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Problems of Fiscal Federalism in RussiaDate of publication: 2020-03-22 19:25:28
Дата модификации: 2020-03-22 19:25:28
The article is timed to the date: 1996-01-01
Other articles related to: Date1996-01-01 Articles for: Year1996
In the recent years, economists have increasingly stressed the idea that good economic institutions, including those in the public sector, are instrumental for economic growth. One of the very important of these institutions in a federative state is the organization of its budgetary system and inter-governmental relations that is usually referred to as fiscal federalism. The many researches (Alexeev, Berkowitz, Lavrov, Shleifer, Treisman, Zhuravskaya, Wallich, etc.) have argued that inefficient inter-governmental relations are a possibly important reason why Russia seriously lags behind other transition countries in economic growth.
Ideally, fiscal federalism should promote territorial justice, economic efficiency and political stability. These goals are often contradictory, but the idea is to find the least costly compromise. From the economists point of view, the most important criterion for the organization of intergovernmental relations is that it has to create incentives at all levels of government to foster private business growth and to provide public goods efficiently. Analysis of Russia's system of intergovernmental relations shows that the country is still very far from having implemented these principles.
The investigations of Chinese structure of fiscal federalism has motivated economists to work out the underlying principles of so-called "market preserving" federalism that serves the objective of economic efficiency (Qian and Weingast, 1996; Jin, Qian and Weingast, 1999).
The most important of these principles are:
Equality of all regions in their budget relations with the federal center and of all localities in their relations with the regional center. Any discrimination against or for certain regions or localities should absolutely not be allowed.
Independence of budgets of different tiers that includes: legislatively fixed own sources of income for each level; the right to decide on own composition of expenditures; impossibility of taxing away additional revenues by the upper level of government through intergovernmental transfers or revenue sharing; the right to be compensated for additional mandatory expenditures that appeared because of legislative amendments of the upper levels of government; the right to give any tax breaks that would affect only own sources of revenue.
Legally established (fixed and transparent) distribution of expenditure responsibilities and sources of revenues between the different levels of government. Research has shown that the principles of revenue sharing may be crucial for creating growth incentives.
Correspondence of the expenditure responsibilities at every level of government with the own revenues at that level.
Any redistribution of financial resources between the subjects of the federation or localities in the region (i.e. financial aid to local governments) should follow objective criteria, be transparent and legally set in the long term, i.e. not be a subject of bargaining.
All the emerging disputes about tax revenues or budgetary process should be solved according to standard legally set procedures.
The numerous research in Russian fiscal federalism as well as the authors' experience in analyzing interbudgetary relations resulted in conclusion that it would be unfair to assert that Russian fiscal federalism is effective according to the listed criteria. As a result of the bilateral treaties signed by the federal and regional authorities several regions enjoy benefits over the others. Independence of subnational budgets is not backed by sufficient level of their own revenues (it is characteristic mostly for the local budgets). The existing system of division of revenue powers and expenditure responsibilities as well as allocation of equalization transfers does not imply stability in subnational revenues and expenditures, transparency of calculations and objective criteria of redistribution. Budget procedure and legal issues of relations between authorities of different levels lacks necessary legislation. But on the other hand one should notice first - understanding of the mentioned problems by participants of the budget process and second - development of positive tendencies in reforming intergovernmental relations. In this paper we will make an attempt of brief review of advantages and disadvantages of interbudgetary relations in Russia and formulate possible avenues for research in this field.
The incentives created by the Russian system of fiscal federalism have been extensively studied. Treisman (1996, 1997), and Lavrov (1996) have done important work the principles of redistribution of the federal funds between the regions and the incentives at the regional level created by these principles. Alexeev and Kurliandskaya (1998) Zhuravskaya (1999) shed light on the economics of regional-local relations and incentives created at the local level. Berkowitz and Li (1998) have studied the problem of lack of coordination between the levels of government.
