has been
withdrawn (due to irresponsible public expenditure programs) all represent some form of
misuse of public resources.
13. Improving natural resource taxation should follow the principle of differentiation, i.e.
withdrawing the rent by imposing higher taxes on resource deposits that are more profitable.
A seemingly desirable instrument, true differentiation of rental payments does not exist in
Russia - in spite of legislative provisions that it should. Several natural resource taxes are
specific taxes (set per volume), regardless of market prices or production costs. Such taxes
favor profitable deposits and penalize marginal ones. Instead, they should attempt to
withdraw the rent.
14. Russia being a federation, it would be crucial that any proposed tax shift from capital
and labor to resource rents be acceptable to the region(s) where the natural resources are
located but also to the federal government, through whose budget interregional equalization
takes place.
15. A final consideration is the volatility of primary commodity prices. This hampers
shifting taxes from capital and labor to natural resource rents, since rent fluctuates along with
commodity prices. In a highly volatile context, a system primarily based on rent extraction
ii
may be characterized by revenue instability. If a total substitution of rental payments for
other taxes is thus unlikely, the government can still extract the rent when it is present and
cut taxes on capital and labor accordingly.
iii
I. INTRODUCTION
Overview of Current Tax Structure
1.1 Like most countries, Russia collects tax revenues from three bases - labor, capital and
natural resources. Table 1 gives the shares of the main revenue categories in the 1999
consolidated and federal budgets.'
Table 1. Russia's 1999 Budget Revenues
Consolidated budget Federal budget
Share mn RUB mn US$ Share mn RUB mn US$
Total revenues 100% 1,197,454 48,284 100% 611,710 24,666
Tax revenues 83.7% 1,002,606 40,428 83.3% 509,507 20,545
CPT 18.4% 220,207 8,879 13.3�/o 81,201 3,274
PIT 9.8% 116,940 4,715 3.3% 19,928 804
VAT 24.0% 286,894 11,568 36.1% 221,031 8,913
Excise taxes 9.1% 108,416 4,372 13.8% 84,212 3,396
Licenses 0.1% 1,620 65 0.1% 689 28
Foreign currency tax 0.2% 2,467 99 0.2% 1,450 58
Sales tax 1.6% 19,293 778 0.0% 0 0
Othertaxes 0.0% 11 0 0.0% 1 0
Imputed income tax 0.6% 6,936 280 0.2% 1,259 51
Property taxes 4.4% 52,600 2,121 0.1% 749 30
"Green taxes" 3.7% 44,575 1,797 1.7% 10,496 423
Foreign trade taxes 7.2% 86,262 3,478 14.1% 86,262 3,478
Other taxes 4.7% 56,386 2,274 0.4% 2,228 90
Non-tax revenues 6.9% 82,583 3,330 7.7% 47,010 1,896
Transfers 1.3% 15,051 607 0.0% 9 0
Budget funds 8.1% 97,214 3,920 9.0% 55,183 2,225
Source: Ministry of Finance.
1.2 Taxes on income (including corporate profits and personal income), goods and
services (including VAT and excises), and foreign trade (import and export duties) together
make up about 70% of consolidated revenues. The concentration of the revenue capacity in a
few taxes is even more marked at the federal level, where the same five taxes provide some
80% of revenues.
1.3 Table 2 breaks down the total revenues from natural resource and environmental
taxes into the various constituent parts. Green taxes, i.e. natural resource user fees and
pollution charges, make up less than 4% of consolidated revenues, and less than 2% of total
federal revenues. They provide more at the sub-national (regional and local) level, namely
' The consolidated budget is the sum of the federal and sub-national budgets of the members of the Russian
Federation (provinces, autonomous republics, etc.)
just over 5%. By far the most important natural resource user fees and environmental taxes
are the subsoil user fees (see the definitions in Table 4). Land tax revenues generate just
under 1% of consolidated revenues2, while forest fees come third with less than 0.15% of
consolidated revenues. The share of pollution charges accruing to the budget is even more
marginal as it provides less than 0.05% of revenues. Although these revenue categories
represent slightly larger shares of the regional budgets, the amounts are low in comparison
with the top five revenue categories mentioned above.
Table 2. Natural Resources and the Environment in Russia's 1999 Budget
Consolidated budget Federal budget
Share mn RUB mn US$ Share mn RUB mn US$
Total revenues 100% 1,197,454 48,284 100% 611,710 24,666
Total "green taxes" 3.72% 44,575 1,797 1.72% 10,496 423
Subsoil user fees 2.51% 30,077 1,213 1.18% 7,190 290
Continental shelf 0.00% 25 1 0.00% 0 0
Forest fees 0.14% 1,727 70 0.07% 447 18
Water fees 0.09% 1,035 42 0.03% 198 8
Pollution charges 0.04% 461 19 0.08% 461 19
Land tax 0.91% 10,939 441 0.36% 2,189 88
Other user fees 0.03% 312 13 0.00% 10 0
Other revenues 96.28% 1,152,878 46,487 98.28% 601,214 24,242
Source: Ministry of Finance.
1.4 Of course, natural resources generate more budget revenues than suggested by the
single item "green taxes" of Table 1 and Table 2. Natural resources also generate revenues
indirectly via profit taxes, excises, VAT, export duties, etc. Table 3 reports the contributions
of the main natural resource sectors to the revenues collected by the Ministry of Taxation.
Out of the tax revenues collected by the Ministry of Taxation in 1999, four of the main
natural resources - namely fuels, metals, wood and fish products - contributed around 20%,
including over 17% from fuels and metals alone. This proportion is much larger than the 4%
of total consolidated revenues due to natural resource user fees. And this is not the whole
picture.
1.5 Table 3 does not contain the revenues collected by the Customs Committee
(Gostamozhkomitet), which is responsible for levying import and export duties, as well as the
excises on exported oil (about one-third of the oil produced). For exarnple,
Gostamozhkomitet reports collections of RUB 39 bn (around US$ 1.5 bn) in export duties in
1999, i.e. over 3% of consolidated budget revenues. Indeed around 80% of export duties
2 Land taxes produce relatively large revenues, although large land users (e.g. the firm Gazprom) pay no land
taxes for most of their production and transport installations (Voronkov 2000b).
2
were due to natural resources, including oil products (51%), ferrous metals (13%), wood
products (7%), and copper (5%) (Kaulbars 2000).3
Table 3. Estimated tax collections by the Ministry of Taxation in 1999
(based on first 9 months)
Total Tax revenues accruing to the federal budget
CPT VAT Excises User fees
mn % mn % mn % mn % mn %
RUB Share RUB Share RUB Share RUB Share RUB Share
Total 760,757 100 70,960 100 138,513 100 69,410 100 8,725 100
Fuels 92,945 12.2 8,412 11.9 10,401 7.5 9,052 13.0 5,046 57.8
Oil 62,357 8.2 6,987 9.8 6,411 4.6 4,317 6.2 3,272 37.5
extr.
Oil ref. 12,044 1.6 825 1.2 846 0.6 3,774 5.4 81 0.9
Gas 12,588 1.7 421 0.6 2,211 1.6 954 1.4 1,316 15.1
Coal 4,864 0.6 112 0.2 682 0.5 0 0.0 67 0.8
Metals 38,274 5.0 79,996 11.3 -4,042 -2.9 14 0.0 1,513 17.3
Wood 13,649 1.8 1,997 2.8 1,523 1.1 21 0.0 260 3.0
Fish 2,843 0.4 372 0.5 446 0.3 6 0.0 5 0.1
Source: Russian Ministry of Finance.
1.6 The total contribution of natural resource sectors to tax revenues under current policy
is thus very substantial. There are, however, two issues to be raised with the current
approach to taxation of these income streams. First, except in the category of natural
resource user fees, which represent a small fraction of total Taxation Ministry collections, the
contribution of natural resource sectors to tax revenues is indirect, to the extent that it is not
the resources themselves that generate the tax revenues, but the value added to these
resources. Taxes on profit, social security contributions and excises may burden the capital
and labor applied to natural resources.
1.7 Second, failure to capture much of the rent potentially available puts the sustainability
of these tax revenues in doubt. This latter issue will become more critical as some of Russia's
reserves become scarcer.4 Of course some of the appropriated rent could be reinvested
directly into productive uses without transiting through the budget, but this is far from
guaranteed. Russia indeed suffers from massive capital outflows, which is largely associated
with natural resources, for example through underrepresented export earnings (Fisher and
Sahay 1999; Loungani and Mauro 2000). Flight capital probably is not reinvested in Russia
in the short term.
3 Such export duties are an effective way of capturing excess profits since they vary with world market prices
and world market prices are not influenced by Russian producers. Nevertheless they are not pure taxes on
excess profits and distort the allocation of resources between exports and domestic sales by penalizing exports.
4According to BP Amoco, at the present rate of extraction, Russia has 22 years left of oil in the ground (BP
Amoco 1999). Beyond absolute scarcity, the remaining oil becomes progressively more expensive to extract.
3
1.8 According to the government's strategy for economic growth, the "aim of tax reform
is not to collect more taxes and thereby solve the problem of the budget crisis, but ... (1) to
reduce the size of the tax burden as the state's obligations ... decrease; (2) to make Russian
tax policy fairer toward taxpayers whose economic conditions differ; (3) to raise the level of
neutrality of the tax system toward the economic decisions of firms and consumers." (GOR
2000, 146) Other problems associated with the Russian tax system include non-compliance
and non-cash payments, both of which have been the topic of a growing literature (see, e.g.
Alexeev 1998; Aslund 1998; Herzog 1997; OECD 1999; Pinto et al. 2000; Pirttila 1999).
1.9 These problems, and others associated with them, in particular capital flight, would
be alleviated if natural resource rents were taxed appropriately, especially if the collected
revenues served to finance a partial and gradual tax shift occurred from capital and labor to
natural resources. Specifically, using natural resource rents as tax base facilitates tax
assessment (calculating rent is easier than defining and assessing "income"), legitimizes
taxation (rent is unearned income), and is less distortionary than income taxes.
Natural Resource Rent and Its Measurement
1.10 One way of ensuring that benefits for the nation continue to flow from its natural
resource is to capture and reinvest resource "rents". In this report, "rent" is defined as
follows:
"Rent is a surplus - the difference between the price of a good produced using a
natural resource and the unit costs of turning that natural resource into the good. The
unit costs include the value of the labor, capital, materials, and energy inputs used to
convert the natural resource into a product. What remains after these factor inputs are
netted out is the value of the natural resource itself - the land, water, . . ., fish,
minerals, forests, and environmental resources such as air and water." (Hartwick and
Olewiler 1998, 59)
1.11 Consider the following hypothetical example: the market price of a resource-based
commodity is US$ 100, its production cost (ie. the operating cost of production plus
depreciation) is US$ 50, and a norrnal (competitive) profit needed to remunerate capital is
US$ 10. The residual value, or economic rent, is $40. If the raw resource (say round wood) is
not exchanged as such, the reference market price may be that of a processed commodity
based upon the resource (say sawn goods or plywood).
1.12 Production cost can be either marginal or average. Using average production costs
overestinates the real rent, however, since average costs are usually lower than marginal
costs, given that marginal costs tend to increase as a function of quantity. Nevertheless,
average cost data are more readily available, so average costs are often used in calculations
of rent.
1.13 Theoretically, rent should be estimated in an intertemporal framework (Boadway and
Flatters 1993) but the data necessary to carry out such an analysis, in particular reliable
discount and inflation rates and marginal cost and revenue stream estimates, are not always
available.
4
1.14 Ideally, rent is best observed and captured through competitive auctions. However, in
the absence of such auctions, the government needs to rely on appraisal techniques to
estimate the rent, and on taxes to capture it.
1.15 Determining normal profit can be controversial. Theoretically, normal, or
competitive, profit is the opportunity cost of allocating one's resources to a specific activity
as opposed to another, in other words the profit that would be recorded in the next best
alternative. Assume that an agent has the choice between investing in natural resource
extraction and manufacturing, having equal access to and knowledge of both industries. If the
agent achieves a 10% rate of return in resource extraction, while he could achieve 15% in
manufacturing, the normal profit, or opportunity cost of extracting natural resources, would
be 15%. In this case, the agent foregoes profit. If, instead, the profit in resource extraction
were 20%, the agent achieves more than the opportunity cost of manufacturing, which is still
the next best alternative to resource extraction. The difference can now be called excess
profit. In a perfectly competitive market (perfect information, no barriers to entry, etc.) more
firms would enter the natural extraction business to compete down this excess profit to zero.
In a non-competitive market, actual profits may stay above competitive profits. In the case of
natural resources, which are in relative scarcity, this excess profit is called economic rent.
1.16 Practically, normal profit may be thought of as the return on a risk-free asset, plus a
premium related to the investment risk involved in a given economic activity. A high-risk
project would thus entail a high premium and a high normal profit. In a natural resource
project, the residual profit above that would be considered economic rent. If possible, normal
profit can be broken down into short-term normal profit (a competitive return on short-term
assets, or working capital, needed in production) and a long-term normal profit (a
competitive return on long-term assets).
1.17 Potential rent is not the same thing as realized rent. For rent to be maximized, in other
words for realized rent to be equal to potential rent, there must be no rent dissipation. For
instance, in the case of wood resources, illegal harvesting and environmental damage
constitute resource waste and rent dissipation. Figure 1 shows how potential timber rent is
used and dissipated. The same logic applies to most every natural resource.
1.18 The rent appropriated by actors along the forestry chain (all the way from the logger
to the final customer) is theoretically much lower than the potential forest rent. The potential
forest rent is the inherent residual value of the forest given a perfectly competitive market
and efficient technology. Neither condition is ever completely met, resulting in part of the
potential rent being unrealized, i.e. dissipated. The market is never perfectly competitive due
to the existence of market failures (monopoly power, transaction costs, imperfect
information, negative externalities, etc.), and technology is at least somewhat inefficient
(there is always some material waste in the harvesting and processing links of the forestry
chain). The environmental damage of logging also detracts from the value of present and
future harvests. Silvicultural rent may arise from less-than-optimal forest management rules.
Finally, high grading ("cutting the best and leaving the rest") causes the loss of potentially
economic timber.
5
1.19 Of the rent that is realized, only a fraction is recorded, the rest being lost to illegal
activities. Ultimately, the recorded rent can be divided into three components: the part that is
captured by the government in the form of forest revenue (sometimes called forest taxes); the
part that is the forest enterprises' normal (competitive) profit to remunerate capital; and the
part that is appropriated by forest and other enterprises as excess profit. This residual value is
called stumpage value. The government may decide to assess the stumpage value and attempt
to capture it through a variety of fiscal or forest management instruments.
The Taxation of Rent
1.20 Taxing rent offers several advantages from a public finance perspective. Rent is
price-determined as opposed to price-determining: rent does not enter production costs and
does not determine value. Given that the price of the resource or the resource-based
comnmodity is given by the competitive market, not driven by the tax on rent, and given that
the tax still allows for cost recovery and a competitive rate of return, taxing rent is neutral
with respect to economic activity. Since pure rent taxes are neutral, they are said to be non-
distortionary. On the contrary, taxes on capital and labor do influence economic activity as
they tend to deter people from working and firms from investing, which is why they are
called distortionary. The idea of neutrality adopted here is that, beyond the reduction in
disposable income itself, a tax should not alter decisions on consumption, production or
trade, nor the ordering of consumption, production and trade options (Gamaut and Clunies
Ross, 1979).
1.21 A pure tax on rent withdraws the excess profit and is purely price-determined. As
such, it does not distort economic decisions, which also implies that it cannot give any price
incentive to consumers for more rational resource use or pollution abatement. The pure tax
on rent has been discussed by various authors, including Gamaut and Clunies Ross (1975).
Other taxes can help withdraw the rent by taxing the use of the rent-generating factor, e.g. a
mineral resource, fish landings, or water pollution. Such taxes withdraw the rent, not from
the firm's bottom line, but through higher costs of production, which are price-determining.
Consequently, these taxes can no longer be viewed as purely non-distorting. On the other
hand, they do create price incentives for more rational resource use or pollution abatement.
