regions share and gas revenues

Federations Vol. 6, No. 1, February/March 2007 www.forumfed.org

even larger and the federal government decided to change the mining tax sharing ratio between the central authority and the regions in its favour. In 2002, the share of taxes on oil production accruing to regional budgets fell from 60 per cent to 20 per cent; in 2003, the share declined to 15 per cent and, in 2005, to five per cent. Since 2004, tax revenues from natural gas production have accrued exclusively to the federal budget.

The decision to centralize tax revenues from oil and gas production at the federal level was dictated by several factors. First was the need to curb the growth of budgetary expenditures caused by the increase in windfall revenues from the climb in prices for oil and gas, and the resulting inflationary pressure on prices. To “freeze” a part of these windfall revenues, the federal government set up a Stabilization Fund as part of the federal budget, effective Jan. 1, 2002. This fund has been one of the principal instruments for holding down excessive liquidity, lowering inflationary pressure and decreasing the dependence on volatile revenues from the export of raw materials. The fund accumulates the revenues derived from the portion of export duties on oil and from the tax on oil production that corresponds to the price for oil of the Urals grade exceeding $27 U.S. per barrel. As a result, 15 per cent of current revenues now accrue to the Stabilization Fund, 55 per cent to the federal budget and 30 per cent to subnational budgets.

Disparities among Russia’s regions

The second factor in the centralization of tax revenues from oil and gas production was the growth in horizontal revenue disparities among the regions, and the resulting pressure on the federal government to equalize those disparities by means of vertical transfers, in this case payments to the regions from the federal government. Horizontal equalization – taking revenues from “rich” regions and turning them over to “poor” ones – is not practiced in the Russian Federation; equalization transfers flow into less affluent regions only from the federal budget. The federal budget therefore needed additional resources with which to fund increasing equalization transfers required by growth in horizontal disparities.

Also playing no small role in the centralization of mining taxes was the federal government’s refusal to impose unfunded mandates on regional budgets and its adoption, starting in 2005, of an obligation to specify how such mandates are to be funded in all regions, taking into account their financial well-being. The provision of cash and non-cash benefits to such categories of the population as veterans of the Second World War, invalids, victims of the Chernobyl disaster, etc. is an example of the kind of mandate covered by this obligation.

Today, the tax on oil production generates 630 billion rubles (about $23 billion U.S.) which equals 12.5 per cent of federal revenues while the tax on gas production produces 92 billion rubles (about $3.5 billion U.S.) or 1.9 per cent of federal revenues. Export customs duties on oil make up another 16.2 per cent of federal revenues, generating 820 billion rubles (about $30 billion U.S.), while those on gas account for 5.3 per cent of federal revenues or 270 billion rubles (about $10 billion U.S.).

Photo: Wikipedia Commons

Aboriginal people, including the Nenents, live in two major oil-producing regions of Russia: the Yamalo-Nenetskiy Autonomous Area and the neighbouring Nenetskiy Autonomous Area. The Nenents family at left lives by traditional hunting and reindeer herding.

In the principal oil- and gas-producing regions, mining taxes currently account for

• 27.8 per cent of budgetary revenues in the Khanty-Mansiyskiy Autonomous Area, or 26.5 billion rubles (about $1 billion U.S.);

• 16.5 per cent of budgetary revenues in the Nenetskiy Autonomous Area, or 1.3 billion rubles (about $47 million U.S.), and

• 7.4 per cent of budgetary revenues in the Yamalo-Nenetskiy Autonomous Area, or 5.2 billion rubles (about $193 million U.S.).

Mining revenues centralized

Centralization of the revenues from mining operations conforms to the notion that mineral resources should belong to the Russian nation as a whole, and that tax revenues on their extraction, which are in essence economic rents, should therefore not be concentrated in individual regions, but utilized in the interest of the entire population. The centralized resources from mining taxes are in particular used by the federal government to decrease regional disparities, although there is no direct tie-in of these resources to the transfers directed into the regional budgets.

The total amount of all kinds of transfers passed on from the federal budget into the regional budgets comprises about half of the total revenues from oil and gas that flow into the federal budget. Oil and gas revenues are thus used to equalize the budgetary revenues of the regions and deliver on constitutional guarantees to the population in all regions of Russia.

