Fiscal Policy and Tax System

by

Shin-ichiro TABATA

March 2001

Economic and Social Research Institute

 Contents

Theme of this chapter

1. Changes in the role of finances

(1) Role of finance under controlled economy ··············································· 1
(2) Changes caused by transition to market economy ···································· 2

2. Reduction of expenditures
(1) Necessity to reduce expenditures··························································· 2
(2) Spending on state enterprises ······························································· 3
(3) Subsidy (price-disparity subsidies) ························································ 4
(4) Social expenses ··················································································· 5

3. Securing revenues
(1) Changes in revenue sources and difficulty to expand revenues ·················· 5
(2) Tax system reform ·············································································· 6
[1] History of reform ············································································· 6
[2] Corporate profit tax ········································································ 7
[3] Value-added tax··············································································· 8
[4] Excise tax ······················································································· 9
[5] Export/import duty········································································· 11
[6] Personal income tax ······································································· 13
(3) Problems in tax collection··································································· 13
[1] Inadequate tax system···································································· 13
[2] Inadequate tax-collection system······················································ 13
[3] Recession and liquidity shortage ······················································ 14
[4] Deliberate tax evasion ···································································· 14

4. Fiscal deficits
(1) Factors behind fiscal deficits······························································· 14
(2) Financing fiscal deficits ····································································· 15

5. Regional/local finances
(1) Fiscal relations among central, regional and local governments ··············· 16
(2) Sources of regional/local budgets ························································· 17
 - Themes of this chapter -

(1) With regard to finances, what changes have been made compared with the Soviet
era? What measures have been taken in the past 10 years? What problems do
remain unresolved?
(2) With regard to expenditures, why was the reduction of expenditures necessary?
What problems has the reduction produced?
(3) With regard to revenue and with regard to tax system reform, in particular, how
each tax was introduced? What problems does each tax have? Why do tax revenues
remain stagnant?
(4) With regard to fiscal deficits, What are the factors behind the deficits? How the
should deficits be financed?
(5) With regard to regional/local finances, what problems are involved in expenditures
and revenue sources? What problems are involved in fiscal support from the
central government?

1. Changes in the role of finances

(1) Role of finance under controlled economy

The role of finance played in the Soviet Union was much bigger than in capitalist
countries. As Table 1 shows, the state budget accounted for nearly half of GDP as of the
end of the 1980s. This is because almost all enterprises were owned by the state and
almost all workers were either central or local government employees and because the
state was controlling most of the production activity of the enterprises and in sole
responsibility of social security. Most of the profits of state-run enterprises were
transferred to the state treasury which, in turn, provided funds for almost all
investment. Education, medical care, and pension were all managed by the state and
funded by the state treasury.
Under such situations, the role of the fiscal system in Russia was, first, to promote
economic development by investing funds obtained from a specific source in specific
sectors and, second, to guarantee stability of national life in a broad sense. That is to
say, its role was to guarantee free education and medical care and provide low-price
daily necessities. In short, the expanded reproduction and income redistribution
mechanisms of the national economy were based on state finances.

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(2) Changes caused by transition to market economy
Table 1 also shows that the proportion of state budget to GDP fell to around 30% in
and after 1992 (if the non-budget funds, such as pension funds, that accounted for
about 8% of GDP are included, the proportion comes to slightly below 40%). The decline
can be attributed to the abolition of the controlled management system on enterprises
(abolition of the material/machinery supply system) and the liberalization (of prices,
trade, foreign exchanges, etc.) and privatization of economic activities. Amid the rapid
changes in the way enterprises are owned and business behavioral pattern, how to
secure the financial resources for state budget was a big problem for the government.
As a result, a drastic tax system reform was implemented and a new tax-collection
system was established. At the same time, it was necessary to establish a new
expanded reproduction mechanism and a new income redistribution system. However,
these problems still remain unresolved.