1.22 More generally, rent capture produces its primary benefits in terms of efficiency and
equity of the tax system. From a classical efficiency point of view, it facilitates tax
assessment since the base for rental payments is easier to define than "income." Sources of
income may not be known, and income tax legislation typically includes many loopholes and
clauses giving rise to "tax engineering," so that income can be hidden or sheltered. In
contrast, it is difficult to hide or shelter a natural resource, and taxing rent makes it possible
to remove some of the existing distortions due to taxes on capital and labor. From an equity
point of view, it enables the current and future generations to benefit from a collective good,
the quantity and quality of which cannot be significantly improved by man's intervention.
1.23 Taxing away the rent may also help to prevent or moderate the "Dutch disease,"
which is the expansion of the natural resource sector benefiting from a windfall (e.g. an
increase in oil prices) and the contraction of other sectors producing tradable goods.
Following such a favorable shock, if income is consumed rather than saved, a resource
6
movement effect occurs: factors of production are drawn towards the booming sector away
from the non-resource producing sectors. In addition, a spending effect takes place whereby
higher incomes also stimulate the demand for non-tradable goods. As a result, the real
exchange rate, defined as the price ratio of non-tradable to tradable goods Pn /IP,
appreciates. With a higher real exchange rate, qualitatively superior imports are substituted
for domestic production. Both these effects combine to hurt the non-resource domestic
tradable goods sectors (Gelb 1988).
1.24 The benefits of capturing rent extend even beyond the efficiency and equity of the tax
system. With respect to exhaustible resources, withdrawing and investing rent is a condition
of long-term sustainability. The "Hartwick rule" states that if investment in produced capital
just equals current rents on the exhaustible resource at each point in time, then the resulting
path for the economy is one where welfare equals a maximal constant value ad infinitum -
one definition of sustainability.5 In other words, for each subsequent generation to enjoy the
same consumption level per capita, all scarcity rents of exhaustible resources must be
reinvested in man-made capital, technical knowledge, etc., and none consumed by the current
generation (Hamilton 1995, 1999; Hartwick 1977; Hartwick and Olewiler 1998; Tietenberg
1 992).6
5 This definition of sustainability refers to "weak sustainability." In this version, a given level of welfare can be
maintained by substituting man-made capital for natural capital. In the "strong sustainability" version, by
contrast, a threshold stock of natural capital would need to be preserved to sustain the diversity of the origins of
welfare.
6 Apropos of renewable resources, the rule is that a resource is managed sustainably, in other words is not
depleted, if it is in steady state, i.e. if withdrawals equal reproduction. Steady state requires that all inputs into
production be set at the appropriate level: in the case of wood production, trees themselves should not be
overharvested, the quantity and quality of man-made harvesting capital should be kept up, and the human
population consuming wood products should be stationary (Hartwick and Olewiler 1998).
7
Figure 1: From potential to appropriated forest rent
Potential
rent
Realized rent Unrealized rent
(efficiency
loss)
Recorded Unrecorded
rent rent (illegal
logging)
Captured Entrepreneurial Appropriated Market Silvicultural High- Logging Waste
rent (forest rent (normnal rent (excess failures rent grading damage (harvesting,
revenue) profit) profit) processing)
Sources: Gillis 1992; Linddal 1999
8
II. NATURAL RESOURCE TAXATION IN RUSSIA: CURRENT SYSTEM AND
RECOMMENDATIONS
Overview
2.1 Russia's current system of natural resource and environmental taxes consists of the
main items listed in Table 4. Various payment types exist, including natural resource user
fees, pollution charges, consumer taxes on energy, and prices paid to acquire public assets
such as land. At their current level, natural resource and environmental taxes cannot provide
real incentives for rational resource management nor capture economic rents (OECD 1999).
Mineral resources provide a case in point.
Table 4. The Russian System of Natural Resource and Environmental Taxes7
Type of payment Description
1. Subsoil user fees
1.1 Rental payment Annual payment for carrying out exploration activities, set
per unit of subsoil area used and determined as a function
of the geographical features and size of the subsoil area, the
type of fossil resources, the duration of activities, the level
of geological study of the subsoil area, and the perceived
degree of risk. Equal to 1-2% of surveying and assessment
costs.
1.2 Royalty The rates, set as percentage of the sales value of extracted
minerals, vary between 1% for low-grade ferrous metals
and underground waters and 16% for high-grade oil and
natural gas. For oil and gas, the range is 6-16%. The fees
for gold and diamonds range from 4 to 10 and 4 to 8% of
sales value, respectively. Payment is to be made by the
investor in cash or in kind.
1.3 Payment for Depletion (severance) tax, set at 10% of the sales price of
replacing the mineral minerals, designed to finance geological exploration. Also
base8 called geological fee.
1.4 Excise taxes for oil For oil: rate set at RUB 66 in 2001 per ton extracted, with
and gas no differentiation according to rent-generating factors, in
contradiction to Article 46 of the Law "On the Subsoil."
For natural gas: 15% of sales value for domestic market
(30% for exports), accruing on a cash basis.
7 Some of these taxes will likely soon be subject to revision in the context of the Putin-Kasyanov
administration's new economic strategy.
8 VSMB in Russian.
9
Type of payment Description
1.5 Fees for the use of
the sea bottom
1.6 Export duties Rates vary according to commodities.
1.7 Production sharing
agreements9
1.7.1 Bonus One-time payment, the level of which is set contractually,
and which is due upon signature of the agreement or
achievement of the contractual results.
1.7.2 Rental Same as 1.1 above.
1.7.3 Royalty Same as 1.2 above.
2. Energy product
taxes
2.1 Taxes on fuels and Tax on oil refineries.
lubricants
2.2 Excise tax on Limited to gasoline sold on the domestic market. Rates
gasoline range from RUB 80 to RUB 370 depending on octane.
3. Fees for the use of Divided into mineral and living resources.
the continental shelf
4. Forest user fees See infra.
5. Surface water user Paid for a number of water uses, including industrial
fees processes, production of drinking water, use by the
hydropower and transport sectors. Irrigation is exempt.
6. Pollution charges See infra.
7. Land use payments
7.1 Land taxes Land taxes are due on private land or land used under
conditions of life-long possession. Land taxes are the
lowest on forested land.
7.2 Land rentals Land rentals are due on public land, i.e. land owned by the
state, regions or municipalities.
7.3 Normative prices Normative prices are paid upon transfer of land from the
state to private hands. Payments are the highest on urban
land, reaching very high levels in city centers, but are
extremely low in rural areas. By law, normative prices do
not exceed 75% of market value.
8. Payments for the use Used to fund research, management, protection and
of aquatic biological reproduction of aquatic biological resources, in addition to
resources fines for damage to resources and violations of normative
acts. Payment made upon receipt of the fishing quota. Rates
range from RUB 20/t for Far Eastern herring and Far
Eastern salnon to RUB 10,000/t of high-grade crab.
9 The final tax status of PSA has not been decided yet. The taxes presented here are probably the minimum.
10
Type of payment Description
9. Payments for the use Payments for hunting wild animals consist of a permit per
of terrestrial biological animal killed or day spent hunting, and a penalty for
resources infractions. Payrnents are determined in relation to the
minimum wage (e.g., the license to kill a beaver equals 0.2-
0.6 * the minimum wage, while for a bear it equals 3-6 *
the minimum wage). For plants and animals listed as
protected species in the Red Book, no regular licenses can
be granted but fines are applicable to punish hunting or
collection. These fines are set as a multiple of the minimum
wage as well (e.g. for plants, they range from 0.2 to 300
times the minimum wage). Finally, small entrance fees are
sometimes charged for the right to visit national parks.
Sources: Arthur Andersen (1998); GOR (1996); IFEI (1998); Kasyanov (2001); Mikheva and Sheingauz
(1999); Roskoshnaya (2000); Sagers et al. (1995); Shevchuk (1999); Titova (2000).
Oil and Natural Gas
Oil and Natural Gas in the Russian Economy
2.2 The energy sector, in particular oil and gas, is central to the Russian economy.
Depending on economic conditions, oil and gas earn 20-40% of consolidated budget
revenues and 30-40% of foreign exchange earnings. In 1999, the oil and gas industry
employed 618,000 people, including 416,000 in oil extraction, 117,000 in oil processing, and
85,000 in gas extraction. It is thought that the relative recovery of the Russian economy in
1999 and 2000 is owed to the comparative advantage of local production following the
depreciation of the ruble, and to the soaring crude oil prices on world markets. Despite years
of adjustment, energy is still much cheaper in Russia than abroad, which distorts resource
allocation by subsidizing domestic industry (IFEI 2000). For example, domestic oil refining
is in some cases value-subtracting since its actual revenues are lower than the potential
exports of crude oil.
Tax Regime in the Upstream Oil Sector
2.3 Taxation has been identified as one of the main issues deterring investments in the
Russian oil sector. "The Russian system of taxation is generally believed to be one of the
most complicated, burdensome and unpredictable in the world" (Arthur Andersen 1998, 5).
The Russian system of upstream oil taxation consists of two regimes: the regime for licensed
oil and the regime for production sharing agreements. By far the largest share of oil
production is under the former regime, although badly needed foreign investments are
overwhelmingly in favor of the latter.
Licensed oil
2.4 In addition to all the general taxes imposed at the national and sub-national levels, oil
companies pay taxes that are specific to the oil sector. These include: (1) export duties; (2)
oil excises; (3) royalties; (4) bonuses; and (5) geological fees.
2.5 The export duty was introduced in January 1992 as a wedge between domestic and
foreign prices. The rate was initially set at ECU 26 per ton of crude oil and gradually reduced
to ECU 15 per ton in mid-1996, as part of the Government's commitment to bringing
domestic energy prices in line with international ones. The oil export duty was completely
phased out in 1997, but then reinstated in 1999 as world prices took off. Export duties accrue
to the federal government. In 2000, the governmental Commission on Foreign Trade
Protection adopted a new floating tariff system, whereby the export duty is tied to the market
price of oil. Table 5 shows the progressive relationship between oil prices and export duties.
This scale refers to crude oil exports beyond the Customs Union of Russia, Belarus,
Kazakhstan, Kyrgyzstan and Tajikistan. Though the scale does not have power of law, the
government broadly follows in when it sets export duties by resolution. The duty currently in
force is in the highest bracket, somewhat independently of fluctuations in the oil price.
Table 5. Oil Export Duty and Oil Prices
Oil price (average price of Export duty
the Urals blend for the (EUR/ton exported)
preceding month, US$/ton)
<12.5 0
12.5-15.0 2
15.0-17.5 5
17.5-20.0 9
20.0-22.5 14
22.5-25.0 20
25.0-27.5 27
27.5-30.0 34
30.0-32.5 41
> 32.5 48
Source: Brunswick Warburg (2000).
2.6 The excise tax was set up in August 1992 at a rate of 18% of oil sales value (ad
valorem). It was then differentiated to account for variations in production costs (0% for
high-cost producers, 24% for medium-cost producers, and 42% for low-cost producers).
Excise rates increased as export tax rates decreased. In April 1994, it was transformed into an
ad quantum (specific) tax indexed to the RUBIUSD exchange rate. The range selected was
RUB 0-85 per ton, with an average of RUB 55. Article 46 in the current law "On the
Subsoil" clearly states that the system of mineral excises must reflect the economic and
geographic conditions of each deposit, i.e. the differential rent (GOR 1992). Nevertheless,
the Russian government has never worked out the corresponding excise rates, so this
provision remains hollow. Instead, in January 2000, the range was eliminated and the excise
12
tax standardized at RUB 55 per ton, regardless of the deposit's economic and geographic
conditions (IFEI 1998). In 2001, the standard rate was raised to RUB 66 per ton. Revenues
accrue to the federal government, except under special agreements between the federal and
regional governments (e.g., the Republic of Bashkortostan and Samara Oblast). Excise taxes,
given their ad quantum nature, have a regressive impact: the relative tax take increases as
market prices decline. On the contrary, for the tax system to be more neutral, the tax take
should increase with profitability (Thomson 1998).
2.7 The royalty was introduced in May 1992 as payment for use of the subsoil. If
properly designed, it could become a reliable rental payment. This is currently not the case,
however. The royalty is an ad valorem tax based on wellhead prices (revenues) before excise
taxes. Lower-cost fields pay a higher rate. The current range is from 6% to 16% of sales, with
the average royalty at about 8%. The royalty is determined by negotiation or through bidding
for new fields. It is fully deductible for tax purposes. Royalties are directly linked to the price
of oil, which makes them neutral with respect to their effect on the timing and level of
investment. Nevertheless, due to their exceedingly uniformn rates, they penalize relatively
marginal fields. Rates should thus be differentiated further.
2.8 Bonuses, first used in October 1992, are one-time payments negotiated as part of the
license bid, and subject to a statutory minimum.
2.9 The mineral replacement tax (also, and more accurately, called geological fee) was
imposed in February 1993, as a deduction to insure exploration and discovery to make up for
depletion. It is an ad valorem tax, ranging from 0 to 10% depending on regions and firms.
Revenues are earmarked to a federal extra-budgetary fund used to cover exploration by the
Geology Committee.
Proposed Changes in Licensed Oil Taxation
2.10 To improve the system, the Russian government has planned for several years to
allow oil producers to move from mainly revenue and excise taxes to a profit-based system
on an elective basis. The latter would have three main components - a reasonable royalty, the
generally applicable corporate profits tax and a special profits tax. The special profits tax is
meant to capture windfall profits, i.e. rents. In order to avert a situation in which oil
companies would return zero profits, depriving the government from crucial revenues, the tax
move would be accompanied by an accounting and auditing reform, mandating that all
companies electing the new profit-based regime adopt international accounting and auditing
standards. At least in principle, the move has the favor of most international investors who
are keen to see taxation vary as a function of profits instead of revenues and volumes.
2.11 Progress in implementing this change has been very slow, but the government is
giving renewed consideration to a "tax on additional profits from fossil fuel extraction"l1
(TAPFFE). A law titled "On the payment for the use of mineral resources" was drafted,
while similar dispositions were included in the draft of Part II of the new Tax Code. This new
10 Nalog na dopolnitelnyi dokhod ot dobychi uglevodorodov in Russian.
13
tax is designed to replace the current oil excise tax on an elective basis. For the companies
electing not to switch to that system, a new differentiated excise tax would be adopted. In
addition, the drafts provide for a widening of the royalty band (Lapyunova and Reznik 2000).
The TAPFFE would work in the following way: all the sales revenues accumulated since the
beginning of a project would be divided by the accumulated eligible costs, to determine a so-
called "R-factor" for each site. The size of the R-factor would then determine the tax rate.
The tax base would be defined as accumulated revenues minus accumulated costs with some
corrections. The TAPFFE takes a long-term approach to taxation as it considers all revenues
and costs accrued since the first year of the project. Table 6 shows one of the latest proposals
of tax rates.
Table 6. Proposed Tax on Additional Profits from Fossil Fuel Extraction
R-factor Tax rate
<1.0 0%
1.0-1.3 20%
1.3-2.0 40%
> 2.0 60%
Source: Ministry of Finance.
2.12 Some of the problems with the TAPFFE are that: (1) tax rates may be too aggressive
(progressive) for investors to adopt the system; (2) the new tax may end up substituting for
the excise tax only, while all other taxes would still apply; (3) it would probably apply to new
oil licenses only, leaving a large share of the rent under existing operations untapped; (4) the
notion of site is vague; and (5) as a profit-based tax, it gives no incentive for rational resource
management and does not rule out profit concealment.
2.13 The new administration has reaffirmed its commitment to some sort of an excess
profits tax. The recent governmental strategy plans a "tax on excess income from extraction
of hydrocarbons ([in] replacement of the excise tax on petroleum for new deposits and a
portion of royalties)." (GOR 2000, 150) The Finance Ministry has confirmed that royalties
would be reduced in order to encourage tax compliance. So the excess profits tax would
replace mostly royalties instead of excise taxes, as under the TAPFFE proposal.
2.14 Regarding the new differentiated excise tax, rates would vary between RUB 0 and
RUB 80 per ton (a return to the old range), as opposed to the currently fixed rate.
2.15 Until these legal provisions become effective, the government will continue to do
what it has done since the escalation in oil prices in 1999, which is to rely on export duties
for withdrawing part of the rent. Export duties, made flexible to vary with world market
prices, are an effective means of capturing the rent, though they discriminate against exports.
To the Ministry of Finance they provide the guarantee that oil ownership translates in
revenue collection.
