Russian Federation Country Study. A Public Finance Perspective

RUSSIAN FEDERATION COUNTRY STUDY
A PUBLIC FINANCE PERSPECTIVE
Ryan Grace rgrace@indiana.edu
Dmitri Maslitchenko dmitri@mailroom.com
David Lamp dlamp@indinana.edu

Political Background
Theseparation of powers which existed under the Soviet constitution wasessentially a myth. A Russian accurately characterized the relationships thatexisted between party, state and society as, ...The state absorbed the society,the Party absorbed the state, and the Party appartchiks,the nomenclature under the totalitarian leadership of the Secretary-Generalabsorbed the Party." Both legislative and judicial branches served asrubber stamps" to the Presidium of the Supreme Soviet which unlike theSupreme Soviet itself was constantly in session. The development of politicalreform in the late 1980s weakened the party's control over the reigns of power.The devolution of power from the Presidium occurred through the creation of theoffice of the President which received the executive powers while thelegislative powers were assigned to Congress of Peoples Deputies. The judicial branchalso achieved higher visibility during the late Soviet period through thecreation of the Committee on Constitutional Supervision. The Soviet Union'scollapse in 1992 introduced radical changes into all aspects of Russiansociety. Russia has little experience with democracy in any form. Without astrong democratic tradition, it should not be unexpected that instability woulddevelop in all aspects of Russian life. The role of governmental finance inpost-Soviet society is no exception. Competing explanations exist for Russia'stravails but a shared trait of many them is the distribution of power at thefederal level and the relationship between the federal and sub-national levelsof government.
Politicalproblems did not take long to develop in the Russian Federation after theUSSR's dissolution. At the federal level, the creation of the presentconstitution is one cause of the instability which plagues Russia today. Afterwinning a national referendum on August 15, 1993 in which the electorate was askedto endorse the Yeltsin's reform policy, he convened aconstitutional assembly to ratify his version of the new constitution. Threedrafts were in contention to replace the constitution under which the SovietUnion was nominally ruled. Other than Yeltsin'sconstitution which became the one implemented, the two other variants were thecommunist draft which advocated a strong Presidium of the Supreme Soviet with achairman who had similar powers to the position of General Secretary during theSoviet period and the Rumyanstev draft whichcontained plans to restrict executive power and grant the legislative body widepowers. Yeltsin's draft advocated the exact oppositeof the aforementioned plans with wide powers to the executive and minimal powerdelegated to the legislative. After the Duma rejectedYeltsin's order to dissolve, he ordered militarytroops to forcefully evacuate the building--which they did by shelling it.Briefly, the president is the protector of the constitution, human rights, andcivil liberty. In order to protect the constitution and the aforementionedrights, the constitution grants the president wide injunctive and declarativepowers. The former powers consist of the president's ability to use«conciliation procedures to resolve disputes between the federalgovernment and the governments of the constituent subjects and disputes betweenthe various subjects of the federation.» A three stage procedure existsfor the adjudication of disputes but his ability to suspend legislation after itis submitted to the appropriate court" which he deems to be in violationof the constitution is considered by many as inappropriate for a fledglingdemocracy. The President also has the power to issue decrees and orders whichare superior to the laws of the government as long as the decree or order doesnot violate the constitution. Further, the president has the ability to appointimportant member of his government without consent for the Dumaand has sole power to appoint and remove the command structure of the ArmedForces. In regards to the legislature, the president has the ability todissolve the Duma if it passes two no-confidence votein the Russian government within three months of each other and if it rejectsthree presidential nominee for Chairman of the Russian government. Althoughthere are limitations of the president's ability to dissolve the Duma, it remains a potential weapon against a contentiousparliament that affects every aspect of public finance.
The powerof the legislative and judicial branch are limited in relation to theexecutive. Russia's judicial system consists of a several court systems thathave different spheres of federal/national jurisdiction." The most visiblecourt is the Constitutional Court which has the right to review the constitutionallyof all federal laws, presidential orders and degrees, legislation ofgovernment, and unratified treaties. Challenges tothe aforementioned areas must be brought by individuals with standing. Althoughthe Constitutional Court's power seems vast, the president's expansive powersand lack of civil relations between the different branches makes the Court'sutilization of this power suspect. Federal law and federal constitution lawsare the two types of laws which exist in the Russian Federation. The latter isconsidered superior to federal laws. The procedure for enactment differ in eachcase. Once a bill is passed it must presented to the president within five daysof the passage by the parliament. The president then has fourteen days to rejectthe law. In order to veto the federal law, a two-thirds majority must be gainedin both parts of the legislative assembly. In the case of federalconstitutional law, three quarters of the Federation Council and two thirds ofthe Duma must approve it for enactment. Theconstitution does not describe any right for the president to veto federalconstitutional laws. According to Article 106 of the Russian Constitution, lawsin regard to the following area must be voted upon by the Federation Council:The federal budget, federal taxes and levies, foreign currencies, customregulation, and currency issuance. Budgeting
Recently, the Dumarejected the government's first draft of the budget. Deputies were divided overthe size of the projected federal budget deficit, which was set at 95.4trillion rubles or 3.5 percent of GNP. When the budget is rejected by the Duma, the government has 20 days to revise and re-submitthe budget. If differences exist between the government's proposed budget andthe Duma's, an option exists to create a committee toreconcile their disagreements. The Duma rejected thegovernment's proposed 1997 budget in October 1996 and did not opt initially forsuch a commission. If no budget agreement is reached, parliament would beforced to pass monthly or quarterly budgets which would cause confusionthroughout the economy. Since the initial rejection however, a reconciliationcommission (in which both houses of parliament and the government arerepresented), has been working on a new version. The reconciliation commissionis due to have a final meeting on Wednesday, with the Dumagiving the budget a new first reading on November 20 or 21. There is no legalframework to cover the failure to pass the budget, but parliament has faced theproblem every year of Russia's independence except 1996 and has in the pastapproved temporary budgets.
