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Russian Federation

The Russian Federation
alexander deryugin
and galina kurlyandskaya
Russia is a federative state with a republican form of government. The
chief executive is the president, who is elected by direct votes of the people
for a term of four years. The same person cannot hold the office of president
for more than two successive terms.
The Russian Parliament comprises two chambers: the State Duma and
the Council of the Federation. The State Duma has 450 deputies – members
of the political parties that successfully passed the 7 percent barrier at
elections. Elections to the Duma are based on universal, secret, equal, and
direct suffrage for a term of four years. The Federation Council comprises
two representatives from each region (subject) of the Russian Federation:
one from the legislative and one from the executive branch of power.
Depending on the region of the Federation, members of the Federation
Council are appointed by either the head of the regional administration or
the legislative assembly.
Russia is the world’s largest federation, consisting of eighty-six (as of
1 January 2007) regions (see Table 1). The parade of sovereignties in the
early 1990s (in the wake of the breakdown of the ussr) reflected the ethnic
republics’ quest for political and economic independence, which led
the existing administrative-territorial units to split up and form the new
constituent units of the Russian Federation.
Disparities in climate, population, and development between regions
hinder the development of symmetric federal-regional relations, thus
making a case for consolidating units of the Federation through mergers.
The first practical steps towards consolidation were made in 2004,
following an official decision on the merger (effective from 1 December
2005) of Perm Region and Komi-Perm Autonomous District. In the
pipeline are Krasnoyarsk Krai with Taimyr and Evenk Autonomous Okrugs,
and Kamchatka Region with Koryak Autonomous Okrug. Further
Russian Federation 237
mergers could hardly be on a mass scale because the merger of a relatively
wealthy region with a poorer one would lower the per capita budget
revenue of the former, so it would not be easy to sell this idea to
residents of wealthier regions.
the s tructure of government
and d iv is ion o f fiscal p owers
The Russian Constitution establishes two levels of government: state government
and local self-government. The state level subdivides into federal
and regional, with local self-government, according to the 1993 Constitution,
falling outside the system of state power.
The procedure for establishment of regional bodies of state governments
is set by federal law according to general principles of the organization
of legislative (representative) and executive state government bodies.
This law establishes, inter alia, a list of powers of state government bodies
and the procedure for conferring powers on the chief executive of a
Table 1
Basic political and geographic indicators
Official name Russian Federation (Russia)
Population 143,474,200
Area 17,075,400 square kilometres
gdp per capita in us$ (2004): 4,214
Constitution 1993, democracy, federation, republic
Levels of government Federal, regional, and local. Local governments
can have one or two tiers; some regions
(autonomous okrugs) have two tiers of state
Constitutional status of local government Separate tier, not part of state government
Official languages The official language of the Federation is Russian.
Ethnic republics have several official languages:
Russian plus ethnic language/s. Some ethnic
localities within constituent units (regions) also
use two official languages.
Number and types of constituent units There are 21 republics (ethnic autonomies),
48 oblasts, 7 krais, 2 federal cities, 1 autonomous
oblast, 7 autonomous okrugs (autonomous
districts). The rf Constitution grants equal
rights to all constituent units of the federation,
disregarding their type.
238 Alexander Deryugin / Galina Kurlyandskaya
region, whose candidacy is nominated by the president of the Russian Federation
and approved by the regional legislative assembly.
Federal law also establishes general principles of organization of selfgovernance
in the Russian Federation. This law was passed in 2003, but it
comes into effect in stages and is not expected to become fully effective
until 2009.
The Russian fiscal system features three to four tiers, depending on the
type of jurisdiction. For state government, it is the federation and region.
For local government, it is the city, or municipal district (raion), and settlements
(poselenniye) in a municipal district.
Formally, federal, regional, and local levels of government have designated
revenue sources and spending obligations, and each level drafts and
approves its own budget. One might see this as evidence of the fiscal autonomy
of subnational and local governments. However, this would be incorrect
as the upper levels of government continue to rule both the revenue and expenditure
arrangements of the lower level governments. Subnational governments
do not have transparent mechanisms to determine the total
amount of revenues that will be available to them in a forthcoming year, nor
do they have the authority to levy taxes other than those established by the
Tax Code of the Russian Federation and other federal laws.1
The Assignment of Spending and Regulatory Responsibilities
Federal laws govern the expenditure obligations of the subnational governments,
although regions and localities (except for the recipients of the
equalization transfers) may choose to expand the list of spending obligations
established for them by the federal government, if they have their
own resources to fulfill them.
The 2000–04 reform of federative relations and local government
targeted comprehensive demarcation of expenditure obligations and
revenue sources across all levels of government in the Russian Federation,
but the result was somewhat disputable. Federal legislation still
sets basic requirements to, or details of, expenditure obligations, and
each level of government is responsible for the provision of public
goods and public services in conformity with the assignment of spending
responsibilities. From that perspective, there are no explicitly federal
or explicitly regional functions in Russia: decentralization is
limited to deciding which level of government would finance the delivery
of standard public goods and/or services, but the standards are established
by the central government.
In the course of the 2000–04 reform, three categories of government
functions were identified: (1) functions that subnational and local
Russian Federation 239
governments perform and finance from their own resources; (2) delegated
functions (i.e., those that governments of lower levels perform and governments
of upper levels finance through earmarked transfers); and (3) functions
that fall into the category of exclusively federal responsibilities
(e.g., national defence [see Table 2]).
In 2005, a new assignment of expenditure responsibilities was enacted,
although, for several reasons, this was unsuccessful. One reason for its
lack of success is that, due to a dramatic reduction in the political weight
of regional governors, the power of regional governments has substantially
shrunk. Then, some actual expenditure needs of the regions were
overlooked, while a significant number of federal functions performed
by the regions remained unfunded (unfunded mandates). These all led
to further revisions of the assignment of spending responsibilities in
2005 and 2006.