2.16 Although taxation is partly to blame for low investments (and thus rent wastage) and
low rent capture in the Russian oil sector, changes in taxation alone will not provide the
14
answer to low rent capture. Other issues must be addressed as well, including access to
export pipeline and transfer pricing.
2.17 Vertically integrated companies (VICs) practice transfer pnrcing, whereby they use
legal loopholes to minimize their tax liability. Under transfer pricing, the oil producer sells
only part of its production directly on export markets, the bulk being sold at artificially low
prices to the parent company, which is located abroad or in regional tax havens. Although the
federal government has cut tax privileges in an effort to reduce transfer pricing, regional and
foreign laws still exist to take advantage of tax havens.
2.18 Acess to export pipelines is restricted through a non-transparent system of quotas. As
a result, approximately 50 million tons of oil are forced on the domestic market every year,
depressing domestic prices and wasting value. For rent to be maximized, the government
should allow oil producers to export up to the level of foreign demand. Short of building new
pipelines, access to existing pipelines should be made more competitive, for example using
auctions, and conditioned on timely tax payments (Thomson 1998). The rent captured could
then be used to cut taxes or target social needs more efficiently than through indiscriminately
low domestic oil prices.
Production Sharing Agreements
2.19 Continuous changes in the tax regime have represented a major impediment to
investments in the Russian oil sector. Investors are wary to spend large sums of money on
long-term, high-risk projects without guarantees about the future tax regime. Production
sharing agreements (PSA) are designed to provide this guarantee. Under a PSA, the private
investor takes on the full risk of the investment and the state retains full ownership of the
resource. When production starts, the oil (or its proceeds) is shared between the state and the
investor according to contractual clauses: one part is "cost oil," which allows investment cost
recovery, and the second part is "profit oil," for remunerating the risk and capital. The
remaining oil (or its proceeds) belongs to the state. In some countries, the financial clauses of
the PSA supplant all other taxes, while in others taxes still apply within the PSA framework.
The important point is that all tax provisions not specifically included in the PSA are waived.
To the investor, PSA offers two advantages of allowing for cost recovery before the payment
of taxes, and locking in taxes for the duration of the project upon contract signature. To the
state, PSA usually ensures a high volume of private investments without investment risk.
2.20 Unfortunately, under the PSA chapter, as under licensed oil, the Russian government
has been slow to pass the necessary legal texts and ensure consistency. As regards taxation,
Article 13 of the Law on Production Sharing Agreements provides that the investor pays a
profit tax, a royalty, and payroll taxes and is exempt from all other taxes, levies, duties,
including customs duties, excise taxes and other mandatory payments imposed by the
Russian legislation. However, the latest drafts of Part II of the new Tax Code contradict the
aforementioned Law by reintroducing several taxes in the PSA investors' tax liability,
including excises. Needless to say, this defeats the purpose of stability and predictability
(Thomson 2000).
15
Estimation of Oil Rents
2.21 Oil production, in particular when sold on foreign markets, has recorded sharp
increases in profitability since 1998, as illustrated in Table 7. As a share of sales, net
profitability rose from 1% in 1998 to 37-55% in 1999. The increase continued in 2000.
2.22 How much of that is normal entrepreneurial profit, how much is rent? Large rents
have been claimed to exist in the oil and gas sector. For example, estimated oil rents were
estimated at over US$ 20 billion per annum in the early to mid-1990s (Lvov 1994;
Markandya and Averchenkova 2000). The paragraphs below renew the estimation of the
current oil rent for the years 1999 and 2000.
Table 7. Financial Breakdown of Russia's Oil Exports
(US$/ton)
1998 a 1999 a 1999 b 1999 c
Export crude oil price 77.9 144.9 120.7 104.8
Excise tax 9.1 2.2 2.2 --
Royalty 6.0 11.6 2.2 --
Mineral base replacement 4.6 8.7 2.6 --
Road fund 1.1 2.9 0.6 --
Property tax 1.7 0.7 0.6 --
Social insurance 2.5 0.9 1.1 --
Local and other taxes 0.5 0.2 0.5 --
Transport, customs fees, port charges, handling 19.0 17.4 18.7 --
Direct production cost 15.6 12.8 6.0 --
Salaries 6.6 1.7 2.9 --
Depreciation, amortization 9.5 2.9 2.5 --
Other costs 0.6 0.4 0.0 --
Management 0.4 0.2 0.0 --
Pre-tax income 0.8 82.4 80.8 --
Net income 0.5 53.6 56.5 58.4
Net margin (%) 1.0% 37.0% 46.8% 55.4%
Sources: a) Nikoil (2000); b) IFEI (2000); c) Institut narodnokhozyaistvennogo prognozirovaniya Rossiiskoy
akademii nauyk.
2.23 Rent should theoretically be estimated in an intertemporal framework but the data
necessary to carry out such an analysis, in particular reliable discount and inflation rates and
marginal cost and revenue stream estimates, were not available. Oil auction data, which
could help measure and collect the rent, are equally absent. The analysis is thus limited to
average current rents using a net-back approach.
2.24 As per the schematic in Figure 1, potential rent consists of realized and unrealized
rent. Unrealized rent is due to allocative inefficiencies. In this case, the inefficiencies can
take the form of sales on the domestic market below the international price, leading to large
revenue losses. The unit unrealized rent (implicit subsidy) to the national economy and those
16
of other Commonwealth of Independent States (CIS) economies was US$ 40 per ton of crude
oil in 1999.
2.25 Such a sizeable subsidy costs oil producers but also gives them leverage on the
government, including in the area of tax reform: as long as they subsidize the national
economy, how can the government expect to capture a greater share of the oil rent?
2.26 Unrealized rent also arises out of waste during extraction or production, e.g. if oil is
left in the ground. Worse, rent is dissipated if the level of investments is insufficient to keep
production levels constant. Russian oil wells have not been kept up, so their productive
capacity has deteriorated and value has been wasted. This trend is hardly visible from one
year to the other, as the volume extracted is relatively stable at 300-320 million tons, but over
a period of 50 years, this appears more clearly, as the chart in Annex illustrates. Production
peaked at 570 million tons in 1987 and declined steadily until 1996, after which it recovered
slightly. Although it seems evident that waste exists, it is difficult to value it. Conservatively,
this value will therefore be left at zero.
2.27 Next, Table 8 estimates the realized rent, or more exactly the recorded rent since it is
assumed that there is little or no illegal extraction to speak of. Recorded rent comprises the
rent captured through taxes and other levies, the entrepreneurial rent (normal profit), and the
appropriated rent (excess payment).
Table 8. Average Current Appropriated Oil Rent
(licensed oil scheme)
1999 2000
No Transfer No Transfer
transfer pricing transfer pricing
pricing pricing
Revenues (US$/ton) 69.2 69.2 110.3 110.3
Production costs (US$/ton) a 19.4 19A4 26.6 26.6
Depreciation (US$/ton) 2.5 2.5 2.4 2.4
Normal profit (US$/ton) b 15.9 15.9 15.3 15.3
Tax take (US$/ton) 27.9 16.6 48.0 28.5
Appropriated rent (US$/ton) 3.5 14.7 18.0 37.5
Total foregone revenues (US$ mn/yr) 1,071 4,492 5,760 12,001
a) Including operating costs and net capital investments, without taxes and depreciation.
b) 20% return on equity defined as market capitalization
Sources: IFEI (2000).
2.28 Revenues represent the weighted average of export and domestic oil sales prices.
Export prices are DAF' Iprices. Domestic prices are the prices charged for oil delivered at the
" Delivered at frontier, i.e. export gate.
17
junction between the producer's and the main pipelines, before VAT, for consumption in
Russia and other CIS countries. Production costs include the weighted cost of transportation
to export gates, labor costs (including auxiliary personnel) and other production costs.
Nonnal profit is the profit needed to ensure a competitive return on assets. Rent captured is
the total tax take of the various levels of government, including the weighted shares of export
duties and customs fees on exports and VAT on domestic sales, oil excises, subsoil user fees
(royalties), mineral replacement fees (geological taxes), road taxes, social security
contributions to extra-budgetary funds, housing taxes, profit taxes, and other taxes. Rent
appropriated is the rent remaining at the enterprises' disposal after cost recovery, allowance
for a normal profit and payment of all taxes. The detailed data are presented in Annex.
2.29 The average rent appropriated by oil companies is derived from market
capitalization.12 The normal profit is the return on equity expected by a new investor
acquiring shares in an oil company for the long term. All Russian oil companies together
were worth an average US$ 75-80 per ton of oil extracted in 1999. The last line in Table 8
suggests that the Russian government forewent US$ 4.5 billion in revenues in 1999 and US$
12 billion in 2000. This does not include part of the unrealized rent that would be realized
and captured if producers were free to export as much oil as they wished. US$ 4.5 billion
represented about 9% of consolidated budget revenues in 1999. In other words, if the Russian
government had captured instead of foregone that rent, taxes on capital and labor could have
been cut by over 9% in 1999.
2.30 The choice of a rate of return is a controversial matter. Theoretically, the normal
profit is the opportunity cost of allocating resources to the current economic activity. The
opportunity cost is the profit that would be achieved in the next best alternative. The
corresponding rate of return is then applied to the investment in the activity at hand. This
method presupposes that opportunity costs are easily quantified. However, conditions in
Russia do not allow easy quantification. Reliable information about profit margins is not
available, and opportunity costs are uncertain because of multifarious risks. The ruble has
experienced wide fluctuations in the past 10 years, ownership rights are not adequately
protected, tax regimes have a high propensity to change, banks go bankrupt, etc.
2.31 Practically, the assumption here is that resources invested in oil extraction could be
allocated to alternative long-term assets. For example, the return on the Russia Eurobond
2007, i.e. the debt issued in foreign currency by the Russian government with a 7-year
maturity yielded an average 16% in 2000. The Russia Eurobond 2007 is a relevant reference
asset as it gives an idea of the opportunity cost of investing money in Russia in the long
term.'3 It involves a 10% risk premium over a risk-free asset such as the 7-year U.S. Treasury
bill. The question is whether investments in the Russian oil sector should receive an
12 This method is used by the U.S. Bureau of Economic Analysis to assess natural resource rent in the United
States under the name Current Rent Method I (BEA 1994, 2000).
13 The Russia Eurobond 2007 yielded an average 30% in 1999, which is quite high, in the aftermath of the
financial meltdown of August 1998. The downward trend in yields since 1999 indicates that investors are
regaining confidence in Russian Eurobonds, which also justifies using that this type of instrument as a
benchmark for normal profit.
18
additional risk premium due to the inherent risk. This question can be debated at length. The
stance taken here is that a premium on the order of 5% on equity is acceptable, which yields
a normal profit rate of 20%.
Table 9. Appropriated Rent on Licensed Oil - Sensitivity Analysis
1999 2000
Profit No Transfer No Transfer
rate* transfer pricing transfer pricing
pricing pricing
25% Normalprofit(US$/ton) 19.9 19.9 19.1 19.1
Appropriated rent (US$/ton) -0.5 10.7 14.2 33.7
Foregone revenues (US$ mn/yr) -143 3,278 4,537 10,778
30% Normal profit (US$/ton) 23.9 23.9 22.9 22.9
Appropriated rent (US$/ton) -4.4 6.8 10.4 29.9
Foregone revenues (US$ mn/yr) -1,357 2,064 3,314 9,555
* Normal return on equity defined as market capitalization.
2.32 Since normal rates of return are controversial, a sensitivity analysis is necessary,
which conveys the change in profitability and rent in response to changes in normal profit
rates. Table 9 indicates that even with a high normal profit rate (30%, i.e. Russia Eurobond
2007 + 15%), the total appropriated rent still amounted to US$ 7 per ton in 1999 and $US 30
per ton in 2000. The normal profit rate that brings the appropriated rent to zero in 2000
(assuming transfer pricing) is around 70%. Assuming a 20% normal profit rate and transfer
pricing, Table 10 reconstructs the total current oil rent per ton of oil produced in Russia in
1999. The total average rent was estimated at US$ 95.4, consisting of the following parts: the
bulk is unrealized rent, as defined above, which amounted to US$ 40.5 per ton, or 42% of the
total; normal profit equaled US$ 15.9 or 17%, which was a little less than either the tax take
or captured rent (US$ 24.2 or 25%) and a little more than the appropriated rent (US$ 14.7 or
15%).
Table 10. Total Current Oil Rent in 1999
(US$/ton)
Unrealized rent (implicit subsidy) 40.5
Entrepreneurial rent (normal profit) 15.9
Captured rent (notional tax take) 24.2
Appropriated rent (excess profit) 14.7
Total rent 95.4
Estimation of Gas Rents
2.33 The firm OAO Gazprom, a natural and legal monopoly, accounts for 92% of natural
gas production in Russia. It is the largest natural gas producer in the world.'4 Gazprom
14 Plans are discussed to break up the monopoly into Gazprom's core functions (production, transportation,
distribution, etc.).
19
employs around 300,000 people and is Russia's largest company on this count. The
production of natural gas, like that of oil, has diminished since the early 1990s, though much
less dramatically than oil, as the chart in Annex illustrates. In 1999 it totaled 591 billion
cubic meters.
2.34 As in the case of oil, a large share of the natural gas produced in Russia is consumed
in the CIS. The Annex indicates that only about 3 1 % of the total production is exported, 58%
is sold on the CIS markets and 11% is consumed by enterprises for their own needs. The
price difference, which arises from local regulations, represents an implicit subsidy to CIS
economies. Given that the price difference between exports and CIS sales was around US$
36 per thousand cubic meters in 1999. As in the case of oil, the size of the total subsidy gives
gas producers, especially Gazprom, some leverage on the government to call for tax
concessions and other privileges. Gazprom can even threaten the government to reduce
investments, which could damage energy security.
2.35 To calculate the current average recorded rent, Table 11 uses Gazprom's market
capitalization as a basis for calculating normal profit. As of December 1999, Gazprom's
market capitalization was US$ 7 billion. A 15% return on equity was applied in the central
scenario. The normal profit rate selected for natural gas is lower than for oil given the lower
level or risk associated with gas production in Russia, mainly because Gazprom is a
monopolist. The average appropriated rent was US$ 8 per thousand cubic meters and total
foregone revenues amounted to US$ 4.6 billion, which does not include the part of the
unrealized rent that would be captured if producers were able to export more.
Table 11. Average Appropriated Natural Gas Rent
(1999, US$/thousand m3)
Revenues 24.8
Costs of sales 5.4
Depreciation 1.0
Normal profit * 2.0
Tax take 8.6
Appropriated rent 7.8
Total foregone revenues (US$ mn) 4,598
* 15% return on shareholders' equity (valued at market capitalization).
2.36 Revenues are the weighted average of domestic and export sales. Production costs
include the expenditures on energy, labor, transportation, gas purchases from independent
suppliers, and marketing. The tax take is the share of the rent that is captured by way of taxes
and other levies, including the weighted share of excise taxes and VAT on domestic sales,
the weighted share of excise taxes and export duties on exports, social security contributions,
as well as the road, housing, property and profit taxes, plus taxes on subsoil use and
geological taxes. The appropriated rent is the share of the rent remaining after recovery of
production costs, allowance for a normal profit and payment of all taxes and duties.
2.37 The rent's sensitivity to the normal profit rate reveals that the appropriated rent
remains above US$ 6 per thousand cubic meters, even if the normal profit rate is set at 25%
20
of market value. Table 12 shows the results. The tax take is assumed fixed, since what varies
is the definition of normal profit, not actual profit.
Table 12. Appropriated Natural Gas Rent - Sensitivity Analysis
(1999)
Normal US$/
profit rate * thousand m3
20% Normal profit 2.7
Tax take 8.6
Appropriated rent 7.1
25% Normal profit 3.4
Tax take 8.6
Appropriated rent 6.4
* Normal profit = % of market capitalization.
Table 13. Total Current Rent on Natural Gas in 1999
(US$/thousand rn3)
Unrealized rent (implicit subsidy) 36.4
Entrepreneurial rent (normal profit) 2.0
Captured rent (notional tax take) 8.6
Appropriated rent (excess profit) 7.8
Total rent 54.8
2.38 The largest portion of the rent was the unrealized rent, which amounted to US$ 36.4
per thousand cubic meters, or 66% of the total; normal profit equaled US$ 2 or 4%, the tax
take or captured rent amounted to US$ 8.6 (or 16%), and the appropriated rent to US$ 7.8 (or
14%).
