STUDIES OF ECONOMIES IN TRANSFORMATION 11476 December 1992 Fiscal Decentralization Intergovemmental Relations in Russia Christine I. Wallich 6 w.t THE WORLD BANK RECENT STUDIES OF ECONOMIES IN TRANSFORMATION PAPERS No. 1 Country Department III, Europe and Central Asia Region, Food ancd Agricultural Policy Reforms in the Former USSR: An Agenda for the Transition No. 2 Michalopoulos and Tarr, Trade and Payments Arrangeraents for States of the Former USSR No. 3 Country Department III, Europe and Central Asia Region, Statistical Handbook: States of the Former USSR No. 4 Barr, Income Transfers and the Social Safety Net in Russia No. 5 Country Department III, Europe and Central Asia Region, Foreign Direct Investment in the States of the Former USSR STUDIES OF ECONOMIES IN TRANSFORMATION PAPER NUMBER 6 Fiscal Decentralization Intergovernmental Relations in Russia Christine I. Wallich The World Bank Washington, D.C. Copyright C 1992 The Intemational Bank for Reconstruction aiwd DevelopmentlTHE WORLD BA-NK I- 4. i[ i '. w~C L - -xt *uluii 114 tcLNWo Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing December 1992 Papers in the "Studies of Economies in Transformation" series present the results of policy analysis and research on the states of the former USSR. The papers have been prepared by World Bank staff and consultants and issued by the World Bank's Europe and Central Asia Country Department IlI. Funding for the effort has been provided in part by the Technical Cooperation Program of the World Bank for states of the former USSR. In light of the worldwide interest in the problems and prospects of these countries, dissemination of these findings is encouraged for discussion and comment. 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Wallich is principal economist in the Public Economics Division, Country Economics Department, of the World Bank. Library of Congress Cataloging-in-Publication Data Wallich, Christine, 1952- Fiscal decentralization: intergovemmental relations in Russia / Christine I. Wallich. p. cm. - (Studies of economies in transformation, ISSN 1014-997X ; paperno.6) Includes bibliographical references. ISBN 0-8213-2359-8 1. Intergovernmental fiscal relations-Russia (Federation) 2. Intergovemmental tax relations-Russia (Federation) 3. Decentralization in government-Russia (Federation) 4. Privatization-Russia (Federation) I. Title. II. Series. HJ1208.52.W35 1992 336.47-dc2O 92-42199 CIP Foreword The design of a well-functioning intergovernmental what functions will the center retain to justify their fiscal system is the key to Russia's macroeconomic continued participation in the Federation? But the stability, structural adjustment, provision of a social intergovernmental fiscal system, if it is carefully de- safety net during the difficult transition to a market signed, can bind disparate regions into a stronger economy, and political cohesion. national entity. Macroeconomic stability cannot be achieved This study is a product of the technical assistance without fiscal balance at both the subnational and program initiated in November 1991 by the World the national levels. In its effort to cut the federal Bank in collaboration with the Ministry of Finance budget deficit, the Russian government has trans- and several commissions of the Supreme Soviet of ferred expenditure responsibilities-including a the Russian Federation to examine fiscal decentrali- large share of the provisions for the social safety zation and intergovernmental fiscal relations. The net and capital investment-to the subnational lev- study describes and analyzes the current system in el while retaining incremental re,venpu at the feder- Russia and makes recommendations for its reform. al level. Underfunded subnationa1'qgovernments, It also addresses the very divisive issue of how to absent a system that provides for revenue-expendi- share the potentially huge revenues from natural ture correspondence, are resorting to "coping resource taxes in Russia as prices rise to world lev- mechanisms", including some that reduce budget- els. And it highlights the important role the inter- ary transparency and threaten macroeconomic governmental system can play in reducing political stability. tensions. Privatization will also be impeded by the present The study is intended for policy makers and system of intergovernmental finances. With the their advisers in the Russian Federation and other transfer of almost all enterprises to oblast and ray- states of the former USSR. All those who are inter- on ownership, responsibility for privatization now ested in social safety nets, macroeconomic stabili- rests with subnational governments. Their interests zation, privatization, fiscal decentralization and the here are unclear at best. As privatization proceeds, critical role of intergovernmental fiscal relations in the subnational governments lose the profits and facilitating a successful transition to the market tax revenues from the enterprises. But they also economy should find this study useful. have to assume the substantial "non-production" expenditures for hospitals, housing, schools, and other services, that the enterprises spin off when privatized. Because Russia is in a period of nation-building W -gS &.WV,_ with significant centrifugal forces emanating from the subnational level, intergovernmental finance is Russell J. Cheetham crucial to the future cohesion of the Federation. Director Dissatisfaction with the present system has pro- Country Department III voked skeptical subnational governments to ask Europe and Central Asia Region iii This study is based on background papers and other chapter inputs prepared by Bank staff and consultants under the Technical Cooperation Program on Intergovernmental Fiscal Relations in the Russian Federation. Among those contributing were: Roy Bahl (tax assignment issues and in- tergovernmental transfers); Jorge Martinez (expenditures and expenditure assignment); Charles McLure (sharing revenues from natural resource taxes); Jennie Litvack (special regimes and fiscal federalism); Helga Muller (the Russian system of intergovernmental finances); Philippe Le Houer- ou, Mario Blejer and Piroshka Nagy (macro-economic issues); and Horst Zimmerman (design of transfers). Invaluable support and cooperation was provided by our Russian counterparts, Mr Stanislas Korolev, Vice Minister of Finance of the Russian Federation; Dr. Benjamin Sokolov, Chairman of the Budget Sub-Commission of the Supreme Soviet; Dr. Sergei Shatalov, Chairman of the Sub- Commission on Taxes and Prices; and Vladimir Ispravnikov, Chairman of the Supreme Soviet Su- preme Economic Commission. Support was also received from Dr Natasha Kalinina, Institute of Forecasting, Russian Academy of Sciences. The work also also benefitted greatly from discussions with many other Russian experts-too numerous to name-who generously shared their insights. Good advice, valuable comments and insightful suggestions were received from many Bank and IMF staff and consultants. In particular, the study has benefitted from the expertise and in- sights of: Johannes Linn, Remy Prud'homme (cons), Shankar Acharva, Amaresh Bagchi (cons), Richard Bird (cons), Nancy Birdsall, Jonathan Brown, Martha de Melo, Gunnar Eskeland, John Holsen, Yukon Huang, Dani Kaufmann, Timothy King, Robert Liebenthal, Costas Michaelopolous, Adrienne Nassau, Richard Podolske, Charles McPherson, William Onorato, Bertrand Renaud, Marcelo Selowsky, Gur Ofer (cons), Carlos Silvani (IMF), Milka Casanegra-Jantscher (IMF), Ved Gandhi, and Emil Sunley (IMF). Secretarial support was cheerfully provided by Susheela Jonnakuty. Ritu Nayyar provided research support. Contents Overview 1 Finance in the Transition: The Expenditure and Revenue Systems of the Russian Federation 2 The Macroeconomic Dimensions of Intergovernmental Finances 3 The Role of Government and Enterprises, and Revenue from Privatization 4 Expenditures and Expenditure Assignment 4 The Tax Sharing and Transfer System 7 Special Fiscal Treatment and Regimes 12 Sharing Revenues from Natural Resources 13 Subnational Government Borrowing 15 Extrabudgetary Funds 15 1 Intergovernmental fiscal relations: Setting the stage 23 The Russian Federation: Federal Administrative and Budgetary Structure 23 The Intergovernmental Tax Sharing and Transfer System at Present 27 Expenditures and Expenditure Assignment 36 2 Subnational finance in the context of stabilization and reforms: Macroeconomic dimensions of subnational finance and privatization 47 The Macroeconomic Dimensions of Intergovernmental Finances 47 The Role of Government and Enterprises in Privatization 55 3 Expenditures and expenditure assignment 61 Some Principles of Expenditure Assignment 61 Expenditure Assignment in Russia 64 Expenditure Discretion at the Subnational Level 70 v 4 The tax and intergovernmental sharing system 77 T' e f :ie Curr.A aa.d ;iopubed initergovernmentai Kegime 77 Options for Reform: A Framework for Tax Sharing 81 Other Issues in the Tax Sharing Framework 90 Special Treatment for Special Areas 91 Data Requirements for Fiscal Management 95 Intra-Oblast Fiscal Relations 95 User Charges, Fees, and Other Benefit Charges 98 5 The division of revenues from natural resource taxes 103 The Taxation and Sharing of Natural-Resource Revenue in Russia 104 How Natural Resources Should be Taxed 105 Which Government Should Receive Resource Revenues and Rents? 106 Sharing Natural Resource Revenue 108 Options for Russia lII Using the Revenue from Natural Resources 112 Concluding Thoughts: Dividing the Spoils 115 Postscript 116 Appendices 117 Bibliography 146 Tables Matrix of Recommendations for Intergovernmental Fiscal Relations 17 1.1 USSR and Russia: State Budget Revenue, 1985-92 Ql 30 1.2 Russian Federation Budget Revenues, 1992: Ql 32 1.3 Revenue Structure and Revenue Sharing, Actual, 1992:Ql 34 1.4 Expenditure Assignment in the Russian Federation 38 1.5 USSR and Russia: State Budget Expenditure, 1988-92, Ql 40 1.6 Russian Federation: Subnational Budgetary Expenditures, 1990 41 4.1 Simulated Impact of Proposed "Basic Principles" on Oblast Revenue 79 4.2 Nontax Budgetary Revenue, Fees and Fines, 1990 99 5.1 Rules for Sharing Oil and Gas Revenues: Russia 104 5.2 Taxes and Quasi-Taxes on Oil Production 106 Boxes 1.1 The Russian Federation: Basic Characteristics 24 1.2 Recent Tax Reforms in the Russian Federation 29 1.3 New Tax Assignments: the Basic Principles Law 31 1.4 Laws on Subnational Governments 35 1.5 State-Owned Enterprises and Public Expenditures 41 1.6 Expenditure Norms in the Health Sector 44 2.1 Subnational Finance and the Banking in Brazil and Argentina 53 2.2 Nizhny Novgorod: State-Owned Enterprises 56 3.1 Fiscal Decentralization: The Long-Term Goal and Its Benefits 63 3.2 How Equally are Expenditures Distributed? 68 vi 3.3 Avenues for Subnational Borrowing: Some Examples 70 3.4 Budgetary Management Issues 74 4.1 Principles for Sharing and Dividing Revenue 81 4.2 Federalism, Tax Sharing, and Tax Assignment in Practice 82 4.3 Revenue Sharing Formulas: Some Strategies 86 4.4 Tax Surcharges and Base-Sharing Model 89 4.5 Special Fiscal Treatment for Special Areas? 93 4.6 Intra-Oblast Revenue Sharing 96 5.1 Natural Resource Taxation: International Practice in Federations 109 5.2 The Experience of Three Funds 114 Figures 1.1 Government Structure In Russia 25 1.2 Hierarchy Of The Government Administration And Finance 26 1.3 Distribution of Actual Tax Revenues 28 4.1 A Framework for Revenue Sharing in the Russian Federation: Reforming the Revenue Sharing System 84 vii Acronyms AR Autonomous Region ASSR Autonomous Soviet Socialist Republic CIS Commonwealth of Independent States CIT Corporate Income Tax EBF Extrabudgetary Funds ECU European Currency Unit GVAIO Gross Value of Industrial and Agricultural Output GVIO Gross Value of Industrial Output MOE Ministry of Economy MOF Ministry of Finance PIT Personal Income Tax R Ruble RSFSR Russian Soviet Federal Socialist Republic STS State Tax Service VAT Value Added Tax viii Overview Russia is facing a difficult period of economic "Basic Principles of Taxation" law. The major and political transition. It is attempting simulta- changes envisaged under these laws were not neously to restructure its entire economic sys- fully implemented in the first three quarters of tem, protect the well-being of its citizens, 1992, and subnational governments are operat- stabilize prices and its external balance, provide ing under transitional rules. Several oblast-level public services to support social and economic governments have also sought special treatment development, and establish a system of gover- outside the laws. A reconsideration of these laws nance acceptable to regions whose cultural iden- and additional legislation are apparently being tity, natural resource endowments, and degree of pursued, addressing such issues as local budget- economic development differ widely. ary rights, the system for natural-resource reve- In facing these challenges, the govermnent is nues sharing, and the rights of ethnic areas. reconsidering some of the basic issues in inter- If implemented, the new intergovernmental governmental finance: the division of expendi- fiscal system would have some merits. The laws ture responsibilities and the assignment of reve- seek to move governance closer to the people, to nue to different government levels. However, in give subnational governments more budgetary the current absence of "correspondence" be- discretion, to make the revenue-sharing system tween these responsibilities and resources, it more transparent and less amenable to negotia- must also design a system of transfers that will tion, and to clarify and define the rights and re- both finance the shortfall and support more effi- sponsibilities of subnational governments vis-a- cient and equitable government service provi- vis the federal level. All of these goals are laud- sion. The fiscal changes that are proposed will able and would support the general economic shape the Russian Federation and the efficiency reform underway. However, the design of the with which its economy performs. new program is incomplete, and new laws may be necessary. Finance in the Transition: The Expenditure and The speed of change in Russia, coupled withe Revenue Systems of the Russian Federation the barrage of issues facing policymakers, intern sifies the complexity of decisions that require a The new intergovernmental fiscal system now long-term view, such as the establishment of a,' evolving gives subnational governments new re- intergovernmental financing system. Nonethe- sponsibilities for expenditures (especially in the less, the present time represents a critical win- social and investment spheres) and guarantees dow of opportunity to introduce such refine-. new budgetary rights under the "Budget Sys- ments, inasmuch as the overall design of the i¶-I tem" law and new financial resources under the tergovernmental system is still in transition. Failing to seize this "time for decision" could To design this framework, policymakers and weaken cpntral cnntrn]k especially in light of the legislato-s sl u>; hange their iew toward public centrifuga! fnrc' itrnffng f¸ˇhebnaticn fi-ance iss- e, to.tsi, rhe riscai issues that al level. To say that the future cohesion of the have traditionally been viewed in isolation-ex- Russian Federation depends on developing a penditure assignment and spending mandates, transparent, fair, consensus-based intergovern- tax sharing or assignment, subventions and mental financing framework that achieves corre- norms, and tax and deficit reduction policies at spondence between revenue and expenditures the macroeconomic level-must be viewed to- is not an overstatement. This framework would gether and incorporated within the intergovern- provide perhaps the only fiscal mechanism for mental system. (For example, recently approved containing these centrifugal forces. changes to the personal income tax (the PIT) and An ideal system of subnational government fi- the value-added tax (the VAT) were made in the nancing would: absence of estimates of their impact on subna- * Ensure correspondence between subnation- tional revenues or on individual oblasts' reve- al expenditure responsibilities and subnational nues and will certainly have significant, un- resources known effects across regions.) More generally, * Incorporate the power and incentives to fiscal policy, tax administration, and intergov- mobilize subnational revenues ernmental fiscal relations are so interconnected * Not compromise the macroeconomic man- in the Russian system of governance and public agement policies of the central government finance that none can be reformed unless the * Give appropriate expenditure discretion to other two are. subnational governments, support public infra- Not surprisingly, in the absence of an integrat- structure development, and improve the account- ed framework, the major benefits envisioned in ability of local officials the Basic Principles and other laws could not be * Be transparent, based on objective, stable, realized in 1992. On the expenditure side, subna- nonnegotiated criteria, as well as administrative- tional governments still have less than full bud- ly simple getary discretion. On the revenue side, the earli- - Be consistent with national income-distri- er system of tax sharing has yet been phased out, bution goals and, in the interests of fiscal balance, the Minis- In addition, the intergovernmental system try of Finance (MOF), still determines on both an specifically in Russia should support the emer- ad hoc basis and in consultation with subnation- gence of a governmental role consistent with al governments the volume of resources to be market-oriented reform. transferred to the subnational level, and the No one intergovernmental system will meet amount thence transferred to individual oblasts. all of these objectives. Different countries attach The current system of intergovernmental fi- different priorities to each of these objectives, nance remains ad hoc, and could increasingly and these priorities sometimes change over time lead to a system of special regimes, "contracts," in response to the dynamics of their economies. and "single channels" bilaterally negotiated by Thus, a single "correct" system of intergovern- separatist or disgruntled oblasts. Although sig- mental financing does not exist. nificant steps have been taken to improve the in- tergovernmental system, Russia continues to be The Transition to an Adequate Long-Term System of constrained from moving away from the earlier Intergovernmental Finance negotiated revenue-sharing system. As one Rus- sian said: "This government has no regional The major challenge facing Russia as it devel- (subnational) policy and it is killing itself." ops an intergovernmental financing system is This discretionary system gives the federal to create an integrated framework for change government great flexibility to determine the fis- that will be compatible with short-term stabili- cal balance overall, and thus, in principle, to pur- zation, will combine "rules with discretion," sue macroeconomic stabilization policies. The and will be flexible enough to accommodate discretionary process also gives MOF the flexi- the major structural shifts in the economy, bility to distribute resources among oblasts in an while also providing stability to subnational attempt to realize equalization or other agreed- governments. upon or implicit objectives. Conversely, for sub- 2 national governments, the system implies bud- tion of resources among subnational govern- getary uncertainty, thwarting their inability to ments in the short and longer term. The Blue plan for service delivery; the absence of trans- Ribbon Commission and a Fiscal Policy Units parency gives rise to perceptions of unfairness should be establish ed irmediatelv by oblasts, which must compete with each other for shares in a revenue "pie" that cannot sustain The Macroeconomic Dimensions of all oblasts equally, necessitating that they resort Intergovernmental Finances to negotiation and bargaining as the only tools available for improving their lot. The government's stabilization program calls for In short, a comprehensive and integrated in- reducing the state budget substantially. How this tergovernmental financing system must be de- reduction affects the different levels of the gov- signed. It is important that this structure be de- emient will depend how governmental func- signed to respond not only to the exigencies of tions are reassigned among the various levels. the current transitional period, but that it also In the fiscal program for 1992, most of the ma- address some fundamental considerations for jor cuts were made in central government expen- the longer-term. An appropriate institutional ditures-centrally financed enterprise invest- framework for focusing on such reforms is ment, producer and consumer subsidies, and de- necessary. fense. These cuts were followed by a decision to Perhaps our most important recommendation delegate an important part of social expendi- is to establish an institutional framework, in- tures (early in 1992), and investment outlays (lat- cluding the appointment of a special "Blue Rib- er on) to the subnational level. On the tax side, bon Committee" to develop an intergovernment the budget envisages a marked increase in taxes, fiscal strategy and a plan for its implementation. primarily on petroleum products and foreign The committee would consist of informed lead- trade. Thus, virtually all additional revenue will ers from several professional areas academia, the accrue to the federal government, while most of Supreme Soviet and relevant ministries, oblasts, the additional social expenditures will emerge at and cities, drawing on foreign advice as neces- the subnational level. sary. The committee would be charged with un- The subnational budgets implemented in mid- dertaking a careful, empirical study of each op- 1992 have not reflected these pressures, due to the tion that may be appropriate for Russia. Con- unexpected buoyancy of the taxes that were as- crete empirical work is a complex but essential signed to the subnational level, rather than to the technical exercise, and should be the first step to- existence of correspondence between tax assign- ward defining the future intergovernmental sys- ments and expenditure responsibilities at the sub- tem. After consensus is reached on the most ap- national level. In fact, subnational governments propriate strategy, the committee would report emerged at half-year with a "surplus" -used to its plan for a new intergovernmental system to justify further downward expenditure assign- the Supreme Soviet, which would then promul- ments. The subnational surplus is in many re- gate a plan for implementing the system. spects illusory: it does not reflect budgetary arrears The second recommendation for implement- and current-expenditure sequestering policies now ing an institutional framework would be to es- in place that have reduced expenditures artificially. tablish a "Fiscal Analysis Unit" (one in MOF and And since the law does not allow subnational gov- one in the Supreme Soviet) to guide continuing emments to run deficits even for liquidity reasons, deliberations in this area and provide the institu- the need for cash in hand for ongoing operations tional basis for further decisionmaking. For ex- generates a cash surplus, by definition. ample, the unit could quantify expenditure re- sponsibilities function by function in order to as- Balance in 1992 and Beyond. In sum, correspon- sess the expenditure requirements of subnational dence between expenditure assignments and rev- governments; analyze alternative options for enue shares does not seem to exist. The "mis- revenue assignment, tax sharing, formula grants, match," which exerts pressure on subnational natural-resource revenue sharing and surcharg- budgets, undermines the national stabilization es; estimate relevant elasticities; and simulate the effort. The basic strategy has been to "push the effects of the system on fiscal balances at the cen- deficit downward" by shifting unfunded expen- tral and subnational levels and on the distribu- diture responsibilities down in the hope that the 3 subnational level will do the cost-cutting. How- improved framework for subnational govern- ever in vieiv of the dif -1cu1- -a haps undcr men' P.nancig may help elin-dinate these acd- t -hk-c "'LuAJALaLa the transition, the outcome might instead be re- pressures which engender them. course to greater central government subven- tions, arrears, borrowing from locally-owned Revenues from Privatization banks or enterprises, and likely monetization of the subnational deficit. Fiscal arrangements that What should subnational governments do with address the needs of each level of government the proceeds from the privatization of public en- and ensure correspondence between expendi- terprises and the sale of other assets? Should they tures and revenues should be a high priority. capitalize them in special funds, invest them in capital projects, or use them to finance current ex- The Role of Government and Enterprises, and penditures? No special strings have been attached Revenue from Privatization to using revenues from privatization in Russia. The most common practice appears to be to use The Role of Government these funds as an additional source of revenue in the recurrent budget. A more conservative princi- Russia has set its goal to move rapidly toward a ple of public finance would call for using the cen- market-oriented economy. However, the roles of ter's share of the proceeds to retire the national different levels of government go well beyond debt. At the subnational level, these proceeds what is considered desirable in a market-oriented should probably be invested in long-term assets, system. Clearly, the involvement of oblast and ray- thus allowing subnational governments to draw on governments in producing and selling goods income from the assets over a long period of time. and services that are more appropriately the baili- These revenues should definitely be viewed as wick of private enterprises cannot be justified. budgetary (not extrabudgetary) resources. With the endorsement of new laws on self- government, at the subnational level, govern- The Role of Enterprises ments continue to view their role as entrepre- neurs and producers. The involvement of subna- Historically, public enterprises have been an im- tional government in economic ventures-using portant financier of many types of expenditures their land or other idle real estate, commercial that would be financed by the public sector in a assets, or industrial resources in partnership market economy (for example, schools, hospi- with other investors-appears to be increasing. tals, roads, and sewage lines). As marketization The proliferation of these activities carries sever- proceeds in Russia, expenditures not directly re- al dangers. The most significant is that local gov- lated to production cannot continue to be enter- ernment-owned businesses will almost certainly prise responsibilities and should be transferred compete unfairly with emerging private compet- to subnational governments. The transfer is al- itors, thus undercutting the government's own ready taking place de facto, in light of the finan- tax base. Too, pressures will again be exerted on cial difficulties besetting many government subnational governments to keep their enterpris- enterprises. Government enterprises should con- es afloat and maintain employment by subsidiz- tribute to subnational finances exactly as private ing them; thus, the role of the government in the enterprises do-by paying taxes and user fees. economy will not diminish. Governments will This shift in expenditure responsibilities from also fall prey to possibly losing ventures. In mar- enterprises to subnational government must ket economies, the rate of small-business failure then be accompanied by a corresponding in- is high; onlv one in five survives the first three crease in revenue shares to the subnational level. years, and there is no reason to expect that Rus- sia can defy these odds. Most important, this en- Expenditures and Expenditure Assignment trepreneurial activity is fundamentally inconsistent with the privatization drive and blocks true decen- The Absence of Specific Expenditure Assignments tralization, Finally, subnational governments should not become involved in setting up banks, The absence of specific assignments of expendi- or in directing their credit or lending policies. An ture responsibilities between levels of govern- 4 ments in the law contrasts with the detailed In mid-1992, many investment responsibilities- emphasis of tax assignment in the Basic Princi- both those with national significance (such as ples. This failure to focus on expenditure assign- highways, military housing, and airports) and ments continues to be an important problem in those with local significance-were shifted to Russian intergovernmental relations. subnational budgets. This policy decision took As in many other countries, Russian policy place after the second quarter revenue-sharing has focussed on changing tax assignment and agreement yielded apparent budgetary surplus- revenue-sharing between the federal and oblast es for many oblasts. governments. Since expenditures must be ascer- The more general issue here is the absence of tained before resource requirements can be es- concreteness in assigning responsibilities. Both tablished, this approach "puts the cart before the subnational and central governments reap ad- horse." The availability of revenue is dictating vantages from their absence. Subnational gov- the distribution of responsibilities among the ernments use their broader responsibilities to different levels of governments, rather than the bargain for a larger share of revenue, and the other way around. federal government has an additional instru- ment- jettisoning expenditure responsibili- Expenditure Assignment: Consistency with ties-to balance its own budget. This lack of def- Principles inition cannot be perpetuated much longer if the system of intergovernmental relations in the Three general theoretical principles underlie the Russian Federation is to move away from the "assignment" of expenditure responsibilities: (1) "bargaining" mode of the past toward greater public services whose benefits do not accrue be- certainty and predictability. If expenditure re- yond the boundaries of a local community sponsibilities are not assigned specifically, deter- should be provided by the local government; (2) mining the revenue sufficiency of alternate tax services whose benefits accrue jointly to individ- assignments-including those in the Basic Prin- uals in several communities should be provided ciples-will be possible, and the desirability of by oblast-level governments; and (3) benefits that alternate systems of sharing will be moot point. affect the entire country should be provided by More important, if this trend persists, what the federal government. These assignment prin- important expenditure functions will the central ciples promote the accountability of subnational government perform to justify its existence to governments and are the most important ratio- skeptical regional governments and give mean- nale for fiscal decentralization. ing to the union? By eschewing the concrete as- These principles of assignment, based on the signment of responsibilities, the federal govern- geographical dimension of benefits, seem to be ment may inadvertently be contributing to its well understood in the Russian Federation; the worst fear-the disintegration of the Russian traditional Union assignments that, through in- Federation. ertia, have largely continued under the Russian Federation, are seemingly appropriate (Chapter The Social Safety Net 3 describes the intergovernmental assignment of expenditures in depth). In early 1992, in an apparent effort to balance the budget, the central government transferred Ad Hoc Assignment Changes: Shifting Central responsibility for social protection and price Functions Downward subsidies to subnational governments; they had previously been financed with transfers Although expenditure assignments are generally from the central government. While the burden appropriate, the murkiness and absence of a le- of price subsidies will cease after prices are gal framework has led to recent assignment freed, the underlying problem of financing so- changes that violate generally accepted princi- cial protection for those most hurt by economic ples in very fundamental ways. For example, in change will not. Apparently, the government early 1992, the central government shifted re- has not generated estimates of the cost of fi- sponsibility for most of the price subsidy and in- nancing this social protection or how this cost come maintenance programs for social might be matched with revenues available in protection to the oblast and rayon governments. each oblast. 5 In addition, the safety-net policy contradicts freedom to provide services according to local the fundampntal nrihwinles of assignin., expen needs, or to build pub.iiu fcilities tilat are dis- diture-'- o U..... tiC:U11s-. oeVeral government. If one believes that the adequacy of constraints on the flexibility and discretion of the the social safety net will become a national prior- budgeting activities of subnational government ity during the hard transition ahead, it should impede realizing the gains in efficiency from de- not be a major responsibility of oblast and rayon centralization, including their scrutiny, if not ap- governments alone. (Even if it were, efforts by proval, by MOF through the negotiation of tax subnational governments to pursue redistribu- shares (until fixed) or, for deficit oblasts, agreed- tive policies will often prove to be self-defeat- upon expenditure levels and subventions. ing.) The central government can play a critical Mandates from higher to lower levels of gov- role in financing subsidies (most likely in the ernments to undertake an expenditure without form of cash payments) targeted at truly needy providing adequate funding reduce subnational people. Rayon administrations should use a autonomy and can destroy the balance of inter- means test to identify the recipients of these sub- governmental relations. Examples of these ex- sidies. This social safety net would continue to be penditure mandates in Russia include shifts in so- administered by the rayons, which, under a pro- cial and investment responsibilities, across-the- gram of "cost-reimbursement" grants, would be board wage increases and pension adjustments, reimbursed by the federal government on the ba- required independently of the budgetary posi- sis of their actual payments. In sum, social expen- tion of each government. There should be "no ditures of national importance are more appro- mandates without funding." When the center priately a subject for "administrative delegation" does fund the mandate, it should ensure that no with local administration and central financing. delays exist between the expenditure decree and its associated funding to subnational budgets. The Assignment of Capital Expenditures Expenditure Norms Until recently, the federal level was responsible for approving, financing, and implementing all Budgets had traditionally been based on subnational capital investment. In mid-1992, the "norms" which ensured that recurrent financing federal government offloaded capital investment for existing facilities was adequate but not neces- responsibilities to subnational governments, in- sarily that the level of service provision per capi- cluding outlays for interregional transport and ta was adequate. If continued, this policy would military housing. Shifting these responsibilities exacerbate previous regional biases and sectoral down to lower-level governments may respond expenditure distortions and may mean that re- to short-run budget pressures, but it is inconsis- gions which experience population growth or tent with expenditure assignmnent principles and above-average inflation will be underserved. creates an inefficient service delivery system. It Uniform expenditure norms will have little is also a provocative action at a time when cen- meaning in a federal fiscal system that cedes trifugal forces at the subnational level are grow- budgetary discretion to the subnational level ing. The federal government should reclaim this and in which costs, conditions of provision, and function. In principle, subnational governments prices differ considerably across jurisdictions. In- should have responsibility only for capital in- deed, recognizing this dilemma, MOF used "in- vestments that correspond to their assigned re- cremental budgeting" in 1992 to adjust 1991 sponsibilities for current expenditures-for expenditure levels upward by an inflation coeffi- example, for schools, roads, and other subna- cient. For the future, MOF must plan ahead and tional infrastructure. The assignment principle develop a simple but robust -methodology for for capital investment activities should be same computing the expenditure needs of subnational as the one used to assign recurrent expenditures. governments. These figures would be required, for example, to implement the equalization pool Subnational Budgetary Discretion and Mandates discussed later in the section on revenue assign- ment. Studying and specifying expenditure To be more responsive to the preferences of local needs-taking into account the per-capita fea- residents, subnational governments need the tures and deficiencies of subnational govern- 6 ments-is a critical necessity that we agreements whose effects and incentives are not recommend be undertaken. well understood. The structure of subnational government fi- Social Respotsibiiities of Enterprises nancing is in transition from those negotiated ar- rangements to a system that "assigns" revenue A serious problem looming on the expenditure sources to each level of government. (The term side is the traditional role of public enterprises in "tax assignment" is in fact a misnomer, since providing social services that must be assumed subnational governments have not been as- by the federal, oblast and local governments. It is signed any major taxes, but only their revenue. essential that these activities be transferred in a The absence of any rate- or base-setting authori- programmed and orderly way. Public enterpris- ty-characteristic of tax assignment-is a major es cannot continue to provide purely public-ser- omission, as we shall see.) The Basic Principles vice functions while also competing in an law, partially implemented, gives the VAT to the increasingly privatized and market-oriented federal government and assigns the personal economy. Some level of government must as- and corporate income taxes as regulating reve- sume these expenditures. The government ap- nue to subnational governments. Twenty-one pears not to have quantified the dimensions of minor taxes accrue to the rayon governments this problem or planned a solution. It should do (without rate-setting autonomy). All tax assess- both. ment and collection is to remain a federal re- sponsibility. Presumably, some subnational gov- The Empirical Quantification of Expenditure ernments will continue to be supported by the Assignments present system of negotiated subventions and cost-reimbursement grants. The necessity of quantifying expenditure respon- These laws (and their current implementation) sibilities, function by function, is perhaps the improve the system of intergovernmental financ- most important recommendation, since it sums ing. They increase the transparency of the sys- up and encompasses all other proposals to re- tem by defining ex ante sharing rates and limit structure the system of intergovernmental fi- opportunities for ad hoc determination. They nancing. An estimate of the expenditure give subnational governments some prescribed requirements of subnational governments would sources of revenue and provide some incentives include those functions that will continue to be for increasing their tax effort. But some flaws in the responsibility of government-functions that the Basic Principles, as well as in the program must be assumed by the government as enter- now in effect, call for adjustments and probably prises give them up-as well as functions that a new law. should no longer be the responsibility of the government at all. The Absence of Correspondence Between Revenues Assigned and Expenditure Needs The Tax Sharing and Transfer System The revenues assigned to the subnational sector, The Russian system of revenue sharing inherited and to the individual oblasts would be deter- from the Union, and in place at the end of 1991, mined by the size of their taxable base-primari- was characterized by two distinct features. First, ly the personal and corporate taxes. There is no unlike most systems of intergovernmental fi- reason to expect that a sufficient amount of reve- nance, in which the center collects and shares nue will be assigned to finance subnational ex- most national revenue with lower levels of gov- penditure responsibilities at "normal" levels. If ernment, revenue in the Russian system is revenue is overassigned to the subnational gov- "shared upward" from rayons, to oblasts and ernments under the Basic Principles, no provi- then to the federal budget. Upward sharing con- sion exits for extracting revenue back to the tributed to the dissolution of the Union, as re- center; if revenue is underassigned, no provision publics stopped making their transfers, and it exists in the law to grant subventions to compen- confers a similar vulnerability on the Russian sate for the difference. Federation. Second, the system is not a "system," In sum, correspondence between the current but a series of ad hoc, bargained, nontransparent subnational tax assignments and expenditure 7 responsibilities appears not to exist. More gener- Equalization ally, legislated revenue assignments have pre- e-.d......... n t sr. I r.ile new iegisiation aoes not consider the neces- step. A dramatic example of the absence of cor- sity for transfers and equalization. The assign- respondence is the recent transfer of expenditure ment of the personal and corporate taxes to the responsibilities for consumer protection and in- subnational level on a derivation basis necessari- vestment outlays to the subnational level, with- ly means that higher-income territories will de- out quantifying or guaranteeing a corresponding rive more revenue. Some form of subvention shift in revenue shares. A similar mismatching must be provided to protect the budgetary posi- may apply in the longer run, since there is no tion of territories whose economic base is not reason to expect that taxes and expenditures as- strong enough to support an adequate level of signed to the subnational level will grow at the public services. Recognizing this need, MOF same rate. provided subventions (not specified in the Basic Principles law) to oblasts on an ad hoc, negotiat- Tax Assignment vs Tax Sharing ed basis beginning at the end of second quarter of 1992. Pure tax assignment is not feasible with- The Basic Principles represents a system of pure out a system of subventions. As currently imple- tax assignment, a major departure from the mented, "equalization" is effected through present, where both the VAT and the corporate oblast-by-oblast negotiated sharing or "regulat- tax are shared. Several reasons argue against the ing revenue." However, it is not clear, whether desirability of changing from a tax-sharing sys- the outcome of the current process has been tem to tax assignment system. equalizing. First, assigning federal taxes to subnational governments leaves their budgets vulnerable to Options for a New Structure: Formula-Based Sharing changes in central policy: federal industrial and price policy and central decisions about wage The government can build on the basic direc- rates, input prices, foreign exchange, and inter- tion suggested by new laws, but should est rates could reduce or increase subnational consider reformulating them. Three consider- revenues, and such impacts could vary substan- ations underlie any decision about restructur- tially across oblasts. More generally, because ing th e anystem of centructur- the base of any one tax is highly volatile, tax as- ing the arussian system of central-oblast signment system would make subnational gov- financing: macroeconomic stabilization, equal- signentsystm wuldmakesubatioal ov- ization, and subnational fiscal discretion. ernment revenue vulnerable to such volatility. Fixed and unchangeable solutions-such as In addition, changes in the base or rate of an as- mixe deuneanga solution-suld signed tax-such as the July 1992 changes in might be delineated in a Constitution-should the personal income tax and in VAT-have criti- boe avoided at this time, given the ongoing cal, unintended effects on subnational govern- structural change of the economy. Thus, the ment revenue. In sum, while assignment would material that follows does not represent a appear to reduce the dependence on subnation- blue-print, but a "framework" that offers al governments on the center-in the sense that structure yet flexibility. all revenues from a given source would be The framework consists of four components: transferred, this 'independence' may be bought (1) a "common pool" of revenue notionally di- at a heavy price since localities remain vulnera- vided between federal and subnational gov- ble to revenue volatility and to centrally deter- ernments based on assigned expenditure re- mined changes in the tax base and the tax rates sponsibilities; (2) the distribution of some por- without any compensating discretion over tion of the subnational pool across oblasts orn a spending. derivation basis; (3) the distribution of the re- In addition, tax assignment may provide in- mainder of the subnational pool to oblasts on centives for the State Tax Service (STS) to collect the basis of a transparent and fixed formula; federal taxes more efficiently than it collects lo- and (4) subnational taxes and surcharges. The cal taxes, unless all major taxes that accrue to federal level would reserve some taxes fully to the subnational level are also shared with the itself (such as those on trade and customs center. duties). 8 The Common Pool. Tax Sharing on a Derivation Basis. Revenue from the major federal taxes (the per- Under derivation sharing, a portion of all or a sonal and corporate income taxes, VAT, and ex- subset of major taxes in the pooi accrue to the cises) would go into a common pool.The central oblasts where they are collected, with uniform and subnational shares in this pool would be de- rates of sharing fixed for five years across all termined according to expenditure assignments. oblasts. If 60 percent of the divisible subnational For illustration, the July 1992 budget revenue es- government pool were to be allocated on a deri- timates imply that just over 50 percent of expen- vation basis, all oblasts would receive a percent- ditures are federal: thus, such a pool would have age from each tax of the derivation pool (the allocated some 50 percent to the federal govern- percentage of each tax could vary), with the per- ment, and just under 50 percent to the subna- centages calculated to exhaust the 60 percent. tional governments. This structure would reward oblasts that at- The subnational share would be distributed tract and promote industry by giving them a across oblasts partly on a derivation basis greater flow of revenue. The fixed sharing rates (meaning that taxes would accrue to the territo- would remove negotiation from of tax-sharing rial budgets where they are collected) and partly determinations and would give subnational gov- on a formula-grant basis. The present system of ernments a more certain flow of revenue, there- subventions would be abolished in favor of the by promoting more efficient budgetary plan- formula grants. To enhance the transparency and ning. The advantage of derivation sharing is that revenue certainty of the system, it is recom- its concept is similar to the one that underlies the mended the following be fixed for a three- or existing system; moreover, the arrangement can five- year period: (1) the tax shares to be as- be administered at relatively little cost, and un- signed to the subnational government sector, (2) less the subnational shares in each tax differ the relative proportions to be allocated on a deri- widely, would not give the State Tax Service vation and formula basis, and (3) the distribu- (STS) an incentive to collect one tax more effi- tion formula. Many countries have established a ciently than another. "Grants Commission" to establish proposals for However, the derivation approach to revenue designing the grant-formula and sharing system. sharing is not without problems.First, the VAT Decisions about the amount to be distributed may not lend itself easily to derivation sharing. by formula or by derivation depend on both po- Industrial provinces with a high value added litical and economic considerations. From an can have a decided advantage, and the zero-rat- economic perspective, the more that is shared by ing exports can lead to a decided disadvantage derivation, the more the system will channel re- to oblasts whose enterprises sell to foreign mar- sources into regions whose taxable base is larger, kets. A VAT on imports would accrue fully to the giving higher-income territories more revenue "port city." This problem could be resolved if (sharing on a derivation basis is generally coun- the VAT were eliminated from the segment of terequalizing). The more that is allocated on a the common pool that is shared on a derivation formula basis, the more equalizing the overall basis. However, eliminating the VAT would system might be, and the more poor localities make the common pool more cyclical, likely re- will be subsidized or made "better off." Equal- quiring that the sharing rates of the personal and ization penalizes the better-off regions whose in- corporate taxes be set at high levels, possibly af- dustrialization and growth potential is greatest. fecting STS incentives. On balance, the probable As with most other countries, Russia must bal- move would be to eliminate the VAT from any ance the tradeoff between encouraging growth derivation-shared pool. and ensuring equalization. In our view, the inter- Allocating the corporate tax on a derivation governmental system should place significant basis will require that some adjustment be made weight on the initiatives and fiscal energies of for multi-location enterprises. Such provisions the better-off areas in the interests of higher eco- can in fact be made, but doing so will increases nomic growth. It could do so by allocating a rela- the complexity of an already overburdened tax tively large share on a derivation basis while system. The current system allows the CIT to be also recognizing the considerable disparities in "prorated" by employment, but this structure fiscal capacity and needs that exist in Russia. may require modification. Government must be- 9 gin planning for the time when the profits of na- A simpler approach would be based on um- tionwide firms must be allocated among oblasts. brelIa vari bles such as population. density. per capita income, city size, poverty rates, the "cen- Sharing According to an Equalization Formula. trality" of a city, and the quality of infrastruc- The remainder of the divisible subnational pool ture. Germany uses a simple model, as does the would be divided among oblasts on a formula ba- United States to operate some of its grant pro- sis. This arrangement would serve same function grams. that is served by intergovernmental transfers in After one of these simple criteria is chosen, the most countries. Since the revenues assigned to next step would be to estimate the "revenue ca- each level of government cannot usually be pacity" of an oblast (considering its actual reve- matched perfectly with their expenditures, trans- nue would allow an oblast to reduce its tax effort fers are used to supplement own or shared reve- and collections in an effort to appear poorer and nues so that subnational expenditures are fi- thus receive higher transfers). Subnational reve- nanced adequately. Depending on what the for- nue capacity in Russia is a function of subnation- mula incorporates, it can be equalizing in the al tax bases, such as property and land values, sense that resources are directed toward oblasts vehicles, and number of businesses. Estimating fiscal capacity is relatively low and/or level of the revenue potential of each estimated base need is great. This formula would also make rev- would entail multiplying it by the average tax enue receipts for subnational governments more rate for the base across all oblasts. certain, thus enhancing their ability to plan In Russia the ultimate objective should be to efficiently develop a formula based on broad indicators of What indicators should be included in the for- need and fiscal capacity. Russia is probably not mula? In most countries that use this arrange- ready to move to a system based on per-capita ment, the "formula" consists of (1) some estimate income, due in part to the difficulty of using ex- of expenditure needs, (2) an assessment of reve- isting income data to measure differences in fis- nues to finance these needs, and (3) rules about cal capacity. Although this system should be the the "reach" of equalization. The structure of the goal in the long run, an alternative would be to formula must always be kept simple. The formu- base the formulas on certain key indicators of la approach is very different from the present public service needs-for example, miles of sub- Russian approach, and is constructed something standard roads, deficiencies in school and hospi- like this: G = E - R, where G is the grant, E is ex- tal space, and so forth. penditure needs, and R is revenue capacity. The initial construction of the formula is an ar- The most difficult component of the formula is bitrary process. Establishing a Grants Commis- to define expenditure needs for each jurisdiction. sion to develop a formula on a consensus basis Definitions should reflect needs based on popu- would address this problem. lation or other indicators, not the recurrent costs of financing existing facilities, as at present. One Enhanced Subnational Taxes. approach would begin with concrete expendi- ture norms, and then seek to "cost them out." In The fourth leg of the framework would give sub- Russia, this could be implemented by modifying national governments additional (but limited) existing expenditure norms to reflect population independent taxing power. Making subnational needs-for example, standardized classroom governments accountable by giving them both size in rural regions versus cities, multiplied by tax and expenditure discretion is a crucial benefit the standard cost of a teacher, classroom opera- of a decentralized system of fiscal relations. tion, and so forth, to derive a cost figure in ru- Three promising types of subnational taxing bies. Performing this calculation for each expen- powers are (1) a surcharge on the PIT, up to a diture function would itemize and build up the limit prescribed by the federal government (2) a expenditure needs of each jurisdiction. While the tax on land values within urban areas, and (3) a "precision" of this approach has much appeal (it tax on the ownership and operation of motor is being applied successfully in Denmark, for in- vehicles. stance), its drawback is it complexity. In Russia, The advantage of these taxes is that they place simplicity should almost certainly be the over- the burden on local citizens, thereby increasing riding concern. the accountability of subnational officials; more- 10 over, the costs of complying with them would be has used this arrangement to distribute revenue- lower and this revenue potential would be great- sharing assistance to state and local govern- er than those of the minor taxes now proposed in ments. the Basic Principles. While the burden of taxes on individuals is already high in Russia, the dis- The Role of the STS. tribution of the burden imposed by these three taxes would probably be progressive, and they Changes in tax administration are not required, would be preferable to other, more regressive but the government should eliminate the de fac- taxes. The property and vehicle taxes would re- to "dual leadership" role faced by the STS result- quire some investment in improved tax adminis- ing from their reliance on local governments for tration, and both would have to be collected by housing and fringe benefits. This dual loyalty the STS, although the federal level would not must be eliminated because, in many localities, share in their revenue. In the long run, subna- the STS is assuming the role previously taken by tional governments should probably have even the central bank and later by commercial banks greater revenue discretion with greater rate or in remitting taxes to the center. This role makes it base fixing discretion over some major revenue both possible and tempting to implement some source. Arguably, subnational governments cur- "single channel" or unilaterally determined tax- rently depend too much on shared central taxes sharing mechanism. Dual leadership could be and subventions. eliminated if, as in many countries, head officials In contrast, the 21 local taxes prescribed in the were rotated and all fringe benefits to STS offi- Basic Principles are likely to generate little reve- cials were federally financed. nue, strain the limited resources of the STS, and, A "local" STS for local taxes has been dis- most important, divert attention from more the cussed. The superior administrative capacity of productive revenue alternatives mentioned earli- the center and the economies of scale and infor- er. Many are "nuisance taxes," whose compli- mation associated with in collecting and auditing ance costs slow down the workings of the local multiple taxes argues for a single federal STS.In economy. the long run, local governments may play a role At least four other issues should be consid- in administer some aspects of the property tax. ered: Fiscal Discretion for Large Cities? Scope of the Intergovernmental System. Should special treatment be offered to large cit- The new legislation is ambiguous about whether ies? As in most countries, the largest cities in the intergovernmental structure should define Russia-oblast seats and other large industrial tax and expenditure assignment only at the centers-have a greater taxable capacity and a oblast level, or whether the central government more complex and arguably expensive set of ex- should prescribe the exact allocation of fiscal re- penditure needs. When these entities are willing sources to cities and rayons. Essentially, the issue to tax their citizens in order to provide better ser- is whether or not Russia sees itself as a federa- vices, special treatment could include a larger tion. This report argues that the government surcharge on central taxes, special support in im- should concentrate its efforts on establishing a plementing the property and vehicle tax, or spe- proper relationship with its oblasts and regions, cial rights to set prices (user charges) for and leave intra-oblast matters to subnational municipally provided services. councils. Local affairs can be handled more effi- ciently by each oblast than by Moscow, especial- Targeted Intergovernmental Grants. ly in a country that contains more than 2,000 rayon-level governments and many more dis- Finally, grants may be used to prompt lower lev- tricts and lower-level soviets, and that covers so els of government to align their spending pat- much territory. terns with higher-level priorities-for example, Some "framework law" may be appropriate, by targeting transfers at local governments for requiring that oblasts "pass through" some of capital investment and social services. Further their revenue to the rayons or cities according to study is required on the degree of matching or some agreed-upon guidelines. The United States the conditionality of these grants. 