It is pertinent to note that, given current budget reporting requirements
in Russia, a number of federal or regional spending obligations
transferred to lower levels of government together with funds are recorded
in relevant sector items as expenditures of lower-level governments,
while the government that provided the funding reports them as
intergovernmental transfers (see Table 3). This is the case, for instance,
with regard to social spending obligations such as education (recently
Table 2
Legislative responsibility and actual provision of services by different orders of government
Legislative responsibility Public service Actual allocation of function
Federal Defence Federal
Federal Law and order Federal
Federal Environment security Federal and provincial
Federal Higher education Federal and provincial
Federal and provincial Secondary education Local
Federal and provincial Health Federal, provincial, and local
Federal and provincial Welfare Provincial
Federal Tax collection Federal
Federal Civilian registry Local
Federal, provincial, and local Culture Federal, provincial, and local
Federal, provincial, and local Housing services Local
240 Alexander Deryugin / Galina Kurlyandskaya
shifted from the regional to local level of government together with the
targeted transfers) and social safety net benefits (transferred from
the federal to regional level and then, in part, from the regional to local
level). Health care does not include spending on the compulsory medical
insurance fund, which stays out of the general budget and has revenues
and expenditures that are less transparent.
Monitoring of budget execution is quite thorough. Local governments
furnish their financial statements of budget execution to the regions,
which, in turn, submit their own plus municipal statements to the federal
Ministry of Finance. The Russian Accounting Chamber (the federal
financial auditing body) performs comprehensive audits of regional
governments that are recipients of federal grants (75 percent of all regions)
on top of regular audits of targeted-use grants transferred to
regional governments for the implementation of federal mandates. Regions
employ the same scheme to monitor local budgets. Monitoring is
focused, inter alia, on the match between reported expenditures and the
expenditure responsibilities of subnational governments established by
federal law.
Table 3
Direct expenditures by function and level of government (2006)
Function Federal (%) State or provincial (%) Local (%) All (%)
Defence 100 0 0 100
Debt servicing 85 13 2 100
General administration 58 22 20 100
Law and order 77 20 3 100
Economic services 36 56 8 100
Social services 46 31 23 100
health 13 69 18 100
education 22 26 52 100
Subsidies 0
Total 54 29 17 100
Local public services* 13 45 42 100
* Local public services include: primary and preschool education, secondary education, public health,
hospitals, urban highways, urban transportation, drinking water and sewerage, waste collection, electric
power supply, fire protection, public order and safety, police
Russian Federation 241
The Subsidiarity Principle and Causes of Conflicts
in Intergovernmental Fiscal Relations
The subsidiarity principle is adhered to only for housing and communal
services, education, maintenance of cultural institutions, and health care.
Some traditionally local services, such as public transport, roads, fire
prevention, and public safety, are funded and provided by regional rather
than local governments.
Regional bodies of the federal government also perform a number of
local functions. These include law and order and tax collection. According
to the Russian Constitution, local self-governments are not authorized to
undertake legislative and/or enforcement measures; these functions are assigned
to the state. However, the Constitution obliges local self-governments
to safeguard public order. The City of Moscow, certain districts of the City of
St Petersburg, and the cities of Perm and Saratov did create municipal police
units; however, these in fact became part of the federal police, and they
report to the Federal Ministry of the Interior rather than to local mayors.
The current system – wherein the assignment of spending responsibilities
and the monitoring of budget execution are controlled by the federal
government, while spending obligations and budget execution per se are
controlled by the subnational governments – often produces clashes of
interests. For instance, in 2005 the law on monetization of social benefits
was enacted to substitute federally guaranteed in-kind social benefits with
cash payments. The provision of these benefits used to be an unfunded
mandate imposed on regional governments by federal regulations. Unfortunately,
the Ministry of Finance underestimated the amount of social
expenditure obligations of the regional governments when allocating
monetization grants to the regions. This led to the inability of the regions
to implement the new law. In January 2005, pensioners in a number of
Russian regions, driven by the loss of their right to use public transportation
free of charge, and not having been fully compensated for this with a
cash subsidy, picketed highways. The federal government then had to take
advantage of the record-breaking surplus of the federal budget in 2005 to
substantially increase the size of the compensation transfers to the regions.
Redistribution of state assets between regional and local governments illustrates
another type of intergovernmental conflict. Federal regulations
prohibit subnational and local governments from holding assets that are
not directly involved in delivering the public services assigned to them.
Federal law mandates that all such property should be assigned to the government
that is responsible for delivering the service; however, it says nothing
about compensation or what should be done with the property that is
not involved in delivering public services but, rather, is a source of local
242 Alexander Deryugin / Galina Kurlyandskaya
government revenues. Hence, there are property shuffles between regions
and municipalities and desperate activities on the part of local governments
to protect property at all costs. Some local authorities have found a
solution in selling off (privatizing through shell companies) municipal
buildings occupied by regional administrations. Courts are snowed under
with claims brought by regions against municipalities and vice versa.
Intergovernmental conflicts resulted in calls to expand the transition period
(established for the full implementation of the law on self-governance
throughout Russia) and to postpone the implementation of a number of
provisions until 2009.
Common Values: Emphasis on Social Services,
Military Spending, and Horizontal Equity
Judging by the allocation of consolidated government funding across
functions, the most important public goods in Russia are education, pensions,
national defence, the social safety net, and law and order. These
expenditures account for almost 60 percent of total spending of the fiscal
system (including all levels of government but excluding special federal
social security funds – the Medical Fund, Pension Fund, and Social
Insurance Fund).
Federal transfers to subnational governments constitute about 15 percent
of total federal expenditures, making it the third largest expenditure
item of the federal government. The largest spending item of the federal
government is transfers to the Pension Fund (18.6 percent of total federal
expenditures), followed by national defence outlays (16 percent). The budget
of the Pensions Fund in fy2005 was $47.5 million, of which $18.1 million
consisted of transfers from the federal budget. As for subnational
governments, their largest spending category is education, followed by
health care and housing and grants for communal services. The purpose of
the latter is to compensate providers of housing and utility services for their
losses from state-regulated tariffs.
To the common people in Russia, the main function of government at
any level is social protection of vulnerable groups, including old-age
pensioners, families with children, war veterans, disabled persons, and
many others (there are more than 150 categories overall). A special category
is the working poor – schoolteachers and doctors in the public
sector, whose wages have been the lowest in the country for years. To correct
this, the federal government has recently launched “national
projects” for education and health care that target increased wages in
these sectors and the purchase of modern equipment. However, these
projects are not contemplating structural reforms and serve mainly as an
additional cash channel.