Timber
2.39 Russia has the largest forest resources of any country, comprising 764 million
hectares or 22% of the world's forest cover. Russian forests also account for 21% of the
world's standing timber volume (82 billion cubic meters) and provide the largest land-based
carbon storage in the world (World Bank 2000a).
The Russian Forest Revenue System
2.40 Like other natural resources, timber is under-priced in Russia. Stumpage fees were
first established under Czar Paul 1. Over time, they were refined to reflect market prices for
wood products and the rent-generating factors specific to different forest areas. With the
advent of communism, however, market relations were obliterated. In the forest sector this
implied a complete overhaul of the stumpage fee system. In keeping with the Marxist labor
theory of value, Soviet economists in 1949 made stumpage fees a function of the labor costs
21
of forest regeneration, disregarding the economic and geographic rent-generating variables of
forest exploitation (Barr and Braden 1988; Letyagin and Pochinkov 1998; Levin 1998;
Pitovranov 2000). The correlation between stumpage fees and rent was thus severed. As the
proceedings of a recent workshop gathering several dozens of forest specialists from around
Russia concluded:
Current forest fee rates hardly correlate with the actual (market) value of forest
resources. The method of stumpage rates calculation was developed under conditions
of the directive plan economy. It is not based on the market pricing mechanisms for
forest products and does not take into account the whole complex of rent fonnation
factors. The current minimum stumpage rates are significantly underestimated and do
not reflect the actual value of forest resources. (FER 2000)
2.41 Today timber user fees are set at the federal level. Article 103 of the 1997 Forest
Code of the Russian Federation provides that "payments for use of the Forest Fund are
collected in the form of forest taxes or a rental charge." (GOR 1997) Forest taxes are
stumpage fees, i.e. charges paid for the right to fell a given volume of standing timber. Rental
charges only differ from stumpage fees by the duration for which the right to fell is acquired:
stumpage fees are paid for a period of up to one year, while rental charges are paid for leases
between one and forty years. 5
2.42 Short-term sales and leases differ in at least two important respects. First, short-term
cutting rights are supposed to be auctioned off, whereas longer-term leases are allocated
through a technical and financial review of sealed bids, in which the price is not the deciding
factor. Second, different specifications are attached to the two schemes: in the short-term
permit, the forest user does not have precise obligations as regards forest management,
whereas a lessee must fulfill a number of conditions related to rotation, logging,
reforestation, road building, etc. One consequence of the absence of requirements, in
particular in terms of road building, under the short-term scheme is that cuts tend to be
limited to areas adjacent to roads and railroads, which become over-harvested, while outlying
forest areas remain undeveloped.
2.43 The Russian forest legislation makes provisions for forest revenue sharing among the
various levels of government. Article 106 of the Forest Code provides that regions with final
allowable cut exceeding 1 million cubic meters apportion the receipts of minimal stumpage
fees and rental charges as follows: 40% to the federal budget, and 60% to the regional
budget. The receipts corresponding to the difference between minimal and actual rates is
reserved for the budgets of the forest management agencies (leskhozy). In 1999, the average
stumpage fee in Russia was RUB 14, or about US$ 0.50, per cubic meter (Petrov 1997 and
2000a).
1 In Russian, forest taxes are called lesnye podati and the rental charge arendnaya plata.
22
The Forestry Sector in the Russian Economy
2.44 In 1999, the forest sector accounted for 1.5% of GDP, 4.8% of industrial output, 4.5%
of export earnings, 1.5% of consolidated budget revenues16, 3.3% of foreign direct
investment, 8% of industrial employment, and 2% of total employment (Goskomstat;
Gostamozhkomitet; Miklashevskaya 2000; NIPIElLesprom).
2.45 The sector has been affected by the economic downturn surrounding the transition to
a market economy. Timber harvesting levels declined drastically as domestic demand for
wood products fell and transportation costs rose, from over 300 million cubic meters in 1990
to 80 million cubic meters in 1997 (see Annex). The officially harvested volume nation-wide
amounted to 157 million cubic meters in 1999, including thinnings and salvage. Illegal
logging and exports are widespread (BROC et al. 2000; OECD 1999; World Bank 2000a).
2.46 Output from the downstream industry also plummeted, especially in the pulp-and-
paper branch. However, production volumes recovered in 1998 and 1999, in the wake of the
August 1998 real depreciation of the ruble, which boosted exports and import substitution.
The recovery is continuing in 2000, with a 17% increase in output in the first 6 months of the
year compared to the first 6 months of 1999 (World Bank 2000b). Table 14 gives the
dynamics in reported profitability of the Russian forest sector. The logging branch is reported
to have been in dire financial straits until 1998, while wood processing, in particular plywood
manufacturing, has fared relatively well. 1998 and especially 1999 have seen sharp gains in
profitability across the board.
Table 14. Profitability of the Russian Forest Industry
(in percentage)
Branch 1990 1992 1993 1994 1995 1996 1997 1998 1999*
Overall 17.4 36.0 24.0 10.1 15.5 -7.4 -7.7 -4.2 25.5
Logging 11.2 35.0 15.0 5.4 -6.2 -14.1 -20.9 -11.1 9.4
Sawn goods 24.1 39.6 23.0 6.7 2.2 -12.9 -14.6 1.8 11.2
Plywood 16.2 46.3 45.1 18.7 17.2 4.7 8.7 28.4 50.6
Furniture 32.0 30.0 33.2 23.0 10.5 1.2 4.1 7.1 17.6
Pulp and 14.9 32.0 27.0 22.6 35.2 -5.9 -2.3 12.9 37.9
paper
9 months.
Source: Burdin et al. (2000)
2.47 The fact that logging was reported unprofitable for four continuous years between
1995 and 1998 is hard to believe, even allowing for accumulation of debt arrears. One must
remember that revenue concealment in one form or another is rampant in the Russian
16 Including an estimated 6.7% of export duties, 2.8% of CPT, 1.1% of VAT, and 3% of natural resource user
fees.
23
economy and the forest sector is no exception. In addition, the system of non-payments
allows firms and the government to trade in non-cash instruments, which do not show up in
official statistics. Given the downward bias of official statistics on profitability, the return to
profitability in 1999 gives even more reason to believe that the sector is indeed recovering.
2.48 The fiscal contribution of the forest sector is not commensurate with the size of the
forest resource (World Bank 1994). The potential tax revenues from the forestry sector were
estimated at US$ 0.9-5.5 billion per year in 1996 depending on assumptions about wood
production and the profitability of forest enterprises, i.e. 0.7-4.4% of consolidated revenues
(World Bank 1996). In 1999, the forest sector still contributed only about US$ 0.55 billion,
or 1.1% of consolidated revenues (including profit taxes, VAT, excises and stumpage fees).
Low Rent Capture
2.49 The mediocre fiscal role of the forest sector is due to a complex set of interrelated
issues, including low stumpage fees, illegal logging and exports, and poor collection rate of
stumpage fees. The first two reasons are considered here. The third reason is common to
most every natural resource and every tax in Russia and is discussed in more detailed later in
the context of the non-payments problem.
Low Stumpage Fees
2.50 Russian stumpage prices are less than 2-3% of the market price for timber, compared
to 65% in Finland (Sokolova 2000). Russian stumpage fees are low for several reasons. As
was explained above, federally mandated minimal stumpage fees do not reflect rent or
market conditions. Other reasons include: (1) the cap imposed on actual stumpage fees; (2)
high road building and transportation costs; (3) low value added; (4) political risks; and (5)
distorted domestic and export timber market structures. When analyzing reasons 2 through 5,
it helps to place Russia in international context. Finland is a meaningful reference for Russia,
as the forests are comparable, and Finland is the largest importer of timber from Russia,
either for processing or re-exporting. Most of the Russian-Finnish wood trade is in round
wood coming from European Russia, in particular the Russian North and Northwest.
Whereas in Northwest Russia the actual average stumpage fee per cubic meter of round wood
was RUB 14.5 in 1999, or about US$ 0.50 at the current exchange rate, in Finland the
average rate hovered around US$ 18, i.e. about 30 times more (Petrov 2000b; Finnish Forest
Research Institute 2000).
2.51 First, the Russian legislation limits the autonomy of regions to raise federally
mandated minimal stumpage fees: regions are only allowed to double the minimum rates.
2.52 Second, Finnish importers invoke the high costs of road building. Russian all-purpose
roads are few and of substandard quality, and the quality of forest roads is even worse.
Harvesters thus spend considerable resources building roads or otherwise overcoming
transportation difficulties. The higher the cost, the lower the residual stumpage value.
Although this argument holds some truth, it should be qualified in the following way. Firstly,
much timber is cut in the winter in Russia, at a time when roads are of less importance since
24
the ground is frozen. Secondly, labor and fuel costs are much lower in Russia than in
Finland, which compensates to a certain degree for high transportation costs.
2.53 Third, the realized rent is much lower than the potential rent due to low value added.
One problem is the overall inefficiency of forest enterprises, starting with high wastes of raw
material. Waste rates ranging between 25% and 75% of all timber cut have been reported for
the Soviet period (Levin 1992; Nilsson et al. 1992; World Bank 1997). Losses of 40-60% are
reported for the present time in the Russian Far East (BROC et al. 2000). Wasted timber
represents unrealized rent, so less efficient operations will be ready to pay only lower
residual stumpage values. In addition, Russian wood may not quite be of the same quality as
Finnish round wood. Wrong assortment size and late delivery damage the quality of timber,
while the sorting, drying and grading of lumber often leave much to be desired. The lower
the quality of timber and lumber, the lower the stumpage value. Arguably, the continental
climate causes the diameter of trees of identical species to be lower in Russia than in Finland
(Myllynen 2000; Voronkov 2000). The lower is the diameter, the higher is the cost to supply
a given volume, and the lower the residual stumpage value. Finally, the Russian forest sector
stands out by the prevalence of logging. This underdevelopment depresses stumpage values
(NIPIEILesprom). Russia predominantly produces round wood, which contains much less
value added than, say, plywood or fiberboard. Wood products with less value added naturally
fetch lower sales prices and generate less rent than higher-value added products. In other
words, stumpage fees in Russia will be lower in Russia than in countries with more
developed wood transformation sectors (Gray 1983; Lebedev 1998).
2.54 Fourth, political risks are widespread in Russia's unstable economy. Arbitrary
changes in tax regime, expropriation, racket, bureaucratic hassles, and corruption all
contribute to increasing the transaction costs of doing business in Russia. The higher the
transaction costs, the lower the stumpage value.
2.55 Fifth, several market structure features prevent competition for timber resources and
can be identified as impeding a raise in stumpage fees. Firstly, leskhozy, the public agencies
in charge of forest management, benefit from legal privileges, which give them market
advantages and reduce competition. By law, leskhozy are exempted from stumpage fees and
most other taxes, except taxes on payrolls, personal income (levied at a rate of 12% only) and
road use (Sokolova 2000). In addition, they do not have to compete in auctions to buy
harvesting rights, yet they exercise commercial activities under the guise of forest
management. These privileges significantly reduce market competition. The lower the
competition for timber, the lower the stumpage price.
2.56 Secondly, timber auctions themselves are deficient. Although auctions have existed in
Russia since the mid-1990s, they are generally thought to be of poor quality, due to a
combination of factors including inadequate publicity, insufficient number of bidders,
collusion among bidders, price fixing by auction organizers, and other market-biasing
practices (Efremov et al. 1999; HIID et aL 1998; Jacobsen 1999; Lehmbruch 1999). 17 Again,
17 Here is a revealing account of how forest auctions are held in Russia: "According to Russian legislation, both
auctions and tenders require more than one bidder. But if the authorities would strictly follow this requirement,
no forest resources would be utilized, since there are so few potential bidders in Murmansk . . . The typical
25
the lower the competition, the lower the stumpage fees and the lower the extraction of rent.
Furthermore, auctions make up only a small share of the total sales of standing timber (15%),
the rest consisting of direct sales. Although these sales are called konkurs, implying
competition, the competitive element may not be present at all.
2.57 Thirdly, market power may be present. The export and domestic market relations are
examined in turn. Since European Russia exports so much to Finland, one can wonder
whether Finnish importers dictate their prices to Russia. It is no secret that every year,
sometimes more than once a year, Russian exporters and Finnish importers gather to
negotiate the import prices of timber for the following period. Prices are set per cubic meter
of round wood (mostly birch pulpwood) delivered at the first railway station past the Finnish
border. The current price is EUR 30.60. To determine whether Finnish importers dictate their
price to Russia, one must compare the import price to the price for domestic birch pulpwood
in Finland. According to Finnish academic and business experts, Russian birch pulpwood is
slightly more expensive than the Finnish equivalent at the border gate. In total, however, it
comes out a little cheaper as transportation distances for Russian wood from the border to the
mills are generally shorter than for Finnish wood, and overhead costs are higher on Finnish
than Russian purchases, essentially due to the high number of Finnish suppliers.18 Finnish
companies thus find it profitable to import Russian birch pulpwood to supply their pulp-and-
paper plants, but not in virtue of the particularly low price of raw materials. Instead, they
need to import Russian birch pulpwood as the capacity of the Finnish supply is inadequate to
meet the demand.19 Nonetheless, by doing so they also depress the demand and price for
Finnish birch pulpwood, which is used here as reference for Russia (Jaaskelainen 2000;
Niskainen 2000; Rytkonen 2000). Hence one can conclude that the import prices of Russian
wood to Finland seem to broadly follow the domestic Finnish market price, even if some
depressing feedback effect on domestic market prices is inevitable. This finding is in line
with earlier literature (University of Joensuu 1996). The low level of Russian stumpage fees
is not the consequence of artificially low import prices imposed by Finland.20
procedure seems to be the following: a single bidder proposes his bid, which is (close to) the reservation price.
The leskhoz selects an appropriate area for leasing and utilization and the formal documents are prepared. Only
then is the auction or tender announced in the newspapers. If more bidders should suddenly appear - fine - this
would increase the price. If not, the first single bid proposed would be realized.... The conmmon denominator
[of forest auctions in Murmansk in 1999] is that there was only one bidder .... Since there is often only one
potential buyer who is located close to the timber resources offered, the FFS [Federal Forest Service] faces a
problem in defining a reservation price, which does not under-value the timber resources. The stumpage price
may easily become the final reservation price. The potential buyer has no intention of giving a higher bid,
knowing that there is no real competition going on." (Jacobsen 1999, 13-14)
18 60% of Finnish forests are owned by 400,000 small holders, which increases the number of business partners.
In Russia, by contrast, the number of exporters is relatively limited.
19 The supply of birch pulpwood from Finnish producers is estimated at 4 million m3, while the Finnish industry
needs 9 million mn3 annually (Jaaskelainen 2000).
20 Incidentally, research has revealed no signs of oligopsony power in the Finnish wood market either (Ronnila
and Toppinen 2000).
26
2.58 One must therefore turn one's attention to the structure of the Russian timber market
itself. Although analysis is limited by the availability of data, Russian loggers might be
subject to some local monopsony or oligopsony power, i.e. the power that one or a few
buyers can exercise on a larger number of sellers (Nilsson 2000). Such power may result
from the naturally small number of buyers at the local level, but in a criminalized context it
may also signify that local buyers use duress to procure raw materials at less-than-
competitive prices. Buyers may be wood processing firms, trading intermediaries or
transporters who engage in rent seeking. Some are downstream enterprises, i.e. down the
forestry chain from loggers, others outside of the forestry chain altogether (e.g. pure trading
intermediaries). The growth of intermediaries in the Russian forest sector has been attested
before (see, e.g., Sokolova 2000). Transporters, too, may appropriate rent. Given the long
distances involved, transportation costs are known to influence enterprises' profitability in
Russia. Most of the timber is transported by railroad. Because of high railroad tariffs,
Siberian timber in CIS countries or European Russia became unprofitable when implicit
transportation subsidies were cut. Indeed in the early 1990s, railroad tariffs were a multiple
of timber sales prices (Blam et al. 2000; Sokolova 2000). Railroad tariffs have been cut and
restructured on several occasions in the past few years but they are still thought to be
excessive nowadays (Carlsson et al. 2000). The Russian railroads discriminate heavily
between domestic deliveries and exports, imposing a de facto additional export duty on
international sales. For example, in the second quarter of 1999, tariffs for export sales were
3-4 times higher than for domestic sales of most commodities including wood products
(GOR 1999). This means that the railroads either appropriate rent on the export of timber or
cross-subsidize domestic sales, or do a mix of the two.