The work ofthe reconciliation commission is being drawn out because neither the communistmajority in parliament nor the government wants to take responsibility formaking a decision on the budget. Russia is trying to keep to a small deficit in1997 under pressure from the International Monetary Fund, but the Duma is eager to increase budget spending to a starvedeconomy. Reform minded deputies want a lower budget deficit to achieve lowercredit rates--which they say are vital for economic growth but which are kepthigh through heavy government borrowing. The dilemma is that the communists inthe parliament want to increase spending and as a majority they can block implementationof any budget bill. Taxation
Russia's tax system is an exercise infrustration for both Russians and foreigners. The problem arises because itseems that many taxes spring out of the blue and carry heavy retroactivepenalties" which are often three times the tax amount due. Russian taxreform is difficult now because the government desperately needs money and haslittle room to maneuver since revenues are static and low. The budget take,both federal and regional, came in at just 27.3 percent of GDP, compared to 50percent in the Czech Republic and 47.7% in Poland Russia's budget deficit hasbeen narrowed in recent years, but this only been achieved by cutting back onexpenditures in real terms, almost 50 percent from 1993 to 1995.
Like the UnitedStates, Russia has a three-tiered system of taxation. Federal taxes areenforced by Parliament, regional taxes enforced by the regional councils, andlocal taxes enforced by the local authorities. Under the existing system, verylittle coordination can be found between the three levels of government whichcauses serious tax policy problems. In a 1993 decree, regional and localauthorities were given the power to decide on types and sizes of taxes fortheir jurisdictions. The hope was that authorities at each level, beingresponsible to its citizens, would act within reasonable limits. Localauthorities, seeing a way to increase revenue, devised more complicated andexotic taxes. There are 150 locally imposed taxes within the Federation. Theywere competing who would invent the more interesting taxes at their respectivelevels--for example a tax on grazing cattle. Tax Code

The Russian tax system is very complicated. The first two sections of the newcode have 416 articles which are contained in more that 100 pages--and this isjust an the overview of general principles. In an effort to improve tax law, anew draft of tax code was presented to the Russian parliament in February 1996.Apart from laws, the tax regime is regulated by many other documents. The listof these tax documents includes 900 items. It is understandable that thetaxpayer can be confused by so many documents. Even a good taxpayer can makemistakes. The code is not expected to be enacted this year but it is a goodstep toward improving the clarity of the tax system. The current system,plagued by an excessive tax burden and rampant tax evasion, has seriouslyimpeded tax collection efforts. The proposed draft code seeks to implement anumber of the reforms prevalent in Western economies during the 1980s,including a broadening of the tax base, lowering of tax rates, and thereduction of incentives, exemptions, and deductions.
A newmechanism for tax refunds in the case of overpayment is also provided in thecode. If a taxpayer paid too much tax at his own initiative, the taxpayer mayrequest the overpayment amount be credited towards his next payment or berefunded within a specified time limit. If the time limit was exceeded, theamount would be refunded with interest at a interest rate tied to the primerate of the Central Bank. In January 1996, new rules came into effectconcerning the refund of VAT if the taxpayer is involved in exports operations.It was a major problem since VAT refunds were the responsibility of localbudgets. The 1996 budget, which was submitted in mid-August, provided such VATrefunds from special funds of the federal budget. Overview of Major TaxesIncome tax
Russia'sindividuals income tax has several bands which range from 30 to 60 percent. The60 percent rate is essentially the only rate in effect for Westerners. In 1993,the tax law was changed. Earlier, individuals could only pay taxes in rubles.Now, taxes on income earned in hard currency may be paid in rubles or in hardcurrency. Proposals to increase the Russian personal income tax rates wererejected by Russia's upper house, so the 1995 personal income tax rates remainin effect as of January 1, 1996 (see appendix). Three tax brackets now exist inthe Russian Federation: 12 percent on income up to Rubles. 10 million, 20percent up to Rubles. 50 million, and 30 percent over Rubles. 50 million. Thecurrent exchange rate is one dollar to approximately 4,700 rubles. While manyindividuals may complain that the higher income tax rates will cripple them,Russia would still have the lowest personal income tax rate in Europe at 35percent. Excise tax
The excisetax in Russia explicitly covers imported luxury goods, including tobaccoproducts, beer wine and spirits, cars and light truck, tires, jewelry,gemstones, rugs, crystal, fur, and leather products. The rate of excise taxranges from 10 percent for crystal to 90 percent for grain alcohol personal. Anew principle was applied, in accordance with a recent decree, to thecalculations of excise taxes on alcohol and tobacco imports. In contrast to theprevious practice where excise taxes were calculated in proportion to thecustoms value of the imported goods, under the new procedure, the taxes (onAugust 1, 1996) will be imposed in ECU per one unit of commodity item. In someways, excise taxes and single-stage retail taxes would seem to be primecandidates for regional taxation in the Russia just as they are in marketeconomies, especially if the taxing locality is large enough to avoid revenueloss from consumers crossing the border to regions with lower tax rates Suchtaxes thus seem more suitable for larger intermediate governments than forsmall local governments. Profit tax
The profittax calls for a 32 percent tax on all profits, with an exception for profitsgenerated by retailers. Profits by retailers are taxed at a 45 percent rate.The tax discriminates against Russian workers because the tax is not applied tothe wages of foreign workers. The profit tax keeps intact the profitreinvestment concept of prior Soviet tax legislation. Essentially, no tax isimposed on profits reinvested in the business venture. Also, the government hasnot changed the 15 percent withholding rate for interest, dividends, and otherpassive income. A 20 percent withholding rate applies to royalties oncopyrights and licenses. VAT