Russian Federation 243
Channels of Federal Influence on Subnational Policies and Vice Versa
Although the federal government has not officially stated the goals and objectives
of intergovernmental fiscal relations, it does have a number of
tools that allow it to influence regional fiscal policies either directly or indirectly.
The tools for exerting financial influence on the regions include:
1 Earmarked transfers. This is a tool that directly influences regional budget
policies (funded mandates). Spending these grants is subject to strict
control by the federal authorities, and the share of these grants in total
subnational revenues is rapidly growing.
2 Budget loans. Because the Russian banking system is underdeveloped, the
federal government budget is often the only source of short-term lending
available to subnational governments for covering cash shortages. Until
gy2005 the budget loans were interest free. The federal budget provides
these loans selectively, although selection criteria are not transparent.
3 Non-formula-based transfers. All regions, including the relatively wealthy
Moscow, Tatarstan, and Bashkortostan, receive transfers other than
equalization grants. Most of these are capital transfers that are invested
in public improvements (e.g., subways, highways, and restoration of
historic sites).
4 Timing of transfers. No schedule is fixed for the disbursement of transfers
to regions; therefore, the federal government can choose the timing, warranting
absolute loyalty on the part of heavily subsidized regions.
Thus, the federal government dictates budget policies to the regional
governments, not the other way around. The Federation Council is not instrumental
in protecting regional interests: it approves virtually all federal
bills that impose unfunded mandates on regional governments and has approved
the abolition of a number of regional and local taxes. Furthermore,
the council approved the president’s initiative to change the council nomination
procedure. Formerly, each region of the Federation was represented
in the Federation Council by the governor and the speaker of the legislative
assembly. Under the new procedure, each region of the Federation is
still represented by two council members, but these are nominated either
by the governor or the legislative assembly of the respective region and approved
by the Federation Council. This new procedure has substantially
weakened the council’s political influence.
The Legal Status of Local Governments and the Provision of Local Services
According to the Russian Constitution, local self-governance should be
implemented throughout Russia. Until recently, however, many localities
244 Alexander Deryugin / Galina Kurlyandskaya
had no elected self-government, and they were administered through local
offices of the regional government.2
The new federal law (2003) introduced two levels of local self-governance,
including settlements (poselennyie), either urban or rural, and municipal districts/
urban districts (i.e., cities that combine the functions of a settlement
and a municipal district). Furthermore, the entire territory of Russia was divided
into municipal districts and urban districts. Territories with low population
density may not have a settlement level of government. All these
entities are called municipalities, and the total number of municipalities in
Russia exceeds 24,000. Federal cities (i.e., Moscow and St Petersburg) have
the right to issue their own regulations regarding the organization of local
self-governance within their boundaries.
The responsibilities of regional authorities with respect to the organization
of local self-governance are limited to procedural matters, such as the
establishment of boundaries and the status of municipalities, scheduling
first elections, and so on. Federal law strictly defines the scope of local selfgovernance,
although regional governments may delegate some regional
functions to local governments, together with the resources to perform
them. This does not work in reverse (i.e., local governments do not
delegate local functions to regional governments), except when local governments
become insolvent. Bilateral agreements on the relocation of
functions (together with their associated resources) are possible only between
municipal districts and settlements within districts.
Special Features of Providing Local Services in Rural Areas
In Soviet times, collective farms used to be major providers of services in
rural areas. Today, most of the former collective farms are joint-stock companies,
with 100 percent of the stock held by regional governments, and
these companies continue to support villagers in one form or another. The
forms of support include providing fodder, seeds, and timber for heating
purposes; plowing land in village smallholdings; and so on. In monetary
terms, the total cost of services provided by such a farm to local residents
may exceed the cost of public services provided to them by the local government.
This, of course, does not favour business development. Reports
do not capture the actual losses of these farms from the performance of social
safety net functions, but it is commonly recognized that their economic
inefficiency correlates with the amount of their welfare activities.
These successors to collective farms and private smallholdings exist as a
symbiosis, and a considerable portion of the subsidies and benefits these
farms receive from the government ends up supporting the private smallholdings
of their labourers. The low labour capacity of these farms is also
Russian Federation 245
attributed, at least partially, to the fact that they continue to provide employment
to local residents as a form of welfare support.
Collective farms used to hold most of the communal utilities in rural areas,
such as roads and heating systems, and these facilities serviced both
the farms and the households. The current ownership of communal utilities
in rural areas is mixed: some of them remain in the ownership of
former collective farms; others were taken over by local self-governments.
Utilities are often subsidized through federal or regional targeted programs.
For instance, improvement of local roads is financed through the
federal program entitled Modernization of the Transport System. In this
program, the federal government transfers funds to regional governments
in the form of earmarked capital transfers, and regional governments upgrade
the internal roads of former collective farms to bring them into the
network of public roads.
Barriers to Trade and Factor Mobility
The Constitution of the Russian Federation guarantees a common economic
space; free movement of goods, services, and capital; support for
competition; and freedom of entrepreneurship. Nevertheless, barriers to
trade between regions do exist and take different forms, such as inspection
of goods en route to prevent export of subsidized agricultural products
from the region, various charges for entry to a regional/local market, and
establishment of onerous sanitary requirements. In the 1990s, regional administrations
even levied taxes on imports (primarily, imports of alcohol),
but this practice was banned by the federal government.
Since regional authorities have virtually no revenue autonomy, they often
set trade barriers for dual purposes: for fundraising and for protecting
local producers. In addition, regional authorities use administrative levers
to drive out competitors. All this leads to serious market distortions. According
to the estimate of the Russian Federation Ministry of Agriculture,
removal of barriers in interregional grain trade would have reduced domestic
grain prices by 25 percent.
Big cities, such as Moscow and St Petersburg, maintain a system of obligatory
residence authorization as a barrier to labour movement in order to
protect their citizenry from competition in the labour market and their
budgets from additional social expenditures.
economic and f i s c a l policy coordination
The legislative and executive branches of the federal government design
and monitor Russian economic and fiscal policies, including regional
246 Alexander Deryugin / Galina Kurlyandskaya
ones. The federal government monitors regional development by means of
statistical observations and departmental reporting, where regional line
ministries report to their federal counterpart ministries. The governors
report on the social and economic achievements of their regions at the
sittings of the federal Cabinet of Ministers.