2.59 Local market power increases with the trends towards integration in the Russian
forestry sector. Through vertical integration, upstream and downstream companies merge to
control the whole production chain from timber logging to advanced wood processing
(Lehmbruch 1999; Popovskaya and Rozanova 1998). The integration under way in the forest
sector has been coined "backward integration:" wood processing companies directly finance
harvesting enterprises (Carlsson et al. 2000). Vertical integration may reduce transaction
costs and boost the efficiency and profitability of forestry operations, which is why experts
have advocated it for the Russian forest sector (Carlsson et al. 2000; Efremov et al. 1999).
Increased allocative efficiency also results from rent maximization, provided that rental
payments are high enough. Unfortunately, large vertically integrated companies exercise
greater influence on the remaining independent loggers, each of them confined within its link
of the forestry chain and with no direct access to the international market.
Illegal Logging and Exports
2.60 When timber is logged or exported illegally, the government foregoes stumpage fees,
export duties, and other revenues. Illegal cuts and exports tend to be linked, since the
customs service is supposed to verify the origin of registered timber exports. When timber is
cut illegally, exporting it legally becomes more difficult.
2.61 The unrecorded rent resulting from such illegal activities could assume large
proportions. For example, expert estimates put the illegal cuts in the Russian Far East at 30%
27
of the total actual cuts and illegal timber cuts in Russia at 12% (WWF 2000). Poachers would
cut around 21 million cubic meters per year, or 15-20% of total reported cuts, with half of
that originating from the Russian Far East (Medetsky 2000).
2.62 A significant part of illegal cuts take the form of sanitary cuts by leskhozy. Here is an
unequivocal testimony by a leskhoz director in the Vladivostok region:
It is no secret that we ourselves, local forest services in administrative districts of the
Russian Far East, are some of the most serious violators of forestry rules and
regulations. Even though logging may be our only means to survive, as we receive
almost no financing from the local administration and from the government, we have
no right, I suppose, to log commercially under the label "salvage logging." (Viktor
Kozachko, Director of the Melnichny Leskhoz, Krasnoarmeiskii District, Primorsky
Krai, cited by BROC et al. 2000, 21)
2.63 Concerning exports, a variety of frauds are possible, including outright avoidance of
customs verification, bribing of officials, forged export licenses, misrepresentation of quality
or quantity, etc. Several estimates of the magnitude of the problem have been published. At
the high end of the spectrum, one source reports that the actual export value of timber is
double the official one (RCN 1999). An audit carried out in 1995 at the customs post of
Vyborg (Leningrad region) revealed that the weight of export cargoes by truck was
underreported by 20-25% (University of Joensuu 1996). Based upon a comparison of the
Novgorod region customs data with import data from Finnish firms, it is estimated that
illegal round wood exports from Novgorod to Finland did not exceed 10-15% in 1999.
Estimation of Timber Rents
2.64 In order to estimate the current average timber rent, at least three methods can be
used. First, the simple net-back method nets out reported timber production costs from timber
market prices. Second, the normative net-back method consists of netting out normnative
(engineering) timber production costs from timber market prices. Third, auction prices can be
used to derive the rent. In this method, the difference between actual auction prices and
minimal stumpage fees reveals the loggers' willingness to pay for the timber, in other words
the stumpage appraisal value.21
2.65 Though some Russian forestry specialists claim they know how to estimate the timber
rent (see, e.g., Moiseev 1999), practically the task presents challenges. Markets are generally
non-competitive and reliable accounting information is not available. The literature is indeed
very poor in attempts to measure the timber rent in Russia. Among the few exceptions,
sources have reported rents in the region of US$ 6-25 per cubic meter in Khabarovsk
(Pankratova 1999; Sheingauz 1997). Recent research on one experimental leskhoz in the
Moscow region using the normative net-back approach estimated that 23 out of the 28 forest
enterprises operating on the territory of that leskhoz register a positive rent ranging from
21 Auctions will reveal the rent in the absence of road building costs, in accordance with the Russian legislation,
which provides that auctions are held for short-term cutting permits not subject to road building obligations.
28
RUB 8 to RUB 66 per cubic meter, with an average of RUB 33 (US$ 1.20), i.e. almost twice
the average minimum stumpage fee in that region (Pochinkov 2000). Separate data from
Irkutsk Oblast (southern Siberia) indicate that export-grade timber fetches RUB 1,000 per
cubic meter but costs only RUB 350 to produce. The profit on such timber would equal RUB
650 or 65% of sales price (Shulyakovskaya 2000).
2.66 In this study, the simple net-back methodology was applied to 8 Russian regions
(Arkhangelsk, Khabarovsk, Krasnoyarsk, Leningrad, Moscow, Novgorod, Pskov and
Vologda) and the Russian Federation as a whole using two data sets.
2.67 The first data set was compiled from original data collected from the 8 regions. For
each region, average costs and prices were obtained, covering from a couple of logging firms
to all of them. The second data set was taken from NIPIElLesprom's database, which
comprises cost information on 20,000 forest enterprises in the whole of Russia for the year
1998. Costs for 1998 were multiplied by the 1999 producer price index in the forestry sector
(Goskomstat reports 1.572) to obtain 1999 costs.
2.68 There exist wide discrepancies between the two data sets. In particular, the costs
reported directly by the regions come out much higher than the NIPIEILesprom equivalent.
The higher costs from the regions are thus taken as the higher bound estimate and the
NIPIElLesprom figures as the lower bound estimate.
2.69 Using the two data sets, notional profits, normal profits, notional tax takes, unit
appropriated rent, and foregone revenues were calculated using two different techniques -
the equity and the costs techniques. Though the data sets are independent, data from both
must be combined to calculate some of the coefficients or variables in each technique, which
means that the calculations themselves are not totally independent. For example, transport
tariffs and handling costs are only available in the regional data set, while the normal profit
rate is calculated with NIPEEILesprom data.
Equity Technique
2.70 This technique calculates normal profit as a return on equity.22 In the regional data
set, production costs = production costs at lower landing minus stumpage fees. In the
NIPIEILesprom set, production costs are taken as such. Then, in the regional data set, the
cost of sales - production costs at lower landing + transport tariffs + handling costs; and, in
the NIPIElLesprom set, the cost of sales = production costs + transport tariffs + handling
costs. Next a notional gross profit can be estimated based upon the available revenues and
costs. Notional profit is a reconstructed, not actual profit: notional gross profit = revenues
minus cost of sales. 23 Using the regional data set, the notional tax take, which is the tax
22 This method corresponds to the "Current Rent Method I" of the U.S. Bureau of Economic Analysis (BEA
1994 and 2000).
23 Data include FOB (free on board) and CIF (cost insurance freight) prices for round wood. CIF prices are used
here as the measure of revenues.
29
liability that would be due if all taxes were properly assessed and collected = notional gross
profit * 30% (if notional gross profit > 0) + stumpage fees + export duties. Using the
NIPEILesprom set, notional tax take = notional gross profit * 30% (if notional gross profit >
0) + export duties (stumpage fees are included in production costs and cannot be dissociated).
All other taxes, in particular social security contributions, are included in production costs in
both data sets. Unlike the oil and gas sectors, forest companies are not traded publicly and no
market capitalization data exists to estimate equity. For the purpose of estimating normal
profit, a standard return on equity therefore had to be reconstructed for the whole Russian
logging sector in the following manner. Total assets in the Russian logging sector had a book
value of RUB 28.6 billion in 1998.24 1999 investments amounted to just over RUB 2 billion
while depreciation amounted to just over RUB 1 billion. Converting each figure in US$ at the
appropriated exchange rate and using the average equity-to-assets ratio in the logging sector
of 70%, total equity in the logging sector in 1999 was around US$ 987 million. A normal
profit rate of 20% (Eurobond 2007 average 2000 yield plus a premium of around 5%) was
selected for the Russian forest sector.25 Given this rate and the timber cut for main usage of
122 million cubic meters, the standard normal profit on equity for the Russian logging sector
for 1999 was estimated at US$ 1.62/m3 (Burdin et al. 2000; Sakhanov 2000). Then, the unit
appropriated rent = notional gross profit minus notional tax take minus normal profit. Since
the unit appropriated rent is estimated for both domestic sales and exports, it is necessary to
weight each figure by the relative sales shares: weighted unit appropriated rent = unit
appropriated rent on domestic sales * domestic sales share + unit appropriated rent on exports
* export share. The total appropriated rent, or foregone revenues = weighted unit
appropriated rent * total timber cut for main usage.26
2.71 The Annex gives the synthesis for each region and both data sets, while Table 15
gives the aggregated results for Russia as a whole. Using the regional data set as lower bound
estimate and the NIPIEILesprom as upper bound estimate, the interval for the average current
appropriated rent on round wood was around US$ 1.9 - 7.8 per cubic meter in 1999, which
means total foregone revenues of around US$ 227 - 944 million per year. In addition, more
revenues are foregone because part of the rent is unrealized through excessive domestic sales,
which could be reallocated to export markets. However, as in the case of oil and gas, no
value is attached to this category of foregone revenues, as it is not clear how much extra
timber from Russia foreign countries could import.
24 Book values tend to over-represent reality given some of the peculiarities of the Russian accounting system.
As a consequence, the calculated normal profit might itself be overestimated, and the appropriated rent
underestimated.
25 NIPIEILesprom recommends 25% as a normal rate of return on capital in the logging sector, but that seemed
too high as the rate for the central scenario.
26 Main usage means timber cut for use as round wood, lumber, or to be processed. It excludes the sanitary and
salvage cuts performed by leskho2y.
30
Table 15. Average Current Timber Rent - Equity Technique
(US$/m3)
Dataset Regions NIPIElLesprom
Domestic Export Domestic Export
Revenues (CIF price) 21.01 52.56 21.01 52.56
Cost of sales 17.00 34.22 10.21 27.42
Normal profit * 1.62 1.62 1.62 1.62
Profit tax take (notional) 2.34 8.90 3.24 9.82
Appropriated rent 0.04 7.83 5.94 13.70
Unrealized rent 12.00 0.00 12.00 0.00
Weighted average appropriated rent 1.86 7.76
Total rent appropriated (US$ inn) 227 944
* 20% return on equity
2.72 Table 16 identifies the various components of rent averaged across domestic sales and
exports, based upon Table 15. It is worth noting that the forest sector generates a large total
rent. The government captures about US$ 4 (or 20%) of the total rent, while less than US$ 2
(or 10%) is earned by forest enterprises and intermediaries as normal and excess profit. The
largest portion of the rent (US$ 9.69 or 57%) is dissipated through the local economy as
unrealized rent.
Table 16. Total Timber Rent in Russia - Equity Technique
(US$/m3)
Regions NIPIEILesprom
Unrealized rent (implicit subsidy) 9.69 9.69
Entrepreneurial rent (normal profit) 1.62 1.62
Captured rent (notional tax take) 3.85 4.76
Appropriated rent (excess profit) 1.86 7.76
Total rent 17.03 23.82
2.73 Based upon the main usage cut of 121.6 million cubic meters in 1999, the total
implicit subsidy to the domestic economy amounted to US$ 900 million. However, total
implicit subsidy does not equal foregone revenues. If all the wood sold domestically were in
fact exported, some additional revenues would be generated. $9.69 per cubic meter would be
the total additional before-tax income to the exporter, of which 30% could be taxed away
under the profit tax and 5% withdrawn by the export duty. 35% of the unrealized rent would
thus turn into public revenues, i.e. $3.40 per cubic meter.
2.74 However, the real effective subsidy to the national economy may still be
underestimated. First, the salvage logging and thinnings undertaken by leskhozy do not
generate any revenues and are an additional implicit subsidy. In 1999, for example, these cuts
amounted to 22.9 million cubic meters, or 19% of the main usage. Second, part of the
logging waste should be included as unrealized rent as well. Conservatively, neither salvage
logging, thinning nor logging waste are captured in the tables.
31
Costs Technique
2.75 The costs method estimates normal profit as a percentage of production costs.
Although profit is usually not measured as a proportion of costs, this benchmark has in fact
been used in the forest sector in the Komi Republic, which is why the method is replicated
here. All variables are calculated as in the equity method, except normal profit. Here, normal
profit = production costs * a coefficient of 15%. 15% is the rate that was used in Komi in
1999.
2.76 Table 18 gives the aggregated results for Russia as a whole (see the Annex for the
details per region). Again using the regional data set as lower bound estimate and the
NIPEILesprom as upper bound estimate, the interval for appropriated rent on round wood
was in the range of US$ 1.6 - 8.5 per cubic meter in 1999, and total annual foregone
revenues amounted to US$ 191 - 1,032 million, to which, as above, 35% of the unrealized
rent should be added to obtain the likely total foregone revenues.
Table 17. Timber Rent in Russia - Costs Technique
(US$/m3)
Dataset Regions NIPIElLesprom
Domestic Export Domestic Export
Revenues (CIF price) 21.01 52.56 21.01 52.56
Cost of sales 17.00 34.22 10.21 27.42
Normal profit * 1.92 1.92 0.90 0.90
Profit tax take (notional) 2.34 8.90 3.24 9.82
Appropriated rent -0.25 7.53 6.66 14.43
Unrealized rent 12.00 0.00 12.00 0.00
Weighted average appropriated rent 1.57 8.49
Total rent appropriated (US$ mn) 191 1,032
a 15% return on costs
2.77 Table 18 distinguishes between the various components of rent averaged across
domestic sales and exports. The only difference compared to Table 16 is the distribution
between normal and excess profit.
Table 18. Total Timber Rent in Russia - Costs Technique
(US$/m3)
Regions NIPIEILesprom
Unrealized rent (implicit subsidy) 9.69 9.69
Entrepreneurial rent (normal profit) 1.92 0.90
Captured rent (notional tax take) 3.85 4.76
Appropriated rent (excess profit) 1.57 8.49
Total rent 17.03 23.82
32
2.78 Several conclusions and caveats are in order before closing this section. First, the
picture emerging is that a significant timber rent exists in Russia, though it varies
considerably across regions. Second, the variance in the data indicates that more refined
methods of rent estimation must be deployed in order to arrive at a more reliable picture of
the reality. Third, the local economy dissipates a large share of the rent. Fourth, the total rent
on round wood was derived from the price of round wood. This method underestimates the
rent since part of the round wood is in fact transformed into processed products, which fetch
higher market prices and profit margin, and thus also generate higher rents. Fifth, the total
forest rent is more than the rent on timber or processed wood, as it also includes the rent of
land bare of forests.
Enhancing Timber Rent Capture
2.79 Forest rent can be captured by a variety of instruments. In the particular case of
Russia, profit taxation is problematic, due to lax accounting and auditing rules. Another
option is to rely on export duties for capturing the rent on profitable export transactions. The
problem is that export duties distort resource allocation between export and domestic sales at
the expense of exports. Moreover, unless substantial rents are known to exist across the
board, export duties penalize marginal operations, since export duties are usually ad quantum
instruments. An improved system of stumpage fees should therefore be privileged as a rent
capture instrument. Enhancing timber rent capture requires more than an improvement in
stumpage fee system, however. It calls for the following more fundamental reforms: (1) a
more accurate definition of forestry costs; (2) improved knowledge of forest resources; (3)
better use of forest resources; (4) increased competition in the timber sector; (5) higher
investments in branches with higher value added; and (6) forest management certification.
2.80 A better definition of costs could imiprove forest revenues and public revenues in
general. At the moment, accounting rules allow firms to include in their production costs
items that have little to do with forestry, which artificially depresses reported profits and
residual stumpage values, and thus also stumpage fees. Normative production costs can be
reconstructed without too much difficulty for each type of technology and location, and help
forest authorities decide which costs and profit margins are acceptable.
2.81 Second, the knowledge of forest resources can be improved, for example through a
forest cadaster (quantitative and qualitative register) and improved inventories, in accordance
with the 1997 Forest Code (Lebedev 1998). This would help the authorities better estimate
the value of the resources they sell, at least until such a time when forest auctions become
reliable price-setting instruments.
2.82 Third, the use of forest resources can improve through better allocation of forest
parcels, based upon more rational forest planning. This, too, will raise stumpage values.
