Russian Economic Reform

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“Decentralization” of power and finances

Published on November 27 2011
Posted by: jeff

The issue of “decentralization” of power and finances (away from Moscow to the regions) is currently a fairly hot agenda item. However, in my view, its strongest proponents are going to be disappointed by the result. This is not so much because of a lack of will by most people involved in examining and making decisions on this issue — but, by very practical impediments which would be there irrespective of who is president!

In June President Medvedev appointed vice-premier Dmitry Kosak and the plenipotentiary to the North Caucasus Federal District, Alexander Khloponin (who also has the status of a vice-premier), to prepare reports on ways to increase “decentralization”. Kozak was give the task of reporting on transferring “powers” and Khloponin on financial issues and taxation. Several weeks ago, I wrote about media coverage of the impending Kozak report which is due to be finalized by December (see “Expert Group 12, Real federalism, local self-government, budgetary relations between the center and lower levels of government” in right-hand column).

Last week there was a considerable media coverage of the financial aspects of “decentralization” being considered by Khloponin, who must also report by December. The week started with coverage of comments by presidential aide Arkady Dvorkovich who again suggested that VAT be replaced by a regions based sales tax. Elvira Nabiullina, the Minister of Economic Development, who still seems to be trying to make up her mind on where she stands on this issue added a little fuel to the fire with comments that the most important thing was that VAT and sales tax did not exist togther. By the end of the week other articles had appeared which directly dealt with the contents of the interim Khloponin report.

What follows is my summary and assessment of where things now stand on the main financial aspects of the “decentralization” issue. I will firstly deal with what was reported about issues other than that of sales tax – and then return to cover sales tax in more detail below.

Russia now has three regional taxes (on the property of legal entities, gambling and transport) and two local (land and property of individuals). Apparently, the interim Khloponin report says that a longer list of taxes are needed — but does not say what they should be. It argues for more regional and local flexibility in setting tax and excise rates above a federally defined minimum rate.

It suggests that the regions fully receive excise on tobacco, alcohol and petrol and also receive all of the income from profits tax (at present 2 percentage points of the 20% profits tax goes to the federal budget).  “Vedomosti” reported that if the suggestions of the Khloponin report are supported, the income of the regions could grow substantially – by over 10% if the numbers in the article are to be believed.

Khloponin says that the methodology of distribution of subsidies to the regions through the “Federal Fund for Financial Support of Regions” (FFSR) needs to be improved, as subsidies are even provided to wealthy regions. The report says that 10-15% of regions get less than 10% of their income from the FFSR, but this “moderate” amount reduces stimulus for their own development. If these regions are deprived of such support, the number of subsidized regions will fall from 70 to 60, and the number of “donor-regions” will grow to 23. This would significantly reduce the differences in income of the richest and poorest regions.

Reading the “Vedomosti” report, it seems that Khloponin levels some criticism at funds being given to regions at the “direction” of the president and/or the prime minister and says that a “single approach” to such distributions is needed.

Getting back to the sales tax issue. Dvokovich wants to see what he calls “cardinal” reform with “up to 1trillion rubles” of tax collection capability transferred away from Moscow. (In 2010 the income of the federal budget was 8.3 trillion rubles while the income of the regions was, according to “Vedomosti”, 6.5 trillion rubles.)

Finance Minister Anton Siluanov says that the VAT verses sales tax discussion has been held before, and VAT one out! A Finance Ministry official described the idea of switching the two as “Utopia”, and pointed out that in 2012 VAT receipts were budgeted to be 3.6 trillion rubles while wondering how this fitted in with  Dvokovich’s “up to 1 trillion”.

Officials say that abolition of VAT would present a risk to the federal budget because it would become even more dependent on income from the resources sector (oil etc). Dvorkovich’s reply to this is that if VAT is abolished then the share of profits tax going to the federal budget could be increased. (Here, I would add my own comment that, based on the Australian experience, profits tax receipts are likely to be more volatile than VAT – although I have not checked the Russian data on this.)

One unidentified regional leader said that rather than thinking about the “stale” sales tax idea, it would be better to get some order in the system of allocation funds from the FFSR – and that few outside the Ministry of Finance understand how the current system works! “Money goes to those who dance to somebody’s tune”, he said. (As noted above, Khloponin seems to have made a similar point about arbitrary allocation of funds to regions by the president and/or prime minister.)  

Officials say that most sales tax revenue would be received by a few regions – most notably Moscow and St. Petersburg. (So, I would add, even with regional based sales tax, the FFSR would still be needed to play some funds distribution and/or re-distribution role.)

In a 23 June commentary on this site about Russia’s “Vertical Fiscal Imbalance” (see “Expert Group 12 , Real federalism, local self-government, budgetary relations between the center and lower levels of government” in right-hand column) I pointed out that “the issues being considered in Russia are the sort of issues that have long bedeviled Australian economic policy makers and politics, and continue to do so”. “In terms of detail – rather than concept – this is one of the most complicated areas of economic policy in Australia, and in my view this is also the case for Russia. Whatever is done, Russia will continue to have its own ‘vertical fiscal imbalance’. It just has to be made to work better.”