Formally, governors have to draft short-, medium-, and long-term programs
for the social and economic development of their regions. Unfortunately,
a typical regional program establishes no objectives, time
frame, or indicators, so it looks more like a political agenda than an action
The revenue autonomy of regional governments is negligible, and their
influence on regional fiscal policy is limited to varying the rates of certain
taxes (within the limits established by the federal government) and introducing
tax exemptions from regional and local taxes. When both regional
development and fiscal equalization are regulated by the federal government,
the issue of interregional economic and fiscal cooperation is not on
the top of the list.
Monetary Policy
The Central Bank of the Russian Federation is responsible for the design
and implementation of monetary policy. The bank reports to the State
Duma, which appoints the chair of the bank nominated by the president,
and members of the board nominated by the chair of the bank. The bank’s
performance is monitored by the National Banking Council, whose members
represent the Federation Council, State Duma, President’s Office,
Cabinet of Ministers, Central Bank, and regional governments.
Soft Budget Constraints and Fiscal Discipline
Until 2000, soft budget constraints created a serious problem. But since
then, federal legislation has established strict limits on regional/local debt
and the level of current budget deficits, and subnational over-borrowing
has ceased to threaten the stability of the budget system. According to
Russian Federation Ministry of Finance surveys, the most common violation
of financial discipline on the part of regional finance departments
is the presence of overdue liabilities. In 2006, thirteen out of eighty-six
regions reported they had overdue liabilities.
The other common breach of financial discipline is excessive remuneration
of regional officials. In many regions that are recipients of federal
equalization transfers, regional officials get higher wages than do federal
officials of the same rank, which is against the federal regulations.
Russian Federation 247
Assignment of Revenue-Raising Powers
Sources of government revenues in Russia are taxes, non-tax collections,
and intergovernmental transfers. Earnings from the business activities of
subnational governments often accrue to extra-budgetary funds that are
controlled by the government but are beyond public control. Regional
taxes account for roughly 3 percent of the total revenues of the consolidated
budget of the Russian Federation, and the share of local taxes is less
than 1 percent. On average, regional and local taxes account for 9 percent
to 10 percent of total subnational government revenues. The majority of
regional revenues are comprised of federal shared taxes.
Taxpayers pay taxes to governments at all levels through the offices of
the Federal Treasury, and the Federal Tax Service administers the collection
of all taxes, federal and subnational alike (see Table 4). Neither
regions nor municipalities have the authority to collect or monitor the collection
of subnational taxes. This sometimes results in under-collection of
subnational taxes because the Federal Tax Service, as a federal body, is interested
primarily in collecting the taxes that accrue to the federal budget.
For the same reason, the collection rate of shared taxes that partly accrue
to regional budgets tends to be higher than that of taxes that accrue
100 percent to subnational budgets. Since the majority of subnational governments
in Russia levy regional and local taxes at the maximum rates allowed
by federal laws, subnational revenue autonomy is limited essentially
to the use of regional/municipal assets for generating non-tax revenues.
According to official reports, non-tax revenues currently account for about
8 percent of regional/local budgets.
But even if they have no formal tax administration powers, regional and
local governments have other means to make businesses pay subnational
taxes. Media campaigns, audits and inspections, threats to bring in the audit
of the Federal Tax Service or the Prosecutor’s Office, and other forms
of pressure on taxpayers often serve as effective fundraising tools. In addition,
subnational governments often succeed in getting businesses to make
in-kind contributions to local communities in exchange for tax breaks,
budget loans or budget guarantees, land lease or sale, and other favours.
Issues of Tax Competition
As mentioned above, the tax autonomy of subnational governments is limited
to the provision of tax breaks and the establishment of tax rates
within the range established by federal laws. The two most important
taxes that are regulated by subnational governments in terms of their tax
rate are the Enterprise Profit Tax (ept) and the Business Property Tax
248 Alexander Deryugin / Galina Kurlyandskaya
Table 4
Tax assignment for various orders of government (2005)
Determination of Shares in revenue (%)
Base Rate
Tax collection
administration Federal State/province Local
Enterprise profits tax Federal Federal Federal 27 73 100
vat Federal Federal Federal 100 100
Excises on alcohol
and alcohol-based
Federal Federal Federal 50 50 100
Excises on gasoline
and diesel fuel
Federal Federal Federal 40 60 100
Excises on alcoholic
products, beer
Federal Federal Federal 100 100
Other excises Federal Federal Federal 100 100
met (fuel gas) Federal Federal Federal 100 100
met (hydrocarbons,
exclusive of fuel gas)
Federal Federal Federal 95 5 100
met (widespread
Federal Federal Federal 100 100
met (other minerals) Federal Federal Federal 40 60 100
Fee for the use of
aquatic biological
Federal Federal Federal 100 100
Fee for the use of
Federal Federal Federal 100 100
Water tax Federal Federal Federal 100 100
Single social tax Federal Federal Federal 100 100
Personal income tax Federal Federal Federal 70 30 100
Tax on inheritance
and gifts
Federal Federal Federal 100 100
Federal special tax
Single tax on
imputed income
Federal Federal Federal 10 90 100
Russian Federation 249
(bpt). The regional rate of the ept, one of the largest tax sources of subnational
budget revenues, which accounts for some 38 percent of total regional
tax revenue, may vary from 13.5 percent to 17.5 percent, and the
rate of the bpt varies from 0 to 2.2 percent.
In terms of real economic growth, establishing lower tax rates or granting
exemptions from these or other taxes is hardly instrumental because
long-term growth depends on investments. Favourable economic and political
conditions attract greater investments than do short-term benefits.
Besides, federal tax legislation that regulates the taxing powers of subnational
governments changes almost every year, and there are no guarantees
that low tax rates and/or tax exemptions granted by a regional government
would remain in force even one year ahead.
