Russian Federation Country Study. A Public Finance Perspective

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

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

compounded by quality decline in social consumption areas. Although the

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

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

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

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

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

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

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

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

the social safety net.

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

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

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

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

Research into question of poverty and therefore poverty alleviation policy

(specifically the question of income inequality and distribution) was

hindered by the imposition of political rather than economic explanations.

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

income norm which was derived from the estimated costs of human

consumption. Goskomstat revised the income level based on the prices

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

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

and inflationary pressures dramatically reduced their purchasing power. The

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

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

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

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

above, and women age 55 and older

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

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

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

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

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

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

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

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

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

services, through state owned enterprise. From a public finance

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

diversification of social spending responsibility through the creation of

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

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

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

for Social Support.

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

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

the form of a mandatory 28 percent contribution while from agricultural

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

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

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

and social pension which are financed from the federal budget are

administered by an independent government agency. The former constitute the

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

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

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

contributions while women must have made 20 years of contribution.

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

hazardous occupations such as coal mining and military service are two

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

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

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

pension.

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

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

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

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

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

contributions remains with the enterprise while the remainder is sent to

the center to finance federal responsibilities. Workers who have accrued

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

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

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

salaries while those with between five and eight years experience receive

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

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

Mothers receive support through a maternity grant which equals five times

the amount of the present minimum wage. Additionally, working mothers

receive a maternity allowance, 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 the minimum wage for up to a year and half.

The expenditure responsibility for family benefits, which generally are

divided into the following broad categories: payment made to all families

with children without regard to income or prerequisites, cash transfers to

disadvantaged families, and payments made to working mothers, is unequally

shared among all three levels of government. Although the national level

contributes, it mandates the levels of benefits while often leaving it to

the sub-national governments to finance the increase.

Unemployment in the region in a relatively new phenomena due to the general

nature of the Soviet system. The Employment Fund was created in 1992 to pay

unemployment benefits to those affected by the transition to a market

economy. Contribution to the fund comes from a mandatory two percent

payroll deduction and budget transfers. Revenue collected from the payroll

tax is shared between the raion and oblast governments on a 45 percent to

55 percent ratio. The former then remits 10 percent to the center for

federal responsibilities. Benefits, from Western perspective, are

considered generous. Individuals just entering the work force receive the

minimum wage. Workers who have been laid of receive in the first three

months receive a cash benefit equal to 75 percent of their previous salary.

The benefits level drops to 60 percent for the following six months and 45

percent for the remainder of the year.

The Fund for Social Support ( FFS) is a limited national source for sub-

national funding of social programs. In 1992, the FFS accounted for only

.01 percent of GDP. The stated purpose of this fund is to aid rayons that

have been particularly hard hit in the transition from a command economy.

The FFS began operations in 1992 with revenue from seized Party assets and

tax from re-appraised inventories. It is also supposed to receive revenue

form the privatization process (although it did not receive the ten percent

assigned in 1992) and "receipts from the revaluation of commodities in

state stores and ruble receipts from sale of food aid."

Although inflation increases revenue to the Russian government, it

naturally impoverishes the population when adjustments are not made (or

insufficient to deal adequately with inflation) to monetary benefits such

as the minimum wage and pensions which provides the basis for the social

safety net. Inflation was one of the primary causes of poverty in Russia.

As chart A5 shows, social subsidies and transfers have also been

ineffective because they do not reach the truly needy. The primary reason

for this economic waste is the lack of means based testing.

The problem of hyper-inflation which had plagued Russia earlier in the

transition period has been replaced" by the dramatic reduction in real

wages and severe dilemma of arrears. By December 1995, real wages declined

by 13 percent and real consumption declined by 5.3 percent. Real wage

decline, and unexpectedly low levels of unemployment, can be attributed to

evasion of excess wage tax and inside the gate employment" by which

enterprise managers hoard labor by paying minimum wage and compensation

workers in non-taxable manners such as payment in kind, low interest long-

term loans that have questionable repayment terms. It should be noted that

the Pension Fund is becoming more experienced in detecting methods of tax

avoidance and recent action has been taken to close loopholes

Reduced inflation has given way to arrears as one of the primary causes of

poverty in the Russian Federation and has primarily been the result of

international pressure to reduce the budget deficit by ending emission

based methods of covering the deficit" and tax avoidance and evasion.

According to ITAR-TASS, pensioner were owed nearly 3 billion dollars in

October 1996. Revealing the revenue gap, 22 regions were able to make

pension payments while the remaining 69 needed transfers from the federal

fund. Wage arrears for both private and public sector were estimated at 43

trillion rubles--9 billion of which was the state's responsibility.

An area of concern which was not addressed in 1992 and continues to be a

problem today is a rapidly deteriorating income distribution between the

regions of the Russian Federation. The disparities between the rich and

poor regions could possibly be the worst amongst all the federations.

