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
The separation of powers which existed under the Soviet
constitution was essentially a myth. A Russian accurately characterized the
relationships that existed 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-General
absorbed the Party." Both legislative and judicial branches served as
rubber stamps" to the Presidium of the Supreme Soviet which unlike the
Supreme Soviet itself was constantly in session. The development of political
reform 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 the
office of the President which received the executive powers while the
legislative powers were assigned to Congress of Peoples Deputies. The judicial branch
also achieved higher visibility during the late Soviet period through the
creation of the Committee on Constitutional Supervision. The Soviet Union's
collapse in 1992 introduced radical changes into all aspects of Russian
society. Russia has little experience with democracy in any form. Without a
strong democratic tradition, it should not be unexpected that instability would
develop in all aspects of Russian life. The role of governmental finance in
post-Soviet society is no exception. Competing explanations exist for Russia's
travails but a shared trait of many them is the distribution of power at the
federal level and the relationship between the federal and sub-national levels
of government.
Political problems did not take long to develop in the Russian
Federation after the USSR's dissolution. At the federal level, the creation of
the present constitution is one cause of the instability which plagues Russia
today. After winning a national referendum on August 15, 1993 in which the
electorate was asked to endorse the Yeltsin's reform policy, he convened a
constitutional assembly to ratify his version of the new constitution. Three
drafts were in contention to replace the constitution under which the Soviet
Union was nominally ruled. Other than Yeltsin's constitution which became the
one implemented, the two other variants were the communist draft which
advocated a strong Presidium of the Supreme Soviet with a chairman who had
similar powers to the position of General Secretary during the Soviet period and
the Rumyanstev draft which contained plans to restrict executive power and
grant the legislative body wide powers. Yeltsin's draft advocated the exact
opposite of the aforementioned plans with wide powers to the executive and
minimal power delegated to the legislative. After the Duma rejected Yeltsin's
order to dissolve, he ordered military troops to forcefully evacuate the
building--which they did by shelling it. Briefly, the president is the
protector of the constitution, human rights, and civil liberty. In order to
protect the constitution and the aforementioned rights, the constitution grants
the president wide injunctive and declarative powers. The former powers consist
of the president's ability to use "conciliation procedures to resolve disputes
between the federal government and the governments of the constituent subjects
and disputes between the various subjects of the federation." A three
stage procedure exists for the adjudication of disputes but his ability to
suspend legislation after it is submitted to the appropriate court" which
he deems to be in violation of the constitution is considered by many as
inappropriate for a fledgling democracy. The President also has the power to
issue decrees and orders which are superior to the laws of the government as
long as the decree or order does not violate the constitution. Further, the
president has the ability to appoint important member of his government without
consent for the Duma and has sole power to appoint and remove the command
structure of the Armed Forces. In regards to the legislature, the president has
the ability to dissolve the Duma if it passes two no-confidence vote in the
Russian government within three months of each other and if it rejects three
presidential nominee for Chairman of the Russian government. Although there are
limitations of the president's ability to dissolve the Duma, it remains a
potential weapon against a contentious parliament that affects every aspect of
public finance.
The power of the legislative and judicial branch are limited
in relation to the executive. Russia's judicial system consists of a several
court systems that have different spheres of federal/national
jurisdiction." The most visible court is the Constitutional Court which
has the right to review the constitutionally of all federal laws, presidential
orders and degrees, legislation of government, and unratified treaties.
Challenges to the aforementioned areas must be brought by individuals with
standing. Although the Constitutional Court's power seems vast, the president's
expansive powers and lack of civil relations between the different branches
makes the Court's utilization of this power suspect. Federal law and federal
constitution laws are the two types of laws which exist in the Russian Federation.
The latter is considered superior to federal laws. The procedure for enactment
differ in each case. Once a bill is passed it must presented to the president
within five days of the passage by the parliament. The president then has
fourteen days to reject the law. In order to veto the federal law, a two-thirds
majority must be gained in both parts of the legislative assembly. In the case
of federal constitutional law, three quarters of the Federation Council and two
thirds of the Duma must approve it for enactment. The constitution does not
describe any right for the president to veto federal constitutional laws.
According to Article 106 of the Russian Constitution, laws in regard to the
following area must be voted upon by the Federation Council: The federal
budget, federal taxes and levies, foreign currencies, custom regulation, and
currency issuance.
Budgeting
Recently, the Duma
rejected the government's first draft of the budget. Deputies were divided over
the size of the projected federal budget deficit, which was set at 95.4
trillion rubles or 3.5 percent of GNP. When the budget is rejected by the Duma,
the government has 20 days to revise and re-submit the budget. If differences
exist between the government's proposed budget and the Duma's, an option exists
to create a committee to reconcile their disagreements. The Duma rejected the
government's proposed 1997 budget in October 1996 and did not opt initially for
such a commission. If no budget agreement is reached, parliament would be
forced to pass monthly or quarterly budgets which would cause confusion
throughout the economy. Since the initial rejection however, a reconciliation
commission (in which both houses of parliament and the government are
represented), has been working on a new version. The reconciliation commission
is due to have a final meeting on Wednesday, with the Duma giving the budget a
new first reading on November 20 or 21. There is no legal framework to cover
the failure to pass the budget, but parliament has faced the problem every year
of Russia's independence except 1996 and has in the past approved temporary
budgets.
The work of the reconciliation commission is being drawn out
because neither the communist majority in parliament nor the government wants
to take responsibility for making a decision on the budget. Russia is trying to
keep to a small deficit in 1997 under pressure from the International Monetary
Fund, but the Duma is eager to increase budget spending to a starved economy.