11 The Need for a Transitional Mechanism. Addressing Special Areas Enacting a new a program immediately might These demands for special treatment can be ad- exert too much of a "shock" on the system. Some dressed in three ways: "ad hocery," special fiscal transition rules to protect oblasts from unreason- regimes, and the proposed four-legged fiscal sys- able one-time effects must be considered. tem containing a comprehensive, equalizing formula. Special Fiscal Treatment and Regimes Ad-Hocery. In the past, the central Russian gov- The design of fiscal federalism in Russia is made ernment has dealt with disgruntled areas on a more complicated by the demands of some terri- piecemeal basis, through intergovernmental ne- tories for political autonomy, greater devolution gotiated subventions. This solution will not work of responsibility for expenditures, and special in the future: it is not transparent, and it creates a tax regimes. Such demands have arisen in three sense of injustice among oblasts, some of which situations. First, areas inhabited by non-Russian perceive that others are striking better "deals" ethnic groups (which form the majority of the with the central government. Transparency is a population only in Tatarstan) claim the right to crucial necessity in Russia at this time, when greater autonomy given their different history people, sometimes skeptical, are testing out and culture. Second, some areas rich in natural democracy. resources feel entitled to special financial arrange- ments that permit localities to derive greater Special Fiscal Regimes. If disgruntled oblasts benefits from natural-resource revenue. Some re- continue to decide unilaterally to implement a gions note that development in their area has not "single channel system" , it could threaten the fi- gion noe tat eveopmnt i thir reahasnot nancial (and political) viability of the Russian benefited from the existence of natural resources, ncal(dpoicl)vbltyfthRusn beee fFederation. (This trend contributed to the finan- and that the area has in fact sustained severe cial bankruptcy of the Soviet Union and hastened economic damage due to resource exploitation. . Tesefirsttwcon ditionsmover resource - . its political demise.) These developments call into These-first two conditions overlap in resource- question whether special fiscal status should be rich territories inhabited by ethnic minorities. granted to some territories within the Russian Third, industrially well-endowed areas that have Federation. A few countries (for example, Spain greater growth potential than others may prefer and Canada) do provide regimes within other- more fiscal autonomy or special fiscal arrange- wise uniform systems. One possible regime in ments in order to benefit from their stronger eco- Russia could call for eligible localities to share an nomic position. Given the nontransparency of amount equivalent to a multiple of the per-capita the current system and the perception that tax national average remittance. sharing works against the better-off oblasts, While widespread single-channel systems many rich oblasts find themselves subsidizing could threaten the viability of the federation, the the poor. Thus, wealthier republics or oblasts insistence on totally uniform fiscal treatment in may come to demand special treatment so that the face of strong forces that demand special they can benefit more fully from their own treatment could also threaten the political exist- resources. ence of Russia if disgruntled groups decide to Reportedly, some regions are insisting that a opt out. Indeed, that fact that certain areas are "single channel system," be instituted, whereby demanding special treatment should not be tak- all revenue flows initially to subnational govern- en lightly. Nevertheless, great care should be ex- ments, which then send a negotiated single pay- ercised in granting a special fiscal regime. As a ment to the feder2a governm,ent. (Bashkina has first principle, such regimes should be rejected. negotiated such an agreement with MOF, but it Since demands for special treatment will spread has not been approved by the Supreme Soviet. In rapidly as soon as past one is granted, if there other cases-such as Tatarstan and reportedly 20 are to be such regimes, eligibility must be de- oblasts that have determined their own sharing fined narrowly and according to objective crite- rates unilaterally-this arrangement is being im- ria. For example, areas in which the majority of plemented on a de facto and presumably illegal the population consists of ethnic minorities manner.) might be granted a special regime only if in light 12 of the potential for serious political conflict in transparency necessary to prevent the sense of in- those areas. When granted, special treatment is justice, thus encouraging areas to stay with the virtually impossible to rescind. system, rather than opt out (and reduce the com- mon pool). While Russia seeks to define itself as a Flexible, Comprehensive Formula-Based Sharing. nation after the dissolution of the Soviet Union, Demands for special fiscal treatment can also be the immediate need for political unity may be addressed within the proposed four-legged, for- greater then the need for equity. Rather than al- mula-based framework. Special regimes would lowing states to negotiate individually for special be unnecessary, because the framework would fiscal regimes or decide unilaterally to leave the give Russian policymakers flexibility in deciding federal system, the government must seek to en- the relative emphasis to be placed on equaliza- gender widespread participation by adopting a tion and on derivation-based tax sharing. If one distribution system that does not overemphasize oblast were granted a special regime, then other, regional equalization and can be flexible enough similarly endowed oblasts could demand the sta- to respond to special circumstances. tus, pulling resources from the equalization pool. In this context, the importance of developing a Ironically, then, imposing equalization at this transparent, fair, consensus-based framework for stage may impel wealthier areas to withdraw uni- intergovernmental finances with revenue-expen- laterally from the pool, thus reducing the scope diture correspondence cannot be overstated. The for any equalization. Emphasizing a derivation- future cohesion of the Russian Federation de- oriented distribution of the common pool would pends on it-the framework is perhaps the only give weight to the revenue concerns of wealthier fiscal mechanism available to contain centrifugal areas while engendering their willingness to par- forces. By fostering the notion of "we" that be- ticipate in the pool. comes grounded more solidly in the nation, con- In addition to its discretionary component to sensus-building can respond appropriately to balance derivation and equalization consider- the fast pace of changes in Russia. ations, the formula-based framework would ad- dress other demands for special treatment (the Sharing Revenues from Natural Resources framework could incorporate numerous specific factors, assigning them appropriate weights). The taxation of natural resources deserves spe- For example, one component of the tax devolu- cial attention. As domestic energy prices rise to tion formula in India provides the politically world levels, potential fiscal revenue from ener- sensitive state of Punjab with additional govern- gy resources could become enormous. Russia's ment funding in recognition of the difficulties of policymakers should examine three issues: how being a border state. In addition, one component taxes on the resource sector should be struc- of India's grant formula assigns backward areas tured, how resource revenues should be shared a special weight that gives them extra compensa- among jurisdictions, and how resource revenues tion. Similarly, In Russia, areas that contain a should be used. The discussion here focuses on large concentration of ethnic minorities could be oil and gas, where the money at stake is most assigned a weight in the formula-based pool, in pronounced, but it is also generally applicable to line with the arguably greater needs of ethnic ar- all natural resources. eas. Resource-rich areas whose developmental needs have been ignored and environment dam- The Design of Resource Taxes ages could also be targeted by components of the formula. Proceeds from the exploitation and sale of re- sources often greatly exceed the costs of exploi- Special Treatment Within the "Four-Legged" tation, creating "economic rents," part of which Framework Is Recommended. Using formula-based can and should be captured for the budget. Taxa- sharing to meet special needs is appealing for tion based solely on the volume or value of out- several reasons. While the formula would be uni- put-as introduced in Russia's present law on form among all oblasts, its components would "Natural Resource Payments" and "Law on the permit policymakers to target special treatment Subsoil"-can discourage otherwise economic at certain areas when appropriate. It would ap- production on marginal fields. Such production pease disgruntled groups while maintaining the taxes also allow enterprises, not the government, 13 to gain most of the rents from highly productive groups, cities and rayons, okrugs, oblasts, or to fields. Resource taxes should be designed care- the federation. We argue for a large (but not ex- ftiiiy to fail on economic rents, therebv dvoidinp chligsive) federal shar E:ev n_ buih probiems. tional areas should receive a sufficient share to enable them to provide social services at the na- The Division of Natural Resource Revenue tional standard. The other taxes paid by natural resource-producing enterprises (the CIT, VAT, The exploitation of resources often generates sig- and export taxes) should be levied and shared nificant "social costs" -the budgetary costs of under the provisions of the standard, unified publicly provided infrastructure (for example, revenue-sharing regime. specialized transportation facilities) and the so- More generally, a more "equitable," transpar- cial costs of environmental degradation, includ- ent, formula- and rules-based intergovernmental ing the costs of cleaning up environmental arrangement may make it easier to reach consen- damage from production activity. Localities sus on natural-resource revenue sharing. If local- should be compensated for the infrastructure ities perceive that they are being treated fairly and other expenditures required by the resource under a uniform system of intergovernmental sector, with charges and levies that would accrue relations, they may cede their demands for directly to the locality that incurs these costs- "asymmetrical federalism." Mineral-rich re- that is, to the subnational governments of pro- gions would be less likely to pursue the centrifu- ducing regions. gal drive with the attitude that "what is mine is mine, what is yours is negotiable" as their only The Political Dimensions. leverage. After localities have been compensated for their "Contracts". The "Law on Ethnic Minorities" financial, social, and environmental costs (in- being considered by the Supreme Soviet (and in- cluding the income loss among ethnic groups terim decrees signed by the president) add an im- whose tradition and heritage have been portant exception to the basic principle that min- usurped by production), the remaining revenue eral wealth be the common property of the Rus- from resource taxes can be divided in several sian state. This law gives ethnic minorities ways. The choice raises fundamental issues important property rights to natural resources, about the nature of the Russian Federation. If because it forbids the exploitation of resources on primary allegiance is to the federation (if "we" the traditional lands of ethnic minorities without are citizens of the Russian Federation), and if their approval. In the absence of limits on the con- the consensus is that resources are "common ditions and terms of the "contracts," much of the wealth" belong to the federation, then resource economic rents will flow directly to those minor- taxes should flow to the federal budget. If, ities, rather than to public budgets. however, primary allegiance is to a smaller re- source-producing jurisdiction within the feder- The Use of Resource Revenues ation (if, for example, "we" are citizens of Khanti-Mansisk okrug), revenue should flow to Revenue from resource taxes can be used to cov- the okrug budget. er current budgetary expenditures; they can be The spectrum of possible choices for dividing set aside in a "Heritage Fund" for future genera- resource revenue is thus broad, depending on tions; or they can be given away through grants the collective "we." In many countries, the bulk to the local population (as in Alaska). The last of of resource revenue goes to federal budget, al- these is a tempting alternative, especially if the though some countries pursue other arrange- locality is poor, but is inadvisable. Some expen- ments. Given thie circumstances of the federal diture financing-especially to redress deficien- budget in Russia today, a large share should al- cies in the subnational infrastructure-may be most certainly accrue to the federal level. In appropriate. Many countries place substantial Khanti Mansisk and Yamal, Russia's largest pro- revenue into a trust fund, whose earnings sup- ducing regions, a share of the revenue from oil plement general budgetary revenues and may be and gas, after compensating localities for costs, invested to help ease the transition to a "post- could be allocated in almost any way: to tribal oil" economy. 14 Given Russia's budgetary difficulties, using be restricted to financing the infrastructure, and the federal share of natural-resource revenue to the center should have the right to control and finance general expenditures may be appropri- monitor all lower-level borrowing. ate. If the flow of resource revenue to subnation- Appropriate sources of borrowing could in- al governments is significant, trust funds are es- clude commercial banks, which might remain sential: most localities could not absorb any sig- the main source, as in Germany. Bond issues nificant volume of funds productively, and must come later, because markets for any such fi- investments in the local area under a policy of nancial instruments must still be developed, and "resource-based industrialization" inevitably subnational governments must establish credit- have a low rate of return. Investing a portion of worthiness. In the meantime, some thought the revenue in a trust fund for the benefit of fu- might be given to municipal development ture generations is the only sensible policy. banks, especially if they are not set up by the central government, but spring up as coopera- Managing the Trust Funds tive efforts (for instance, groups of cities and de- signed to provide technical assistance). Borrow- It is important that both resource-rich subnation- ing from central bank branches should probably al governments and native populations avoid a always be prohibited. Subnational governments seductive but wasteful trap. Much of the trust should not receive subsidized credit through any fund of the Canadian province of Alberta has source. been devoted to local investments, including in- vestment in petroleum-related activities; many Extrabudgetary Funds petroleum-exporting countries have pursued similar policies. The rate of return on these local The large proliferation of extrabudgetary funds projects is usually quite low, and in the end less since mid-1991 at all levels of government pre- is left for future generations, than would invest- sents serious problems for effective budgetary ing where the return is highest. (A "high-return management at the macroeconomic level. These strategy" has been used by Alaska.) Such invest- funds reduce the transparency of budgetary op- ments will generally be outside the local area, erations and complicate assessing the impact of and perhaps outside Russia. Income from these fiscal policy. Extrabudgetary funds function as investments can be used for local purposes, and parallel budgets, escaping the strictures of con- the principal that continues to grow will ensure ventional budgetary procedures. Using these ongoing funding for the future. When the time funds is an inefficient budgetary practice, creat- comes, the best possible investment advice will ing loopholes for public-sector operations not be essential. approved through the proper (budgetary) chan- nels. In addition, the presence of multiple "bud- Subnational Govermment Borrowing gets" implies a loss of control and information, undermining the use of fiscal policy as a macr- Borrowing by subnational governments does not oeconomic instrument. All legitimate revenue have much of a history in Russia. At the mo- sources should be incorporated fully into the ment, recently passed laws give oblasts, cities, regular budget to provide full accountability of and rayons an unlimited right to borrow; how- fiscal operations. ever, given the needs of the stabilization pro- Although extrabudgetary funds are claimed to gram, these rights have temporarily been reduce uncertainties during the budgetary pro- restructured. Subnational borrowing is also cur- cess, localities in fact use them to shelter revenue rently limited by lack of commercial bank facili- from sharing arrangements. We would ordinari- ties and suitable financial markets. ly recommend that extrabudgetary accounts be In the short term, very limited or no borrow- eliminated. Operationally, however, given that ing is appropriate for macroeconomic reasons. the law grants the right to set these funds and However, for the long run, discussion should that the practice is entrenched, as a realistic tran- now be pursued on ways to incorporating facili- sitional mechanism we recommend that subna- ties for limited subnational borrowing in the in- tional governments be required to disclose their terim, in light of the experience in federal and sources and use of extrabudgetary funds fully to unified countries. Long-term borrowing should the central fiscal authorities. 15 Summary of Priorities nized. A transparent, equitable, and revenue- productive system of intergovernmental fiscal Establishing an institutional framework for re- relations will enhance not only stabilization ef- form is the first priority. The second is to abolish forts, but also service delivery, the social safety the practice of "pushing the deficit down" from net, and the incentives to privatize locally the federal to the subnational level-for exam- owned enterprises. A new law will almost cer- ple, by offloading federal expenditures. Only by tainly be required. doing so can macroeconomic stabilization objec- These issues will be elaborated in the chapters tives be achieved and the cohesiveness of the na- of this report. What follows is a summary of the tion be preserved. Third, the Basic Principles major problems related to Russia's system of in- must be reconsidered and revenue shares and tergovernmental fiscal relations, as well as some transfers to subnational governments be scruti- proposed recommendations. 16 MATRIX OF RECOMMENDATIONS FOR INTERGOVERNMENTAL FISCAL RELATIONS Macroeconomic and Institutional Dimensions Problems Recommendations Insufficient coordination among tax sharing, Establish "Blue Ribbon Commission" on In- expenditure assignment, and deficit policy, tergovernmental Finances. currently creating a macroeconomically de- stabilizing and divisive system. Insufficient transparency and politically di- Establish "Grants Commission" and "Tax visive approach to intergovernmental rela- Policy Unit" in the Ministry of Economy and tions. Supreme Soviet to seek consensus, maintain dialog, and (quantitatively) analyze changes in intergovernmental policy. Lack of correspondence between revenues Provide adequate financing to subnational and expenditures at the subnational level, governments through a well-designed and and the strategy of "pushing the deficit balanced system of tax sharing and trans- down," could manifest itself in pressures to fers, contributing to macroeconomic stability borrow, or cause localities to seek monetary and national cohesiveness. financing of their deficits and to perverse revenue sources (entrepreneurial activity) for financing. Expenditure Assignments Expenditure assignments are murky, and of- Assign and define expenditure responsibili- ten shift between levels of government in ad ties at each level by law. Reverse the "jetti- hoc ways (for example, social protection and soning" of federal responsibilities to the sub- investment shifted downward in 1992). national level. The assignments of responsibilities between Phase out the obligations of enterprises to fi- the private sector (enterprises) and subna- nance public schools, hospitals, roads, and tional governments must be reforned: sub- urban infrastructure, and adjust subnational national enterprises can no longer afford to tax assignment accordingly to let them as- finance public "expenditures" that are prop- sume this obligation. erly the role of government. Expenditure norms and uniform coefficients Develop "norms" targeted at expenditure not address the adequacy of service delivery needs and help eliminate deficiencies and levels in areas where past investments have shortfalls in providing services in disadvan- left them underserved. taged areas. 17 Responsibility for capital investments has Give subnational governments responsibili- been shifted "downstairs" to protect the fed- ty for capital investments in spheres that eral budget. correspond to their responsibility for current expenditures and urban infrastructure. Highways, airports, telecommunications, and military housing are properly central re- sponsibilities and should be the financial re- sponsibility of the central budget. Central expenditure mandates and expendi- Eliminate central mandates and uniform ture norms exert pressure on subnational norms, which are increasingly distorting as budgets and restrict the discretion of subna- regional price and income differences tional governments over expenditures. emerge. Shifting social expenditures "downstairs" As necessary, resume central financing of so- without commensurate changes in the reve- cial protection through "cost reimbursement nue-sharing system has exerted pressure on grants." subnational budgets and may jeopardize the social safety net in the transition. The Tax and Transfer System: Tax Assignment Problems Recommendations Correspondence between the tax assignment Quantify expenditure assignments as the ba- and expenditure responsibilities of each lev- sis for developing the corresponding, and el of government is absent. matching, revenue yields and a new system of revenue-sharing. Empirical research is necessary. The assignment of taxes between levels of Tax pooling and sharing, rather than tax as- government as proposed in the Basic Princi- signment, is recommended. Tax sharing ples-with the PIT and the CIT as regulating would cover most major taxes. The system revenues at the lower level and the VAT as would have four components: revenue at the central level-is unworkable. First, the share of total revenue to go to the subnational sector in aggregate would be de- termined. Second, some proportion of the subnational pool would be shared with sub- national governments on a derivation basis. Third, some would be shared on an equal- ization basis. Fourth, subnational govern- ments would be given greater revenue dis- cretion to raise own revenues. Revenue-sharing now takes place under Introduce a tax-sharing and transfer system transition rules, through ad hoc negotiated in which major taxes would be shared ac- tax shares on some taxes, outside the frame- cording to transparent criteria (including work of the Basic Principles. derivation) in an equalization formula. 18 The Basic Principles does not address Introduce equalization (via formula equalization explicitly, but rather in an ad grants), but recognize the tradeoffs: exces- hoc non-transparent way in a system of sive equalization can reduce tax effort and subventions, as of Q3. penalize rapidly growing and industrializ- ing regions and cities to the benefit of less- developed areas. The VAT is shared with subnational gov- Preferably do not share VAT with the sub- ernments, unfairly hurting exporters (due national level. While it is possible to devel- to VAT zero-rating) and capital goods pro- op compensation mechanisms for any ducers. Extending the VAT to imports will shortcomings, they are administratively unfairly benefit importing regions. The ex- very difficult. perience of Brazil also shows how difficult the inter-oblast crediting of the VAT can be. Many of the proposed local taxes in the "Basic Develop the land tax, and possibly the ve- Principles" are largy "nuisance taxes" and hicle tax, as major local resources, not other cannot be expected to yield much revenue. minor taxes. Localities should be allowed to set sur-rates on the PIT to generate local revenue. Subnational governments rely almost total- Large cities and oblast seats may have spe- ly on taxes whose rates and base are set by cial needs for fiscal flexibility and should the central level; they have no rate-setting be accommodated to the extent possible by discretion whatsoever. Thus, they are vul- permitting them additional fiscal discretion nerable to central government decisions to in rate-setting (for example, via larger sur- change the rate or base of taxes assigned or charges on central taxes). shared with them. The State Tax Service is de facto a federal State Tax Service responsibilities for collect- agency, but may be more tied closely to lo- ing both national and subnational taxes cal governments than to the federal level. should continue, and establishing separate local administration is not recommended. The "dual leadership" problem should be addressed by rotating local officials and by paying all fringe benefits and housing from the federal budget, as in other countries. Potentially, the State Tax Service incentives If tax sharing is introduced, it will incorpo- to collect purely local or purely central tax- rate incentives to collect all taxes with es are undear. equal a level of efficiency. The scope of the future system is unde- Extending the revenue-sharing and trans- fined: should the system define only cen- fer system to the oblast-rayon level would ter-oblast relations, or should it also define be administratively complex and would re- oblast-city-rayon relations? duce oblast autonomy. A national "frame- work law" to define objectives for oblast- rayon relations might be appropriate. A special regime for large cities may also be necessary. 19 The current revenue-sharing system with- A national framework law should be de- in oblasts-which equalizes between cit- veloped to guide the intra-oblast distribu- ies, and rayons within the oblast-is gov- tion of resources, but it should not be ad- erned by a similarly nontransparent and ministered centrally. complex system. Transfers The current system does not incorporate Introduce a concrete, objective formula for transfers; rather equalization has been tar- equalization, incorporating both expendi- geted by "tailormade" tax-sharing rates be- ture needs and revenue capacity. tween center and oblasts. The central government has transferred re- Central government should provide "cost- sponsibility for paying price subsidies and reimbursement" transfers for the social social protection to local governments protection responsibilities transferred to without providing commensurate financ- the local governments. ing. The subventions introduced in late 1992 to Transfers should be based on concrete crite- fill fiscal gaps are similarly negotiated, ad ria, and support, both equalizing and the hoc, and possibly counter-equalizing. revenue efforts of oblasts. Special Fiscal Regimes Demands for special treatment are being Russia may need to respond to such de- made by ethnic areas. mands to "buy" continued participation of areas in the union, but addressing their needs within the "four-legged framework" would be preferable, using the formula- based transfer pool to address the concerns and characteristics of these regions. Demands for special treatment are being Accommodate these demands by sharing made by natural resource-producing regions. taxes on natural resources and designing a transparent, fair system with a formula- based transfer pool that addresses the con- cerns and characteristics of these regions. Demand for special treatment (that is, "sin- Do not accommodate these demands gle channel") are being made by better-off, through special regimes; contain the centrif- economically prosperous regions, currently ugal forces by creating a consensus-based, subsidizing the poorer ones. not overly equalizing intergovernmental fis- cal regime that avoids heavy cross-subsidiza- tion and incorporates a formula-based trans- fer pool that addresses the concerns and characteristics of these regions. 20 Natural Resource Taxation Production taxes, such as those introduced Tax the "economic rents" from resource ex- in the "law on the Subsoil," discourage and ploitation, rather than production. distort production. Localities are increasingly seeking to obtain Devise a federal subnational revenue-shar- a larger share of revenue from natural re- ing formula that is perceived to be equita- sources. ble. Local share should at least compensate for income losses from traditional activities and other costs (see below). Natural-resource revenue is being used to Establish a "Heritage Fund" so that future supplement current budgetary revenues to generations also benefit from these monies. finance ongoing expenditures. An insufficient focus exists on how the Resist investments in local area and low-re- "Heritage Fund" should be managed. turn local activities. Consider portfolio di- versification with respect to currency com- position, industrial sectors, and location. Exploitation of natural resources involves Compensate local areas for these costs, per- environmental and social costs and budget- haps through their share in the revenues ary costs for the development of infrastruc- ture. Extrabudgetary Funds, Borrowing, Local Entrepreneuralism Extrabudgetary funds are being set up by In principle, all revenue should be included subnational governments, inter alia, to con- in the budget, but, since extrabudgetary ceal revenue that might be subject to ad hoc funds have been endorsed in national legis- sharing or "surplus extraction." lation, subnational governments should at least be required to report on extrabudget- ary funds. Subnational governments have been given These restrictions should remain in the near unlimited borrowing rights in the Law, al- term for macroeconomic stabilization rea- though these rights have been restricted by sons; in the longer term, to avoid misuse of decree at present. borrowing, suitable modalities (bank fi- nance, bonds, and possibly municipal banks) could be developed. Subnational governments should not own banks. Subnational governments are continuing to Discourage government joint ventures and be entrepreneurial, undertaking internal do not endorse them in the legislation. joint ventures using their land and other re- sources as their share. This practice is incon- sistent with privatization. 21 Intergovernmental fiscal relations: Setting the stage The Russian Federation has embarked on a bold tional governments also makes them crucial process of economic restructuring-privatizing players in privatization efforts. Finally, expendi- industry, instituting agricultural reform, institut- ture reform has given subnational governments ing price liberalization, modernizing the finan- important new responsibilities for the social cial sector, and reforming the tax system. These safety net. The safety net itself is to take a new reforms will significantly change the role of the shape, shifting away from subsidies toward tar- government in the economy, reducing its direct geted safety net programs. control over the allocation of resources and fi- The Federation has ambitious plans for fiscal nancing and strengthening the regulatory and reform. It has already introduced several chang- other functions characteristic of government in es in the overall revenue and expenditure system market economies. The same reforms imply ma- at the federal level. However, in intergoverr- jor changes in the nature of rural and industrial mental relations and subnational finances-the enterprises, which will divest themselves of so- focus of this report-reforms have only just be- cial and other responsibilities as they strive to re- gun, and are less well developed.1 semble the production and profit-oriented firms The remainder of this chapter sets the stage that characterize a market economy. for the subsequent analysis and discussion in These reforms have changed responsibilities at the body of the report. This chapter discusses all levels of government-from the federal par- the context and evolution of the current tax- liament to the village soviet. In particular, they sharing and transfer system in Russia, as well as change the governments' expenditure responsi- its expenditures and expenditure assignment bilities, their need for revenue, and the avenues policy. To provide background to this discus- available to collect it. Fiscal reform began in the sion, the next section provides an overview of USSR in the late 1980s, and accelerated after the the fiscal and administrative structure of the former USSR was dissolved and the Russian Russian Federation and its intergovernmental Federation became independent in 1991. dimensions. Fiscal reform will continue to play an impor- tant role in the success of Russia's reform effort. The Russian Federation: Federal First, sound fiscal policies are crucial to a suc- Administrative and Budgetary Structure cessful stabilization effort in the present environ- ment. Second, the equity and incentive aspects The Federal Administrative Structure of tax policy are crucial to structural reforms- creating an environment in which the private The Russian Federation is a three-tiered federal sector can flourish. The ownership role of subna- state. Administratively, the Russian Federation2 23 consists of 91 provinces or states directly subor- Federation or by any other country). Tatarstan and dinate to the federal government. With varying Chenchen-Ingush have added special covenants to degrees of administrative autonomy, the 91 states the Federation Agreement signed by all other diredly subordinate to the federal government oblast-level govermments in July 1992 and thus comprise (1) the oblasts, okrugs and krais, (2) met- have special status within the Russian Federation. ropolitan cities with "oblast" status (Moscow and In addition, the Federation consists of 5 autono- St. Petersburg), (3) republics, that until mid-1992, mous regions (Adygei, Gorno Altai, Jewish, were called "autonomous republics," (4) autono- Karachayevo-Cherkass, and Khakass) and 10 na- mous regions, and (5) national regions. The Federa- tional regions (Aginsky-Buryat, Chukot, Evenki, tion includes 16 republics (Bashkir, Buryat, Khanty-Mansi, Komi-Permyak, Koryak, Nenetz, Checheno-Ingush, Chuvash, Dagestan, Kabardino- Taimyr, Ust-Ordynsky-Buryat, and Yamalo- Balkar, Kalmyk, Karelian, Komi, Mari, Mordovian, Nenets). The regional diversity and other charac- North Ossetian, Tatar, Tuva, Udmunt, and Yakut). teristics of Russia's regions are described in Box 1.1. These republics have their own governments ("su- In the Russian system, the central government preme" soviets) with some autonomy in principle. interacts directly with oblast-level governments. Some of them have declared independence (al- Immediately below the central government are though these declarations have not been recog- the governments of the 91 oblasts, autonomous nized by the Supreme Soviet of the Russian regions, krais, and okrugs. (They are collectively Box 1.1 The Russian Federation: Basic Characteristics The Russian Federation and Its "Nationalities." With a population of 148.5 million (in 1991), the Russian Fed- eration accounted for 51 percent of the USSR's total population. The Russian Federation itself embraces dozens of ethnic groups. About 82 percent of the population is ethnically Russian. Other nationalities in- clude Tatars (3.8 percent), Ukrainians (3 percent), Byelorussians (0.8 percent), Germans (0.6 percent), and Jews, Armenians, and Kazakhs (each 0.4 percent). The European part of the Russian Federation is relative- ly densely populated and includes the cities of Moscow (9 million inhabitants) and St. Petersbeig (5 mil- lion). The Asian part is more sparsely populated, with major urban centers situated in the Urals and along the Trans-Siberian Railroad. Resource Endowments across Regions. The Russian Federation has vast natural resources. Its agricultural sec- tor produced over 50 percent of the total grain output of the former USSR, 50 percent of its potatoes, 25 percent of its sugar beets, and about 50 percent of its livestock. Its large mineral deposits include coal, oil, natural gas, phosphorites, potassium salts, iron ores, gold, diamonds, rare metals, copper, lead, tin, baux- ite, manganese, silver, molybdenum, graphite, nickel, and uranium. Some of the most important mineral deposits are located in republics and ethnic regions. For instance, a large part of the western Siberian oil fields is found on the territory of the Khanti-Mansi autonomous okrug, the Yamal Autonomous okrug, and the major diamond deposits are located in the Yakutia republic. Important oil fields are also located in Ta- tarstan. Geography. With an area of 17,075 thousand square kilometers, the Russian Federation accounts for over 76 percent of the territory of the former USSR. Spanning 11 time zones (from Kaliningrad on the Baltic Sea to the Bering Straits) and covering one-eighth of the world's land surface, the Russian Federation is the laig- est country in the world. With the exception of the Central Asian deserts, the Russian Federation retains all the major geographical features of the USSR. The northernmost part of the country is arctic desert and tundra (two-fifths of the territory of the Russian Federation is permafrost); south of the tundra stretch for- ests (the taiga); farther south lie the steppes. Income and Expenditure Differentials across Regions. These resource endowments are reflected in Russian per- capita incomes, which vary widely across oblasts. In 1989, the richest oblast (Tyumen Oblast-which until 1991 included the oil-producing Khanti Mansisk Okrug) had a per capita income of R 5971 (GVAIO) ap- proximately ten times the per capita income of the poorest, the Kalmytskaya AR. With respect to the bud- get, the regions are similarly differentiated: per-capita expenditures range from R 139 in Adygei to R 4253 in Chuvask, with a standard deviation of R 667 (1991). Source: (See IMF, 1991a) 24 referred to throughout this report as "oblast-lev- reflects the territorial principle of administration. el" or "subnational" governments). Below the The organizational framework on the left side of oblast level are the municipalities and rayons, Figure 1.2 shows how the territorial principle of subordinate to them. Each oblast supervises the responsibility works. The territorial unit has full urban and rural areas within its jurisdiction. The administrative jurisdiction or "competence," for hierarchy is depicted roughly in Figure 1.1. All functions that take place within its territory. governments within an oblast report directly (or Thus, under the territorial principle, the federal indirectly) to the oblast government, and carry government has competence for all governmen- out their duties according to regulations estab- tal functions within the federation-from diplo- lished by the oblast. This system of vertical rela- macy and defense to social expenditures and tax tionships creates a setting within the oblast that collections. The oblast-level governments are re- can accommodate some fiscal decentralization to sponsible for governmental functions within the the rayon government level. For example, the oblast; the rayons, for affairs within the rayon. Moscow oblast at the end of 1991 contained 60 (This is drawn from Gleason, 1990.) cities (whose population ranged from 60,000 to Since some of these functions of subnational 200,000) and 650 independent settlements (ray- governments are also federal functions (accord- ons, cities, and rural settlements). Each of these ing to the territorial principle) they are subject to 710 units has an independent budget and ad- central guidance (or, for rayons, to oblast guid- ministrative status. ance). Thus, paralleling the territorial principle, the branch principle of organization applies to Budgetary Management and Autonomy functions for which higher levels also have com- at Subnational Level petence. Most ministries are organized along branch lines, on a vertical hierarchy, from the The sovereignty of the oblast for the activities highest to lowest level (see Figure 1.2, right and administrative units within its jurisdiction side). Thus, republic-level ministries coordinate Figure 1.1 Government Structure In Russia Russian Federation Central Government Oblasts (Urban) |(Rural) Municipalities | Rayons | f City Proper Urban Districtsa (District) or Rayons l Urban | Urban '- Rural Soviets | ~~~~Soviets Soviets a. In some oblasts, and in some special cases, urban rayons may be directly subordinate to the oblast government. 25 Figure 1.2 Hierarchy Of The Government Administration And Finance |Supreme Soviet:l | RSFSR| and supervise the work of Oblast-Level Ministry of Govertments Finance Obeast ti nicipal an t bOf st Finance STS Rayno Governments Department Offices Rayon d Rayon F inance ST(S Departments Offices and supervise the work of oblast-level struc- ments of finance and by finance officers of the tures, which coordinate city and rayon-level ac- federal ministry. However, no single authority tivities. While branch management pertains to (such as a lrevenue commissioner") was in the administration of a branch of economic activi- charge of a y taxeadinistration activities. This oies throughout the republic, territorial leadge-shulleadership"ipr of the tax officers-reporting ment refers to the administration of aan activities to both the Ministry of Finance and their own lo- within a region (oblast, republic, and so forth). cal-level govertnents was a source of major Until the recent decentralization, most adminis- conflict of interest, most of it apparently resolved trative bodies (such as the oblast departments of by giving pwscreaed as antausts of the lower finance) were simultaneously part of a branch level. Inasmuch as local enterprises generated organization (e.g., the MOF) and a territorial ad- employment and until recently remitted their winistration (the oblast govecment). The coor- taxes to local-level goveiments, local authori- dination of the territorial organs with the by Rsienefited by keeping taxes low and increas- organs ensured that the "dual leadership" ing the proportion of earnings retained in worked smoothly. enterprises and thus in the local area. Such eanr- ings could then be tapped into for "donations" Tax Administration-entral and Subnational to local pr-ojects. Responsibilities During 1991, the government began imple- menting a new fiscal strategy, in which tax ad- lJntil November 1991, tax administration was ministration became crucial. In November 1991, the responsibility of the Ministry of Finance, and the ST'S was created as an autonomous agency the State Tax Service (STS) was a department with ministerial ranking, and is now in charge of ,within that ministry. Highly decentralized oblast administering all taxes in the territory of the and rayon (local) offices were supervised by Russian Federation. Its organizational structure t]heir respective oblast and rayon level depart- consists of three levels: central, oblast, and ray- 26 on. The oblast offices coordinate and supervise the impact of the current and proposed intergov- rayon/local offices under their jurisdiction and ernmental regimes. It also proposes a framework provide the central level with tax revenue data. for reforming the system of tax sharing through- The 91 oblast STS directors report directly to the out the Federation while permitting flexibility to minister heading the STS, eliminating the formal accommodate those regions demanding greater "dual" leadership structure previously in place. fiscal autonomy. However, substantial conflicts of interest remain, as outlined below. Revenue Structure and Tax Sharing in the Russian Federation The Fiscal Dimensions of "Dual Subordination" The revenue and tax-sharing system in place While according to the territorial principle the when Russia gained independence in 1991 was oblast-level finance departments were organs of an extension of the system that had governed in- oblast governments, responsible for oblast-level tergovernmental relations in the pre-indepen- fiscal policies, according to the "branch princi- dence period. Beginning in November 1991, the ple" they were also subordinate to MOF. Recent Russian Federation took over Union revenue laws on "Local Self-Government" have given and expenditure responsibilities and began to oblasts greater autonomy; however, oblast fi- pursue "sovereign" tax policies. Thus, many di- nance officers are still paid by the central govern- mensions of the old system of negotiated tax- ment. To this extent, the finance departments of sharing rates between the central government the oblasts, though formally autonomous, may and subnational governments remained in place. still have one foot in Moscow and one foot in the The bargaining inherent in this system made oblast, and may even now respond to competing subnational governments highly dependent on realms of authority. Figure 1.2 reflects this dual the center, creating considerable uncertainty leadership (adapted from Gleason, 1990). The about their fiscal autonomy and responsibilities. branch principle still applies in full to intra-oblast The major tax source for subnational govern- governance. ments has traditionally been their share of per- As organs of the oblast government, finance sonal income taxes (PIT), company income taxes department directors report horizontally to the (CIT), and sales tax. In 1989, PIT revenue com- oblast government (in the past, they also report- prised about 25 percent of total subnational reve- ed hierarchically to the Republic's MOF for im- nue, profit tax comprised 22 percent of the total, plementing official tax policy and delivering tax turnover tax comprised 20 percent, and sales tax revenue). In theory, the nomination of an oblast 5 percent. In 1989 subnational governments re- finance department director requires approval tained more than 50 percent of national collec- by MOF Similarly, nominations for rayon-level tions from PIT; in contrast, subnational govern- finance department heads require oblast-level ments retained only about 20 to 30 percent of the approval. This approval process is considerably nationally more important turnover and profit less strict under the new laws. In contrast, the taxes. The percentage distribution of subnational STS is no longer under this informal dual leader- revenue, by the first quarter of 1992, was weight- ship, although substantial loyalty to (and possi- ed toward the CIT and PIT (40.9 percent and 27.5 ble conflict of interest with) the local government percent of total revenues, respectively), and val- administration still remains. The local adminis- ue-added tax (VAT) at 16.2 percent (see Figure tration continues to be responsible for allocating 1.3). However, these averages concealed major and providing housing to the STS staff and for differences across oblasts. For some oblasts, VAT, paying all of their fringe benefits (only their profit, and sales taxes contributed almost zero to wages come from the federal budget.) total revenue; in other oblasts, these taxes con- tributed about 40 percent of total revenue. The Intergovernmental Tax Sharing and Transfer System at Present3 The Reform of the Tax and Assignment System in 1992 This section describes the current system of reve- nue sharing in Russia and sets the stage for more Recent tax reforms in the Russian Federation are detailed analysis in Chapter 4 which discusses a continuation of the fiscal reform efforts that had 27 Figure 1.3 Distribution of Actual Tax Revenues Central and Subnational Levels 1992: Ql (percent) Other & nontax rev 10 activiy -=PT a i_8C IT VAT 78.9 CIT 46.1 nontax rev VAT Excise taxes Excise taxes 7 Nontax revenues are budget estimates (not actuals) & allocated as R 10 billion to federal and R 8.3 billion to subnational. Source: Ministry of Finance. First Quarter 1992. been initiated by the USSR in 1990 and 1991. tions are described in Box 1.2. A breakdown of They were oriented toward replacing the former tax revenue since 1985 is in Table 1.1. system of state financing, which relied heavily on profit remittances from state enterprises, with Law on Basic Principles of Taxation taxes on income, profits, consumption, and trade, similar to those in market economies. These re- Enacted in January 1992, the "Basic Principles" forms began in mid-1990, when the Russian Fed- represents the fundamental framework for taxa- eration began to introduce laws that superseded tion in the Russian Federation at all levels of or amended those of the Union, and accelerated government, and builds on the earlier laws gov- toward the end of 1991, when the Russian Feder- erning the value-added tax and corporate profit ation formally introduced its own budget (IMF, tax. In its present form, the law consists of two 1992a). parts. The first part establishes the "unified" tax By mid-1992, a wide range of new tax laws structure, general taxation rules, penalties, and had been enacted, including those that imple- tax administration powers. The second part spec- mented the VAT, excise taxes, and the PIT. The ifies the taxes that may be levied by the federal, full tax-reform package consists of the "Law on oblast, and rayon governments, and assigns the Basic Principles of Taxation" and a series of laws revenue from each tax to the budgets of various on particular taxes. This section discusses the levels of government.4The "Basic Principles" en- main features of the actual and proposed tax visages a unitary system where the tax rates and structure and their intergovernmental aspects. bases of all major taxes are set by the federal gov- The primary intergovernmental feature is a emient, but all revenue from individual taxes is planned, radical shift from the earlier system of dedicated to particular levels. The provisions of negotiated, bargained "tax sharing" to a system "Basic Principles" are outlined in Box 1.3. of pure "tax assignment." The main features of Revenue from some of these taxes assigned to Russia's actual and proposed tax structure and or shared with subnational governments in pro- brief details on its tax bases, rates, and exemp- portions specified in the law. According to the 28 Box 1.2 Recent Tax Reforms in the Russian Federation Personal Income Tax. The PIT is a federal tax withheld by employers and that applies to most wage earners. A standard deduction, exemptions for children and other dependents, and several other deductions are al- lowed. While in principle the PIT incorporates a schedule of rates ranging from 12 percent to 60 percent, it is essentially a flat rate tax: the bracket of 12 percent is very wide, applying to annual income up to R 42,000, (until July 1992 and up to R 250,000 thereafter) or more than ten times the then prevailing minimum wage. The highest rate-60 percent-applies to earned income that, when it was introduced exceeded, the minimum wage by more than 100 times. The self-employed are required to file and pay the PIT quarterly. For the purposes of "tax assignment" under Basic Principles, the PIT is assigned to the locality of the tax payer's employment, not his residence. In the law, PIT is assigned 100 percent to the Oblast level. Oblasts may pass it on to rayons. Corporate Profits Tax. This tax was modeled after the corporate tax of industrial countries and is levied at a rate of 32 percent. The law permits oblast-level governments to offer exemptions and preferences on the part of the CIT that accrues to the oblast level. While 100 percent of CIT accrues to the oblast level by law, it is being divided in the third quarter of 1992 between federal and oblast levels, which receive 13 of 32 per- centage points and 19 of 32 percentage points, respectively. The CIT has several shortcomings: no adjust- ments are made to insulate taxable profits from inflation, and depreciation rules do not yet conform to any notion of economic depreciation. There is a move to "reform" the CIT by replacing it with a tax on the en- terprise's "income"-defined as profits plus wages. This change would seek to discourage excessive wage increases in state enterprises. Special laws deal with the taxation of the net income of the banking and in- surance sectors. (See appendix tables for a complete list of tax laws and for a descriptive summary of each). Value Added Tax. The federal VAT was introduced on January 1, 1992 to replace both the classical turnover tax (which was levied on the difference between administratively set retail and wholesale prices) and the 5 percent sales tax that had gone into effect in February 1991. Under the VAT, exports outside the CIS are zero rated. Imports from the rest of the world are exempt. The standard rate is 28 percent, but in February 1992 a 15 percent rate was introduced for retail sales of some foodstuffs. Some oblasts have also made uni- lateral adjustments (downward) to VAT rates applicable in their territory In the current law, the VAT is as- signed 100 percent to the federal level; however, for 1992, it is shared between the center and oblasts; the latter received 20 percent in the third quarter. In July, 1992, the Supreme Soviet voted to lower the VAT rate to 20 percent, effective in 1993. Excise Taxes. Federal taxes are levied on alcoholic beverages, tobacco products, automobiles, and some lux- ury goods at rates varying from 14 percent to 90 percent. These rates are expressed as a proportion of the excise-inclusive price. For spirits, for example, the statutory rate of 90 percent means that for every R 100 paid by purchasers, R 90 is tax, and R10 is kept by the producer. The 90 percent rate thus corresponds to an implicit rate of 900 percent on the excise-exclusive price. Excises are not levied on exports outside the Commonwealth of Independent States (CIS) area, nor on imports. Excises are shared between the federal and subnational governments, with rates identical for all oblasts, but sharing rates depending on the type of commodity. All excise taxes collected from beer, leather, fur, and certain other luxury items are retained locally and go to the oblast government. The excise on vodka is shared 50/50 by the federal and oblast lev- els. Motor vehicle excises are a federal revenue. In total, about 60 percent of all excise tax collections are al- located to subnational governments. Taxation of International Transactions. Taxation in this area remains in a state of flux. The 1981 customs tariff was revoked on January 15, 1992, and it has been announced that a new tariff would be introduced. An ex- port tax on oil was introduced on January 1, 1992, designed to capture 30 to 40 percent of the value of taxed exports; the tax is denominated in ECUs per ton of exported oil, and the proceeds are earmarked for servicing the external debt and supporting government imports. However, in the first quarter, the collec- tion of this tax was deferred. All customs revenue accrues to the federal level, per Basic Principles. Other Taxes. Other legislation imposes taxes on inheritance and gifts; individual property (automobiles and real estate); transfers of bonds, stocks, and other securities; and various small taxes and stamp duties. Most of these are federal taxes. Oblast and local taxes are described in greater detail in Box 1.3. 29 Table 1.1 USSR and Russia: State Budget Revenue, 1985-92 01 (in billions of rubles; percent of GDP in parentheses) USSR Russia Estmated Actual 1985 1986 1987 1988 1989 1990 1992: Q1 1992: Q1 Total Revenue 367.7 366.0 360.1 365.1 384.9 410.1 499.8 250 (47.3) (45.8) (43.6) (41.7) (41.0) (42.8) (55.0) (26.8) Tax Revenue 337.1 335.6 342.9 340.0 361.6 387.8 466.8 250 (50.0) (26.8) Personal Income Tax 30.0 31.2 32.5 35.9 41.7 43.5 19.3 27.6 (2.1) (3.0) Income tax 28.3 29.5 30.9 33.9 37.5 40.2 - Agriculture tax 0.2 0.2 0.2 0.2 0.2 0.2 - Tax on adults without children 1.5 1.5 1.4 1.4 1.5 1.5 - Patents and other income taxes - - - 0.4 1.5 1.5 Profit Taxes and Transfers 118.4 128.5 126.3 118.4 115.6 124.4 67.0 87 (7.2) (9.3) Enterprisesa 115.9 125.9 123.4 115.6 111.4 120.4 Cooperatives 2.5 2.6 2.9 2.8 4.2 4.1 Social Insurance Contributions 25.4 26.5 28.1 30.1 33.1 44.8 - - Turnover TaxlVAT/Excises 97.7 91.5 94.4 101.0 111.1 121.9 140.8 95.0 (15.1) (10.2) Alcohol excise 30.1 27.2 29.1 33.4 40.4 39.0 19.3 14.0 (2.1) (1.5) Other indirect 67.6 64.3 65.3 67.6 70.7 82.9 121.5 81.0 Natural Resource Taxes - - - - - - 7.8 - (0.8) - Foreign Trade Taxes 65.0 57.3 60.9 53.9 58.2 49.4 197.0 8.3 (21.1) (0.9) Exports: of which: 33.8 26.3 29.4 24.0 33,8,.. 16.0 - Oil and Gas - - -14 0 11.5 Import Tariffs 31.2 31.0 31.5 29.9 34.3 33.3 - Nontax Revenue 30.6 30.4 17.2 25.1 23.3 22.3 48.2 - (5.1) a. Includes the labor resource tax in 1988 and the excess wage tax in 1989-90. Source: Ministry of Finance; and IMF estimates from the Joint Economic Study (1991), p. 282. "Basic Principles," the PIT and CIT are "regulat- biles and computers, and a levy on foreign-ex- ing revenues" of the oblast level,5 while the VAT, change transactions. For the most part, the export taxes, and certain excise taxes (vehicles) oblasts have final say on how revenues will be accrue 100 percent to the federal level. Excises on shared with rayon governments, but the law vodka are shared; excises on most other prod- makes some provisions (and there are long- ucts accrue to the subnational level. Revenue standing conventions) for tax sharing with local from taxes on natural resources, petroleum, and governments (rayon and below). natural gas products is shared. Subnational gov- The "Basic Principles" represents a major ermnents are assigned 21 different taxes and change in intergovernmental fiscal relations in fees. The federal level defines the tax bases and the Russian Federation. If fully implemented, it sets maximum rates on almost all of these taxes. would represent a complete switch from the The "Basic Principles" establishes maximum former system of "tax sharing" to a system of rates-for example, for the sales of used automo- pure "tax assignment." (Strictly speaking, since 30 Box 1.3 New Tax Assignments: the Basic Principles Law FEDERAL TAXES Taxes that accrue fully to the federal level. The federal government has full control over the rate and the base. These include: (a) VAT (b) Export taxes (c) Excises on motor vehicles and alcohol (50% oblast) (d) Tax on bank profits (e) Tax on insurance profits (f) Tax "exchange activities" (g) Tax on securities operation (h) Customs duties (i) The natural resource "payments" (shared 20/80 or 40/60 by the federal and subnational levels). SUBNATIONAL TAXES (Assigned and "Own") The regulating revenues of subnational governments include two federal taxes. Oblast governments have no control over the base or rates of these taxes: (j) PIT (k) CIT (c) 50 percent of vodka excises and 100 percent of all other excises except motor vehicles In addition, subnational governments receive all of revenue from the collection of their "own taxes": (1) Road fund taxes (m) Stamp duty (n) Estate duty (o) Gift tax and inheritance tax In addition, some taxes are "oblast level" taxes. The center defines the base of these taxes; the subnational lev- el has control over the rate, and receives all of the revenues (not all these taxes have yet been introduced): (p) Property tax/asset tax on enterprises (q) Forestry tax (r) Payment for water use RAYON/LOCAL TAXES Rayon and local level taxes indclude 21 taxes and fees, some of which are best thought of as "nuisance taxes," noted below. Their rate and base can be set locally, but the law has set maximum rates for most of them: (a) Property tax on natural persons (b) Land tax (c) Business registration fees (d) Construction in resort areas (e) Resort fee (f) Tax on the right to trade (g) Special-purpose taxes for the maintenance of militia, etc. (h) Tax on advertising (i) Tax on the resale of cars, computers (j) Tax on owners of dogs (k) License fee for the sale of wine and liquor (l) License fee for the right to hold auctions (m) Fee to move into apartments (n) Fee for car parking (o) Trademark fee (use of logos) (p) Fee to participate in horse races (q) Fee on winnings at horse races (r) Fee on participating in the "totalizer game at races" (s) Fees for commodity exchange transactions (t) Fee on cinema and TV shooting (u) Fee for cleaning settlements Note: listed and referenced in order of their listng in the Law. 31 subnational governments cannot set the rate or Implementation of the Intergovernmental base of the federal taxes assigned to them, the System in 1992 law envisages revenue assignment). The "Basic Principles" envisages the "independence" of Intergovernmental Relations in the First Quarter of subnational budgets, and would guarantee them 1992. Given the difficulty of moving quickly from revenues from their assigned tax sources. The as- an intergovernmental fiscal system of tax sharing signed revenues would accrue 100 percent on a to one of pure tax assignment, the Basic Princi- pure "derivation" basis (that is, on the basis of ples (and the assignment it implies) has been su- the origin of collections) to those subnational perseded by the introduction of quarterly budget governments where they were collected. laws, beginning in the first-quarter 1992 budget. The Basic Principles did not make specific al- Thus, the system of tax assignment has not yet lowances for intergovernmental transfers to off- been implemented. The recourse to quarterly set any revenue shortfall resulting from revenue budgets was also necessitated by revenue volatil- assignment. But shortfalls will occur, and a grant ity and the difficulties in formulating a budget for ("subvention") system seems to be necessary in the entire year: for the first quarter alone, actual the proposed reform. Its current absence may be total national revenue fell short of budgeted rev- explained by the objective of moving as far away enue by 50 percent (see Table 1.2). Thus, revenue as possible from the earlier system of negotiated sharing continued to prevail in the first-quarter settlements and governmental interdependence budget. Revenue from all major federal taxes (the as possible. The Basic Principles does not ad- PIT, CIT, VAT, and excise taxes) was shared by the dress subnational expenditures or other general federal level and the subnational levels, albeit in a budgetary issues, both of which are addressed in modified form. other legislation (discussed below). The salient components of the first-quarter budget were as follows: First, the federal CIT was shared: 15 of its 32 percentage points went to the federal level, and 17 percentage points to Table 1.2 Russian Federation Budget Revenues, 1992: 01 (in billions of rubles) Revenue Shortfall Estimated a Actual b Percent Percent Percent of total of total of total Amount revenue Amount revenue Amount revenue Total Revenue 499.4 (100) 250 100 -250 -50 1. VAT 140.8 (28.2) 95 (38.0) -45 -33 2. Excise Tax 19.3 (3.9) 14 (5.6) -5.3 -27 3. Profit Tax 67.0 (13.4) 87 (34.5) +20 +30 4. Personal Income Tax 19.2 (3.8) 27.5 (11.0) +8.3 +43 5. Timber Tax 1.6 (0.3) na na - - 6. Natural Resource Tax 0.8 (0.2) na na 7. Geological Research Tax 5.4 (1.1) na na - - 8. Foreign Trade Taxes 228.0 (45.7) 8.3 (3.3) -220 -96 Export tax 197.1 (39.5) - - - Import tariff 30.9 (6.2) 9. Nontax Revenue 48.2 (3.5) na na 10. Other' - - 18.2 (7.3) Source: MOF, 1992. a. MOF budget, Jan. 17,1991. b. Estimates from International Monetary Fund (March 1992a). c. 'Other' includes tax on timber, natural resources, geological research, and nontax revenue. 32 the subnational level. (Oblast governments fixing public-sector prices, including rents, user could levy less than "their" 17 percent rate, and charges, and other services. This greater flexibili- would receive whatever accrued to them at that ty could reduce local government subsidies to lower rate). Second, the PIT was channeled in these enterprises, depending on how subnation- full to the subnational level, and, in turn, most al governments exploit this new flexibility. oblasts gave some 5 to 10 percentage points of it to the rayon level. Third, the VAT-which the The Intergovernmental System in the Third Quar- basic principles had notionally assigned 100 per- ter of 1992. The Basic Principles was again partial- cent to the federal level-was shared by the fed- ly superseded by the third-quarter budget, in an eral and oblast levels, with the shares negotiated extension of earlier trends. Subventions were on an ad hoc basis that differed across the 91 granted on an ex ante but still negotiated basis for oblasts. The average subnational share of the oblasts deemed to need them. VAT shares contin- VAT was budgeted at 17 percent; 83 percent ac- ued to be fixed and uniform. But the Supreme So- crued to the center (the actual assignment was 14 viet made changes to the overall tax system that percent and 86 percent, respectively). Fourth, ex- will take effect in 1993 and that are likely to have a cises on vodka-which the "Basic Principles" as- significant impact on subnational governments. signed to the center-were shared equally with The VAT sharing rate will be reduced from 28 to the oblasts.6 20 percent-a reduction that will lower subna- The purpose of these revenues was to provide tional revenue that can be obtained from the VAT. in full for the budgetary expenditures of oblasts, The PIT exemption threshold will be raised six- and no provision was made for transfers or fold, from R 42,000 to R 250,000; because all PIT grants. The purpose of the ad hoc negotiated accrues to subnational governments, the higher VAT shares was to eliminate any ex ante deficits exemption will also lower their revenue. for the oblasts. Future Developments. Further adjustments to Intergovernmental Relations in the Second Quarter the sharing system and the system of subventions of 1992. Assignment under the Basic Principles are likely. In the fourth quarter, MOF intends to was again partially superseded by a second-quar- replace the uniform VAT sharing and retention ter budget in which the sharing system was mod- rates with graduated rates ranging from 20 per- ified further. Reacting to the continued negotia- cent to 30 percent, depending on the oblast. These tion of the earlier system, the Supreme Soviet de- greater VAT retention rates would be instituted at cided that VAT sharing rates be fixed and uni- the sacrifice of lower and fewer subventions. form across all oblasts. Each oblast was assigned 20 percent of VAT on a derivation basis. CIT was The "Transitional Arrangements" for 1992: Hori- still shared; subnational governments retained 19 zontal and Vertical Balance. The move to remain percentage points of the 32 percent rate. The 50/ with discretionary tax sharing in 1992 has several 50 sharing of vodka excises continued. However, interesting implications for subnational govern- it was almost inevitable that the fixed uniform ments. First, tax shares (and per-capita revenues) VAT shares would lead to mismatches between vary significantly across oblasts. Subnational CIT expenditures and revenue for certain oblasts- shares ranged from 10.8 percentage points to 14.8 something the negotiated VAT shares were de- percentage points (of the 32 percent rate) in the signed to avoid. Too, the second-quarter budget first quarter. VAT sharing rates, negotiated sepa- omitted any explicit provision ex ante for subven- rately for each oblast, ranged from 1 percent to tions or grants to oblast facing deficits-provi- 100 percent of collected VAT revenues. Oblasts sions whose need was subsequently recognized whose VAT collections were high generally re- toward the end of the quarter. MOF then intro- tained a smaller percentage of their collections, duced negotiated, ad hoc subventions for deficit while those whose total collections were low re- oblasts. tained a relatively larger proportion (chapter 4 One other critical development accompanied discusses the equalizing impacts of the transi- the second quarter budget. Laws on budgetary tional system). Per-capita VAT revenues ranged policy and expenditures were enacted (see be- from R 518 to R 15,491 (average revenue per cap- low) to give greater flexibility to subnational ita was R 3,497). Per-acpita CIT retentions ranged governments, including greater autonomy for from zero to R 3,526. The very large differences 33 Table 1.3 Revenue Structure and Revenue Sharing, Actual, 1992:Q1 Billions of rubles Percent retained Total Subnational by subnational Tax/revenue collections amount governments PIT 27.5 27.5 100.0 CIT 87.0 40.9 47.0 VAT 95.1 16.2 17.0 Excises 14.0 7.0 50.0 Foreign trade taxes 8.3 0.0 0.0 All other taxesa 18.3 8.7 45.0 Total revenue 249.8 100.8 40.1 Source: Ministry of Finance, April 1992. a. Includes revenues from privatization and certain user charges. in per-capita revenue from the different taxes rounds both revenue and expenditure trends suggests that, in the absence of intergovernmen- and expenditure assignments. tal transfers, the pure tax assignment system pro- posed in the Basic Principles, would create large Special Fiscal Regimes disparities among oblasts. (Table 1.3) The quarterly budgets that superseded the The Basic Principles and the corresponding bud- Basic Principles also helped shift the vertical rev- gets that superseded them in 1992 reflect the enue balance toward the central government. "uniform fiscal regime" for all oblasts. Through- The Basic Principles sought to make the VAT out 1992, several oblasts have adopted special and the newly introduced export taxes the fiscal relations with the federal government mainstay of the central budget, assigning them (without legal sanction). In Bashkiria, the oblast in full to the center. In actuality, these taxes sig- government has a "single channel" agreement with nificantly underperformed; returning to "tax the federal government, retaining all revenue sharing" enabled the federal budget to retain from all taxes collected in its territory, and trans- revenue from sources that otherwise would fering a fixed nominal amount each month to the have been channeled entirely to subnational federal budget. This agreement has not been governments (and which had performed very sanctioned by the Supreme Soviet. In Tatar- well). (Chapter 2 provides detailed discussion stan-an oil-rich oblast with potentially huge on the impact of subnational finances on macr- natural resource revenues-the government has oeconomic balance.) yet to reach agreement with the MOF; Since While the sharing arrangements secured in March 1992, it has withheld transfers to MOF, the quarterly budgets favored the central gov- and negotiations are continuing. In Urmurt, the ernment, the tax assignment mechanisms pro- government had also not reached agreement as posed in the Basic Principles would not neces- of mid-1992: the arrangements are for a single sarily provide sufficient revenue for subnation- channel agreement similar to the one exercised al governments or enable the oblasts to balance by Bashkiria. MOF has also agreed to a special fis- expenditure responsibilities and their revenue. cal arrangement with Karelia by which, in addi- This "correspondence" between expenditures tion to its regular budgetary allocation, Karelia and revenue requires detailed empirical study, receives a monthly transfer equal to 90 percent of based not only on estimates of the initial expen- all revenue collected in its territory that month. diture and revenue assignments, but also on These funds are earmarked for investment in infra- forecasts of future revenue and expenditure structure. In addition, the federal government has growth, according to calculated elasticities. In established a development fund for the territory. any country, generating these measures ia a Some 20 oblasts have reportedly decided uni- complex undertaking, in Russia the more so, laterally to determine the proportion of taxes to given the tremendous uncertainty that sur- be shared with the center. (The shares would be 34 lower than shares under the Basic Principles, or of resources. Transfers can also be used to influ- those negotiated with the MOF). Discussions ence the spending behavior of subnational gov- with all of these oblasts are ongoing, and the Su- ernments-providing an incentive to meet preme Soviet has taken a very hard line in deal- higher-level priorities and raise the standard of ing with them. The proliferation of such regimes service at the subnational level. could spell the fiscal dissolution of the Russian The USSR intergovernmental system did not Federation-just as the failure of Union repub- provide explicit or legislated rules or guidelines lics to contribute to the Union budget helped for intergovernmental transfers; some deficit-fill- foster to the dissolution of the USSR in 1991. The ing transfers did exist and were negotiated be- Supreme Soviet has threatened to apply sanc- tween MOF and the Union republics. The role of tions to oblasts that pursue either single channel transfers in most countries-to achieve fiscal agreements or unilaterally determined sharing parity-was supplanted in the former USSR rates. The sanctions would call for halting all cen- (and now in the Russian Federation; see below) tral expenditure on the territory, withholding ex- with the variable, negotiated tax-sharing rate. port and import licenses, denying central bank The disadvantage of this approach was that a credit, halting material supply from the central single instrument-the sharing rate-was at- supply system and withholding cash or currency. tempting to address two objectives-vertical and These measures reflect the tools available to the horizontal balances-simultaneously. The tax- federal level to influence subnational behavior. shazing rates were chosen to balance the division of revenue between the subnational and central Intergovernmental Transfers in the Fiscal System levels in aggregate, and to achieve fiscal parity among oblasts. Intergovernmental transfers are an important element of most federal systems. They address Transfers in the Russian Federation. Neither the the vertical imbalances that exist when the reve- Basic Principles nor the other new laws recently nue assigned to each level is not perfectly passed governing subnational fiscal policies- matched with its expenditure responsibility. laws on the budget and the draft laws on budget- Transfers also address horizontal imbalances ary rights in the Russian Federation (see Box among subnational units, narrowing the inequi- 1.4)-include any explicit arrangements for inter- ties associated with the disparate endowments governmental transfers. Without transfers, tax Box 1.4 Laws on Subnational Governments Law on Local Self-Government. The law on local self-government describes the rights and responsibilities of subnational governments. It includes a description of municipal property (Art.37) and gives subnational governments the right to grant tax benefits and other forms of preferential treatment to local enterprises (Art.39). Furthermore, subnational governments can determine the enterprise profit tax rate in accordance with the applicable legislation. The law also endorses a balanced budget and gives subnational govern- ments the right to borrow and set up extrabudgetary funds (Art.46). Draft Law on the Budget Rights of Representative Bodies of Krais, Regions, Autonomous Republics, Local Govern- ments. This law has five parts. The first describes general provisions of the budgets of subnational levels. The second describes the division of budget revenues at the subnational levels. Each level shares certain taxes with other levels of subnational governments, but the sharing rates are negotiable among the subna- tional governments. Examples of shared taxes are the PIT, CIT, payments for natural resources and water, and the land tax; another category contains revenues that accrue 100 percent to one level of subnational government, such as stamp duties (districts), the tax on inherited prperty (district and city budget), tim- ber revenues and revenues from state-owned property (level of government that is the owner). The third part of the law addresses the expenditure side of the budget but is silent on expenditure responsibilities. The fourth part addresses the budget process. The fifth part describes the budgetary rights of subnational governments. These guaranteed rights state explicitly that budget surpluses at the subnational level can- not be extracted and can be used at the discretion of the respective subnational government. It also in- cludes a detailed description of extrabudgetary funds and currency funds at the subnational level. 