2.83 Fourth, more effective competition in the timber sector would raise stumpage fees.
Possible measures, based on the above discussion, include: (1) more transparent timber
auctions; (2) regulation of monopolies and monopsonies; (3) limiting leskhozy to forest
33
management; and (4) regulation of relations among buyers and sellers to guarantee sellers
proper market access.
2.84 Fifth, stumpage fees will not rise to their full potential unless the economy upgrades
to products with higher added value, e.g. plywood and pulp and paper instead of round wood.
The resources needed for such investments should not necessarily come from the state,
however. The decades of central planning have shown that the state often is a wasteful
entrepreneur. Instead, the federal and regional governments should ensure that the conditions
are favorable for private enterprises to invest. Ensuring an "enabling environment" has to do
with general economic policy, which extends well beyond this paper. But without such an
environment, it is unlikely that the forest sector will develop. Road building represents one
small, forest-related, aspect of that enabling environment where the state may have a role to
play.
2.85 Sixth, certification of the ecological, economic and social aspects of forest
management by internationally recognized auditors and following internationally established
standards27 can help add value to timber production in the form of price rises and/or gains in
market shares, and alleviate illegal or harmful practices. Certification can play an important
role in the Russian regions with access to export markets, in particular the Northwest, the Far
East and even southern Siberia, the latter being about to benefit from sharp increases in
China's demand for wood over the coming decades (Ptichnikov 1999; Simula 1999, 2000).
III. RECENT NATURAL RESOURCES TAX REFORM INITIATIVES
3.1 A few recent developments in Russian regions and new economic initiatives at the
federal level may be signaling renewed interest for enhancing the fiscal role of natural
resources.
3.2 At the federal level, declarations have been made in favor of enhancing the role of
rental payments. The Putin administration adopted an economic strategy that intends to lower
the fiscal burden on capital and labor and "to increase the fiscal importance of taxes related
to use of natural resources and also of property taxes, which should become the basic source
of revenue for regional and local budgets." (GOR 2000, 149) The policy of lowering the tax
burden on capital and labor is already being implemented. As of January 2001, the income
tax was transformed from a progressive structure with top marginal rates exceeding 45% to a
flat rate of 13%, while employers' social security contributions were cut from 38.5% to
35.6%.
3.3 In the natural resource taxation area, the new Tax Code draft (Part II) and a draft Law
"On Paying for Mineral Use" provide for reforming the current system of licensed oil
27 Existing certification systems include, inter alia, the ISO (International Standards Organization) 14001, the
FSC (Forest Stewardship Council), and the PEFC (Pan-European Forest Certification).
34
taxation. The new system would reduce the number of taxes to three - a reasonable royalty,
the general corporate profits tax and a special (excess) profits tax.
3.4 At the regional level, Komi and Samara have started differentiating some natural
resource user fees in order to reflect and capture a greater share of the rent. The northern
territories, for their part, have passed a resolution to do the same.
3.5 Russia is a very large and diverse country. Legislative changes involving as many as
89 different regions usually involve long debates. In addition, natural resource sectors wield
considerable political influence. It is therefore hardly surprising that reforms of the resource
taxation system are slow to take place at the federal level. In contrast, some regions have
exhibited innovative approaches. These demonstrate that changes are possible when political
will is present. They also show options for the federation as a whole.
Komi Republic
3.6 The Komi Republic, located in the far north of European Russia, contains one of the
last remaining expanses of taiga (old-growth dense forest) in Europe and the large Pechora
oil basin. The region has launched a pioneering experiment in forest tax reform and might
apply the same principles to oil. In January 2000, a new regional forest law came into force,
which introduced the notion of timber rent and took steps towards withdrawing it.28 The law
applies a normative cost methodology: logging costs are determined using a series of
engineering relationships based on the quality of the forest stand, distance to roads, soil
quality, etc. These factors are objective rent-generating variables. Subtracting costs and a
normal profit allowance from the market price of round wood gives the residual rent on
timber. Using the new methodology, the average rent was estimated at RUB 100 per i3, and
the total appropriated timber rent at around RUJB 690 million, i.e. 6 times the regional budget
for forest management and 8% of the total regional budget (Karakchiev 2000).
3.7 The average stumpage was RUB 10 per m3 fee in Komi in 1999, in other words just
the federally mandated minimum rate. By the middle of 2000, stumpage fees ranged from
RUB 6 to RUB 24 per m3, with an average of RUB 15. In effect, the new Komi forest law
differentiated stumpage fees by determining a series of rent-generating coefficients in 11
different locations of the republic (instead of 4 formerly), and applying these coefficients to
the standard minimal fees. This method results in more than twice as many stumpage fees as
under the federally mandated scheme. Over a period of one year (first quarter of 2000 over
first quarter of 1999), the weight of stumpage in the price of round wood rose from 4.8 to
6.1%, while the profitability of round wood production declined from 25 to 21%. On an
annual basis, profitability is expected to decrease from 14.8% in 1999 to 13.5% in 2000.
Despite the new coefficients, the regional administration estimates that no more than 6% of
the timber rent is captured (GOK 2000; Obukhov 2000; Shutikov 2000).
2r In Russian the timber rent is actually called forest rent (lesnaya renta), although what is meant is usually the
rent on standing timber.
35
3.8 The forest revenue distribution key has also been modified, with the newly generated
revenues being allocated partly to leskhozy for reforestation, and partly to the regional
budget. The initial proposal for a regional forest fund to develop the forest sector in general
was rejected by industrialists. Instead, a proposal is now tabled for such a regional fund to
finance forest road building specifically.
3.9 The normative cost methodology is now being extended to the wood processing
sector. Profitability calculations for the pulp-and-paper, chip, plywood and sawn goods
branches have revealed that wood processing is appropriating rent. The Komi government is
therefore contemplating raising stumpage fees further in order to capture part of this rent. For
example, in the pulp-and-paper branch, one proposal consists of reducing the profit margin
from 31% to about 25% by raising stumpage fees by RUB 13 per m3 of round wood.
3.10 Based upon the timber sector experiment, Komi is working on a draft federal law that
would allow the region to apply the same methodology to other resources, in particular oil.
The Komi experiment is a premiere in contemporary Russia. It falls short of a revenue-
neutral shift, since no taxes have been cut as a result of the reform. Nevertheless, it takes a
step towards capturing resource rents and turning them into public revenue. The impact on
the region's forest revenue and overall fiscal position, the reaction of the forest industry (will
firms relocate to neighboring regions?), etc. will need careful monitoring. If the reform turns
out to be a success, it might trigger a demonstration effect.
3.11 Of course, care must be taken not to hurt the sector when removing the rent.
Capturing the rent should not do away with profits. In particular, it could be argued that the
profitability of 13.5% predicted for the year 2000 may be insufficient. Admittedly, one must
keep in mind that profitability figures generally suffer from gross underestimation in Russia.
Nevertheless, the impact of the reform on logging must be monitored. One must know
whether timber prices have increased in real terms and find out the elasticity of round wood
prices with respect to stumpage fees. A low elasticity would suggest that round wood prices
are in fact insensitive to stumpage fees, and that the potential for withdrawing the timber rent
is limited to loggers. It might then be that the Syktyvkar pulp-and-paper plant exercises
oligopsony power (it consumes 36% of local round wood), which would severely constrain
stumpage fee reform. If anything, the reduction in the profitability of logging indicates that
loggers have shouldered part of the rise in stumpage fees instead of fully passing it on to
customers.
Northern Territories
3.12 Leaning in part on Komi's innovative approach, the Government Committee of the
Russian Federation for Northern Affairs, which until 2000 handled questions of economic
development in the resource-rich northern territories (from Karelia in the west to Chukotka in
the Far East), adopted a resolution to differentiate natural resource use payments to develop
the regions' industrial base (Goskomsev 2000).
36
Samara Oblast
3.13 The region of Samara has decided to fill the legal and fiscal vacuum left by Article 41
of the 1992 Russian "Law on Use of the Subsoil," which provides that "regular payments for
the right the extract minerals are determined taking into account the type of mineral, the
quantity and quality of their reserves, the natural, geographic, technical and economic
conditions of their reclamation and exploitation of their deposit." Samara Oblast has thus
started differentiating mineral resource user fees to reflect rent-generating factors and capture
part of the rent. It has implemented the 6-16% range set for oil and gas in the legislation so
that now, for deposits with relatively advantageous conditions, fees range from 12.29% to
13.14%, while users of relatively disadvantaged deposits pay only 8-10.43% (Evteeva 2000).
A Practical Experiment: Novgorod Oblast
3.14 The forest sector used to figure prominently among the sources of revenues of this
northwestern region of Russia. In 1904, for example, they represented 26% of total regional
budget revenues (Novgorod Oblast 1965-1976-1986). This role was dramatically reduced
with the new rules for stumpage fee calculation established in 1949 as well as the massive
industrialization campaign undertaken by Stalin. By the 1960s, the share of forestry in
regional budget revenues had been reduced to less than 5%. Nowadays, forest revenues play
an even smaller role. The share of natural resource user fees in Novgorod's consolidated
regional budget revenues represented 2.7% in 1999, with stumpage fees accounting for half
of that. The share of the whole forest sector in the region's consolidated tax revenues is
estimated at around 5%, or US$ 3.4 million (GNIVTs 2000).
3.15 Eismont et al. have tried to overcome the problems of using the net-back method to
estimate the timber rent in Novgorod (2001). As highlighted above, depending on the origin
of the data, the net-back method can lead to serious uncertainties in the estimation process.
The innovation of Eismout et al. (2001) consists of using timber auction data to estimate the
timber rent econometrically.
3.16 The model assumes perfect competition among loggers and sets the rent equal to the
auction price (stumpage fee). The auction price is a function of several explanatory variables:
(1) timber type (coniferous vs. deciduous, with coniferous fetching higher prices than
deciduous); (2) volume per tree (the higher the volume the higher the price); and (3) hauling
distance (the smaller the distance the higher the price).
3.17 As a first step, a linear specification is used to estimate the rent:
C= C + C2 TYPE +C3 -QUALITY C DISTANCE (4)
where PA is the auction price (stumpage fee), and TYPE is a dummy variable, representing
timber type (one if coniferous, zero otherwise). The estimation results are as follows. Except
for the constant, all of the estimated coefficients are of the correct sign and statistically
significant at the 1% level:
37
PA = -7.1458 +18.3557 - TYPE + 125.2861 - QUALITY - 0.3187 - DISTANCE
Std. Errors (14.1155) (2.5431) (34.8736) (0.0927)
t-statistic (-0.5062) (7.2177) (3.5923) (-3.4373)
3.18 The coefficients suggest that, ceteris paribus, coniferous wood is worth RUB 18 more
per cubic meter than deciduous wood; as the volume per tree increases by one cubic meter,
the price of timber increases by RUB 125; and as the distance from the forest plot to the
market increases by one kilometer, the price of timber declines by RUB 0.32. The forest
authority could use this simple model to set the price of timber sold outside of auctions: by
entering the parameters of a given cubic meter, the equation will return its price.
3.19 Unfortunately, logging costs do not appear in the linear specification, which is why
the following non-linear specification of the function defining auction price was also used:
PA = CI + C2 'TYPE + c3 * QUALITYC4 - exp(c, - DISTANCE) (5)
3.20 Equation (5) has a clearer economic interpretation than (4). The sum of the first two
terms on the right-hand side correspond to the market price of timber for either deciduous
(with TYPE=O) or coniferous (with TYPE=1) trees. The third term on the right-hand side
stands for logging costs, which depend on timber quality and hauling distance. The
difference between the market price for timber and logging costs is an approximation of the
rent (stumpage value).
3.21 Estimation of equation (5) under engineering values for the coefficients C4 and C5
(C4 = 0.2644 and c5 = 0.0043) produced the following results:
PRICE =178.6845 + 22.2406 - TYPE -102.6373 _ QO.2644 * e0.0043d
Std. Errors (29.5923) (3.1906) (21.2042)
t-statistic (6.0382) (6.9705) (-4.8404)
3.22 The problem with this method of estimation is the stability of the obtained results
relative to the variation of the exogenously given parameters c4 and c5. These two
coefficients indeed vary with the logging technology employed. The engineering values
noted above are based upon a traditional, mostly manual, logging technology, which is still
prevalent in Russia. For more mechanized or fully mechanized technologies, the coefficients
assume slightly different engineering values. To assess the robustness of the estimation one
may calculate the values of the coefficients cl, c2 and c3 as a function of different
parameter values, e.g. the values given above i 50%. This procedure reveals that the
estimation may be regarded as robust.
3.23 This econometric approach predicts logging costs well below reported costs, which
may be due to the facts that: (1) auction prices do not include road building costs (auctions
concern short-term felling rights without road-building obligations); (2) loggers participating
38
in auctions are more competitive than those who do not; and (3) reported logging costs are
artificially bloated to avoid taxation.
3.24 This approach also predicts market prices for timber well below actual market prices
(around RUB 200 as opposed to RUB 400). One reason is that administrative and marketing
costs have not been taken into account in (5). Another possible explanation is the presence of
market power. Novgorod Oblast counts as many as 300 logging companies producing an
average of only about 7,000 cubic meters per year. These small loggers may find themselves
subject to non-competitive practices by buyers and intermediaries. Further research is needed
to determine the ratio of timber buyers to sellers and test the market power hypothesis.
IV. SOME POLITICAL ECONOMY DIMENSIONS OF NATURAL RESOURCE
RENT TAXATION IN RUSSIA
Natural Resource Taxation and the Non-Payments Problem
4.1 Since the end of communism the Russian economy has been plagued, in some cases
crippled, by non-payments. "Non-payments" refer to financial obligations not settled in cash
or not settled at all. As the problem spread in Russia, the formal economy became
increasingly cash-strapped. In-kind payments, barter and a range of promissory notes with
low credibility and limited geographical recognition took over as the prevalent means of
payment, and arrears accumulated, eventually contributing to the meltdown of August 1998.
Natural resource sectors were far from immune, indeed they were, and arguably still are, at
the heart of the non-payments problem.29
4.2 It is the energy sector that played a central role in the non-payments story. Over 60%
of the oil produced in Russia is sold domestically or in the CIS, and non-payment problems
existed throughout this supply chain. In addition, many of the wholesale transactions in the
domestic sector were handled on a barter basis. Cash transactions did take place at the
gasoline pump but suppliers further up the chain did not access this cash, and neither did tax
authorities (Thomson 1998).
4.3 Utilities, in particular RAO UES, the public electric monopoly, and its network of
regional subsidiaries subsidized inefficient local companies by providing them with cheap or
free electricity. Since these companies were not able to pay for their energy bills, ROA UES
had trouble paying its own suppliers (Gazprom, and oil and coal producers mainly) and all of
them failed to meet their tax obligations to the government. As a result, the state coffers
yearned for cash to support Russia's extensive social safety net (Pinto et al. 2000).
29 In the forest sector, one of the symptoms was the low collection rate of stumpage fees. For example, in the
Far Eastern region of Khabarovsk, about 63% of forest fees were collected in June 1997. This ratio fell to 36%
in June 1998, time at which the backlog in unpaid forest fees amounted to US$ 17 million (Markandya et al.
1999).
39
4.4 To dismantle the non-payments problem, it is key to involve natural resource
producers, especially oil and gas companies. By requiring that they pay their taxes in cash
and on time, the government would give them an incentive to recover costs from their
customers, in spite of regional and local pressures that they abstain from doing so. In
addition, by liberalizing energy sales, in particular by removing restrictions on energy
exports, the government would help clear the glut on the domestic market, thus enhancing
realized rent. Part of the additional realized rent could then be captured through more
effective rental payments. This process would likely unlock large amounts of cash, which
could be used, in a more discriminate way than today, to alleviate the social consequences of
full energy cost recovery.
4.5 Under government pressure, timely, in-cash tax payments by oil and gas companies
increased in 2000, according to the Ministry of Taxation. Energy suppliers now also more
commonly demand that their customers pay their bills, lest they be disconnected. However,
non-payments are still believed to be rampant.
Fiscal Federalism
4.6 Questions of resource ownership are traditionally sensitive in Russia. Land is no
exception. For years now, the federal Duma has been discussing a draft Land Code, whereby
a legal framework would be designed for the privatization of land. No significant progress
has been made, and the total amount of Russian land held in private property is truly
negligible.