Reform minded deputies want a lower budget deficit to achieve lower credit
rates--which they say are vital for economic growth but which are kept high
through heavy government borrowing. The dilemma is that the communists in the
parliament want to increase spending and as a majority they can block implementation
of any budget bill.
Taxation
Russia's tax system
is an exercise in frustration for both Russians and foreigners. The problem
arises because it seems that many taxes spring out of the blue and carry heavy
retroactive penalties" which are often three times the tax amount due.
Russian tax reform is difficult now because the government desperately needs
money and has little 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 50 percent in the Czech Republic and 47.7% in Poland Russia's
budget deficit has been narrowed in recent years, but this only been achieved
by cutting back on expenditures in real terms, almost 50 percent from 1993 to
1995.
Like the United States, Russia has a three-tiered system of
taxation. Federal taxes are enforced by Parliament, regional taxes enforced by
the regional councils, and local taxes enforced by the local authorities. Under
the existing system, very little coordination can be found between the three
levels of government which causes serious tax policy problems. In a 1993
decree, regional and local authorities were given the power to decide on types
and sizes of taxes for their jurisdictions. The hope was that authorities at
each level, being responsible to its citizens, would act within reasonable
limits. Local authorities, seeing a way to increase revenue, devised more
complicated and exotic taxes. There are 150 locally imposed taxes within the
Federation . They were competing who would invent the more interesting taxes at
their respective levels--for example a tax on grazing cattle.
Tax Code
The Russian tax system is very complicated. The first two sections of the new
code have 416 articles which are contained in more that 100 pages--and this is
just an the overview of general principles. In an effort to improve tax law, a
new 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 list
of these tax documents includes 900 items. It is understandable that the
taxpayer can be confused by so many documents. Even a good taxpayer can make
mistakes. The code is not expected to be enacted this year but it is a good
step toward improving the clarity of the tax system. The current system,
plagued by an excessive tax burden and rampant tax evasion, has seriously
impeded tax collection efforts. The proposed draft code seeks to implement a
number of the reforms prevalent in Western economies during the 1980s,
including a broadening of the tax base, lowering of tax rates, and the
reduction of incentives, exemptions, and deductions.
A new mechanism for tax refunds in the case of overpayment
is also provided in the code. If a taxpayer paid too much tax at his own
initiative, the taxpayer may request the overpayment amount be credited towards
his next payment or be refunded within a specified time limit. If the time
limit was exceeded, the amount would be refunded with interest at a interest
rate tied to the prime rate of the Central Bank. In January 1996, new rules
came into effect concerning the refund of VAT if the taxpayer is involved in
exports operations. It was a major problem since VAT refunds were the
responsibility of local budgets. The 1996 budget, which was submitted in
mid-August, provided such VAT refunds from special funds of the federal budget.
Overview of Major Taxes
Income tax
Russia's individuals income tax has several bands which
range from 30 to 60 percent. The 60 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 hard currency. Proposals to increase the
Russian personal income tax rates were rejected by Russia's upper house, so the
1995 personal income tax rates remain in effect as of January 1, 1996 (see
appendix). Three tax brackets now exist in the Russian Federation: 12 percent
on income up to Rubles. 10 million, 20 percent up to Rubles. 50 million, and 30
percent over Rubles. 50 million. The current exchange rate is one dollar to
approximately 4,700 rubles. While many individuals may complain that the higher
income tax rates will cripple them, Russia would still have the lowest personal
income tax rate in Europe at 35 percent.
Excise tax
The excise tax in Russia explicitly covers imported luxury
goods, including tobacco products, beer wine and spirits, cars and light truck,
tires, jewelry, gemstones, rugs, crystal, fur, and leather products. The rate
of excise tax ranges from 10 percent for crystal to 90 percent for grain
alcohol personal. A new principle was applied, in accordance with a recent
decree, to the calculations of excise taxes on alcohol and tobacco imports. In
contrast to the previous practice where excise taxes were calculated in
proportion to the customs value of the imported goods, under the new procedure,
the taxes (on August 1, 1996) will be imposed in ECU per one unit of commodity
item. In some ways, excise taxes and single-stage retail taxes would seem to be
prime candidates for regional taxation in the Russia just as they are in market
economies, especially if the taxing locality is large enough to avoid revenue
loss from consumers crossing the border to regions with lower tax rates Such
taxes thus seem more suitable for larger intermediate governments than for
small local governments.
Profit tax
The profit tax calls for a 32 percent tax on all profits,
with an exception for profits generated by retailers. Profits by retailers are
taxed at a 45 percent rate. The tax discriminates against Russian workers
because the tax is not applied to the wages of foreign workers. The profit tax
keeps intact the profit reinvestment concept of prior Soviet tax legislation.
Essentially, no tax is imposed on profits reinvested in the business venture.
Also, the government has not changed the 15 percent withholding rate for
interest, dividends, and other passive income. A 20 percent withholding rate applies
to royalties on copyrights and licenses.
VAT
A VAT of 28 percent passed into a law on December 6, 1991
and became effective on January 1, 1992. The VAT was not initially imposed on
imports or exports. However, the government changed the policy very soon
afterwards. For instance Russian neighbor, Ukraine will be happy to realize
that Russia imposed a VAT on imported goods originating from Ukraine (Decree No
1216 of August 18, 1996). The reason for the decree is to preserve stability of
the Russian commodity market. The decree also takes into account that Ukraine
is not a part to an agreement signed by the member states of the Commonwealth
of Independent states on 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 and children's goods. Payment of the profits tax and VAT of
state owned enterprises is centralized at the level of their ministries
administrative departments (Decision No 629 of May 22, 1996).
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