Federal-regional fiscal relations are characterized by the following factors:
1) Over the last decade federal government has signed bilateral treaties with different subjects of the federation that individually set its relationships with the regions. The terms of these treaties vary substantially and that creates confusing and nontransparent system. See, for instance, an agreement between the governments of the Russian Federation and the Republic of Tatarstan "On inter-budgetary relations between the Russian Federation and the Republic of Tatarstan" (signed 15.02.1994). This agreement envisaged that the Republic of Tatarstan transfers VAT revenues to the federal budget in accordance with annual treaties which had to be signed between federal ministry of finance and the ministry of finance of Tatarstan. At the same time VAT sharing rates for the other regions are set in the federal budget law which is to be approved by the parliament and signed by the president.
2) The division of power and responsibilities between the different levels of government is specified by law in a very vague fashion (it is true for all levels). In general, sub-federal governments are responsible for provision of the most important and least elastic expenditures like health, education, and housing subsidies, however, the most inelastic revenues accrue to the center. The mismatch in elasticities of expenditures and revenues has created a need for an unreasonable amount of fiscal redistribution. This problem has played a role in intensifying the payments crises; it contributed to growing income disparities and the emergence of administrative controls over inter-regional trade and mobility of people and capital.
Apart from ineffective scheme of division of expenditure responsibilities and revenue powers Russian budgetary system is characterized by the high level of federal mandates imposed by the federal authorities on the regional and municipal budgets. Financing of additional expenditures which emerge due to mandates proved to be both non-regular and selective (as a consequence of the lack of resources of the federal and regional budgets). Under such circumstances allocation of funds to finance certain social benefits and subsidies turns to an effective instruments of exercising pressure over regional and municipal authorities aimed at pursuing goals set by the upper-level government.
3) The fiscal redistribution between the regions is very large in overall quantity. It has never been transparent or followed a pre-set rule, however. As a result, negotiations over the federal transfers have created a system with perverse incentives for regional inefficient spending and poor tax collection. According to Treisman, neither low ability to pay for public services nor implementation of economic reform (policy aligned with the policy chosen by the center), nor the efficiency in tax collection has earned a region a larger net transfer. In fact at times the reverse seemed to be the case. In contrast, regional expressions of political discontent (such as anti-reform voting or governor publicly opposing Yeltsin) seem to elicit outbursts of central generosity.
However, as a result of the high degree of inter-regional differentiation in terms of socio-economic development it is impossible to reduce amount of funds redistributed through the federal budget below a certain level. According to estimations of the Institute of the Economy in Transition even if all budget revenues accrued to the regional budgets in 1997, 40 regions would have suffered deficit and in 30 regions expenditures would have exceeded revenues by more that 10% of the former. In other words, apart from the need in the federal budget in order to finance federal expenditures there is a necessity of federal financial support to regions.
4) While redistribution favored big spenders and currently unprofitable regions over their frugal and efficient neighbors, it did not seem to be channeling transfers to the regions with the poorest provision of social infrastructure given the regions past revenues and spending.
That was caused by the redistribution rules. Before 1994 all kinds of federal financial aid to regions (including revenue sharing agreements) were distributed according to the results of individual agreements between regional and federal authorities and that ruled out any objective criteria while taking financial decisions. But even after transition to uniform tax sharing rates and formalized scheme of calculation federal equalization transfers the criteria of federal financial support distribution were far from objective for the following reasons. Up to 1998 transfers from the federal Fund for Financial Support to Regions (the FFSR) constituted less than a half of the total amount of federal financial aid to regions (including unredeemed federal budget loans), the aforementioned bilateral agreements with several regions had not been cancelled and the scheme of the transfers distribution which was based on reported budgetary data on regional revenues and expenditures for the previous years (the figures were agreed with regional authorities) resulted in fixing and strengthening existing differentiation rather that in inter-regional equalization.
5) Almost any transparent formula based on objective criteria would improve incentives in the regions if implemented. Unfortunately, the center for a long time was politically unable to commit to a rule for redistribution.
