Russian Federation Country Study. A Public Finance Perspective

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

percent and 100 percent of state mandated prices. Since retail prices were

unaltered, the state lost a huge amount of revenue from the turnover tax.

In addition, Russia offered to lower the profit tax for those enterprises

willing to pledge" allegiance to the Russian Republic. Finally, the

dissolution of the Soviet Union was hastened by the rise of Russian

nationalism and populism both of which had economic implications. The

Russian Republic provided 80 percent of the revenue to the USSR's budget.

Yeltsin, using his powerful position within the Russian parliament,

declared in October of 1989 that the Republic would halt all payment to

Union institutions. He followed this devastating maneuver by nationalizing"

the USSR Ministry of Finance and seizing its mints. In October of that

year, Russia seized her share of the USSR'S precious metals. Faced with

such tremendous loss of revenue which created a budget deficit that equaled

10 percent of GNP, the Soviet government elected to increase the amount of

money in circulation without a corresponding increase in the production of

consumer goods and services. The decision to increase money circulation,

through wage increases, had a jarring effect on Soviet society. The first

impact, characterized by the indelible image of long bread lines and the

stereotype that a large profit could be made on a pair of Levis familiar to

many Westerner was the result of the disruption of goods and services to

the general population.

Price stability began to go by the wayside in the fall of 1988 with an

estimated inflation rate of 7 percent which mushroomed to 10 percent in

1990. As Table A3 and A4 indicate, the state increased both the level of

wages and subsidies in the other which constituted the component parts of

the Soviet safety net. Real wages, however did not compensate for

inflation. The decline in social welfare from a monetary angle was

compounded by quality decline in social consumption areas. Although the

state increase subsides to social consumption areas, the collapse of the

Council on Mutual Economic Assistance (CMEA) which provided much of the

USSR's medicine and medical supplies and a growing environmental movement

which forced the closure of many chemical plant that supplied the limited

domestic market. Gorbachev's attempts at reforms destroyed not only the

social contract which existed between the state and its citizens but the

USSR as well. The late Soviet period thus provides the starting point for

examining poverty and the Russian Federations response to it in the form of

the social safety net.

The Soviet social welfare system was effective in that absolute poverty, i.

e. wide spread hunger or inadequate diet, was avoided in the latter years

of the Soviet period since the state could supply the basic needs of the

population through its control of USSR's resources and society as a whole.

Research into question of poverty and therefore poverty alleviation policy

(specifically the question of income inequality and distribution) was

hindered by the imposition of political rather than economic explanations.

In 1965, the Soviet Labor Research Institute adopted a social minimum

income norm which was derived from the estimated costs of human

consumption. Goskomstat revised the income level based on the prices

reported by state-owned stores. The price consumers were faced with,

however, due to their shopping habits, the existence of a black market,"

and inflationary pressures dramatically reduced their purchasing power. The

Russian Federation revised the poverty line in 1992 to encompass the age

and gender of individual households. The six categories are: children under

six years of age children between the ages of 6 and 17, men between the

ages of 18 and 59, women between the ages of 18 and 54, men age 60 and

above, and women age 55 and older

Closer to the U.S poverty line definition, the Russian poverty level is

established by first collecting low-cost cost food baskets for each

demographic group... [and] after pricing each market food basket at

national prices, age, and gender-specific multipliers yield individual

poverty line for each demographic group. The definition of poverty is

critically important to social welfare of Russia because, in theory, it

sets pension, minimum wage level, and welfare payments. The USSR's

dissolution has altered the scope, source and method of financing of social

welfare programs. The Soviet state provided a broad range of social

services, through state owned enterprise. From a public finance

perspective, the transition to a more market oriented system has meant the

diversification of social spending responsibility through the creation of

off-budgetary funds (OBF) and passing down the bulk of public social

spending mandates to sub-national governments. The following are the major

OBFs: Pension Fund, Social Insurance Fund, Employment Fund, and the Fund

for Social Support.

Created in 1991, the Pension Fund was designed to take pressure of federal

budget and is authorized to collect a mandatory payment from employers in

the form of a mandatory 28 percent contribution while from agricultural

enterprises the mandatory contribution is 20. 6 percent and 5 percent of

the total income of self-employed individuals. Employees make a 1 percent

contribution to the Fund. Labor pensions, financed from these contribution,

and social pension which are financed from the federal budget are

administered by an independent government agency. The former constitute the

majority (80 percent) of Russian pensioners and thus the level of labor

pensions affect the lives 19. 5 percent of the Russian population. To be

eligible for labor pensions, men must have made 25 years worth of

contributions while women must have made 20 years of contribution.

Eligibility for labor pensions can be lower depending on occupation--

hazardous occupations such as coal mining and military service are two

examples. Social pensions are for individual with less than 5 years of work

experience and is equal two-thirds of the minimum old-age pension or in the

case of disability the amount varies but does not exceed the minimum labor

pension.

Payroll contributions are the also the main source of funding for the

Social Insurance Fund (SIF) and the Employment Fund. Created in August

1992, the SIF is funded by a 5.4 percent payroll deduction from every

worker. The SIF is intended to fund child care, maternal care benefits, and

sick care. Generally, 74 percent of revenue collected from the SIF

contributions remains with the enterprise while the remainder is sent to

the center to finance federal responsibilities. Workers who have accrued

eight or more years of experience receive their entire salary as do

Chernobyl victims, parents with three or more children, and war victims.

Workers with less that five years experience receive 60 percent of their

salaries while those with between five and eight years experience receive

80 percent of their salaries. It is accepted practice that benefits are

paid until the worker recovers or is granted a disability pension.

Mothers receive support through a maternity grant which equals five times

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