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Russian Federation Country Study. A Public Finance Perspective

Russian Federation Country Study. A Public Finance Perspective



Ryan Grace rgrace@indiana.edu

Dmitri Maslitchenko dmitri@mailroom.com

David Lamp dlamp@indinana.edu

Political Background

The separation of powers which existed under the Soviet constitution was

essentially a myth. A Russian accurately characterized the relationships

that existed between party, state and society as, ...The state absorbed the

society, the Party absorbed the state, and the Party appartchiks, the

nomenclature under the totalitarian leadership of the Secretary-General

absorbed the Party." Both legislative and judicial branches served as

rubber stamps" to the Presidium of the Supreme Soviet which unlike the

Supreme Soviet itself was constantly in session. The development of

political reform in the late 1980s weakened the party's control over the

reigns of power. The devolution of power from the Presidium occurred

through the creation of the office of the President which received the

executive powers while the legislative powers were assigned to Congress of

Peoples Deputies. The judicial branch also achieved higher visibility

during the late Soviet period through the creation of the Committee on

Constitutional Supervision. The Soviet Union's collapse in 1992 introduced

radical changes into all aspects of Russian society. Russia has little

experience with democracy in any form. Without a strong democratic

tradition, it should not be unexpected that instability would develop in

all aspects of Russian life. The role of governmental finance in post-

Soviet society is no exception. Competing explanations exist for Russia's

travails but a shared trait of many them is the distribution of power at

the federal level and the relationship between the federal and sub-national

levels of government.

Political problems did not take long to develop in the Russian Federation

after the USSR's dissolution. At the federal level, the creation of the

present constitution is one cause of the instability which plagues Russia

today. After winning a national referendum on August 15, 1993 in which the

electorate was asked to endorse the Yeltsin's reform policy, he convened a

constitutional assembly to ratify his version of the new constitution.

Three drafts were in contention to replace the constitution under which the

Soviet Union was nominally ruled. Other than Yeltsin's constitution which

became the one implemented, the two other variants were the communist draft

which advocated a strong Presidium of the Supreme Soviet with a chairman

who had similar powers to the position of General Secretary during the

Soviet period and the Rumyanstev draft which contained plans to restrict

executive power and grant the legislative body wide powers. Yeltsin's draft

advocated the exact opposite of the aforementioned plans with wide powers

to the executive and minimal power delegated to the legislative. After the

Duma rejected Yeltsin's order to dissolve, he ordered military troops to

forcefully evacuate the building--which they did by shelling it. Briefly,

the president is the protector of the constitution, human rights, and civil

liberty. In order to protect the constitution and the aforementioned

rights, the constitution grants the president wide injunctive and

declarative powers. The former powers consist of the president's ability to

use "conciliation procedures to resolve disputes between the federal

government and the governments of the constituent subjects and disputes

between the various subjects of the federation." A three stage procedure

exists for the adjudication of disputes but his ability to suspend

legislation after it is submitted to the appropriate court" which he deems

to be in violation of the constitution is considered by many as

inappropriate for a fledgling democracy. The President also has the power

to issue decrees and orders which are superior to the laws of the

government as long as the decree or order does not violate the

constitution. Further, the president has the ability to appoint important

member of his government without consent for the Duma and has sole power to

appoint and remove the command structure of the Armed Forces. In regards to

the legislature, the president has the ability to dissolve the Duma if it

passes two no-confidence vote in the Russian government within three months

of each other and if it rejects three presidential nominee for Chairman of

the Russian government. Although there are limitations of the president's

ability to dissolve the Duma, it remains a potential weapon against a

contentious parliament that affects every aspect of public finance.

The power of the legislative and judicial branch are limited in relation to

the executive. Russia's judicial system consists of a several court systems

that have different spheres of federal/national jurisdiction." The most

visible court is the Constitutional Court which has the right to review the

constitutionally of all federal laws, presidential orders and degrees,

legislation of government, and unratified treaties. Challenges to the

aforementioned areas must be brought by individuals with standing. Although

the Constitutional Court's power seems vast, the president's expansive

powers and lack of civil relations between the different branches makes the

Court's utilization of this power suspect. Federal law and federal

constitution laws are the two types of laws which exist in the Russian

Federation. The latter is considered superior to federal laws. The

procedure for enactment differ in each case. Once a bill is passed it must

presented to the president within five days of the passage by the

parliament. The president then has fourteen days to reject the law. In

order to veto the federal law, a two-thirds majority must be gained in both

parts of the legislative assembly. In the case of federal constitutional

law, three quarters of the Federation Council and two thirds of the Duma

must approve it for enactment. The constitution does not describe any right

for the president to veto federal constitutional laws. According to Article

106 of the Russian Constitution, laws in regard to the following area must

be voted upon by the Federation Council: The federal budget, federal taxes

and levies, foreign currencies, custom regulation, and currency issuance.


Recently, the Duma rejected the government's first draft of the budget.