6) The important consequence of the political process in the last 5 years is the tremendous increase of the fiscal power of the regional governments. Economic models of federalism generally emphasize beneficial effects of decentralization and especially the importance of competition between regions to attract mobile voters or capital. In Russia so far we have observed several less benign aspects of regional competition. Regions have competed not just to provide public goods cost-effectively but also 1) to offer enterprises political protection against federal tax collectors and bankruptcy agents, and 2) to restrict inter-regional trade to protect large regional enterprises from global competition and to set price controls in agricultural sector. (Treisman, Bercowitz, Zhuravskaya). Political protection against federal tax collectors seriously undermines federal attempts to solve budgetary crises. Efforts of the federal government in tax collections in 1997 and 1998 lead no-where because of the strength of the political lobby of the alliance of regional governors and the managers of large enterprises.
Regional-local relations are characterized by the following factors:
The main underlying principle of fiscal federalism - independence of different tiers of government - has been harshly violated at the regional-local level. Local governments of the large donor-cities have been unable to benefit from an increase in the local tax base because any increase in own revenues immediately followed by an equal decrease in regional transfer or share of regional taxes that goes to the local budget. Moreover, local governments that experience decrease in budget revenues have been bailed out by the regional administrations.
2. The aforementioned unfunded regional mandates prevents municipal authorities from getting real independence. Due to the lack of their own revenue base municipal administrations are strongly dependent on regional authorities in receiving funds necessary for financing expenditure responsibilities assigned by law.
3. As a result, this system encourages poor tax collection at the local level and attempts of local administrations to protect their own revenues from being tax away through barter tax collection and non-transparent off-budget funds. The enormous scale of economically unjustified political intervention of local administrations into business, such as excessive regulation and governmental subsidies to large inefficient enterprises, could also be explained by the lack of fiscal incentives to support private business. Theory suggests that in a system where local governments do not have their own revenues being taxed away, one should observe smaller subsidies, more benign regulation, and higher growth compared to a system that we observe in Russia.
Overall, the federal government should demonstrate its credibility (where possible) in 1) implementing the policy of tax discipline by bankrupting large non-payers and repossessing their assets and 2) following the pre-set rules of distributions of transfer. However, one has to keep in mind the presence of serious political constraints on the federal government. There may be a need for a greater devolution or centralization of tax collection to make the solution for many of the outlined problems feasible. Despite of the fact that federal budget is administered through federal treasury system, regional and municipal budgets are mainly executed through assigned banks or regional branches of the Central Bank. At present there are no ways of enforcing regional authorities to introduce transparent system of budget administration (it is evident that highly depressed regions must be taken into consideration - it might be expedient to impose external financial administration in such regions to control the proper use of budget funds).
To conclude: Russia's major problems is its structure of fiscal federalism. Russian system of inter-governmental relations gives incentives to the government officials at all levels to poor tax collection; rebellion against the federal center (in case of regions) and against the region (in case of localities); and to inefficient over-spending and subsidies. Lack of clarity in definition of revenues and expenditure responsibilities division results in constant negotiation of regions with the federation.
At the same time it is worth to overview current tendencies in development of intergovernmental relations system in Russia. It is also must be taken into consideration that some of these tendencies are quite positive by its significance.
Serious reforms in the field of intergovernmental relations in the Russian Federation started in 1997-98 with approval of the federal law "On financial grounds for municipal governing in Russian Federation", organization of the tripartite working group on the reform of interbudgetary relations, which resulted in the approval of the Conception of reforming interbudgetary relations. Signing of the presidential decree on the issues of relations between federal budget and budgets of the subjects of the Federation and approval of the federal budget law for the year 1999 which fixed new principles of interbudgetary relations proved to be important stages on the way of reforming intergovernmental relations in Russia.