35 assignment implies that "each tub will sit on its National Expenditure Policies own bottom." The revenue of each oblast will de- termine its expenditure level, and revenue-ex- Expenditures in the Russian Federation.9 The penditure correspondence is unlikely, either for most salient feature of the expenditure program subnational governments in aggregate or for the in the Russian Federation is the sharp decline in individual oblast-level governments. Thus, dif- government expenditures relative to GNP, as de- ferential expenditures and service provision lev- manded by the economic stabilization and aus- els will grow, since lower-income territories will terity program. This decline has occurred despite also receive less revenue.8 the fact that Russia has assumed expenditure Even if the scope of equalization and redistri- functions of the former Union. Expenditures rel- bution objectives is limited, some transfers will ative to GNP are expected to decline to 41 per- inevitably be required to secure fiscal balance in cent of GDP in the first quarter of 1992 and then all territories. further to near 30 percent of GDP for the year as Indeed, in each of the quarterly budgets in Notable also is the changing allocation of ex- 1992, most oblasts have negotiated such "gap- Ndtureso in the first-quater et filling" transfers. In the first quarter, the gap-fill- called for 28 percent to be spent on the national ing and equalization tool was the variable VAT economy, (including price and other subsidies), retentions, in which oblasts/republics whose 13 percent on defense, and 24 percent on social total tax collections were low retained a higher and cultural activities, education, and health. In share of the taxes collected. The outcome of this the future, increased priority will be given to practice did not necessarily ensure equalization, outlays for protecting the most vulnerable since total tax collections are not necessarily cor- groups. The projected 1992 budget assumes that, related to tax collections per ca pita. despite efforts at more effective targeting, expen- In sum, the challenge posed by the Basic Prin- ditures on family benefits as a whole will not be ciples of Taxation and the Basic Principles of the less. Economic restructuring is expected to re- Budget System and Budgetary Process is acute. quire increased outlays for unemployment bene- By assigning all taxes to subnational govern- fits, retraining programs, and possible public ments, the federal level formally has, only VAT works employment. Financed from extrabudget- and international trade taxes to fill budgetary ary funds, the cost of these social outlays is ex- gaps or to effect redistribution. Further, the fed- pected to be an incremental 2.5 percent of GDP. eral level cannot extract budget surpluses at the With the dismantling of the central planning subnational level, which may be used only at the system, cuts should be possible in the budgetary discretion of the Soviet of People's deputies at wage bill. Producer subsidies could decline by the level of government to which the surpluses 1.5 percent of GDP or more, if subsidies to indus- accrue. Thus, the federal level has no mechanism tries such as coal can be controlled. Goven- to "claw back" revenues from oblasts whose rev- ment-financed investment has already been cut enue retentions far exceed their expenditure sharply, and the centrally financed portion will needs. It is not surprising that the intergover- be reduced to near zero by the end of 1992. De- mental system remains in flux. fense spending will decline by roughly one half in real terms, to around 4.5 percent of GDP. The budget contains no explicit provision for paying Expenditures and Expenditure Assignment interest subsidies to priority sectors. Granting such subsidies would imply higher budgetary This section describes the current system of outlays. expenditure assignment in Russia including the shifting responsibility of expenditures between Expenditure Issues in the Longer Term levels of government and the determination of expenditure norms and needs. The issue of ex- For the longer term the economic restructuring penditures is further explored in Chapter 3 with program calls for a substantial net reduction in a theoretical discussion of principles of expendi- the size of the general-central and subnation- ture assignment and-based on these princi- al-government. However, specific levels will be ples-an analysis of how Russia measures up. affected differently. Economic restructuring is 36 predicated on the government withdrawing responsibility has been ill defined, leading to from activities that can be undertaken more effi- somewhat frequently overlapping assignments. ciently by privately owned-or, until privatiza- As distinct from market economies, expenditure tion is completed, financially independent- responsibility has included not only the public firms. At the same time, government will as- service functions assigned to each level of gov- sume responsibility for providing "government" emient, but also ownership responsibility for services delivered previously by enterprises. certain industrial sectors and their enterprises. They include such nonproduction-related servic- es as building roads, buildings, schools, hospi- Assignment of Capital Expenditure. While recur- tals, cultural centers, kindergartens for the local rent expenditures were assigned according to community, and so forth. In contrast to other fac- some concept of "benefit areas" throughout the tors, providing these services will increase the Soviet period and under Russian budget policy size of government. The overall size of government until 1992, capital expenditures were fully cen- in the transitional period and beyond will de- tralized. All capital investments were financed pend on how policy evolves in Russia. In partic- and implemented by the Ministry of Economics ular, although privatization has begun only (the former Gosplan), with the exception of those recently in Russia the government will eventual- funded directly by the MOF or by public enter- ly retire from direct intervention in enterprise ac- prises. Thus, oblast and rayon levels had no re- tivities. It will also relinquish the financing of en- sponsibility for capital expenditures whatsoever. terprise investment to the financial sector, and However, the oblast and rayon governments in wil no longer provide subsidies to unprofitable which these capital investments were made were firms. In the same vein, it would also terminate responsible for financing the operation and mainte- accommodating credit policy to enterprises. This nance costs of unused facilities. Unused invest- withdrawal will have ramifications for all levels ment funds had to be returned to the central gov- of government. However, certain new functions emient and could not be spent for other purposes. are likely to increase the outlays of subnational governments. The implications of the analysis of Expenditure Assignment in the Russian Federation: expenditure assignments for the changes in the Recent Policy expenditure patterns at each level of government and for the intergovernmental financing system In many respects, the system inherited from the are outlined later in this report. Soviet Union governs expenditure assignment in the Russian Federation. However, in 1992, some Expenditure Assignment major rearrangements have been made in expen- diture responsibilities. As in the past, the expen- The expenditure assignment system in Russia is diture assignment system in the Russian generally consistent with the public finance prin- Federation is not clear cut, and recent changes in ciples of assigning expenditures according to expenditure responsibilities have been ad hoc. "benefit areas." Under these principles, (1) pub- This system contrasts with efforts for assigning lic services whose benefits do not extend beyond revenue responsibility clearly Yet many respon- the boundaries of a local community should be sibilities, at the federal and subnational levels of provided by the local government, (2) services government are distinct. Obviously, national de- whose benefits are enjoyed jointly by individuals fense, state apparatus, foreign affairs, and funda- in several communities should be provided at mental research are reserved for the federal the oblast level, and (3) services that affect the government (see Table 1.4). Expenditures for all entire country should be provided by the federal other categories can appear in the budgets of any government. level of government, according to the level at The principle of assigning public service activ- which benefits are received. For example, since ities to the different levels of government accord- 85 percent of enterprises are still in state hands, ing to the geographical distribution of benefits responsibility for these enterprises will be found seems to be well understood in the Russia. Yet in the budgets of all levels of government. the lack of clarity with which service responsibil- ity has been assigned to the different levels of Expenditure Assignment at the Federal Level. Al- government has at times meant that expenditure most all former Union functions have been as- 37 Table 1.4 Expenditure Assignment In the Russian Federation Expenditure Federal Obbsts Rayons Villaw Soves Defense 100 percent (except - Military housing military housing) Justice/internal security 100 percent Foreign economic relations 100 percent Educationa -All university and research - Several special -Wages; operation, institute expenditures vocational schools construction, and maintenance of all -All technical and primary and secondary vocational schools schools Culture and parksb National museums Some museums with Some museums oblast significance National theater All recurrent expendi- tures of all sport and park facilities and all other cultural facilities Healthc Medical research institutes Tertiary hospitals, Secondary hospitals Paramedics psychiatric hospitals, veteran hospitals, Primary health clinics diagnostic centers, and special service hospitals Medicines (cardiology, etc.) Roadsd Construction of all roads Maintenance of federal roads Maintenance of oblast Maintenance of rayon Maintenance of roads and city roads commercial roads Public transportation (Previously interjurisdictional Most public transportation Some transporation highways, air, and rail) facilities (assigned earlier facilities, including to federal govemment) subway systems Fire protectione -Most fire protection Voluntary, military, and services enterprise services possible at this level Libraries Special libraries (for Special library services Most local example, the Lenin library) library services Police services National militia Road (traffic) police Local security police (since 1991) Sanitationf - Part of garbage Part of garbage (garbage collection) collection Sewage(g) Infrastructure capital Most of the operational Some investment expenditures operational expenditures Public utilities - Subsidies to house- (gas, electricity, and water) holds (not enterprises) 38 Housingh Building and development - Maintenance and small-scale building Price subsidies - Fuels; mass transport; food (bread, milk); medicines Welfare compensation Part central government Part oblast government Managing programs responsibility responsibility funded by upper- level governments Public enterprises Capacity to invest in Capacity to invest in (productive sectors) joint ventures (keeping 50 joint ventures (keeping percent of privatization 50 percent of privatiza- proceeds if rayon tion proceeds if rayon subordination) subordination, and 10 percent of any other subordination) Environment National environmental Local environmental issues problems, (for example, the preservation of forests) Enterprises "Group A" enterprises 'Group C" enterprises If transferred to (for example, transport (for example) local light local level and heavy industry) industry, housing construction, and food 'Group B" enterprises industry) (for example, light industry, transport, and agriculture (a) Public enterprises also build schools but typically do not operate them. They frequently operate kindergarten services. (b) Some enterprises build sport facilities. (c) Some enterprises build hospitals and in some cases also operate them. Social insurance financed primarily by enterprises pays for the health services of those covered. (d) A "Special Extrabudgetary Fund' is financed by an excise tax on oil consumption. (e) Special fire-protection services are provided by enterprises, but they are on the decline. (f) Separate user charges do not normally apply for garbage collection. (g) Separate user charges apply for sewage. (h) Enterprises have been important builders of housing and own nearly half of the housing stock in Russia. The central government has transferred housing to local governments; maintenance is the responsibility of the level of government or enterprises owning them. Capital expenditures are included unless otherwise noted. sumed by the Russian Federation. The federal Expenditures Assigned to the Oblast and Rayon budget is now responsible for "Group A" and Levels. The oblast level is responsible for facilities "Group B" enterprises, and for pipelines, electric of an interjurisdictional nature: river transport, power, marine transport, and national (but not lo- oblast roads, environment at the oblast level, the cal) environmental problems (for example, Cher- preservation of forests, oblasts-run vocational nobyl). However, transfers to public enterprises schools, health care for oblast hospitals, and spe- have severely been restricted in 1992. The federal cialized clinics. The oblasts and republics are also budget also finances foreign economic activity responsible for "Group C" enterprises-local (export and trade subsidies, inter alia) and funda- light industry and consumer goods. Oblasts are mental science. In the social sectors, the federal increasingly transferring such enterprises down budget accounts for a small share of financing for to the rayon level (Table 1.6). universities, higher learning institutions, special- The expenditure responsibilities of rayons and ized health-care facilities, and culture and muse- townships are concentrated in the social area. ums-in keeping with the principle of benefit dis- Rayon budgets account for almost 100 percent of tribution and jurisdiction at the national level. total expenditures on basic education, 85 percent (Table 1.5). of total expenditures on health, 60 percent of 39 Table 1.5 USSR and Russia: State Budget Expenditure, 1988-92, Q1 (in billions of rubles) USSR 1988 USSR 1989a USSR 1990b Russian Federation 1992:01 Percent Percent Percent Percent Amount of GDP Amount of GOP Amount of GDP Amount of GDP Total Expenditures 445.9 51.0 465.1 49.5 485.6 50.6 383 41.0 National Economy 203.1 23.2 200.1 21.3 188.2 19.6 108.7 11.6 Investment 76.3 8.7 68.0 7.2 42.2 4.4 39.5 4.2 Subsidies 1.9 0.2 1.8 0.2 16.8 1.8 41.0c 4.4C Operational expenditures 12.7 1.5 8.0 0.9 11.8 1.2 na Price differentials 64.3 7.3 66.3 7.1 95.9 10.0 na increase in procurement prices 21.9 2.5 31.6 3.4 - 0.0 na Other 26.0 3.0 24.4 2.6 21.5 2.2 na - Defense 57.3 6.5 75.2 8.0 71 7.4 50.4 5.4 Justice/internal Security 6.6 0.8 8.2 0.9 9.6 1.0 19.3 2.1 Administration 3.0 0.3 2.9 0.3 2.9 0.3 7.0 0.8 Science 16.9 1.9 10.1 1.1 11 1.1 10.1 1.1 Social and Cultural Activities 134.3 15.3 139.3 14.8 160.5 16.7 91.1 9.9 Education 42.7 4.9 44.5 4.7 49.6 5.2 na - Health 21.9 2.5 24.6 2.6 27.6 2.9 na Social insurance 25.5 2.9 25.3 2.7 4.9 0.5 na Grants to collective farm ins. 4.1 0.5 4.0 0.4 6.6 0.7 na Mothers - 0.0 0.7 0.1 0.8 0.1 rn Social security 40.1 4.6 40.2 4.3 71 7.4 na Other - - 4.4 0.5 29.8 3.1 na Lottery 0.2 0.0 0.2 0.0 0.2 0.0 na - Foreign Economic Activities 15.6 1.8 15.4 1.6 14.9 1.6 14 1.5 Other Expenditures 9.1 1.0 13.7 1.5 27.3 2.8 82.8 8.8 Source: Ministry of Finance and IMF estimates from the Joint Economic Study (1991), p. 289. a. Figures for 1989 are estimates. b. Figures for 1990 are planned data. c. Figures for subsidy payments in 1992 include payments for price subsidies. Other expenditures for the first quarter of 1992 include R 36.5 billion for domestic debt service, R 5.1 billion for transfers associated with Chemobyl, and R 30.1 for reserve funds. kindergarten services, 60 percent of housing ments in the social sectors to benefit the local expenditures, and 80 percent of public utility population at large. This role typically consists of expenditures. building schools and hospital facilities and then transferring their operation to oblast or rayon Expenditure Assignment and Public Enterprises. governments. No discussion of expenditure assignment in Rus- The capital expenditures of some larger public sia can be complete without the "public expendi- enterprises extend to roads, sewage, and water tures" assigned to the enterprise sector. As in lines. Most enterprises provide housing for their many other former socialist economies, enter- employees, and, in principle, large enterprises prises in Russia, provide several services for are involved in environmental protection. Many their employees and their families which else- public enterprises also build and operate child where are thought to fall under government ju- care facilities, such as summer camps. The oper- risdiction. For example, they construct and sup- ation of kindergartens is sometimes transferred port hospitals, construct and maintain housing, to local governments-for example, if similar build and run kindergartens and preschools, services are provided for the rest of the commu- make "voluntary donations" toward financing nity. The Nizhny Novgorod oblast, for example, public transport systems, and make voluntary grants special tax advantages to firms that fi- donations to the extrabudgetary funds of subna- nance their own kindergartens. Not only do tional governments. Public enterprises also play public enterprises frequently provide money for an important role in undertaking capital invest- construction, but they also contribute labor and 40 Table 1.6 Russian Federation: Subnational Budgetary Expenditures, 1990 (in billion of rubles) Of which: Total Percent of Krai, Percent of Cities, Percent of subnational subnational Oblast subnational Rayon subnational Type of Outlay expenditures expenditures expenditures expenditures expenditures expenditures Agro-Industrial Complex 138 3.2 1,266 65.3 671 34.6 Social Complex 718 1.2 301 41.9 417 58.0 Construction Complex 462 0.7 248 53.6 214 46.3 Transportation Complex 248 0.2 84 33.7 165 66.2 Items Not Included Above Communal services 377 0.6 183 48.6 193 51.3 Housing and utilities 10,163 17.2 2,60 20.2 8,03 79.7 Local industries 55 0.0 34 61.6 21 38.3 Fuel and peat industry 421 0.7 98 23.1 323 76.8 Environmental protection committees 79 0.1 74 93.8 4.8 6.1 Other expenditures 6,274 10.6 4,733 75.4 1541 24.5 External economic activities 2 0.0 0.9 58.9 0.6 41.0 Social and Cultural Activities 32,696 55.5 6,037 18.4 26,659 81.2 Education 17,264 29.3 2369 13.7 14,895 86.2 Public health 14,043 23.8 2,593 18.4 11,450 81.5 Physical education 51 0.0 24 46.5 27 53.4 Social welfare 1,338 2.2 1,051 78.5 287 21.4 Science 47 0.0 25 53.4 22 46.5 Public Authorities and Administration 1,640 2.7 333 20.3 1,292 78.7 Miscellaneous Expenditures 3 0.0 1.4 48.8 1.4 51.1 Funds To Be Transferred through Mutual Accounts Settlements 2,061 3.5 1,203 58.3 858 41.6 Total expenditures 58,841 100.0 18,316 31.1 40,525 68.8 Source: Ministry of Finance; Bank staff calculations. Box 1.5 State-Owned Enterprises and Public Expenditures Like many other Russian enterprises, the Volga Car Factory provides a wide range of social services and produces many outputs not related to its main production activities. Located in the Nizhny Novgorod Oblast, it produces cars and tractors and has 120,000 employees. The enterprise is essentially a "full ser- vice" company that provides employees and their families with a full range of facilities The enterprise financed (in early 1992)the following private goods and public expenditures and services: * Meal subsidies of R 10-15 per person, per day. * Operating and maintenance costs of a 1000-bed hospital. 2 * Building and maintenance costs of housing, at a rate of about 200,000 m of housing per year, for about 22,000 people. In 1991, it subsidized housing maintenance by R 70 mil. In 1992, the outlay will be R 650 million. * 117 kindergartens and preschools, serving 20,000 students. In 1992, the cost will be R 350 million. * Mass transportation subsidies (bus, tramway, and subway). * Collective farm purchases to help provide workers with food. * Construction of roads, water, and sewer lines and other infrastructure with operations then transferred to local governments in the oblast. The current cost of these social expenditures is estimated at about 10 percent of profits (25 percent includ- ing construction cost). The Volga car factory is perhaps exceptional, given its size and its ability to provide such services. Nevertheless, Russian enterprises are an unusually important provider of "public services." 41 materials, and participate in their upkeep. Some airports, highways, utilities, and housing for mil- local jurisdictions were in fact born around an itary personnel.' industrial project. This decision was announced by the federal It is clear from field visits that subnational government as a permanent policy The policy governments look to enterprises to finance seems to have been prompted by the apparent many essential public services. However, struc- budget surplus generated for many oblasts by tural change and the privatization process will the revenue-sharing agreement of the second require that enterprises off-load these nonpro- quarter, which provided fixed sharing rates in duction-related service responsibilities, and several taxes, and disallowed extracting surplus- that all levels of government assume responsi- es. Thus, subnational governments now have re- bility for providing them. The major question is sponsibility for major interregional transport which level of government will assume the var- and infrastructure investment, airports, interre- ious expenditure responsibilities. The aggregate gional transport, and even military housing. amount of these expenditures may be quite sig- Shiffing investment responsibilities to subna- nificant, as shown in Box 1.5. The aggregate fig- tional governments (for capital goods with a lo- ure heard in the field in mid-1992 was R 100 cal benefit zone) can increase efficiency signifi- billion (equivalent to 40 percent of subnational cantly, provided that subnational governments budgetary outlays in the first quarter of 1992), have adequate funds. Local governments have a but MOF has not yet revealed a concrete better understanding of the type and level of in- estimate. vestment required. Unifying the decisionmak- ing process for investment and maintenance will Changing Expenditure Assignments: Recent also address of the perverse incentives associat- Transfers to the Subnational Level ed with level-specific discretion. However, giv- ing subnational governments responsibility for Social Expend itures. Unlike revenue assign- capital investments whose scope is more nation- al could substantially weaken the provision of ments, the law does not prescribe expenditure as- y signments. In early 1992, several expenditures for- sevce an has alray m etth r merly undertaken at the Union or Republic level tane bynobasthand rayo g nments. *.vee shftedto te sbnatonalleve-notbly More generally, the fact that an Important part were shifted to the subnational level-notably, of social expenditures and most capital expendi- consumer price subsidies (milk, meat, bread, tures have been delegated to the subnational lev- baby food, and so forth) and cash subsidies for el suggests that the overall subnational expendi- vulnerable groups, welfare programs for pen- ture envelope may not have been reduced much, sioners, various family allowances, and child if at all. Revenues assigned to subnational gov- compensation and support for the homeless. Un- ernments in the first half of 1992 were insuffi- til 1992, the central government financed these cient, ex ante, to finance their assigned expendi- price subsidies by transferring funds to the oblast tures; only the unexpected first-quarter buoyan- level, which in turn disbursed them to the rayons. cy of the taxes assigned to the subnational level, But in the first quarter 1992, when the price sub- and the slow start of actual expenditure dis- sidies for milk, baby food, and bread alone ac- bursements in January, made revenues adequate, counted for about 7 percent of total federal ex- ex post, for the expenditures assigned. penditures, responsibility for financing these ex- penditures was shifted to the rayon level. Expenditure Autonomy Expenditures for these subsidies amount to about 4.2 percent of GNP (also including subsidies for To realize economic efficiency, subnational gov- coal, food, housing, heat, and transport). ernments require flexibility and discretion in their budget decisions. The "Law on the Rights Capital Investments. As noted earlier, responsi- of Local Self-Governments" grants local soviets bility for all types of capital investment were complete discretion in formulating and execut- shifted in mid-1992 to subnational governments, ing their budgets. Article 43 of the law states that including responsibility not only for local capital interference by other governments will not be al- projects (such as schools and hospitals), but also lowed unless authorized by express legislation for large nationally significant projects, such as from the Supreme Soviet. Thus, the principle of 42 budgetary independence is strong. Article 43 lating minimum physical quantities into ruble also disallows passing on mandates to lower lev- amounts (see Box 1.6). Norms were used to deter- el governments without adequate funding, and mine the costs of operating existing facilities- forbids higher levels of government from ex- that is, to determine the amount required, for ex- tracting surplus funds of any kind from the low- ample, to maintain an existing hospital bed. How- er level. ever, norms were not used to determine the funds required to provide an adequate or desirable Budget Review and Budget Balance. Budget oper- number of hospital beds per capita. The adequa- ations are regulated by the "Law on Basic Princi- cy of infrastructure was left to the entirely differ- ples of the Budget System and Budgetary Pro- ent process of capital budget determination. Until cess." The principle of budget independence is 1988, all expenditures were based on these protected by the jurisdictions' autonomous norms, determined annually by MOF and the line sources of revenues and by the power to deter- ministries for each sector. The consistency of mine how all funds should be spent. This law dis- oblast budget requests against these norms was tinguishes between recurrent and capital bud- scrutinized by MOF. Funds allocated according to gets-which are to be voted on and approved the norms could not be transferred from one bud- separately. As with the "Law on Rights of Self- get item to another. Several thousands of norms Government," this law espouses the principle of were promulgated; in the past, these norms may balanced budget operations for oblast and rayon have been population-based. Now, given migra- governments. Balanced budgets are required ex tion patterns and population growth rates, cur- ante, although transfers from higher-level gov- rent norms are almost certainly not. Areas whose ernments can be incorporated. In this case, the populations have grown may be vastly under- oblast soviet may establish a deficit ceiling for the served. lower-level subnational governments in its juris- In 1988-89, MOF changed the budget process diction. and simplified and standardized the norms. Even though "full autonomy" is prescribed in Their primary disadvantage continues to be that the laws, the budgetary activities of subnational they frequently do not incorporate regional cost governments in the Russian Federation are con- differentials, their cost terms may be obsolete, strained in several ways. Among the constraints and they reduce budget flexibility. are the unfunded "central mandates" that gov- In 1991, MOF attempted to develop a "mini- ern many subnational expenditures. For exam- mum budget" for subnational expenditures, us- ple, the federal government determines wages ing the norms as minimum, or normative nation- for all public employees, and federally mandat- al expenditure standards for different expendi- ed wage increases affect the budgets of the sub- ture responsibilities. These standards were never national governments directly. The central gov- refined or implemented, and a system for quan- ermment also continues to set ceilings on several tifying or defining the expenditure needs of sub- public-sector prices-notably, tariffs on public national governments has yet to be established; transport and utilities, which affect cost recov- its absence creates controversy among levels of ery. Rents on housing owned by enterprises and government at each budget discussion. For 1992, local governments were controlled until mid- the MOF used incremental budgeting, adjusting 1992. The fact that the central government dic- 1991 expenditure levels upward by an inflation tates the center-oblast tax-sharing rates also im- coefficient, thus prolonging the biases and prob- plies that subnational governments do not deter- lems of the past. In June, in the last round of mine the aggregate level of their budgets auton- oblast budget determinations for all of 1992, 85 omously. Finally, rayon budgets are subject to of the 91 oblasts protested the budgets arrived at scrutiny and approval by oblast levels; until the by MOF and sent delegates to Moscow for nego- second quarter of 1992, oblast budgets were in tiations. turn scrutinized by MOE Line-Item Flexibility. In principle, subnational Expenditure Norms. A system of "budget governments now have autonomy for reallocat- norms" has traditionally been used to determine ing expenditures across categories: once the the financial requirements for each subnational physical norms are identified and the federal and expenditure item-(for example, schools), trans- oblast indexation formulas are applied to yield 43 Box 1.6 Expenditure Norms in the Health Sector Expenditure norms existed, for most expenditure items in the social sphere of the budget, at each level of government. The norms for the health sector are released by MOF and the Ministry of Health. They in- clude extremely detailed standards for the cost of each part of the health care sector's operations and out- lays-that is, cost standards for the acquisition of beds and uniforms, for doctors' visits, for the acquisition of medicine, and so forth. The standards differ according to the specialization of the hospitals or hospital departments. The following is an example of the cost standards (in rubles) for one patient's food ration per day at each of the 17 different types of health institution: Budgetary Norm Per Capita per For Type of Patients/Hospital: Day, Rubles Children 7.00 Maternity 7.00 Infants' 1.00 Gynecology 5.60 Gastroenterology/hematology 5.60 Necrology 5.40 Leprosy 4.71 Pneumoconios' 4.71 Oncology 3.89 Endocrinology 5.18 Bum 4.56 Tuberculosis 4.71 Children's tuberculosis 5.18 War invalids 6.48 Daytime in-patient 3.89 Unpaid blood donors 3.91 Paid blood donors 1.71 This ruble amount would be multiplied by the estimated patient-days for each year in each type of hospi- tal to yield a budgeted amount for "food." A similar exercise would be undertaken for "medicine" in each category and every other type of hospital expenditure, as well as for expenditures in every other sector. In 1992, price liberalization precluded establishing norms. Rather, the physical norms, were costed out by each individual locality (which asked the hospitals, schools, etc., to estimate the cost of providing each ser- vice item.) Costing is made each quarter; some expenditure items (drugs, food), must be indexed accord- ing to figures still provided by the central government; for others (heat), local costing is acceptable. With price liberalization, different regions have experienced different inflation rates: in one region visited, the index provided by the center accounted for a six-fold increase in prices, while the actual price rise in that region (a northern territory) was fifteenfold. Source: USSR Ministry of Finance and Ministry of Health; Resolution #105 of March 19, 1991, 'On the Retail Prices' Reform and Social Pro- tection Population." 44 aggregate allowable expenditures, oblasts can 5. In the Russian terminology, a "regulating revenue" spend the funds as they please. However, in prac- is a revenue shared between levels to regulate the rev- tice, they must reallocate funds judiciously, else enue retained by the lower level and to ensure budget risk a reduction in their budget the next year (for that the lower level achieves a balance. example, a change in tax shares or the size of sub- 6. The excise on vodka came to be shared 50/50 with ventions). Since each year's budget is established the oblast level, on the presumption that assigning it in according to amounts/norms necessary to fi- full to the center would encourage local governments nance the recurrent costs of specific items (say, a to support bootlegging and mislabeling to conceal li- kindergarten), reallocating funds to an invest- quor sales. Excises on alcohol-the single most impor- ment that does not generate the same level of re- tant source of indirect tax revenue-are collected by current costs as thknthe over-stretched STS at distilleries located only in a current costseas dthe ktdergarten Will reduce the small minority of oblasts. This excise probably could following year's budget accordingly. Thus, bud- not be used as a subnational tax in Russia (in many getary flexibility at the subnational level is some- countries, it is thought to be a good local tax), due to what limited in practice. administrative difficulties and because the base is dis- tributed so unequally. Notes 7. Data on per-capita revenues are from oblast-level data provided by the Ministry of Finance; they are not 1. Throughout this report, references to the "oblast lev- fully consistent with aggregate subnational data pro- el" include: constituent republics of the Russian Feder- vided by MOF. Data on per-capita revenues in the ap- ation, krais, okrugs, regions, and national areas. The "local pendix tables are for the first and second quarters of level" refers to cities and rayons and below. The term 1992; while nominal magnitudes will change due to in- "subnational refers to all levels below the federal or flation, the overall dispersion can be expected to con- central level. tinue. Oblast-by-oblast VAT sharing rates are 2. The Russian Federation was proclaimed a sovereign presented in appendix tables. country by the Supreme Soviet of the RSFSR on June 8. In practice, the dispersion in per-capita expendi- 20, 1991. Following the resignation on December 25, tures among oblasts was substantial in 1991, averaging 1991 of Gorbachev as President of the USSR, the Rus- R 1,243, and ranging from R 139 to R 4,253. Per-capita sian Federation claimed successor status to the USSR. expenditures for public health, education and social se- Together with other ex-republics it is now, a member of curity - the main budgetary expenditure of subna- the Commonwealth of Independent States (established tional governments-ranged from R 138 to R 549. at Minsk in December 1991.) Strikingly, the differences in per-capita expenditures 3. The discussion of taxation policy in .1989 draws on are about the same as for per-capita tax revenues, indi- joint Economic Study (1991), and the discussion of tax- cating that a significant amount of equalization did not ation policy in the 1990-91 period draws on The Inter- take place. The analysis of the equalization capability national Monetary Fund (1992a and 1992b). of the intergovernmental system to achieve equaliza- tion, reported in Chapter 4 suggests that, overall, nei- 4. Some components of the text of the Basic Principles ther the Basic Principles nor the interim sharing law remain subject to interpretation, including the ex- arrangements have strong equalizing capabilities. tent to which taxes are assigned in full to subnational 9. This discussion draws on International Monetary governments. One adviser to the drafting committee Fund (1992a and 1992b) and joint Economic Study acknowledged that this aspect of the law was worded Fu9919J in a "cunning" fashion. The description of Basic Princi- ples outlined here conforms to the generally agreed- 10. This military housing issue is particularly com- upon interpretation, and is based on our understand- plex. Russia is to repatriate former Union (now Rus- ing of the intentions of the Supreme Soviet in enacting sian) army personnel from the former Republics this law. Separate laws governing each tax mentioned (especially the Baltics), and finding and building their in Basic Principles have also been passed or drafted, housing has been a major impediment to the repatria- such as the Law on VAT, Law on Taxation of Enterpris- tion effort. es Profits, Law on Property Tax, Law on Land Tax, Law on Excises, and so forth. Appendix A contains a partial list and a brief description of the main features. 45 I Subnational finance in the context of stabilization and reforms: Macroeconomic dimensions of subnational finance and privatization Traditional analysis of subnational public financ- First, the design of the intergovernmental system es in market economies focuses on the responsi- is flawed. Consider the need for "correspon- bilities of government as a "service provider." dence" between revenues and expenditures. The This focus ignores the pervasive role of subna- absence of correspondence places significant tional government as owner and producer - pressure on the revenue and expenditure sides which is particularly true of subnational govern- of subnational budgets, as a result of price poli- ments in most transitional economies, including cies, the cost of the social safety net, and pres- Russia. Traditional analysis of subnational fi- sures from wage and other mandates. Second, nance also focuses far more exclusively than ap- political forces that have favored greater autono- propriate for transitional economies, on the my for oblasts, when combined with the "bot- allocative and equity dimensions of the fiscal re- tom up" tax administration system, leave the gime. This focus stems from the twin assump- federal budget vulnerable. Third, the prolifera- tions that stabilization and macroeconomics are tion of extrabudgetary funds set up at the sub- the responsibility of the central government, and national level, as well as legislation that that the activities of subnational governments endorses borrowing by the subnational level, are unlikely to have a major effect on the macro- may complicate macroeconomic management.1 economy. In Russia, the macroeconomic dimen- On economic and efficiency grounds, for the fed- sion of subnational finances, including borrowing eral government must regain control over these and extrabudgetary funds, is crucial to stabiliza- broader aspects of fiscal policy and devise an in- tion (discussed in the next section). The effect of tergovernmental system that addresses the intergovernmental fiscal relations on the privati- needs of both levels of government. On the tax zation effort is also a critical issue. side, the federal government must continue to improve the unified revenue system and The Macroeconomic Dimensions of strengthen tax policy implementation by im- Intergovernmental Finances proving the tax administration system. Intergovernmental fiscal relations affect, and are The Macroeconomic Framework in 1992 affected by, macroeconomic policy. Experience in early 1992 suggests that, for three reasons, the The primary objective of Russia's present macro- present transitional approach to intergovern- economic stabilization policy is to stem the enor- mental fiscal relations is a potential threat to the mous inflationary pressures. On the monetary success of Russia's macroeconomic stabilization. side, a commitment is being made to tighten 47 credit and eliminate interenterprise arrears,2 going reassignment of governmental functions and a call has been made to raise the central and revenues. Hitherto, most cuts in expendi- bank discount rate to market levels. In the exter- tures, except for consumer subsidies, affected nal sphere, exchange-rate and trade liberaliza- primarily the central government budget. The tion are planned. This macroeconomic program, shift of large components of social expenditures together with a commitment to improve interna- and capital investment to the subnational level tional creditworthiness and to effect a move suggests an increase in subnational expendi- toward a market economy, seeks to clear the tures. Thus, most of the additional (social) ex- way for foreign financial support and private penditures will emerge at the subnational level, investment. while virtually all additional revenue (from trade and energy taxes) will accrue to the federal National Fiscal Policies. Fiscal policy plays a cru- government. The a priori presumption. is that cial role in the stabilization effort. Broad mea- mismatching will occur. sures call for reducing the budget deficit by mak- As the reform and stabilization programs are ing further cuts in unnecessary expenditures, and carried out for 1992 and beyond, the absence of instituting additional tax reforms to raise reve- equalizing transfers and the reliance on deriva- nue. The central government is aiming to reduce tion-based revenue sharing or tax assignment in the fiscal deficit from 20 percent of GDP (on a the current intergovernmental fiscal arrange- commitment basis) in 1991 to 10 percent in the ment is likely to (1) place a major fiscal squeeze first half of 1992 and 8 percent by the end of 1992, on subnational governments as a whole, and (2) for a deficit of 11 percent for 1992 as a whole. The increase financial differentiation among subna- stabilization program implies austerity at both tional governments. This trend could lead to the the central and subnational levels, and has had "federalization" of losses and the "localization" (and will continue to have) a major influence on of gains from economic growth and reform. In the evolution of intergovernmental relations and turn, depending on how the central government subnational finances. responds, this disparity may jeopardize the mac- On the revenue side, the fiscal program calls for roeconomic and the economic reform program. a marked increase in taxes, primarily on petro- leum products and foreign trade. Actual perfor- Expenditure Pressures at the Subnational Level. mance in early 1992 was characterized by con- The additional, emerging subnational expendi- trasting trends: (1) the sluggish performance of in- tures triggered by economic reform include those direct taxes, especially VAT and trade taxes, and associated with enterprise subsidies: many pub- (2) the buoyancy of income taxes, particularly the lic-sector prices, representing potential fee in- CIT. Giving rise to these trends were the positive come to subnational governments, have not been impact of inflation on the CIT and PIT bases, the deregulated. They include the prices of most pub- negative impact of inter-enterprise arrears on the lic utilities and public transportation, for which VAT, and difficulties with the technical aspects of service provision is the responsibility of subna- import and export taxes. On the expenditure side, tional governments, but whose prices are deter- the program calls for reducing expenditures from mined by the central government. For the time about 48 percent of GDP in 1991 to slightly below being, gas and electric utilities are operated by 37 percent in 1992. Major cuts are planned in in- the central government, and their prices are vestment, producer and consumer subsidies, op- scheduled to rise to world-market levels within eration and maintenance outlays, and defense, two years. Housing rents may be set by subna- and expenditures are to be restructured toward tional governments, but their levels are hostage priority areas such as social protection. Social pro- to national wage policies and levels. Subsidies to tection expenditures are projected to increase sig- these enterprises and to housing maintenance nificantly in the transitional period, and will be fi- companies will be heavy burdens until price and nanced from subnational budgets. wage liberalization is complete. Given the severity and duration of the unem- Intergovernmental Aspects of Budgetary Reform in 1992 ployment likely to accompany structural adjust- ment, and the impact of inflation on fixed in- These budgetary measures may affect each level comes, pressure to help the most vulnerable of government differently, depending on the on- groups of society will increase. Expenditures on 48 public welfare-family allowances, meals for the indirect enterprise subsidies (including interest poor, and shelter for the homeless-are to be and exchange-rate subsidies, as well as subsidies funded by a central extrabudgetary fund-the in the form of controlled energy and other pric- Social Support Fund. Because this fund is ex- es), the economic reform program will reduce pected to be in deficit by over R100 mnillion by the (largely fictitious) profitability of enterpris- the end of 1992, subnational governments will al- es. This will severely erode the base of the corpo- most certainly have to use their own funds to ad- rate income tax, the most important source of dress these needs. The plans to make all consum- revenue for subnational governments. As a er and family subsidies means-tested and to whole, subnational revenues from CIT, the VAT, streamline the system of family allowances and the PIT (that is, their three main sources of should yield some savings, but with a lag, since tax revenues) are expected to fall from 9 percent these programs will take time to implement. In of GDP in the first half of 1992 to 7.5 percent of the meantime, subnational governments will still GDP in the second half. The decline in subna- be under pressure to use strictly local funds to tional revenues is likely to be more pronounced continue social subsidies. The number of fami- in 1993. lies below the poverty line is also likely to swell In sum, the budget position of subnational in the face economic readjustment. Finally, sub- governments is fragile, and, with the correspon- national governments must assume the social dence of expenditure and revenue assignments expenditures that have been until now been car- far from guaranteed, subnational governments ried by their state-owned enterprises. In sum, may be caught in a vise of declining tax revenues while subnational expenditures may well in- and increased expenditures. In addition, because crease, the present intergovernmental system revenue volatility highlights the weaknesses of has not focused on these new responsibilities, introducing tax assignment at this time, a flexi- nor on the budgetary pressures implied at the ble sharing-based framework that is not locked subnational level. into fixed assignments or nominal magnitudes should be developed. Revenue Pressures at the Subnational Level. The fiscal squeeze will also be felt on the revenue side. The Macroeconomic Outlook In the Longer Run Had the assignment system been implemented (as called for under the Basic Principles), the un- Revenue-Expend iture Correspondence. For the fu- expected buoyancy of the assigned taxes in the ture, expenditure and revenue assignments at the first quarter would have increased subnational subnational level appear to be inconsistent. Pric- revenue significantly at the expense of the central ing policies, the cost of the social safety net and government, whose assigned revenues underper- capital investment, pressures from wage and oth- formed significantly. In contrast, the transitional er mandates, and the assumption of public ser- sharing arrangements under the 1992 Budget vice responsibilities now handled by state enter- Laws for the first quarter, which superseded the prises will probably continue to reflect major ex- Basic Principles, had the reverse effect. Indeed, penditure pressures. Each can throw subnational shared revenues were supposed to be inade- budgets into deficit; more important, subnational quate, to force subnational governments to draw governments have little control over any of these down cash balances to finance their newly as- factors. The basic strategy of the central govern- signed expenditures.3 The transitional tax-shar- ment has been to "push the deficit down" by ing arrangements were also crucial to raising the shifting unfunded expenditure responsibilities revenue flow to the central government, and to down, in the hope that the subnational sector will improving its vertical revenue balance. They en- do the cost-cutting. abled the central government to finance its own The pressure on budgets at the subnational shortfall by "clawing back" revenues that should level may undermine the national stabilization have been assigned to subnational governments. effort. Fiscal arrangements are necessary to ad- In contrast to the experience in early 1992, the dress the needs of each level of government and most buoyant taxes during the rest of 1992-the provide correspondence between expenditures export taxes and the VAT-are expected to ac- and revenues. Without adequate revenue and crue in whole or largely to the federal govern- transfers, and with an increase in expenditures, ment. Conversely, by reducing both direct and subnational governments are likely to resort to 49 solutions that could threaten stabilization and a source of vulnerability to the federal budget. As reform. While data are unavailable, field work in with the Union budget, the Russian Federation is five oblasts indicates that subnational govern- vulnerable to the exercise of fiscal sovereignty by ments have reacted to this revenue insufficiency better off, powerful oblasts, and is constrained in several ways. First, they simply spend and ac- from strengthening its position by the absence of cumulate arrears. Second, they negotiate unilat- both a strong tax administration system and an eral, lower revenue transfers, or shares, with the intergovernmental system whose rules are center. Third, they borrow from locally owned agreed upon and followed. The dynamics of cen- banks (or from "their" enterprises, given the cur- ter-oblast sharing outcomes in recent months ap- rent ban on local government borrowing)-in ef- pear consistent with strengthening the relative fect, monetizing the subnational deficit. They position of subnational governments. While the also rely more heavily on "their" enterprises to transitional tax sharing arrangements have been finance infrastructure investments in the locality. more negative than tax assignment under the Ba- All of these actions (discussed in greater detail in sic Principles for the subnational level, the transi- the following paragraphs) are inconsistent with tional arrangements themselves appear to have the stabilization program and with enterprise become more favorable to the subnational level reform. with each subsequent quarterly budget. Subna- In facing insufficient revenue, revenue-short tional VAT retentions have increased from an av- subnational governments also have the option of erage of 14 percent in the first quarter to 20 per- protecting their tax base, by protecting local en- cent in the third quarter, and are projected to be terprises which also serve as important provid- 25 percent for the fourth.4 The subnational CIT ers of social services. They can do so by pressur- share has risen from 17 of 32 percentage points to ing the banks to increase credit to enterprises in 19 of 32 percentage points. Pressure from better their area. In China, for example, local govern- endowed and politically strong oblasts, which ments pressured banks to lend to the enterprises might otherwise decide sharing rates unilaterally, they own. Pressure from the subnational govern- and from a legislative branch with "populist" in- ment for credit creation further axacerbates mac- terests may be responsible for this shift. In re- roeconomic destabilization. Moreover, as subna- sponse, or perhaps, in anticipation, the federal tional governments continually search for ways level has reduced subventions and shifted expen- to fund many locally provided services, they will ditures "downstairs." Each of these actions has have incentives to resist privatizing their local limits: subventions cannot be reduced beyond enterprises, which have been an important pro- zero, and further downward shifts of expendi- vider of social services. This incentive runs tures will become politically provocative. counter to one of the primary objectives of Rus- This "game" is risky and unsustainable mac- sia at this time-privatization. Moreover, linking roeconomically and reflects the failure of the in- tax revenues to the ownership of industry en- tergovernmental system to capture either con- courages an unhealthy form of intergovernmen- sensus or revenue-expenditure correspondence. tal mercantilistic rivalry. Local governments may If institutionalized, the single-channel ap- be tempted to protect "their" enterprises from proach-including unilateral sharing agree- "foreign" competition-"imports" from enter- ments-could seriously destabilize the federal prises in adjacent oblasts, or require "domestic budget. At best, it will perpetuate negotiations sourcing" of inputs. Such behavior has been ob- between central and subnational governments. served between the former Union republics and If, as in Bashkyria and Tatarstan, subnational is not uncommon between oblasts in Russia. The governments negotiate a fixed nominal share of behavior not only reduces competition but also delivery to the central government, the single- perpetuates bureaucratic management, the ob- channel approach will mean not only a lower jective of the enterprise reform. It will inevitably federal yield but also a procyclical revenue yield, and severely compromise Russia's future eco- in which the center's share remains fixed as the nomic growth. economy booms or slows, and also of course prone to inflation erosion, thus leading to addi- Emerging Federal Budgetary Vulnerability. Spe- tional stabilization problems. The experience of cial, anomolous fiscal regimes and "single chan- China, where such "fiscal contracts" became the nel" agreements have already been mentioned as norm, shows how problematical they can be. 50 While strengthening and centralization of the geographical industrial concentration and spe- STS would address the loose central control over cialization, the impact of the reform program is revenue collections, the political-economy di- likely to vary significantly among regions. In ad- mensions of the single channel approach to tax dition, the reliance of the Basic Principles on der- remittance, and the "centrifugal" forces that ivation-based sharing necessarily gives more to might sweep over Russia must also be ad- better endowed regions, while the absence of dressed. transfers implies that avenues for equalization are unavailable for the less endowed. Role of the Intergovernmental System. The inter- Given the current flux of intergovernmental governmental system has an important role to fiscal relations in Russia, the prospects sketched play in defusing these centrifugal forces by con- could lead to the localization of the benefits of taining them within an agreed upon framework. the reform program. Its costs would be federal- Unless a transparent system of intergovernmen- ized if the central government felt compelled to tal relations is developed and agreed upon by all relieve the inequities or the intense budget pres- parties with something at stake, the risk to the sures. In this scenario, the central government federal level will probably continue in a negotiat- could corner itself in a no-win position. If it ed system without rules. Subnational govern- transfers the resources required by the deficit ments will bargain for whatever they can get: subnational governments to fulfill their expendi- they will create their own "asymmetrical federal- ture responsibilities, the enlarged fiscal deficit ism" and special regimes. An equitable, transpar- and its monetization is likely to overshoot what ent, rules-based intergovernmental arrangement is required to ensure macroeconomic stabiliza- may also make it easier to reach consensus on tion. If the federal government resists transfer- natural resource tax sharing-another potentially ring adequate financial resources, subnational important source of federal revenues. If produc- governments would resort to other solutions to ing localities believe that they are being treated address their fiscal squeeze (see below), also fairly under the uniform system of intergovern- threatening economic reform. mental relations, they may concede demands for Caught without enough revenue to cover their asymmetrical federalism, demands that they will newly assigned expenditure mandates, subna- not currently surrender with their natural re- tional governments, have been forced to develop source base. Mineral-rich regions are less likely to "coping mechanisms." These mechanisms have pursue the centrifugal drive witnessed during taken the form of accumulating arrears, borrow- the first half of the year, using "what is mine is ing (which adds pressure for creating credit), re- mine, what is yours is negotiable" behavior as lying on extrabudgetary funds, and retaining lo- their only leverage. cal enterprises to ensure that social and other lo- cal services are provided. All of these coping Responses to Budgetary Pressure. In addition to mechanisms, when deployed in response to mis- this growing mismatch between aggregate reve- aligned expenditure and revenue responsibili- nues and expenditures of subnational govern- ties, threaten macroeconomic stability and priva- ments, the combination of the economic reforms, tization. Ironically, economic stabilization and current intergovernmental fiscal arrange- efforts-pursued through budget deficit reduc- ments will widen the fiscal differentiation among tion at the federal level, is leading to subnational subnational governments. The reform program actions that will further destabilize the economy, will favor regions that benefit from price liberal- while also reducing budgetary transparency. ization, especially the mineral-rich regions. Not only will these regions accrue additional reve- Borrowing by Subnational Governments nues (2.5 percent of GDP by some estimates) from taxes on mineral resources, but they will also en- As mentioned earlier, as subnational govern- joy a higher level of economic activity than other ments have tried to cope with increase expendi- regions and thus higher revenue from profit and ture mandates and reduced revenues, one option other taxes as discussed further in Chapter 5. has been to finance their deficit by borrowing. Conversely, lower tax revenue and higher social This important aspect of intergovernmental fi- expenditures are likely to be concentrated in re- nances could have major macroeconomic conse- source-consuming regions. Given the extent of quences, depending on the extent of borrowing. 51 The laws in the Soviet Union were unclear: sub- In the short term, Russia may want to limit or national governments took liquidity loans from prohibit borrowing for macroeconomic reasons, the central bank and borrowed from commercial which include controlling inflation, reducing banks under the credit plan, but long-term bor- spending at the subnational level, and address- rowing at the subnational level does not have ing the fear that some oblast-level governments much of a history in Russia. rush into heavy debts under the current influ- The new budget laws give subnational gov- ence of highly volatile revenue and expenditure ernments an unlimited right to borrow and to es- developments. tablish and own banks. The laws on the Budget System and Budgetary Process give subnational Debt Financing in the Longer Run. Relative to in- governments the right to receive loans from dustrial countries, borrowing is usually a minor higher-level governments or commercial loans. source of finances for subnational governments The law on Local Self-Governments states that in developing market economies, reflecting the local soviets may use credit for production and generally conservative position of most such gov- social purposes, can establish and operate finan- ernments and limited sources of finance. Theoret- cial and credit institutions on a shareholder ba- ically, there is no reason that subnational govern- sis, can grant interest and interest-free loans to ments should not borrow, and, in practice, they govemment organizations and enterprises, and often do. In most countries, however, the central issue local debt in order to develop the social government or its agency establishes the total and production infrastructuTe. However, the use amount of credit available to local governments, of credit at the subnational level is currently lim- sets the terms of the loans, defines the acceptable ited by the lack of financial bank facilities and uses of debt financing, and controls the flow of suitable financial markets.5 loan funds. One reason for imposing such disci- In the first quarter of 1992, the borrowing right pline is that, in countries whose capital and credit of subnational governments was suspended by markets are underdeveloped, subnational gov- the Central Bank of Russia, which issued instruc- ernment borrowing competes with, and crowds tions to its own branches and to Russia's 2,000 out, the credit demands of other borrowers (such plus commercial banks. However, field visits as the central government). Second, from a macr- suggested that some subnational governments oeconomic point of view, increasing overall pub- idid borrow, at least for liquidity reasons: in lic borrowing is often undesirable. Mytishchi rayon, a loan from the local bank cov- The arguments in favor of debt financing are ered 16 percent of the rayon's budget in 1991. microeconomic: if an infrastructure investment delivers services over many years, it is appropri- The Short-Term Stabilization Perspective. Borrow- ate to finance the "lumpy" costs through bor- ing at the subnatinal level is a critical issue in in- rowing and to repay them over time. Short-term tergovernmental finances, and in many countries "liquidity" borrowing is necessary for covering subnational governments are not allowed to bor- revenue and expenditure fluctuations during the row at all. Extensive subnational borrowing can execution of the annual budget, and is not con- make it difficult for the central level to achieve its troversial. Problems can arise if lower-level gov- macroeconomic objectives, especially in the ab- ernments incur too much debt, or if the revenue sence of reliable information on the overall level situation deteriorates so unexpectedly that local- of public-sector borrowing at all levels. Uncon- ities cannot repay this debt. A strict rule would trolled facilities for deficit financing by lower lev- stipulate that bail-out by the upper-level govern- els of government could also constrain the central ment would not be permitted, and that bank- government from controlling budgetary imbal- ruptcy must take place; this mechanism works in znces. This experience has indeed been felt in the private sector, but may be inappropriate for some decentralized countries such as Brazil (see the public sector. Thus, in many countries, the Box 2.1). It does not argue for a complete ban on budgetary authority of subnational governments subnational government deficit financing, but might be suspended temporarily, and/or they rather for the right of the central government to may be bailed-out, with the central government control and monitor lower-level borrowing, both temporarily assuming the debt service. This, from the banking system and from the bond mar- action too, often exerabates macroeconomic kets. Neither is the case in Russia at the moment. pressures. 