A VAT of 28percent passed into a law on December 6, 1991 and became effective on January1, 1992. The VAT was not initially imposed on imports or exports. However, thegovernment changed the policy very soon afterwards. For instance Russianneighbor, Ukraine will be happy to realize that Russia imposed a VAT onimported goods originating from Ukraine (Decree No 1216 of August 18, 1996).The reason for the decree is to preserve stability of the Russian commoditymarket. The decree also takes into account that Ukraine is not a part to anagreement signed by the member states of the Commonwealth of Independent stateson the coordination of tax policy. The general VAT rate as of January 12, 1996,remains at 20 percent. A rate of 10 percent applies to certain food items andchildren's goods. Payment of the profits tax and VAT of state owned enterprisesis centralized at the level of their ministries administrative departments(Decision No 629 of May 22, 1996). Corporate income tax
Thecorporate income tax has three tax rates and the application is based on thetype of income earned. Manufacturing income is taxed at 18 percent, serviceincome at 25 percent, and income earned by retailers at 45 percent. One of themost interesting things is that the revenue is not intended to go to thecentral government. Moreover, the law is written that regional authorities cantax corporate profits up to 18 percent, 25 percent, and 45 percent. Sales tax
The salestax was first introduced on December 29, 1990 by USSR Cabinet of Ministers. Itwas decided to approve a list of goods and services whose sale on USSRterritory will not incur the 5 percent sales tax. The local and regionalauthorities may make additions to list of goods in everyday demand and servicesto the population which are exempt from the sales tax (see the appendix).population. Further Drawbacks of theRussian Tax System
Attorneysand tax specialists in Russia say the greatest problem facing enterprises is thelack of a satisfactory tax code. It is necessary that tax policy should becircumscribed and that more power should be given to the legislature. Thenature of the tax structure allows some people to be heroes by breaking therules. For example, a pharmaceutical company chief who had his security guardexpel tax inspectors from his head quarters and vowed to shoot them if theyreturned, was elected to a seat in Parliament instead of going to jail. Thepenalties for non-payment of taxes is a defiency ofthe tax system that drives people from the tax system because they are soafraid of making a mistake that they prefer not to pay. For example, a standard100 percent fine exists for understating income. The interest rate on latepayments alone amounts to 0.7 percent a day, or 255 percent per annum, apenalty that can dwarf the actual liability. The penalty amount is presentlyreduced and is tied to the refinancing rate of the Bank of Russia. The penaltyfor each day of delinquent payments would equal 1/300 of the prime rate of theCentral Russian Bank.
Russia alsodoes not have a specialized tax court. To seek justice in tax issues, taxpayershave to find a people's court which is willing to accept the case. The courtsdo not have expertise in the area of tax law which is why most of the courtsare reluctant to accept tax cases. The lack of legal recourse leads tocorruption within the tax collection system. Russia does not have a law likethe Freedom of Information Act (FOIA) or the Privacy Act which hinders theaccountability of the tax service.
Aside fromample monetary reasons to evade and avoid taxes, taxes (in the Western sense)did not exist in Russia during the Soviet period and therefore the idea of aWestern style taxation is unpalatable to many Russians. Taxes began to appearin the USSR only in 1991 which means that the current population has only hadto deal with the issue of taxation over a short period of time. The result ofthis historical experience is that only between 60 and 75 percent of projectedtax revenues have been collected this year. Recent attempts to ImproveRevenue
Decree No1212 of August 18, 1996 is designed to improve tax collection by preventing taxevasion and streamlining cash and non cash turnover. Among other measures, the decreeorders enterprises in arrears of payments to the government to open settlementaccounts in banks or credit institution within the Russian Federation. Thoseaccounts are referred to as accounts of enterprise in arrears. When requestedby the appropriate tax authorities, banks and other credit organizations arerequired to provide data about the transaction of enterprises holding theseaccounts. Taxation organ may refuse to register the account of an enterprise inarrears in case there are no funds available on the correspondent account ofthe bank or other credit organizations. An interesting aspect of this decree isthat the government finally began to crack down on misrepresentation «incase of noncompliance with this requirement or intentional provision of falseinformation in the notice submitted to taxation organ enterprise in arrearsthat had performed the transactions in question will be fined by the taxationorgan in the amount of the transaction value». It has proposed to improvethe tax system by scrutinizing financial transactions through banks. If anenterprise opens a bank account, the bank or other type of credit institutionmust immediately inform the tax organs about the accounts for tax purposes.Such tax policy will let the tax agencies observe tax payments more efficientlyas everything will be recorded.
PresidentialDecree No 1212 of August 18, 1996 also introduced policies concerning casescontaining the circumstances stipulated in the Law of the Russian Federation onInsolvency (Bankruptcy) of Enterprises, the Federal Department on Insolvency(Bankruptcy) at the State Property Management Committee of the RussiaFederation shall file with arbitration court request to institute proceedingson insolvency (bankruptcy) against enterprises that have repeatedly violatedthis Decree during one calendar year. As it was with collective farms and statefarms, enterprises can just change their names and continue to evade taxes. Animportant issue related to insolvency is loss of massive amounts of jobs andwhat will workers and one enterprise" towns do for a living and revenue.