Nevertheless, regions do benefit from setting lower tax rates because
lower rates induce businesses to move their headquarters to these jurisdictions
and to register as payers of the profit tax. By using transfer prices,
such companies turn their headquarters located in domestic offshore
zones into profit centres. Although offshore regions report high profits,
Single tax levied
under an applicable
simplified taxation
Federal Federal Federal 10 90 100
Single agricultural tax Federal Federal Federal 10 30 60 100
State or Provincial
Enterprise property
Federal Provincial Federal 100 100
Transport tax Federal Provincial Federal 100 100
Tax on gambling
Federal Provincial Federal 100 100
Personal property tax Federal Local Federal 100 100
Land tax Federal Local Federal 100 100
Table 4
Tax assignment for various orders of government (2005) (Continued)
Determination of Shares in revenue (%)
Base Rate
Tax collection
administration Federal State/province Local
250 Alexander Deryugin / Galina Kurlyandskaya
they do not lose in terms of federal equalization. This is possible because
the transfer allocation methodology used by the federal Ministry of
Finance relies on economic performance data rather than on actual tax
collections. The State Statistical Agency (Rosstat) registers economic performance
(production) where it actually occurs rather than where production
taxes are paid. Therefore, although the drain of businesses from other
regions occurs only on paper, it significantly increases regional revenues.
Notable cases of tax competition include the Republic of Mordovia,
which, in 2002, granted $700 million worth of tax concessions, whereas in
2002 its revenue-generation capacity (estimated by means of a methodology
based on economic performance) amounted to only $130 million. As
a region with low per capita fiscal capacity, the republic receives federal
equalization transfers and capital transfers for regional development.
The scale of losses that regions can suffer if large taxpayers decide to
move the registration of their businesses elsewhere is illustrated by the case
of Sibneft. One of the largest oil companies in Russia, Sibneft, whose
owner, Roman Abramovich, was the elected governor of Chukotka, set up
an affiliated company, Sibneft-Chukotka, specifically for paying taxes in
Chukotka. This generated a fourfold growth of regional budget revenues
over four years. Later, the new owners of Sibneft refused to continue paying
taxes to Chukotka and dissolved the affiliated company. Now they are
considering shifting the registration of the parent company, which was
originally registered in Omsk Oblast, to the City of St Petersburg. This will
reduce the Omsk Oblast budget revenues by 60 percent.
f i s c al equity and efficiency concerns
The existing assignment of revenue sources across levels of government
creates vertical imbalance in the budget system of the Russian Federation,
and this imbalance keeps growing over time. The gap between the richest
and the poorest regions exceeds 280-fold in terms of per capita taxes
collected. The upper revenue group comprises oil- and gas-producing
regions, and the lowest revenue group includes the republics of the Northern
Caucasus, whose fiscal capacities are affected by ethnic and/or religious
strife, the predominance of the shadow economy, and a rapidly
growing population.
Regional fiscal capacities vary dramatically, and so do geoclimatic conditions
and distances from centres of production, leading to disparities in energy
prices and prices of other inputs and, ultimately, to disparities in the
cost of delivery of public services. The difference in the cost of living between
the richest and the poorest regions is threefold, disparities in the
costs of communal services are twentyfold, and the difference in the length
of the heating season across Russian regions is ninefold.
Russian Federation 251
To reduce the fiscal gap, the federal government allocates general-purpose
(fiscal equalization) and other transfers to subnational governments.
The number of subsidies, subventions, and other transfers that the federal
government allocates every year is close to one hundred, as measured by the
number of line items under the intergovernmental transfers section of the
federal budget. The major types of federal transfers are equalization transfers,
gap-filling subsidies, the Compensation Fund, co-financing of social
programs, capital transfers, regional finance reform transfers, operating
transfers to special territories, ad hoc subsidies, and transfers to closed cities.
Equalization transfers are formula-based, general-purpose grants. The
Budget Code – the federal code of laws that govern public spending procedures
across all levels of government in Russia – does not restrict the
spending of this grant money to any specific purpose. But in reality these
transfers are spent primarily on paying the wage bill and go by the name of
“wage subsidies” in the parlance of regional finance officials.
Gap-filling subsidies, which were first introduced in 2004, compensate
regions for implementation of federal policies leading to regional revenue
gaps and/or expenditure increases (see Table 5). In 2004, these subsidies
compensated regional governments for the federally mandated increase in
wages in the public sector. In 2005, gap-filling subsidies had a three-part
purpose: (1) to compensate for losses from changes in the equalization
formula; (2) to compensate for revenue gaps caused by the reduction in
the regional share in the oil and gas extraction tax, 100 percent federal
retention of the water tax, and a 1.5 percentage point reduction in the regional
component of the corporate income tax; and (3) to compensate for
the devolution of vocational schools and so on. Note that the increase in
the minimum wage in 2004 was not included in the list of purposes for
allocating gap-filling subsidies in 2005.
Transfers from the Compensation Fund compensate regional governments
for implementing federal mandates. These include (1) the rental
subsidy granted to certain categories of federal beneficiaries (such as war
veterans and victims of irradiation catastrophes), (2) benefits for blood donors,
and (3) compensation of regional governments for civil status registration
(all three are federal functions).
Co-financing of social programs partially compensates regional governments
for a number of social safety net entitlements. In fact, federal laws
have introduced most of these entitlements, so they can be interpreted as
federal mandates. These include childcare subsidies and subsidies for victims
of political repression, distinguished retirees, and individuals who
worked in military enterprises during the Second World War. Subsidies for
co-financing social safety net programs resemble mirror grants, but they do
not create incentives for increasing the regional contribution: the federal
government estimates the spending needs of the regions for implementing
252 Alexander Deryugin / Galina Kurlyandskaya
federal mandates and transfers funds that cover a certain fixed share of
this spending need. If the regions chose to contribute more, this would not
make the federal government liable to increase its share in the total funding
of social programs.
Capital transfers include transfers targeted for capital investments in the
public sector (e.g., construction of schools, hospitals, and information
technology). Regional finance reform transfers are awarded to regions
through competition for prompt reform of public finance management.
Participating regions must submit an action plan and demonstrate successful
implementation of the plan in order to win the grant. The World Bank
initiated the Regional Finance Reform program in 2000; currently, the
World Bank and the federal government co-finance the program.
