A meeting of the expert advisory group on fiscal policy and macroeconomic indicators of growth was held at the end of August in the Russian Accounts Audit Chamber, chaired by the Chamber’s Deputy Chairman Valery Goreglyad. The topics of the meeting were intergovernmental relations, budget balancing, and revenue sources.

The expert advisory group was set up in preparation for the finalization of the draft federal budget for 2013 and the planning period of 2014 and 2015. The experts included the country’s leading economists working in government, business, and research institutions.

In opening the meeting, Valery Goreglyad reminded the participants that in the area of interbudgetary relations, the main budgetary policy for 2013, as well as for the planning period of 2014 and 2015, was aimed at redistributing funds between levels of public authority, balancing budgets, ensuring budgetary consolidation transfers within the key areas of public policy, and enhancing the predictability of distribution transfers.

According to the Deputy Head of the Accounts Audit Chamber, by the year 2015, income and expenses of consolidated regional budgets, as planned, will increase over the current year by 26 percent, while the overall deficit of the budget will be maintained. The volume of intergovernmental transfers in the three years will be reduced by more than 15 percent. Accordingly, the share of transfers in budget revenues will decrease by almost two-fold, from 19.2 percent in 2011 to 11.1 percent in 2015. At the same time, budgetary revenues of only 15 subjects of the Russian Federation formed more than half of all redistributed funds.

The Russian President’s message on the budget proposed changes in the structure of budgetary expenditures in favor of those that are aimed at development, including infrastructure costs. For its part, the Chamber has consistently emphasized in its reports on draft federal budgets the need for enhancing the role of intergovernmental transfers in long-term investment, of instituting accountability safeguards as to the formation of structural changes in regional economies, and of directing spending in a way so as to maximize future returns from taxation.

However, a large percentage of total transfers still is directed at covering operating costs. As such, in 2010 the share of intergovernmental investment grants was only 13.4 percent of total intergovernmental transfers, discounting subsidies. In 2011, the figure was 13.5 percent.

If this situation persists into the future, underdeveloped regions will remain dependent on federal financial aid and would not have the motivation to spur economic growth. The regional difference in wealth between the top 10 and the 10 least financially secure subjects of the Russian Federation in 2011 was 5.8 times, and the forecast for 2012-2014 reflects that the figure will increase to 6.2 times.

According to the Accounts Audit Chamber, existing mechanisms for the centralization of financial resources and their subsequent redistribution is not lessening the dependency of regional and municipal budgets on the federal government and is not encouraging local development. In particular, only 37 percent of the income generated in a particular territory of the Russian Federation stays in that territory. The federal budget gets 63 percent of the total revenue generated, on average 20 percent of which amount returns to the regions in the form of intergovernmental transfers. The negative impact of the redistribution mechanism is felt much stronger in the developed regions. These subjects of the Russian Federation transmit to the federal budget between 55 and 85 percent of revenues.

According to Valery Goreglyad, the share of regional and local taxes is insignificant compared with the share of revenues from federal taxes in the consolidated budget of the Russian Federation. The Chamber urged competent regulators to consider expanding the type and number of taxes and duties assigned to the regional and local budgets. Another significant recommendation was that the national governing bodies rebate a consistent percentage of federal taxes and fees to regional budgets. This could create a revenue base for independent solutions to territorial development challenges.

Total tax incentives granted by the federal legislature to organization exempt from state and local taxes in 2010 was about 200 billion roubles. Yet, the government has not yet implemented any integrated system of tracking the tax benefits granted and has not developed any standard procedures for assessing the effectiveness of the tax incentives.

The President’s budget message on fiscal policy in 2013-2015 contemplated phasing out the practice of granting incentives for regional and local taxes at the federal level. However, while the draft of the tax policy of the Russian Federation for 2013 and the planning period of 2014 and 2015 does include proposals for phasing out the cancellation of tax incentives for the payment of regional property taxes for companies and organizations, the tax policy does not address the granting of local property tax incentives for individuals at the federal level. According to Valery Goreglyad, it is imperative to optimize the existing system of tax credits and exemptions by creating a system for identifying ineffective forms of tax incentives.

In addition, according to the Chamber, any exemption from regional and local taxes should be regulated only by regional legislation. The draft of federal legislation to accomplish that end is currently being developed by the Committee of the Federation Council on the Budget and the Financial Markets.

The main directions of the budget policy for 2013 and the planning period of 2014 and 2015 include the consolidation of subsidies from government programs of the Russian Federation. In the case of delegation of federal spending powers to the regions, the subjects of the Russian Federation are encouraged to strive for independent financial security apart from federal subsidies. At the same time, the President’s budget message outlined the task of transitioning from the practice of delegating federal authority to the regions to transferring such powers to the Russian Federation’s subjects on a regular basis. Such a permanent transfer of taxing and spending authority will fix constant sources of income for the regions that need it most. However, no specific proposals with respect to the partial transfer of the taxing and spending power have yet been made.