Investments made from the Stabilization Fund are another instrument whereby federal budgetary revenues from oil and gas are used in the interest of the entire population. In accordance with the legislation governing the Fund, accumulated amounts in excess of $20 billion (a threshold that was surpassed in 2005) may be used by the federal government at its discretion. By decision of the federal government in 2006, an Investment Fund was established in the Russian Federation to direct resources of the Stabilization Fund to state support of investment projects of national importance.

Stabilization fund grew from $2.5 billion

The initial size of the fund was $2.5 billion U.S. The selection of projects for state support should be carried out on a competitive basis. The projects should be directed to such goals as increasing employment levels, improving the

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Forum of Federations

Federations Vol. 6, No. 1, February/March 2007

orders of government tax the same base, and this vertical fiscal externality offsets the tax reduction by some cantonal governments. The picture is completed by evidence of strategictax setting by cantons and local jurisdictions.They, indeed, set their tax rates to attract desirable taxpayers, although other factors also affect their choices. Thus, the bottom line is that tax competition exists in Switzerland,but it is not as fierce as the tax rate differentials suggest.

Where does tax competition lead?

Given that tax competition exists in Switzerland, does it have the effects that most proponents of tax harmonization fear? Empirical studies of the efficiency of tax competition in Switzerland largely indicate that tax competition enhances efficiency rather than reducing it. First, regional spillovers are less important than is often thought, or they balance each other out. In addition, the horizontal components of fiscal equalizationinternalize regional spillovers – that is,negative effects of one canton’s policies on a neighbouring canton. Second, tax competitionleads to lower spending and revenue in the cantons because there is lower tax revenue. Third, tax competition likewise shifts the revenue structure toward a greater use of fees and user charges. (However, larger user fees contribute to an increased inequality of aftertax income.) Fourth, it leads to higher overall labour productivity in the cantons, indicatinghigher efficiency as the cantons are forced to use their scarce resources at the lowest cost and according to citizens’ preferences. However, tax competition also restricts the ability of cantons to redistribute income through broadbased tax-transfer programs, although cantons and local jurisdictions do conduct income redistribution nevertheless. Thus the federal level, with its system of social security and the highly progressive federal income tax, is more important for income redistribution.

A balanced approach

Tax competition between the Swiss cantons and local jurisdictions is thus a very importantphenomenon. Given the empirical evidence,however, there are not strong grounds to justify a major tax harmonization at the moment. The Swiss fiscal constitution appearsto be well-adapted to the advantages and disadvantages of its competitive federalism. In particular, the federal income tax system plays an important role as regulator of cantonal tax competition and is, thus, able to serve demands for individual equality. The new fiscal equalization system is supposed to lead to a fairer regional distribution of income. Further measures restricting cantonal fiscal competition will only increase inefficiency in the public sector.

Forum of Federations

-thy-neighbour” or “race-to-the-bottom” fiscal policiesthe mobility of goods and factors of production have to undermine gains from decentralized decision-making, in Brazil, India, Mexico and Spain indicate. The U.S. federal systems have, on the other hand, successfullyby securing a common economic union.

Incentives for responsive governance

countries, especially in the developing world,transfers are focused on dividing the pie without incentives for responsive and accountable service arrangements often discourage local taxation oduce perverse fiscal incentives through gap-filling transfers in most federal countries are focused ols and micromanagement, thereby undermining local a few countries such as the United States, they serve as a el politics. The practice of output-based transfers with standards and access to public services but having flexible programs and in spending allocations to create results-based accountability is virtually non-existent. A is the Canadian Health Transfers (CHT) program byThe principal conditions of the CHT program of access to health care and portability of health oss provinces.

The ability to adapt

have shown a remarkable ability to adapt and to meet in fiscal federalism. While the challenges they face similar, the solutions they discover and adopt are alwaysThis represents a remarkable attestation to the triumphfederalism in its never-ending quest for balance and responsive, responsible and accountable governance. The attain new heights in inclusive governance continues.

Federations Vol. 6, No. 1, February/March 2007