On thebases of the decree, the government has widened its crackdown on taxevaders--adding several leading oil companies to a list of tax delinquents thatmight be forced into bankruptcy court unless they pay their arrears. The movewas the latest in a series of desperate measures the government is taking toboost tax collection and mend its thread bare budget. The government hopes thatby threatening major tax evaders with bankruptcy, they will scare the country'serrant tax payers into filling empty coffers. Major companies targeted forbankruptcy can avoid insolvency proceedings, if their accounts showed thegovernment owes them an amounts equal to their tax debts for fuel supplied tostate organizations.
The mostrecent step in fighting tax evaders was Russian presidential decree No 1428,(dated (October 11, 1996, which created a Processional Emergency Commission(the Commission) on strengthening fiscal discipline. The major principals andobjectives are:
. Controlover the timely and full payment of taxes and customs and other compulsorypayments;. The elaboration of measures to secure a full-scale collection oftaxes and other compulsory payments;. Securing the legality and efficiency ofthe work of tax and customs, as well as tax police agencies;. Control over thetimely and special-purpose use of the resources of the federal budget and stateextra budgetary funds.. Take decisions to carry out checks of the financialand economic activity of legal entities and compliance by individuals andentities with the tax, customs and banking legislation of the RussianFederation;. Check the operations of tax and customs bodies;
. Organizecheck of the timely and special-purpose use of the resources of the federalbudget and state extra budgetary funds.
Inaddition, the President granted broad powers to the Commission to meet theobjectives of the decree and secure its accountability. Monetary Policy
Interest rates, much to the chagrin ofreformers, in the past barely reacted to currency stabilization and the ensuingdrop in inflation. Little confidence existed in the sustainability of reformswhile inflation expectations remained high. In 1996, interest rates finally startedto 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 tobecome convertible by 1997. Better access to the ruble market could thus leadto a rapid increase in international interest in the currency. Nevertheless,the ruble is trying to join the club of respectable currencies. Due to theestablishment of a crawling peg, the currency's downslide is almost undercontrol. A generally more stable economic environment and high interest ratescould make the ruble more attractive. The ruble's recent past has been eventfulto say the least. Between January 1992--effectively the start of economicreform under Yeltsin--and March 1995,the currencydepreciated by a massive 2,130 percent. In the second quarter of 1995, anover-restrictive monetary policy led to a severe shortage of the currency whichthen duly appreciated by 15 percent within three months. As concerns rose thattoo rapid currency appreciation would further destabilize the economy, thefree-floating ruble program was abandoned and a 'ruble corridor', whichenvisaged 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 itsforeign exchange reserves at a satisfactory level, and the business communityhas 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 beredefined every few months) was transformed into a 'variable' ruble corridor,with the band shifting on a daily basis. Under this program, monthlydepreciation now stands at around 1.5 percent. By the end of December 1996, theexchange rate against the dollar should have reached Rb5,700/US $.
Russia'smonetary environment started showing promising signs of stabilizing in 1996.During 1995, inflation reached 200 percent by December. 1996 is drawing to aclose and the inflation rate seems set to fall to 19 percent. The central bankhas been pursuing a very consistent policy lately, so its goal of maintainingmonetary stability looks credible. Moreover, low inflation is one of theconditions imposed by the IMF in return for its monthly credit and it istherefore hardly in the government's interest to start emission based means offinancing the budget deficit. The main risk for inflation could come from ahigh budget deficit due to low tax revenues. Financing the deficit has becomeeasier than in the past due to good international credit ratings--for example,IBCA: BB+, Moody's: Ba2.--are making it cheaper forRussia to borrow on the foreign capital markets.
A keyelement of Russia's macroeconomic stabilization program has been a tightmonetary policy to soak up excess rubles floating around the Russian economyand fueling inflation. That policy's success is among the factors that droveT-bill yields up by 26.6 percent Monday to an annualized 121.4 percent on thesecondary market. Just a month ago, yields stood at 53.33 percent, according toSkate-to Press Consulting Agency.
The reasonfor the jump, analysts say, is simple supply and demand — little ruble supplyin the market at a time when government spending demands revenue. The banks donot have the money to invest in GKO (treasury bills) at 3 percent permonth--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 ofreforms on the social sphere, that tight policy has forced the government toraise yields as a lure to banks to loan the government money. Intergovernmental Finance
The decentralization of the RussianFederation's intergovernmental financial relationships began with a series ofsuccessive tax sharing arrangements along with the regions expenditureresponsibilities increasing. This sharing and reassignment strategy continuedup to and on through the adoption of a new constitution in December 1993. InRussia, the tax formula sharing rates vary by region and are often negotiatedby each locality with the center. This makes any assessment about the equityimpact of transfers or their effects on local revenue effort difficult. Ageneral disadvantage of tax sharing is that it does little to enhance localaccountability or efficiency. Localities receive revenue regardless of theirtax effort and have no discretion to set the tax rate or base. If they viewthese revenues as costless, their incentive to spendefficiently is lessened. The result may be undue expansion of subnational spending. In Russia shared taxes are retainedby (or accrue to) the jurisdiction in which they are collected. This differsfrom most market industrial and developing economies where shared taxes (likethe VAT in Germany) may be shared through a formula based on factors such aspopulation, per capita income, urbanization or other factors. Derivation-basedsharing as a rule channels resources to high income areas where the tax baseand, therefore, revenue collections are largest. It is thus inherentlycounter-equalizing. This may be a problem in countries where regional inequitiesare serious and where the intergovernmental system lacks other instruments(such as transfers) to address such imbalances.
