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Russian Federation Country Study. A Public Finance Perspective

collected this year.

Recent attempts to Improve Revenue

Decree No 1212 of August 18, 1996 is designed to improve tax collection by

preventing tax evasion and streamlining cash and non cash turnover. Among

other measures, the decree orders enterprises in arrears of payments to the

government to open settlement accounts in banks or credit institution

within the Russian Federation. Those accounts are referred to as accounts

of enterprise in arrears. When requested by the appropriate tax

authorities, banks and other credit organizations are required to provide

data about the transaction of enterprises holding these accounts. Taxation

organ may refuse to register the account of an enterprise in arrears in

case there are no funds available on the correspondent account of the bank

or other credit organizations. An interesting aspect of this decree is that

the government finally began to crack down on misrepresentation "in case of

noncompliance with this requirement or intentional provision of false

information in the notice submitted to taxation organ enterprise in arrears

that had performed the transactions in question will be fined by the

taxation organ in the amount of the transaction value". It has proposed to

improve the tax system by scrutinizing financial transactions through

banks. If an enterprise opens a bank account, the bank or other type of

credit institution must immediately inform the tax organs about the

accounts for tax purposes. Such tax policy will let the tax agencies

observe tax payments more efficiently as everything will be recorded.

Presidential Decree No 1212 of August 18, 1996 also introduced policies

concerning cases containing the circumstances stipulated in the Law of the

Russian Federation on Insolvency (Bankruptcy) of Enterprises, the Federal

Department on Insolvency (Bankruptcy) at the State Property Management

Committee of the Russia Federation shall file with arbitration court

request to institute proceedings on insolvency (bankruptcy) against

enterprises that have repeatedly violated this Decree during one calendar

year. As it was with collective farms and state farms, enterprises can just

change their names and continue to evade taxes. An important issue related

to insolvency is loss of massive amounts of jobs and what will workers and

one enterprise" towns do for a living and revenue.

On the bases of the decree, the government has widened its crackdown on tax

evaders--adding several leading oil companies to a list of tax delinquents

that might be forced into bankruptcy court unless they pay their arrears.

The move was the latest in a series of desperate measures the government is

taking to boost tax collection and mend its thread bare budget. The

government hopes that by threatening major tax evaders with bankruptcy,

they will scare the country's errant tax payers into filling empty coffers.

Major companies targeted for bankruptcy can avoid insolvency proceedings,

if their accounts showed the government owes them an amounts equal to their

tax debts for fuel supplied to state organizations.

The most recent step in fighting tax evaders was Russian presidential

decree No 1428, (dated (October 11, 1996, which created a Processional

Emergency Commission (the Commission) on strengthening fiscal discipline.

The major principals and objectives are:

. Control over the timely and full payment of taxes and customs and other

compulsory payments; . The elaboration of measures to secure a full-scale

collection of taxes and other compulsory payments; . Securing the legality

and efficiency of the work of tax and customs, as well as tax police

agencies; . Control over the timely and special-purpose use of the

resources of the federal budget and state extra budgetary funds. . Take

decisions to carry out checks of the financial and economic activity of

legal entities and compliance by individuals and entities with the tax,

customs and banking legislation of the Russian Federation; . Check the

operations of tax and customs bodies;

. Organize check of the timely and special-purpose use of the resources of

the federal budget and state extra budgetary funds.

In addition, the President granted broad powers to the Commission to meet

the objectives of the decree and secure its accountability.

Monetary Policy

Interest rates, much to the chagrin of reformers, in the past barely

reacted to currency stabilization and the ensuing drop in inflation. Little

confidence existed in the sustainability of reforms while inflation

expectations remained high. In 1996, interest rates finally started to come

down--albeit slowly. Real interest rates, however, are still very high. As

recently agreed by the Russian government and the IMF, the ruble is due to

become convertible by 1997. Better access to the ruble market could thus

lead to a rapid increase in international interest in the currency.

Nevertheless, the ruble is trying to join the club of respectable

currencies. Due to the establishment of a crawling peg, the currency's

downslide is almost under control. A generally more stable economic

environment and high interest rates could make the ruble more attractive.

The ruble's recent past has been eventful to say the least. Between January

1992--effectively the start of economic reform under Yeltsin--and March

1995,the currency depreciated by a massive 2,130 percent. In the second

quarter of 1995, an over-restrictive monetary policy led to a severe

shortage of the currency which then duly appreciated by 15 percent within

three months. As concerns rose that too rapid currency appreciation would

further destabilize the economy, the free-floating ruble program was

abandoned and a 'ruble corridor', which envisaged further depreciation but

within predetermined limits, was introduced. The ruble corridor program has

proven to be quite successful. The Central Bank, which has been intervening

repeatedly in the market, has managed to keep its foreign exchange reserves

at a satisfactory level, and the business community has been able to rely

on a more predictable exchange rate trend. In July 1996, the 'fixed' ruble

corridor (the upper and lower limits of which only had to be redefined

every few months) was transformed into a 'variable' ruble corridor, with

the band shifting on a daily basis. Under this program, monthly

depreciation now stands at around 1.5 percent. By the end of December 1996,

the exchange rate against the dollar should have reached Rb 5,700/US $.