Finally, the execution of regional and local budgets continues to present certain risks associated with the significant leverage of creditors. This year, the cost of debt servicing to the regions will increase to 99 billion roubles, up 31 percent compared to the same period of the previous year. Regional authorities and municipalities have been instructed to reign in deficit spending and keep to balanced budgets.

In the view of Galina Kurlandskayaskaya, director of the Center for Fiscal Policy, it would be impossible to replace federal budget subsidies with increasing the region’s taxing authority in the near future. The redistribution of taxation at the sub-national level, in her opinion, would benefit only the donor regions. “There are vast economic and infrastructural disparities between the territories,” the expert said. “For the poor regions, where there is no tax base, even if one transfers the revenues from the value-added tax (VAT) from the federal to the regional budgets – nothing good will come of it. Clear, transparent rules of distributing intergovernmental transfers are long overdue.”

One important factor that creates imbalances and deficits with regional budgets is the institution of untested reforms, believes the director of the Center for Fiscal Policy. Some examples here are the transfer of health care financing to the regions and the creation of regional road restoration funds. “Many regions simply cannot afford these mandates. Revenue streams assigned to the regions to fund new mandates often do not generate sufficient income,” said Galina Kurlandskaya.

The head of the Center for Post-Industrial Studies Vladislav Inozemtsev also pointed to the need for increasing the transparency of transfer distribution procedures. “A classic case is this. The mayor opposes the region’s governor both in politics and in business. This has a negative impact on the fiscal security of the inhabitants of the regional capital city, where most of the population of the territory lives, and all economic indicators per capita are lower in the regional capital than the average for the region.”

As such, in terms of gross regional product per capita Novosibirsk and Tomsk are about equal, but in terms of the size of the budget per capita Novosibirsk is behind Moscow seven times and Tomsk 17 times, the expert said. In his view, a certain minimum budgetary capacity per capita in the regions should be fixed by law. This should be the minimum and guide the allocation of intergovernmental transfers.

Equally important, according to Vladislav Inozemtsev is the change of taxation policy as it relates to large, vertically integrated companies, whose activity is based on transfer pricing: “The value-added goods are produced in the Urals or in Siberia, yet taxes are paid either in Moscow or in offshore jurisdictions. Federal companies do not give the regions their fair share. It is one of the reasons for the misalignment of intergovernmental relations in the Russian federal fiscal system.” As such, the expert believes that Russia needs to get back to parity distribution of revenues between the federal budget and the consolidated budgets of regions and municipalities.

Today, the provision of federal budgetary public services to donor regions is often lower than the provision of such services to recipient regions, noted the president of the Russian Financial Corporation Andrei Nechayev. In addition, recipient regions are not always effectively using the federal funds available to them. In addition, the expert believes that the co-financing of regional projects by the Federal Target Investment Program is inherently flawed. The federal government almost always fulfills its obligations, but the regions do not. “Of course, the federal government should, where possible, finance such large projects on a scale appropriate for co-financing from the region. The main thing is to keep the principle of sharing expenditures 50:50.”

In this view, Andrei Nechayev is of the opinion that the region should have fiscal autonomy in being able to impose such taxes, for which it has a strong base.

As Marina Maslova, consultant for the municipal finance and intergovernmental relations sector of the Institute for Urban Economics, emphasized that before embarking on a reform of intergovernmental relations, it is indispensible to get a clear picture of the real balance of tax sources and tax revenues in the regions and municipalities. Today, that picture does not have the necessary detail. For example, local taxes do not affect migrant workers, the number of which is growing steadily in Russia. The tax system does not “see” that, the expert said.

“Before the reform of budgetary relations, we should create a normal taxing system,” expressed his opinion Professor of Finance at the Russian Government University Vladimir Hamza. “We have it standing on its head: working citizens pay taxes where they work, not where they live. Companies pay taxes at the place of registration, and not where production activities take place. We have to understand where and how value is added. Only then will it be a normal system of intergovernmental relations. Until then we will have only a patchwork.”

“In terms of improving the system of intergovernmental relations, the government in recent years has achieved undeniable success,” said Valery Goreglyad. “This, however, does not negate the need for effective methods for assessing the real fiscal capacity of regions and for ensuring the transparency of federal allocations. The government should not focus only on the distribution of federal funds to the region, but on creating the conditions and prerequisites for maximizing the tax revenues of the territories.”