Theintergovernmental fiscal relations of the Russian Federation continues to behighly opaque due to the bargain-based system which presently is beingutilized. The bargain-based system is making accountability in fiscal policyeven worse than is necessary--therefore further reducing the transparency. Thesize and structure of the Russian Federation contributes to the problemsoccurring in its fiscal relationships. It is made up of 89 regions consistingof 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 ofthe federation» in the constitution. The regions are even furthersubdivided into more than 2000 districts, where all the local governmentswithin a region report to the regional governments and are subject to regionalregulations, although each local government has independent" (emphasisadded) budgetary and administrative status. Effects ofDecentralization
Economic decentralization has led to thetransfer of a number of services with major benefit spillovers (education,health, and social welfare) to the regional and local levels. While theadministration of these programs by local governments may be appropriatebecause they are closer to the people, the many small local governments thathave been created as a result of the strong political push for decentralizationcannot likely provide these services at an adequate level from their ownresources. In some regions, enterprises' «public» spending exceedsbudgetary social spending and, in a few «one-company towns» there isno public spending by the budget at all on non-administrative functions.Enterprises did not provide these services once privatized, and responsibilityfell onto regional and local governments to finance them. But local governmentswill need revenue sources to finance the additional burden.
Decentralization,which led to ownership assignment and financial responsibility, has caused theregions to become more involved in the commercial sector through producersubsidies, capital transfers, and privatization. It has also led to thebudgetary expenditures by the regional governments to increase from 13 percentof the GDP in 1992 to around 18 percent in 1994. Recent policy changes havesuggested that this trend of more subnationalspending is likely to continue.
The Federalgovernment has approved legislation which led to the previously discussedchanges in expenditure assignment and also gave local governments the power toformulate budgets and raise revenues without worrying that their surpluses weregoing to be extracted by the central government. These new assignments ofexpenditures are not efficient, in part because the federal government haspassed down" many of the expenditure assignments which were formerly theresponsibility of the Soviet state. Revenue autonomy has not been reachedpartially due to the yearly changes in tax sharing rates. Disparities betweenthe rich and poor regions has also contributed to a problem budgetary concern.Along with these disparities, the high rate of inflation has significantlycontributed to revenue unpredictability of the rayonsand oblasts. Revenue predictability and the subnational area's economic state due is of the utmostimportance when one is considering expenditure assignment of the federation. Social Welfare and Russia
The significance and necessity of an efficientsocial safety net in the Russian Federation can only be understood within thecontext of the Soviet experience of social security and how today theideological inclination toward a welfare state is affecting Russian society.The state's pervasive role in Soviet society affected both economic and socialconditions. Economically, a state-caused inverse relationship existed betweenGDP and the state's commitment to social safety during the Brezhnevregime. Economic and political stagnation characterized the latter years of theBrezhnev era. Economically, GNP growth declinedprecipitously between 1961 and 1985 (see A1 and A2). Prior to 1960, the USSRutilized extensive rather than intensive factors of production--specificallylabor, capital (stock), and natural resources. In essence, Soviet authoritieswere able to take advantage of Imperial Russia's lack of a strong industrialbase by transferring much of the population from agriculture to industrialproduction during Stalin rapid industrialization drive of the 1930s and 1940s.The emphasis placed on heavy industry produced a correspondingly high rate ofconsumer saving which allowed for increased capital growth, that when combinedwith the natural resource abundance and intensive use of existing capitalhelped sustain economic growth The USSR's ability to sustain economic growth inthe 1970s was fostered by its large reserve of oil that helped finance importsof western technology.
Theexhaustion of labor surplus, declining birth rates, inefficient use of naturalresources and other factors of production, the growing expenditures needed tomaintain military parity with the United States, and the sudden drop in oilprices, and the mis-development of the economy allwere factors that contributed to the USSR's economic stagnation in the late1970s and early 1980s. While economic efficiency decreased during the Brezhnev period, the USSR's leadership demonstratedincreased commitment to the Soviet version of the social safety net. Theparty-state's pervasive role in society had the effect of slowing economicgrowth through poor re-allocation of resources and the social effect ofretarding the development of a civic society. As a result, Soviet societydeveloped an enduring attachment to the idea of an omnipotent state whichprovided for their basic needs regardless of the economic costs.
From aWestern perspective, the Soviet Union was ideologically a hyper" welfarestate in the sense that prior to the Gorbachev era,the state attempted to provide a high level of social security for everycitizen, often to the point of harming economic efficiency. Additionally, itheavily restricted the development of private sector in order to prevent widewage disparity. As mentioned above, the CPSU'smonopoly on power extended to every aspect of society and in exchange for partydominance the working population received implicit social guarantees in theform of a social contract." Linda J. Cook succinctly identifies eachsides' basic commitments and responsibilities:
Basically,the regime provided broad guarantees of full and secure employment, statecontrolled and heavily subsidized prices for essential goods, fully socializedhuman services, and egalitarian wage policies. In exchange for suchcomprehensive state provision of economic and social security, Soviet workersconsented to the party's extensive and monopolistic power, accepted statedomination of the economy, and compiled with authoritarian political norms.Maintenance of labor peace in this political system thus required relativelylittle use of overt coercion.
Theweakening 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 attemptto make state owned enterprises more efficient all had a direct impact onlowering the standard living for the USSR's population. Gorbachevtried and failed to cut the guarantees of the social contract. In contrast toearlier in the Soviet period, the perestroika reformshad the effect of giving significance to money" in the sense that inputshad developed value through the economic decisions which constituted perestroika. From the center's perspective, the problemscaused by the inability to cut expenditures through revision of the socialguarantees were compounded by revenue loss in three key areas: vodka sales,turnover tax, and republic contribution to the center--especially from theRussian Republic.