Russia's monetary environment started showing promising signs of

stabilizing in 1996. During 1995, inflation reached 200 percent by

December. 1996 is drawing to a close and the inflation rate seems set to

fall to 19 percent. The central bank has been pursuing a very consistent

policy lately, so its goal of maintaining monetary stability looks

credible. Moreover, low inflation is one of the conditions imposed by the

IMF in return for its monthly credit and it is therefore hardly in the

government's interest to start emission based means of financing the budget

deficit. The main risk for inflation could come from a high budget deficit

due to low tax revenues. Financing the deficit has become easier than in

the past due to good international credit ratings--for example, IBCA: BB+,

Moody's: Ba2.--are making it cheaper for Russia to borrow on the foreign

capital markets.

A key element of Russia's macroeconomic stabilization program has been a

tight monetary policy to soak up excess rubles floating around the Russian

economy and fueling inflation. That policy's success is among the factors

that drove T-bill yields up by 26.6 percent Monday to an annualized 121.4

percent on the secondary market. Just a month ago, yields stood at 53.33

percent, according to Skate-to Press Consulting Agency.

The reason for the jump, analysts say, is simple supply and demand - little

ruble supply in the market at a time when government spending demands

revenue. The banks do not have the money to invest in GKO (treasury bills)

at 3 percent per month--but they will find the money to invest for 10

percent per month. Russia's monetary expansion under the IMF agreement is

not to exceed 3 percent, compared with 9 percent in December. Combined with

promises by Yeltsin to repay wage arrears and ease the impact of reforms on

the social sphere, that tight policy has forced the government to raise

yields as a lure to banks to loan the government money.

Intergovernmental Finance

The decentralization of the Russian Federation's intergovernmental

financial relationships began with a series of successive tax sharing

arrangements along with the regions expenditure responsibilities

increasing. This sharing and reassignment strategy continued up to and on

through the adoption of a new constitution in December 1993. In Russia, the

tax formula sharing rates vary by region and are often negotiated by each

locality with the center. This makes any assessment about the equity impact

of transfers or their effects on local revenue effort difficult. A general

disadvantage of tax sharing is that it does little to enhance local

accountability or efficiency. Localities receive revenue regardless of

their tax effort and have no discretion to set the tax rate or base. If

they view these revenues as costless, their incentive to spend efficiently

is lessened. The result may be undue expansion of subnational spending. In

Russia shared taxes are retained by (or accrue to) the jurisdiction in

which they are collected. This differs from most market industrial and

developing economies where shared taxes (like the VAT in Germany) may be

shared through a formula based on factors such as population, per capita

income, urbanization or other factors. Derivation-based sharing as a rule

channels resources to high income areas where the tax base and, therefore,

revenue collections are largest. It is thus inherently counter-equalizing.

This may be a problem in countries where regional inequities are serious

and where the intergovernmental system lacks other instruments (such as

transfers) to address such imbalances.

The intergovernmental fiscal relations of the Russian Federation continues

to be highly opaque due to the bargain-based system which presently is

being utilized. The bargain-based system is making accountability in fiscal

policy even worse than is necessary--therefore further reducing the

transparency. The size and structure of the Russian Federation contributes

to the problems occurring in its fiscal relationships. It is made up of 89

regions consisting of 29 republics, 50 oblasts, 6 krais, and 10 autonomous

okrugs, plus 2 metropolitan cities (Moscow and St. Petersburg) which are

referred to as the 89 "subjects of the federation" in the constitution. The

regions are even further subdivided into more than 2000 districts, where

all the local governments within a region report to the regional

governments and are subject to regional regulations, although each local

government has independent" (emphasis added) budgetary and administrative

status.

Effects of Decentralization

Economic decentralization has led to the transfer of a number of services

with major benefit spillovers (education, health, and social welfare) to

the regional and local levels. While the administration of these programs

by local governments may be appropriate because they are closer to the

people, the many small local governments that have been created as a result

of the strong political push for decentralization cannot likely provide

these services at an adequate level from their own resources. In some

regions, enterprises' "public" spending exceeds budgetary social spending

and, in a few "one-company towns" there is no public spending by the budget

at all on non-administrative functions. Enterprises did not provide these

services once privatized, and responsibility fell onto regional and local

governments to finance them. But local governments will need revenue

sources to finance the additional burden.

Decentralization, which led to ownership assignment and financial

responsibility, has caused the regions to become more involved in the

commercial sector through producer subsidies, capital transfers, and

privatization. It has also led to the budgetary expenditures by the

regional governments to increase from 13 percent of the GDP in 1992 to

around 18 percent in 1994. Recent policy changes have suggested that this

trend of more subnational spending is likely to continue.