2. Reduction of expenditures

(1) Necessity to reduce expenditures

A drastic cut in state budget expenditures was necessary for the following three
reasons:
[1] When the transition to market economy began (early 1992), the government was
already producing a huge amount of fiscal deficits every year. Fiscal deficits began to
increase drastically in the second half of the 1980s due to a fall in oil prices worldwide,
a decrease in payments of corporate profits to the state treasury by enterprises
following their increased discretion, and an increase in spending on subsidies and
investment. Since the deficits were financed by direct lending from the central bank
(then, state bank) in those days, it produced excessive liquidity. This resulted in an
oversupply of funds to enterprises and households, causing a severe scarcity of goods
under the state-set, fixed-pricing system. Therefore, the Russian government was
burdened with the task of putting the fiscal house in order, in addition to the task of
promoting the transition to market economy.
[2] Since the government implemented “price liberalization” in the initial stage of
the transition to market economy amid excessive liquidity, it had no choice but to take
an austere fiscal policy. However, it resulted in hyperinflation in 1992~1993. Since
prices kept rising at a pace of more than 10% a month in 1994~1995, the government
had to keep adopting austere fiscal policies. The government was unable to take price

2
control measures outright in the face of a call for liberalization from international
financial institutions, etc. The government was left with no choice but to keep taking
austere measures, as austere fiscal and monetary policies were thought to be the only
effective measures to fight inflation and as it was under pressure from international
financial institutions, etc. to come up with specific figures for its economic recovery.
[3] The government had to cut expenditures drastically, as state budget revenues
decreased sharply due to disorders shortly after the transition to market economy and
confusions caused by the demise of the Soviet Union and the independence of the
Russian Federation. Under pressure from international financial institutions, etc. to
establish a specific target for the reduction of fiscal deficits as a priority issue, the
government had to keep slashing expenditures amid decreasing revenues.
As revenues decreased faster than initially expected, expenditures were slashed
drastically (See Table 2). During the first quarter of 1992, the principle of reducing
expenditures in the amount corresponding to a shortfall of tax revenues was applied
strictly. Although the application of the principle was eased in and after the second
quarter of 1992, the government kept following the practice of suspending expenditures
on some items in case of a revenue shortfall and setting aside beforehand the
“protected items” that would not be affected by the suspension.
Among the items whose expenditures were reduced drastically are defense spending
and agricultural investment (large irrigation projects) that had not been seen as
effective. They should be evaluated positively from the standpoint of economic
development. However, as will be described in (2)~(4), there were also cuts that
generated big problems.

(2) Spending on state enterprises

Expenditures on state enterprises were slashed drastically (See “National economy
expenditures” in Table 2). They included payments to cover enterprises’ current
expenditures and investment funds. In the first quarter of 1992, all expenditures on
state enterprises were virtually suspended, as the government strictly applied the
principle of slashing expenditure corresponding to a shortfall of tax revenues amid the
confusions caused by the transition to market economy, the demise of the Soviet Union
and the independence of the Russian Federation. As a result, the financial conditions of
state enterprises deteriorated sharply, causing delays in payments to suppliers and
banks. In mid-1992, when it became difficult to keep slashing expenditures, the
government started increasing expenditures and the central bank began extending
loans to rescue the state enterprises.

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 However, the financial conditions of state enterprises did not improve, as the
economy remained in recession throughout the 1990s. Moreover, there was no
mechanism in place to let companies chronically in the red go bankrupt. This was
partly because of the absence of a bankruptcy law. But a bigger reason was that the
government could not let state enterprises go bankrupt, given their functions to
maintain employment and social infrastructure (such as housing, roads, hospitals,
nurseries, and cultural facilities). The “soft budge constraints” in socialism have yet to
be hardened.
After all, with the support from the state budget cut off and going bankrupt not
allowed, many of the state enterprises continued to exist by increasing accounts
payable. Even now, it is a big issue to improve the financial conditions of state
enterprises (including joint-stock companies whose stocks are held by the state to a
considerable extent) and reduce their dependence on state budget.

(3) Subsidy (price-disparity subsidy)

During the Soviet era, both retail and wholesale prices were set by the state. When
the former was higher than the latter, the balance was paid to the state treasury as
trade tax, and when the latter was higher than the former, the state provided subsidy
for the balance. This is the income redistribution mechanism that was automatically
created by the state price-setting system and it played an important role in socialist
countries. In the case of the Soviet Union, prices of meats and dairy products were kept
low by using revenues from taxes on durable consumer goods and liquors.
This mechanism has ceased to exist as a result of price liberalization in 1992. In
Table 2, this price-disparity subsidy is included in the “national economy expenditure”
(The national economy expenditure of 2000 is small, as it does not include
housing/public management). As the conventional automatic income redistribution
mechanism disappeared but no new income redistribution mechanism was created,
many of the people’s living standards declined.
However, there were many goods and services to which subsidies were kept
provided. In some regions, subsidies to foods, etc. were kept provided shortly after the
transition to market economy. Even now, subsidies are provided to rents, household
electricity, gas, and heating expenses, and passenger fares. The government cannot
completely liberalize these items and let their prices rise sharply, in view of their social
influence. Most of them received subsidies from regional and local government budgets.
When subsidy from the budget is not enough, electric power and gas companies
provided subsidies.