Operating transfers to special territories are subsidies to Chechnya and
regions that have suffered from irradiation. Ad hoc subsidies include the
annual Best Run City Award, grants to cities celebrating anniversaries, ad
hoc compensation for federal mandates other than those covered elsewhere,
and so on. Transfers to closed cities are general-purpose subsidies
for military industrial centres as well as research and development centres.
The federal government provides direct support to these cities rather than
going through subnational governments.
Every year almost half of the total federal transfers (about $6,329 million)
goes through the federal Fund of Financial Support to Regions as an
equalization allowance for the low-income regions. Each year, sixty-five to
sixty-eight regions out of eighty-six receive equalization grants from the
federal government. Equalization grants are allocated through two windows.
First, 80 percent of the total amount is allocated to all regions
whose per capita fiscal capacity before equalization is less than the
Table 5
Vertical fiscal gaps
Total revenue collected
(in current us$
in millions – 2006)
Total revenue available,
including net transfers
for that level of gov’t
(in current us$
in millions – 2006)
(in current us$
in millions – 2006)
National 273,000 248,000 171,000
state/provincial 106,000 98,000 93,000
local 25,000 58,000 54,000
All orders 404,000 404,000 318,000
Russian Federation 253
national average. The greater the difference between the national average
and the regional per capita fiscal capacity, the greater the equalization
grant allocated to that region. And second, the remaining 20 percent is allocated
to the lowest-income regions in order to bring their fiscal capacity
up to a certain uniform level.
The government used a formula-based approach for grant allocation to
prevent regions from influencing the grant allocation process. Estimation
of a region’s fiscal capacity is based on value added by economic sectors,
ignoring tax migration, a practice that is widely used by businesses. To account
for differences in the demand for public services and input costs
across regions, per capita fiscal capacities are adjusted by applying expenditure
needs indices that account for price, demographic, socio-economic,
geographic, climatic, and other objective factors that influence the per
capita cost of providing the same public service in different regions.
Estimation of the per capita cost of public services relies, to a large
extent, on the judgment of federal experts, which introduces a certain
degree of opacity into the equalization formula, even if comprehensive statistical
information is available.
Special federal transfers, such as compensation for federal mandates
and certain capital transfers (these include subsidies for implementation
of the Federal Targeted Program Reducing Disparities in Socio-Economic
Development of Regions of the Russian Federation) are also allocated
based on transparent formulas. Distribution of grants from the Regional
Finance Reform Fund is also transparent, but distributable amounts are
rather small.
The allocation of all other transfers remains non-transparent, and strong
regions seem to have the power to negotiate the allocation of federal funds
in their favour. For instance, the lion’s share of federal transfers for implementation
of regional development programs ends up in Tatarstan and
Bashkortostan, two republics that are in the upper-income group of the regions,
ranking fifth and nineteenth, respectively, in per capita fiscal capacity.
The two regions used to receive two-thirds of the regional development
grant pool, although their combined population is only 5.5 percent of the
total Russian population. In total, the federal government allocates about
12 percent to 13 percent of its annual expenditure budget for support to
the regions, and these finance about 16 percent of subnational government
expenditures in Russia.
Size of the Grant Pool and Allocation of Fiscal Transfers
Different types of transfers are estimated differently, and the size of the total
pool of federal grants to the regions is determined as a sum of these different
types of transfers. Some types of transfers are adjusted for inflation,
254 Alexander Deryugin / Galina Kurlyandskaya
and others are not. For instance, for many years, the Best Run City Award
has been equivalent to $3 million. By contrast, the size of the fiscal equalization
pool is determined every year based on the figure from the preceding
year, which is adjusted for inflation and changes in federal tax and
budget legislation. Transfers from the Compensation Fund cover 100 percent
of the estimated expenditure needs of the regions associated with
implementing federal mandates. Apparently, there is no formalized methodology
for estimating the need for financing the gap-filling subsidy since
this subsidy was used for financing different needs in fy2004 and fy2005.
Nevertheless, in this case too the Ministry of Finance presumably takes into
account the figure from the preceding year.
Fiscal Disparities across Localities
The prosperity of a municipality almost completely depends on the local
businesses or, better to say, on the businesses that locate their headquarters
in the municipality rather than on the well-being of its citizenry. Therefore,
disparities across localities are as dramatic (and even worse) as are
those across regions.
The personal property tax generates a minor part of the overall local
revenue due to the underdeveloped personal property market. And income
tax (paid by employers) accrues to the budget of the locality where
the employer is registered as a taxpayer rather than to the locality where
the employees reside.
Typically, the presence of a strong and profitable business, such as an oil
company or a liquor factory, allows the host municipality to prosper in
comparison with its neighbours. The difference in the per capita fiscal capacity
of the richest municipality of the region is 1.5 to two times as high as
is the average per capita fiscal capacity across all municipalities of the region,
and in oil producing regions this gap can be three- to sevenfold.
Most of the rural municipalities fall into the lowest income category as
their taxable base is negligible (if they have one at all), and regional transfers
generate 80 percent to 90 percent or more of their revenues.
For example, significant disparities across the 290 settlements of Stavropol
Krai reflect the tax potential of rural versus urban settlements. The tax
base of the former is far beyond that of the latter. Further, urban settlements
(small towns) tend to drain labour along with income tax from
rural areas.
Fiscal Disparities across Regions as a Matter of Political and Policy Concern
Given the significant variations between regional conditions and development
opportunities, the fiscal inequality of regions is often taken for
granted and is seen as something that would be impossible to change.
Russian Federation 255
Despite ongoing increases in the volume of federal transfers, inequality
between regions continues to grow, which calls for a revision of the equalization
policy. The main concern is that the current policy reproduces inequality
rather than providing regions with development incentives. So far,
policy makers have discussed putting heavily subsidized regions under external
financial management, but the first candidates that have been
placed under external control are ethnic republics, which makes this issue
extremely sensitive.
Allocation of Equalization Transfers and the Degree
of the Resulting Equalization
The federal equalization transfers are premised on a formula-based assessment
of the regions’ fiscal capacity and current expenditure needs. The
equalizing exercise results in the reduction of the gap in per capita revenue
capacity between the wealthiest and poorest regions from about 100-
fold to seventeenfold. The federal government does not take negative
transfers from richer regions, but the new law on local self-governance contains
provisions that allow regional governments to use negative transfers
to equalize the per capita fiscal capacities of local governments.