52 Box 2.1 Subnational Finance and the Banking in Brazil and Argentina Macroeconomic stabilization by the federal government hinges on the central authorities' ability to exert con- trol over key policy instruments-that is, fiscal and monetary policy The success of fiscal policy depends not only on how the federal government administers taxes and public spending but also on the size of the subna- tional deficit, and how it is managed and financed. Fiscal discipline at the national level can be totally offset by fiscal undiscipline and uncontrolled borrowing at the provincial level. Both Brazil and Argentina are exam- ples of how subnational financing of deficits via borrowing from banks owned by provinces can jeopardize macroeconomic stability and the reliability of government finances. Extensive borrowing and other facilities for deficit financing by lower levels of government can offset attempts by the central government to reach a budgetary balance. Brazil. Brazil's experience shows how different levels of government and the banking system can interact and implicitly finance subnational expenditures, mostly by creating money. Before 1987, the Central Bank in Brazil was a potential direct source of funds for financing intergovernmental transfers, due primarily to two factors: the Brazilian states' ownership of banks, and the segmentation of the Brazilian budget. Until reformed in 1987, Brazil's "monetary budget" was not restricted by the same legislative limitations imposed in the fiscal budget; it could be (and was) used to finance expenditures not programmed in the fiscal budget. Monetary budgeting decisions, under the jurisdiction of the National Monetary Council, constituted essentially a parallel budget. Its expenditures - primarily financial assistance to local and state governments-were carried out primarily by the Bank of Brazil, which financed itself at the Central Bank, which relied on new issues of paper money The monetary budget often also financed priority federal expenditures, including intergovernmental transfers and subsidies. The Constitution of 1988 introduced some important changes: the monetary budget was replaced with the credit budget, which is a part of the annual budget exercise and subject to standard budgetary and legislative practices. The new constitution also prevents the Central Bank from issuing new money to finance public ex- penditures directly. Despite these new rules, many implicit transfers from the federal to state governments remain, given the in- teraction between their official banking institutions. State governments in Brazil own "their" state banks, and have substantial power over the banks' lending decisions. In 1983-87, between 70 percent and 80 percent of state bank loans were made to their state governments, to finance state expenditures. Not all of these loans performed well, and when the Central Bank had to bail out these failing commercial banks, an implicit trans- fer from the federal to the state government took place. Such a system not only significantly impairs the trans- parency of intergovernmental relations, but it could also be used to avoid the constitutional prohibition on the direct money financing of government expenditures. Argentina. In Argentina, macroeconomic stabilization has ranked at the forefront in the debates about fiscal federalism. The provinces have behaved in "fiscally perverse" ways that work against the stabilization policy of the central government. As in Brazil, provinces have also "borrowed" from the Central Bank via provincial banks to cover their deficits, usually in the form of rediscounts or overdrafts. Provinces have also tried to ob- tain resources in the form of discretionary grants from the federal government, by running up high fiscal defi- cits and asking the federal government to step in. (In 1986, provincial deficits in Argentina before transfers from the central government were 6.2 percent of GDP, about US$4 billion.) Only recently has it been realized that there are no "winners" in this struggle and that coordinated effort is required at both levels to achieve price stability Sources: Brazil: Bomfin and Shah (1991) and Shah (1990). Argentina: World Bank (1990). In Russia, the oblasts or large cities might be abroad. Appropriate sources for borrowing in granted some discretion in using debt. Restrict- Russia could differ in the short and longer terms. ing long-term borrowing to finance only capital Borrowing from central bank branches should facilities is perhaps also appropriate for Russia. probably always be prohibited. Commercial Foreign borrowing should be restricted to the banks might be the first source available as soon federal government, and subnational govern- as they develop, and they might remain the ments should not be permitted to borrow main source, as in Germany. Bond issues would 53 have to come later. Markets for bonds and other cording to the law, extrabudgetary funds can in- such financial instruments must still be devel- clude (1) unspent funds earmarked for local so- oped, and subnational governments establish cial and economic programs; (2) voluntary creditworthiness (local government bond mar- contributions and donations; (3) revenues from kets are quite unusual in countries whose capital local loans; (4) local commodity and monetary markets are thin and that do not have long-term lotteries and auctions; and (5) certain fines and financing). In the meantime, municipal develop- penalties from enterprises, including all penal- ment banks might be a source of liquidity, espe- ties for tax nonpayment (a feature that encourag- cially if they are not established by the central es local authorities to collude with enterprises to government but originate as the cooperative ef- evade taxes). Certain nontax revenues have been fort of, say, groups of oblasts or cities. They designated as local extrabudgetary funds. Penal- could then also give technical assistance to the ties for environmental pollution or damage his- individual governments in this new field of bor- torical or cultural items are also part of the ex- rowing, accept deposits from them, and lend to trabudgetary funds, but they are earmarked for them. Local governments should not of course environmental expenditures or restoration activ- receive subsidized credit through any such ities. Other sources of extrabudgetary revenues source. may include profits from joint-ventures enter- prises, proceeds from 'voluntary" contributions Extrabudgetary Funds and donations by enterprises and individuals, and sales of unclaimed and confiscated property. As the central deficit is pushed "downstairs" In general, all these funds can be spent fully at and subnational governments lack the funds to the discretion of the respective level of govern- fulfill their expenditure responsibilities, the sub- ment. This independence-as distinct from bud- national level and its governmental units have getary funds, which may be subject to approval relied increasingly on extrabudgetary funds. by higher-level governments-is part of their Oblast governments also have a tendency to great attraction and lies behind their rapid pro- push expenditures down to rayons, which in liferation. Another advantage is that they need turn pass them on to districts or set up munici- not be shared with higher levels-they are re- pal enterprises to assume these outlays specifi- tained 100 percent by the subnatinal level. cally. Such enterprises will often be Oblast governments thus try to shift as much of extrabudgetary entities, with special earmarked, their revenues as possible from budgetary to the extrabudgetary revenue sources. Though ex- extrabudgetary category. The size of the ex- trabudgetary funds have long existed in both the trabudgetary funds cannot be quantified, but in- UJSSR and Russia, they were until recently, insig- dications are that they have grown to the equiva- nificant and dispersed over many budgetary or- lent of 10 percent of total subnational budgetary ganizations. At the federal level, major funds since their authorization in 1991. extrabudgetary funds include, in addition to the Pension Fund created in 1981, the Road Fund, Improving Macroeconomic Management. The pro- the Social Support Fund of the Population, the liferation of extrabudgetary funds since mid-1991 Fund for Medical Insurance, the State Social In- at all levels of government presents serious prob- surance Fund, the Employment Fund, the Social lems for effective budgetary management at the Security Fund, the Environment Fund, and a macroeconomic level. These funds reduce the several industrial funds, including the Conver- transparency of budgetary operations and com- sion Fund, the Fund for Energy, and Fuel Indus- plicate assessing the impact of fiscal policy: ex- try and the Scientific Research Fund. Most trabudgetary funds function as parallel account- extrabudgetary funds are recent creations and ing systems, and for all purposes, are full parallel are managed independently by different agen- budgets outside the strictures of conventional cies, including MOF and the Supreme Soviet. budgetary procedures. Using such funds is an in- At the subnational level, there are many more efficient budgetary practice and provides loop- such funds. The law on the Rights of Local Self- holes for public-sector operations not approved Governments (Article 46) authorizes the use of through the proper (budgetary) channels. In extrabudgetary funds, and since 1991, extrabud- addition, the presence of multiple budgets getary funds have been growing rapidly. Ac- implies a loss of control and information, which is 54 bound to weaken fiscal policy as a macroeconom- ing new local enterprises so that they can ic instrument. continue to provide services required locally (such as health care, education, child care, and Inclusion in the Budget. There is no legitimate basic infrastructure). All of these coping mecha- reason not to include the aforementioned subna- nisms aggravate macroeconomic destabilization. tional revenues in the budget or to permit ex- Retaining enterprises or setting up new domestic trabudgetary funds to continue to be established. joint ventures-another common practice-also Legitimate extrabudgetary revenue sources threatens another primary national objective- should be included fully in the regular budget to privatization. This section describes Russia's ef- ensure full accountability of fiscal operations. Ex- fort to privatize, pointing out how some dimen- trabudgetary funds might have been justified sions of subnational finances and the current when oblast governments were not protected practices of subnational governments run against the extraction of surpluses or unspent counter to privatization, and may also be macro- balances by higher levels of government. At economically destabilizing. Specifically, the par- present, their main attraction to subnational gov- ticipation of subnational governments in ernments is to shelter oblast revenues-in the ex- enterprise joint ventures is antithetical to the trabudgetary accounts-from sharing arrange- privatization and may keep unprofitable enter- ments with higher levels of government when prises in existence. As subnational budgets are budgetary resources are negotiated. This gain is squeezed, they may "cope" by exploiting the en- minor relative to the damage it imposes on the ef- terprises' soft budget constraint and transferring ficient allocation of subnational funds and the po- some expenditures to "their" enterprises (but tential loss in accountability and control of bud- only if they own them). Moreover, since enter- gets. However, to the extent that the present inter- prises have greater access to credit than do the governmental arrangements are not perceived to government units themselves, transfers to enter- be "fair," one can expect that extrabudgetary prises are highly attractive. If successful, the funds continue to be established. practice could provide further impetus to credit expansion and inflation. Finally, the present Phasing Out Extrabudgetary Funds at the Subna- practice of using privatization revenue to finance tional Level. Given the macroeconomic disadvan- the operating budgets of subnational government tages of loose budgetary control and the informa- is unsustainable and, unless alternative sources tional complications implicit in this practice, ex- of revenues are found, will aggravate the fiscal trabudgetary accounts should be discontinued. squeeze at the subnational level as these reve- However, because the law establishes the right to nues dry up in the long run. create these funds and the practice is now en- Russia has sought to move rapidly toward a trenched, a realistic transitional approach for the market economy, but current interventions by central fiscal authorities would be to require that the central, oblast, and rayon governments in the subnational governments disclose full informa- economy go well beyond what is considered de- tion sources and the application of all extrabud- sirable in a market-oriented system. Thus subna- getary funds. In the longer term, the law should tional governments will either play an important forbid the use of extrabudgetary funds, and for role as supporters of the privatization drive or the time being discourage their use. impede privatization efforts. They can, for exam- ple, use public assets in joint ventures in which The Role of Government and Enterprises in they are a partner. Alternatively the sale and liq- Privatization uidation of the public asset stock transferred to subnational governments as ownership is reor- The first section described how Russia's effort to ganized, is also an important potential source of achieve its macroeconomic objective of stabiliza- subnational revenue. Thus, the use of privatiza- tion by reducing the budget deficit has been ac- tion revenue by subnational governments de- complished in part by pushing the deficit serves close scrutiny. "downstairs." When fiscally squeezed, subna- No level of government can justify producing tional governments turn to other strategies, such and selling goods and services that can be man- as accumulating arrears, borrowing, using ex- aged more effectively in the private sector (see trabudgetary funds, and retaining or establish- Box 2.2). This realization has led all levels of 55 Box 2.2 Nizhny Novgorod: State-Owned Enterprises The city of Nizhny-Novgorod owns the following enterprises and carries them on budget: (a) heat and electrical supply, (b) transport, (c) water supply, (d) hotels/laundry, (e) local construction, (f) repair and maintenance enterprises for local services, (g) public housing, (h) garbage collection, (i) horticulture, and (j) subways. The hotel and laundry sectors remain city-owned but have operated without subsidies from the budget since the first quarter of 1992. Most of these enterprises also pmvide "public goods," such as schools and hospitals, that cannot be carried in a privatized system. The city appears to be trying to transfer these en- terprises, as well as enterprises with high losses (that is, enterprises responsible for repairs of roads, etc.) to the rayon level. government in Russia to seek to privatize many were transferred to the balance sheet of the new ongoing economic concerns. In a market econo- federal government; housing, to rayon govern- my, sufficient resources are allocated to the pub- ments; nonrenewable resources, to the union re- lic sector to provide public services, as well as publics and autonomous republics; and state commodities that, due to "market failure," the enterprises, to their corresponding government private sector could not provide adequately or at of subordination (see chapter 3). More recently, all. This market failure may be due to the diffi- the Russian Federation has taken steps decen- culty of charging for certain services or to cir- tralize ownership further.6 cumstances that exclude beneficiaries from using Oblast and rayon governments are increasingly them. becoming owners of enterprises, housing, vacant However, the privatization process has been urban land, and retail establishments as such as- slow. A major roadblock has been the delay in as- sets are transferred from the central government. signing private property rights to land. Privatiza- The 1991 decree on property assigns it three ways: tion efforts should be advanced, since they will * Federal Property. Federal property includes creat a better allocation of resources, raise output, national resource-related items, such as national and expand revenues for the public sector. An parks, health resorts, wild-life sanctuaries, art, added benefit is the savings that privatization and historical and cultural items. All state prop- can yield at all levels of government, by reducing erty with a "national function" is assigned to the subsidies now paid to unprofitable enterprises. central level, including such items as the Pension All levels of government may also achieve sub- Fund, the Social Insurance Fund (SIF), other ex- stantial savings by privatizing ("contracting trabudgetary state funds of the Russian Federa- out") the production and delivery of several pub- tion, the Central Bank, the stock of gold, hard- lic services, even when ultimate responsibility for currency funds, military property, railroads, oth- these services rests with the public sector. er property that was formerly financed by the USSR state budget, institutions under higher Recent Ownership Changes and Asset Transfers learning, research institutions, institutions of sev- eral ministries, geological and agricultural insti- As fiscal decentralization takes place, one of its tutions and enterprises, the defense industry, salient features in Russia, as in other transitional enterprises operating in the area of natural re- economies, has been the transfer of assets such sources (energy and mining), transport enterpris- as enterprises, land, and housing from central es, and communication enterprises. state ownership to the subnational and local * Federal Property Transferrable to Subnational govemments. Until 1990, enterprise ownership Governments. Some state property belongs to the was centralized at the Union level. However, af- federal level, but may be transferred to subnation- ter the dissolution of the Union and its transfor- al governments at the discretion of the central mnation into the CIS, a broad agreement was government. If transferred, the properties will still reached that the ownership of real property be managed administratively by the central level. should be reassigned to the different levels of This category includes a large proportion of the government: pipelines and transport faclities state-owned enterprises, all "major" enterprises 56 (defined as all enterprises whose annual value of governments in Russia appear to view their role capital funds exceeds R200 million or which have not only as service providers-the role of local gov- more than 10,000 employees), nuclear enterprises, ernments in a market economy-but as entrepre- the fishery industry, and so forth. The central gov- neurs and producers. Fieldwork indicated that, emnment has exclusive discretion to transfer these since the onset of the transfer of assets to subna- enterprises to the oblast-level. The oblast can de- tional governments as a part of the decentralization cide unilaterally to transfer these enterprises process, subnational governments are increasingly down to the rayon/municipal level. involved in economnic ventures. This pattern is wor- * Oblast and Rayon Property. Subnational gov- risome, and is antithetical to privatization. ernments also own state property. Rayons and cities own buildings, housing, urban infrastruc- Domestic Joint Ventures. Localities appear to be ture facilities (including the subway in some cit- optimistic about their ability to enhance revenue ies), retail sale outlets, consumer service by establishing joint ventures with a domestic or enterprises, wholesale depots, public health insti- foreign partner, or another state enterprise, using tutions, schools, and so forth. A large proportion (or sometimes informally mortgaging) local as- of these enterprises or institutions operate in non- sets as the equity share. In localities that are well productive areas and provide local public goods endowed with land, land appears to be the pre- and services, and many operate at a loss. The ferred equity contribution, and localities also ap- privatization of the existing housing stock, which pear to see potential in developing and servicing was transferred to the rayon and city govern- empty land to enhance its value as equity. (Real ments in 1992, is considered a priority, but will estate development and financing is one of the take time. Until mid-1992, housing rents were fro- riskiest businesses in market economies.) But oth- zen at their nominal January 1928 levels, and fail- er locally owned assets serve, as well. These ven- ure to cover maintenance from rental incomes led tures typically involve purely private-market-ori- to the deterioration of the housing stock. More- ented activities, such as industrial products or ho- over, until the large subsidy to renters is reduced, tel services. Where localities have inherited privatization will remain an unattractive option important real properties, ventures-in-process because home ownership will be much more ex- have included domestic industrial joint ventures, pensive than renting (Renaud, 1991). such as bakeries, construction firms, and food These asset transfers are a mixed blessing. processing. In several of oblasts and rayons, the Though consistent with decentralization and rhet- government bought up shares in state enterprises oric about subnational autonomy, such transfers formerly owned by the central government. are also often compatible with the objective of the Some oblast-level governments are also planning central government to reduce its own involvement to buy or set up commercial banks. in the economy-in particular, to reducing its bud- On the surface, there may be good reasons getary involvement. Thus, an equally important that government becomes involved in new joint motivation for these asset transfers has been to market ventures. With available land or enter- avoid the fiscal burden (subsidies, maintenance, prise assets frequently idle and difficult to priva- and repair) associated with ownership responsi- tize, the perceived cost to the government of bilities. By shifting both assets-better thought of contributing this resource to a joint venture may as liabilities in many cases-and certain re-current be low. Public officials may also want to create expenditure responsibilities, the central govern- immediate business employment opportunities ment has shifted the subsidy responsibility down- in economically depressed jurisdictions. It is un- ward, protecting its own budget. Subnational gov- derstandable that local governments feel respon- ernments will thus face these major maintenance sible for promoting economic activity, especially and subsidy burdens, unless costs can be recovere with a dearth of private entrepreneurship. Inter- quickly or assets privatize quickly. est in joint ventures also comes from the possi- bility of obtaining extrabudgetary revenues (the "Reverse Privatization" and the Entrepreneurial enterprise profits or dividends are extrabudget- Activities of Subnational Governments ary) to supplement rapidly dwindling budgetary sources. However, such joint ventures will slow Increasingly, and under the endorsement of new down, if not reverse, the process of privatization. laws on local self-government, some subnational This pattern contradicts the long-term goal of the 57 government to completely exit from economic either privatization or decentralization. The activities that the private sector can perform more rapidly such risks are understood by sub- more efficiently. national governments, the better they will be able to protect themselves from risk, and turn Reducing "Government Entrepreneurship". The themselves to the true business of government- trend toward domestic joint ventures carries sig- to provide services. The introduction of an im- nificant risks. If the joint venture is a profitable ac- proved framework for subnational government tivity, it can well be performed in the private sec- finance may help eliminate such activity by re- tor. If it is not profitable, it should not (with very moving pressures on localities relying on reve- few exceptions) be undertaken by any entity, in- nue sources, transfers, or tax shares that are per- cluding the public sector. "Government entrepre- ceived to be inadequate or uncertain. neurship" is potentially dangerous because it is almost certain that government-owned enterpris- Phasing Out Joint Venture Banks. Just as subna- es will compete unfairly with private concerns tional governments should not own enterprises, and, in doing so, localities will undercut their they should not become involved in setting up own tax base. Where this strategy is pursued in banks or joint venture financial institutions, as market economies, economic pressures often re- some are doing, and as authorized by the laws on quire that these enterprises be subsidized. But, budgetary process. Moreover, they should not di- most important, these local entrepreneurial activ- rect the credit or lending policies of such institu- ities are inconsistent with the "proper" role of tions. The law on Budgetary Process that gives governments in market economies. authority to set up banks should be reconsidered In sum, the hope for profit sharing in joint as soon as possible. ventures can quickly turn into budgetary obliga- tions to cover losses. (In market economies, the Using the Proceeds from Privatization rate at which small businesses fail is high. Only one in five of such businesses survives its first The division of government property affects the three years, and there is no reason to expect that financial situation of subnational governments Russia can improve on these odds.) The perspec- in several ways. Since the level of government tives of public officials, not only in Russia but that owns an enterprise or institution is finan- worldwide, tend to make them poor business cially responsible for it, these outlays will be re- managers. Bureaucrats and politicians mix such flected on the expenditure side of the budget. If objectives as maintaining income or retaining sold or privatized, any proceeds accrue to the their jobs with the objective of maximizing prof- budget (or extrabudgetary funds) of the selling its. Experience in other countries and now in government. Each level of government also re- Russia and the former USSR Republics shows ceives the profits/dividends from the enterprises the difficulty of deciding when concerns should it owns; similarly, rents and lease income accrue be shut down, even when their "value-added" is to the jurisdictional budget or extrabudgetary negative. The longer-run damage arising from accounts. this basic incompatibility between objectives has Subnational governments apparently lack spe- led to an unprecedented move toward privatiza- cial guidelines or rules on using revenue from tion in most western economies and in many de- the privatization of public enterprises. The most veloping countries in the last decade. If subna- common practice appears to be to use the pro- tional governments retain unprofitable enter- ceeds as an additional source of current budget- prises, local budgetary burdens increase and the ary revenues. The sale of state property may not revenue base declines. This experience exacer- generate much revenue for oblast and rayon bates the fiscal squeeze at the subnational level owners. Many enterprises, especially those and is ultimately destabilizing. owned by subnational governments, provide Most important, entrepreneurial activity is public goods and services, and cannot easily be fundamentally inconsistent with the privatiza- privatized. In light of the poor financial condi- tion drive, and represents a bottleneck to true tion of most of the inherited enterprises, privati- decentralization-that is, decentralization from zation may not create any revenue. Local gov- the state to the private sector. Entrepreneurial ac- ermments will, however, have to take over their tivity at the subnational level does not represent social outlays. More generally, the transfer of 58 state enterprises to lower-level governments of- At the present time, however, enterprises find ten involves budgetary expenditures, since it is it difficult to transfer their social responsibilities the loss-making enterprises that are transferred. to subnational governments that lack the re- When privatization is feasible and profitable, sources to assume their functions. Indeed, as what should be done with the proceeds? Should revenues diminish and expenditure mandates they be capitalized in special funds, invested in increase, subnational governments rely increas- capital projects, or used to finance current ex- ingly on enterprises to provide basic services. penditures? In practice, no special strings have Since enterprises have greater access to credit been attached to using revenues from privatiza- than do subnational governments, responsibili- tion. The most common practice appears to be to ties have been transferred toward-not away- use these funds as an additional source of reve- from enterprises. This shift can have major macr- nue in the recurrent budget. If expenditure man- oeconomic consequences as noted earlier. dates are financed with privatization revenue These observations call for the urgent institu- (which will eventually be depleted unless invest- tional strengthening of the federal MOF and the ed wisely), this source is not sustainable and will institutional basis for intergovernmental rela- lead to further deficits at the subnational level. A tions and reform. Weaknesses in the present sys- more conservative principle of public finance tem of budget preparation, execution, and re- would call for using the center's share of the porting, as well as in the intergovernmental sys- proceeds to retire of the national debt. At the tem, significantly impair the ability of MOF to subnational level, the proceeds should be invest- manage government finances effectively in such ed in long-term assets (the infrastructure), thus an unsettled environment. To address these allowing subnational governments to draw in- weaknesses and to regain fiscal control, the gov- come from those assets over a long period of ernment should (1) establish the Blue Ribbon time. The revenue from these privatizations Commission to address intergovernmental is- should definitely should be viewed as budgetary sues and to design and implement a full-fledged (not extrabudgetary) resources.7 intergovernmental budgetary reform to im- prove intergovernmental coordination; (2) The Role of Enterprises: The Divestiture of strengthen expenditure control and introduce Nonproduction Expenditures modern cash management procedures, as well as monitor procedures for extrabudgetary funds Historically, public enterprises have played an and borrowing; (3) strengthen the STS; and (4) important role in financing a wide range of ex- establish a treasury. The federal tax and treasury penditures that would be financed by the pub- administrations should operate at all levels of lic sector in a market economy. Enterprises government. have built schools and hospitals. For large en- terprises, capital expenditures extend to other Notes types of infrastructure, such as roads or sewage lines. As marketization proceeds in Russia, ex- 1. The emergence of extrabudgetary funds at the sub- penditures not directly related to production national level is an extension of the mushrooming of cannot continue to be enterprise responsibili- these funds at the national level, and reflects the diffi- ties, and should be transferred to subnational culties experienced in the national design and imple- governments. De facto, transfer is already tak- mentation of an integrated and coherent fiscal policy. ing place, given of the financial difficulties of 2. Arrears dwarf the budget in terms of their potential many government enterprises. Government impact on macroeconomic variables. MOF 'guessti- enterprises should contribute to local finances mates" of net inter-enterprise arrears (that is, the sum just as private enterprises do: through taxes of each enterprise's inter-enterprise liabilities not and user fees. This shift in expenditure respon- matched by an outstanding claim of that firm on anoth- sibilities from enterprises to subnational gov- er enterprise) put them at about one third of the gross ernment must then be accommodated by a amount of inter-enterprise arrears (RI trillion on July 1, corresponding change in the revenue shares to 1992). the subnational level. (Chapter 3 discusses 3. Subnational governments built-up an aggregate dealing with the spun-off responsibilities in cash surplus equivalent to 1.7 percent of GDP during greater detail.) the first half of 1992. Given the fiscal squeeze, this sur- 59 plus (a positive cash balance) at the subnational level is buoyancy is not expected again). In sum, this unexpect- surprising but not difficult to explain, and is in many ed subnational surplus is largely illusory, explained by respects illusory. First, this is a cash budget surplus, a "balanced budget rule," a conservative spending and does not reflect accrued commitments, which may stance, and other short-term, or one-time factors. be large if arrears in the goverhment sector parallel ar- rears in the enterprise sector. Second, subnational gov- 4. The legislated sharing rate was 17 percent in the ernments are required to run balanced budgets, and first-quarter budget, but was reduced to 14 percent must therefore keep "cash on hand" to meet ongoing when implemented. obligations. Third, subnational governments are re- 5. The Law on Basic Principles of the Budget System sponsible for numerous outlays on social benefits and divides the budget into current and capital outlays wage increases for which they receive delayed com- (Art. 11), and states that the capital budget may be fi- pensation (sometimes by several months) from the fed- nanced through government bond issues or "credit re- eral government. Since subnational governments sources" (Art. 13). This could be used to establish a cannot have a deficit, these transfers immediately gen- borrowing limit by purpose-in this case, capital out- erate a surplus when they are credited; indeed, their lays. The draft law on Budget Rights permits deficits or magnitude (1.6 percent of GDP in early 1992), almost "temporary financial difficulties" to be financed with equal to the overall subnational surplus, suggests that loans (Art. 13) and does not appear to tie borrowing to they are related. Fourth, uncertai'ty about the overall capital financing; the only limit appears to be the neb- economic situation and revenue flows has led to a cau- ulous "financing-capacity" rule, which however, but tious spending stance, and localities have delayed Op- suggests that thought is being given to constraining lo- eration and maintenance and other outlays. Fifth, sget httogti en ie ocntann o erativn the"balanced maintetnle" and otheneedfor ou . Fcal borrowing. These laws are difficult to reconcile with given the "balanced budget rule" and the need for op- the law that prohibits on subnational goverrnments erating cash, subnational budgets will always show a fro rni a deficit (h lawion geroces "surplus." Perversely, neither additional expenditure from running a deficit (the law on Budget Process). responsibilities nor revenue cuts will ever eliminate the Fieldwork suggests that localities do make strong ef- surplus: localities, bound by budget balance, will cut forts to balance their budgets, and that the balanced expenditures (or accumulate arrears) to stay within the budget rule applies ex post, taking into account trans- available resources. "Fiscal balance" in one locality vis- fers from higher levels (and other coping mechanisms, ited was achieved by cutting monthly pension pay- such as arrears). ments to pensioners from their official level of R900 to 6. The Decree of the Supreme Soviet of the Russian R300. Finally, the accumulation of inter-enterprise ar- Federation on the "Division of State Property" (Decem- rears mitigated the burden of subnational social expen- ber 17,1991). ditures, since enterprises continued to carry these expenditures and saved the localities the costs of un- 7. See Newbery (1991). His argument is that many of employment and the safety net associated with enter- the assets may have been financed with debt (localities prise bankruptcy had the enterprises been forced to have substantial liabilities), in which case the proceeds meet these payments. On the revenue side, the taxes should be used to pay off this debt, rather than burden- shared with subnational governments were much ing present and future local taxpayers with debt more buoyant than anticipated in early 1992 (such service. 60 Expenditures and expenditure assignment The most basic issue associated with expendi- Some Principles of Expenditure Assignment tures and expenditure assignment is the divi- sion of responsibilities: What are the key The basic question in expenditure assignment functions of government (relative to the private is, "What level of government should be re- sector), and what level of government should sponsible for carrying out different government be responsible for carrying out which func- functions and service provision?" The answer tions? In most market economies, the role of relates to the three important goals of govern- government is much more limited than in so- ment-economic stabilization, efficiency, and cialist economies, and this role is shrinking fur- equity-and depends on which level of govern- ther as private investment is drawn into such ment is best positioned to fulfill those objec- activities as building roads and bridges that tives. Only after expenditures have been were formerly the bailiwick of the government assigned, and their overall volume is known at sector. In market economies, governments play each level of government, can tax assignment a major role in regulating the economy, but and a system of intergovernmental transfers be their intervention is indirect, rather than direct considered. Expenditure assignment is thus an in an ownership capacity. At the local level, important (and, in many countries, often over- governments are generally limited to providing looked) first step in rationalizing the intergov- services that benefit the local population, but ernmental fiscal system. do not have a large ownership stake in the pro- ductive sectors of the economy. Efficiency This chapter discusses the traditional public expenditure functions in a market economy. An "efficient" assignment of expenditures is one The first section addresses some general princi- which ensures that the services provided by gov- ples of expenditure assignment: How should ernment suit the tastes and preferences of the lo- public expenditure responsibilities be assigned cal residents; efficiency results when the to each level of government-federal, oblast, government is accountable and responsive to and rayon-for those activities that do belong taxpayers. Efficiency requires that expenditure to the public sector? The next section addresses and service responsibilities be assigned among the extent to which actual assignment in to- the different levels of government according to day's Russia fits the general principles. A final their "benefit area." Thus, services whose bene- section discusses the discretion and account- fits do not go beyond the boundaries of a local ability associated with greater subnational-level community, such as neighborhood parks, should expenditures. be provided by the local (rayon) government. 61 Services whose benefits affect several different ment. Local government efforts to improve the communities, such as intercity highways, should well-being of lower-income households in any be provided by the oblast-level government; one region can be self-defeating, since the redis- those that affect the entire country (for example, tributive programs tend to attract the needy national defense) should be provided by the fed- from other parts of the country. Such efforts may eral government. also repel the "better off," who perceive that The provision of public services will be most their taxes are being used to finance public ser- efficient when expenditure assignment allocates vices from which they do not benefit directly, each function to the lowest level of government and the net effect of the distributional policies of that is able to perform that functin most effec- local governments is to undermine the local tax tively. Doing so will ensure, for instance, that lo- base. Thus, unless little mobility exists among cal populations will receive the public services taxpayers (or strict eligibility rules, such as ra- they want, rather than what is centrally deter- tion books or residence permits that entitle fami- mined. To the extent that preferences for public lies to benefits), aggressive redistribution services differ, efficiency will create, and indeed policies by subnational governments may not be require, considerable diversity among subna- successful. tional jurisdictions (see Box 3.1). Locally provid- ed services should also be financed at the local Stabilization level so that the costs and benefits of public ex- penditures are closely linked. When "the benefi- It is generally agreed that the central government ciary pays," efficiency is greater, and govern- is best equipped to pursue macroeconomic stabi- ment decisionmaking more responsive and lization via expenditure and tax policies that are responsible. sensitive to the overall level of macroeconomic This decentralization principle has a few ex- activity. In Russia (and in other countries), it is ceptions. First, if important economies of scale has been argued that the central government are associated with providing services, centraliz- must exercise tight control over the budgets of ing this provision may be sensible. For example, subnational governments in order to stablize the this might be true of the centralized procurement economy. Internationally, although macroeco- of textbooks or pharmaceuticals, or other items nomic management may be more complicated, for which purchasers are numerous and suppli- more decentralized systems have not necessarily ers are few. A case can also be made for assign- experienced greater economic instability. ing certain services to the national level if the costs of duplicative local administrations are Assignment Rules high. In many cases (for example, public utili- ties), regional governments are large enough to Expenditures that are necessary for achieving capture economies of scale. Second, if important stabilization (such as unemployment benefits) national interests go beyond purely local inter- and expenditures that affect income distribution ests (externalities or spill-over effects), central- (such as the social safety net) are typically as- ized provision may be desirable. For example, a signed to the central government. Expenditures case is often made the involvement of the central on services for which an efficient allocation of re- government in education, in recognition of its sources is crucial are best assigned to the differ- importantance to economic development, nation- ent levels of government according to the size of al welfare, and income distribution. In general, economies of scale or spill-over effects. In con- however, decentralization, not centralization, crete terms, functions assigned to the national promotes accountability among public officials. level could include defense, the postal services and telecommunications, national roads and Equity highways, and civil aviation. These services pro- vide benefit nationwide and are properly (and Improving income distribution is a proper role typically) the responsibility of the national bud- for government. Given a consensus that equal- get. The legal framework and courts, the en- ization is important, it is often thought that any forcement of national laws, foreign affairs and serious attempt to affect income redistribution diplomacy, scientific research, and environmen- should be undertaken by the central govern- tal legislation would also be national-level re- 62 Box 3.1 Fiscal Decentralization: The Long-Term Goal and Its Benefits. The ultimate goal of a decentralized system of intergovernmental relations is to make government more re- sponsive to the needs and preferences of individuals in different communities. Although "unitary" or more centralized systems of intergovernmental relations can be as effective, and sometimes more effective, at achieving stabilization and equity, they fail to provide the gains in efficiency that decentralized systems can achieve. But achieving efficiency in the provision of local services-maximizing the welfare of local taxpayers subject to the government budget-is difficult even in decentralized systems. A decentralized structure must be complemented by other features to yield an acceptable degree of efficiency. Requirements for Efficient Local Government. Efficiency requires, first, that local officials have discretion in budgetary matters involving expenditures, wages and staffing, and revenue raising. Limits on the autonomy of local authorities make it more difficult or impossible for them to take into account local conditions in many important activities. The lack of discretion by public officials eventually makes local residents look to the cen- tral government for a solution to their problems. Second, efficiency requires a mechanism for taxpayers to convey their preferences and desires to local authori- ties, together with a mechanism to make local authorities accountable to local taxpayers. The ability of voters to remove or reappoint democratically elected local authorities is a critical element for both achieving ac- countability and revealing preferences. Third, taxpayers must be made aware of the link between the costs of providing a service and the quality and quantity of the public services they demand. The best way to provide this link is to finance a share of services with local taxes. The higher the share of expenditures that is financed by local taxes, the more likely taxpayers will be to hold local officials accountable. The ability to use local taxes also gives local jurisdictions indepen- dence to determine the overall level of public services. From the perspective of promoting accountability, us- ing tax sharing to finance local services is better than using central government grants. Expenditure Discretion and Diversity. Greater responsiveness to the needs and preferences of local residents requires that local governments have discretion to determine the composition of expenditures. The gains in economic efficiency associated with a decentralized system of local governance will not be realized unless lo- cal officials have adequate flexibility to set budget priorities and to determine the level of spending. Thus in general, local budget officials, should not be subject to national or general norms of public service provision (unless the service is financed with central funds). Taking advantage of local conditions or responding to spe- cial needs will frequently require diverse standards of provision. Local authorities also need independence to set employee wages and salaries. Universal or countrywide pay scales will detract from the necessary flexibil- ity to take advantage of favorable labor-market conditions or the necessity of offering higher compensation in the presence of labor shortages. Diversity in Service Provision. The ability of local authorities to determine the level and composition of expen- ditures can lead to a distinctive characteristic of decentralized governments: significant differences in the level and profile of local budgets. This variety supports matching the provision of local services more efficiently with the needs and preferences of local residents. However, inequality in the level of provision may be due to different levels of economic development. In this case, the gap among jurisdictions may be closed with appro- priate intergovernmental transfers. The Political Dimension. All three elements-discretion, the ability to express preferences, and linkage be- tween costs and benefits-must be present to ensure that a decentralized system of intergovernmental relations is efficient. The complexity of institutional arrangements can make this set of conditions very difficult to achieve. In Russia, at present, although, de jure, local authorities have independence to formulate their own budgets, de facto institutional constraints, such as nationwide wage scales and budget norms, leave local decisionmak- ers little discretion. The principle of democratically elected public officials is endorsed in the laws, but its ef- fectiveness has yet been proved in practice. Local soviets tend to be too large to be effective (the Moscow City Council has 800 elected representatives), and bureaucrats, remnants of the old regime, have been accused of controlling the apparatus of government and not being accountable to elected officials. The role of local taxa- tion in the overall financing of local governments is still being thought out, and its importance seems not to be well understood by all parties involved in the decision. 63 sponsibilities. Establishing regulatory rules and ture assignment. The design of an intergovern- legislation to guide privately owned industries mental system should incorporate this built-in and interstate commerce are further examples. ability to adapt over time to changes in prefer- A clear distinction must be made between pro- ences and to the relative importance of efficiency, viding services and financing them. Many func- equity. and stabilization. As with any other tions may be provided at the subnational level country, Russia must find its own compromise but financed centrally. For example, social wel- and approach to assigning government expendi- fare is best administered at the level closest to ture responsibilities. Not surprisingly, interna- the problem-by local governments. However, tional experience shows that stable systems of the central or federal government may have a le- intergovernmental relations are characterized gitimate interest in "equalization," ensuring that by objective and clearly stated expenditure rules. the service is financed and provided according Transparent and objective rules that move away to a certain standard; therefore, it may delegate from the subjective discretion characteristic of responsibility for implementating the program the previous system should be the paramount but retain financing. A further distinction must objective of the legislation coming out of the Su- be drawn between financing and producing preme Soviet. goods and services, which may be contracted in whole or in part to the private sector. Expenditure Assignment in Russia Public services are best delivered at the subna- tional level, with local decision-makers responsi- Consistency with Assignment Principles ble for determining the types of services to be provided, and their quantity and quality, as well In general, the assignment of public service activi- as to whom they are targeted. Services whose ties to different levels of government in Russia ap- benefits favor the local area include local roads pears to be based on the correct principles. The and road maintenance, the police, hospitals, san- principle of assignment according to the geo- itation and urban services (such as street lighting graphical dimension of benefits was inherited and cleaning), gas utilities, electric power utili- from the old Soviet Union. Public service activi- ties, water, sewage, public markets, local trans- ties whose "benefit area" is the entire nation are port networks, title and cadastral registries, and provided by the central government. Those with a building permits. regional dimension (for example, universities and Straddling these clear assignments to either tertiary and psychiatric hospitals) are provided by the federal or subnational government are ex- the oblast and autonomous republic level of gov- penditures for education, health, and social wel- emient; and those with a local dimension (ele- jfare. On one hand, local area schools and clinics mentary schools and parks) are provided by clearly benefit the residents of the local area. On rayon and city governments. However, the actual the other, a well-educated and healthy popula- implementation of the expenditure assignment tion has national benefits. Equity concerns can violates these principles in some important ways. also call for an evening out of spending so that a minimum level of service is maintained through- The Absence of Assignment Specificity. out the country. Given these equity concerns and benefit spill-overs, expenditure responsibility for The absence of a concrete assignment of expendi- education and health is often provided by a re- ture responsibilities in the law is the most serious gional government or shared by the local and obstacle for moving Russian intergovernmental central governments. In many countries, the cen- relations away from the bargaining mode inherit- tral government may provide grants to subna- ed from the old regime. The reality is in stark tional governments that require or enable them contrast with the explicit tax assignments in the to provide services that meet certain standards. Basic Principles of Taxation. By focusing policy In reality, while general guidelines may be efforts exclusively on tax assignment and reve- useful, no absolute "best system" of expenditure nue-sharing mechanisms between the federal assignment or service decentralization exists and the oblast governments, the Russian govern- across countries and over time. Different local ment is "putting the cart before the horse." As re- preferences, household mobility, and economies cent events show, the availability of revenue is of scale will suggest the most desirable expendi- dictating the distribution of responsibilities be- 64 tween the different levels of government, rather to balance the budget of the central government than the other way around. A critical policy step and to "claw back" the apparent surpluses of that must now be taken by the Russian govern- subnational governments, which were thought ment is to develop detailed and specific assign- to have been created by the introduction of fixed ments of service responsibilities. Only then will it sharing rates. Another goal of these mandates be meaningful to assess the adequacy of alternate may have been to force the eventual discontinu- tax assignments and the desirability of various ation of some expenditures (for example, price mechanisms for intergovernmental transfers. subsidies) in the public sector. The shift in re- Several considerations may help explain why sponsibilities appears to have created serious a service and expenditure responsibilities have budget pressures on subnational governments, not yet been defined concretely, and why it may creating the risk that other subnational expendi- be difficult to do so in the near future. Both the tures (health care and education) would be subnational and the central governments have crowded out. Though too early to quantify, the seen the advantages of the absence of specific of impact is visible on expenditures in the tradi- expenditure responsibilities. Lower-level gov- tional subnational expenditure areas. emments have been using their increased re- A system of ad hoc assignment changes, in sponsibilities to bargain for a larger share of rev- which higher levels of government can jettison enues from upper levels. The federal govern- responsibilities, enterprises, or assets onto lower ment has used the absence of a legal definition of levels without corresponding adjustments in the expenditure responsibilities as an additional pol- revenue system, is not likely to be sustainable. icy instrument to offload its own budget deficit. These actions, a dangerous precedent, carry seri- The changing expenditure assignments were ous political risks. If the trend persists, what im- paralleled on the revenue side by bargained portant expenditure functions will the central sharing rates between MOF and the oblast gov- government have left to justify its existence to ernment in the first quarter of 1992. Not surpris- skeptical subnational governments and give ingly, the assignment of fixed and uniform shar- meaning to the union? With this provocative ing rates to oblasts from the second quarter of type of policy, the federal government may be 1992 has made oblasts much less willing to ac- inadvertently contributing to its worst fear, the cept additional expenditure responsibilities. disintegration of the Russian Federation. Ad Hoc Approach to Assignment. Next Steps Changes in expenditure responsibilities in the The concrete and stable assignment of expendi- first half of 1992 have been ad hoc and have fre- ture responsibilities is imperative to a well-func- quently violated the principles of expenditure tioning system of intergovernmental relations. assignment. Two important examples illustrate Without it, the Russian Federation will not be this point. First, beginning in 1992, the central able to shed the negotiated mode of intergovern- government shifted responsibility for most of mental relations, with all of its undesirable con- the price subsidy program, social protection pro- sequences. Neither the fixed sharing rates of the grams, local transportation (including subway second quarter nor the tax assignments in the systems), and public utilities to local govern- Basic Principles will work in the medium term if ments.1 This "reassignment" was initiated by the the federal level can change expenditure respon- central government. Second, and quite precipi- sibilities continually. The absence of precise defi- tously, all capital investment responsibilities- nitions of responsibilities will almost certainly be some with national significance, such as military a severe source of tension between the central housing and airports, and some with subnation- and oblast-level governments. al significance-were shifted to subnational gov- ernment budgets in the second quarter of 1992. Concrete Quantification. Political Convenience and Political Risks. What this report recommends is a systematic, data-intensive approach to redesigning intergov- The main rationale for the reassignment of ex- emnental fiscal relations, in which the expendi- penditure responsibilities appears to have been ture responsibilities of subnational governments 65 and their financing requirements are itemized the poorest, received nothing because they did and quantified. This task will require (1) an anal- not present the required information to the cen- ysis of expenditure responsibilities, function by tral authorities. For the rest of 1992, no specific function, (2) an estimate of their financial re- allocations have been made to oblast budgets for quirements, and (3) an assessment of the yield of social safety net outlays. Instead, social safety alternative revenue assignments against these net funds have been placed into an open reserve expenditure needs, based on a simulation analy- item of the federal government-again putting sis of alternative assignment possibilities. Any poorer oblasts at risk, especially because MOF transfer of responsibilities, assets, or enterprises, does not count the number of poor families in or any central mandates for wage increases and the oblast, or any other welfare indicator, when price ceilings, should be modeled explicitly and it formulates oblast budgets and overall subven- the impact on the fiscal balance estimated. tion policies. Reassignment of Social Expenditures. Reassignment of Assets and Recurrent Budget Implications. Some consensus has now been reached that the decision to transfer responsibilities for consumer Asset ownership has also been newly assigned subsidies to subnational governments was made in the transitional period. All housing ownership too quickly. Oblast and rayon governments are has been assigned to local govemments or to not well positioned, either theoretically or in public enterprises with local subordination. The practice, to finance redistributional programs or division of govermnent assets among the differ- to administer direct transfers. But shifting re- ent levels of govemment has been remarkably sponsibilities to subnational governments was smooth, all things considered. (Issues and rec- politically expedient, in the hopes that the prob- ommendations pertaining to the distribution of lem would soon resolve itself, given that most asset ownership were discussed in depth in subsidies would be phased out. In fact, while the Chapter 2.) These transfers should also help ad- burden of financing price subsidies will be re- dress responsibilities for maintaining capital duced when prices are freed, the underlying structures. Shifting ownership responsibility has problem of financing social protection for those not eliminated this expenditure need. However, most hurt by price liberalization will not. It does reassignment of asset ownership, especially of not appear that the government has made hard housing, has added significant demands to local estimates of the cost of financing social protec- government budgets. The Ministry of Economy tion, or that it has planned for financing these estimates that expenditues on housing mainte- additional costs. nance will range anywhere from between R 67 The adequacy of the social safety net will be- billion and R 100 billion in 1992. This level of come a national priority during the difficult tran- funding has not been budgeted by the central sition ahead and should not be a major responsi- government, and local govemments are likely to bility of subnational governments alone. The cover only a small portion of it. The recurrent central government can play the critical role of budget implications of the new assignment of as- financing subsidies (most likely in the form of set ownership in the Russian Federation must be cash) targeted at the needy. Rayon administra- considered explicitly when revenue is assigned. tions could use some form of means testing to identify the subsidy recipients. The rayons Assignment of "Public Functions" to Enterprises would continue to administer this social safety net, and their actual costs would be reimbursed A major feature of the Russian enterprise system on the basis of actual payments made by the fed- is that enterprises are assigned responsibility for eral level in a program of "cost-reimbursement" providing or financing a wide range of social grants. Thus far, social safety net budgeting has services. Their most important role has been to been haphazard, the budgeted amounts insuffi- provide infrastructure in education and health cient, and none of the necessary data are being care. The contributions of public enterprises to collected. In the first quarter of 1992, R 1.3 billion oblast and rayon budgets vary considerably ac- from the Social Support Fund were allocated to cording to the relative size of the public enter- 23 oblasts; sixty-five oblasts, including many of prise vis-a-vis the local jurisdiction. Some recent 66 estimates of the overall contribution of public ment would be indirectly responsible for a enterprises to subnational public services put health clinic in a centrally owned enterprise, their contribution as high as 40 percent of the even though health clinics are a subnational subnational budget.2 function. It is not clear whether the system has The assignment of these expenditures must be yet identified the level of government that is best clarified, identifying what is truly an enterprise situated to assume responsibility as these func- responsibility and what is legitimately the job of tions are spun off. As a general principle, the di- government. This issue has been recognized in vested enterprise expenditures should be Russia, and some progress has been made toward assigned notionally on the basis of overall assign- a solution, although such a massive change will ment principles, regardless of former ownership. take time to implement fully. The divestiture of Just as reassigning expenditure responsibili- these activities is taking place de facto, given the ties rashly between levels of government is dis- financial difficulties of many public enterprises. ruptive, the jettisoning of social expenditures by Public enterprise contributions have fallen dra- enterprises disrupts local budgets. In terms of matically in line with the reduction or elimination their net impact, the spin-off of social expendi- of subventions to them and new pressures to be- tures will reduce the need for government subsi- come more efficient. Indeed, the financial incen- dies to enterprises (or increase their disposable tives for discontinuing the role of public enter- after-tax profits). However, it is not certain that prise as a public service provider appear to be these revenue benefits will accrue to the same strong because only housing maintenance and level of government that must pick up the ex- losses are deductible before profits, while invest- penditure responsibility (see below). Concrete, ment in schools, health facilities, and housing are quantitative analysis of the budgetary implica- funded from after-tax profits. This residual net in- tions of this divestiture must be undertaken to come is now required more than ever for invest- determine whether the reassignment of these ex- ment in plant and equipment. Some enterprise penditures corresponds with the local govern- directors believe that expenditures falling in the ment's ability to finance them. Paradoxically, the "social sphere" are a form of concealed taxation. regions of Russia that historically benefited the However, financially pressured subnational most from a greater presence of enterprises (fre- governments are still attempting to require that quently highly subsidized military enterprises) public enterprises assume this traditional role. In are now at greatest risk from the discontinuation some cases, the enterprise worker collective itself of the enterprises' social responsibilities. These has voted for higher enterprise expenditures on regional differences should also be incorporated social services, sacrificing their own salary raises in the assignment of tax revenues (see Box 3.2). and bonuses.3 In the final analysis, the provision of public services does not belong in the private The Assignment of Capital Expenditure sector and should be transferred to subnational Responsibilities governments. Public enterprises will not be able to compete in a market-oriented economy if they Under budgetary pressures at the beginning of remain burdened by these responsibilities. More 1992, the federal government suspended virtual- generally, public enterprises should contribute to ly all infrastructure investment projects. Some the local finances exactly as private enterprises oblast and rayon governments jumped into this do, through taxes and user fees. breach and invested limited funds in capital projects. Beginning with the second quarter of What Level of Government Should Assume Enterprise 1992, all budgetary capital investment responsi- Functions? bilities were shifted to subnational governments budgets. But many oblasts have refused to un- When enterprises relinquish their social respon- dertake some of the newly assigned capital ex- sibilities, the assignment of these expenditure penditures, such as for military housing. The functions among different levels of government reigning confusion and the ad hoc decisions on must be addressed. Traditionally, the central expenditure responsibilities are likely to contrib- government was responsible for "its" enterprises ute to the shrinkage of local infrastructures, thus and the locals for "theirs," with all the implicit also likely reducing the overall productivity of outlays and subsidies. Thus, the central govern- the economy. 