Deputies were divided over the size of the projected federal budget

deficit, which was set at 95.4 trillion rubles or 3.5 percent of GNP. When

the budget is rejected by the Duma, the government has 20 days to revise

and re-submit the budget. If differences exist between the government's

proposed budget and the Duma's, an option exists to create a committee to

reconcile their disagreements. The Duma rejected the government's proposed

1997 budget in October 1996 and did not opt initially for such a

commission. If no budget agreement is reached, parliament would be forced

to pass monthly or quarterly budgets which would cause confusion throughout

the economy. Since the initial rejection however, a reconciliation

commission (in which both houses of parliament and the government are

represented), has been working on a new version. The reconciliation

commission is due to have a final meeting on Wednesday, with the Duma

giving the budget a new first reading on November 20 or 21. There is no

legal framework to cover the failure to pass the budget, but parliament has

faced the problem every year of Russia's independence except 1996 and has

in the past approved temporary budgets.

The work of the reconciliation commission is being drawn out because

neither the communist majority in parliament nor the government wants to

take responsibility for making a decision on the budget. Russia is trying

to keep to a small deficit in 1997 under pressure from the International

Monetary Fund, but the Duma is eager to increase budget spending to a

starved economy. Reform minded deputies want a lower budget deficit to

achieve lower credit rates--which they say are vital for economic growth

but which are kept high through heavy government borrowing. The dilemma is

that the communists in the parliament want to increase spending and as a

majority they can block implementation of any budget bill.


Russia's tax system is an exercise in frustration for both Russians and

foreigners. The problem arises because it seems that many taxes spring out

of the blue and carry heavy retroactive penalties" which are often three

times the tax amount due. Russian tax reform is difficult now because the

government desperately needs money and has little room to maneuver since

revenues are static and low. The budget take, both federal and regional,

came in at just 27.3 percent of GDP, compared to 50 percent in the Czech

Republic and 47.7% in Poland Russia's budget deficit has been narrowed in

recent years, but this only been achieved by cutting back on expenditures

in real terms, almost 50 percent from 1993 to 1995.

Like the United States, Russia has a three-tiered system of taxation.

Federal taxes are enforced by Parliament, regional taxes enforced by the

regional councils, and local taxes enforced by the local authorities. Under

the existing system, very little coordination can be found between the

three levels of government which causes serious tax policy problems. In a

1993 decree, regional and local authorities were given the power to decide

on types and sizes of taxes for their jurisdictions. The hope was that

authorities at each level, being responsible to its citizens, would act

within reasonable limits. Local authorities, seeing a way to increase

revenue, devised more complicated and exotic taxes. There are 150 locally

imposed taxes within the Federation . They were competing who would invent

the more interesting taxes at their respective levels--for example a tax on

grazing cattle.

Tax Code

The Russian tax system is very complicated. The first two sections of the

new code have 416 articles which are contained in more that 100 pages--and

this is just an the overview of general principles. In an effort to improve

tax law, a new draft of tax code was presented to the Russian parliament in

February 1996. Apart from laws, the tax regime is regulated by many other

documents. The list of these tax documents includes 900 items. It is

understandable that the taxpayer can be confused by so many documents. Even

a good taxpayer can make mistakes. The code is not expected to be enacted

this year but it is a good step toward improving the clarity of the tax

system. The current system, plagued by an excessive tax burden and rampant

tax evasion, has seriously impeded tax collection efforts. The proposed

draft code seeks to implement a number of the reforms prevalent in Western

economies during the 1980s, including a broadening of the tax base,

lowering of tax rates, and the reduction of incentives, exemptions, and


A new mechanism for tax refunds in the case of overpayment is also provided

in the code. If a taxpayer paid too much tax at his own initiative, the

taxpayer may request the overpayment amount be credited towards his next

payment or be refunded within a specified time limit. If the time limit was

exceeded, the amount would be refunded with interest at a interest rate

tied to the prime rate of the Central Bank. In January 1996, new rules came

into effect concerning the refund of VAT if the taxpayer is involved in

exports operations. It was a major problem since VAT refunds were the

responsibility of local budgets. The 1996 budget, which was submitted in

mid-August, provided such VAT refunds from special funds of the federal


Overview of Major Taxes

Income tax

Russia's individuals income tax has several bands which range from 30 to 60

percent. The 60 percent rate is essentially the only rate in effect for

Westerners. In 1993, the tax law was changed. Earlier, individuals could

only pay taxes in rubles. Now, taxes on income earned in hard currency may

be paid in rubles or in hard currency. Proposals to increase the Russian

personal income tax rates were rejected by Russia's upper house, so the

1995 personal income tax rates remain in effect as of January 1, 1996 (see

appendix). Three tax brackets now exist in the Russian Federation: 12

percent on income up to Rubles. 10 million, 20 percent up to Rubles. 50

million, and 30 percent over Rubles. 50 million. The current exchange rate

is one dollar to approximately 4,700 rubles. While many individuals may

complain that the higher income tax rates will cripple them, Russia would

still have the lowest personal income tax rate in Europe at 35 percent.