Two out of five regions in the upper income group – Chukotka and
Evenk – receive equalization transfers due to the exceptionally high expenditure
needs attributable to their remote northern location.
Other Equalization Instruments
Allocation of equalization transfers is the main, if not the only, equalization
instrument used by the federal government. Federal/regional shares in the
co-financing of social programs depend, to some extent, on the fiscal capacity
of the region in question. A portion of capital transfers is allocated based
on a formula that captures the interregional inequalities in per capita availability
of communal networks and social facilities, such as schools and hospitals,
but this is a relatively small portion of capital transfers. Compensation
for federal mandates is based on estimated expenditure needs and does not
depend on the per capita fiscal capacity of the regions. In fact, allocation of
such compensation enhances the inequality across regions. Direct investments
of the federal government could serve as an equalization tool but, in
fact, also contribute to inequality enhancement, as is demonstrated by their
bias towards stronger regions, such as Tatarstan and Bashkortostan.
Transfers to Local Governments
The share of transfers in local revenues is about 30 percent to 80 percent.
The Russian Federation Budget Code requires that regional governments
256 Alexander Deryugin / Galina Kurlyandskaya
allocate their equalization transfers to municipalities based on the localities’
per capita fiscal capacities. However, regions customarily equalize local government
capacities in order to maintain the existing social infrastructure.
For instance, education expenditure needs are estimated by the number of
schools and teachers rather than by the number of schoolchildren.
The Budget Code allows regions to use several equalization windows: one
for equalization transfers, one for capital transfers, and so on. The choice of
the equalization algorithm is up to the regions. The Budget Code provides
for several possibilities: regions may choose to allocate grants from the regional
pool to all municipalities (i.e., municipal districts/urban districts and
settlements) directly, or they may choose to use a two-step procedure (i.e., to
equalize municipal districts/urban districts at the regional level and then allow
districts to equalize settlements). The majority of the regions are using
the second approach because it means less work for them.
Impact of Fiscal Transfers on Efficiency and Equity of Service Delivery
and Interjurisdictional Equity
Federal laws set the requirements and terms for most of the public services
delivered by subnational governments in Russia. However, regions differ dramatically
in terms of accessibility of services and per capita expenditures.
The diversity of Russian regions resembles the diversity of the countries in
the world: there are megacities, oil regions, oriental-type appendages, northern
territories with tribal relations, and so on. Equalization of all of those territories
is impossible in principle, especially if the same approach is applied
to all regions. The federal government’s recent efforts to diversify its regional
policy show that policy makers are aware of this problem. So far the
search for new solutions has tended to focus on strengthening financial controls,
including the introduction of external financial management.
capital finan c e , public management,
and corrupt ion
Financing Capital Investment
In the majority of regions in Russia, private business is the major investor
in business as well as in social infrastructure development. This is explained
not so much by the “good citizen” attitude of businesses as it is by
the existence of high entrance fees to regional and/or local markets. Recent
scandals around Ikea in Yekaterinburg, Voronezh, and St Petersburg;
the Mega Trade Centre in the Moscow region; and so on, testify to this.
Federal capital transfers are a source of about one-fourth of all subnational
public investments ($3,111 million out of $12,261 million in 2004).
Russian Federation 257
Only 1.6 percent of subnational investments are financed with bank loans.
Increased bond-related liabilities cover 13 percent of subnational investments,
and proceeds from sales of regional/local assets add another 8 percent.
All these sources cover not more than half of the reported investments
of subnational governments. Thus, the conclusion is that at least half of subnational
investments are financed from the regions’ current own revenues.
This has been made possible by the hike in the world oil price.
The market for regional bonds is small, although it exhibits a high
growth rate: most of the regions have either issued or redeemed regional
bonds in the last two to three years. Moscow and Moscow region’s bonds
prevail on the market, and, according to expert estimates, they account for
more than 70 percent of total sales of regional securities.
The Budget Code restricts subnational borrowing by setting a limit on
debt (the allowed debt cannot exceed the regional government’s own revenues)
and the deficit (the allowed deficit cannot exceed 15 percent of regional
own revenue exclusive of proceeds from property sales).
Formally, the Budget Code allows foreign borrowing by subnational governments,
but any such borrowing is allowed in Russian rubles only, which
effectively prevents foreign lenders from entering this market. Nevertheless,
as of the end of the first quarter of 2005 (the most recent data available at
the time of writing), the aggregate debt of the subnational governments to
international credit institutions was about $230 million.
The Budget Code does not restrict the federal government’s borrowing in
foreign currency. Subnational governments widely use sublending by the
Ministry of Finance as an alternative to foreign borrowing. As of the end of
the first quarter of 2005, these loans amounted to about $400 million.
Problems with Financing Capital Investments and Implications for Reform
Most of the federal government’s capital expenditures are non-program
expenditures that are scattered among regions and individual construction
projects, thus giving rise to delays in construction. The federal government
finances several thousands of projects, including those of local importance
(such as water and gas network utilities).
Another problem with financing capital investments is that spending
across levels of government in Russia is shared by type of expenditures –
such as operating or capital – rather than by function or service. Subnational
governments responsible for service delivery often do not have
enough resources to bear the corresponding capital expenditures; instead,
these expenditures are undertaken by the higher level of government –
federal government in the case of regional functions, regional government
in the case of local government functions. A one-year-based budgeting process
contributes to the problem as no one can guarantee that financing for
258 Alexander Deryugin / Galina Kurlyandskaya
a capital construction project that spans several years will continue in the
next year. It is hoped that medium-term budgeting, which is being introduced
under the current state budget reform, will largely resolve this
particular problem.
Fiscal Federalism Dimensions of the Public Management Framework
Many state functions are centralized at the federal level, and the federal
government appoints the heads of its territorial branches. Either the regional
governor or the legislative assembly of the region appoints the
regional chief executive officials. Members of regional legislative assemblies
and, until recently, governors were elected by a direct vote of the people
and had a fixed term.
After the Beslan school hostage crisis in September 2004, the federal
government took more serious measures to concentrate political power.