4
 A policy to gradually raise the burden on the household is now being implemented
in Russia. The policy is designed not only to reduce the fiscal burden on the state but
also to slash the so-called cross subsidies (subsidies to the household sector provided by
the revenues of the industrial sector whose prices are set high) paid by electric power
and gas companies. The cross subsidy is straining the management resources of electric
power and gas companies and is one of the causes for unpaid or back taxes.

(4) Social expenses

Budgetary expenditures on education, medical care, insurance and pensions were
drastically reduced amid inflation (See “Social/Cultural Measures” in Table 2).
However, since pensions and social insurance were transferred to the non-budget funds
in and after 1992 and they accounted for about 8% of GDP, it can be said that the
expenditures were not so drastically reduced in terms of the ratio to GDP. Still, given
the fact that GDP itself shrank sharply, such social expenses have virtually decreased
drastically.
In advanced capitalist countries, part of such social expenses is covered by systems
in the private sector. In Russia, however, such system has yet to be fully developed.
Therefore, the cut in such social expenses immediately resulted in lowering the living
standards of the people. Since providing such services free was one of the big
characteristics of socialism, their decline both in terms of quantity and quality invited
strong public dissatisfaction and the people became disillusioned with market economy.

* Discussion themes
♦ Was it necessary to reduce fiscal spending? Was it necessary to implement price
liberalization at a stroke that forced the government to take an austere fiscal
policy?
♦ What do you think is the ideal relationship between state enterprises and budget?
♦ How do you think the various subsidies to the household should be addressed?
What reform do you think is necessary in this regard?
♦ How do you think the social expenses from the budget should be addressed? What
reform do you think is necessary in this regard?

3. Securing revenues

(1) Changes in revenue sources and difficulty to expand revenues

5
 Before the switchover to market economy, state enterprise profit deduction,
transaction tax and special trade revenue (this is included in “Revenues from foreign
economic activity” in Table 3) constituted the three major sources of state budget. In
the process of the transition to market economy, the state enterprise profit deduction
that was based on the state ownership of enterprises ceased to exist as a system and
the transaction tax and special trade revenue ceased to exist as a result of price
liberalization, trade liberalization and foreign exchange liberalization (See Table 3). In
their stead, corporate profit tax, value-added/excise taxes, and export/import duties
were introduced. But in terms of the ratio to GDP, it is not as large as that of the
previous three major sources of revenue.
There are two major reasons that make it difficult to increase revenue.
[1] It was difficult to establish a new tax system. Since the previous tax system was not
suitable for market economy, it was necessary to reform the system drastically.
However, it was impossible to carry out tax reform in several months, or in several
years for that matter. Moreover, it was necessary to make various modifications to
each of the new tax systems introduced. As things stand now, a stable tax system has
yet to be firmly in place. In fact, a wholesale tax reform has been under way since the
beginning of 2001.
[2] Tax revenue was not as much as the new tax system intended to collect and
nonpayment of taxes was common. This was due to inadequacy in the tax system, tax
collection system, recession and lack of liquidity, and intentional evasion of taxes.

(2) Tax system reform

[1] History of reform
In Russia, new taxes were introduced at a stroke with the start of a switchover to
market economy in 1992. This is to say, many taxes that were not in place before, such
as corporate profit taxes, value-added taxes, excise taxes and export duties, were
introduced and tax collection began. These taxes were introduced based on the “Basic
Law on Tax System” and other laws related to individual taxes that were announced in
December 1991. Since then, these laws were revised repeatedly. Work to unify these
tax laws into a tax code began in the second half of 1990s and the Vol. 1 of the Tax
Code that outlines these laws was implemented from the beginning of 1999 and the Vol.
2 that stipulates value-added tax, excise tax, personal income tax, and unified social
tax was implemented from the beginning of 2001. The work on the rest of the code is
still going on.
It is said that if corporations have to pay taxes exactly in accordance with the