Gorbachevbegan perestroika with an attack on workerefficiency. One measure adopted to combat this perceived evil was restrictionon the sale of alcohol. The consequence was a loss in revenue which was furthercompounded by expenditures related to the Chernoybldisaster and the massive Armernian earthquake in1987. In 1990, the center granted state owned enterprise (SOEs)greater leeway in the setting of prices--between 50 percent and 100 percent ofstate mandated prices. Since retail prices were unaltered, the state lost ahuge amount of revenue from the turnover tax. In addition, Russia offered tolower the profit tax for those enterprises willing to pledge" allegianceto the Russian Republic. Finally, the dissolution of the Soviet Union washastened by the rise of Russian nationalism and populism both of which hadeconomic implications. The Russian Republic provided 80 percent of the revenueto the USSR's budget. Yeltsin, using his powerfulposition within the Russian parliament, declared in October of 1989 that theRepublic would halt all payment to Union institutions. He followed thisdevastating maneuver by nationalizing" the USSR Ministry of Finance andseizing its mints. In October of that year, Russia seized her share of the USSR'S precious metals. Faced with such tremendous loss ofrevenue which created a budget deficit that equaled 10 percent of GNP, theSoviet government elected to increase the amount of money in circulationwithout a corresponding increase in the production of consumer goods andservices. The decision to increase money circulation, through wage increases,had a jarring effect on Soviet society. The first impact, characterized by theindelible image of long bread lines and the stereotype that a large profitcould be made on a pair of Levis familiar to manyWesterner was the result of the disruption of goods and services to the generalpopulation.
Pricestability began to go by the wayside in the fall of 1988 with an estimatedinflation rate of 7 percent which mushroomed to 10 percent in 1990. As Table A3and A4 indicate, the state increased both the level of wages and subsidies inthe other which constituted the component parts of the Soviet safety net. Realwages, however did not compensate for inflation. The decline in social welfarefrom a monetary angle was compounded by quality decline in social consumptionareas. Although the state increase subsides to social consumption areas, thecollapse of the Council on Mutual Economic Assistance (CMEA) which providedmuch of the USSR's medicine and medical supplies and a growing environmentalmovement which forced the closure of many chemical plant that supplied thelimited domestic market. Gorbachev's attempts atreforms destroyed not only the social contract which existed between the stateand its citizens but the USSR as well. The late Soviet period thus provides thestarting point for examining poverty and the Russian Federations response to itin the form of the social safety net.
The Sovietsocial welfare system was effective in that absolute poverty, i. e. wide spreadhunger or inadequate diet, was avoided in the latter years of the Soviet periodsince the state could supply the basic needs of the population through itscontrol of USSR's resources and society as a whole. Research into question ofpoverty and therefore poverty alleviation policy (specifically the question ofincome inequality and distribution) was hindered by the imposition of politicalrather than economic explanations. In 1965, the Soviet Labor Research Instituteadopted a social minimum income norm which was derived from the estimated costsof human consumption. Goskomstat revised the incomelevel based on the prices reported by state-owned stores. The price consumerswere faced with, however, due to their shopping habits, the existence of ablack market," and inflationary pressures dramatically reduced theirpurchasing power. The Russian Federation revised the poverty line in 1992 toencompass 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, menbetween the ages of 18 and 59, women between the ages of 18 and 54, men age 60and above, and women age 55 and older
Closer tothe U.S poverty line definition, the Russian poverty level is established byfirst collecting low-cost cost food baskets for each demographic group… [and]after pricing each market food basket at national prices, age, andgender-specific multipliers yield individual poverty line for each demographicgroup. The definition of poverty is critically important to social welfare ofRussia because, in theory, it sets pension, minimum wage level, and welfarepayments. The USSR's dissolution has altered the scope, source and method offinancing of social welfare programs. The Soviet state provided a broad rangeof social services, through state owned enterprise. From a public financeperspective, the transition to a more market oriented system has meant thediversification of social spending responsibility through the creation ofoff-budgetary funds (OBF) and passing down the bulk of public social spendingmandates to sub-national governments. The following are the major OBFs: Pension Fund, Social Insurance Fund, Employment Fund,and the Fund for Social Support.
Created in1991, the Pension Fund was designed to take pressure of federal budget and isauthorized to collect a mandatory payment from employers in the form of amandatory 28 percent contribution while from agricultural enterprises themandatory contribution is 20. 6 percent and 5 percent of the total income ofself-employed individuals. Employees make a 1 percent contribution to the Fund.Labor pensions, financed from these contribution, and social pension which arefinanced from the federal budget are administered by an independent governmentagency. The former constitute the majority (80 percent) of Russian pensionersand thus the level of labor pensions affect the lives 19. 5 percent of theRussian population. To be eligible for labor pensions, men must have made 25years worth of contributions while women must have made 20 years ofcontribution. Eligibility for labor pensions can be lower depending onoccupation--hazardous occupations such as coal mining and military service aretwo examples. Social pensions are for individual with less than 5 years of workexperience and is equal two-thirds of the minimum old-age pension or in thecase of disability the amount varies but does not exceed the minimum laborpension.
Payrollcontributions are the also the main source of funding for the Social InsuranceFund (SIF) and the Employment Fund. Created in August 1992, the SIF is fundedby a 5.4 percent payroll deduction from every worker. The SIF is intended tofund child care, maternal care benefits, and sick care. Generally, 74 percentof revenue collected from the SIF contributions remains with the enterprisewhile the remainder is sent to the center to finance federal responsibilities.Workers who have accrued eight or more years of experience receive their entiresalary as do Chernobyl victims, parents with three or more children, and warvictims. Workers with less that five years experience receive 60 percent oftheir salaries while those with between five and eight years experience receive80 percent of their salaries. It is accepted practice that benefits are paiduntil the worker recovers or is granted a disability pension.