Federal law "On financial grounds for municipal governing in Russian Federation" defines main directions of developing relations between regional and municipal budgets. Provisions of the law fixed basic principles of setting sharing rates of taxes shared between regional and municipal governments as well as rules of regional financial support distribution. However, those provisions have important drawbacks that don't allow to actualize progressive innovations. As a result in a majority of Russian regions tax sharing rates cannot be fixed in long term i.e. municipalities cannot be secured from reducing tax sharing rates by regional authorities. For the same reason there is no legal instruments (except for good will of regional administration) for setting stable, transparent and formalized procedure of regional financial support distribution. All this adversely affects incentives for local governments to good tax collection and to effective expenditure administration and doesn't lead to their independence.
Provisions of the presidential decree mentioned above were aimed mainly at regulating fiscal relations between federal and regional governments, at prevention of misuse of federal transfers and at reducing of financing unreasonable ineffective regional expenditures at the account of federal financial support. For this purpose the decree offers federal government to grant a delay on federal budget loans only under the condition that regional administration has signed an agreement on the normalization of regional finance and conditions of extending financial support, which should include commitments to stop making off-sets regarding regional shares of federal taxes, to restructure regional expenditure responsibilities and to give all necessary information to federal bodies about regional budgets execution and proper usage of budget funds.
Conception of reforming interbudgetary relations in the Russian Federation in 1999-2001, approved by the federal government in July 1998 defines the following directions of reforming intergovernmental fiscal relations: thorough division of expenditure responsibilities among governments of different levels, assignment of revenue powers to levels of public administration, improvement of procedure of the FFSR distribution among the recipients of federal financial aid, federal investment support to Russian regions.
Provisions of the Conception that set rules for expenditures assignment to levels of budget system enumerate main kinds of public expenditures that are to be financed from different levels in accordance with the Constitution as well as public expenditures that are to be co-financed by different authorities. Besides, the Conception recommends to regional authorities that starting from the year 2001 expenditure needs of localities must be assessed on the basis of expenditure norms.
Items of the Conception that regulate revenue assignment to levels of budget system envisage close-ended list of federal, regional an local taxes, that is to be approved by appropriate laws and regulations, as well as list of federal taxes which are shared among budgets of different levels. The Conception also envisages that tax sharing between federal and regional budgets must be effected according to long-term rates, set for minimal period of 3 years and tax sharing between regional and local budgets is to be done on the basis of minimal rates set for the same term.
One of the most important chapters of the Conception is devoted to the procedure of formation and distribution of the FFSR. The document envisages that in future the sum of the federal transfer to a region will be calculated on the basis of expenditure norms, the total volume of the FFSR will be set for 3 years term as a proportion of federal tax revenues and a share of the FFSR could be channeled by separate procedure to depressed regions that require large amounts of federal aid.
For the purpose of investment support of regions the Conception suggests that a federal Fund for regional development will be established which will accumulate funds of public investment, that at present are financed through federal, regional and sector investment programs. For the aim of creating incentives for economic reforms in the regions it is offered to establish federal Fund for development of regional finance which is suggested to be lent to donor-regions and regions that create good conditions for economic development.
Efforts of the federal government in the field of reforming intergovernmental fiscal relations resulted in gradual increase of the proportion of federal financial aid channeled through the FFSR transfers in the total amount of federal financial support of regional budgets. If in 1997 the share of the FFSR transfers constituted 50% of the total amount of the federal financial aid (including unrepaid federal loans) the same share for 1998 amounted to 70% and in the first seven months of 1999 it grew to 82%. At the same time, the total amount of the federal financial support to regional budgets has been diminishing from 2.6% of GDP in 1997 to 1.57% in 1998 and to 1.37% of GDP in January-July of 1999.
We also should dwell on approved and proposed amendments to the procedure of distribution of the Fund for financial support to regions. As it was mentioned before, the procedure that had been in force from 1994 was based on reported budget figures, which required approval of regional authorities. It means that the process of transfers distribution was far from objective and the results of the tranfers' calculations were strongly dependent on the lobbying of regional representatives. And what is more, final amounts of transfers calculated by the Ministry of Finance, could be significantly changed while approving in the State Duma and it goes without saying that it eliminated any transparency and formality of transfers' calculation.