CONCLUSION AND SUGGESTION

One of the greatest obstacles to successful Russian market economic

development is the absence of a modern and effective tax system and lack of

reliable data. Foreign capital always seeks predictability, especially in

terms of projecting tax liabilities. Lack of a stable tax regime is the

number one reason why Russia's direct foreign investment dollar level is so

low compared with other emerging markets. A frequent and common concern

expressed by foreign companies is the fear (whether real or perceived) of

an unstable, inequitable, unreliable, and unpredictable tax system in

Russia. As a result, capital that could potentially be invested in Russia

is instead invested in other countries that are perceived as enjoying more

stable tax systems. For Russia, it is time to introduce tax breaks or other

incentives by the end of the year for companies using international

accounting methods as part of a new business reform plan. For example,

companies which would follow these (international accounting) standards

will have their profit tax lowered by, say, five percent... or maybe they

will receive other privileges. Most Russian companies use domestic

accounting practices developed to calculate tax levels. Western accountants

say Russian accounting has limited use for business planning and

investment. Below, we have stated some suggestion and concerns regarding

public finance in transitional economies:

Before making any changes in the tax system the officials have to think

very carefully to avoid unplanned changes. For instance, the law on the VAT

has been changed 13 times since it was enacted. Proper tax reform would

also solve another of Russia's problems--its chronic budget deficit. The

country's inadequate system of tax revenue collection has been unable to

keep pace with the rise in government expenditure, leading to a budget

deficit of 6.3 per cent of GDP in the first half of this year. According to

Mr. Stuart Brown, eastern Europe economist at Paribas Capital Markets,

while fiscal policy has been lax in Russia, monetary policy has had to bear

the burden of reducing inflation. The result has been high real interest

rates. No wonder then that several leading companies are looking abroad for

capital. Reducing the budget deficit, to reduce "crowding out" at home and

allow fiscal policy to take some of the burden in controlling inflation,

must therefore be a priority for the Russian government. The problem is

that tax evasion and a culture of non-payment in Russian industry, will

hamper efforts to improve revenue collection.

Regulate the movement of budget money by reorganize the Russian treasury

and concentrate all budgetary financial flows within it.

A good approach to battling non-compliance would be the implementation of a

unified computer information system to control revenues and expenditures of

the federal budget and state extra-budgetary funds, which should contain

taxpayers registration system and bring together information on tax and

customs duties payments, banking transactions and cash disbursements, as

well as data on tracing and utilization of the federal budget resources.

But it is still difficult to implement. First, Russia does not have high

qualified specialists in database and management information systems (MIS).

Second, it will require buying expensive mainframe computers what is

critical under collected (60 percent - percent) revenue. It is also

important to decide what kind of tax information is going to be the first

to be put in the database. The State Tax Service of the Russian Federation

recently began this process by requiring all taxpayers to indicate a

personal taxpayer identification number (PTIN) on payments and settlement

documents for taxes and other levies beginning on August 1, 1995. The rule

as of January 1, 1996, states that a PTIN should be included on all payment

and settlement documents. Also Russia's State Taxation Service is

redoubling its efforts to stop commercial banks from hiding income from tax

authorities. The taxation service recently found that credit institutions

failed to transfer 3 trillion rubles to the state on time, and that they

have used legal means to hide their income. With the centralized computer

tax information system, it would be easier to observe taxpayers and prevent

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.

Some services should be financed by taxes levied on local beneficiaries.

"Local taxes" are those over which local authorities have some control.

Which taxes 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 cyclical

corporate income tax, leaving more stable revenue sources levied on a

consumption base or property to the local level. For example, some federal

systems (the U.S., Switzerland, Canada) allow subnational corporate taxes,

it would be better for the federal government to set the corporate income

tax. For the transition economies, considerations of both administrative

complexity and allocative efficiency suggest that subnationally levied

corporate taxes should be avoided at the present time. Permitting the many

small subnational governments in the transition economies to set corporate

tax rates (or adjust the tax base) will allow substantial tax competition

and differentiation in enterprise taxation, influencing enterprise location

decisions in perhaps undesirable directions.

.The development of a more efficient and effective social safety net in

perhaps the most immediate and difficult task to accomplish in the Russian

Federation. Aside from cultural reasons outlined earlier, economic growth

cannot occur without social stability which will not happen until Russia

can design an effective system of coverage. Some possible ways to improve

this critical area are: diversify the tax base for social programs,

redesign the system of federal-sub-national relation which has made the

latter bear an unjust amount of the burden--unfair because of regional

differences and compounded by Soviet planning--, and make stronger attempts

to reduce arrears which is a difficult task due to the temptation to return

to emission-based methods of covering expenditure requirements.

APPENDIX

| | | | | | |

| |1961-70 |1971-75 |1976-80 |1981-85 |1986-90 |

|1. Net material |6.4 |5.1 |3.9 |3.1 |4.1 |

|2. Gross national |5.1 |3.7 |2.1 |1.9 |C |

|3. Gross fixed |6.9 |6.8 |3.5 |3.5 |4.9 |

|4. Industrial |8.5 |7.4 |4.4 |3.7 |4.6 |

|5. Industrial |6.6 |5.9 |2.4 |2.0 |C |

|6. Agricultural |C |2.5 |1.8 |1.0 |2.7 |

|7. Agricultural |C |1.4 |0.4 |(-)0.6 |C |

|8. Real income per|6.5 |4.3 |3.4 |2.1 |2.7 |

|9. Consumption per|3.8 |2.9 |2.0 |1.9 |C |

| | | | | | |

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Russian Federation Country Study. A Public Finance Perspective