Intergovernmental Transfers Reform in Russia: Trends and Perspectives Washington, DC - May, Ilya Trunin Institute for the Economy in Transition Regional Fiscal Technical Assistance Project

Budgetary System in the Early Transition Period Sharp decrease in the public revenue during transition to a new tax system Decentralizing public expenditures instead of cutting them down Need for preventing the federation from decay Emerging of the practices of unfunded mandates as an alternative to decrease public expenditures in accordance with revenue possibilities Using intergovernmental fiscal transfers and shared taxes in political process Results: unstable and inefficient system of intergovernmental fiscal arrangements

First Stage of the Intergovernmental Fiscal Reform – 1993 Constitution New principles of federal-regional-municipal relations – formally close to the modern federations Legislative allocation of tax revenues and taxing powers across levels of government – to a possible extent New system of intergovernmental transfers with its key element – a formula based equalization grants Growing amount of unfunded mandates and political reasons (the federal government kept being dependent of strong regions) hampered the fiscal reform process Results: Excessive decentralization in case of reach regions and strong centralization concerning the majority of the subjects of the Federation

Second Stage of the Intergovernmental Fiscal Reform – 1998 Crisis The process of federal grants allocation went out of control sharp decline in tax revenue Introduction of new principles of equalization grants allocation Refraining from changing the results of formula- based calculations as well as from providing large discretionary grants Tax revenue allocation between the budgets Conceptual programs of the fiscal federalism reform Results: Hardening budget constraints for the regions, new psychology of grants allocation

Federal Grants to the Regions Since

Horizontal Fiscal Imbalances in 2002 (Lorenz curves for main tax revenues per capita)

The Main Features of the Federal Grants to the Regions at Present 1.Equalization Grants – a formula-based mechanism, equalization of regional fiscal capacity adjusted for expenditure needs differentials 2.Compensation Grants – formula-based specific purpose grants aimed at funding certain federal mandates 3.Regional Finance Reform Grants – conditional grants to regions performing regional finance reform program 4.Social Expenditure Grants – matching grants aimed at funding certain most important regional expenditures 5.Regional Development Grants – specific purpose grants to finance regional public investment in infrastructure 6.Other Grants and Loans – numerous grants (road construction, compensation for changes in federal legislation, etc) allocated mainly on discretionary basis

Adjusted Fiscal Capacity Equalization Principle in Russia

Positive Impacts of the Reforms The new system has been established that has got many features of an efficient system of intergovenmental fiscal equalizationThe new system has been established that has got many features of an efficient system of intergovenmental fiscal equalization Federal government started to base its calculations on the fiscal capacity and expenditure needs indicators rather than on the actual revenues and expenditures in the previous periods (see Kadotchnikov, Sinelnikov, Trunin (2002))Federal government started to base its calculations on the fiscal capacity and expenditure needs indicators rather than on the actual revenues and expenditures in the previous periods (see Kadotchnikov, Sinelnikov, Trunin (2002)) The procedures of formula-based calculations has been elaborated and introduced to the budget planning practicesThe procedures of formula-based calculations has been elaborated and introduced to the budget planning practices Compensation of unfunded mandates Compensation of unfunded mandates Regional (and federal) governments started to get used to the new philosophy of equalization – unified approach on the basis of the independent statistics instead of the case by case ad hoc agreementsRegional (and federal) governments started to get used to the new philosophy of equalization – unified approach on the basis of the independent statistics instead of the case by case ad hoc agreements

Current Deficiencies of the Transfers System No further improvement of the system since 2001 No improvement at the regional-local level Grant allocation formulae due to various corrections have become complex and non-transparent Importance of discretionary grants increased again (formula- based grants share in the total federal grants amount fell to %) Changes to the federal budget act during the fiscal year lead to softening budget constraints of the regions (in 2003 two amendments in July and November increased total amount of grants by 30%, allocated at discretionary basis) Region still do have the opportunity of obtaining financial resources from the federal budget on a negotiable basis (loans on preparation to the winter season, wages in the public sector, liquidation of natural disasters)

Large amount of unfunded federal mandates that enable regions to apply for additional grants and federation – to influence regional fiscal decisions Unwillingness of the federal center to lose control over regional governments in political sense Many reforms in different sectors (taxation, natural monopolies etc.) at the same time lead to seeking compromise in less important areas Intergovernmental transfers reform should follow general federative reform that really started in 2003 only Reasons for Deficiencies

Main Features of the Current Reform Plans Related to Intergovernmental Transfers Elimination of unfunded mandates: normative regulation, financing and administration powers will be assigned to different levels of governmentElimination of unfunded mandates: normative regulation, financing and administration powers will be assigned to different levels of government This envisages increasing role of Compensation Grants that will finance federal mandates imposed on regionsThis envisages increasing role of Compensation Grants that will finance federal mandates imposed on regions Increasing fiscal autonomy of regional and municipal governments (more on expenditure that on revenue side)Increasing fiscal autonomy of regional and municipal governments (more on expenditure that on revenue side) Simplification of the transfers allocation formulaSimplification of the transfers allocation formula

Main Features of the Current Reform Plans Related to Intergovernmental Transfers Actual start of the reform at the sub-regional level (implementation of a complicated system of different grant types to municipalities of 2 types)Actual start of the reform at the sub-regional level (implementation of a complicated system of different grant types to municipalities of 2 types) Need for education of regional authorities that will implement the new transfers system in a 2-type municipal structureNeed for education of regional authorities that will implement the new transfers system in a 2-type municipal structure Normative regulation of the transfers mechanism (federal laws and government acts)Normative regulation of the transfers mechanism (federal laws and government acts) Introduction of “negative transfers” at the sub- regional levelIntroduction of “negative transfers” at the sub- regional level

Further Reform Agenda Creating incentives for responsible behavior at the regional and municipal levels of governmentCreating incentives for responsible behavior at the regional and municipal levels of government Extensive usage of matching grants to pursuit federal objectives at the regional levelExtensive usage of matching grants to pursuit federal objectives at the regional level Creating unified system of federal grants to regions including various kinds of present discretionary transfers (road construction, investment programs, ad hoc grants)Creating unified system of federal grants to regions including various kinds of present discretionary transfers (road construction, investment programs, ad hoc grants) Moving to real equalization of fiscal capacity from grants allocation according to “normative” revenues and expendituresMoving to real equalization of fiscal capacity from grants allocation according to “normative” revenues and expenditures