67 Box 3.2 How Equally are Expenditures Distributed? Subnational officials frequently expressed the view that, under their past regime, their community had been treated unfairly, in both an absolute sense-they retained only a small portion of what they paid in taxes- and in a relative sense-vis-a-vis other communities. The perception may be accurate, since a large share of GDP was taken by the Union for military purposes or dissipated in other prestige objectives. Such expendi- tures may never have been perceived as benefiting any local communities. They have been reduced drastical- ly by the new regime. Whether some regions or communities benefited more than others under the old regime is interesting from both a historical and a contemporary perspective: it gives us a better idea of the starting conditions of subna- tional governments under the new regime. Perceptions about past inequities in treatment appear to play an im- portant role in the views of subnational governments about the design of the Russian system of intergovern- mental fiscal relations. Are we departing from an egalitarian system, or a system with pronounced inequalities? Enterprise Social Expenditures. When examining the regional distribution of public expenditures, most countries look at the distribution of budgetary funds across jurisdictions. Russia must go beyond this view, because gov- ernment investments in state-owned enterprises can also facilitate the provision of social services. Comparison of local service provision based on budget data for local governments might be misleading. Data on the expen- ditures undertaken by public enterprises on behalf of local governments are rarely readily available. The historical importance of public enterprise contributions to social expenditures and housing meant that the actual level of these services differed considerably according to the industrial bases of the jurisdictions. In the Mitischi rayon of the Moscow Oblast, two large enterprises provided housing for their employees within 3 years of their employment there; another enterprise in the same rayon provided housing only after 10 years or longer of employment. Similarly, some enterprises provided kindergartens, but smaller ones could not. Budgetary Expenditures in the Past. Little is known about which regions benefited most from budgetary deci- sions in the old regime. Ideally, one would want to analyze budgetary allocations, including capital invest- ments from the central government and expenditures by public enterprises on local services. These data should also provide insight into the center's long-term strategy for closing the ethnic gap by reducing eco- nomic inequalities between regions. Budgetary Expenditures in the Present. Investment data are incomplete and are available only for the more re- cent past. As a first approximation, data for public service infrastructure and per-capita expenditures for 88 oblasts in Russia for 1989, 1991, and 1992 is used to analyze recent public service disparities. Taking the index for "fixed capital for public health, physical education, and social security" available at the oblast level for 1989 as a proxy for accumulated past fiscal disparities, we find a mean of R264.5, a maximum value of R549, and a minimum value of R138, with a coefficient of variation of 0.30. To explain this relatively high variation, our regressions of the index on several characteristics of the oblast showed the following: (t-statistics are shown in parentheses): FIXED SOCIAL CAPITAL = 82.7 + 0.695 MONTHLY WAGE -2 (3.03) (6.90) Adj. R =0.41 Income (as proxied by the average monthly wage in the oblast in 1989) is positively related to and explains a large part of the variance of "fixed social capital." Adding other explanatory variables, such as population, population density, percentage of urban population, and industrial output per capita, did not improve the equation. Only den- sity was marginally significant and took a positive sign. The results support the condusion that expenditures were not always equalized among different regions, but varied positively with the average income level of the region. Analysis of Expenditures: 1991-92. Similar analysis was undertaken for 1991-92 using total expenditures. In 1991, per-capita expenditures among oblasts ranged from R 139 to R 4,253, with a mean value of R 1,243 and a coef- ficient of variation of 0.54. In the first quarter of 1992, expenditures per capita ranged from R 1,992 to R 16,212 with a mean value of R3,587 and a coefficient of variation of 0.63. This range also suggests significant dispari- ties among oblasts, and, if the numbers are to be taken at face value, a noticeable increase in the degree of vari- ation in per-capita total expenditures among oblasts. To explain this variation, regressions of expenditures (for the first quarter of 1992) on the same set of variables showed the following: 68 Box 3.2 (cont'd) Expenditures per capita = 5.47 + 12.3 MONTHLY WAGE - 41.7% URBAN - 47.6 # of RAYONS (3.08) (3.60) (1.81) (2.38) F: 6.57 Adj. R-Sqr =0.204; N = 69 The results parallel those for fixed social capital: per-capita expenditures are positively related to the average income in the oblast (as proxied by the monthly wage). Oblasts with a higher proportion of urban population and more jurisdictional fragmentation (proxied by the number of rayons in the oblast) tend to have lower ex- penditures per capita, after income levels are controlled for. Well-endowed regions receive higher budgetary expenditure allocations, and the urban areas are relatively "under-served" in terms of expenditures, if one perceives that their "central place functions" imply a greater need for services in urban areas. A similar equa- tion was estimated for 1991, but the results were considerably weaker. The monthly wage is still significant, but all other variables are insignificant, and the adjusted R-squared is only 0.02. The assignment of all capital expenditure re- Capital Expenditures and their Financing sponsibilities to subnational governments con- tradicts the fundamental principles of fiscal fed- When capital expenditure responsibilities are eralism. Subnational funds are not the proper fi- assigned to the different levels of government, nancial source for infrastructure and investment the revenue side of the fiscal system must ac- projects whose benefits go beyond the bound- commodate the assignments. Adequate fund- aries of any single local jurisdiction. This is the ing for investment projects whose expenditure most compelling reason for financing those dimensions are local and regional is the next projects centrally. The current policy was decided consideration. Thus, together with the explicit under budgetary pressures in the second quarter, assignment of capital expenditures, the inter- when it seemed that many oblasts could run a governmental arrangements on the revenue surplus that could not be shared by the federal side must incorporate these new expenditure government. The decision may help the central functions. This process could be done explicit- government meet short-run budget pressures, ly, by adjusting the agreed-upon tax shares, or but in the long run it will also impair the efficien- by implementing a system of investment cy with which certain basic services are provided. grants and/or borrowing. (see Box 3.3). The federal government must reclaim responsi- The central government should use targeted bility for investments with a national dimension. grants for projects whose benefits spill over Subnational governments should be assigned re- into the individual communities in order to sponsibility for capital investment corresponding stimulate subnational local investment, be- to their assigned responsibility for recurrent expen- cause by design capital expenditures in the ditures (schools, hospitals, roads, and other subna- past were not equalizing, and the stock of in- tional infrastructure). Expenditures whose dimen- frastructure differs considerably by oblast. sions are regional or local should be transferred to Equalization should also become a more im- oblast and rayon governments. The assignment portant objective for central government principle for capital investment activities should be grants for subnational infrastructure invest- exactly the same as the principle used to assign re- ment. MOF and MOE do not currently have a current expenditures. Doing so is crucial for ensur- mechanism for assigning investment priori- ing that capital expenditures are consistent with ties by oblast. Nor is it clear whether the the current operating and maintenance outlays of mechanism contained in the "Draft Law on subnational governments. Requiring that subna- Subventions to Local Governments" will be tional governments assume many central govern- the right one for this purpose. The Law envis- ment capital expenditure responsibilities is feasi- ages the formation of an extrabudgetary fund ble, and it is unrealistic to believe that the central to finance capital projects, based on selection government will have the information or the re- criteria that differ from the regular budget. sources necessary to make efficient expenditure choices for 91 oblasts and thousands of rayons. 69 Box 3.3 Avenues for Subnational Borrowing: Some Examples For the longer run in Russia, ways to incorporate facilities for limited subnational borrowing in the medium term deserve some thought. Experience in federal and unitary countries, where local governments have such powers, may be a guide. Many countries limit borrowing to agreed-upon and defined purposes and amounts. For example, borrowing may be limited to capital investment financing. This is true, for instance, in Germany for both the federal and state budgets, where the total amount of borrowing must not exceed that year's in- vestments. This limit must be accompanied by a tight definition of "investment." The rationale for tying bor- rowing to investment is this type of expenditures is "self-financing." Self-financing can be direct, when user charges are introduced to recover the costs of capital investment. In that case, revenue bonds may be an ade- quate mode of financing. Internationally, the form and type of subnational borrowing and its intermediaries vary widely Some com- mon models and traditions are as follows: Loans funds operating out of ministries of local government. These are characteristic of countries with British influence, such as Kenya, Sri Lanka, Tanzania, Uganda, Zambia, and Zimbabwe. They are normally revolving funds, capitalized from government budgets; Windows for grants and loans to municipal infrastructure (Fonds d'Equipement Communal) operated by national Caisse de Prets that manage state-controlled pension, insurance, and saving funds. The model is found in fran- cophone states in North and West Africa though reproduced in the Brazilian National Housing Bank. Autonomous institutions for promoting municipal government, such as those that exist in several Latin Ameri- can countries-Bolivia, Colombia, Costa Rica, Guatemala, Paraguay, and Venezuela, for example. These bod- ies are supposed to supply technical assistance and training, as well as loan finance. A heavy emphasis on the development of municipal water supply and sewerage systems has characterized these bodies, and they have commonly designed and built such facilities, and then handed them over to municipal enterprises for opera- tion and debt service. Historically, few of these institutions have developed the capacity for providing assistance to municipal gov- ernment and investment on the scale necessary. Most have been undercapitalized. They have tended to play a narrow and passive financing role, applying little technical or financial appraisal to the projects funded, and offering little positive assistance to municipalities other than capital finance. Designed to provide technical as- sistance they have tended to focus skills and resources on the direct execution of capital works, which are turned over to municipalities for operation and debt service. While this process has added to the stock of ur- ban infrastructure, it has done little to promote the capacity or commitment of municipalities to operate or ex- pand it effectively, or to recover costs. More important, loans have not always been repaid. Municipal Devel- opment Banks (MDI) in many countries have tolerated substantial arrears, and many have even made new advances to borrowers already in default on previous loans. Unfortunately, the experience with such banks has been negative; poor repayment records have weakened the institutions and local repayment incentives. Whether or not borrowing is restricted by purpose, many countries permit borrowing only through a special "local window" of a public or private bank, or other methods. Other restrictions include absolute ceilings. In the United States, federal borrowing is limited by an absolute nominal ceiling (but no state limits), and this amount is continually increased by modifications to the law. For subnational governments in Russia, this pro- cedure would be cumbersome, because the amount would have to be set for each government unit according to its medium-term fiscal situation. Whatever the approach, the amount of debt that may be incurred by a lo- cality must be related to its payment potential. Repayment may be based on revenues from the investment (for example, user charges), general taxes, or other revenues. Source: Davey (1990). L Expenditure Discretion at the Subnational Given the massive involvement of government Level in all types of economic activity, many tradition- al public services were relegated to lower levels Despite these shortcomings, the general division of government. This has set the stage for fiscal of expenditure responsibilities among the differ- decentralization and the much more efficient ent levels of government has positive aspects. provision of government services, once 70 discretionary budget powers are given to subna- has increased since the second quarter of 1992. tional govemments. Fixed sharing rates on some major taxes will The new legislation on the budget process, generate budget surpluses for some oblast gov- self-govemment and the budget system is a clear emments, and mandates may be the only tool break with the past, and provides a solid founda- left to MOF to extract surpluses. The practice of tion for building a decentralized process of bud- imposing mandates is not restricted to the cen- get making. However, practices inherited from tral government; oblast governments also im- the old regime still undermine local autonomy in pose mandates on rayons. For example, the level the budget formulation. While local goventments of price subsidies for heating, bread, milk, and have been promised budgetary autonomy their meat are fixed at the oblast level, but the rayon effective, or de facto, discretion remains limited pays for the subsidies. The incentive to impose in several ways. One is the application of central mandates is less strong at the oblast-rayon level, "mandates" that compromise the ability of local because the financial dependency of the rayon govermnents to control expenditures fully. Other on the oblast government budget is greater. constraints are unpredictability of subnational Many countries have found that protection budgetary resources, a "balanced budget act" from mandates can be secured where subnation- that includes central guidelines for expenditure al govermnent powers emanate from constitu- reductions, central wage policies, and the contin- tional principles. (The U.S. Constitution, for ex- ued influence of higher-level govemments in the ample, states that "the power of the states" in appointment of local finance officials. certain areas "shall not be abridged by the feder- al govemment.") When subnational powers are Central Expenditure Aandates. Unfunded expen- legislated by the government, a greater legal diture mandates from the central govemment foundation, exists for "mandated" legislation have been an important and growing source of from the federal government. The appropriate friction in the division of expenditure responsibil- forum for determing such responsibilities in ities among the different levels of govemment. Russia requires further study. At this stage of The term mandate refers to an order from an up- transition, it is perhaps unwise to set in concrete per level of government to a lower level of gov- those elements for which some flexibility is re- ernment to take an expenditure responsibility quired or for which experience may suggest without adequate funding. For example, the cen- changes. However, in the longer run, Russia may tral government has shifted responsibility for want to learn from other federations. In general, price subsidies to the local level, and central min- most types of unfunded mandates might best be istries continue to set tariffs or price ceilings (for abolished. example, for transportation and heating), limit- ing the ability of local governments to set tariffs Budget Scrutiny. The budget process today is whereby they can recover costs. Wage increases still anchored largely in the process of the old re- for health and education employees, ordered by gime, and administrative practices have changed the central government, have crippled local bud- less than the basic principles of intergovernmen- gets, because the refunding of these costs to local tal finance. Despite the formal appearance of a governments was delayed. The steep increases federal system of government, budget formula- (190%) in wages mandated in a January 1991 tion and execution remains highly centralized. Presidential decree for local workers in the edu- Budgets are still scrutinized (though no longer cation and health sectors were finally funded by formally approved) by higher levels of govern- MOF in March 1992. The new round of wage in- ment. This practice explains the strong control creases decreed in May 1992 (130%) and August that some oblast finance departments still seem to 1992 (150%) will be funded in the 1992 budget exercise over rayons. The first important break subventions, but only for oblasts which MOF with the old regime took place in the second deems are not in a surplus position. Funding to quarter of 1992, when fixed tax-sharing rates the local governments to compensate for infla- were assigned to oblasts. For the first time, some tionary adjustments for welfare payments to fam- subnational governments-oblasts with a budget ilies has also been delayed. surplus-did not have their budgets scrutinized The incentive of the federal government to or changed by the federal government, but mandate expenditures on oblast governments changes in the sharing formula next year could 71 undo this new independence. In the longer run, system of intergovernmental finances-outlined subnational governments cannot have budgetary in chapter 4-to provide budgetary certainty.4 independence without some degree of revenue autonomy. The Use of Norms in the Expenditure Budget. In Recently approved laws have tightened the the old regime, the expenditure budget was for- degree of central control over subnational bud- mulated according to a detailed set of norms that gets. For example, if a rayon is expected to incur involved physical and value standards of provi- a deficit (revenue collections fall short of sion-for example per student or per patient and planned expenditures) or if the deficit ceiling is hospital type. These standards were meant to reached during the budget execution, the Law represent be minimum levels of provision. How- on Basic Principles of the System Budget estab- ever, the federal government often considers the lishes the specific mechanism whereby subna- norms to be adequate (maximum) levels of provi- tional governments should attempt to balance sion in its negotiations with oblast governments. their budgets. The law requires that current ex- The existence of norms appears not to have penditures take priority over capital expendi- guaranteed adequate provision or the elimina- tures. If a deficit remains after all capital spending tion of fiscal disparities. Disparities in the level is made, the subnational government must then of public service provision among oblasts are take monthly pro rata reductions of current ex- pronounced, despite the basic uniformity of penditures (by 5, 10, or 15 percent or as needed) budgetary norms in the national territory, be- across the entire budget. The only exception per- cause the norms sought only to determine the tains to items "protected" as such by the local so- cost of keeping existing facilities running. They viet or by the upper level of government soviets, were not intended to respond to the needs of the These restrictions in the law, as well as those local population or to be equalizing in any sense. derived from convention or practice, limit the The consideration of needs was part of the capi- ' ~~~tal investment budget, which followed a deci- expenditure discretion required by subnational tao invest m entdgent whi f ec i- gover,nments to deliver public services more effi- pes independent of the recurrent bud- In som loaiis an e. anedfci8aet. The separation of recurrent and capital bud- ciently. In some localities, an ex ante deficit may get decisions thus led to serious inefficiencies. best be eliminated by cutbacks in current expen- For example, local governments had the per- ditures, or across-the-board cuts may not be war- verse incentive to keep unnecessary facilities ranted. Only the locality can judge this best, in running because, by closing them, they would line with the preferences of its inhabitants. In lose part of their recurrent budget support. general, these restrictions should be eliminated. While MOF discontinued the strict use of In particular, the requirement that capital expen- norms in 1988, budgets at all levels in 1991 and ditures be sacrificed first is inappropriate. The 1992, were based primarily on historical levels of oblast or rayon government is in the best posi- expenditures, adjusted for inflation, and negotia- tion to decide what should be "protected," and tions involved disagreements about the proper the ability of higher levels to impose protected inflationary adjustment coefficients or so-called items or budget categories is, in essence, yet an- "price norms." Given the scarcity of regional and other "mandate" that is inappropriate unless the local price indices, it is difficult to assess the ade- service is characterized by external effects. quacy of the adjustments. But, some subnational governments visited in the course of field work Unpredictability of Revenues. The absence of complained about large gaps between actual in- budgetary certainty on the revenue side has con- flation and the inflation allowed for by MOF. tributed to the lack of expenditure autonomy. The use of "incremental budgeting" by MOF in With the overall level of funding exposed to ad 1991 and 1992 probably exacerbated regional bi- hoc changes and negotiations with upper-level ases and past distortions in sectoral expendi- government, budgetary outcomes have tradition- tures. Thus, regions that have experienced popu- ally reflected the bargaining power of the parties lation growth or above-average inflation may involved rather than any objective factor. The well be underserved. fixed revenue shares introduced in the second Using rigid expenditure norms for recurrent quarter of 1992 and the Basic Principles could costs for the entire country will have little mean- provide some stability. This report recommends a ing in a system of subnational public finance 72 with local budgetary discretion, and where the budgets independently, in practice their budgets costs and conditions of provision differ consider- are subject to the scrutiny, if not the approval, of ably across jurisdictions. Any desirable equaliz- the oblast finance and budget office. For obvious ing effects from using norms could be intro- reasons, this phenomenon appears to be stronger duced with an appropriate system for estimating in rayons that rely more heavily on the oblast expenditure needs on the basis of norms. MOF government for their operating funds. Nor is it should plan ahead and develop a methodology surprising that poorer and more rural rayons are for computing the expenditure needs of local more likely to be under the control of the oblast government. (This methodology would be re- government. In some cases, the rayon budget is quired to implement the equalization pool dis- not only approved but also formulated entirely cussed in chapter 4 of this report.) Oblast gov- by the oblast government (see Box 3.4). ernments would require similar methodologies One reason for this interference with local dis- to address the budgetary needs of rayons and cretion may be the traditional lack of confidence cities. in lower levels of government. This interference stems from the vertical structure of all finance Fixed Wage Scales and Mandates. Unreimbursed departments in Russia and the continued princi- federally mandated wage increases wreak havoc ple of dual leadership. with subnational budgets. Recent experience with mandated increases in the salaries of teach- More Budgetary Discretion Needed ers and local employees demonstrates that this threat is not just hypothetical. Delays in compen- The de facto lack of autonomy in budget formu- sation by the federal government imposed addi- lation and the subordination of local employees tional burdens on local governments. National to upper-level governments reduces the efficien- wage scales limit the ability to compensate public cy gains from decentralization. The more limits employees for the different costs of living or to at- that exist on subnational authorities, the less in- tract people to particular jobs or locations. Coun- terested taxpayers will be in becoming involved trywide wage scales for local government em- in the local political process. It will also be less ployees are common in unitary or centralized likely that the subnational government will satis- systems of government organization, and are fy the needs and preferences of these taxpayers, sometimes used in federal systems, often due to which, again, is the most important justification union demands. for decentralization. Budgetary reporting by For the near term, the demands of stabiliza- subnational governments to MOF should be re- tion policy call for a national wage policy. In the quired to take place in a standardized format longer run, each oblast and rayon could have its with a uniform set of accounting rules and at fre- independent compensation system. Some of the quent intervals. Audit is also essential. local governments visited had been adding com- In a truly decentralized system of fiscal rela- pensation supplements or bonuses to local sala- tions, upper-level governments oversee only ries, so some initial softening in the rigid wage those activities of subnational governments for scales has already occurred. Multiple sources of which they are finally liable. Subnational gov- funding are used for this additional compensa- ernments are essentially free to formulate their tion. For example, in the Nizhny Novgorod own budgets, and all local government employ- Oblast, the 10 percent bonus paid to doctors ees are paid from local funds to avoid conflicts of came from budgetary savings in health care op- interest. In Russia's case, all finance officers at erations. the oblast and rayon levels should be paid from local funds. The only exception should be the Budgetary Review and Approval. Even though, in employees of the STS, which should remain un- principle, rayon governments formulate their der central government subordination. 73 Box 3.4 Budgetary Management Issues. Despite the recent enactment of a series of laws addressing budget procedures, several important budgeting principles are not being observed in practice and in some cases are ignored in the laws. Field visits suggest a significant degree of confusion about proper budget procedures. Payment Arrears. Some subnational governments are increasingly using unpaid balances as a source of regular financing. The size of the arrears would have been more apparent if subnational governments used an accrual accounting basis. However, the law allows subnational governments to use a cash accounting basis, which helps to obscure the size of their budget deficits. The federal government has also been consistently in arrears with subnational governments-an average delay of two months in the flow of funds. Falling into arrears is inconsistent with budgetary discipline. From a practical viewpoint, the practice of arrears offers governments only temporary relief, since prices charged by suppliers are quickly adjusted upward to compensate for the additional costs of delayed payment. More often than not, total costs for local governments go up, since all suppliers, rather than only the creditors in the arrears, adjust their prices upward. Budget Formulation and Execution. Subnational governments spend considerable time and effort in identifying and justifying every line item in the budget to higher levels. However, oblasts, rayons, and cities have com- plete line-item flexibility, being able to spend their allocated funds however they choose. These approaches to budget formulation and to budget execution will not be able to survive side by side. A more aggregate, less time-intensive approach to funding lower-level governments is desirable. Broader expenditure norms based on per-capita terms and adjusted for inflation would work. Sequestering Practices. Some subnational governments operate on very conservative basis as they execute the budget, with some sort of sequestering in place-that is, authorizations for disbursement in excess of revenue collections are not allowed. Although responsible budget practices are laudable, especially under the present macroeconomic circumstances, the perverse consequences of sequestering must be avoided. In particular, without a detailed plan from the local soviet on priorities for all items in the local budget, sequestering em- powers the local finance officer to rewrite or redirect budget priorities. The room for distortion is larger as the smaller the budget that is eventually executed becomes smaller. Budget Accounting and Its Conformity with Accepted Principles. Russia's budgetary accounting differs from gen- erally accepted international accounting practices, such as those delineated in the IMFs Government Finance Statistics Handbook. In Russia's public-sector accounting, borrowed funds are considered a "revenue," and re- payments of the principal borrowed are considered part of "budgetary expenditures" ; in the IMF Handbook methodology, both transactions are considered "below the line" financing items. In budget practice, reserves from previous years are often included as revenues in the budget for the present year, even though the law states explicitly that there should be an unchanged reserve fund at the end of each fiscal year. Budgeting Coordination. The involvement of multiple institutions in some activities makes it too difficult to as- sess how well certain budgetary objectives are being achieved and probably leads to duplication and waste. The most clear example of this type of problem is the social safety net, where local governments, the Social Support Fund, and the Pension Fund are all involved. Coordination should become a priority for all agencies in the same policy area. 74 Notes sue at the rayon level. The overriding goal of the draft legislation is to create certainty for rayons-in particu- 1. The transfer of responsibility for subway expendi- lar, to ensure funding for 70 percent of the minimum tures was partially compensated by additional financ- required budget for five years. The minimum required ing from the center. (See Chapter 1 for a more in-depth budget would be determined on the basis of new ex- discussion of expenditure assignments.) penditure norms. The revenue-sharing formula that provides the 70 percent funding cannot be changed for 2. Data were provided to the World Bank mission in five years. If the revenue-sharing formula in any year March 1992. (See Chapter 1 for a general discussion of yields revenues below 70 percent, the oblast govern- enterprise responsibilities.) ment would have to cover the gap; but if revenues 3. A presidential decree that prohibits enterprises from yield a surplus, the rayon government would keep it. jettisoning their social expenditures has apparently not However, a uniform approach to relations between yet been effected fully. oblast governments and their rayons and cities, as in the draft legislation, may not be necessary. This law 4. Revenue uncertainty is as much a problem for rayon represents an attempt to mandate some "pass- and city governments, which depend on the financial through" of oblast funds to the rayon. However, until decisions of the oblasts, as it is for oblasts vis-a-vis the the federal-oblast relationship is sorted out, in its objec- federal government. The Supreme Soviet recently in- tives-ensuring equalized service provision across troduced draft legislation to address this important is- rayons-is not likely to be successful. 75 4 The tax and intergovernmental sharing system The structure of subnational government financ- subventions.1 For the final quarter of 1992, the ing is in transition-moving from a system of ne- plan is to share the VAT at rates of 25 percent, 30 gotiated tax sharing to one in which revenue percent, and 35 percent (depending on the eco- sources are to be "assigned" to each level of gov- nomic situation of the oblast), and to reduce the ernment. The "Basic Principles of Taxation" law, level of transfers by a corresponding amount. was passed in December 1991, gives the VAT to the federal government and assigns the corpo- The Impact of the Current and Proposed rate and personal income taxes (CIT and PIT) as Intergovernmental Regime regulating revenues to subnational govern- ments. Several minor taxes go to the oblast and The recent reforms of the intergovernmental sys- rayon governments, without rate-setting autono- tem and the proposals contained in the Basic my. The federal government is responsible for Principles have many strengths. They move to- assessing and collecting all taxes. ward making intergovernmental finances more The new system has not yet been implement- transparent and less subject to negotiation, and ed fully. In the first quarter of 1992, it was super- attempt to define a sphere of revenue influence seded by a transitional budget, which continued for each level of government. Giving subnational the traditional negotiated tax sharing and sub- governments some prescribed revenue sources ventions; transitional arrangements are also in of their own also creates incentives for increas- place for the remainder of 1992. In the second ing tax effort at the subnational level. Reforms and third quarters, the VAT was shared at a uni- have also addressed the fiscal gap at the subna- form 20 percent, about 60 percent of the CIT (19 tional level. of 32 percentage points) was retained at the sub- But some problems with the assignment sys- national level, and the PIT was allocated fully to tem proposed in the Basic Principles as well as subnational governments. Excises from vodka with the transitional system currently imple- are shared 50/50, excises from motor vehicles go mented require adjustment and probably call for to the federal level, and other excises go fully to a new law. While these reforms have sought to the subnational level. Transfers and subventions, improve the transparency of the intergovern- not specified in the law, are negotiated between mental system by defining all sharing rates and MOF and the oblasts; both the aggregate volume removing the opportunity for bargaining, the tax of the transfers and their amount for individual regime has not been successful at reducing the oblasts are determined on a quarterly basis for ad hoc approach to assignments and sharing. deficit oblasts. The ad hoc mechanism for filling The sharing rates have been adjusted each quar- revenue shortfalls has apparently shifted from ter, and transparency is clouded by negotiated variable tax-sharing rates to the distribution of subventions. The "unified" approach to tax 77 administration has not been successful at forcing Principles. Their median per-capita loss would compliance, and subnational governments still be R 118 (under these simulations)-about 20 influence the central collectors. Much uncertain- percent of revenues. Some oblasts would lose as ty surrounds the new tax regime, and oblast much as one third of their revenues. Revenue for governments often overrule the tax laws and the 28 oblasts would increase under the Basic Princi- revenue-sharing rules. ples, with a median per-capita increase of R 139, In summary, the intergovernmental financing about 18 percent of revenue. Some oblasts would system is still in transition, and more changes gain more than 30 percent of current revenue. Re- are necessary. Subnational governments do not gression analysis shows that the "winning" have confidence in the system-some have oblasts under the Basic Principles would be those openly defied the rules-and the central govern- with a lower per-capita GVIO, higher average ment has not found the right way to balance the wages, a smaller population, and lower rates of expenditure needs of subnational governments urbanization.2 with the assignment of revenue. Searching for a The underlying problem is that the decisions solution will require addressing several, addi- about revenue assignment have preceded deci- tional challenges. sions about expenditure assignment, and have been made in the absence of a detailed assess- The Absence of "Correspondence" between Assigned ment of expenditure needs. Essential to deter- Revenues and Expenditure Needs mining the division of revenue is understanding the fiscal implications of expenditure assign- Correspondence between the taxes assigned to ment. "How much will it cost subnational gov- the subnational level of government and their ernments to carry out the expenditure responsi- expenditure responsibilities seems to be absent. bilities they have been given?" The recent trans- The revenues available to subnational govern- fer of expenditure responsibilities for consumer ments under the Basic Principles are a function protection to the subnational level without quan- of the corporate tax (CIT) and personal income tifying or effecting a corresponding shift in reve- tax (PIT) collected in their jurisdiction. The bases nue shares is a dramatic example of what hap- of these two taxes (profits and workers' wages) pens when revenue and expenditure assign- may be unrelated to expenditure needs-proba- ment are not considered jointly. This mismatch bly for the subnational sector as a whole and cer- will continue, since there is no reason to expect tainly for the individual oblasts. If revenue is that the taxes and expenditures assigned to the overassigned to the subnational governments subnational level will grow at the same rate. under the Basic Principles, no provision has been Achieving correspondence requires concrete em- made for an extraction back to the center; if reve- pirical work to define the present magnitudes nue is underassigned, no provision has been (and the elasticities) of taxes and expenditures as- made to grant subventions to compensate for the signed to the subnational level. This complex and difference. technical task should be the next step in planning A full analysis of correspondence would re- Russia's future intergovernmental system. quire a detailed assessment of expenditure needs for each oblast, which is beyond the scope of this Equalization report. However, an idea of the magnitude of the potential mismatch implied by the Basic Princi- In attempting to define tax assignments con- ples emerges from a comparison of the distribu- cretely, the Basic Principles do not give the nec- tion of the revenue of each oblast under the essary prominence to the "equalization" issue. present transitional system and a simulation of Assigning income taxes to the subnational level its (hypothetical) revenue under the Basic Princi- on a derivation basis necessarily means that ples (see Table 4.1). Based on first-quarter 1992 higher-income territories regions will derive revenue data, for example, simulations show more revenue. Only by pure happenstance that the median oblast in Russia would lose 29 would revenue assignments match expenditure rubles per capita under the Basic Principles, an needs, either for the entire subnational sector or amount equal to about 4 percent of its present for any particular subnational government. For revenue. Of the 69 oblasts analyzed, 41 (60 per- this reason, intergovernmental transfers are used cent) would suffer revenue loss under the Basic to supplement revenue so that subnational gov- 78 Table 4.1 Simulated Impact of Proposed "Basic Principles" on Oblast Revenue for selected oblasts, 1992:01 Simulated per capita Actual per Revenue capita under Basic Oblast Principles Difference Difference Revenue(R) (R) per Capita(R) (Percent) Revenue Shares (percent) Present Basic system Principles Difference Oblast (1) (2) (3) (4) (5) (6) (7) Baskirskaya AR 627 592 -35 -5.65 2.46 2.19 -0.27 Buriatskaya AR 890 525 -365 -41.02 0.92 0.51 -0.41 Dagestanskaya AR 448 197 -251 -56.08 0.80 0.33 -0.47 Kabaldino-Balkarskaya 652 415 -237 -36.35 0.49 0.30 -0.20 Kalmytskaya AR 883 268 -614 -69.59 0.28 0.08 -0.20 Karel AR 835 837 2 0.19 0.66 0.62 -0.04 Komi AR 830 1079 250 30.07 1.04 1.28 0.24 Mariysaya AR 713 484 -230 -32.22 0.53 0.34 -0.19 Mirdovskaya AR 699 550 -149 -21.30 0.67 0.50 -0.17 Severo-Osetinskaya AR 747 503 -244 -32.66 0.47 0.30 -0.17 Tatarskaya AR 567 721 154 27.18 2.05 2.46 0.41 Udmurdskaya AR 686 550 -136 -19.81 1.09 0.83 -0.27 Checheno-lnkuskaya AR 574 256 -318 -55.40 0.73 0.31 -0.42 Median value of loss (R) (29) (4.29) Number of losers 41 41 62 Median negative value (R) (118) (20) (0.15) Number of gainers 28 28 27 Median positive value of gain (R) 139 18 0.29 ernments can meet their expenditure responsi- provide incentives to mobilize revenue). In the bilities. Transfers also help equalize the often first quarter, equalization was targeted by the substantial differential capacity of localities to oblast-by-oblast negotiated VAT sharing rates, raise revenues, in the light of the wide inter-re- an approach that does not address equalization gional variations in resource endowments. The explicitly, since expenditure needs are not con- Basic Principles and the quarterly budgets that sidered explicitly. Russia lacks a tradition of us- have superseded it are silent in this area. Of ing an objective formula for revenue sharing.3 course, equalization may have been overlooked There is no strong evidence that the transition- intentionally: not all countries give priority to al system of revenue sharing is equalizing. The evening out inequalities fully. But some form of VAT distributions in the first quarter were ad subvention for equalization will almost certainly hoc, as was the distribution of subventions in the be necessary for protecting the budgetary posi- second and third quarters. According to empiri- tion of territories whose economic base is not cal regression results, a larger percentage of tax- strong enough to support an adequate level of es are retained by (arguably better off) oblasts in public services. which the average wage is higher and the popu- One possibility is that the Basic Principles will lation smaller and less urbanized. However, no introduce the system of subventions similar to evidence exists that the revenue allocated to what is currently used to address revenue short- oblasts corresponds to expenditure needs, or rec- falls. The current system is oriented toward ognizes low fiscal capacity in a special way. A "gap-filling" transfers (that is, providing the ad- significant negative relationship exists between ditional resources necessary to meet subnational the share of retained revenues and per capita deficits when they occur) than toward transfers output (GVIO). Taken alone, this relationship whose objective is to ensure equalization (or to would suggest that the federal government did 79 redistribute resources toward poorer oblasts. tional governments. Thus, tax assignment may be However, regressions also show that tax yields too inflexible, and assignment per se leaves sub- are also higher in oblasts in which average national governments vulnerable. The term tax monthly wages are higher (primarily because in- assignment is in fact a misnomer, since subna- come taxes are retained on a derivation basis). tional governments have not been assigned any (See Appendix Tables) This finding is important major taxes, but only their revenue. The absence because the Basic Principles assigns income tax- of any rate or base-setting authority (characteris- es to the subnational level-and will have the tic of true tax assignment) is a major omission. most beneficial impacts on oblasts in which aver- * All revenue bases are highly volatile. Recent age wages are higher. estimates for the first half of 1992 show that, at the Because per-capita subventions are significant- aggregate level, the PIT and CIT overshot budget ly higher in oblasts whose per-capita GVIO is estimates by a factor of 50 percent, while the VAT lower they appear to be equalizing according to substantially underperformed. For some oblasts, this measure of fiscal capacity. However, subven- the overshooting or undershooting was on the or- tions are significantly higher in oblasts in which der of 300 percent. The assignment of any one or the average wage is higher, suggesting a two tax sources to any level of government will counter-equalizing pattern. Finally, per-capita certainly generate erratic and unpredictable reve- subventions tend to be significantly higher in nue; sharing all taxes would mitigate this volatil- oblasts whose populations are smaller and ity, giving all levels of government greater which are more urbanized. In sum, no strong ev- revenue stability. idence exists that either the old the first-quarter * Revenue assignment means that subnational system of variable VAT retention rates or the governments lack fiscal discretion and remain new second-quarter system in which retention without the ability to raise taxes in line with local rates are uniform and subventions are also pro- preferences, creating disincentives for strengthen- vided, is equalizing. Certainly, there is no evi- ing tax effort by subnational governments. In- dence that either is strongly equalizing. deed, the analysis of tax effort in the Russian Federation (see the following discussion) suggests "Tax Assignment" vs "Tax Sharing" that the scope for encouraging revenue mobiliza- tion at the subnational level is limited unless sub- Is tax assignment appropriate for Russia? For the national governments receive additional following reasons, the proposed changes speci- discretion. (See box 4.1 for principles of revenue fied in the Basic Principles may not be desirable. sharing and box 4.2 for international experience.) * Tax assignment may provide incentives for the State Tax Service (STS) to collect national tax- Revenue Adequacy es more efficiently than subnational taxes (in which the federal level does not retain a share). Deficits at the subnational level indicate that the * While tax assignment channels all revenue present system is not revenue adequate. Final from the assigned taxes to the subnational level, budget results for the first quarter of 1992 it does not give subnational governments any showed that 57 of 91 oblasts had a revenue discretion over the tax base or rate setting, and shortfall totaling R 99 billion, while 34 had a rev- the leaves subnational revenue base vulnerable to enue surplus totaling R 48 billion.4 This finding federal tax policy and other economic policy of revenue inadequacy was verified in field in- changes. The CIT base is sensitive to changes in vestigations of individual subnational govern- federal industrial policy. For example, new cen- ments. The deficits were covered through some tral decisions about wage rates, commodity and combination of ad hoc subventions from the fed- input prices, foreign exchange and interest rates, eral government, deferred expenditures, or late and so forth, could have a direct impact on the payments to creditors (increasing arrears). revenue of subnational governments, and the im- pacts could vary substantially across oblasts. Revenue Mobilization Incentives Changes in the PIT base or VAT rate (such as those that were made in the third quarter of 1992 The current system does not offer strong incen- in the name of social policy) will have important tives to subnational governments to increase and unintended effects on the revenue of subna- their rate of revenue mobilization. Our (admit- 80 tedly crude) estimates are that tax effort among reconsider the Basic Principles and the ad hoc the oblasts range from two times the national av- nature of the implemented budgets. Indeed, erage to less than half of the national average. enthusiasm for implementing the Basic Princi- Thus the extent to which subnational govern- ples does not appear to be pervasive, and cur- ments urge tougher enforcement on the local rent plans are to continue modifying the STS authorities and better compliance on their current system. If the door is in fact open to re- enterprises varies widely. thinking the intergovernmental system, the first step is to weigh the objectives of the gov- Options for Reform: A Framework for Tax ernment. No one can determine for Russia Sharing what its priorities should be-this decision is political. It is possible, however, to enumerate Objectives of An Alternative Tax and Transfer System the various objectives that most countries would consider: The problems inherent in tax assignment are * Enhancing ability of the central government severe enough that the government should to use fiscal policy for macroeconomic stabilization Box 4.1 Principles for Sharing and Dividing Revenue Subnational governments are financed in a variety of ways. Sources often include shares of national taxes. In addition, subnational governments, in many market economies, have their own tax sources, such as property tax, excises and taxes on industry and the professions. To finance the expenditures not covered by these taxes and charges, subnational governments rely on additional revenue from transfers, which are often formula- based. Several models for providing subnational governments with shares in national tax revenues are available. Four ways to assign or share taxes are described below. (Box 4.2 describes some international experience with tax assignment and sharing.) Tax Separation/Tax Assignment. A rigid separation of revenue sources is sometimes used for its simplicity Un- der this system, taxes are "assigned" to one or another level of government, which then has sole rights to col- lect and use the tax, and often full authority to set its rate and base. Typically, the central government will be assigned the individual and the corporation income taxes, while subnational governments may be assigned taxes whose yield potential is lower, often including the property tax, business taxes, and a variety of licenses. When subnational governments do not have authority to determine the tax base or rate, they will be vulnera- ble to changes in central tax policy, and will not be able to pursue discretionary tax policy on their own. An advantage of this system to the center is that it keeps local governments on a "short leash," making them re- sponsible for meeting their expenditures from the assigned tax sources. However, because these taxes are un- likely to be sufficient for financing subnational expenditures, assignment systems are almost always accompa- nied by transfers from the central government. Tax sharing. When the central government levies and collects most taxes, a proportion of these revenues can formally be assigned to subnational governments. These funds may be shared by each subnational govern- ment on the basis of collections, or they may go into a central pool to be redistributed on the basis of popula- tion, urbanization, per-capita income, or other criteria. The advantage of this system is its simplicity, and its strength is that certain share of revenues is guaranteed. Tax-base sharing/surcharges. Another alternative is to allow localities to levy surcharges on national taxes or on national tax bases, usually subject to some ceiling. This system of "piggy-backing" on the national tax base is simple, and can work well when all levels of government use a consistent definition of the tax base, and if the surcharges do not differ too much among localities. Subnational governments can usually rely on the superior administrative machinery of the central government to collect these surtaxes. Concurrent tax powers. Both levels of government may tax an activity or tax base, and the precise definition of the base may differ. Switzerland is an example: federal and cantonal governments tax the same bases, but the precise definition of the base (personal income and corporate profits) varies between the national level and the cantons. The same is true for many U.S. states. 81 Box 4.2 Federalism, Tax Sharing, and Tax Assignment in Practice Intergovernmental systems vary considerably, with actual practice explained by historical and political factors and by the administrative capacities of each level of govermnent. As a general principle, trade taxes and taxes with stabilization and income redistribution properties (the CIT and the PIT) should be central taxes; broad- based, stable-yield sales taxes (other than the VAT) and excises are well suited to the subnational level, and prop- erty taxes and other business taxes and fees are appropriate for the local level. Practice does not always parallel these principles, and, depending on a country's particular situation and goals, the principles may not apply In some federal systems, subnational governments enjoy substantial fiscal sovereignty. State and/or provin- cial governments in some Western federations levy one or more of the following taxes: individual income tax (levied by the state/province of residence), corporate (enterprise) income tax (levied by the state/province of the source of income), retail sales tax (levied where consumption occurs), the VAT (Brazil only), and excise taxes (levied by the state of consumption). Resource-rich states and provinces have used revenues from taxes on natural resources to replace such taxes, to avoid having to levy them, or to support lower rates than would otherwise be the case. In the United States, each of the three levels of government is responsible for collecting its own taxes. Taxes are not shared by the federal and state governments. The federal government has been authorized to collect in- come taxes for the states, but no state has availed itself of this service. However, the federal and state tax ad- ministrations cooperate closely, and over half of the states have adopted the federal income tax base as their tax base. The U.S. Constitution does not assign tax instruments to different levels of government. Both federal and state governments can use any tax not prohibited by the Constitution or, for the states, by federal law. Moreover, few limitations are placed on the taxing power of the states (which thus enjoy considerable fiscal sovereignty) and lo- cal governments. The only explicit limitations contained in the Constitution prohibit states from using import and export duties. In sum, the U.S. states have substantial fiscal responsibility. While grants comprise about 17 percent of their revenue sources, U.S. states cannot rely on federal grants to compensate for revenue shortfalls. In Australia the federal government is empowered to impose all forms of taxation but cannot discriminate among the states. States are prohibited from using any form of sales or indirect tax, given a judicial interpreta- tion of the constitutional prohibition against states' using customs and excise taxes. A law dating from World War II excludes states from the taxation of individual and company income. Because these restrictions leave the states dependent on relatively unimportant sources of own-tax revenues, and on grants from the federal government, the states were given exclusive right to payroll taxation during the 1970s. As late as 1981-82, the central government collected 80 percent of total taxes. Switzerland has "concurrent tax powers": local jurisdictions (the cantons and states) are allowed to levy corpo- rate income taxes, as well as personal income taxes and natural resource taxes. In Canada, provinces can levy a surtax on the central income tax, which is transferred directly to them. In Hungary, a combination of tax sharing and tax assignment is used. Local govemments have access to gener- al taxes and also receive a share (based on "derivation" ) of the central government's personal income tax. In Brazil a combination of tax assignment and overlapping tax authorities is used. State governments have substantial and elastic revenue sources, including a VAT. Since a federally levied VAT also exists, the central government fixes maximum rates and has limited the tax base by exempting certain goods or services from taxation for social equity purposes, and in order to avoid possible conflicts and competition among provinces. In India, a system that combines tax sharing and tax assignment methods is used; the center shares a fixed pro- portion of the proceeds of certain taxes with the provinces. Thus, 85 percent of the income tax and 40 percent of the excise tax are shared with state governments. These taxes are shared and allocated among the states on the basis of an index of need, population, and provincial collections. The provinces have complete operating flexibility over those taxes that are "assigned" exclusively to them (sales, excise, and certain minor taxes). In Germany, 35 percent of the VAT currently belongs to mid-level governments (Lander), and is distributed among them according to an equalization formula. In Nigeria, where the tax assignment method is also used and the states have been assigned income taxes, steps have been taken by the current government to make the tax rates and the base uniform across provinces. Until recently, export duties were local taxes. 82 * Achieving correspondence between the ex- be to quantify the expenditure responsibilities of penditures necessary for providing a minimum the central and subnational governments in or- level of services across localities and the revenues der to establish the relative magnitudes of the re- assigned to the subnational governments source requirements of each level (see figure 4.1). * Ensuring equalization to offset differences in fiscal capacity or to reflect differences in expen- The "Common Pool" diture needs * Providing incentives to subnational govern- All revenue from four major federal taxes (the ments to increase their revenue mobilization CIT, PIT, VAT, and excises) would go into a com- * Involving the local population in budgetary mon pool. The central and subnational shares in decisions and increasing the accountability of this pool would be determined on the basis of subnational government officials to their local expenditure assignment. For illustration, MOF's constituencies. July budget estimates for 1992 would imply that * Ensuring the flow of resources to regions 57 percent of the resources in this pool would whose marginal productivity of additional in- have been allocated to the federal government, vestment is greater and 43 percent to subnational governments.6 * Minimizing administrative costs Figure 4.1 thus assumes that the subnational * Gaining public acceptance and share is the smaller of the two, but this assump- confidence-by individuals, enterprises, and tion is a function of any modifications of expen- subnational governments-thus increasing diture assignments that might be made. Such compliance. clarity and transparency in establishing the size of the subnational pool is preferable to ad hoc ar- An Alternative Approach to Tax Sharing rangements or annual decisions by MOF because it permits subnational governments to budget Any restructuring of the Russian system of inter- and plan. governmental financing should currently focus The share for subnational governments heavily on stabilization issues but any new sys- would then be distributed across oblasts partly tem should also include elements of equalization on a "derivation" basis (meaning that taxes and at least some provision for enhancing the would accrue to the territorial budgets where fiscal discretion of subnational governments. they are collected) and partly on a formula basis. The importance of these objectives, and how (The present system of subventions would be they may be achieved, will change as the Rus- abolished in favor of the distribution formula.) sian economy changes. For this reason, and giv- The shares to be distributed by formula and der- en the economic and structural changes in the ivation would depend on the priorities of the transitional period, fixed and unchangeable so- government according to the objectives delineat- lutions-such as those delineated in a constitu- ed earlier. A "Grants Commission" could be es- tion-should be avoided at this time. tablished to design the grant formula and shar- To assist the Government in thinking about ing system (as in Australia and other countries). the options available for reforming its intergov- To enhance the transparency and the revenue ernmental financing system, this report suggests certainty of the system further, as well as to insu- a flexible design framework with four "legs" 5: late it from ongoing political pressures, the Com- * A "common pool" of revenues divided first mission would fix both the size of these two between the federal and the subnational govern- pools of funds (the overall volume of funds ments based on expenditure assignments shared and the volume to be shared on a deriva- * The allocation of a portion of the subnation- tion basis) and the distribution formulas for a al pool on a derivation basis three- to five-year period. * The distribution of the remainder of the subnational pool according to a formula Sharing on a "Derivation" Basis * Subnational taxes and surcharges This four-part proposal retains many of the One portion of the subnational pool of major tax- good features of the Basic Principles but at- es would be shared on a derivation, or "origin," tempts to remove some of its weaker features basis-that is, the locality where the taxes are and ambiguities. As noted, the first step would collected-and a uniform rate of sharing across 83 Figure 4.1 A Framework for Revenue Sharing in the Russian Federation Reforming the Revenue Sharing System Subnational Federal Expenditures Expenditures Revenues: The Sharing Pool 4 _ Subnational Revenues: shrdon "formula basis" {/ ~~Federal 4A Subnational Revenues: shared on Share derivation basis FVAT M ICIT PIT LExcises '1Local" own taxes Federal Taxes m .