Among the most controversial was the president’s bypassing of direct governors’
elections in favour of appointing them himself. As a result, governors
have become integral to the national executive power, and political
centralization has replaced decentralization of responsibilities (although
the centralized state now exists in a deconcentrated form).
Corruption and Its Possible Causes
All studies of corruption in Russia agree on one point: the level of corruption
is high. Leaving aside such considerations as historical traditions and
low civil service wages, one may presume that one reason for the high level
of corruption in the regions is the federal equalization policy. The regions
tend to report lower revenues and to hide their revenue sources in the
shadow economy in order to be able to claim a larger share of the federal
equalization grants.
Corruption is also rooted in the unavailability of legal levers that
would allow regional and local governments to adjust their revenues to
their spending needs. Subnational governments in Russia have very
limited tax-raising authority, which drives them into entrepreneurship,
especially as they can use their administrative resources to efficiently
oust competitors.
Corruption may get even worse thanks to the enactment of the new
law on local self-governance. This law does not allow local governments
to hold assets that are not directly related to the provision of the public
services assigned to them. Local governments have started stripping
themselves of such assets and transferring them to hastily created firms
that, although not formally government-owned, are in fact controlled by
the government.
Russian Federation 259
the way forward
Russian statehood is going through a period of very rapid changes. The
vertical line of power has been strengthened considerably under Vladimir
Putin, while federalism seems to be growing thin. Is it just another swing of
the pendulum or will centralist tendencies stay for good? It is difficult to say
because these new developments are somewhat controversial. The new legislation
upon which the federal government is working will devolve more
state powers to the governors, but the president will continue to appoint
those governors. The federal government has already delegated new federal
functions to the regions, and it promises to add more. Monitoring of
the governors’ performance will be exercised by federal inspectors who report
to presidential envoys in each of the seven federal districts as well as to
the Main Control Department at the Administrative Board of the president.
Thus, Putin’s strategy of federalism has become clear. The federal centre
appoints regional authorities, delegates the federal functions that are supported
with relevant funding, and keeps this spending under strict control.
If these earmarked transfers are ever misappropriated and the situation in
a region worsens, the president possesses the means to reverse it. There is a
potential danger inherent in this strategy. Once the centre has started to
exercise control over the execution of federal responsibilities by the regions,
it may also be tempted to assume control of regional functions. The
danger is quite real because the regions now carry out many additional
functions that are not exempt from the federal centre’s interference.
How was it possible to turn from decentralization to centralization – that
is, to the unitary past? Why did the regions not put up some resistance?
One of the explanations is that agreeing with the president’s policy in
modern Russia warrants a successful political or business career. Another is
that, given heavy financial reliance on the federal centre, many governors
consider accountability to the president to be more important than accountability
to the voters. Besides, the taxable base in Russia’s regions is
created by businesses, not by citizens, and the governors seek to attract
businesses rather than to improve the living conditions of households.
Fixing the assignment of revenue sources and sharing rates across
government levels in the Budget Code (2004) as an alternative to annual
revisions has lessened the fiscal dependence of subnational governments
on federal government budget policies. However, it has not noticeably
strengthened the fiscal autonomy of the regions. The same applies to the
equalization transfer formula. On the one hand, formula-based transfers
make cash flows to the regions more transparent; on the other hand, it is
the federal government that devises the formula. Given annual amendments
to the formula, the revenues of the regions have not become more
predictable. In any case, experts have failed to notice some statistically
260 Alexander Deryugin / Galina Kurlyandskaya
meaningful correlation between changes in the independent variables describing
the economic situation in a region (and its expenditure needs)
and the resulting changes in the volume of the equalization transfer.
Today, there is no federal strategy in Russia to further fiscal federalism,
and there is no unanimity about the prospects of political federalism. Most
experts are of the opinion that subnational governments should have different
spending obligations because of disparities in regional development, climate,
ethnic traditions, and the like. Therefore, a return to the asymmetrical
model of federalism looks almost inevitable. However, the wrapper will be
different. In the 1990s, strong regions received additional powers under bilateral
agreements with the federal centre, while the model discussed today
provides for taking powers away from weaker regions.
Is it valid to say that the efforts to develop intergovernmental fiscal relations
in the period between 1999 and 2005 were wasted because fiscal federalism
will inevitably die away right after political federalism? Or could
steps towards the financial autonomy of the regions be perceived as evidence
that federalism is going to stay?
Is fiscal federalism possible without political federalism? And is political
federalism possible without some degree of fiscal autonomy? Some experts
believe that Russia’s present return to a unitary system will not last – that
fiscal federalism will pave the way for the further development of political
federalism. They point to the greater financial autonomy of the regions
due to the revenue sources – however scarce – assigned to them, the formula-
driven allocation of equalization transfers, and several federal funds
that have been set up to allocate targeted transfers to the regions. Others
believe that fiscal federalism and local self-governance are impossible without
true revenue autonomy and that fiscal federalism cannot co-exist with a
vertical axis of executive power. In other words, the highly centralized authority
in Moscow trumps the ability of the regions to exercise any real
powers of their own. There is one thing upon which many can agree: in
attempting to improve fiscal federalism, the country must not wait for the
appearance of an ideal form of federalism.
1 For more on revenue autonomy, see Michael Alekseev and Galina Kurlyandskaya,
“Fiscal Federalism and Incentives in a Russian Region,” Journal of Comparative
Economics 31 (2003): 20–33; Galina Kurlyandskaya and Natalia Golovanova,
“Decentralization in the Russian Federation,” forthcoming in Economic Change and
Restructuring; and Jorge Martinez-Vazquez, Andrey Timofeev, and Jameson Boex,
“Reforming Regional-Local Finance in Russia,” wbi Learning Resource Series,
World Bank, Washington, dc, 2006.
Russian Federation 261
2 For a historical overview of local self-governance in Russia, see Galina Kourliandskaia,
Yelena Nikolayenko, and Natalia Golovanova, “Local Governments in the Russian
Federation,” in Developing New Rules in the Old Environment: Local Governments in Eastern
Europe, Caucasus and Central Asia, ed. Victor Popa and Igor Munteanu, 161–264
(Budapest: lgi/osi, 2002); and Irina Starodubrovskaya, Analysis of Revenues and
Expenses of Local Budgets (Moscow: cepra, 2003).