Excise tax

The excise tax in Russia explicitly covers imported luxury goods, including

tobacco products, beer wine and spirits, cars and light truck, tires,

jewelry, gemstones, rugs, crystal, fur, and leather products. The rate of

excise tax ranges from 10 percent for crystal to 90 percent for grain

alcohol personal. A new principle was applied, in accordance with a recent

decree, to the calculations of excise taxes on alcohol and tobacco imports.

In contrast to the previous practice where excise taxes were calculated in

proportion to the customs value of the imported goods, under the new

procedure, the taxes (on August 1, 1996) will be imposed in ECU per one

unit of commodity item. In some ways, excise taxes and single-stage retail

taxes would seem to be prime candidates for regional taxation in the Russia

just as they are in market economies, especially if the taxing locality is

large enough to avoid revenue loss from consumers crossing the border to

regions with lower tax rates Such taxes thus seem more suitable for larger

intermediate governments than for small local governments.

Profit tax

The profit tax calls for a 32 percent tax on all profits, with an exception

for profits generated by retailers. Profits by retailers are taxed at a 45

percent rate. The tax discriminates against Russian workers because the tax

is not applied to the wages of foreign workers. The profit tax keeps intact

the profit reinvestment concept of prior Soviet tax legislation.

Essentially, no tax is imposed on profits reinvested in the business

venture. Also, the government has not changed the 15 percent withholding

rate for interest, dividends, and other passive income. A 20 percent

withholding rate applies to royalties on copyrights and licenses.


A VAT of 28 percent passed into a law on December 6, 1991 and became

effective on January 1, 1992. The VAT was not initially imposed on imports

or exports. However, the government changed the policy very soon

afterwards. For instance Russian neighbor, Ukraine will be happy to realize

that Russia imposed a VAT on imported goods originating from Ukraine

(Decree No 1216 of August 18, 1996). The reason for the decree is to

preserve stability of the Russian commodity market. The decree also takes

into account that Ukraine is not a part to an agreement signed by the

member states of the Commonwealth of Independent states on the coordination

of tax policy. The general VAT rate as of January 12, 1996, remains at 20

percent. A rate of 10 percent applies to certain food items and children's

goods. Payment of the profits tax and VAT of state owned enterprises is

centralized at the level of their ministries administrative departments

(Decision No 629 of May 22, 1996).

Corporate income tax

The corporate income tax has three tax rates and the application is based

on the type of income earned. Manufacturing income is taxed at 18 percent,

service income at 25 percent, and income earned by retailers at 45 percent.

One of the most interesting things is that the revenue is not intended to

go to the central government. Moreover, the law is written that regional

authorities can tax corporate profits up to 18 percent, 25 percent, and 45


Sales tax

The sales tax was first introduced on December 29, 1990 by USSR Cabinet of

Ministers. It was decided to approve a list of goods and services whose

sale on USSR territory will not incur the 5 percent sales tax. The local

and regional authorities may make additions to list of goods in everyday

demand and services to the population which are exempt from the sales tax

(see the appendix). population.

Further Drawbacks of the Russian Tax System

Attorneys and tax specialists in Russia say the greatest problem facing

enterprises is the lack of a satisfactory tax code. It is necessary that

tax policy should be circumscribed and that more power should be given to

the legislature. The nature of the tax structure allows some people to be

heroes by breaking the rules. For example, a pharmaceutical company chief

who had his security guard expel tax inspectors from his head quarters and

vowed to shoot them if they returned, was elected to a seat in Parliament

instead of going to jail. The penalties for non-payment of taxes is a

defiency of the tax system that drives people from the tax system because

they are so afraid of making a mistake that they prefer not to pay. For

example, a standard 100 percent fine exists for understating income. The

interest rate on late payments alone amounts to 0.7 percent a day, or 255

percent per annum, a penalty that can dwarf the actual liability. The

penalty amount is presently reduced and is tied to the refinancing rate of

the Bank of Russia. The penalty for each day of delinquent payments would

equal 1/300 of the prime rate of the Central Russian Bank.

Russia also does not have a specialized tax court. To seek justice in tax

issues, taxpayers have to find a people's court which is willing to accept

the case. The courts do not have expertise in the area of tax law which is

why most of the courts are reluctant to accept tax cases. The lack of legal

recourse leads to corruption within the tax collection system. Russia does

not have a law like the Freedom of Information Act (FOIA) or the Privacy

Act which hinders the accountability of the tax service.

Aside from ample monetary reasons to evade and avoid taxes, taxes (in the

Western sense) did not exist in Russia during the Soviet period and

therefore the idea of a Western style taxation is unpalatable to many

Russians. Taxes began to appear in the USSR only in 1991 which means that

the current population has only had to deal with the issue of taxation over

a short period of time. The result of this historical experience is that

only between 60 and 75 percent of projected tax revenues have been

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