-u1J 1(trade, customs) Natural Resource Taxes 4.._. Shared on Formula Basis? A Shared with subnational Federal Share A governments to compensate for ecological damage L Shared on derivation basis 84 all oblasts would be established. The derivation more vulnerable to the business cycle, and it sharing rule could be simple. For example, sup- would probably necessitate setting the PIT and pose that a decision was made to allocate on a CIT sharing rates at high levels, possibly increas- derivation basis an amount equivalent to 50 per- ing the STS incentive problem. Balancing these cent of the divisible subnational government concerns would probably necessitate eliminating pool. Some share of the collections from each tax the VAT from the derivation-shared pool. in the derivation pool would be retained by the A derivation-shared (or subnationally as- oblasts, calculated to exhaust the 50 percent. The signed) CIT must eventually be allocated among tax shares should be fixed for three to five years, jurisdictions for enterprises with branch opera- and would be uniform across all oblasts. The tions. This necessity is not yet a major problem greater the proportion of the subnational gov- because few enterprises in Russia have locations ernment pool that is shared on the basis of deri- in more than one oblast, and because the present vation, the more resources the system will system allows the CIT to be prorated on an em- channel into regions whose taxable base is larger. ployment basis. But the government must begin The advantage of this derivation proposal is planning for the time when it must allocate the that it can easily be understood, and is similar in profits of national firms among oblasts, because concept to the existing system. Moreover, ad- the solution will inevitably imply a more com- ministering and monitoring the system would plex tax system-one whose administration is al- not be expensive, and, as long as the retained ready overburdened. Moreover, the current as- shares do not vary too widely, it would not give signment of total PIT revenues to the rayon of the STS an incentive to collect one tax more effi- employment, and not to the rayon of residence ciently than another. This sharing strategy must be adjusted. would reward oblasts that can attract and pro- mote industry, and the uniform sharing rates Sharing Through Formula Distribution would remove the negotiation and bargaining that characterize today's sharing system. It A second part of the common pool would be ear- would also give subnational governments a marked for subnational governments according more certain flow of revenue and would pro- to a formula that explicitly considers expendi- mote efficient budget planning. ture needs and tax capacity. The distribution for- mula would provide sufficient funds to enable Some Complications. One concern is that reve- subnational governments whose tax capacity is nue sharing on a derivation basis is not equaliz- weak and expenditure needs are great to provide ing. Since this method assigns taxes to the juris- a "minimum" level of service. Formula-based diction where they are collected, higher-income sharing makes receipts for subnational govern- territories will receive greater revenue. This ments more certain, thus enhancing their ability mechanism would be counter-equalizing, requir- to plan efficiently. Depending on what the for- ing that the distribution formula incorporate an mula includes, distributions from this pool can equalizing component. direct resources toward oblasts whose fiscal ca- Another major issue is that the VAT may not pacity is relatively weak and/or whose level of lend itself easily to derivation sharing as the need is relatively great. The more of the pool that Russian economy changes in the next few years. is allocated to the formula component (and thus Industrial provinces whose value added is high the less that is allocated to the derivation compo- may have a decided advantage, and oblasts nent), the more equalizing the overall system whose enterprises sell to foreign markets may might be. suffer a decided disadvantage from zero-rated What indicators should be included in the for- exports, "port" cities and oblasts would gain, if mula? In most countries that use this strategy, and when imports are taxable under VAT. In the the formula consists of (1) some estimate of ex- model proposed here, this problem could be ac- penditure needs, (2) an assessment of revenues commodated if the VAT were eliminated from to finance these needs, and (3) a rule about how the part of the common pool that is shared on a far the equalization should reach. The most diffi- derivation basis. However, doing so would in- cult task is to define the expenditure needs of volve an important trade-off because eliminating each jurisdiction. The configuration of the for- the VAT would make the derivation sharing pool mula is as follows: Grants = Expenditure needs - 85 Revenue capacity. With expenditure needs and Derivation Sharing and Formulas: Some Issues. revenue capacity estimated, the formula-based distribution would be allocated across oblasts to How large should the derivation pool be relative fill either the estimated deficiency or a propor- to the formula distribution pool? In most coun- tion of the estimated shortfall. Some strategies tries, some equalizing is appropriate, thus argu- used by other countries are described in Box 4.3. ing for a sizeable formula-based pool, especially In Russia for the time being, simplicity should if the national consensus is that levels of service be an overriding concern. Some countries use as provision should not differ "excessively" across simple an indicator as population, and establish oblasts. And if the federal government does not equal per-capita needs. (Ultimately, the objec- provide cost-reimbursement for nationally man- tive should be to move toward broad indicators dated safety net programs, some equalization of need and fiscal capacity.) Russia is probably might also be necessary, given that responsibility not ready to move to a system based on income for the social safety net has been passed to sub- as an indicator of fiscal capacity, due in part to national governments. the difficulties associated with existing measures But important tradeoffs exist. Equalization of income. But it should be possible to identify will penalize better-off regions that have the some broad indicators of need. For example, the greatest potential for industrialization and size of the population, the concentration of high- growth; excessive equalization can push a region cost citizens (for example, pensioners), and the to rely on transfers, and can reduce incentives dlegree of urbanization are examples of indica- for local resource mobilization efforts. At this tors sometimes used in industrialized countries. point in Russia's history, the intergovernmental Basing the formulas on certain key indicators of fiscal system should probably place priority on public service needs (for example, miles of sub- the initiatives and fiscal energies of the better-off standard roads, or deficiencies in school and areas, in the interests of more rapid economic hospital space), is a strategy used by other coun- growth. It could do so by allocating a relatively tries. Still other countries (notably Denmark) larger proportion of revenues on a derivation ba- qjuantify expenditures, item by item. This con- sis, but also by giving oblasts and larger cities cept of this strategy is similar to the system of some powers to set tax rates, possibly through a expenditure norms once used to determine ex- surcharge mechanism (described later). penditure needs in Russia. However, the draw- back of this strategy is that keeping it up-to-date Enhanced Subnational Taxes is complicated and expensive. The initial construction of the formula is an ar- The fourth leg of this framework is independent bitrary process. Many countries have chosen to subnational taxing power. Until oblast govern- resolve this problem by establishing a Grants ments are allowed to make not only tax but also Commission to develop a formula on a consen- expenditure decisions, they will never be fully sus basis. accountable for the efficiency with which they Box 4.3 Revenue Sharing Formulas: Some Strategies Two strategies are available for estimating expenditure needs, a crucial element in any formula-based system. One begins with concrete expenditure norms, and then seeks to "cost them out." Russia could do so by using existing (or modified) expenditure norms-for example, per-pupil costs of education, given the standard cost of a teacher, classroom operation, and so forth, to derive a cost figure in rubles. Performing this calculation for each expenditure function can build up each jurisdiction's expenditure need. While the precision of this strat- egy has much appeal (it is being applied successfully, for instance, in Denmark), its drawback is its complexity and the cost of keeping the indicators current. A different and far simpler way to define expenditure needs is based on umbrella variables such as popula- tion, per-capita income, city size, poverty rates, density, the centrality of a city, and so forth. This strategy is used in Germany and for some grant programs in the United States. The population figure is weighted higher for larger German cities to reflect their "central place" functions. The total weighted population is used to dis- tribute the available equalization funds. 86 Box 4.3 continued The formulas in many countries also incorporate an estimate of the revenue capacity of localities. The reve- nue-raising capacity of localiiies is important, because, if actual revenues and not tax capacities are used, an oblast could reduce its tax effort and collections and receive correspondingly higher transfers. An appropriate measure for estimating local revenue capacity might include any local tax bases-in Russia, tax bases such as property values and business turnover; in other countries, taxes over which the local government has discre- tion. Estimating the revenue potential of an oblast would entail multiplying the estimated tax base by the av- erage tax rate for each base. In Brazil, taxes on income and industrial products are placed in a common pool from which a pre-specified share of federal taxes is transferred to the States' Participation Fund (FPE). The Council of States then deter- mines state shares based on area, population, and per-capita income. Other taxes, such as payroll tax and a tax on hydroelectricity and on minerals, are not distributed via the formula, but based on derivation. The merits of the FPE are transparency, predictability, autonomy, and redistribution. The distribution also re- flects fiscal need (by basing it on population), reflects fiscal capacity (basing it on per-capita income), and a guaranteed basic minimum grant. The FPE also has flaws: income is an imperfect measure of fiscal capacity; the formula lacks any explicit standard of equalization; states with similar fiscal capacity receive widely dif- ferent entitlements; and the States Council finds the formula results unacceptable. In India, each major tax is assigned a formula that dictates how revenues will be distributed between the cen- ter and states, and among states. Although the weights placed on formula components differ by tax, the fac- tors included in the formula are generally the same. For example, 85 percent of income tax goes into a state pool from which allocations are made according to each state's "contribution" to taxes, the "distance" of in- come per-capita relative to states with higher per-capita income multiplied by the population, population and "backwardness" (as measured by the population of tribal groups associated with underdevelopment and the number of agricultural laborers). The Finance Commission meets at least once every five years to make rec- ommendations about the design of tax sharing and grant formula. In Nigeria, most taxes are collected by the federal government, except for the personal income tax, which is collected and retained in full by the states. A share of federally collected funds (31.5 percent) is allocated into a States Joint Account (SJA). A formula is used to distribute 95 percent of the SJA, with the following compo- nents: population (40 percent); "minimum responsibilities of government" (40 percent-the proportion of re- current expenditure to total federal revenue of the state with the smallest budget in a given period); a social development factor (15 percent) that currently includes indicators of school enrollment and may be expanded to include health indicators; and internal revenue effort (5 percent). The other 5 percent of the SJA is not placed in the equalizing pool, but is distributed to mineral-producing states on the basis of derivation. In Nigeria, local governments also receive federal funding. Ten percent of all federally collected revenues are allocated to the local governments. Of this amount, 25 percent is distributed in equal shares to local govern- ments; the rest is distributed by population. A problem with the local scheme is that it does not consider the capacities of local governments. A third special fund allocates 3.5 percent of federally collected funds for Fed- eral Capital Territory and to states on the basis of their ecological problems. Formula-based distribution is im- portant in Nigeria because, without it, distributions could be sensitive to political pressures. In the Philippines, 20 percent of federally collected taxes are allocated to the subnational pool. This pool is dis- tributed according to a formula which includes population (70 percent), land area (20 percent), and equal shares (10 percent). The tax on petroleum products is allocated on the basis of derivation. In Canada, the goal of the equalization formula is to ensure that all provinces receive the equivalent of at least the national average tax rate applied to the national average revenue base. The following calculation is made for each provincial tax for each province. First, the national average tax rate is determined by dividing the total tax revenue for all provinces by the total tax base for all provinces. Second, this rate is applied to a province's revenue base, and a provincial per-capita yield is determined, which is applied to the total revenue base to de- termine a national per capita yield. The provincial entitlement is the difference in the above national and pro- vincial per-capita yields, times the province's population. 87 deliver services to the local population. Account- more accountable to their constituents. One ef- ability is one of the most important benefits of a fective way to levy them is to allow subnational decentralized system of intergovernmental fiscal governments to place a surtax rate on the nation- relations. Moreover, the local population would al PIT base. The surtax could be administered by be more amenable to tax increases if they are the STS. The added administrative burden im- willing to pay to receive better services. At posed by this system is surprisingly small. Each present, subnational governments can influence year, the oblast governments would establish the the rate of revenue mobilization but only next year's surcharge rate. The local STS office through "back door" methods-exerting pres- would be informed of the rate and, together with sure on their enterprises to comply, and urging the central rate, would apply it to the personal stricter enforcement by the STS. income tax base. The amounts thus collected would be remitted to the oblast accounts in the The "21 Local Taxes" usual way. Box 4.4 shows how such a surtax might work. The Basic Principles prescribe a list of 21 local The importance of increasing revenue from taxes. With the exception of the land and proper- oblasts property, land, vehicle, and other taxes ty tax, the time may not be ripe to push ahead should not be underestimated. The present sub- with these taxes, since they are not likely to be national tax base is weak. Many subnational very revenue-productive and will strain the lim- govemments continue to receive revenues from ited resources of the STS. In many countries, the profits of their enterprises, including some they would be considered "nuisance taxes' newly established joint ventures. They may also whose compliance costs slow down the work- receive revenue from the sales of assets they ings of the economy. Finally, they are liable to di- o vert the attention of policymakers away from But both are shrinking sources, since privatiza- more productive revenue altematives, such as t surcharges~~ ~ (seblw .n heices nue tion will leave all earnings in private hands, and surcharges asee loeow anl tl e increase in user the locally owned stock of enterprises will even- charges at the local level.tulydsper Some discretionary subnational tax sources tuallydisappear are better and more revenue-productive: (1) a surcharge on the PIT, up to a limit prescribed by Conclusions the federal government; (2) a tax on land values within urban areas; (3) a tax on the ownership This "four-legged" structre provides a flexible and operation of motor vehicles. These taxes are framework for intergovernmental finances. First, advantageous because their burden falls on local it supports a combination of strategies and per- citizens, thereby increasing the accountability of mits these strategies to change over time. It is local officials; and they could engender greater compatible with shifts in expenditure responsi- compliance and be more revenue-productive bilities between the federal and subnational lev- than the minor taxes now proposed in the Basic el; if additional expenditures are shifted Principles. All three would probably support the "downstairs," the subnational portion of the di- more progressive distribution of burdens. Their visible pool can be increased. Second, it is com- major disadvantage is that the property and ve- patible with changing the emphasis on growth hicle taxes would require some investment in rather than on equalization. If greater emphasis setting up an administration, and both would on equalization is desired at some later stage, the have to be collected by the STS, which would not portion of the subnational pool distributed on a share in the revenues. formula basis would be made larger. If a deci- sion is made to allow the better-off areas to reap Surcharges the benefits of their larger fiscal capacities, the derivation pool could be enlarged. Choosing the Introducing surcharges would give subnational degree of equalization is essentially a political governments some limited power to set tax judgment, made differently in different coun- rates, giving oblast and rayon governments tries, and changeable over time. Third, the four- some influence over the amount of government legged structure is compatible with changing the spending, and making their spending decisions share of "own revenues" and shared revenues: 88 Box 4.4 Tax Surcharges and Base-Sharing Model Under tax-base sharing, subnational and central governments share in the base of major national taxes, such as those on personal or enterprise income. In principle, a surcharge on the PIT is preferred because the PIT falls on local residents, and a tax imposed on local residents is more suitable for local financing than one that falls on those outside the local area, such as a CIT or VAT. Moreover, subnational governments already share in the PIT in Russia. The PIT may also give subnational governments a more stable tax base (wage income) than would the CIT or VAT; and a PIT surcharge is administratively simpler than a surcharge on the VAT or CIT. The VAT is especially unsuited for a surtax (or for derivation sharing). One problem is that oblasts that spe- cialize in intermediate goods would almost certainly prefer to "export" taxes to other oblasts, rather than to zero-rate their own "exports." A true destination VAT would require an adjustment for taxes on "imported" goods, as will now be the case in European Community (EC) countries. However, it is doubtful that oblast governments would wish to give credit for "foreign" taxes on "imported" inputs purchased from suppliers in other oblasts. In Brazil, the provincial VAT, creates considerable administrative and collection problems, even though the federal government sets maximum rates. While the EC experience of VAT harmonization offers some parallels here, it appears unlikely that a regionally rate-differentiated VAT could operate satisfactorily in Russia.' Under a surcharge model, the national (central) tax would be totally independent of the subnational tax; as long as subnational governments did not change the central base, they would be permitted to elect a surtax rate on the central tax (within a range). For example, a basic rate (say 12 percent) on the PIT could remain, and individ- ual subnational govemments could impose an additional rate of 1 percent (minimum) or 5 percent (maximum) at their discretion. The simple numerical example below describes one version of how a PIT surcharge could work, and how an employee would be treated under this system. We have assumed a national tax rate of 12 percent and a sur- charge of 1 percent, with the result that the STS collects R 2500 from this employee for the individual local government and R 31250 for the federal government. Under this surcharge, all employees would have to inform their employer each year of their locality of resi- dence, as of a certain date, just as they now disclose their family status. The withholding agent would with- hold the tax appropriate to each individual, based on the tax tables. The amounts would be remitted to the STS, and, via the banking system, to the central and subnational government accounts. In another version of the surcharge, local governments would receive a percentage of the tax: an additional (say, 5) percent of the tax would be collected for remittance to the local government. This differs from the base-sharing version, in that the local government would be affected by central decisions about tax rates, as well as tax-base structure. China uses this strategy for the local sharing of sales taxes, and some by the local governments in the United States use this method to share income taxes. Gross Income 300,000 Less Exemptions 50,000 equals Net Taxable Income(tax base) 250,000 National PIT at 12 percent 31250 Oblast Surtax at 1 percent 2500 a. See Tait (1988). as experience with surtaxes and other local taxes difficult resource allocation issues in the federa- is gained, they can be modified. tion, such as natural-resources revenue sharing The importance of developing a framework and the demands for autonomy by oblasts that such as this, built on consensus and in the con- contain ethnic populations. A transparent and text of an institutional process to which all fair system-where all agree on the rules- oblasts and the center adhere, cannot be over- means that oblasts need not hold on to their few stated. An intergovernmental system that is per- bargaining chips-natural resources and their ceived to be fair and equitable can defuse other revenue share. In sum, at a time when nation 89 building is paramount, a well- designed inter- the local level, have no existing capability to ad- governmental fiscal system can make an impor- minister taxes, and a change would disrupt the tant contribution. functioning of govermnent further at a time when stability is necessary. In the longer run, Other Issues in the Tax Sharing Framework subnational governments may play a role in some aspects of property tax administration, but Scope of the Intergovernmental System at present this is not advisable, given the dearth of administrative personnel.7 Should the fiscal structure define tax (and expen- However, the government should seek to diture) assignments only to the oblast level, and eliminate the de facto "dual leadership" faced allow the oblast soviet to decide the distribution by the STS, relating to its reliance on local gov- within its boundaries? Or should the intergov- ernments for housing and fringe benefits. As ernmental system be structured to prescribe the in many other countries, rotating lead officials exact allocation of fiscal resources to oblasts, as could address this dual leadership problem. well as to cities and rayons? Extending the sys- The problem could also be resolved if the fed- tem to the sub-oblast level would give the feder- eral government assumed responsibility for al government maximum control over the providing all fringe benefits to STS officials, regional distribution of resources, since tax col- and for providing office arrangements, and so lection and assessment and much of the expen- forth. Eliminating this dual loyalty is essential, diture delivery and budgeting actually takes since the STS is assuming a larger role in col- place below the oblast level. However, local af- lecting and remitting taxes to the center. In fairs may be handled more efficiently by the Tyumen, for example, the STS has assumed the oblast than by Moscow, especially in a country role previously handled by the State bank, in as large as Russia. A later section of this chapter remitting locally collected taxes to the center: discusses this issue in greater depth. this role-and dual loyalty-make it both pos- Tax Administration Responsibilities sible and tempting to remit less than the full amount-in effect going the "single channel" The assignment of taxing powers specified in route. the Basic Principles conflicts with the present as- signment of tax administration responsibility- Fiscal Discretionfor Large Cities the STS. The Basic Principles requires that the STS collect taxes which accrue to subnational govern- Should special treatment be given to large cities? ments, as well as several minor local taxes (from In Russia, as in most countries, the taxable ca- which the center derives no revenue), as efficient- pacity of the largest cities is greater, and they ly as it collects taxes that would accrue to the cen- also have more complex and expensive expendi- ter. A reasonable fear is that, since local STS offic- ture needs. Special treatment could be thought of es suffer from scarce resources, they may devote as additional taxing powers (for example, a larg- their resources more heavily to collecting central er surcharge on central taxes); alternatively, larg- taxes. er cities could also receive special support in Given scarce administrative resources, the cur- implementing the property tax, or special rights rent central tax administration can and should to set prices (user charges) for municipally pro- be retained to collect taxes shared with subna- vided services over and above those allowed by tional governments. The superior administra- the supervising ministries at the federal or oblast tive capacity of the center, and the economies of level. Special investments could also be made in scale associated with collecting and auditing better tax administration, and, in the future, bor- multiple taxes, argue for a single tax administra- rowing powers could be enhanced. In Russia, ion. However, a central tax administration may these actions could include all oblast seats, or not be a viable collection agency for purely local other large industrial centers whose expendi- government taxes. tures needs are high and that are willing to tax Switching to separate subnational and central their own citizens in order to provide better ser- tax administrations would be ill-advised at vices than those financed through the standard present. Subnational governments, especially at regime. 90 The Need for a Transitional Mechanism Targeted Transfers for Social Protection Would the immediate enactment of a program In 1992, the transfer of social protection responsi- such as the one proposed in this report be too bilities has placed a great burden on subnational much of a "shock" to the system? In all likeli- budgets and has put vulnerable groups at risk. hood, it would. Some transition rules would be Because the protection of socially vulnerable required to protect oblasts from unreasonable groups during economic transition is a priority one-time effects. of the federal government, it is appropriate that the federal budget resume financing these ex- The Conditionality of Tax Shares and Transfers penditures. After prices have been liberalized, the subsidies will no longer take the form of pro- The Basic Principles assigns taxes to subnational ducer price subsidies, but will be cash subsidies. governments, and other legislation gives them Reaching truly needy persons will require that autonomy in spending these funds. Thus, subna- these cash benefits be targeted. The administra- tional governments could emphasize spending tion would continue to operate through the ray- on projects that generate benefit primarily to lo- ons, which would be reimbursed on the basis of calities, while underfunding projects whose ben- actual payments made by the federal level in a efits accrue to the national interests-those program of "cost-reimbursement." The rationale whose externalities are sizable. This tradeoff is for financing federal-level capital investments at an issue that faces designers of intergovernmen- the central level was discussed in chapter 3. tal fiscal systems in all countries, and they usual- ly resolve it by imposing some conditionality on Special Treatment for Special Areas the subnational governments. Somehow, issues ahessociatedwithofinaniovemmeng Servcesha, h ues m The design of fiscal federalism in Russia is made associated with financing services that have ma- more complicated b the fact that some territo- jor externalities must be addressed-either some mrcopliae bythfathtsoeer expenditure mandates must be imposed sore ries are demanding political autonomy, greater tapenditunctio musatbes aussmed directly b ter devolution of responsibility for expenditures, or federal govnsmuen special tax regimes. Such demands have arisen in three situations. First, areas inhabited by non- Subnational governments should be able to Russian ethnic groups (which form the majority spend their own revenue sources as they want.8 of the population only in Tatarstan) claim the If local taxpayers are unhappy with the actions right to greater autonomy given their different' of their locally elected authorities, they can dis- history and culture. Second, some areas rich in miss them. Conversely, local autonomy can natural resources feel entitled to special financial make local governments more accountable to the arrangements that allow them to derive greater central government (that is, to taxpayers in gen- benefits from their resources. Some of these re- eral) depending on how central government gions note that development in their area has not transfers are designed. In many countries, sub- benefited from the presence of natural resources; national governments are made accountable to in fact, their area has suffered severe environ- national service provision standards-that is, ed- mental damage in the light of resource exploita- ucational achievement, health care provision, in- tion. These first two categories overlap where frastructure maintenance, and so forth. territories inhabited by ethnic minorities are re- source-rich. Third, areas that are currently more Targeted Intergovernmental Transfers developed, and can grow more rapidly than oth- ers, may prefer greater fiscal autonomy or spe- In many countries, transfers may be used to in- cial fiscal arrangements in order to benefit from fluence spending patterns at lower levels of gov- their stronger economic position. ernment. In Russia, the most important application of such transfers was to provide so- Ethnic "Separatism." Separatist sentiments ex- cial protection and support capital investment, pressed by areas that contain ethnic minorities financed entirely or partly with nonmatching have manifested themselves in disturbing ways. targeted grants to oblast-level governments until Some oblasts (most notably Tatarstan) have de- mid-1992. clared a state of quasi-independence from the 91 Russian Federation. Reportedly, some regions are regimes, and the proposed four-legged fiscal sys- insisting that a "single channel system" by estab- tem that incorporates a comprehensive distribu- lished, whereby all revenue flows initially to sub- tion formula. national governments, and then through a nego- tiated single payment to the federal government. Ad-Hocery. In the past, the Russian central gov- Bashkiria has already negotiated such an agree- ernment has dealt with disgruntled areas in an ad ment with MOF, although it has not been ap- hoc fashion, primarily by providing intergovern- proved by the Supreme Soviet. In other cases, mentally negotiated subventions. This solution is such as Tatarstan and the reportedly 20 oblasts not transparent, and some oblasts perceive that that have determined their own sharing rates uni- others are striking deals with the central govern- laterally, this approach is being implemented in a ment, creating a sense of injustice. The need for de facto and presumably illegal manner. transparency is particularly great in Russia at this time, when people, many of whom are skeptical, Resource-Rich Areas. Whether resource-rich re- are testing out democracy gions should receive an extraordinary share of the resource taxes depends, conceptually, on the Special Fiscal Regimes. The current trend in nature of the Russian Federation (whether "we" which some disgruntled oblasts are deciding uni- represents the citizens of the Russian Federation laterally to implement a "single channel system" or the citizens of a smaller jurisdiction). The draft is dangerous, potentially threatening the finan- law on ethnic minorities appears to accord sub- cial (and political) viability of the Russian Feder- stantial property rights to the native populations ation. (This trend contributed to the financial of resource-rich areas. Moving beyond the claims bankruptcy of the Soviet Union and hastened its of native populations to resource revenues, it is not political demise.) These developments call into obvious which level of subnational government question whether special fiscal status should be should benefit from resource rents and which granted to some territories within the Russian should not. Nevertheless, natural resource-rich ar- Federation. A few countries (for example, Spain, eas are demanding greater benefits from their re- Australia, and the Philippines) do provide "spe- sources than they have received in the past. cial regimes" within otherwise uniform systems (see Box 4.5). One possible regime in Russia could Industrially Well-Endowed Regions. The claims of call for eligible localities to share an amount territories whose industrial bases are large and ef- equivalent to a multiple of the per capita national ficient are similar to those of resource-rich areas: average remittance. Alternatively, a smaller pro- the previous totalitarian regime left an "industrial portion of revenues could be shared as soon as a endowment" akin to the natural-resource endow- certain level of remittance had been reached. ments. Should the local populace or the people of While widespread single-channel systems Russia benefit from this industrial endowment? could threaten the viability of the Federation, in- This issue is complicated somewhat by the possi- sistence on totally uniform fiscal treatment in the bility that areas whose industrial bases are strong face of strong forces that demand preferential might be best able to utilize public revenues to in- treatment could also threaten the political exist- vest in infrastructure that support production and ence of the Federation if disgruntled groups de- thus fast-growing enterprises. Given the non- cide to opt out. While the need for special treat- transparency of the present system, and the per- ment should not be taken lightly, special fiscal ception that tax sharing works against the better- regimes should be granted judiciously. Once off oblasts, many rich oblasts perceive that they granted, demands for special treatment will are subsidizing the poor. This perception may en- spread rapidly (ideally, special regimes should courage the wealthier republics or oblasts to de- not exist, unless serious political conflict would mand special treatment that permits them to ben- exist without them). When granted, special treat- efit more fully from their own endowments. ment is virtually impossible to claw back. Addressing Special Areas Flexible Comprehensive Formulas. The third way to address demands for special fiscal treatment is These demands for special treatment can be ad- consistent with the four-legged fiscal framework. dressed in three ways: "ad hocery," special fiscal Many oblasts-those rich in natural and industri- 92 Box 4.5 Special Fiscal Treatment for Special Areas? Complicating the process of expenditure assignment, and the design of fiscal federalism in general, are the de- mands for autonomy and pressures for political devolution aired by territories inhabited by ethnic minorities. These demands have been "louder" when disputes about the rights to oil and other mineral resources are in- volved. This conflict calls into question whether special fiscal status should be granted to some territories. Several decentralized systems of intergovernmental relations allow for special regimes within the unified sys- tem. Such regimes may be appropriate when regional diversity is significant, and when the uniform fiscal sta- tus of all provinces vis-a-vis the federation is not manageable. In Spain, the fast switch from a strongly unitary state to a semifederal structure of government in the late 1970s was made partly in response to deep-seated cultural differences and was conceived as a way to strengthen the return to democratic rule. As in Russia today, addressing regional autonomy was the most dif- ficult task for the designers of the new constitution in Spain. One of the most interesting lessons from the Spanish experience is that a nonuniform approach to decentrali- zation and local autonomy can work. Special treatment was granted to territories that claimed special status for historical and cultural reasons, including the Basque Country, Navarre, Catalonia, and Galicia. This special treatment did not create important problems with the rest of the regions, because their demands for autono- my were much less pronounced. While most regions rely on central government transfers of centrally collected taxes for their finances, Navarle and the Basque country acquired the right to levy and collect all taxes, except for customs taxes and excises on petroleum products and tobacco. From the revenues collected from all other taxes, the regional authorities in the Basque country and Navarre must make an annual lump-sum payment to the central government for the services still provided at the central level. These payments are agreed upon for a period of five years, but an- nual payments can be adjusted for inflation. In the Philippines, the Muslim Mindanao and Cordillera have demanded and received more self-government due to their different religious and cultural heritage. Insurrection and calls for secession led the government to pro- claim greater autonomy for these regions in 1989. The Organic Act for Muslim Mindanao provided a new finan- cial structure for the region by devolving significant fiscal powers and responsibilities to the autonomous region. Most expenditure functions were devolved to the local governments, and central approval of expenditure lev- el and composition was eliminated. (Only national defense-type functions were kept for the central govern- ment.) The revenue base for the autonomous region was defined differently from the rest of the country, and the regional government was given broad taxing powers. Income taxes and customs duties may not be levied by the regional government; however, the region may impose other taxes, levy fees and charges, and share in the revenues generated by public utilities within the region. The region may also retain 60 percent of internal revenue collections, to be divided equally between the regional and provincial governments. Legislation has also ensured that all corporations engaged directly in business in the autonomous region pay the regional government a portion of their annual tax on net business income in their region. In China, beginning in 1979, Guangdong province was accorded special rights and privileges. Fiscal contract- ing-under which the province delivered a fixed nominal revenue amount to the center annually-allowed Guangdong to retain a growing share of revenues collected in the province over a five-year period (a system similar to the system that Bashkyria has negotiated with the federal government in Russia). The fiscal contract was revised twice, and the basic "delivery" was increased by 9 percent a year. It was highly beneficial to Guandong (and the other provinces that had this special regime), but damaging to the central government in that the contract impaired macroeconomic stabilization policy, and prevented the center from sharing in the revenue growth of one of the revenue-richest provinces. In Australia, beginning in 1978, the Northern Territory became a "self-governing" territory, with expenditure responsibilities and revenue-raising powers approximating those of a state. The Northern Territory (Self-Gov- ernment) Act provides that its revenues, loans, and other moneys received constitute public moneys available to defray its expenditures. The Australian "Grants Commission" t also gave special assistance to the Northern Territories, given its high proportion of aboriginal people, and their special problems: higher expenditures were granted to enable the aboriginal peoples to manage their own affairs. In addition to the general revenue assistance provided on the basis of a formula, "additional assistance," "special assistance," and "specific pur- pose revenue grants" can be issued to the Territory on an annual basis. Each year, the Grants Commission re- views such requests and recommends action. 93 al resources, for example-resent the (perceived) cy necessary to prevent the sense of injustice. cross-subsidies inherent in the present system The perceived fairness of the formula would en- and want to opt out. However, if one oblast is courage areas to stay within the system, rather granted a special regime, others whose economic than to opt out (thus reducing the common strength is almost on par could demand similar pool). Moreover, while disgruntled areas could status, leaving only the poorer oblasts in the sys- still demand special treatment in the formula tem. Ironically, then, too much emphasis on (rather than via a special regime outside the sys- equalization at this stage may be a stimulus for tem), formula decisions would be fixed by an the wealthier to withdraw from the pool, thus objective commission for a period of, say, five compromising the system's potential for imple- years, thus insulating itself from political menting any equalization. The framework pro- pressure. posed herein for a new intergovernmental system As Russia searches for national definition after can help address this tension by providing a the dissolution of the Soviet Union, the immedi- transparent division of revenue-sharing between ate need for political unity may be as great as the equalization (the formula grant component of the need for equity. Rather than allowing oblasts to divisible pool) and derivation-based sharing. The negotiate individually for special fiscal regimes possibility that an independent, objective Grants or decide unilaterally to opt out of the federal Commission would decide on the distributions system, the government should encourage wide- would enable the nation at large to participate in spread participation by establishing a distribu- determining the size of the two components. tion system that does not overemphasize region- The equalization formula can also address the al equalization and which incorporates special demands for other special treatment, by incorpo- circumstances within its distribution formula. rating specific factors that are assigned higher Formula-based distribution can promote democ- weights. For example, the politically sensitive racy, engender patience with economic reforms state of Punjab in India receives additional gov- through its transparency, pacify disgruntled ar- emnment funding from a component of their tax eas and keep them in the equalization pool as devolution formula that recognizes the difficul- the notion of "we" becomes grounded more sol- ty of being a border state. Moreover, as part of idly in the nation, and changes with the times-a India's grant formula, "backward" areas are as- very relevant issue given the pace of economic signed a extra weight that gives them extra com- and institutional change in Russia. pensation. In Russia, the distribution in formula The intergovernmental system can play an im- might assign a higher weight to areas that con- portant role in defusing the centrifugal forces tain a large concentration of ethnic minorities, arising in well-endowed or natural-resource- thus giving them more revenues. These areas producing regions by containing them within an could perhaps assume even greater expenditure agreed-upon framework. Unless a transparent responsibilities than others, thus giving them system of intergovernmental relations is devel- greater autonomy than other areas while allow- oped, based on the consensus of all parties with ing them to retain their participation in the com- something at stake, the risk to the federal level mon pool. The formula could also be structured will probably continue in a negotiated system. to compensate areas rich in natural resources Without rules, subnational governments will that have suffered from underdevelopment and bargain for the best package they can get; they environmental degradation. will create their own "asymmetrical federalism" and special regimes. If localities perceive that Special Treatment under the Proposed System they are being treated fairly by the uniform sys- tem of intergovernmental relations, they may The idea of using a formula to meet special cede demands for "asymmetrical federalism." needs is appealing for several reasons. While the In particular, a formula-based regime that ad- formula is an objective distribution method, dresses their needs may be able to respond to the once established, its component parts permit demands for "special treatment" more objective- special treatment where deemed appropriate by ly-but treatment will be accorded by virtue of policymakers. The components of the formula the formula, not on the basis of ad hocery. A flex- would appease disgruntled groups, while the ible formula that responds to shorter-term fiscal formula overall would maintain the transparen- goals while also promoting the nation-building 94 is necessary for longer-term fiscal health. More Intra-Oblast Fiscal Relations generally, a system that is perceived to be fair, is transparent, and is developed in the course of an The oblast Soviet is responsible for allocating fi- institutional process in which all oblasts have nancial resources among the rayons and munici- participated, is itself likely to improve consensus palities within the oblast. It determines the share on revenue sharing and improve the system of of taxes that may be retained by each rayon gov- fiscal federalism. emient (and by the oblast government). Be- cause it may choose to allocate an additional Data Requirements for Fiscal Management subsidy to rayon governments, it determines the level of spending by each local government. Developing and quantifying any options for re- In making these decisions about intra-oblast designing Russia's system of intergovernmental fiscal relations, the oblast Soviet is locked into relations will require detailed empirical work. some constraints: Designing (and, later, monitoring the perfor- * The tax rates and tax bases are fixed by the mance) of the new system of intergovernmental center and may not be adjusted. relations will be a data-intensive exercise. The * Some minor taxes and charges are pre- necessary data are not currently available. For scribed as fully local. example, investment data for the Russian oblasts * A national law, passed in April 1992, pre- have not been published since 1975. The central scribes revenue sharing from oil and specifically government, oblast-level organizations, and the mandates the local (rayon) share. In Tyumen League of Cities must begin to develop several oblast and Khanti-Mansisk okrug, the prescribed data bases. These data should include tax collec- sharing is okrug (30 percent), rayon (30 percent), tion and tax base statistics, expenditure composi- federal (20 percent), and oblast (20 percent). tion and needs measures, socioeconomic These constraints have three advantages.First, population characteristics, and the stock of phys- they get the central government out of the busi- ical infrastructure and its state of maintenance. ness of having to make fiscal decisions about the The tasks ahead for data collection are formi- revenue needs of thousands of local gover- db.dlicoordi- ments. Second, they make the oblast Soviet more dable. Ideally, the central government,siaccountable to the local population for the re- nation with the subnational governments, sults of its fiscal decisions. Third, they clearly should work to put together a 'Census of Gov- represent a step toward fiscal decentralization, in ernments." Subnational governments whose that they bring government "closer to the peo- record of data collection iS soor and which lack , trediof data clen ction is a w lack pie." However, the system also raises several is- tradition illustrate the need for ~bold action at the sues and problems. top level of government. Designing the new system of intergovernmen- Issues and Problems tal relations requires an explicit and detailed ac- counting of the costs to be borne by subnational Disparities among Rayons. The economic well- governments for both newly transferred respon- being and fiscal capacity, within each oblast vary sibilities and traditional responsibilities. Without widely. Thus, each oblast must make some very a rigorous effort on this front, the adequacy of difficult decisions about fiscal equalization. The subnational revenue assignments will remain at oblast Soviet cannot simply extend the central- a conjectural level. Similarly, designing a system oblast revenue-sharing scheme based on the of intergovernmental transfers whose objective derivation principle, because it would exacer- is to equalize opportunities across oblasts will bate the economic disparities among the local require accurate information on expenditure governments. For example, within Ryazan needs, tax bases, and subnational government oblast (which has 13 rayons and 2 cities), per- tax efforts. Most industrial countries have stan- capita expenditures were more than three times dardized data sets that are used regularly for larger in the highest-spending locality than in policy and research purposes. Experience else- the lowest. Per-capita expenditures were 50 per- where could be useful to the Russian govern- cent to 100 percent greater in the city of Ryazan ment, and this area may be a rewarding one for and in Skopin than the average for all Ryazan's technical assistance. rayons. 95 Box 4.6 Intra-Oblast Revenue Sharing Based on field work in Tyumen, Nizhny Novgorod, Ryazan, and Moscow oblasts and in Khanti Mansisk okrug, it appears that the manner in which oblast governments allocate revenues among local governments varies widely. However, all of these oblasts use a derivation principle as their primary of revenue-sharing mechanism. After the central government changed its revenue-sharing program on the VAT to a flat 20 per- cent, and increased the locally retained share of CIT from 15 to 19 points on the 32 percent rate, all the oblasts visited in the course of field work also adjusted the oblast-rayon sharing formulas. All three of the oblasts visited after the change switched to flat-percentage sharing for all rayon gov- ernments. These shared taxes were supplemented with various types of subventions. The exam- ples in the following table give some idea of the variety of sharing arrangements as of July 1992. Revenue Sharing in Three Oblasts: July 1992 (Percent of revenues accruing to each level) Moscow Oblast Tvumen Oblast Khanti-Mansisk Okruj Tax Rayon Oblast Rayon Oblast Rayon Okrug PIT 100 0 100 0 92.5 7.5 CIT 63 37 74 26 53 47 VAT 0 100 75 25 75 25 Moreover, the oblast government must allo- growth strategy for the next ten years on the de- cate a share of retained revenues for its own velopment of urban centers and on the develop- functions. Thus, the oblast Soviet must incorpo- ment of industries that require skilled labor and rate equalization features in its revenue-sharing infrastructure at a certain level of provision. Un- system. But doing so raises some tension with der the current system, the central government the better-off local governments-particularly could not implement this strategy easily. The the urban centers-which perceive that they are oblast Soviet could still choose to allocate re- unduly discriminated against as equalization sources away from urban areas and toward rural proceeds. The situation is exacerbated because areas, and could choose whatever focus on edu- urban areas have very pressing needs for public cation that it wanted. The existence of this option services. At present, at least some oblast govern- illustrates a major problem with strong subna- ments have opted to use flat-rate tax sharing tional governance. In truly decentralized sys- (which is counterequalizing) in tandem with tems, the central government loses considerable equalizing subventions (see Box 4.6). control over how such national strategies are im- plemented. Revenue-Raising Efforts. A second, closely relat- ed problem is that equalization may tend to Planning Certainty. A third problem with the dampen efforts to increase the rate of revenue present system is certainty. Oblast and rayon gov- mobilization. STS staff is closely linked with the ernments must be able to ascertain the flow of subnational governments (rayon and cities), and as- revenue to them in order to plan their budgets. sessment and collection efforts at the local level may The current revenue-sharing system has changed 'be less successful (perhaps less vigorous) if the local markedly during 1992, and efficient fiscal plan- community believes that it will not receive an ade- ning has virtually been impossible. And because ,quate return from its increased revenue effort. taxes are shared on a derivation basis, the oblast Both issues point to a major underlying con- Soviets have changed the intra-oblast fiscal ar- cern-that the decisions of oblast Soviets may rangements each quarter. not be reinforcing the economic policy of the central government. One can best illustrate this Subnational Autonomy. Fourth, even if decisions concern with an example. Suppose that the cen- about fiscal distribution were left to the oblast So- tral government decided to base its economic viet, it would not be enough for the strongest ad- 96 vocates of fiscal decentralization. They would ar- * An exact allocation of fiscal resources could gue that greater autonomy be granted to the local be prescribed to oblasts, cities, and rayons. (rayon and municipal) Soviets. Afterall, the pop- * General guidelines could be established for ulation of the oblast may consist of several mil- the distribution of fiscal resources within the oblast. lions of persons, and the oblast Soviet is far re- Centralization may be the least desirable of moved from the needs of the local population. these alternatives. In a country as large and di- The local Soviets are closer to their people and the verse as Russia, it is unrealistic to believe that the problems, and to those who must ultimately pay public service needs of each local area can be as- the taxes to support government expenditures. sessed properly from the center. Moreover, the Thus far, the lowest-level Soviets have not been central government is ill-equipped to undertake given much say in determining the level of the lo- this task. Data that describe the fiscal situation in cal budget. local government areas are unavailable, and local Finally, a special problem is associated with areas do not have the capacity to monitor fiscal the allocation of the individual income tax. The outcomes. Perhaps the greatest drawback is that tax currently accrues to the place of collection- centralization would be a move away from fiscal where the job is located. Because none of the rev- decentralization, which would make oblast-level enue accrues to the place of residence, a mis- officials less accountable for their fiscal decisions. match exists between the rayon where a worker Thus, the report recommends that federal-sub- uses services and the rayon that receives the tax national fiscal relations not go below the oblast paid by him. level, for two reasons. First, it would imply a federal program that, in one single effort, would Reform Possibilities purport to equalization of almost 2,000 rayons among 91 oblasts. Second, it would necessitate The government is at the crossroads of decision applying the same formula to all sub-oblast about intra-oblast relations. The Basic Principles equalization, nationwide. A better route would law is ambiguous about this issue. Allocation be to leave the distribution to each oblast. If Rus- choices currently rest with the oblast govern- sia sees itself as a federation, such center-rayon ments, and some have opted to redistribute a relations would be inappropriate. In sum, the substantial amount of revenue away from the federal government should concentrate on find- urban centers to less-developed rayons. The is- ing a proper relationship with its oblasts and re- sue has become contentious, and calls have been gions, and leave intra-oblast matters to the sub- made for a federal formula that identifies the national councils. share of each local government, either to en- Continuing with the present framework hance the position of the rural rayons or to pro- would seem to be a reasonable option. It would tect the larger revenue base of the cities. impose less shock on the system at a time when In principle, there are three ways to deal with the system is fragile and undergoing major this issue. The first is complete centralization- changes. It would continue to give accountabili- that is, making intra-oblast relations a function ty for fiscal decisions to the oblast Soviet. It of the central government. Second, the situation would be consistent with the reality that certain could be left as is, allowing each oblast to work republics will be given greater autonomy. Oblast out its own difficulties. Third, the oblast Soviet Soviets are in a position to shape an equaliza- could be left to decide its basic fiscal structure, tion program for the rayons, and can assign the but required to conform to a prescribed set of oblast government those services for which ma- central mandates to constrain its decision where- jor externalities or economies of scale exist. by it conforms to central objectives. Each of these The central government may believe that the three strategies has its advocates. In other words, problems with oblast autonomy in this area are an intra-oblast intergovernmental system could severe enough to require some adjustments. In in principle operate in three ways: fact, a new draft law-Budgetary Rights of Local * A traditional federalism could be created Self-Governments-spells out the relationships whereby taxes are assigned to either the federal among levels of government, and proposes some or the oblast level, and the oblast could then de- important changes in revenue sharing and ex- cide on their distribution among the local govern- penditure autonomy.9 One basic principle in ments. this law is to give "structure to the relationship 97 between the rayon govermnent and its oblast to cover only about 30 percent of the operating government." The proposal is that the oblast cost. Many housing rents are still at their nomi- guarantee funding for 70 percent of the amount nal levels of 13 kopecks per square meter (set in necessary to provide a "minimum" level of pub- 1928). A recent law allows subnational govern- lic services in each rayon. ments to fix rents at any level. Many other user The advantage of this proposal is that it would charges are also set by the central government, allow the central government to set minimum without consideration of the cost differences standards in the delivery of some services. It among localities. Subnational governments have would also give the rayon and city governments no discretion to set rates. some degree of certainty in planning their bud- User charges do not contribute a large amount gets, since the 70 percent guarantee would be for to overall budgetary revenue. In 1990, nontax five years. The disadvantage of the proposal is revenues such as fees and fines accounted for that it would restrict the autonomy of the oblast about 3 percent of total revenue (see table 4.2). to plan its own economic development, thus Most of the local revenue proposed in the Basic constraining efforts to define needs in a "reason- Principles of Taxation is essentially user charges, able" manner. and they cannot be expected to create any signif- The problem of finding the proper fiscal rela- icant amount of revenue. However, user charges tionships among the central, oblast, and local should be used much more widely in Russia, governments is one that plagues countries both to create revenue and to increase efficiency. around the world. Many different solutions have Since subnational governments are in the busi- been found. The United States gives autonomy ness of providing services that benefit the local to the states in decisions about the proper rela- population, they must be able to maintain the tionship between state and local governments, strength of local finances by recovering the costs much as the present-day Russian system does.10 of providing such services, and to the extent pos- Both Nigeria and Brazil have defined the specific sible assessing those costs to the users of those role of local versus state governments in the sys- services. The first rule of local finance should be: tem, and many European countries (for example, "Wherever possible, charge." France and Great Britain) take a unitary ap- proach, whereby the central government plays a Cost-Benefit Signals direct role in determining local fiscal outcomes. Some "framework law" -perhaps a variant of The importance of user charges, benefit levies, the law currently under discussion-may be ap- and fees goes beyond the revenue collected propriate, in which oblasts are required to "pass from them. To the extent that a subnational through" part of their revenues to the rayon or government is viewed primarily as a provider city level, according to some agreed-upon guide- of services and that the services benefit specif- lines-perhaps on the minimum amount of the ic individual citizens, properties, or business- tax sharing that must be passed through. The es, the appropriate policy is to charge the United States used guidelines to distribute reve- correct price. Only with correct pricing will nue-sharing assistance to state and local govern- the right amount and type of service be pro- ments during the 1970s and early 1980s. vided to the right people, that is, those willing to pay for them. User charges are thus based User Charges, Fees, and Other Benefit Charges on the principle that, whenever possible, local public services should be charged for, rather User charges are currently applied in Russia to than given away. Correct pricing helps public some extent. User charges are assessed for water officials make sensible judgments about about consumption, and are levied on enterprises and how scarce resources can be balanced against on private households. For public utilities such rising demand. When the true cost (and relat- as gas, user charges do not exist, or are levied at ed user charges) rises so high that demand very low rates. It is not likely that the existing falls, it is clear that the costs of the services ex- user charges cover marginal costs precisely. ceed their benefits from the users) perspective. MOF recently raised the ceiling on urban trans- The signal is quick and clear. A decision must port fees from 10 kopecks (the original 1956 then be made to (1) increase the price and price) to 50 kopecks. But these fares are projected serve fewer people, (2) cut back on the cost 98 Table 4.2 Nontax Budgetary Revenue, Fees and Fines, 1990 Amount Percent of total (mil. rbl.) revenues Proceeds from Fines 167.0 0.26 Tax Evasion Fees 2.5 0.00 Proceeds from Claims Outside the Statue of Limitations 123.0 0.19 Fines on Officials 0.2 0.00 Proceeds from Sales of Public Property 69.0 0.11 Proceeds from Public Auctions 5.9 0.01 Proceeds from Sobering Houses 95.0 0.15 Special Fund of Budgetary Institutions 26.0 0.04 Unused and Returned Funds from Institutions and Organizations 138.0 0.21 Fees from Boarding Schools 6.8 0.01 Other Proceeds 408.0 0.63 Proceeds by Services Rendered by Budgetary Organizations 5.4 0.01 Sales from Damages and Outlet Products 5.1 0.01 Proceeds from Purchase Discounts 0.1 0.00 Dues from Public Inspectorate 4.7 0.01 Proceeds from Wholesale Discount Purchases 1.1 0.00 Rental Revenues 54.0 0.08 Proceeds from the Sale of Goods at Negotiable Retail Prices 500.0 0.77 Fines from Nonmaintenance of Quality Standards 4.8 0.01 Payments from Profits of Councils on Tourism 3.1 0.00 Proceeds from Sales of Apartments to Citizens 85.5 0.13 Payments for Delays in Commissioning of Projects 12.0 0.02 Proceeds from Economic Sanctions for Inappropriate Use of Material Resources 0.7 0.00 Water Usage Fees from Enterprises (USSR subordination) 231.0 0.36 Water Usage Fees from Enterprises (Russian Federation subordination) 30.0 0.05 Water Usage Fees from Enterprises (local subordination) 7.6 0.01 Tax on Owners of Motor Vehicles 6.5 0.01 Land Rental Fees 0.4 0.00 Total Nontax Budgetary Revenues 1,994.0 3.08 Total Revenues 64,793.0 100 Source: Ministry of Finance, mission calculations and standard of service to keep it affordable, Cost Recovery or (3) subsidize the service from general reve- nues. User charges are similar to prices: they charge An exception to this general principle pertains users of a particular service provided by the sub- to income redistribution policies. However, at- national government. For efficiency, user charges tempting to correct fundamental distributional should be levied on those who receive the bene- problems with inefficient pricing is essentially an fits-direct recipients, businesses, or property. unsound idea, and, consequently, many govern- The charges should be related to the amount of ments have encountered serious budgetary the service each individual consumes or benefits problems (and little redistribution). Some servic- from. For example, when subnational govern- es are difficult to charge for-because their bene- ments provide goods through local public ser- fits are diffused (spread over a large population) vice enterprises, such as water, power, gas, and or because they benefit difficult-to-reach groups. public transit, the goods should generally be Water delivery to a standpipe is an example. In charged for on a cost-recovery basis. Thus the these cases, the service can be financed with in- cost of providing the service should be recovered direct charges (property taxes) or general taxes from the users or the buyers of the service either (discussed below). Unfortunately, in most coun- immediately or over time. The price of water tries, user charges are used much less at the local should reflect the cost of piping it to the homes level than seems desirable. or standpipe, as well as the cost to maintain the 99 pipes, treat the water, and so forth. Likewise, a tlighting would be charged to help defray the bus fare should cover the cost of bus purchase, cost. A development charge may cover only one maintenance, gas, drivers, insurance, and so project-for example, a neighborhood road pav- forth. ing scheme or the construction of a sewage ca- Russia relies little on these charges at the nal-or it may cover the full development of a household level, and their future use may be new area. Development charges can be an equita- constrained by the difficulties of metering usage. ble tax, because those who benefit from develop- Nonetheless, at the industrial level, these con- ment pay for its cost. Two particularly successful straints do not generally apply, and such charges systems are land readjustment in East Asia and should be used more widely wherever possible. the "valorization system" in Latin America. Finally, to the extent that weak accounting sys- While benefit charges will be important for tems that do not identify these costs clearly lead Russia, the absence of private ownership will to underpricing these services, accounting pose a significant constraint against developing needs to be strengthened. More generally, the them. Exacerbating the difficulty is the quality central government should not, as it presently of data on land values. A properly functioning does, set ceilings on these fees or prices, and property tax is an administrative prerequisite to should allow subnational governments to set introducing development charges; when this tax them at cost-recovery levels. (It has been argued is introduced in key, pilot cities in Russia, seri- that the central government is much more likely ous attempts should also be made to supple- than the subnational government to raise prices. ment subnational revenues with development If so, then the center should develop estimates of charges. appropriate level of fees in different services ac- cording to broad orders of magnitude, and use Notes them as an indicative "floor" for such fees.) 1. While the rapid pace of change in Russia may seem Other Charges: Service Fees and Benefit Levies head spinning, some of the changes in the intergovern- mental fiscal system may be more apparent than real. Subnational governments can also obtain reve- For example, the substitution of negotiated VAT shares nue from "service fees" from providing services under the old system (first quarter 1992) has been re- such as..egitratiosandice . Veplaced by fixed VAT shares and negotiated subven- suchasregitration sandines licenses. vehricenregis- tions (second quarter 1992). Thus, despite the changes 'ration, business licenses, vendor licenses, in fiscal mechanisms used each quarter, a detailed anal- marriage registrations, and property-title regis- ysis of the fiscal outcomes of any one quarter is likely trations are a few examples. As with user fees, to carry lessons that go beyond that quarter. subnational governments should use these subnationars gove mensively. shouldusethe 2. For example, Bashkyria received R 627 per capita charges more extensively, under the first-quarter transitional system, but would have received only R 592 under the Basic Principles. "Benefit Charges." These fees are yet another The loss-R 35 per capita-is equivalent to 5.6 percent source of revenue for the subnational govern- of Bashkyria's first-quarter revenue under the current ments of many countries. These taxes recover system. The results in Table 4.1 simulate the outcome of benefits received by specific citizens due to public the Basic Principles for all oblasts, based on revenue expenditures. For example, if a new road, better data from the first quarter. streetlights, or a new sewer system increase prop- 3. Of course, the negotiated sharing rates could be erty values or increase business sales, a "benefit based on some ad hoc notion of expenditure needs, and levy" might be introduced. The levy could take could thus be equalizing. However, empirical analysis several different forms: (1) a special assessment, (reported below) indicates that this has not been the l(2) a land-value increment tax, (3) an improve- case in Russia. :ment tax, and (4) supplementary tax. These terms Pertain~~~~~~~~~~~ ~ to slgtydfeetwast4einte . These figures were reported to a Bank mission by pertain to Slightly different ways to cdesign the the MOF Territorial Department in July 1992. Ex post charge. A common benefit-related charge is the executed budgets, including transfers and ex post ad- development charge (or "betterment tax"): a justments, show a surplus. More generally, the concept lump-sum charge to recover the cost of infra- of a "deficit" at the subnational level is questionable, structure development from beneficiaries. Thus, given that expenditures are approved by the center (for those whose land is near newly installed stree- oblasts in deficit), and subnational revenues are deter- ;lOO mined quarterly by the center through subventions 7. In Canada and Australia, provincial governments and tax sharing policy. are responsible for property valuation and administra- 5. Special regimes could deal with the special prob- tion. In Germany and New Zealand, valuation is na- lems of ethnic minorities, and other special cases that tional, and rate setting and administration local. In the cannot be accommodated with this general framework. United States, both rate setting and valuation are local This possibility is not recommended in this report. Is- responsibilities in most states. sues associated with natural resource tax sharing are 8. Subnational authorities should not have unrestrict- discussed in chapter 5. ed access to taxes that may be "exported" or shifted 6. MOF's July budget estimates show a revenue total forward to nonresidents. of R 3,585 billion for these four taxes for 1992. Of this 9. The Draft Law passed a first reading in the Supreme amount, the subnational governments are budgeted to Soviet in July 1992. retain R 1,300 billion, and to receive R 250 billion in "subventions." The subnational share is thus 1,50 10. However, in the United States, the states and the lo- 'subventions t, includi subnationalvsharentions, ts 3cal governments have considerable freedom to deter- 3,585-43 percent, including subventions, and 39 per- mine their tax rates and tax bases. cent including shared taxes alone. 