Mothersreceive support through a maternity grant which equals five times the amount ofthe present minimum wage. Additionally, working mothers receive a maternityallowance, over the span of 126 days, which is equivalent to her entire salary.When this time has elapsed, the mother can receive a payments that equals theminimum wage for up to a year and half.
Theexpenditure responsibility for family benefits, which generally are divided intothe following broad categories: payment made to all families with childrenwithout regard to income or prerequisites, cash transfers to disadvantagedfamilies, and payments made to working mothers, is unequally shared among allthree levels of government. Although the national level contributes, itmandates the levels of benefits while often leaving it to the sub-nationalgovernments to finance the increase.
Unemploymentin the region in a relatively new phenomena due to the general nature of theSoviet system. The Employment Fund was created in 1992 to pay unemploymentbenefits to those affected by the transition to a market economy. Contributionto the fund comes from a mandatory two percent payroll deduction and budgettransfers. Revenue collected from the payroll tax is shared between the raion and oblast governments on a45 percent to 55 percent ratio. The former then remits 10 percent to the centerfor federal responsibilities. Benefits, from Western perspective, areconsidered generous. Individuals just entering the work force receive theminimum wage. Workers who have been laid of receive in the first three monthsreceive a cash benefit equal to 75 percent of their previous salary. Thebenefits level drops to 60 percent for the following six months and 45 percentfor the remainder of the year.
The Fundfor Social Support ( FFS) is a limited national source for sub-national fundingof social programs. In 1992, the FFS accounted for only .01 percent of GDP. Thestated purpose of this fund is to aid rayons thathave been particularly hard hit in the transition from a command economy. TheFFS began operations in 1992 with revenue from seized Party assets and tax fromre-appraised inventories. It is also supposed to receive revenue form theprivatization process (although it did not receive the ten percent assigned in1992) and «receipts from the revaluation of commodities in state storesand ruble receipts from sale of food aid.»
Althoughinflation increases revenue to the Russian government, it naturallyimpoverishes the population when adjustments are not made (or insufficient todeal adequately with inflation) to monetary benefits such as the minimum wageand pensions which provides the basis for the social safety net. Inflation wasone of the primary causes of poverty in Russia. As chart A5 shows, socialsubsidies and transfers have also been ineffective because they do not reachthe truly needy. The primary reason for this economic waste is the lack ofmeans based testing.
The problemof hyper-inflation which had plagued Russia earlier in the transition periodhas been replaced" by the dramatic reduction in real wages and severedilemma of arrears. By December 1995, real wages declined by 13 percent andreal consumption declined by 5.3 percent. Real wage decline, and unexpectedlylow levels of unemployment, can be attributed to evasion of excess wage tax andinside the gate employment" by which enterprise managers hoard labor bypaying minimum wage and compensation workers in non-taxable manners such aspayment in kind, low interest long-term loans that have questionable repaymentterms. It should be noted that the Pension Fund is becoming more experienced indetecting methods of tax avoidance and recent action has been taken to closeloopholes
Reducedinflation has given way to arrears as one of the primary causes of poverty inthe Russian Federation and has primarily been the result of internationalpressure to reduce the budget deficit by ending emission based methods ofcovering the deficit" and tax avoidance and evasion. According toITAR-TASS, pensioner were owed nearly 3 billion dollars in October 1996.Revealing the revenue gap, 22 regions were able to make pension payments whilethe remaining 69 needed transfers from the federal fund. Wage arrears for bothprivate and public sector were estimated at 43 trillion rubles--9 billion ofwhich was the state's responsibility.
An area ofconcern which was not addressed in 1992 and continues to be a problem today isa rapidly deteriorating income distribution between the regions of the RussianFederation. The disparities between the rich and poor regions could possibly bethe worst amongst all the federations. CONCLUSION AND SUGGESTION
One of the greatest obstacles to successfulRussian market economic development is the absence of a modern and effectivetax system and lack of reliable data. Foreign capital always seekspredictability, especially in terms of projecting tax liabilities. Lack of astable tax regime is the number one reason why Russia's direct foreigninvestment dollar level is so low compared with other emerging markets. Afrequent and common concern expressed by foreign companies is the fear (whetherreal or perceived) of an unstable, inequitable, unreliable, and unpredictabletax system in Russia. As a result, capital that could potentially be investedin Russia is instead invested in other countries that are perceived as enjoyingmore stable tax systems. For Russia, it is time to introduce tax breaks orother incentives by the end of the year for companies using internationalaccounting methods as part of a new business reform plan. For example,companies which would follow these (international accounting) standards willhave their profit tax lowered by, say, five percent… or maybe they willreceive other privileges. Most Russian companies use domestic accountingpractices developed to calculate tax levels. Western accountants say Russianaccounting has limited use for business planning and investment. Below, we havestated some suggestion and concerns regarding public finance in transitionaleconomies:
Beforemaking any changes in the tax system the officials have to think very carefullyto avoid unplanned changes. For instance, the law on the VAT has been changed13 times since it was enacted. Proper tax reform would also solve another ofRussia's problems--its chronic budget deficit. The country's inadequate systemof tax revenue collection has been unable to keep pace with the rise ingovernment expenditure, leading to a budget deficit of 6.3 per cent of GDP inthe first half of this year. According to Mr. Stuart Brown, eastern Europeeconomist at Paribas Capital Markets, while fiscalpolicy has been lax in Russia, monetary policy has had to bear the burden ofreducing inflation. The result has been high real interest rates. No wonderthen that several leading companies are looking abroad for capital. Reducingthe budget deficit, to reduce «crowding out» at home and allow fiscalpolicy to take some of the burden in controlling inflation, must therefore be apriority for the Russian government. The problem is that tax evasion and aculture of non-payment in Russian industry, will hamper efforts to improverevenue collection.
