Russian Economic Reform


Russia’s “Vertical Fiscal Imbalance”

Published on June 23 2011
Posted by: jeff

One paper prepared for Group 12 says that there is a “critical level of economic differentiation between the regions”, and suggests that there are no easy ways of overcoming this. The “All-Russian Council of Local Self-Government” has prepared its own paper, but again there are no easy answers to this sector’s financial dependency on higher levels of government.

Jeff says 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. All Australian income taxes (individual and profits) are collected by the central government, as is VAT. There is then a very complex system (which often gets modified due to politics or the administrative system) for reducing this “vertical fiscal imbalance” by transferring funds to lower levels of government. There is no “fixed” methodology for transfer of income tax revenues to regions, but there is one for VAT which is completely transferred (although not necessarily in proportion to where it was collected). Australian local government can only levy taxes on property, while about 7% of this sector’s income is received directly from the central government in the form of grants. 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.)

A report by the “All-Russian Council of Local Self-Government” listed a number of problems with the existing arrangements at the local government level. These include:

1.  Municipal borders formed without account of economic potential;

2.  Low level of financial independence, high level of dependence on assistance from budgets of higher level, absence of clear rules of the game and standards in inter-budget relations;

3.  Narrow income base of local government and extremely limited possibilities for widening it;

4.  Low levels of professionalism among officials;

5.  Excessive control by “organs of state power” (through financial levers, supervisory bodies, appointment of city-managers etc).

This report suggests widening the income base of municipalities, including the possibility of assigning part of SME profits tax to local budgets. It says that such measures would also increase the interest of municipalities in developing businesses.

It is necessary to increase the share of Personal Income Tax going to local budgets (up to 50%).

In addition, the report calls for cancelation of federally imposed concessions covering regional and municipal taxes.

The report also suggests widening the system of grants to support particular municipal projects aimed at solving specific economic, social and infrastructure problems. At the same time, it wants a system of general subsidies not aimed at particular areas of local government expenditure.

Another paper looks at the possibilities for “increasing taxation autonomy of regions and local government, and improving demarcation of taxation powers”.

It says that one of the more “radical” suggestions is to give regions and municipalities the right to impose a sales tax. Given that there is already a VAT, this would mean two taxes on consumption and increase tax administration and compliance costs. Generally, it says that a VAT is preferable to a sales tax.

But, the paper also suggests that in present conditions, introduction of a sales tax appears to be the only significant instrument for increasing the independence of the regions in the area of taxation. Sales tax was removed in 2004.

This paper suggests a number of detailed changes to the mooted tax on “real-estate” (to replace various existing property taxes, including that on land), which it describes as “excessively centralized”.

This paper also considers, in considerable detail, various ways to increase the effectiveness of transfers from the Federal level to lower levels of government. This includes strengthening the role of the “Fund for Financial Support of Regions” (FFSR), with grants from it becoming the main inter-budgetary transfer.

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