4.7 The ownership of natural resources is equally controversial. Natural resource tax
revenues are shared among the three levels of government in Russia, and natural resource tax
revenue assignment is a sensitive matter. Article 72 of the Constitution of the Russian
Federation provides for the joint jurisdiction of the federal government and its 89 subjects
(members of the Federation) over "issues of the possession, utilization and management of
land and of sub-surface, water and other natural resources" and "administrative,
administrative-procedural, labor, family, housing, land, water and forest legislation;
legislation on subsurface resources and on environmental protection." The Constitution thus
remains vague on who has authority with respect to possession, utilization and management.
Not surprisingly, the federal and sub-national governments often disagree on how to share
the fiscal revenues from natural resources (McLure 1994; McLure et al. 1996). For instance,
in 1997-1998, the governors of the regions of Karelia and Khabarovsk challenged the federal
ownership of forests before the Supreme Court, but lost.
4.8 The contention over sharing natural resource tax revenues also has to do with the
regional concentration of these resources. Most oil and gas production is located in two
autonomous regions (Khanty-Mansi and Yamalo-Nenets). About three-fourths of all metal
production originate from 10 regions. Natural resource revenues are thus highly concentrated
in a small number of regions. For instance, in 1997 the three regions best endowed in natural
resources collected 47% of the sum of regional revenues from taxes, fees and charges on
natural resources (Klotsvog and Kushnikova 1998; USGTAT 1998a).
40
4.9 The literature on fiscal federalism has touched upon the assignrment of natural
resource tax revenues. Generally speaking, arguments in favor of assigning revenues to the
federal government include: (1) regional revenue stability; (2) allocative efficiency; (3)
horizontal equity; and (4) the communal property of the natural resource heritage. On the
other hand, arguments in favor of assignment to sub-national governments include: (1)
compensating for the negative externalities suffered locally due to resource exploitation; (2)
the local heritage of natural resources; and (3) the prevention of secession from the
Federation because of fiscal abuse (McLure 1'994; McLure et al. 1996; USGTAT 1998b).
4.10 Table 19 shows how the revenues collected from some natural resource and
environmental taxes are supposed to be shared among the various levels of government.
Table 19. Statutory Assignment of Selected Natural Resource Revenues in Russia
(in percentage)
User fee type Federal Regional Local share
share share
Subsoil user fees (oil and gas) 40 30 30
Subsoil user fees (other than oil and gas) 25 25 50
Subsoil water user fees 40 60 0
Oil excises 100 0 0
Gas excises 100 0 0
Oil replacement fee a 20 (100) 20 (0) 0
Forest user fees b 40 60 0 (100)
Surface water user fees 40 60 0
Aquatic biological resource user fees c 100 0 0
Pollution charges d 19 27 54
Water supply, sewage and treatment e 0 0 100
Land taxes and rentals 30 20 50
a) 20% to the federal fund for mineral base replacement and 20% to the regional fund for mineral base
replacement. The remaining 60% stays in the company conducting exploration activities, depending on the
clauses of the ad hoc agreement with the Ministry of Natural Resources. If the company does not conduct
such activities itself, 100% flow to the federal fund for mineral base replacement.
b) The breakdown corresponds to the revenues from minimal stumpage fees. Excess stumnpage fees accrue to
the local leskhozy.
c) The receipts are sent to the federal fund for the management, research, protection and reproduction of
biological resources.
d) Divided into general budget revenues and earmarked budgetary environmental funds: the federal share
breaks down into 10% to the federal budget and 9% to the federal environmental fund; the regional and
local shares accrue to the regional and local environmental funds, respectively.
e) All proceeds go to municipal water utilities for cost recovery.
Sources: East West Institute (1999); GOR (1996); IFEI (1998); Roskoshnaya (2000); Summers (2000); Titova
(2000); USGTAT (1998a); Ezhov (2000).
41
4.11 It is interesting to note that of those categories, only four (subsoil user fees, pollution
charges and land payments) are shared across the three levels. Three categories (oil and gas
excises and aquatic biological resource user fees) flow to the federal level exclusively. One
category (water supply, sewage and wastewater treatment fees) accrues to the local level
only.
4.12 These are statutory, not actual rates, however. As Table 20 indicates, actual data show
greater shares staying at the regional and local levels, as regions and municipalities often
resent remitting all the revenues due to the federal budget.
Table 20. Actual Revenue Sharing Among Levels of Government (1998)
Federal Regional Local Total
RUB % RUB % RUB % RUB %
bn. Share bn. Share bn. Share bn. Share
CPT 35 38 36 39 21 23 93 100
PIT 0 0 26 37 44 62 71 100
VAT 105 67 33 21 19 12 156 100
Excises 52 77 12 17 4 6 68 100
Property tax 0 0 23 49 24 51 47 100
"Green taxes" 3 14 9 41 10 45 23 100
Foreign trade taxes 37 100 0 0 0 0 37 100
Othertaxes 4 8 14 30 30 63 48 100
Total tax revenues 236 44 154 28 153 28 542 100
Non-tax revenues 40 45 14 43 10 12 64 100
Budget funds 26 59 18 41 0 0 44 100
Total revenues 302 46 186 29 163 25 650 100
Source: USGTAT (1998a).
4.13 In contrast to Table 19, which indicated that the law mandates regions to direct the
larger share of natural resource tax revenues to the federal government, Table 21 shows that
regions and municipalities instead retained as much as 86% in 1998. With respect to the
impact of fiscal federalism on the feasibility of a shift to rental payments, two main issues
arise. First, would regions raise the tax burden on natural resources if they knew they would
have to relinquish part of the resulting revenues to Moscow? As Table 20 suggested, sub-
national governments do end up retaining the bulk of natural resource revenues. Second and
more importantly, could Russia, as a federation, sustain a tax system relying more heavily on
natural resources? Revenue disparity across regions is at the heart of the problem.
4.14 A shift from capital and labor taxes to rental payments could be criticized because it
risks heightening regional revenue disparity. The argument would go as follows. First,
natural resource endowments vary greatly across regions, so that resource-poor regions
would find it hard to sustain themselves on natural resource revenues. Second, regions remit
relatively smaller shares of their natural resource tax revenues to the federal budget than
other tax revenues. Not only do sub-national governments retain a larger share of the
42
revenues than the federal government, they fail to remit even the statutory federal share, as
Table 20 revealed. So, if the share of natural resource taxes increases, the federal budget
would be expected to suffer some losses.
4.15 The first argument is flawed. In Russia, natural resource tax revenues per capita are
highly correlated with non-natural resource tax revenues per capita. The correlation
coefficient was 0.906 in 1997 (USGTAT 1998b). In other words, resource-poor regions find
it hard to sustain themselves with high or low reliance on natural resource taxes because they
do not have a solid tax base. The shift does not make matters any worse. Interregional
subsidies are currently needed to help poor regions and would still be needed after the role of
natural resource taxes has been enhanced.
4.16 As to the second risk, it is real but can mitigated. Greater centralization of natural
resource revenues, and redistribution of the revenues on a needs basis, may be necessary to
make the natural resource taxation reform sustainable in a federal context. This is in fact
what the Putin administration is proposing to do by federalizing a greater proportion of the
natural resources not equally distributed across regions (essentially hydrocarbons and
precious metals): "the basic federal taxes should be: customs duties, the VAT, excise taxes
(paid by business firms), the federal profit tax (corporate income tax on enterprises and
organizations), the personal income tax, payments for use of natural resources which are not
uniformly distributed (above all for extraction of raw hydrocarbons and other raw material
resources for export), and federal licensing and registration fees." (GOR 2000, 162)30 In
addition, unlocking the rent would inject more cash into the state's finances, only a portion of
which would be retained by the region. The federal governiment could therefore witness a net
inflow of revenues.
A Hypothetical Example: Timber Rent Tax Reform
4.17 This section envisions the potential response to increased taxation of rent grounded in
the withdrawal of the timber rent. This simple political analysis gives some insight into the
future of natural resource tax reform, in particular by trying to identify the political
constituency at the federal, regional and local level. At least 10 different types of
stakeholders can be distinguished, including the three levels of government (federal, regional
and local), the three branches of authority of the Forest Service, the three main groups of
protagonists in the forest industry (loggers, processors and vertically integrated companies),
and traders. All stakeholders are interested in forest rents, though for different reasons. For
simplicity purposes, we assume that increases in rental payments would materialize through
increases in stumpage fees.
3O The distinction between "uniformly distributed" and unevenly distributed natural resources is somewhat
artificial since the disparity in natural resource endowment is not just driven by the absolute quantities of
resource reserves, but also by the inherent value (rent) of those reserves, which is itself a function of quantity,
quality and distance to market. Siberia, for example, is well endowed in timber and fossil fuels, but the distance
to the market raises costs tremendously, so that it may not be economically feasible to exploit the corresponding
endowments.
43
4.18 Table 21 attempts to summarize the expected reactions to the proposed tax shift,
deconstructing the response for each measure making up the policy package. Each measure
(A through I) is scored based upon the response expected from each stakeholder.
Table 21. Predicted Initial Responses to Timber Rent Tax Reform
Forest Service Administration Forest industry
- o0 X - 0 X o .)
v X4 v X I >
Measure proposed C .,, ) r o, -o
A Better definition of + + + + + + ?
forest costs
B Better knowledge + + + + + + ? ? ? ?
of forests
C Better use of forests + + + + + + ? ? ? ?
D Moretransparent + ? ? + ? ? ? ? ? ?
forest auctions
E Regulation of + ? ? + ? ? + ?
timber oligopsony
F Limit leskhozy to + ? - + ? ? + + + ?
management
G Differentiate ? ?
stumpage fees
H Forest revenue ? + + + + + +
recycling
Earmark for forest + + + +
management
TOTALSCORE 7 4 3 6 3 3 2 -1 -2 -2
* VIC means vertically integrated company.
"+" means favorable and equals + 1; "-" means unfavorable and equals -1; "?" means difficult to predict and
equals 0.
4.19 Each measure receives a score between 1 (well received) and -1 (rejected). Scores are
then totalled per stakeholder. A total score of +9 suggests that the stakeholder accepts all
measures; -9 means the stakeholder is opposed to all measures. The measures are the
following: (A) to better define forest costs, i.e. to know more accurately how much it costs to
produce timber depending on local conditions. Once costs are known with greater certainty,
stumpage rates can also be set more precisely; (B) to develop a better knowledge of forests
implies better inventories of timber and non-timber resources, so that sellers and buyers
ascertain more accurately the value of the standing plot to be logged; (C) to improve the use
of forests means, inter alia, putting up for sale the most appropriate timber plots,
encouraging more rational logging, etc.; (D) making forest auctions more transparent means
44
making them more competitive, so that the rent is more properly revealed and captured; (E)
regulating the timber oligopsony means curbing the market power possibly exercised by
wood processors and intermediaries in the forest business. The objective is to ensure greater
competition and openness in market relations; (F) leskhozy need to limit their activities to
their core function of forest management and refrain from carrying out commercial activities;
(G) stumpage fees need to be differentiated to better reflect site-specific rent-generating
conditions; (H) recycling means that the revenues of higher stumpage fees will be used to
reduce taxes on capital and labor; (I) revenues could be earmarked, i.e. reserved for
investments and expenditures on forest management and environmental protection.
4.20 The Federal Forest Service (FFS)31 favors all measures fostering better forest
management. It would oppose the use of forest revenues for other purposes than forestry. The
earmarking proposal would certainly be well received.
4.21 The regional branch of the Forest Service (RFS) should look favorably at improved
forest management. Its position is less clear regarding the regulation of wood markets, as it
may have a vested interest in non-transparency and market distortions. The RFS, may be
divided on forest revenue recycling.
4.22 For reasons similar to those invoked for the RFS, the reaction of the leskhozy is
expected to be positive on the aspects of forest management, but less predictable with respect
to market regulation. Their reaction should be negative on the question whether to confine
leskhozy in their legally defined function of forest management. Of all actors, leskhozy
should the most favorable to increases in stumpage fees, since the 1997 Forest Code
mandates that all revenues above minimal stumpage rates be directed to leskhozy. They are
expected to oppose the recycling of those additional forest revenues.
4.23 The federal administration should look favorably upon all the measures proposed,
with the possible exception of revenue recycling and the exception of earmarking revenues
for forest management. The Ministry of Finance, for example, might think it wiser to let the
additional forest revenue swell the federal coffers.
4.24 Similarly to the RFS, the regional administration will likely react positively to the
proposed improvements in forest management. It would be equally ambivalent regarding the
proposed market regulation. In contrast to the RFS and the federal administration, the
regional administration would be divided on the issue of a raise in stumpage fees. Since
increased stumpage fees mean additional revenues and possibly also a more competitive
timber market, the regional administration should favor increases in stumpage fees. However,
it is also concerned to develop the regional forestry sector by attracting new investors. The
regional administration should support forest revenue recycling to cut taxes on capital and
labor.
31 The FFS was placed under the authority of the Ministry of Natural Resources in May 2000. Environmental
organizations have voiced their concern that the Ministry of Natural Resources will promote a more intensive
use of natural resources, including timber, perhaps at the expense of environmental protection.
45
4.25 The local administration reacts as the regional administration.
4.26 Logging firms would not welcome the tightening in forestry cost accounting if these
rules hurt their profitability. They should be indifferent to improvements in forest
management, favorable to measures designed to curb oligopsonistic power in the timber
market, hostile to increases in stumpage fees, favorable to forest revenue recycling
(especially if recycling helps reduce their tax burden), and favorable to earmarking as this
helps ensure long-term supplies of raw materials.
4.27 Wood processors would react in a way similar to loggers, except on the question of
oligopsony regulation, as some processing firms benefit from oligopsony.
4.28 Vertically integrated companies (VIC) combine the functions of logging, processing
and sometimes also trading. They will respond positively to the confinement of leskhozy in
forest management and to forest revenue recycling but negatively to proposals hurting their
profitability.
4.29 Wood traders should generally be hostile to the measured designed to capture some
of the rent currently appropriated by traders. They would welcome revenue recycling. They
should be indifferent to changes in cost accounting rules, though this could ultimately have
an effect on market prices as well.
Volatility of Commodity Prices
4.30 The feasibility of a natural tax reform must be considered in the context of the
volatility of primary commodity prices. The price of oil, to name but one commodity, has
varied greatly over the past two years alone, rising from US$ 10 to US$ 30 a barrel. Russia,
as an oil exporter, has greatly benefited from this rise through additional export earnings and
export tax revenues. In times of high world market prices, the rent of natural resources is
high, heightening the potential of rent capture. On the contrary, when prices are low, excess
profits are also lower, and so is the ability of the government to extract more rent.
4.31 This has important implications for a revenue system in which the share of rental
payments is expected to grow and gradually replace taxes on labor and capital. Among the
qualities of a good tax system is a stable level of revenues. Since resource rent can vary
significantly in the course of time, and the government is mostly powerless in the face of
fluctuations in international commodity prices, it is unlikely that rent should replace all other
sources of revenues in any given economy. However, further research would be needed to
compare the relative stability of rent and income to determine where the fluctuations are the
smallest.
4.32 Moreover, the rent on land is not the same as the rent on resources. Land rent shows
greater stability over time than resource rent, as it is more closely associated with economic
growth and perhaps less affected by international cycles. This suggests that a land tax should
generally be contemplated as a way to finance a shift towards natural resource taxes. The
difficulty of applying this approach to Russia is the lack of a land market to reveal the rent.
46
4.33 Even though taxing resource rents would not suffice to provide revenue stability, this
realization should not deter the government from assessing resource rent and taking steps to
capture it when it is positive. Stability of revenues requires diversifying revenue sources and
efficiency in resource allocation requires removing tax distortions. A balance must be struck
between these two potentially conflicting objectives.
V. CONCLUSION
5.1 Despite their importance in the Russian economy, natural resources do not contribute
as much as they should to public revenues and private interests appropriate significant
resource rents. Several natural resource taxes are set regardless of market prices or
production costs. Such taxes favor profitable deposits and penalize marginal ones. The
natural resource sector supplies a large amount of revenues to the budget, but mostly through
taxes on the value that is added to natural resources, not the value, i.e. rent, of resources
themselves.