101 5 The division of revenues from natural resource taxes Russia is a resource-rich country that produces shared between levels of government are espe- a large share of the world's output of many im- cially important and controversial issues. portant minerals, including oil, gas, coal, gold, Russia is in a period of nation-building; the and diamonds. The production of most of these nature of the federation is still being defined. natural resources is concentrated geographical- This stands in marked contrast to the situation in ly in a few areas-oil and gas in the Tyumen the United States and Canada during the energy and Yamal autonomous okrugs and Tatarstan, crisis of the 1970s. Although debate in those and hard minerals in the republics of Yakutia countries about the intergovernmental sharing and Bashkyria. Together, Yamal and Khanti-Man- of resource rents (sometimes called the "new sisk produce more than 80 percent of Russia's oil war between the states") was heated, the contin- and gas; Tatarstan produces the bulk of the ued existence and nature of the federal system remainder. was not a topic of controversy. This is not the The existence of geographically concentrated case in Russia. With conflict over the Federation and potentially large resources makes the tax Agreement and the nature and structure of fed- treatment and intergovernmental sharing of nat- eralism in flux, the natural resource issue is po- ural resource revenues especially important. De- tentially divisive. pending on the quality of resource deposits, In Russia, natural-resource revenue sharing is their accessibility, and the market price of the re- intertwined with special fiscal treatment and sources, resource revenues can be enormous, ethnic independence since some resource-rich and they can be sustained for long periods. But regions (for example, Tatarstan, Khanti Mansisk, problems also exist. Subnational taxation of these Yamal, and the Sakhlin Islands) are inhabited by resources could create enormous disparities in ethnically different populations. Allowing re- the fiscal capacity of different governments. In- publics or oblasts that are resource-rich to in- dustrial and household consumers can react crease their share of revenues at the expense of strongly ff they feel squeezed by price increases the federal government could set a precedent while producing states collect large revenue. In- that would increase the demands of other better- creased awareness of environmental degrada- off industrial oblasts and okrugs for similar tion has also heightened interest in the division treatment. Given the importance of natural re- of revenue from taxes on natural resources, in sources in the Russian economy, and the fragility that jurisdictions experiencing such costs want to of the consensus about the revenue-sharing sys- be compensated for the damage they experience. tem, this chain of events could, in the extreme, For these reasons, the questions of which level(s) lead to the fiscal disintegration of the Russian of government should levy resource taxes and Federation. Russian authorities have correctly at- how revenue from natural resources should be tached priority to this issue. 103 This chapter focuses on revenues from oil and mestic sale of oil. Thus, the natural-resource sec- gas, given their enormous potential importance tor is one of the most heavily taxed sectors, sub- for Russia, but much of what is said here is ject to the VAT and CIT, and the PIT on employ- equally relevant to revenues from other resourc- ees' wages, as well as the range of taxes described es, including hydroelectric power and coal. After earlier. (Also see the example in Table 5.2). a brief discussion of the present system in the first section, the next section of the chapter pre- Intergovernmental Relations and Natural-Resource sents a set of recommendations that address Revenue Sharing in Russia three issues: (1) how natural resources should be taxed, (2) who should receive resource revenues, In the Russian system of federalism, certain tax- and (3) how such revenues should be used.' es are assigned to the central or subnational gov- ernments, and some, designated "regulating" The Taxation and Sharing of Natural-Resource taxes, are shared according to either negotiated Revenue in Russia or fixed sharing rates. The most important di- mensions of this regime for the petroleum sector Taxation of the Natural-Resource Sector are shown in Table 5.1. The VAT, CIT, and PIT paid by resource-based Natural resources in Russia are formally the prop- industries are shared by federal and other levels, erty of the state, and thus part of the "common as in the Basic Principles or its subsequent im- wealth" of Russia. The natural-resource sector in plementation (see chapter 1). No retail-level ex- Russia is governed by the unified direct and indi- cise taxes are levied on oil and gas; an excise tax rect tax regimes levied on households and enter- of 18 percent levied at the wellhead and as- prises, as well as by export taxes on petroleum. A signed to the federal budget was introduced in new "Law on the Subsoil" was passed in May September 1992. 1992 to attempt to capture additional revenues from the natural-resource sector for the budget. It "Contracts" and Resource Quasi-Ownership specifies a royalty or severance tax, which, for oil and gas, is levied at least 8 percent of the value of While natural resources are owned formally by production. Rates can range from 8 percent to 21 the state, recent events have challenged the basic percent, depending on the profitability of petro- principle that mineral wealth is the property of leum fields. The tax base is calculated as the vol- the Russian State. The "Law on Ethnic Minori- ume of output multiplied by the domestic ties," under consideration by the Supreme wholesale value, R2000 per ton of oil in mid-1992. In addition, the petroleum sector is subject to Table 5.1 Rules for Sharing Oil and Gas Revenues: (1) an export tax of 38 ECUs (European Currency Russia Units, roughly $49.4) per ton of oil exported, and (2) "fees for the reproduction of resources," Export Tax: 100 percent to Russian Federation equivalent to 10 percent of the value of produc- Production Tax (royalty): tion (in foreign exchange if the output is export- ed) and earmarked for a fund for petroleum- sec- Production not in autonomous national region or okrug tor investments by state-owned enterprises and 40 percent to Russian Federation selected private enterprises. Finally, an explora- 30 percent to oblast or republic tion fee of 1 to 3 percent of the value of explora- 30 percent to rayon or city tion expenditures is being considered, as is a fee Production in autonomous national region/okrug for the exploitation of the continental shelf. Until 20 percent to Russian Federation recently, 40 percent of foreign-currency earnings 20 percent to oblast or republic had to be surrendered to the central government 30 percent to okrug at 50 percent of the free-market rate. 30 percent to rayon or city Domestic price controls are an additional "tax." Take ol as a exampe. Wit the dmesticwhole- Production from continental shelf Take oil as an example. With the domestic whole- 60 percent to oblast, republic, or okrug sale price of crude oil at about 17 percent of the 40 percent to Russian Federation world price, these controls are equivalent to a tax Exploration fee: of 83 percent of potential proceeds from the do- 100 percent to cities and rayons 104 Soviet, would give indigenous populations including the costs of cleaning up environmental essentially what amounts to veto power over the damage from production. Charges to compen- development of natural resources in their tradi- sate for environmental damage deserve greater tional lands. The native peoples of Khanti Man- attention, because enterprises that exploit natu- sisk already have such power under a ral resources should pay taxes that are tied as presidential decree. "Contracts" between the en- precisely as possible to the costs of maintaining terprise and the tribe are to define compensation the infrastructure or to the costs of environmen- and govern the resource exploitation process. tal degradation. If such legislation is implemented and en- Russia does not levy environmental taxes. If forced, indigenous people would hold one of the such taxes are introduced (they should be, but most important attributes of ownership-veto detailed recommendations go beyond the scope power. If upheld, it would enable native peoples of this report), they should be based on estimates to extract much of the resource rents derived of social costs-the cost of the transportation in- from production on their traditional lands. The frastructure, for example, or the increased native population of some of the resource-pro- health-care needs attributable to environmental ducing areas is quite small-in Khanti Mansisk, degradation. All such costs should be covered only 54,000. If they could extract resource rents, through the use of taxes, fees, and charges relat- it could make them very wealthy. ed as closely as possible to the social costs gener- ated. Some resource-related activities (for exam- How Natural Resources Should be Taxed ple, oil and gas) create more social costs than others (diamonds). It is often difficult to quantify Governments have several instruments at their the costs of environmental degradation; in some disposal for taxing natural resources. First, the cases, taxes based on the volume (not the value) government may own natural resources, receiv- of production may be a reasonable surrogate for ing compensation in such forms as royalties, charges tied more precisely to environmental production sharing, lease payments, and bonus damage. Taxes to cover the social costs of exploi- bids (if others exploit the resources); it may also tation should not normally be based on rents, receive dividends if it establishes a state enter- since rents do not bear a close relationship to the prise to exploit the natural resources. Second, the social costs of resource exploitation. However, government may use taxes tc appropriate re- the calculation of economic rents must incorpo- source income, including severance taxes (on ei- rate such costs; rents do not exist until all such ther the volume or the value of production), costs are covered. Such charges would not cover profit taxes, property taxes (on resource re- the costs of correcting previous environmental serves), and export duties. Third, governments degradation or compensate those who must live may use price controls, export restrictions, and with it. Since such costs are not related to present other measures to transfer potential income from production, they should be incurred from gener- producing enterprises to consumers of natural al revenues.2 resources. Localities should be compensated for the in- It is crucial that national and subnational gov- frastructure and other expenditures required by ernments agree on a consistent set of "rules" for the resource sector; revenue from taxes, fees, or taxing natural resources and assigning or shar- charges should go to the locality that incurs the ing taxes. Otherwise, gaps and overlaps can lead environmental costs. Thus, revenue should gen- to undesirable disincentives to engage in appro- erally go to the subnational governments in the priate economic behavior. producing regions. Taxes and Fees for Environmental Damage Taxation of Economic Rents. The exploitation of natural resources sometimes The exploitation of natural resources often pro- creates social costs that are not borne by the ex- duces economic rents-the surplus left after the ploiting enterprise. They include the budgetary costs of production are met. Costs include labor costs of publicly provided infrastructure (for ex- payments, interest and other payments for debt, ample, specialized transportation facilities) and capital depreciation of equipment and supplies, the social costs of environmental degradation, governmental charges for services and facilities, 105 compensation for the environmental damage viable in the absence of taxation. It is especially and other social costs of production, and the burdensome on high-cost production, while, "normal" return to equity capital required to in- perversely, the tax on low-cost, high-yield out- duce investment. put is relatively small. Thus, the Russian tax sys- Rent taxation is desirable because it does not tem is ill-suited to capture economic rents from affect decisions about investment, production resource exploitation. techniques, or the timing and quantity of output. Russia should move to a system of resource By comparison, most other forms of taxation- taxation that falls on economic rents. These taxes taxation based on output (for example, sever- (and similar instruments) capture a portion of re- ance taxes and royalties) and taxation based on source rents for the fiscal year in a neutral way, the estimated value of reserves (for example, and ensure that the budget, not foreign or property taxes)-do affect these decisions and domestic enterprises, benefit from resource can threaten the optimal exploitation of resourc- exploitation. es. (See, however, the discussion on taxes and iFees for environmental damages.) Competitive Which Government Should Receive Resource bidding and auctions are other methods for ex- Revenues and Rents? tracting rents, given a sufficient number of inde- pendent, noncolluding bidders. Some considerations suggest that assignrnent to or the taxation of resource revenue by subnation- Overreliance on Production-Based Taxation. The al governments is appropriate. However, general tax and related regimes being applied to natural consensus is that most revenue from resource resources in Russia are based (directly or indirect- taxes should accrue to the federal government, ly) almost entirely on the value of production. due to the instability of natural resource reve- Taxes and quasi-taxes based on production, rath- nues, the geographic concentration of the re- er than profits, appropriate more than half of the sources, and equity considerations. market value of exported oil, making it highly unlikely that any but the most productive fields Economic Stabilization. could cover expenses and show a profit, even be- fore profit tax (Table 5.2). Revenue from resource rents is volatile, varying according to output and especially price. A sub- Table 5.2 Taxes and Quasi-Taxes on Oil Production national government that depends on revenue Domestic Export from an extractive resource may find its fiscal Maket Market position dangerously unstable. Moreover, the as- signment of unstable revenue sources to subna- Nlarket value (one ton)a 12,000 12,000 tional governments can complicate Tax implicit in price controls 10,000 -0- macroeconomic management, especially if sub- Production tax 160 160 national governments base spending on the Export tax -0- 4,940 short-run availability of revenue, rather than the Reproduction tax 200 1,200 long-run availability of revenue. National gov- Net revenues, before expenses 1640 5,700 ernments are likely to be able to deal more effi- Aggregate 'tax rate" ciently with the potential instability of resource (percent) 91.8 52.5 rents than can subnational governrments. a. Assuming an exchange rate of R 100 = $1 and a domestic wholesa- Economic Efficiency. le oil price of R 2000; and a foreign price of $120 per ton in mid-1992. Assigning resource revenue to subnational gov- The situation is even worse for production for ernments makes it possible for a resource-rich the domestic market, where taxes and similar in- subnational jurisdiction to lower taxes on local struments appropriate more than 90 percent of residents and businesses, to make cash pay- revenue. Given these high taxes, production for ments to residents, or to provide an exceptional- the domestic market is unlikely ever to be profit- ly high level of public services and subsidize able. The heavy reliance on production taxes dis- business activity within the jurisdiction. Any of courages production that would be economically these responses would distort economic choices, 106 inducing "inefficient" inflows of capital and/or world levels (R 12,000 in this example). The oth- labor that are not justified by the relative factor er eight jurisdictions would have windfalls rang- productivity in the producing locality, thereby ing from R 304 to R 1,232 with a lower domestic reducing national output. Wasteful investments prices for oil, and six times that, with the world in industries based on natural resource process- price. Adding gas to the analysis will accentuate ing-so-called "resource-based industrializa- the disparities. Other jurisdictions join Tyumen tion"-without recognizing the economic in the list of resource-rich jurisdictions when prospect for such investments, as well as large nonoil natural endowments are considered. outlays on public services of low priority, led one analyst of the Alaskan situation to suggest, Tax Exporting "The case for limiting Alaskan petroleum reve- nues at the margin is very compelling." Consuming states often argue that their resi- (Mieskowski, in McLure, 1983). dents are being exploited by the resource-rich states, which export their resource taxes to them. Equity Considerations and Fiscal Disparities In most situations in a market economy, taxes levied by natural-resource states cannot be ex- Since natural resources are not distributed uni- ported to consumers in other states. First, by def- formly, the assignment of resource rents to sub- inition, taxes on economic rents do not affect national governments can create large differences product prices and thus cannot be exported to in the fiscal capacities of subnational govern- out-of-state consumers. Second, subnational ju- ments. During the era of high energy prices in the risdictions do not have the market power to af- 1970s, the "energy-rich" American states of Mon- fect the market price of their natural resources; tana and Alaska were estimated to have 200 per- they are essentially "price-takers." Higher pro- cent and 515 percent, respectively, of the per- duction taxes would be borne by resource own- capita tax capacity of other states. In Canada, ers, not by consumers. One important exception even after oil prices had eased, Alberta's fiscal ca- is relevant to Russia: if government-controlled pacity was 145.6 percent of the Canadian national prices allowed the pass-through of production average. Not surprisingly, regional disparities taxes, these taxes would be borne by consumers have been the source of much conflict in various and could thus be "exported." countries; in the United States, attempts to limit Among the arguments for natural-resource state severance taxes and to enact a preemptive taxation (or in revenue sharing) by the subnation- federal severance taxes were unsuccessful. al level are (1) that environmental degradation Given the unequal distribution of natural re- must be compensated for, (2) that the local level sources in the Russian Federation, sharing feder- has rights to the resource "heritage," and (3) that al resource revenue on a derivation basis could political opposition must be "bought off." create large fiscal disparities. The results of an analysis of the regional distribution of 31 pro- The Social Costs of Exploitation duction associations-the Russian oil compa- nies-is quite dramatic: almost 65 percent of Again social costs are often associated with the 1993 production is projected to occur in Tyumen, exploitation of natural resources, such as de- an oblast with barely 2 percent of Russia's popu- mands for a special transportation infrastruc- lation. Thus, Tyumen's share of production is 30 ture, the increased costs of health care, and local times its share of the population. The production environmental degradation. To ensure both equi- shares of eight other oblasts exceed their popula- ty and economic efficiency, subnational govern- tion shares by more than 10 percent. ments should receive enough tax revenues (or In per-capita terms, assuming the production fees) to defray these localized costs, but this ar- tax rate and domestic and foreign prices noted gument does not justify supporting subnational earlier, the shared revenues that would accrue to taxation or the full assignment of resource rents. some producing republics/oblasts are enor- mous. Under these assumptions, Tyumen Subnational Entitlement and Heritage would receive R 8,912 per capita in shared taxes if the price were R 2,000 per ton and R 54,000 Subnational governments often argue that they per-capita if the domestic price were raised to are "entitled" to a share of the resource rents. 107 This would enable them to convert resource gions should receive a share large enough to wealth-the jurisdiction's "heritage" -into fi- bring their social provision levels up to average nancial capital. The resource revenue is consid- national levels over an agreed-upon time frame. ered to be as just compensation for "losing forever a one time harvest." The locality may Political Survival of the Federation also believe that, because other jurisdictions reaped benefits from natural resource exploita- Finally, the decision to allow subnational gov- tion under the previous regime, it should receive ernments access to natural resources may be reparations or indemnities. purely political: subnational jurisdictions may be These questions are essentially political and de- willing to join a federation (or be willing to re- pend on the nature of the governmental system main part of one) only if their natural resource and the view of resource ownership. Are natural patrimony is protected. The last argument for resources part of the nation's "common wealth" or subnational assignment is a powerful one, and do they belong to the subnational jurisdiction? If may in the end be the most important in Russia. primary allegiance is to the subnational govern- The division of the revenue from energy is argu- ment, as it might be in a confederation, the entitle- ably one of the most important elements in Can- ment argument has some validity If, on the other ada's ongoing constitutional discussions. hand, primary allegiance is to the national govern- ment, the heritage belongs to the nation, not the lo- Weakness of the Executive cality. If the resource is part of the national "com- mon wealth" (as perceived in most federations), its The executive branch in Moscow lacks the benefits should accrue to the entire nation. strength of the federal governments of Australia, Canada, or the United States. Thus, it has no ob- Indemnification vious recourse when subnational governments refuse to allow tax revenues to be remitted to the A special feature of Russia is the irony of pover- federal government.3 The larger role now as- ty in resource-rich areas. The production of oil sumed by the STS in collecting resource reve- and gas (or other natural resources) has not pro- nues, combined with its continued "dual duced a well-off population in producing re- leadership" conflict of interest, gives it both the gions, and inhabitants of resource-rich regions tool and the willingness to act in a manner con- have not shared in resource wealth as they com- trary to national collection policy. This argues for monly have in Western market economies. In- national taxation and for strengthening the STS stead, they are among the poorest members of as a federal institution, it also calls for a fair, Soviet society. Depending on how resource rents transparent natural resource and general-revenue are shared, this situation could change dramati- sharing system that is the product of consensus. cally, especially as domestic prices are brought in line with world prices. Other Natural Resources. The law on the subsoil Thus, in Russia, those who live where oil has also stipulates that subnational governments (1) been produced tend to see future payments for be in charge of regulating the development of gen- natural resources as a form of indemnification erally disseminated minerals (sand, gravel, etc.; for previous abuses under the Soviet system- see Sec.I, Art. 5) and (2) receive payment for the poverty, environmental degradation, and the de- right to extract such minerals (Sec. V, Art. 42). This spoliation of areas traditionally used by indige- subnational sharing seems appropriate, since nous people for hunting and fishing and for reli- rents on these minerals cannot be very great and gious ceremonies. (In the extreme case, residents they would not be geographically concentrated- of oil-producing areas may feel that the entire the major argument for national-level taxation. difference between the world price of resources iand the controlled domestic price is an illegal Sharing Natural Resource Revenue transfer to the central government, without con- sideration of the value of federal expenditures International Practice on their behalf.) Such considerations must be rec- ognized if consensus is to be reached on sharing. As shown in the discussion in Box 5.1, there are a A (political) case can be made that producing re- variety of approaches to sharing natural resource 108 Box 5.1 Natural Resource Taxation: International Practice in Federations Throughout the world, industrialized nations with federal systems of government have ineffectively assigned taxes on natural resources, according to commonly accepted normative considerations. United States. Natural resources are taxed under federal and state income taxes (levied by about 36 of the 50 states), state severance (production) taxes, and local property taxes. In addition, Alaska obtains an enormous amount of revenue from oil and gas produced on state lands, and Texas obtains some. The federal govern- ment and the states also receive royalty payments from natural resources produced on federal lands located within their boundaries. During the energy crisis of the 1970s, fiscal disparities due to the concentration of natural resources in a few states threatened to mount a "new war between the states.' Canada. Under the Constitution of Canada, natural resources belong to the provinces. Thus, the provinces have access to royalties, as well as to tax revenue. Extreme geographic differences in resource endowments created large disparities in resource revenue during the 1970s and early 1980s. (Roughly 85 percent of all oil and gas is located in one sparsely settled western province, Alberta.) Given the differences in the fiscal capaci- ty of the various provinces, equalization has been an important part of the Canadian landscape. The federal government also has authority to tax natural resources under the constitutional provision that al- lows it to regulate trade and commerce. The primary source of federal revenue from oil and gas has tradition- ally been the corporate income tax. This division of powers-provincial ownership and federal regulation- inevitably gave rise to intergovemmental conflicts. For example, before 1974, provincial royalties were a de- ductible expense in federal tax liabilities. In 1974 they were made nondeductible in response to increases in provincial royalty rates enacted in 1973 and 1974. It has been observed that, "if there is a tax jungle in this country, it is in the area of resource taxation," and that "efficiency and simplicity considerations point strongly to the need to reallocate resource taxes from the pro- vincial to the federal level." How this reallocation could be achieved is questionable, since provincial owner- ship and control of resources are "undoubtedly one aspect of the federation which is immutable." Australia. The Australian Constitution reserves to the states all powers not mentioned. Its silence on owner- ship of natural resources thus gives the states title to natural resources located within their borders; thus, the states can tax these resources, despite constitutional prohibitions on the use of both income taxes and indirect taxes. The federal government also has wide-ranging revenue powers in this field, including the leasing of off- shore drilling rights, an export duty on coal, a levy on natural gas and crude oil, and the company income tax. It collects a 10 percent royalty on offshore minerals and passes 60 percent of it to the states. As in Canada and the United States, the uneven geographic concentration of resources has led to disparities in state revenues from resources. For example, in 1978-79, states raised from $3 to $43 per capita (from 2 percent to 20 percent of total revenues) from resource taxes. (By comparison, the federal government raised $137 per capita, or 9 percent of taxes, from resources.) These disparities are less troubling than those in the United States, or even Canada, because federal grants are provided generously to the states. One observer has noted, "Australia has the most equalizing federalist system in the world." Some have noted that states tolerate high federal taxes on natural resources which leaves relatively little for the states to tax because the grant system offsets any resulting "inequities." Nigeria. The Constitution of Nigeria recognizes three levels of government. Most revenue from natural re- sources (essentially petroleum profit taxes and rents and royalties from mines) flows initially to the federal government and is then distributed to subnational governments as part of the common pool. Revenue sharing from natural resources is not based strongly on derivation: prior to 1985, 2 percent of federal revenues (which represents 35 percent of the total Federation Account) were distributed to mineral producing areas in propor- tion to the minerals extracted from each. Another 1.5 percent was set aside for the development of the natural resource-producing areas. Since 1985, the amount paid to mineral-producing states on the basis of derivation has been reduced to 2 percent of revenue derived from mineral production in their states, while 1.5 percent of the revenue is earmarked for developing of the mineral-producing areas. One problem experienced by mineral-producing areas is the failure of state or local governments to spend al- located funds on developing oil-producing areas within the states. Critics argue that an outside body should be used to address the particular problems of oil producing areas-not states, but the localities where the min- eral is actually produced. 109 Box 5.1 (cont'd) Malaysia. Oil production in Malaysia started in 1911 but did not reach economically important levels until the early 1970s. The federal government has depended increasingly on revenue from the petroleum sector, which currently accounts for 7 percent of GDP. The Malaysian states ceded all rights for oil and gas resources to the federal government. In compensation, the three oil-producing states receive 50 percent of total royalty payments-that is, 5 percent of gross production. In 1990, royalty receipts contributed to 11.5 percent of state revenue. While the federal government collects royalties and profit taxes on petroleum, some taxes on natural resourc- es, forests, and mines have been assigned to the states. Because natural resources are distributed unevenly throughout the country, the revenue capacity of the various states has varied considerably (For example, in 1977-79, per-capita revenues from own sources in Sarawak were five to six times those in the states with the next highest figures; these in turn were well above the national average.) These differences are not corrected by federal grants to states; per-capita differences in grants are small. Papua New Guinea. Papua New Guinea raises 15 percent of its internal resources through natural resources. Provinces receive all royalties for petroleum, minerals, natural gas, timber, and fish collected by the National Government from activities in their province, less the cost of collection. Royalties from natural resource projects are payable at 1.25 percent, and derivation grants are paid at 1.25 percent on the value of exports, less any royalties paid. Provinces rely on federal government funding, primarily through the Minimum Unconditional Grant (MUG). The MUG corresponds to the cost of services administered by the national government in a base year of 1976- 77 (and adjusted annually based on the lesser of the cost of living or the growth in government revenues). Since the MUG depends on the level of services provided in 1976 when some regions were far more devel- oped than others, provincial inequalities are exacerbated rather than rectified by this grant. While the Ministry of Finance did form a commission to distribute nonminimum, unconditional grants to equalize provinces, the endowment of this pool is modest. Brazil. State and municipal governments are separate and independent levels of government. Seventy percent of the revenue from the federal taxation of minerals is shared with the states of origin. An additional 20 per- cent of federal mineral taxes are shared with municipal governments. Because state governments have impor- tant revenue sources of their own (especially the VAT), transfers from the federal government are relatively unimportant. revenue. The academic consensus is that, aside ations have considerable latitude (which they from what is necessary to offset the social costs use) to levy taxes on natural resources, despite of exploiting natural resources and, arguably, the the geographic unevenness of this tax base. By revenues necessary to bring public-service levels comparison, in four developing countries tax as- in the producing localities up to acceptable lev- signment is "rational and consistent with theo- els, revenues from taxes on natural resource retical principles." This practice may simply re- rents should be assigned to national govern- flect a general tendency among developing ments, not to subnational ones. Both distribu- countries to exhibit more highly centralized gov- tional and efficiency reasons support the emient finances. (The local taxation of natural consensus. (The taxes on natural resources in a resources in Malaysia is an important exception country such as Russia should be federal taxes; to this generalization; see Gandhi 1983.) One im- oblasts and okrugs should not introduce their portant reason for the divergence between theo- own national resource taxes.) This report recom- retical principles and reality may be that aca- mends a sharing formula that accords most of demic analysis did not exist when the constitu- the resource rents to the federal level. tions of Australia, Canada, and the United States Not all of the taxing arrangements in the coun- were drafted. Similarly, the extent and actual lo- tries surveyed are in accord with the academic cation of resources was probably unknown and view that national taxation is preferred. Subna- neither level of government knew the stakes. In tional governments in the three industrial feder- Russia, the location and value of many resources 110 are fairly well known. There is little reason to be- Fourth, address inter-governmental sharing. lieve that this knowledge will be ignored. It is difficult to provide firm advice on the prop- er intergovernmental division of revenue from Options for Russia natural resources. Although some disagreement about the issue is inevitable, the consensus aca- The issue under examination clearly raises a fun- demically is that, aside from the taxes (or the tax damental question: What is the nature of federal- share) necessary to compensate for the social ism in Russia? Depending on the answer five costs of exploiting natural resources, tax revenue conclusions are perhaps key to Russia. from natural resource rents should be assigned First, compensate for social costs. Subnational to national governments, not to subnational ones. jurisdictions and the ethnic groups whose in- Both distributional and efficiency reasons sup- come from traditional activities may be lost port this view. Tax bases that are distributed should be compensated for their financial, social, very unequally among subjurisdictions should and environmental costs and losses related to re- be used centrally. Nevertheless, in many coun- source extraction. tries, political realities dictate that in subnational Second, ensure that rents are appropriated by governments receive at least some preferential the government budget. Potentially available re- benefit from their resources. source rents in Russia are quite large. There will As emphasized earlier, the question is also one be-and are-many claimants to these rents. of the nature and survival of federalism. Is pri- They include consumers, producers, workers mary allegiance to the Russian Federation or to a and managers, shareholders, foreign investors, smaller subdivision? Will the federation survive related industries, and indigenous peoples, to if the federal government insists on taking the li- name just a few. A delay in constructing an ap- on's share of resource revenues? The division of propriate tax system does not mean that the resource revenue can take many forms, depend- rents will not be appropriated; they will be ap- ing on how this question is answered (that is, on propriated, but not necessarily in a fair and eco- who "we" are for this purpose). Other countries nomically sensible manner. Once a given distri- facing this issue have used several approaches, bution of rents is established, it may be difficult and thus there is no single, correct answer. to revise the system, since the wealth generated by resource rents can pikwide-political influence The "Federal" View. If one takes the federal that impedes reform. view-and of citizens of Russia perceive that Third, distinguish between tax assignment their primary political allegiance is to the Rus- and revenue assignment. In Russia, it is recoin- sian Federation rather than to subnational gov- mended that natural resources continue to be ernments (if, for example, they think of them- taxed at the federal level under the unified fiscal selves as "Russians," rather than as "Siberi- system, even though some of the revenues ans")-there is much to be said for the position might be shared. Multiple and conflicting that the federal government should have prima- oblast-level taxes on natural resources would ry access to fiscal revenues from important natu- spell chaos for foreign or domestic investors. ral resources that are distributed unequally There is no inherent reason that particular taxes throughout the federation. The argument for this must be assigned solely to one level of govern- position stems from both equity and economic ment; in many cases it is quite possible that both efficiency-to prevent the inequities and loca- the federation and the subnational governments tional distortions created by the large differences could tax the same base. In this case, substantial in the fiscal resources available to the various cooperation would be desirable-both horizon- subnational entities. The disparity in these re- tally (that is, among oblasts) and vertically (be- sources translate into the differential ability to tween the federation and the various subnation- supply public services from given taxes on activ- al entities)-to avoid administrative chaos and ities other than natural resources or different tax economic distortions. In Russia today, some rates on nonresource activities. In addition to subnational governments are apparently intro- promoting undesirable migration to resource- ducing their own "natural resource taxes," inde- rich jurisdictions, differentials in well being are pendently and without central approval. This is arguably unfair. Implicit in this view of equity is undesirable. that large discrepancies in the average incomes 111 of various subnational governments (including tirely to financing federal outlays in the federal the value of public services) is undesirable and budget, given resource constraints. Alternatively. should not be aggravated by allocating resource it could be channeled in part to the "subnational revenues to these entities. equalization pool," to be shared with the oblast- level governments according to a formula. Doing The "Confederation" View. If, on the other hand, so would allow nonproducing oblasts to benefit primary allegiance is to the subnational entities, from resource exploitation. Sharing of resource they will naturally want to have primary access to revenues among oblasts in this manner (a "frater- fiscal revenue from natural resources. Under this nal" approach) might be more palatable than view, differences in the average incomes of various sharing them only between levels of government. subnational governments are not of major concern. In sum, the taxation of natural resources should be a "federal affair," since the economic Compromise. These views do not necessarily arguments favor the national taxation of natural translate into "either/or" options. The fact that resources. However, the local jurisdiction should natural-resource producing regions have histori- be compensated for the environmental damage cally received very little from their endowments from production and for the costs of any social suggests that compromise can be reached that infrastructure it must provide. They should also would be beneficial to both levels of government, be entitled to a share of revenues sufficient to and to the federal budget. The compromise bring the level of services in the jurisdiction- would be a share for the federal budget, and schools, hospitals, elder care, roads, and hous- share for the oblast okrug. The currently legislat- ing-up to national standards. In Russia, both ed 40/60 split for oblasts (or 20/80 split for an ok- considerations are important, since the earlier re- rug) may excessively favor the subnational level, gime has left producing areas environmentally especially when prices rise to world levels. degraded, and has not allowed the benefits of Fifth, coordinate the natural resource and in- natural resource revenues to flow to them in any tergovernmental regimes. Linking the design of substantial way. Khanti Mansisk, Yamal, Tatar- natural-resource tax sharing with the tax-sharing stan, Baskyria, and other such regions are argu- configuration of the general intergovernmental ably among the poorest in Russia in terms of so- system will be essential. Oblasts want tax au- cial infrastructure, roads, schools, health facili- thority over their natural resources (whatever ties, and so forth. those resources may be) primarily because they perceive that the revenue sharing and transfer Sharing Export Tax Revenue system treats them unfairly. The introduction of a transparent and fair formula-based grants sys- Export tax revenue is now assigned 100 percent tem could well be a sine qua non of an increased to the federal level. Theoretically, no a priori ba- federal share in natural-resource revenue. In this sis exists for distributing them any other way, regard, one aspect of the Australian approach and it is recommended that this policy be may, be particularly relevant to Russia today: the retained. disparities inherent in Australia's state taxation of natural resources have partially been offset by Using the Revenue from Natural Resources an equalizing grant system that helps areas poor in natural resources. The converse may well be Natural-resource-rich jurisdictions often have that federal taxation of resources (desired by the "windfall gains"-budgetary inflows that far ex- federal authorities in Russia) may be palatable for ceed current budgetary outlays or immediate in- the producing oblasts if (1) the common pool of vestment opportunities. In Khanti Mansisk, for revenues is divided generously between deriva- example, the okrug government estimates that tion and equalization funds, and (2) the formula- production tax revenues for the seven months based equalization fund includes a special weight remaining in 1992 will be about R 11 billion; factor for natural-resource-producing oblasts. when annualized, this figure represents about An additional point is how the "federal share" half of the total okrug budget for 1992 (R 44 bil- would be used. In the context of the unified in- lion). At world prices for oil, these revenues tergovernmental sharing regime described in would be R 70 billion, or four times the annual chapter 4, the federal share could be devoted en- budget. Khanti-Mansisk will benefit greatly from 112 even its modest (30 percent) share in the produc- natural resources other than petroleum (for ex- tion tax revenues. ample, gold, peat, and forestry), furniture mak- ing, food processing, and investments for the in- Alternative Uses. At least four options are avail- digenous population. The concentration on re- able for using these windfalls: (1) spending them gional development through local investment, on current outlays; (2) investing the excess reve- including resource-based industrialization- nue in a "Heritage Fund"; (3) giving the revenue and the virtual neglect of both the potential risks to local citizens through "demogrants," and (4) of this policy and the possible benefits of invest- using the additional revenue to reduce the tax ment in the rest of Russia or in world capital burden on local citizens. In Russia, increased sub- markets-is troubling. (See Gelb, 1988.) It is all national revenue from natural resources cannot too reminiscent of the unfortunate experience of be used to reduce or minimize the nonresource the Alberta Heritage Saving Trust Fund (see Box taxes of subnational governments-as they have 5.2). in North America, since subnational govern- The opposite experiences of Kuwait and Saudi ments levy no important taxes. (An increase in re- Arabia-which invested primarily in world cap- source revenue could reduce federal subventions ital markets-and the oil-rich countries of the and federal tax shares, if these continue to be ne- third world-which borrowed against future oil gotiated). The greatest likelihood is that most revenues and invested heavily in resource- such revenue would be used to finance increased based industries show how important these public services and to provide heritage funds; decisions can be. The heritage fund should pur- they might also be used to finance cash grants. sue a strategy of high returns. "Permanent Given the budgetary stringency in the current Funds" (sometimes to benefit native peoples) fiscal environment, it is probable that any re- have been established by several resource-rich source revenue obtained by the federal level will states and provinces of Canada. Their invest- be devoted to current budgetary outlays. It ment strategies can be characterized as the pure would be unwise for the okrugs to do the same. "trust" model or the "developmental" model: While a case can be made for using some of the The trust model (followed by Alaska) emphasiz- revenue to raise the level of public services to na- es the security of principal, risk avoidance, and tional standards, spending amounts that are income generation. Fund managers select invest- multiples of current budgets can imply only low ments based on financial criteria alone. They productivity outlays. Establishing a trust fund or search for the best investment (providing a high a "Heritage Fund" to convert the nonrenewable return with a low risk), wherever the investment natural resource into "renewable financial capi- is located (inside or outside the region). Trust tal" is a judicious strategy. models emphasize stability, portfolio diversifica- tion, and guaranteed return. The "Heritage Fund" Issue: The Investment of Trust The "Developmental Model" (followed in Alber- Funds ta and by corporations established under the Alaskan Native Claims SA) considers social crite- The three obvious alternatives for devoting un- ria in its investment decisions. A developmental spent resource revenues to the trust fund are: (1) fund maintains investments within the region in investing in the resource-producing jurisdiction; the hope of stimulating employment or provid- (2) investing throughout Russia, and (3) investing ing local capital. Some low-risk, high-income in- in financial assets outside Russia. Several produc- vestments are sacrificed in favor of those with a ing oblasts mentioned the first option as the most direct local impact. Developing infrastructure attractive: building up a local industrial base, of- and diversifying the local economy are two paths ten oil-based, was thought to be desirable. open to developmental funds. Their investments Government officials in Khanti Mansisk and may not produce a financial return, but they may Tyumen appear to call for creating an investment provide some benefit to the community. fund for the future that would be available once oil production has declined. Among the types of Managing the Trust Funds investments espoused were regional invest- ments in petroleum-related industries (for exam- In sum, it is important that both resource-rich ple, refineries and plastics), the development of subnational governments and native popula- 113 Box 5.2 The Experience of Three Funds Alaska Permanent Fund. The Alaska PF was established in 1976 to prevent $900 million in lease receipts from being spent quickly on state projects of questionable merit. Twenty-five percent of state mineral royalties and other resource revenues are deposited in the fund. The fund is required to invest in order to maintain the real value of the fund. The purpose of the fund is threefold: to save part of the state's oil wealth, to invest these savings, and to use the savings to produce income. Reflecting the fund's investment objective, the fund's 1987 investment targets were 83 percent bonds, 12 per- cent stocks, and 5 percent real estate. Only 5 percent of all investments were made within Alaska, on the as- sumption that if a project is worthy of investment, outside capital will support it. Indeed, "local invest- ments-which are not only risky but also subject to political bias-are eschewed." Under this policy, 11.5 percent was the nominal realized annual return over the five-year period ending in 1986. By the late 1980s, the principal of the fund was nearing $10 billion, and income was roughly $1.0 billion annually. Beginning in 1982 the fund has paid dividends to residents of the state. Following an initial dividend of $1,000 per capita, dividends have ranged from $331 in 1984 to $708 in 1987. The payment of dividends reflects the view that income from the fund will be spent more productively by individuals than by government. These payments give Alaskans a stake in managing the fund successfully, thus increasing the accountability of the fund managers. Alberta Heritage Savings TRust Fund. From 1976 until 1987, a portion of all provincial revenues from petroleum, natural gas, and coal were deposited in the Alberta HSTF. In 1988, when the fund reached Can$ 13 billion, a cap was placed on the fund, and no more money was deposited in it. Unlike the Alaska PF, the principal of the Alberta HSTF is not inviolate; it can be appropriated by the provin- cial cabinet at any time. This gives the provincial government considerable latitude, and op2ns the way for us- ing the fund for political purposes. In fact, the Alberta Fund has been used to achieve both social and econom- ic objectives. Its investments include "loans to other provinces, equity investments in capital development projects, common stocks, as well as nonfinancial investments such as irrigation projects, recreation facilities, hospitals, and scholarship funds." Almost all AHSTF investments are within Alberta. Alaska Native Claims SA Corporations. These corporations were capitalized with surface and subsurface rights to 18 million hectares of land and a one-time cash settlement of $962.5 million, for the benefit of native persons (they numbered 78,436 in 1971). The developmental strategy followed by these trusts has produced a dismal profit performance. Over the ten- year period 1974-84, the average return on equity has been a negative 4 percent. Moreover, the trusts have per- formed so poorly with a 30 percent ratio of debt to total assets, increasing their vulnerability to loss of princi- pal-and even bankruptcy-due to bad investments. "Superior investment results would have been achieved by simply investing in U.S. government savings bonds." To some extent, the performance of the regional corporations reflects a conflict of objectives. It is impossible si- multaneously to improve "health, education, social and economic welfare" to "provide employment and busi- ness opportunities," and "to preserve and increase the value of corporation assets for future generations." To achieve these objectives, the corporations made direct investments in several Alaskan resource-based indus- tries, including sand and gravel, timber, minerals, fishing, and petroleum exploration, as well as support ser- vices. The corporations have made few, if any, dividend payments to beneficiaries. This is not surprising, since the corporations were created and sustained under the forced draft provided by large sums of money to be in- vested locally, and not by the stimulus of business opportunities. Their poor results are not surprising. 114 tions avoid the seductive but wasteful trap of de- substantial. Unless they are captured by indige- velopmental funds. Some areas-such as nous peoples, the tax assignment issue will be Alberta-have devoted much of the trust fund to important. local investments, including investment in petro- It is difficult to provide firm advice on the leum-related activities, or "resource-based in- proper intergovernmental division of revenue dustrialization." Many petroleum-exporting from natural resources. In principle, the taxation countries have followed similar policies. The of natural resources is a "federal affair." The rate of return on these local projects is usually economic arguments favor the taxation of natu- low, and, in the end, less is left for future genera- ral resources at the federal level. However, the tions relative to investments for which the return local jurisdiction should be compensated for the is highest. (This high-return strategy has been environmental damage associated with produc- used by Alaska.) Such investments will general- tion as well as for the costs of any social infra- ly be outside the local area, and perhaps outside structure it must provide. Moreover, local juris- Russia. Income generated from these invest- dictions should be entitled to a share of revenue ments can be used for local purposes, while the that brings local services up to a national stan- principal will continue to grow to ensure ongo- dard. As emphasized earlier, the question is also ing funding for the future. When the time comes, one of the nature and survival of federalism. it will also be essential that the best possible in- Should primary allegiance be to Russia or to a vestment advice be sought. smaller subdivision? Will the federation survive if the federal government insists on taking the li- Concluding Thoughts: Dividing the Spoils on's share of resource revenues? The potentially available resource rents in Rus- The answers to these questions may depend on the design of revenue sharing under the gen- sia are quite large. There will be and are many eral intergovernmental system. Oblasts want claimants to these rents. Not only the govern- tax authority over their natural resources ment-any of its three levels-but also consum- ers, producers, workers and managers. (whatever these may be), primarily because indutris, workeig inv mand in-r they perceive that the revenue sharing and consuming industries, foreign investors, transfer system is treating them unfairly The digenous peoples could claim the rents from introduction of transparent and fair formula- natural resources, depending on how economic grants syste n and fair qua liberalization moves forward. The issue is more based grants system could well be a sine qua complex than it may seem at first, and more non of an increased federal share in natural re- complex in Russia than in most market econo- source revenue. mies. It encompasses such diverse issues as price liberalization, privatization, demonopoli- Notes zation, the regulation of public utilities (pipe- lines), labor relations law, the inadequacies of 1. The discussion is based on the recommendations of domestic capital markets, and the liberalization the World Bank Technical Cooperation Project on Re- of international trade-in short, most of the is- form of the Petroleum Sector, including its recommen- sues associated with transition to a market econ- dations on the taxation of rents. omy, and that are pertinent to the rights of 2. From a practical point of view, such fees or taxes indigenous peoples. While the same issues are should not be applied retroactively to existing agree- potentially relevant in a Western economy, they ments, so as to avoid discouraging investment in the generally do not arise because the legal and eco- petroleum sector. nomic setting in which the debate occurs is nomichmor setting in pewhich onhow thed o se is- 3. The federal government can threaten to use the fol- much more stable. Depending on how these is- lowing tools to force compliance with revenue sharing: sues are handled, there may not be much rent to (1) halting all central expenditures to the territory; (2) divide among governmental claimants. If, how- refusing to grant export and import licenses; (3) disal- ever, these issues are handled whereby they cre- lowing central bank credit; (4) blocking material sup- ate an essentially competitive environment, the ply from the central supply system; and (5) abstaining resource rents in the resource sector should be from cash or currency provision. 115 Postscript Recent Developments in Intergovemmental Finances in Russia: Q4 1992 and 1993. Very little has changed in the intergovernmental fiscal system since the third quarter of 1992. The pri- mary modifications are: (i) the sharing rates between federal and oblast budgets for the fourth quarter remained as in the third quarter. However, there are plans to increase the retentions in favor of the oblasts for the 1993 budget as follows: (a) For the CIT, 22 of its 32 points would stay in the oblast; 10 would go to the federal budget (as compared to 19 of 32 points to the oblast in late 1992) (b) VAT would be retained 5%-50% by the oblast-this amount is larger and compares to 20% retained by the oblasts in late 1992. The balance of the VAT goes to the federal budget. In addition, there have been discussions, but no firm decisions on (c) the export tax on petroleum and other exports, which may be shared 30% with the oblasts Oit was previously all federal). (d) the excise on petroleum, which may be shared 30% with the oblast level (it was previously 100% federal). VAT rates were reduced to 20% (general rate), and 10% on foodstuffs, effective January 1993. (ii) The Law on Subventions was passed. This provides for targeted grants to from the federal bud- get to the oblasts (and from oblasts to their rayons) for specific purposes-roads, health, etc, as the higher level governments deems appropriate and can afford. Both the aggregate volume and the dis- tribution between oblasts is negotiable. These are not "equalizing" transfers in the usual sense, and moreover, their distribution (they have been provided previously, but were not established in law) seems not to have been equalizing. 