The Federal government has approved legislation which led to the previously

discussed changes in expenditure assignment and also gave local governments

the power to formulate budgets and raise revenues without worrying that

their surpluses were going to be extracted by the central government. These

new assignments of expenditures are not efficient, in part because the

federal government has passed down" many of the expenditure assignments

which were formerly the responsibility of the Soviet state. Revenue

autonomy has not been reached partially due to the yearly changes in tax

sharing rates. Disparities between the rich and poor regions has also

contributed to a problem budgetary concern. Along with these disparities,

the high rate of inflation has significantly contributed to revenue

unpredictability of the rayons and oblasts. Revenue predictability and the

subnational area's economic state due is of the utmost importance when one

is considering expenditure assignment of the federation.

Social Welfare and Russia

The significance and necessity of an efficient social safety net in the

Russian Federation can only be understood within the context of the Soviet

experience of social security and how today the ideological inclination

toward a welfare state is affecting Russian society. The state's pervasive

role in Soviet society affected both economic and social conditions.

Economically, a state-caused inverse relationship existed between GDP and

the state's commitment to social safety during the Brezhnev regime.

Economic and political stagnation characterized the latter years of the

Brezhnev era. Economically, GNP growth declined precipitously between 1961

and 1985 (see A1 and A2). Prior to 1960, the USSR utilized extensive rather

than intensive factors of production--specifically labor, capital (stock),

and natural resources. In essence, Soviet authorities were able to take

advantage of Imperial Russia's lack of a strong industrial base by

transferring much of the population from agriculture to industrial

production during Stalin rapid industrialization drive of the 1930s and

1940s. The emphasis placed on heavy industry produced a correspondingly

high rate of consumer saving which allowed for increased capital growth,

that when combined with the natural resource abundance and intensive use of

existing capital helped sustain economic growth The USSR's ability to

sustain economic growth in the 1970s was fostered by its large reserve of

oil that helped finance imports of western technology.

The exhaustion of labor surplus, declining birth rates, inefficient use of

natural resources and other factors of production, the growing expenditures

needed to maintain military parity with the United States, and the sudden

drop in oil prices, and the mis-development of the economy all were factors

that contributed to the USSR's economic stagnation in the late 1970s and

early 1980s. While economic efficiency decreased during the Brezhnev

period, the USSR's leadership demonstrated increased commitment to the

Soviet version of the social safety net. The party-state's pervasive role

in society had the effect of slowing economic growth through poor re-

allocation of resources and the social effect of retarding the development

of a civic society. As a result, Soviet society developed an enduring

attachment to the idea of an omnipotent state which provided for their

basic needs regardless of the economic costs.

From a Western perspective, the Soviet Union was ideologically a hyper"

welfare state in the sense that prior to the Gorbachev era, the state

attempted to provide a high level of social security for every citizen,

often to the point of harming economic efficiency. Additionally, it heavily

restricted the development of private sector in order to prevent wide wage

disparity. As mentioned above, the CPSU's monopoly on power extended to

every aspect of society and in exchange for party dominance the working

population received implicit social guarantees in the form of a social

contract." Linda J. Cook succinctly identifies each sides' basic

commitments and responsibilities:

Basically, the regime provided broad guarantees of full and secure

employment, state controlled and heavily subsidized prices for essential

goods, fully socialized human services, and egalitarian wage policies. In

exchange for such comprehensive state provision of economic and social

security, Soviet workers consented to the party's extensive and

monopolistic power, accepted state domination of the economy, and compiled

with authoritarian political norms. Maintenance of labor peace in this

political system thus required relatively little use of overt coercion.

The weakening of the party and other unintended consequences of glasnost

and perestroika such as the emergence of the Russian Republic, the decision

to release Eastern Europe from Soviet domination, and the attempt to make

state owned enterprises more efficient all had a direct impact on lowering

the standard living for the USSR's population. Gorbachev tried and failed

to cut the guarantees of the social contract. In contrast to earlier in the

Soviet period, the perestroika reforms had the effect of giving

significance to money" in the sense that inputs had developed value through

the economic decisions which constituted perestroika. From the center's

perspective, the problems caused by the inability to cut expenditures

through revision of the social guarantees were compounded by revenue loss

in three key areas: vodka sales, turnover tax, and republic contribution to

the center--especially from the Russian Republic.

Gorbachev began perestroika with an attack on worker efficiency. One

measure adopted to combat this perceived evil was restriction on the sale

of alcohol. The consequence was a loss in revenue which was further

compounded by expenditures related to the Chernoybl disaster and the

massive Armernian earthquake in 1987. In 1990, the center granted state

owned enterprise (SOEs) greater leeway in the setting of prices--between 50

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