Regulatethe movement of budget money by reorganize the Russian treasury and concentrateall budgetary financial flows within it.
A goodapproach to battling non-compliance would be the implementation of a unifiedcomputer information system to control revenues and expenditures of the federalbudget and state extra-budgetary funds, which should contain taxpayersregistration system and bring together information on tax and customs dutiespayments, banking transactions and cash disbursements, as well as data ontracing and utilization of the federal budget resources. But it is stilldifficult to implement. First, Russia does not have high qualified specialistsin database and management information systems (MIS). Second, it will requirebuying expensive mainframe computers what is critical under collected (60percent — percent) revenue. It is also important to decide what kind of taxinformation is going to be the first to be put in the database. The State TaxService of the Russian Federation recently began this process by requiring alltaxpayers to indicate a personal taxpayer identification number (PTIN) onpayments and settlement documents for taxes and other levies beginning onAugust 1, 1995. The rule as of January 1, 1996, states that a PTIN should beincluded on all payment and settlement documents. Also Russia's State TaxationService is redoubling its efforts to stop commercial banks from hiding incomefrom tax authorities. The taxation service recently found that creditinstitutions failed to transfer 3 trillion rubles to the state on time, andthat they have used legal means to hide their income. With the centralizedcomputer tax information system, it would be easier to observe taxpayers andprevent tax evasion. Reduce the cost of servicing the state debt. Stop the emission of money. Improve control over monopolies. Reorganize the banking system. Set up a federal deposit of insurance bond. Reform ministry of finance and economy. Diversification of the tax base.
Someservices should be financed by taxes levied on local beneficiaries. «Localtaxes» are those over which local authorities have some control. Whichtaxes to assign? The question is not easy for Russia. In many market economies,the central government controls those taxes considered to be most redistributive, such as personal income taxes, and the cyclicalcorporate income tax, leaving more stable revenue sources levied on aconsumption base or property to the local level. For example, some federalsystems (the U.S., Switzerland, Canada) allow subnationalcorporate taxes, it would be better for the federal government to set thecorporate income tax. For the transition economies, considerations of bothadministrative complexity and allocative efficiencysuggest that subnationally levied corporate taxesshould be avoided at the present time. Permitting the many small subnational governments in the transition economies to setcorporate tax rates (or adjust the tax base) will allow substantial taxcompetition and differentiation in enterprise taxation, influencing enterpriselocation decisions in perhaps undesirable directions.
.Thedevelopment of a more efficient and effective social safety net in perhaps themost immediate and difficult task to accomplish in the Russian Federation.Aside from cultural reasons outlined earlier, economic growth cannot occurwithout social stability which will not happen until Russia can design aneffective system of coverage. Some possible ways to improve this critical areaare: diversify the tax base for social programs, redesign the system offederal-sub-national relation which has made the latter bear an unjust amountof the burden--unfair because of regional differences and compounded by Sovietplanning--, and make stronger attempts to reduce arrears which is a difficulttask due to the temptation to return to emission-based methods of coveringexpenditure requirements.

APPENDIX
PRIVATE
Table A1 Selected Economic Indicators, Average Annual Rate of Growth
1961-70
1971-75
1976-80
1981-85
1986-90
1. Net material product (NMP), Soviet official*
6.4
5.1
3.9
3.1
4.1
2. Gross national product (GNP), CIA estimates*
5.1
3.7
2.1
1.9
C
3. Gross fixed capital investment, Soviet official*
6.9
6.8
3.5
3.5
4.9
4. Industrial output, Soviet official
8.5
7.4
4.4
3.7
4.6

5. Industrial output, CIA estimates b.
6.6
5.9
2.4
2.0
C
6. Agricultural output, Soviet official c.
C
2.5
1.8
1.0
2.7
7. Agricultural output, CIA estimates b.,c.
C
1.4
0.4
(-)0.6
C
8. Real income per capita, Soviet official
6.5
4.3
3.4
2.1
2.7
9. Consumption per capita, CIA estimates b.
3.8
2.9
2.0
1.9
C

SOURCES: Soviet official data and plan goals, TSSU (1986) and earlier volumes in the same series; Pravda, March 9, 1986; June 19, 1986; June 20, 1986; John Pitzer (1982), CIA (1985, pp. 64ff; 1989, pp. 45, 59ff); Gertrude E. Schroeder and M. Elizabeth Denton (1982). For consumption, 1981-1985, and agricultural output, 1976-85, unclassified CIA data supplied to author. Authors' Source: Abrham Bergson Soviet Economic Reform Under Gorbachev" in From Socialism to Market Economy .ed William Kern 1992 p. 37
a. Utilized for consumption and accumulation.
b. Output valued in 1970 prices for growth rates for 1961-75 and in 1982 prices for growth rates for 1976-85.
c. Not available.
d. CIA estimates essentially accord with Soviet official data.
e. Yearly growth rate of average for five-year period over average for previous five-year period.




PRIVATE
Table A2 Comparison of GNP Growth in USSR and Western Countries 1961-85
(Average Annual Growth in Per Cent)
USSR
US
FRG
France
Italy
UK
1961-65
4.8
4.6
4.8
5.8
5.2
3.2
1966-70
5.1