1:16 APPENDICES Appendix 1 List of Laws Reviewed 1. Law on the Basic Principles of Taxation 2. Law on the Rights of Local Self-Governments 3. Law on Budgetary Rights of Local Self-Governments (draft) 4. Law on Property Tax 5. Law on Payments for Natural Resources 6. Law on Land Tax 7. Draft Law on Subventions to Local Governments 8. Decision of the Supreme Soviet of the RSFSR on Taxation of Profits of Enterprises and Organi- zations in 1992 9. Decree on the Division of State Property 10. Law on Basic Principles of the Budget System and Budgetary Process in the Russian Federation 11. Law on the Subsoil 118 Appendix 2-a Ordinary Least Squares Estimates of Determinants of Subnational Governments' Per Capita Revenues by Oblast, 1992: Ql and Q2 Percent of population Average Independent Per capita Population living in Populatign monthly Variables Constant GVIO (in thousands) urban areas per km wage R?2 b Dependent variableb: 1. Per capita 400.99 -0.04 -0.08 8.01 ... ... 0.22 52 subnational (2.69) (-1.35) (-3.87) (2.82) retained revenues Q0 2. Per capita 298.58 ... -0.06 ... 0.62 1.76 0.52 64 subnational (3.01) (-3.36) (0.61) (6.16) retained revenues 01 3. Per capita -117.70 0.09 -0.07 42.79 ... ... 0.09 73 subnational (-0.10) (0.25) (-0.30) (1.70) retained revenues 01 and 02 4. Per capita -905.04 ... 0.04 ... 4.23 14.15 0.22 73 subnational (-1.00) (0.18) (0.49) (4.36) retained revenues Q1 and Q2 Note: Regression coefficients and t-statistics (in parenthesis) are presented. Source: Estimated from data provided by the Ministry of Finance, March and July 1992. a. Data for the second quarter are revised budget estimates. b. Some observations were dropped because data for all 91 oblasts were not available. 119 Appendix 2-b Ordinary Least Squares Estimates of Determinants of Subnational Governments' Total Tax and VAT Retention and Per Capita Subventions, 1992 Percent of population Average Independent Per capita Population living in Populatign monthly Variables Constant GVIO (in thousands) urban areas per km wage R2 Nb Dependent variable 1. Total 46.5011 -0.0018 -0.0017 -0.1133 0.0400 0.0224 0.51 64 retention (14.95) (-2.92) (-4.18) (-2.07) (1.63) (2.809) rate: 01 2. VAT 83.08 -0.0125 -0.00348 -0.6989 0.2389 0.136 0.66 65 retention (6.135) (-5.225) (-2.10) (-3.126) (2.37) (4.1630) rate: 01 3. Per capita 394.78 -0.28 -0.30 24.96 ... ... 0.32 73 subventions: (1.45) (-3.4) (-5.23) (4.18) 01 and 02 4. Per capita 116.69 ... -0.24 ... 2.77 3.79 0.34 73 subventions: (0.51) (-4.12) (1.26) (4.61) 01 and 02 Note: T-statistics are shown In parenthesis below regression coefficients. Source: Estimated from data provided by the Ministry of Finance, March and July, 1992. 120 Appendix 3 Russian Federation, Tax Summary as of March 1, 1992 (All values in rubles) (IMF). Tax Nature of Tax Deductions and Exemptions Rates i. Taxes on Income proits, and capitat galns 1.t individual Income 1.11 Tax on the Income A federal, schedular tax on Individual Income. income received abroad is taxed, but a tax Annual income Marginal of r,hvslcal persons credit Is granted. A permanent resident Is a person who spends In the country at teast 183 11n rubles) rates days In a calendar year. Law on Income Tax Up to 200,000 12X from Physical Persons Enterprises wIthold the tax from employees, monthly, on a cumulative basis, prorating family 200,001 to 400,000 20% (7 Dec 91). allowances. Persons with income from varfous sources present an annual return. 400,001 to 600,000 30a Tax Law (16 Jul 92). Business expenses are deductible. Advance payments are required from Individual businesses. Over 600,000 40% Exempltons: social Insurance benefits; state-granted family benefits; pensions; student In the Far North and other stIpends end grants; cooperative Income from the prospectIng of certafn metals; bank and hardship areas, and on state-debt Interest; disability coapensations; compensatfons for the donation of blood and unemiployment benefits' human milk; gains obtained In the occasional sale of property; rural income (sale of animats, regionat supplements 12X vegetables, etc. except flowers and medical herbs); Inheritances (see 3.2), except author and artistic rights; tottery prizes (4.32); Insurance compensations; divorce settlements; Foreign residents 20% emergency and calamity relief; gifts received from enterprises, up to 12 MMW; competition prizes, up to the MMU; dismissal comopensations; conpensatfon for the transfer to a new place The tax proceeds are fully allocated of work; compensations received by parents and widows of military personnel; housing to the regional and local budgets. allowance; food allowance; unemployment benefit, up to the MMW; income derived from a family farm during Its first 5 years; wages earned for work abroad; certain work Income of students; reinvested dividends; certain benefits granted by emproyers to employees' children and the disabled; proceeds from the sale of skins and meat of wild animals; and members of nomadic tribes. A flat allowancen, limited to 5 MMV, is deducted monthly from the taxable income, as follows. 5 NMW, for Heroes of the Soviet Unfon and Russia, holders of the Order of Stave, certafn war veterans, evacuees from atomic contaminated zones, survivors no Nazi concentration camps, and certain Invalid persons. 3 MMW, for parents and spouses survivors of war casualties, veterans of Afghanistan and other mIlitary operations abroad, and persons takIng care of certafn Invalids. I MMW, for any other person. Other deductions: contributions to charity and institutions of culture, education, health care, and social Insurance; 1 MMW per child under 18 (24 If fulltime student) and other economically dependent (deduction granted to each employed parent). Alien residents are entitled to special exemptions and deductions. 1.2 Enterprises (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptlons Rates 1.21 Enterprise profits tax A federal tax on the profits and capital Are exemot or deductible: profits from agri- Standard rate 32% gains of juridical persons, branches with culture and hunting (except agro industry); Brokerage, Intermediation 45S Law on Profits Tax on separate books of accounts and bank account, religious and public organizations and Concerts and shows in open air, Enterprises and and foreign enterprises with a permanent associations (except trade unions, political stadits, and halts with Organizations (27 Dec 91). establishment. Profits made abroad are parties and movements); enterprises with 70% 2,000 seats or more 50% Law on Investment Tax taxed, but a tax credit Is granted. of disabled or retired staff; Casinos/gambting, video shows, Credit (20 Dec 91). dividends and interest (see 1.25); reinvest- video/audio rentals 90% Tax Law (16 Jul 92). Wages are deductible up to 4 MMW times the ed dividends; amounts, up to 50% of profits, average number of employees. This Limit does allocated to form reserve funds until they The rate is reduced by half when 50% not apply to foreign-owned enterprises, reach 25% of the statutory capftaL; profits of employees are invalids, or 70% are Deductible local taxes: on land (3.11) and already taxed in Joint participations; invalids or pensfoneers. publicity (4.31), and the cleanup fees donations received from Individuals; (3J13), parking (4.42.c), photography and profits connected with assistance to the Advance payments are due on the 10th filming (4.41.e), and police and communal disabled; profits spent on restorations; and 25th of each month, except: fees (7.3). Depreciaton Is deductible on the profits of handicrafts; and certain revenues a) authorIzed small taxpayers--on the basis of 1992-revalued bookt values. Interest from the Chernobyl cleanup. 20th of each month; is deductible up to the CDR referential rate b) enterprises with foreign + 3%. In the determinatfon of capital gains, Are deductible. w to 50% of taxable profit: investment--on the 15th of the last the cost is adjusted for inflatfon, beginning on 1 Oct 92, profits reinvested in month of each quarter; and modernization, expansion, and reorgani- c) foreign enterprises--not subject Speciat rutes apply to raltroad transport; zation; profits reinvested In new facilities to advance payments. enterprises operating gas facilities; by the industries of oit, coat, food, Tax adjustments are made quarterly communication services; banking income medicines, food and medicat equipment, and and annualty. (1.23): Insurance income (1.24); and consumer goods; profits reinvested by small commodity exchanges. enterprises in fixed assets or new The proceeds are shared by the technotogies; 30% of expenditure for federat and subnational budgets. In An enterprise is considered smatl, for environment protection; authorized August 1992 the federal budget's purpose of tax incentives, if it has no more expenditure in health, public education, share was 41%. than the foltowing number of emptoyees: culture, sports, housing, children pre- a) retalt trade and other services 15 school and rest camps, services for inmates, Smalt enterprises may claim an b) scientific services 100 and expenditure in social infrastructure; lnvestment credit of 10% of the cost c) Industry and construction 200 charity and other contributions, up to 2% of of specified equipment, up to 50% of d) other productive branches 50. the taxable profit; investment by the state- the tax Liability. The credit is owned telecomajnication enterprfses, higher repayable in 5 years after a 2 year education Institutions, and psychiatric grace period, and interest is limited institutions; and loss carriovers up to 5 to the inflation rate. years, not covered by reserve funds. A two-year tax holiday applies to joint ventures set up before 1/1/92; new smell enterprises in agriculturat production and processing, production of consumer goods, construction including repairs, and production of construction materale; and editorial offices of mass media products. Local councils may, whiting their tax revenue shares, grant requited tax privileges through taxation agreements with enterpr lses. (Appendix 3 continued) Tax Nature of Tax Deductions and ExemptIons Rates 1.22 Entercrfse income tax A federal tax on the realized gross income, Are exeaDt or deductible Maximum standard rate 18X operational or passive, including proceeds bank, credit and Insurance institutions Nondiscriminatory rates, proportion- Law on the Enterprise from the sates of fixed assets, minus cost (see however 1.23 and 1.24 below); income at or progressive according to enter- Income Tax.(20 Dec 91). (neglecting wages) and the VAT and excise from state securities, and from loans made prise size, are set at regional Decree of the Supreme taxes, of juridical persons, dependencies to, or guaranteed by, the Government, the level. Soviet of the RSFSR on the without such status, and foreign enterprises Central Bank, and the Bank for Foreign Consulting, auditing 25% Procedure for Introduction which engage In econiomic activities in the Trade; income agricultural production; Commodity exchanges, of the Law on the Enterprise Russian Federation. Also taxed are income of religious organizations; Income brokerage, and Income Tax (20 Dec 91). dividends, interest, royalties, leasing, and from assistance or rehabfiltation of intermediation 45% Law on Investment Tax other passive income of foreign residents. Invalids; Income from crafts and public Auctions, casinos, video Credit (20 Dec 91). performances of ethnic minoritles; profits shows, leasing of video Speclal rules apply to ralfway transport, and already taxed In joint ventures; and aud audio, slot machines 70% THE ENTERPRISE INCOME TAX communication services, donations made by Individuats. Freight Income 6% LAW WILL COME INTO FORCE, IN REPLACEMENT OF THE ENTER- Individual firms are treated as any other Deductions limited globalivo to 50X of the The rate Is reduced by haif for PRISE PROFITS TAX (1.21 enterprise, and their owners' labor reward Is taxable base: profits reinvsted In enterprises where S0X of employees ABOVE), ON A DATE TO BE taxed according to 1.11 above. lnovation, conversion, expanslon, end RID; are lnvalids, or 70% are Invalids or AGREED BY THE SUPREME SOVIET profits reinvested In the production of pensioneers. AND THE GOVERNMENT. In the determination of capital gains, the food, baby food, medicines, medical original or residual cost is adjusted for equipment, construction materials, and Advance osyments are due on the 10th inflation, listed consumer goods; authorized and 25th of each month, except: expenditure in health care, public a) authorfzed small taxpayers--on the Foreign enterprisses may opt for paying the education, culture, sports, housing, and 20th; and enterprise profits tax (1.21) instead. children pre-school and rest camps; matching b) enterprises with foreign Invest- funds for employees' cooperative housing ment--on the 15th of the last month An enterprise Is considered JEtt, for construction; charity and other of each quarter; purpose of tax Incentives, if It has no more contributions, up to 2% of the taxabte c) foreign enterprises--not subject than the followfng number of employees: Income; incom of enterprises owned by to advance payments. a) retail trade and other services 15 religious and pubifc associations (except tax adjustments are made quarterly b) sclentific services 100 trade unions and political parties and and annualty. c) Industry and construction 200 movements); and losa carriovars up to 5 d) other productive branches 50 years, not covered by reserve funds. Tax credit Is granted for the tax Are not subJect to the 50% timit: vocational paid abroad on income Included In the associations; associations of invalids, war base. and tabor veterans; religious organizations; and charity foundratons. A 10 percent Investment credit is granted to small enterprises on the A 1 veer tax holiday applies to Incomes basis of a tax credit agreement, on derived from the Introductlon of production purchases of capitat goods. experiments. The proceeds are fully allocated to A 5 vears tax holiday applies to regional and tocal budgets. Incomes derived from the property or use of patents. Limited to their revenue share, regions may grant additional tax privileges. I-' (Appendix 3 continued) Tax Nature of Tax Deductlons and Exemptions Rates 1.23 Tax on bank income A federal tax on the profits of commerciat Exempt Income: interest on credit extended Standard rate 30% banks (and their branches that have a to or guaranteed by the Government, the Commercial banks lending Law on Bank Income Tax separate bealnce sheet and clearing account), Central Bank, and the Bank for Foreign primarily to agriculture 20% (12 Dec 91). authorfzed credit Institutions, the Forefgn Trade. Profits, dividends, and State Tax Service Trade Bank, the Savings Bank, specialized interest received from 18% Instruction No.10 (development) banks, and foreign-invested Exempt banks: equity participation, (at (7 Apr 92). banks and branches of foreign banks. a) the Central Bank of Russia; and bonds, other securities source) Tax Law (16 Jul 92). The taxable base is the banking income b) forefgn banks and their subsidiaries, Foreign banks without (received interest; comeissions; income from where an exemption had been granted by permanent establishment 18% currency operations, ticensing, factoring, international agreeements of the USSR/RSFSR. and brokerage; expenses reimbursement; Progressive rates are levied on services Income; and loans repayments), net Deductions, tmited globally to 50X of the profits exceeding the established of the following deductions: land, property, taxable base: premia on insurance on 0l) margin, In connection with the use of and road fund taxes; compulsory contributions deposits and against (2) bankruptcy and (3) Central Bank credits. such as to the pension, medical Insurance, Interest risks (up to 3X of profit--IX social insurance, and employment funds; each); authorized expenditure on health; The tax on transfers abroad is paid interest; commissions; expenses for exchange housing for the elder and disabled; children In the currency of the transfer. operations; depreciation; acqufsftion of pre-schoot and rest camps; education, intangibles; advertisement; advisory and sports, culture, and housing; and up to 1X Advance pavments are determined auditing services; physical plant maintenance of taxable income, contributions to charity quarterly, and 1/6 pafd on the 10th costs; business trips; operational expenses and institutfons of ecology, culture, and the 25th of each month, except: including on stationary, mail and tetegraph, education, pubtlc health, sociat protection, a) authorized small taxpayers--1/3 on transportatlon, deposit of valuables, other physical culture, and sports. the 20th of each month; banks, settlement/cash services, and computer b) foreign banks' branches--quarterly services. advance payments. Capital gains (with cost adJusted for Tax adjustments are made quarterly inflation) and dividend income are also and annually. taxed. Wage costs are not deductfble. Credit is provided for the tax paid abroad on taxable income. (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptlons Rates 1.24 Tax on Insurance A federal tax on the gross Income of the Deductions: Standard rate 25% income insurance and reinsurance activity, adjusted a) approved expenditure on heatth, housing by the following deductions: Insurance and for the elder and invalids, education, Profits, dividends, and Law on the Taxation of reinsurance indemnlzations; commissions; culture, sports, children pre-school and Interest received from 15% income from the Insurance reinsurance premia; payments as return of rest camps, and the housing fund; and equity partfcipation, (at Activity (13 Dec 91). nonutilized reinsurance reserves; provisions b) up to 1 percent of taxable Income, bonds, other securities source) Tax Law (16 Jul 92). for special insurance reserves; property, and contributions to charitles and organizations taxes for the maintenance of highways; of ecology, health, Invalids, religion, The rate is reduced by half for mandatory contributions to social funds; culture, education, and social security, enterprises where 50X of employees other Insurance costs, In line with the A -c1 coefficient is applied to the income are Invalids, or 70X are invalids or enterprIse profits tax. depreciation and derived from the temporary investment of pensioners. amortization; other insurance-related long-term Insurance funds. expenses. Credit Is provided for the tax paid Wage costs are not deductible. abroad on taxable Income. Advance Pawments are determined quarterly, and paid in sixths on the 10th and the 25th of each month, except: a) authorized smatl taxpayers--on the 20th of each month; b) enterprises with foreign investment--on the 15th of the last month of each quarter; and c) foreign enterprises--not subject to advance payments. Tax adjustments are made quarterly and annuatly. 1.25 Tax on investment A federal, witholding tax on profits, Exeanot income from state bonds and other 15% income of enterprises dividends, and interest derived by state securities. enterprises from shares, bonds, and other The proceeds are fully allocated to Law on Profits Tax on securities Issues In the Russian Federation, regional and local budgets. Enterprises and organizations (27 Dec 91) 1.26 Tax on foreiLo A federal witholding tax on dividends, Dividends and interest 15% iuridical persons interest, copyright, licenses, rent payments Copyright, licenses, rent and other income of foreign juridical payments, other income 20% Law on Profits Tax on persons, derived from Russian sources. Freight for International Enterprises and transportation 6% Organizations (27 Dec 91). (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptfons Rates 2. Sociat security contributions 2.1 Pension fund A payrolt contribution paid monthly by Are exemot: (a) organizations of disabled Employer's contribution contribution emptoyers, employees, and self-employed persons; and (b) retirees. Standard rate 31.6% persons, on the amount of wages and salaries, Agricutture 15.6% Decree of the Supreme or fncome, to the Pension Fund. Self-employed, lawyers 5% Soviet on Matters Related to Enployees 1% the Pension Fund (27 Dec 91). Decree of the Supreme Soviet on Procedures for the Payments of Insurance Premfe to the Pension Fund (27 Dec 91). Administration: Pension Fund. 2.2 Social insurance fund Apayroll contribution paid monthly by Standard rate 5.4% contribution employers. Agriculture 5% Adm inistration: Federation of Independent Trade Unions of Russia. 2.3 Emplovment fund A payroll contribution paid monthly by 1% contribution employers. Administration: State Employment Committee. (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptions Rates 3. Taxes on property 3.1 Recurrent taxes on imovable rocerty 3.11 Land tax A locat, mandatory tax on arabte land, Are exempt: reserves, notional parks, and Basic rates for the tand tax varies assessed on the basis of the quatity of tand, botanicat gardens; ethnic minorities in the among regions from rub 10 (minimum Law on Land Rent area, and location. This Is to be the only respective areas; scientific, experimental, rate) to rub 176/ha. Individual plots (11 Oct 91). tax paid by cottective farms, state farms, and educationat agricutturat and forestry are taxed at rub 0.01/m2. Basic Law on the Bases of peasant farms, agroeconomic entities and institutions; artistic, scientific, health, rates for the fixed payment for the the Tax System (27 Dec 91). organizatlons, cooperative and other sport, and educational estabifshments use of arabte tand varies from zero Land Code, agricutturat enterprises (but not by agro financed by the budget or the trade unions: to rub 129/ha. Tax Law (16 Jul 92). industriat enterprises). They are liabte to veterans of WII; disabled persons; persons other taxes, however, If non-agricutturat exempt from the IndividuaL Income tax; Coefficlents are applied for income exceeds 25% of total income border lands; tands under communaL use; historicat sites, certain cities, and state radio and TV; defense communications resort areas. The tax proceeds are earmarked for tand enterprises; residentiat ptots atLocated to devetopment, military servicemen, In retation to the The rates are doubted for the land In federaL budget,s tax share; tand atLocated excess of the estabtished norm. to the Ministry of Defense and other goverrnent services; cultural, sport, The tax Is peid in two installments, tourist, and fitness facilities; certain on September 15 and November 15. educational and scientific organizations; and pubtlic sanatoria, heatth resorts, and The proceeds of the tax belong to the recreational facilities, budgets of the rural, town, and district councits, depending on the Regional and Locat councils may reduce the location of the land. A share is rates and establish tax benefits. transfered to reglonal and federal funds. The centralized federal fund Tax hotidavs: (a) 5 years, for Individual share varies from zero to 50%. peasant farms; (b) 10 years, for spolted land received to recultivate; (c) variable period, for land ptots undergoing agricul- tural development. 3.12 Tax on individual A local, mandatory tax tevied annualty on the Persons exempt: 0.1% property value of buildings, premises, and structures, Heroes of the Soviet Union and holders of including apartments, residential houses, the Order of Glory; disabled persons; war The tax proceeds belong to the budget Law on Individual dachas, and garages, owned by Individuals, veterans; specified Chernobyl survivors; of the local where the property is Property Tax (9 Dec 91) pensioners; certain tow-ranking military located. Law on the Bases of personnet. the Tax System (27 Dec 91). Other benefits may be granted by the regional and locat soviets. 3.13 Cleanup paYrnent A locat levy on owners of bultdings (both Rates are established by the local Individuals and enterprises) for the cleaning councits of people's deputies. Law on the Bases of of territories of cities, towns, settlements, the Tax System (27 Dec 91). etc. Tax Law (16 Jul 92). N (Appendix 3 continued) oo Tax Nature of Tax Deductions and Exemptions Rates 3.2 Gifts and A federat tax levied on behalf of the local Are exempt: Inheritance value Marginal inheritance tax budgets, on the acquisition of property (a) inheritances under 850 MMW and gifts (in MMW) rates through inheritance or gift, including under 80 MMtW; First degree heirs Law on the Gifts and houses, dachas, apartments, share capital (b) transfers between spouses; Up to 1,700 5% Inheritance Tax (12 Dce 91). accumuLation in housing construction, garage (c) transfers of residential houses or 1,701 to 2,550 10% Law on the Bases of the construction or dacha construction shares in housing construction cooperatives Over 2,550 15% Tax System (27 Dec 91). cooperatives, garden houses in gardening between persons who lived together; Second degree heirs State Tax Service associations, cars and trucks, motorcycles, (d) inheritance from persons who died in Up to 1,700 10% Instruction No.6 motor boats, launches, yachts and other defense of the USSR and Russia or in other 1,701 to 2,550 20% (13 Mar 92). vehicles, antiques and art objects, money, specified cfrcumstances; Over 2,550 30% Tax Law (16 Jul 92). securities, jewelry, other products made from (e) houses and means of transportation Other beneficiaries valuable metal and gemstones and their inherited by disabled persons. Up to 1,700 20% scraps, shares in housing, garage, and 1,701 to 2,550 30% country house construction cooperatives, Over 2,550 40% valuables in foreign exchange, and securities. Gift value marginal (in MMW) rates Children and parents Up to 850 3% 851 to 1,700 7% 1,701 to 2,550 11% Over 2,550 15% Other beneficiaries Up to 850 10% 851 to 1,700 20% 1,701 to 2,550 30% Over 2,550 40% 3.3 Taxes on financial and capital transactions 3.31 Tax on securities A federal tax on the Issuing and purchases- Exempt transactions: Registration of issue 0.5% operations sales of securities (shares, savings (a) the first transfer of shares of a joint- Purchases-sales certificates, all types of bonds, and stock company, after its registration; State securities 0.1% Law on the Taxation of transfer bills). The tax is witheld by the (b) the initial Issuing of securities; Other securities 0.3% Operations with Securities stock exchange or financial institution which (c) financial intermediation. (12 Dec 91). registers the issue or intermediates the Exempt securitles: operation. (a) State Bonds of 1982; (b) U.S.S.R. Savings Bank certificates; On registration, the tax is levied or the (c) U.S.S.R. Treasury sills. nominal value. On secondary trading, the tax Exempt taxpayers: workers' collectives, In is levied on each party. relation to the shares they hold. (Appendix 3 continued) Tax Nature of Tax Deduct1ons and Exemptions Rates 3.4 Other recurrent taxes on PropertY 3.41 Enterprise A tax paid annually by enterprises and ExemOt entitles: Up to 1%, and graduated by type of DroPerty tax institutions (including banks, firms with (a) budgetary Institutions and the legal economic activity, as established by foreign participation, permanent bar; (b) enterprises engaged in the the regions. Law on the Bases of establishments of foreign enterprises, and production, processing, and storage of the Tax System (27 Dec 91). affiliates and branches with separate books agricultural products, and in fishing and Advance payments are due quarterly. Law on the Enterprise of accounts and bank account) on the gross fish processing; (c) enterprises producing Property Tax (13 Dec 91). book value of the assets minus: orthopedic devices; (d) religious Half of the proceeds belong to the Law on Investment Tax (a) depreciation allowances, (b) expensing of organizations and ethnic- cultural regional budget, and the other haltf Credit (20 Dec 91). short-tived and inexpensive fixed assets, (c) societies; (e) municipal enterprises, to the local budgets. Tax Law (16 Jul 92). use of profits; (d) loans; (e) bank credits inclusive housing enterprises, and to employees; (f) settlements with the enterprises located in ethnic enclaves; and Privatized enterprises may claim an budget; (9) foreign currency deposits at the (f) enterprises and organizations owned by investment credit up to 50X of the VEB as of 1/1/92; and (h) loans, funds, and Invalids, or with more than 50% disabled tax liabitity. The credit is reserves of credit and insurance enterprises, staff; (g) nonprofit associations financed repayable in 5 years after a 3 year financed with borrowed funds, on the basis of votuntary contributions; and grace period, and interest Is limited (h) budget-financed scientific and research to the inflation rate. instftutions. Exempt assets: (a) property used for education and culture; (b) property used for seasonal accumutation (thermat power ptants etc.); (c) stockpiles created in acordance with Government decisions; (d) housing and co,mmjnal enterprises (except hotels and other highly profitable enterprises); e) assets used for environment protection and fire safety; (f) property used in agriculture and fishing; (g) pipetlines, roads, commjnication channels, high-voltage tines and adjacent strips of land; (h) coemmnication sateltites; (i) satellites of the Earth; (j) leased property; and (k) transport equipment required for use no more than 3 months a year. A one-year tax holiday applies to new enterprises, except those resulting from privatization. Local councilts of peopte's deputies may, within their tax revenue shares, grant requited tax privlteges to enterprises. ,,A (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptlons Rates 4. Domestic taxes on goods and services 4.1 GeneraL sales taxes (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptions Rates (a) Value-added tax A federal tax on the value, actually Zero-rated goods and services: exports Standard rate 28% 1/ received, of goods sotd and services rendered outside the CIS, lncluding transportation, Flour, cereals, pasta, Law on the Value-Added by enterprises, associations, and individuals toading, unloading, and transfer of exports mitk, kefir, curds, Tax (6 Dec 91). who engage In entrepreneurial activity. outside the CIS, and passthrough cargoes; vegetable ofl 15% 2/ Instruction of the The base lncludes (a) detiveries to branches goods and services used by dipLomatic 1/ 20% beginning on 1/1/93 State Tax Service No.1 who have separate settlement bank accounts; representations and their personnel; 2/ lOX beginning on 1/1/93, on all (9 Dec 91). (b) barter sates; (c) transfers gratis; and msnicipat passenger transportation, except foodstuffs (except those excised) and Resolution of the (d) sates of fixed assets and intangibles. taxis, and on suburban maritime, river, children's goods. Presidium of the Supreme rail, or automotive routes; apartment rent, Soviet (3 Feb 92). The tax base Includes the excises taxes but incl.hostels; sale and lease of privatized Payment Is due on the 15th day Law on Changes in the not the VAT itseltf. state enterprises; coal mining and process- foltowing the assessment period, VAT Law (22 May 92). Ing; assets sold during privatizatfon; except raltways (on the 25th) and Tax Law (16 Jul 92). On trading activities (wholesale, retail, rental payments for leased state annual assessment (on January 20th). procurement, supply, marketing, etc.) the enterprises. base Is the difference between the selling Exesftions: individual traders w/sales S rub Excess of credits over debits in a price (before retail VAT) and the after-VAT 100,000/year; sales and purchases made by month is carried over or refunded. purchase price. * psychiatric institutions, enterprises with 50% of staff disabled; social organizations Advanced Payments are due between Beginning on 1/1/93, the VAT paid on the of the disabled; insurance, reinsurance; the 10th and the 28th of each month purchases of fixed assets and intangibles in credit and deposit transactions; foreign by enterprises with average monthly deductible: (a) Immediatety, by agricultural exchange operations; financiat securities payments t rub 300,000. enterprises; and (b) in monthly instatiments (but not financial Intermediation); postal over 2 years, by other taxpayers. stamps (except cotlectibtes) and cards; lottery cards; goverranent fees; legal servi- Exports to the CIS are taxed, and VAT credit ces; language transtation services; intel- is granted on the VAT paid to other CIS lectual property rights; certain education countries. revenues; cultural, artistic, and religious services; theater performances, pageants, The tax is assessed by the taxpayer with the and athletic, cultural, educational, and fotlowing frequency: entertain-ment events; video shows, casinos, Average monthly tax Assessment coin-operated games, and winnings on horse payment (in rubles) Pariod races (4.34); funeral services; public Over 100,000 month catering services of budget-supported 10,000 to 100,000 quarter institutions; caring for the sick and Less than 10,000 year 1/ elderly; rental of sport facitities; certain 1/ Under STS permission. services for children; R&D performed for specified institutions; transactions of the State Fund of Precfous Metals and Stones; state sates of confiscated, abandoned, and inherited assets, and found treasures; sales of social, cultural, and consumer service facilities to the local councits; medical services and products; medicines, protheses; room and board at sanatorfi and health resorts; vehicles and technical facitities for the disabled; touristic packages; pay- ments for mineral resources; Interior Minis- try's security services; house building; agricultural output pald in-kind to, or consumed by employees; artistfc handicrafts. 9j (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptions Rates 4.12 Tax on the users A tax on the sales of goods and services, Officiat purchasing agencies, of motor roads earmarked 25% for the Federal Road Fund and Incl.wholesste organizations 0.03% 75% for the territorfal road funds. Other enterprises 0.40% Law on the Road Funds in the RSFSR (18 Oct 91). 4.2 Excises 4.21 Excise taxes A federal tax on the excise-inclusive Price Are exempt: Goods of tisted goods, at rates set by the a) goods exported outside the CIS; Atcoholic beverages Law on Excise Taxes Goverrnment. b) passenger car tires dispatched for car Spirits, exc.vodka 90% (6 Dec 91). assembly. Vodka 80% State Tax Service The tax is self-assessed by the taxpayer: Liqueur 75% Instruction Mo.2 (9 Dec 91). a) on atcoholic beverages, datly; Wine 46.5% Presidentiat Decision b) other goods, according to the tax amount: Brandy 55% (publ. Rossiyskaya Gazeta Average monthly Assessment Sparkling wine 47.5% 3 Jan 92). tax payment (in rubtes) period Beer 25% Tax Law (16 Jul 92). Over 100,000 10 days Deticatessen 10,000 to 100,000 month Chocotate 40% Less than 10.000 quarter caviar 40 Tobacco products 14/20/25/40% Payment: atcoholic beverages and large Automobiles taxpayers, on the 3rd day foltowing the GAS 35% assessment period; other taxpayers, on the Other automobiles 25% 15th of the month following the assessment Tires 62% period. Jewels 10% Furs 10/20/35% The proceeds of the excise tax on the sales High-quatity porcelain 30% of automobites for personal use are earmarked Articles of crystal 45% for the Federal Road Fund. Carpets 20/45% Leather clothing 35% 4.22 Tax on the purchase A tax paid by the buyers of new and used Are exemot: Trucks 20% of means of motor motor vehicles, due before registration. The a) persons affected by radiation from the Pickups, vans 20% transportation tax is calculated on the selling price before Chernobyl disaster; Buses 40% the VAT and excises. b) disabled persons and their public Special cars 20% Law on the Road Funds organizations, Trailers 40% (18 Oct 91). The proceeds of the tax are earmarked for the c) vehicles for public transportation, Automobiles sold at territorial road funds. except taxicabs; wholesale price 40% d) enterprises engaged in the maintenance of Taxicabs 20% highways; Auctloned vehtcles 40% e) farms and their associations. of the starting call price (Appendix 3 continued) Tex Nature of Tax Deductions and Exemfptions Rates 4.23 Contribution for the A levy on the sales of crude petroleum end Price (in rubles) Marginal rate price regulation fund natural gasat prices above the minimnum state Crude petroteum (per ton) regulated wholesale producer prices (SRWPP). Up to 1.800 0% Goverrnent Resolution The proceeds belong to the Price Regulation 1,801 to 1,900 60% No.318 (18 May 92). Fund, of the Ministry of Finance. 1,901 to 2.000 70% The ranges of C.l.F. SRWPP, before VAT, were 2,001 to 2.100 80% set at: 2,101 to 2,200 90% (a) oil: rub 1,800 to rub 2,200 per ton; Over 2,200 100% (b) gas: rub 1,100 to rub 1,600 per 1000N . Natural gas (per 1,000m3) Up to 1,100 .0% 1,101 to 1,200 70% 1.201 to 1,500 80% 1.501 to 1,600 90% Over 1,600 100% 4.24 Tax on fuels and A twin tax on the sales of fuet and lubri- Federal tax 18% lubricants cents (gasoline, diesel fuel, automotive Territorial tax 7% oils, and condensed and liqutfied gas used as TotaL 25% Law on the Road Funds motor fuel), earmarked for financing the road (18 Oct 91). funds. The rates are set by the Council of Ministers of the Russian Federation. 4.3 Taxes on specific services 4.31 PubtleftY tax A local tax paid by individuals and Up to 5% of the cost of advertising. enterprises which advertise their goods. Law on the Bases of the Tax System (27 Dec 91). 4.32 Levy on auctions A local levy paid by the organizers of Up to 10% and lotteries auctions and lotteries on the cost of auctioned goods and the value for which Law on the Bases of lottery tickets are issued. the Tax System (27 Dec 91). 4.33 Tax on horse races A local tax on the value of bettings on horse Up to 5% races. Law on the Bases of the Tax System (27 Dec 91). 4.34 Tax on horse A local tax on the amounts won in horse race Up to 5% race winnings bettings. Law on the Bases of the Tax System (27 Dec 91). 4.35 Tax on transactions A local tax paid by each party on Up to 0.1% at trade exchanges transactions, other than securities transactions, held at exchange houses. Law on the Bases of the Tax System (27 Dec 91). CoA (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptions Rates 4.4 Taxes on the use of goods or on vermissfon to use goods or to perform activities 4.41 Business and Professional licenses (a) Levy on trading rights A local, mandatory levy for the issuance of a Tax benefits may be established by the Local Maximum rates are established by the coupon or patent which grants the right, council of people's deputies. Ministry of Finance. Law on the Bases of the permanent or temrporary, of individuals to Tax System (27 Dec 91). conduct retail trade. Tax Law (16 Jul 92). (b) Licensing fee on trade A local tevy paid annuatly on legal entitles In MMW in alcoholic beverages and Individusas who sell alcoholic beverages Enterprises 50 to the public. Temporary traders, serving Individuals 25 Law on the Bases of the parties, balls, carnivats, etc. pay an amount Temporary traders Y. per day Tax System (27 Dec 91). fixed per day of trading. (c) Levy on the A local tax on individuals and partnerships The federal law may establish rates registratfon of of unlimited responsibility, levied when they uniform for the whole country. individual businesses register or reregister. In the case of a Otherwise, they are set by the partnership, each member is registered regionat and local governments. Law on the Bases of the separatety. Tax System (27 Dec 91). (d) Levy on owners of A local levy on individuals and legal Rates set by the local councils of racing horses entities whose horses participate in races or the place where the hippodrome is other commercfae competition. located. Law on the Bases of the Tax System (27 Dec 9 ). (e) Levy on photography A local fee payable by cinema and television Amounts determined by the local and filming enterprises for the right to shoot cinema and council of people's deputies. television films outdoor, when the activity Law on the Bases of the requires that the authority take measures Tax System (27 Dec 91). such as deployment of police units and Tax Law (16 Jul 92). cordoning off of the location. f) Fee for the use of A federal charge for the right to use the the Russia name names Russia, Russia Federation, and their combinat ions. Tax Law (16 Jul 92). (g) Gambling licence A locat fee charged for the right to open a Rates are set by the local councils gambling business, inctuding game machines of people's deputies. Tax Law (16 Jul 92). and other equipment offering in-kind or cash prices, card tables, roulette, and other game facitities. 4.42 Motor vehicle taxes (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptlons Rates (a) Tax on vehicles A loest, mandatory tax levied annually on the Vehicles exemot: motor boats under 10 HP or Helicopter, air- rub 0.50/HP individuat property of motorboats, 7.4 kW. planes, motorships or rub 0.68/kW Law on Individual helicopters, airplanes, and other means of Property Tax (9 Dec 91). transportation except passenger cars; Persons exemot: Yachts, powerboats rub 0.30/Hp motorcycles: and other setf-propelted a) Heroes of the Soviet Union holders of the or rub 0.408/kW vehicles and pneumatic drive mechanisms. Order of Gtory; b) disabled persons; motorsiedges, rub 0.15/HP c) war veterans; motorboats, other or rub 0.204/kW d) specified Chernobyl survivors, vehicles Other benefits may be granted by the The tax proceeds belong to the budget regionat and locat councits, of the local council where the vehicle is registered. (b) Tax on the owners of A tax paid annually by the owners of motor Are exent: Rate per HP means of transportation vehicles. it Is also levied when property of a) persons affected by radiation from the Automobiles (in HP) the vehicle Is transferred., Chernobyl disaster; Up to 100 rub 0.50 Law On the Road Funds b) disabled persons and their public Over 100 rub 1.30 in the RSFSR, of October 18, The proceeds of the tax are earmarked for the organizations; Motorcycles rub 0.30 1991. terrftorial road funds. c) vehicles for public transportation, Buses rub 2.00 except taxicabs; Trucks and tractors (in HP) d) farms and their associations; Up to 100 rub 2.00 e) enterprises engaged in the maintenence of 100 to 150 rub 4.00 highwys; 150 to 200 rub 4.80 f) harvesters and other agricultural 200 to 250 rub 5.20 machines. Over 250 rub 7.15 The legislative power may grant other Other self-propelled exenptions. wnd pneustic vehicles rub 2.00 (c) Automobile oarkino fees A local levy payable by individuals and Rates set by the local councils of enterprises for the right to park of motor people's deputies. Law on the Bases of the vehicles In designated parking lots. Tax System (27 Dec 91). 4,43 Other taxes on the use of goods or on ermission to use goods or to perform activities (a) Resort tax A tax which my be levied by local Are exenot: (a) chfidren under 16; Ib) dis- Up to rub 10 goverrnents on persons who arrive in resort abled persons; (c) visitors for purpose of Law on the Bases of the locations without a pass. business, schooling, work, and permanent Tax System (27 Dec 91). residence; Id) certain tourist groups; (e) elderly citizens arriving to visit children, or vice versa. (b) Tax on construction in A tax which may be levied by local resort zones governeents on the construction of Industrial projects In health-resort zones. Law on the Bases of the Tax System (27 Dec 91). (Appendix 3 continued) Tax Nature of Tax Deductlons and Exeeyptions Rates (c) Levy on dog owners A tocat, annual tax payable by city dwellers Exempt: service dogs. Up to 12/7 MMW who own dogs. Law on the Bases of the Tax System (27 Dec 91). (d) Lew on the occuDation A one-time local levy payable by individuals Up to 3/4 MM, depending of saartments and legal entities who obtain the right to on the area and quality. occupy an apartment. Law on the Bases of the Tax System (27 Dec 91). (e) Fee for the use A tocal sates tax levied on the value of Up to SX of local symbols products in whose labets appear tocat symbots such as crests, city views, tandscapes, and Law on the Oases of the hystorical monuments. Tax System (27 Dec 91). 4.5 other taxes on goods and services 4.51 Tax on the resale A local tax on the second-hand sale value of Up to M of automobiles automobiles, computer hardware, and personal and computers computers by legal entities and individuals. Law on the Bases of the Tax System (27 Dec 91). (Appendix 3 continued) Tax Nature of Tax Deductions and Exeoptfons Rates 5. Taxes on international trade and transactions A provisional, ad valorem miport customs Exempt aoods: Goods not tisted, except 5.1 Imoort duties tariff, Introduced on Juty 1, 1992, and later (a) accompanied baggage, except motor exempt goods 15% modified. Goods are listed according to the vehicles, up to US$ 10,000, and products for Presidentiat Decree TN VED classification, personal consumptfon within the timits fixed Malt beer (220300) No.630 (14 Jun 92). by the SCC; and grape wines (220421/9) 20% CSS Ordinance No.219 There are three regimes: (b) foodstuffs and medicines, and the raw Sparkting wine (220410) (24 Jun 92). a) Basic tariff rates, corresponding to the materials for their production, within the and vermouths etc. (2205) 25% Presidential Decree most favoured nation treatment (MFN); limits fixed by the Goverrinent [list Alcohol (22071. 22081) 30% No.825 (7 Aug 92). b) Developing countries: rates are half the attached to the SCC ordinance 2191; Spirits (220820/90) 50% CSS ordinance No.367 MFN rates tl01 countries listed In Attachment (c) books, newspapers (TN VED group 49); (21 Aug 92). 5 to Ordinance 3671; (d) children articLes (6111, 6208); Video equipment (8521), Administration: State c) Least developed countries: imports te) wheeLchairs, medicaL and surgicat recorded (852421/90) and un- Customs Committee (SCC). originating from these countries are exempt Instruments, therapy equipment, and recorded audio media (8523), (47 countries listed In Attachment 4 to orthopedic aids (84192, 8713, 87142, 9018/9, camcorders (852530910). and Ordinance 3673. 9021, 902211, 9402); television receivers (8528) 25% (f) one vehicle per permanent resident--the Passenger vehictes, when imported by exemption is revoked if vehicle Is resoLd Passenger vehicles (8703): individusts, are taxed fn ECUs per cm3 of wfthin two years from the fmportatfon date. Enterprfses 25% engine capacity. Individuats ECU 0.1/cm3 Payment is rade In rubles, based on the market exchange rate quoted by the Central Sank. Import tariff revenues belong to the federat budget. ""4 (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptions Rates 5.2 Export duties A federal tax on the export, from the A specfal regime applies to exports for use An ad valorem rate of 20% applies to territory of the Russia Federation, of the In qualifying projects abroad, groups 1-5 (livestock, animal Presidential Decree goods tisted by the Government. products), 6-14 (vegetal products), No.629 (14 Jun 92). Exempt: goods classified in the following 16-24 ex (ready-made food, beverages, SCC ordinance No.219 Special norms apply to exports to the CIS groups of the TN VED: tobacco), 30 (pharmaceuticals), 32-33 (24 Jun 92). member countries. 2 (meat and Its products), 3 (fish, (pigments, essential oils, perfumes, Adainistration: State molluscs, etc., ex code 030110), 4 (dairy cosmetics), 35-38 (glue, ferments, Customs Committee (SCC). Payment of the tax may be deferred up to 60 products, eggs, other foods of animal explosives, matches, photo and cine days under bank guarantee or permission of origin), 7 (vegetebles, certain tubers), 8 equipment, other chemicaes), 43 (fur the Ministry of Finance. In this case a fee (edible frults and nuts, etc.), 9 (coffee, and producta), 45-46 (cork, wicker), of 0.2% a day is charged (0.01% If payment is tea, mate, spices), 10 (cereals), 11 (flour 46 (printed matter), and 71 (precious made In convertible currency), products), 12 (olt seeds, ex), 13 (some metaels and stones, pearls, coins). Items: plant Juices, extracts), iS (fats and oilts or animal or plant origin, ex Sanple of ECUs-aer-ton rates: Industrial oils), 16 (seafood products), 17 crude petroleum 38, natural gas 31, (sugar and products), 18 (cocoa and gasotlne and gasoll 55, fuet oil 25, products), 19 (cereal foods), 20 (processed lubricants 490, coking coal 8, gas vegetables, fruits, nuts), 21 (other food), coal 24. other coal 2, coke 16, 22 (non-alcoholic beverages ax, and copper ore 10, Iron ore 2, mica 40, vinegar), 30 (medicines), 40 (rubber and niobfum 16,000, quartz 4, silver products ex), 560110 (napkins, diapers, 100,000, tungsten 900, uranium 5,000, etc.), and 90 (medical Instruments). zinc ore 40, non-specified minerals 30, cement 3, fertilizers 7-15, A number of discretionary exemptions has naturat leather 250-500, salt 5, been granted by the Government. skins 70-130, timber 10-100, vodka 190. Surtax: On barter trade, the amount of the tax is Increased by 30% (50% beginning on 11/93). 6. Taxes on natural resources 6.1 Taxes on mineral Are exempt, resources a) land owners legally extracting. for their own needs, generatty used minerase In land Law on tlineral owned or rented by them; Resources (21 Feb 92). b) geological work such as for surveying, forecast earthquakes, study of volcenic activfty, paleonthogy, and underground water regimes, which do not violete the integrity of mineral resources; c) author1ied exploration for listed non- comesrcalt purposes; d) other exemptions granted by regional governments against their share of revenue. (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptions Rates 6.11 Payment for the One-time or periodic payments during the Specific payment amounts are fixed by right to utilize exercise of the right granted. Criteria for the licensing authority. mineral resources payments are established by the federal Goverrnent. Law on Mineral Resources (21 Feb 92). (a) Payment for the A payment determined on the basis of economic Proceeds from the payments belong to right to and geographical conditions, size and area of the budgets of rayons and cities. Prospect minerals the resources, type of mineral, duration of work, degree of geotogical study, and risk Law on Mineral involved. Resources (21 Feb 92). (b) Payment for the A two-tier payment, consisting of an initial Piyment is not required from the user of A percentage of the value of the raw right to payment and periodic payments starting at the minerals that acquires the right to extract materials extracted. For energy extract minerals beginning of extraction. Payments are fixed directty from areas already allocatc'. carriers (petroleum, natural gas, and on the basis on the type, quantity, and coal) the rates is 8% of the SRWPP. Law on Mineral quatity of the minerat in deposit, and on Resources (21 Feb 92). geographicat, technological, and economic Percentage revenue share of federal, Government Resotution conditions of the exploration. and risk regional, and locat budgets, resp. No.318 (18 May 92). involved, a) Hydrocarbons 40 30 30 b) Generat-use minerats 0 0 100 c) Other onshore minerals 25 25 50 d) Continentat shetf 40 60 0 e) High seas 0 0 100 Natf the federal take goes to the krsi/oblast of the tocation. Governfents may agree on different sharlng in special cases. (c) Payment for the A one-time payment and/or periodic payments Proceeds from the payments betong to riaht to utitize for the utitization of mineral resources for the budgets of rayons and cities. minerals for purposes unrelated to extraction, such as the other Purposes construction or development or underground facfities. Payments are fixed on the basis Law on Minerat of area, useful properties of the minerats, Resources (21 Feb 92). and ecological risk. Depletion atlowance may be granted by the ticensing agency for the extraction of low- yielding deposits of rare minerats. (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptions Rates 6.12 Provisions for A payment earmarked for the federal off- The rates of provisions and the reproduction of the budget Fund for Reproduction of the Minerals proceeds sharing and utilization are minerals and raw and Raw Materials Base. This payment is to established by the Supreme Soviet. materials base replace the contribution for the geological surveying and prospecting budget, charged on Rates of the geological contribution: Law on Mineral the wholesale price of mineral products, and Crude petroleum, natural gas, Resources (21 Feb 92). administered by the Ministry of Geology. and gas condensate 10X Government Resolution Coal SX Mo.318 (18 May 92). 6.13 Mineral resources A charge estabifshed by the agency issuing a licence revenue license for the utilization of mineral resources, on the basis of the cost for Law on Mineral analyzing the application and other Resources (21 Feb 92). administrative costs. 6.14 Hineral excise A tax the federal Government may introduce on individuat types of raw minerals from Law on Minerat deposits with comparativety better mining- Resources (21 Feb 92). geological and economic-geographical charate- ristics, In the event of the user's deriving excess profits. 6.15 pawents for A payment for the utilization of areas of Rates are established by the federal utilization ot areas water and parts of the sea bottom, by Government. of water and parts prospectors and extractors of mineral of the sea bottom resources. Law on Mineral Resources (21 Feb 92). 6.16 Water fee A levy established at the national level, on The federat taw may establish rates behatf of the regional budgets, on industrial for the whole country. Otherwise, Law on the Bases of the enterprises that have access to water supply each region may set its own rates. Tax System (27 Dec 91). systems. 6.2 Other taxes on naturat resources 6.21 Forest tax A tax levied at the national level, on behalf The federat law may establish rates of the regional budgets, on the use of for the whote country. Otherwise, Low an the Bases of the developed forest tands for togging or each region may set its own rates. Tax System (27 Dec 91). recreational purposes. The base is the Law on Land Rent taxable cost of standing timber. Rates: (11 Oct 91). Logging 5% Recreation SX (Appendix 3 continued) Tax Nature of Tax Deductions and Exemptions Rates 7. other taxes 7.1 State dutv Sample of rates: A tax which may be levied by local Lawsuits: Law on the State governments on the filing of Lawsuits, Precontract disputes rub 25 Revenue Duty (9 Dec 91). precontract and reviews In arbitration other, up to rub 1,000 SX Law on the Bases of the courts, and documents brought before or Other, over rub 1,000 15X Tax System (27 Dec 91). produced by public notaries. CompLaints against On transactions typicalLy having a known state officers rub 10 value, the rates are ad valorem, otherwise Divorce appLication rub 30 they are set In rubles, If on a second tfme rub 50 Copy of court decisfon rub S Property claima loX Non-property claims rub 1,000 Certification of land tenancy rub 50 Housing rentaLs: To children, parents 3X To nonrelated parties 10X Certification of other contracts, fincluding privetization of state enterprises' houses 5X 7.2 Stamp duties Levies which may be introduced by locat governments. Law on the Bases of the Tax System (27 Dec 91). 7.3 Special-puroose levies Local tevies earmarked for the maintenance of Rates are set, In cities and rayons, the potice force, for sociat development, and by the tocat councits, and, in Law on the Bases of the other purposes. setttements end vittages, by a Tax System (27 Dec 91). meeting of poputation. the annuat Tax Law (16 Jul 92) rate may not exceed, for individuals, 3X of 12 M. and, for enterprises, lX of the annual wage biit. Notes: 1. MMl * monthly minimum wage. As of September 1, 1992, MMU * rub 900. 2. SRWPP * state regulated wholesate producer prfce. 3. Regional governments may provide additional tax incentives--except those of a personal character--within the limits of their tax shares. 4. Regional and local governments cannot introduce taxes not listed in the Law on the Bases of the Tax System. S. Except where otherwise indicated, all taxes are administered by the State Tax Service (STS). Appendix 4 Revenues and Expenditures (Planned and Actual) by Oblast (in '000 rbl.) 1992 Ql Budget and Actual Total Total Total Revenues Expenditures Total Revenues Expenditures Surplus/Deficit Actual Actual Surplus/Deficit Oblast Budgeted Budgeted Budgeted (March) (March) Actual (March) Baskirskaya AR 2478934 2170601 308333 14114147 14321719 -207572 BuriatskayaAR 927706 793514 134192 3792666 5947685 -2155019 DagestanskayaAR 803245 1076186 -272941 3120875 7584535 -4463660 Kabaldino-Balkarskayat 495529 429105 66424 1998824 2934846 -936022 Kalmytskaya AR 284233 266075 18158 794809 2445542 -1650733 Karel AR 661253 563789 97464 3779943 4468081 -688138 KomiAR 1048134 878120 170014 7033929 7781080 -747151 MariysayaAR 535000 460307 74693 2361371 3587227 -1225856 Mirdovskaya AR 673489 584459 89030 3410025 4602190 -1192165 Severo-OsetinskayaAR 473707 411143 62564 2260109 2770403 -510294 TatarskayaAR 2064729 1821896 242833 16604462 11923348 4681114 Tuvinskaya 195316 313314 -117998 891406 2969313 -2077907 Udmurdskaya AR 1103837 970064 133773 6029430 6876404 -846974 Checheno-InkuskayaAR 733020 647619 85401 2143350 4621525 -2478175 ChuvaskayaAR 887031 770907 116124 5028666 5479667 -451001 Jakutskaya AR 1885639 1451136 434503 16946970 10649292 6297678 Altay Kray 1865955 1629923 236032 8974206 11828936 -2854730 Krasnodar Kray 2407256 2121510 285746 14599311 14653461 -54150 Krasnoyjarsk Kray 2166049 1887194 278855 20304446 13734635 6569811 Primorskiy Kray 1548322 1346580 201742 12174939 9815887 2359052 Stavropol Kray 1321439 1161580 159859 8788731 7827117 961614 Amurskaya 816696 712745 103951 5149966 5822821 -672855 Arkhangelsk 1071457 924010 147447 5994419 6702119 -707700 Khaberov Kray 1326098 1145046 181052 8457441 8868139 -410698 Astrakhan 638816 556574 82242 3309823 4539394 -1229571 Belgorod 910738 778214 132524 5484930 5714635 -229705 Bransk 900056 795581 104475 5255420 5781076 -525656 Wladimir 890450 778499 111951 7251232 5695379 1555853 Volgograd 1505378 1323661 181717 10262525 9426223 836302 Vologda 878106 772082 106024 6523182 6260491 262691 Vorosezh 1392835 1233420 159415 8267128 8734073 -466945 Gorki 1963683 1689738 273945 20296278 12709524 7586754 Ivanov 778684 686951 91733 6664788 4862511 1802277 Evenkiyskiy AR 1866666 1526989 339677 12144345 11065530 1078815 Kaliningrad 557053 490897 66156 4051924 3703252 348672 Trer 924180 815315 108865 6732413 6439865 292548 Kaluga 633655 557680 75975 3864796 4059124 -194328 Kamchatskaya 498064 412699 85365 2969740 4148814 -1179074 Kemerovo 2439538 2122393 317145 16792372 17397695 -605323 Kirov 1149872 1004336 145536 7191847 7574861 -383014 Kostroma 546403 475701 70702 4010591 3772452 238139 Kuibyshev 1746423 1440718 305705 15114807 10460920 4653887 Kurgan 762717 654237 108480 3974679 4916251 -941572 Kursk 844744 730741 114003 5337502 5221705 115797 Leningrad 939599 807669 131930 6127148 6362402 -235254 Lipetsk 784309 681538 102771 4891516 0 4891516 Magadan 594326 498834 95492 6965243 4034318 2930925 Moscow 2973299 2432846 540453 23781352 17465703 6315649 Murmansk 1121929 970870 151059 4963177 7016136 -2052959 Novgorod 568429 474647 93782 3281680 4319772 -1038092 Novosibirsk 1712919 1468076 244843 11351287 10562389 788898 Omsk 1440187 1262111 178076 8233320 8898588 -665268 Orenburg 1356033 1190336 165697 8709397 8371836 337561 :142 (Appendix 4 continued) Total Total Total Revenues Expenditures Total Revenues Expenditures Surplus/Deficit Actual Actual Surplus/Deficit Oblast Budgeted Budgeted Budgeted (March) (March) Actual (March) Orlov 591977 513335 78642 3325853 4335401 -1009548 Penza 882417 770283 112134 5041550 5484310 -442760 Perm 1698784 1484373 214411 12981934 10722819 2259115 Pskov 612577 499814 112763 2813954 4538711 -1724757 Rostov 2123494 1886737 236757 17268933 12411487 4857446 Riazan 766937 675099 91838 5763762 5431686 332076 Saradov 1460299 1289171 171128 9570432 8786853 783579 Sakalinskaya 836351 699057 137294 4580766 5789476 -1208710 Sverdlovsk 2973943 2411490 562453 20956519 18165946 2790573 Smolensk 724395 638728 85667 4572467 5353647 -781180 Tambov 781756 685205 96551 4962131 0 4962131 Tomsk 798026 703846 94180 4005794 5211808 -1206014 Tula 977998 862903 115095 7677468 6121470 1555998 Tymen 1175302 961713 213589 5792786 6109673 -316887 Ulianovsk 816603 707424 109179 5324499 5906863 -582364 Cheliabinsk 2098580 1832511 266069 15153180 13430724 1722456 Chita 919183 800298 118885 4707407 5882814 -1175407 Yaroslavl 781956 684705 97251 7016727 5239404 1777323 City of St.Petersburg 4156132 3432520 723612 27572019 25433761 2138258 City of Moskow 10153926 5889341 4264585 65794903 48053163 17741740 Adygeyskaya AR 264814 227161 37653 1463040 1706221 -243181 Gorno-Altayskaya AR 143611 144001 -390 467044 1098716 -631672 Evreyskaya AO 207165 176933 30232 905943 1587199 -681256 Karachayevo-Cherkeskaya AR246267 212520 33747 1145099 1616616 -471517 Khakasskaya AO 375826 321434 54392 2714118 2359877 354241 Aginsky-Buriatsky AR 58469 66882 -8413 199234 632488 -433254 Komi-Permiak AO 114785 109998 4787 304902 835466 -530564 Koriakskaya 34302 94410 -60108 339367 1018935 -679568 Nenets AR 35225 63150 -27925 226826 775375 -548549 Taymyrsky AR 65388 77406 -12018 259415 812129 -552714 Ust-Ordynskiy-Buriatsk iy AR 64565 99931 -35366 12347805 4552811 7794994 Hanty-Mansiykiy AR 1607699 825116 782583 3127811 2012184 1115627 Chukotskaya 258246 224118 34128 73141 367064 -293923 Evenkiyskiy AR 34530 36878 -2348 6663904 3219455 3444449 Total Subnational 99934693 83278667 16656026 673679616 612735443 60944173 Total Russian Federation 366800000 408300000 -42500000 1. Source of Data: Ministry of Finance, February 1992. 143 Appendix 5 Population of the Russian Federation by Economic Regions, Republics, Krais, Oblasts and Okrugs,1991 (mid-January) Total Urban Density (thousands) (percent) (pop/sq. km) North 6,161 77.0 4.2 Arkhangelkaia Oblast 1,577 73.8 2.7 Nenetskaia Soviet Autonomous Republic 55 61.8 0.3 Republic of Karelia 799 82.0 4.6 Republic of Komi 1,265 76.0 3.0 Murmanskaia Oblast 1,159 92.1 8.0 Vologodskaia Oblast 1,361 66.0 9.3 Northwest 8,305 86.8 42.3 St. Petersburg City 5,035 100.0 Leningradskaia Oblast 1,670 66.0 78.1a Novgorodskaia Oblast 755 70.2 13.6 Pskovskaia Oblast 845 63.9 15.3 Central 30,478 82.8 62.8 Brianskaia Oblast 1,464 68.3 42.0 Ivanovskaia Oblast 1,317 81.7 55.1 Kaluzhskaia Oblast 1,080 70.3 36.1 Kostromskaia Oblast 813 68.9 14.0 Moskovskaia Oblast 6,718 79.5 334.5b Moscow City 9,003 100.0 Orioskala Oblast 901 62.8 36.5 Riazanskaia Oblast 1,349 66.6 34.1 Smolenskaia Oblast 1,166 68.8 23.4 Tverskaia Oblast 1,676 71.8 19.9 Tul'skaia Oblast 1,855 81.5 72.2 Vladimirskaia Oblast 1,660 79.6 57.2 laroslavskaia Oblast 1,476 81.9 40.5 Volgo-Vyatka 8,480 69.6 32.2 Republic of Chavash 1,346 59.4 73.6 Kirovskaia Oblast 1,700 70.7 14.1 Republic of Marli-EI 758 62.0 32.7 Mordovian Soviet Socialist Republic 964 57.7 36.8 Nizhegorodskaia Oblast 3,712 77.4 49.6 Central Chernozem 7.761 61.2 46.3 13elgorodskaia Oblast 1,401 64.0 51.7 Kurskaia Oblast 1,336 59.3 44.8 ILipetskaia Oblast 1,234 63.5 51.2 'rambovskaia Oblast 1,315 57.1 38.3 Voronezhskaia Oblast 2,475 61.5 47.2 Vfolga 16,586 73.7 30.9 Astrakhanskaia Oblast 1,007 68.0 22.8 Republic of Kalmykia 328 46.0 4.3 Penzenskaia Oblast 1,512 62.7 35.0 Samarskaia Oblast 3,290 81.1 61.4 Saratovskaia Oblast 2,708 74.8 27.0 Republic of Tatarstan 3,679 73.8 54.1 UJlianovskaia Oblast 1,430 72.2 38.3 Volgogradskaia Oblast 2,632 75.9 23.1 North Caucasus 17,030 57.7 48.0 Republic of Dagestan 1,854 44.0 36.9 Chechen Republic and Ingush Republic 1,307 45.8 67.7 144 Kabardino-Balkar Republic 777 61.5 62.2 Krasnodarskil Krai 5,175 54.4 61.9 Republic of Adygeya 437 52.6 57.6 North-Osetien Soviet Socialist Republic 643 68.9 80.3 Rostovskaia Oblast 4,348 71.3 43.1 Stavropolskil Krai 2,926 53.8 36.3 Karachai-Cherkess Republic 427 49.4 30.3 Urals 20,397 75.1 24.8 Republic of Bashkortostan 3,984 64.6 27.7 Cheliabinskaia Oblast 3,641 82.4 41.4 Kurganskaia Oblast 1,110 55.1 15.6 Orenburgskaia Oblast 2,194 65.3 17.7 Permskaia Oblast 3,110 77.5 19.4 Koml-Permyatskaia Autonomous Oblast 160 30.0 4.9 Sverdiovskaia Oblast 4,730 87.4 24.3 Udmurt Republic 1,628 70.3 38.7 Western Siberia 15,158 78.2 6.2 Altaiskil Krai 2,851 56.2 10.9 Republic of Altal 196 27.0 2.1 Kemerovskaia Oblast 3,180 87.4 33.3 Novosibirskaia Oblast 2,796 75.0 15.7 Omskaia Oblast 2,163 68.2 15.5 Tomskaia Oblast 1,012 68.8 3.2 Tiumenskaia Oblast 3,156 77.3 2.2 Khanty-Mansilskil Autonomous Okrug 1,314 91.4 2.5 lamal-Nenets Republic 493 82.6 0.7 Eastern Siberia 9,243 72.0 2.2 Republic of Buryatlia 1,056 60.1 3.0 Chitinskaia Oblast 1,392 65.8 3.2 Aginskil Buryatskil Autonomous Okrug 78 33.3 4.1 lrkutskaia Oblast 2,863 80.8 3.7 Ust'-Ordynskil Buryatskil Autonomous Okrug 138 18.8 6.2 Krasnoiatskil Krai 3,625 72.9 1.5 Republic of Khakasia 577 72.6 9.3 Taimyrskii (Dolgano-Nenetskii) Autonomous Okrug 54 66.7 0.1 Evenkilskaia Autonomous Oblast 25 28.0 0.03 Republic of Tuva 307 47.6 1.8 Far East 8,057 76.3 1.3 Amurskaia Oblast 1,074 68.0 3.0 Kamchatskaia Oblast 473 81.2 1.0 Koriak Autonomous Soviet Republic 40 37.5 0.1 Khabarovskil Kral 1,851 79.0 2.2 Jewish Autonomous Oblast 220 65.9 6.1 Magadanskaia Oblast 534 81.6 0.4 Chukchi Soviet Autonomous Republic 154 72.1 0.2 Primoskil Krai 2,299 77.6 13.9 Sakhalinskaia Oblast 717 85.4 8.2 Republic of Sakha (Yakutia) 1,109 66.5 0.4 Kaliningradskaia Oblast 887 79.0 58.7 Source: Russian Goskomstat, Statistical Yearbook, National Economy of Russia in 1990, pp. 77-80; Ann Sheehy, The Republics of the Russian Fe- deration. Note: The last population census was conducted in mid-January 1989. Population data for 1991 are estimated on the basis of population census data and Information on births and deaths compiled by offices of the 'Registry of Acts of Civil Status." t These population data are reported on a de facto basis, i.e., these population figures include both permanent and temporary residents in Russian republic and exclude long-term de jure residents who are temporarily in other republics or abroad. Military residents, who may be included in population totals for their republic of origin, constitute a. possible exception. a. Including St. Petersburg. b. Including Moscow. 145 Bibliography Antulio, Bomfim N., and Anwar Shah, "Macr- onto: Canadian Tax Foundation, 1982), pp. oeconomic Management and the Division of 255-88. 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