5.2 The appropriated rent on crude oil, natural gas and standing timber was estimated.
What was estimated was the current average rent. Through rent should theoretically be
estimated in an intertemporal framework, the data necessary to carry out such an analysis, in
particular reliable discount and inflation rates and marginal cost and revenue stream
estimates, were not available. Auction data, which could help measure and collect the rent,
were equally absent, except in the case of timber in Novgorod Oblast. For the other
estimations, the method consisted of netting out costs from commodity prices.
5.3 The sum of appropriated rents on oil and natural gas alone represented about 18% of
consolidated tax revenues in 1999. In other words, if the appropriated rent on oil and gas had
been captured by the government, all taxes at the federal, regional and municipal levels could
have been cut by 18%.
5.4 The current tax reform explicitly aims to reduce the tax burden on capital and labor so
as to stimulate investment and employment. Green tax shifting would help realize these
objectives without running a budget deficit. The Putin Administration seems aware that
natural resources are inadequately taxed and has proposed that the public finance role of
rental payments should be enhanced and these payments should be differentiated according
to the objective conditions.
5.5 Failure to tax away the rent negatively affects the economy in several ways. First,
public revenues must be raised elsewhere, i.e. on capital and labor. Most taxes discourage
what is being taxed. Capital taxes discourage investments and labor taxes discourage
employment. Investment and employment are exactly what should be stimulated to foster the
reorganization of the Russian economy. As long as rents remain insufficiently taxed, resource
extraction will continue to attract resources that could otherwise be allocated to activities
with higher value added and greater labor intensity, such as manufacturing and services.
47
Russia has indeed suffered from the Dutch disease since it began its transition to a market
economy. The exports of primary commodities, in particular oil and gas, increased, while the
domestic production of tradable goods, in particular agriculture, plummeted. With
overvalued real exchange rates propped up by massive capital inflows, the consumption of
imported goods rose at the expense of domestic production. This reallocation of factors of
production was also associated with higher income inequality, since the income of resource
extraction and spin-offs as financial services is concentrated in a small fraction of the
population (Gelb 2001).
5.6 Second, it is unlikely that the rent appropriated is reinvested in productive capital,
which is a requirement for sustainable development. For example, Russians keep huge
holdings of US dollars at home and abroad through capital flight. In the short term, these
liquid assets do not return to the Russian economy.
5.7 Third, the failure to capture more rent causes a monetary imbalance. With high oil
prices, large amounts of foreign exchange are earned. The legislation obliges oil exporters to
sell 75% of their earnings to the Central Bank. For the Central Bank to buy this foreign
currency, it prints rubles. Thus, it increases the money supply and risks fueling inflation. One
proposal to sterilize this increase in the money supply is for the Ministry of Finance to pay its
debt to the Central Bank. Another one is to allocate higher oil export tax revenues to a
budgetary fund earmarked for enterprise reorganization (World Bank 2000b). Alternatively,
windfall revenues could be used to cut traditional taxes.
5.8 There is a variety of ways in which economic rent can be captured, including auctions
and taxes. Competitive auctions allow to measure and collect the rent. However, auctions are
still undeveloped in Russia. They need to be encouraged and made more transparent. In
parallel, taxes still need to be used, in particular differentiated requited payments. Insofar as
differentiated requited payments capture rent and create incentives for better resource
management, they should be privileged over unrequited payments. For example, profit taxes
do not guarantee stable revenues to the government in light of poor accounting and auditing.
They incite firms to conceal revenues and bloat costs, in particular labor costs, in order to
minimize taxes. As a result, the govermnent is at risk of receiving little revenue from
resource ownership (Conrad and Shalizi 1988; Conrad et al. 1990; Nellor and Sunley 1994).
For their part, export duties distort resource allocation. As accounting and auditing improves,
the government should be able to rely increasingly on pure resource rent taxes. If such a
system were ushered in immediately, however, the risk of profit concealment by resource
producing firms would be serious. An additional advantage of requited over unrequited
payments is that Russian regions are generally entitled to increasing the former but not the
latter. In particular, regions are authorized to raise (and lower) user fees.
5.9 A well-differentiated system of resource user fees requires site-specific information,
which in the case of Russia represents significant challenges. The administrative costs of
such a system could be high and administrative abuse is possible, but the alternative is the
current system, which also contains arbitrary elements and generates little revenue.
Moreover, the current legislation for capturing rent, which includes oil royalties and timber
48
stumpage fees, does provide for proper differentiation. Building upon the existing system
instead of afresh is an additional advantage of using requited payments in Russia.
5.10 Among requited payments, user fees should be used rather than property taxes. In
addition to being more adequate from an ecological perspective (certain resource uses, not
the resources themselves, are the bads to be discouraged), user fees obviate the ownership
question. This is precious, especially in light of the tribulations of the new federal Land Tax
code and other arduous questions of resource ownership.
5.11 Once the rent is captured, the state could use it to cut the tax burden on labor and
capital, and possibly investing it in public programs. The Russian or Soviet state has
traditionally been the principal investor in the economy, with very mixed records judging by
market economy standards. Rent could also be consumed, but this would conflict with the
rule that all rents on exhaustible resources should be reinvested in human and machine
capital in order to maintain future income levels. Eventually, even the appropriated rent is
reinvested, but the question is to know how. It is only legitimate to expect that a social good
should retain its social value. The accumulation of private assets with little or no social return
would not qualify as appropriate reinvestment of the rent.
5.12 There is little doubt that the socialization of rent would meet a barrage of opposition
from influential interests currently appropriating the rent. Nevertheless, it is the collective
welfare of the present and future Russian generations that is at stake..
49
ANNEXES
Prices and Costs in the Oil Extracting Industry
(US$/ton)
1999 2000
No transfer Transfer No transfer Transfer
pricing pricing prcing pricing
Export share (of oil extracted) 37.5% 37.5% 39.0% 39.0%
Sales price 110.5 110.5 177.9 177.9
Export duty 4.8 4.8 20.9 20.9
Customs fee 0.1 0.1 0.2 0.2
Transportation to export gate 13.7 13.7 14.2 14.2
Border price a 91.9 91.9 142.6 142.6
Share of domestic and CIS sales (of
oil extracted) 62.5% 62.5% 61.0% 61.0%
Domestic sales price b 44.5 27.1 67.1 37.4
Average price for tax estimation 62.2 27.1 96.5 37.4
Oil excise 2.2 2.2 2.0 2.0
Average price for tax estimation d 60.0 24.9 94.6 35.4
Subsoil user fee (royalty) 5.2 2.1 8.1 3.0
Mineral replacement fee 6.0 2.5 9.5 3.5
Road tax 1.6 0.6 2.5 0.9
Labor (including auxiliary personnel) 3.0 3.0 3.2 3.2
Depreciation 2.5 2.5 2.4 2.4
Production costs e 6.2 6.2 6.8 6.8
Payroll taxes to extra-budgetary
funds 1.2 1.2 1.2 1.2
Housing tax 1.0 0.6 1.5 0.9
Other taxes 0.5 0.5 0.7 0.5
Gross profit 32.9 5.6 58.6 12.9
Profit tax 8.3 5.0 14.3 8.2
Capital investments (excl. mineral
replacement fee) 7.6 7.6 13.5 13.5
a) Delivered at frontier, i.e. export gate.
b) Delivered at the junction between local producer's and main pipelines, before VAT.
c) Excluding VAT, tariffs and transportation.
d) Excluding VAT, tariffs, excises and transportation.
e) Except labor costs, taxes and depreciation.
Source: IFEI (2000).
50
Estimation of Rent in Natural Gas Production
(US$/thou sand mi3)
Extraction 100%
Use for enterprises' own needs 11.4%
Share of domestic sales 57.9%
Wholesale price 9.80
VAT 1.63
Gas excise 1.22
Price without taxes 6.94
Share of exports 30.7%
Border price 62.24
International transport (abroad) 10.20
Export duties 2.60
Gas excise 14.83
Price without taxes 34.61
Net proceeds from sales 14.63
Transportation cost 2.19
including labor 0.30
depreciation 0.62
Production cost 0.91
including labor 0.10
depreciation 0.33
Marketing costs 0.03
including labor 0.02
depreciation 0.00
Gas purchase from independent producers 0.11
Social security contributions 0.16
Road tax 0.48
Housing tax 0.29
Property tax 0.24
Price used by Gazprom in transfers to subsidiaries 1.94
Subsoil user fee (royalty) 0.29
Mineral replacement fee (VSMB) 0.19
Other taxes on subsoil use 0.05
Profit on sales 9.81
Profit tax 0.84
Capital investments (excluding VSMB) 4.90
Source: IFEI (2000).
Oil Extraction in Russia
6 00 - - - - -s . -- ._ __ _
600 ~~~~~~~~~~~~~~~~~~~~~~~ 05 69 -saur~c- \ N1IEJG -
| |42 | |||561 | 32
462
3959
400-.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
31 32301 0
~~~~300 ~~~~~~~~~~~~~~g5- --~~~~~~~~~..-- .
3 0 - ----200- - -----
200.-- .~~~ 0
200
........ ... .. - ; . ... .... - ....
0
1 950 1 955 1 9 60 19 65 1 9 70 1 9 75 1 9 80 1 98 5 1 9 86 1 9 87 1 98 8 1 9 89 1 99 0 1 991 1 9 92 1 993 1 994 1 995 1 99 6 1 99 7 1 9 98 1 99 9 2 00 0
52
Natural Gas Production in Russia
700
S70 ces Gasprom 1994:Goskomnal.m - - . - = _ I
- - ~~4J643 64o
4 ? 9X-Z; --t , -F,- j. an. - < < -r 616 61 60 60
600 ;. , . - 59 0 585 .... -5 *- 46Z 30 1 | | 1 Dl l ' l ' 195
503
500.------- .....
413
~4 0 0 -- --- - --- - -
364
~S 3 0 0 - ----- ---- --- ---288 - - -- - - - -
200 1----8.... ..... ... . 6
J. 158,
137 1
388 87'88.10 U I.
100 64 .
04
53
6661 8661 tL661 9661 �661 F661 �661 Z661t 1661 0661
* r~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~5
. . . . . . . . . . - - - - - - - - -8 -- -- . . . . . . .. . .. . . . .0 0. .1
()flI K~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Oil Ml~~~~~~~~~~~~~~~~~9
. . . . . . . . . . . . . ... . . .. . . . . . . . . .. . . . . .. . .
.. . . . .. ..-... .. ..6
SM~~~~~~~~~~~~~~g
b,issna ui IsOAJuH 'Oqw!,I00z
Estimates of Timber Rent in Selected Russian Regions - Equity Technique
(US$/m)
Regions Arkhangelsk Khabarovsk Krasnoyarsk Leningrad Moscow Novgorod Pskov Vologda
Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp.
Revenues (CIF price) 16.7 37.9 31.1 72.2 28.0 120.2 16.9 25.6 16.9 26.0 22.3 35.8 20.6 32.5 16.2 24.0
Cost of sales 10.8 17.8 22.6 59.0 30.3 75.3 11.5 17.0 12.5 15.4 18.3 28.4 12.0 14.1 13.1 18.7
Nornal profit* 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6
Tax take (notional) 2.7 8.8 3.0 7.0 1.2 19.4 3.8 6.2 2.3 5.5 2.1 6.3 4.7 9.2 1.5 3.3
Appropriated rent 1.6 9.6 3.9 4.6 -5.1 23.9 0.0 0.8 0.5 3.5 0.3 -0.5 2.3 7.5 0.0 0.3
Weighted average rent 2.0 4.3 3.6 0.3 0.9 0.0 3.4 0.0
Foregone revenues (US$ 21.5 22.2 28.0 1.6 0.5 0.1 4.1 0.2
mn/yr)
NIPIElLesprom Arkhangelsk Khabarovsk Krasnoyarsk Leningrad Moscow Novgorod Pskov Vologda
Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp.
Revenues (CIF price) 16.7 37.9 31.1 72.2 28.0 120.2 16.9 25.6 16.9 26.0 22.3 35.8 20.6 32.5 16.2 24.0
Costofsales 11.4 18.3 11.8 48.1 13.5 58.6 5.6 11.1 10.4 13.3 8.2 18.3 5.0 7.1 8.9 14.5
Normal profit* 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.6
Tax take (notional) 1.6 7.7 5.8 9.8 4.3 23.2 3.4 5.7 1.9 5.1 4.2 7.0 4.7 9.2 2.2 4.0
Appropriated rent 2.1 10.1 11.9 12.6 8.5 36.8 6.3 7.1 2.9 5.9 8.3 8.8 9.3 14.5 3.5 3.8
Weighted average rent 2.5 12.3 17.0 6.6 3.3 8.5 10.3 3.5
Foregone revenues (US$ 26.9 63.2 131.9 32.5 2.0 26.4 12.6 30.0
mn/yr)
Dom= Domestic; Exp= Export.
Sources: Arkhangelsk forest committee (regional average); Khabarovskii Krai administration (regional average); Krasnoyarskii Krai forest committee (based
upon 2 firms); Leningrad Oblast forest industry comnmittee (regional average); Moscow: VIPKLKh (regional average); Novgorod: Novgorodlesprom (based upon
several firms); Pskov forest commnittee (based upon 1 firm); NIPIElLesprom.
55
Estimates of Timber Rent in Selected Russian Regions - Costs Technique
(US$/m3)
Regions Arkhangelsk Khabarovsk Krasnoyarsk Leningrad Moscow Novgorod Pskov Vologda
Donm Exp. Donm Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Dom.
Revenues (CIF price) 16.7 37.9 31.1 72.2 28.0 120.2 16.9 25.6 16.9 26.0 22.3 35.8 20.6 32.5 16.2 24.0
Cost of sales 10.8 17.8 22.6 59.0 30.3 75.3 11.5 17.0 12.5 15.4 18.3 28.4 12.0 14.1 13.1 18.7
Normal profit* 1.0 1.0 3.0 3.0 3.7 3.7 1.4 1.4 0.9 0.9 2.0 2.0 1.1 1.1 1.3 1.3
Tax take (notional) 2.7 8.8 3.0 7.0 1.2 19.4 3.8 6.2 2.3 5.5 2.1 6.3 4.7 9.2 1.5 3.3
Appropriated rent 2.3 10.3 2.6 3.2 -7.1 21.8 0.2 1.1 1.2 4.2 0.0 -0.9 2.8 8.0 0.3 0.6
Weighted average rent 2.7 2.9 1.5 0.6 1.6 -0.3 3.8 0.3
Foregone revenues 28.6 15.1 12.0 3.0 1.0 -0.9 4.7 2.6
(US$ mn/yr)
NIPIEILesprom Arkhangelsk Khabarovsk Krasnoyarsk Leningrad Moscow Novgorod Pskov Vologda
Dom. Exp. Dom. Exp. Dom. Exp. Dom. Exp. Donm Exp. Donm Exp. Dom. Exp. Dom. Exp.
Revenues (CIF price) 16.7 37.9 31.1 72.2 28.0 120.2 16.9 25.6 16.9 26.0 22.3 35.8 20.6 32.5 16.2 24.0
Cost of sales 11.4 18.3 11.8 48.1 13.5 58.6 5.6 11.1 10.4 13.3 8.2 18.3 5.0 7.1 8.9 14.5
Normal profit* 1.0 1.0 1.4 1.4 1.2 1.2 0.5 0.5 0.6 0.6 0.4 0.4 0.1 0.1 0.7 0.7
Tax take (notional) 1.6 7.7 5.8 9.8 4.3 23.2 3.4 5.7 1.9 5.1 4.2 7.0 4.7 9.2 2.2 4.0
Appropriated rent 2.7 10.7 12.2 12.8 9.0 37.3 7.4 8.3 3.9 6.9 9.5 10.0 10.8 16.0 4.4 4.7
Weighted average rent 3.1 12.6 17.5 7.8 4.3 9.7 11.8 4.4
Foregone revenues 33.1 64.5 135.3 38.1 2.6 30.1 14.4 37.7
(US$ mn/yr)
Dom= Domestic; Exp= Export.
Sources: Arkhangelsk forest committee (regional average); Khabarovskii Krai administration (regional average); Krasnoyarskii Krai forest committee (based
upon 2 firms); Leningrad Oblast forest industry committee (regional average); Moscow: VIPKLKh (regional average); Novgorod: Novgorodlesprom (based upon
several firms); Pskov forest committee (based upon I firm); NIPlEILesprom
56
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Regulation: Do Standards Matter to Tsunehiro Otsuki 32724
Trade?