According to provisions of the Conception of reforming intergovernmental fiscal relations the Ministry of Finance worked out an improved procedure of the FFSR distribution which was based on the new principle of revenue equalization as well as on the input figures of regional expenditure needs and revenue capacity. Due to the lack of time necessary for developing procedures of expenditure needs and revenue capacity estimation regional shares in the FFSR for 1999 were calculated in the base of the corrected reported budget data (the final shares were approved by the State Duma without changes), but the draft law on the federal budget for the year 2000 envisages special estimation procedures both for revenue capacity and expenditure needs of the subjects of the Federation.
Regional revenue capacity is supposed to calculate by mean of averaging the tax incidence on the value added by sectors of economy and expenditure needs are defined by differentiation of the average chosen level of regional expenditure per capita by regional indices of intensity of need in particular kind of budget expenditures. Both expenditure needs and revenue capacity are derived from statistical data open to general use with could be hardly influenced by regional authorities.
Thus, in case of approval of the proposed procedure of the FFSR distribution by the State Duma and if all provisions of the said Conception are realized the aforementioned deficiencies of fiscal relations between federal and regional governments will be partly eliminated. However, in our opinion, the main policy goal of the federal government should be demonstration of stickiness to the approved directions of the reform: transparency of transfers' calculations and distribution, reducing the total amount of non-formalized financial support (including extension of the federal budget loan which are not supposed to be repaid), resistance to the regional authorities lobbying while distributing federal funds.
To conclude let us outline possible important future avenues of research in Russia's fiscal intergovernmental relations:
General overview of Russia's system of intergovernmental fiscal relations, its efficiencies, deficiencies and possible routes of reform:
- an overview of the history of developing the system of intergovernmental fiscal relations;
- collection and analysis of the facts of the regional budgetary and taxation laws and regulations incompliance with the federal law;
- estimation of the degree of "asymmetry" of Russian fiscal federalism - analysis of federal priorities in intergovernmental relations, analysis of selectivity of federal authorities in their relation with regions;
- understanding conditions for mobility of capital and labor in Russian Federation.
Estimating the degree of "equilibration" of the Russia's budget system:
- quantitative and qualitative analysis of vertical and horizontal imbalances of the Russia's budget system;
- analysis of Russia's system of division of revenue powers and expenditure responsibilities among levels of budgetary system, matching of seasonal elasticities and variability of collection of different kinds of taxes with seasonal elasticities and variability of different kinds of expenditures;
- analysis of the Russia's pattern of tax revenues division among levels of government;
- estimating of the centralized redistribution of budget funds among subjects of the Federation;
- elaborating recommendations for federal authorities regarding improving the degree of of "equilibration" of the Russia's budget system.
Developing the model of the federal financial support distribution and elaboration of policy recommendations for the federal government
- factor analysis of federal transfers' distribution (revelation and qualitative estimation of factors);
- analysis of major behavior patterns of regional governments towards the federal government regarding fiscal relations;
- analysis of the existing mechanism of the federal financial support distribution, understanding the equilibrium mechanism for regional lobbing for fiscal redistribution;
- elaboration of scenarios of federal equalization transfers' reform concerning current circumstances, political and economical opportunities both at the federal and regional levels.
Analysis of intergovernmental fiscal relations at the regional level
- thorough analysis and understanding of the underlying legislative base of fiscal relations between local and regional governments, general analysis of fiscal relations at regional level;
- understanding the differences in the fiscal status of the relationship between the different types Russian localities (rural districts vs. large industrialized cities, net-donors vs. net-recipients, etc.) The research so far has concentrated only an large cities;
- understanding the underlying mechanism of regional political protection of Russian enterprises against the outside (Moscow) creditors and the federal government. Structure of regional competition for protection;
- collecting the stylized facts about recent regional trade and capital flight restrictions, understanding the enforcement mechanism of "Russian internal borders";
- developing possible scenarios and policy recommendations for both federal and regional authorities regarding intra-regional fiscal relations.
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Article description: In the recent years, economists have increasingly stressed the idea that good economic institutions, including those in the public sector, are instrumental for economic growth.
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