6
Russian tax system, it would become an extremely big burden on them. It is especially
true of state enterprises that are under strict supervision of the tax authorities. So,
corporations take various measures to avoid paying taxes. Each tax system reform is
partly designed to cope with such behavior of corporations. Meanwhile, there appeared
a move, especially from around 1999, toward easing the tax-paying burden and have
corporations pay taxes exactly.
The Russian taxes can be classified into the following three kinds according to what
level of legislative organ can establish and implement the tax in what areas. But, the
kinds of taxes are defined by the Tax Code (federal law) and no new tax can be
established and implemented at the regional (subjects composing the Federation) or
local levels. Moreover, the classification into the three kinds is not based on to which
level of budget each tax is paid. For example, a part of the federal tax becomes a source
of budget revenues for regional and local governments.
(i) Federal tax: Defined by the Tax Code (federal law) and imposed on all territory of
Russia. Value-added tax, excise tax, personal income tax, unified social tax, customs
duty, mineral/raw material foundation reproduction deduction, natural resource
utilization fees, corporate profit tax, etc.
(ii) Regional tax: Defined by the Tax Code and regional laws and imposed in respective
region. Corporate asset tax, sales tax, etc.
(iii) Local tax: Defined by the Tax Code and the laws of local governments and imposed
in respective local area. Personal asset tax, land tax, advertisement tax, etc.
[2] Corporate profit tax
The corporate profit tax was introduced in place of the state enterprise profit
deduction in the socialist era. It was introduced in the closing days of the Soviet Union.
A profit tax was introduced from the beginning of 1991 based of the “Taxes from
enterprises, trusts and organizations,” a Soviet Union law of June 14, 1990. The tax
rate was set at 22% for the portion that goes to federal budget and at up to 23% for the
portion that goes to the budgets of federation-composing republics and local
governments. In Russia, two laws concerning corporate income tax (on profits plus
labor payments) and corporate profit tax - were adopted in December 1991. The latter
was introduced in 1992 and then it was scheduled to shift to the former. But up to the
present, the former has yet to be introduced.
The profit tax was revised repeatedly with regard to its tax rate and the distribution
rate to the federal budget and regional budget. The rate was first set at 32%, with the
portion that goes to federal budget set at 17% for the first quarter of 1992. The tax rate
for the portion that goes to federal budget was set at 13% for the second to fourth

7
quarters of 1992 and at 10% for 1993. The profit tax rate was raised to 35% in 1994,
with the portion that goes to federal budget set at 13% and the portion that goes to the
budgets of regional governments at up to 22%. Then, as part of easing the tax burden
on corporations, the profit tax rate was lowered to 30% in April 1999, with the portion
to federal budget set at 11% and the portion to regional budgets at up to 19%. The tax
rate and the distribution rate to federal and regional budgets are likely to be revised
again before they are incorporated into the Tax Code shortly.
[3] Value-added tax
The value-added tax was introduced in the beginning of 1992 as the most important
indirect tax after the abolition of the transaction tax. The tax rate was initially set at
28% across the board. But in response to criticism that the rate is too high, the rate on
some foods was lowered to 15% as early as February the same year. The value-added
tax was lowered to 20% in the beginning of 1993 and the rate on foods and child goods
was set at 10%. Although the rates were kept unchanged thereafter, the list of items
subject to the 10% tax was revised frequently, depending on economic conditions and
economic policy of the times.
Another problem with regard to the value-added tax was taxation on imports and
exports. There was distinction between trade with CIS and trade with countries other
than CIS. With regard to trade with countries other than CIS, the value-added tax was
imposed on imports from February 1993 but exports were kept tax-free, the same
treatment as in Europe and the U.S. But, with regard to trade with CIS, exports were
taxed and imports were tax exempted, a system based on the idea of treating trade
among CIS in the same way as domestic transactions. However, as the gap between the
idea and the reality widened, there arose calls among CIS that their trade should be
treated in the same way as trade with countries other than CIS. This was partly
because Russia chronically posted a surplus in its trade with other CIS nations on the
strength of its exports of oil and gas. The system of imposing taxes on exports but no
taxes on imports worked in favor of Russia in terms of tax revenue. The issue was
settled by the Vol. 2 of the Tax Code. Starting in July 2001, a system that, in principle,
imposes taxes on imports but no taxes on exports is to be applied to trade with CIS,
just as in trade with other countries. But, the taxes on exports of oil and gas to CIS will
remain as they are.
Revisions have been made repeatedly with regard to the distribution of value-added
tax revenues to federal and regional budgets. The revisions had something to do with
the problem of federal government’s financial assistance to regional governments. The
regional budgets’ shares of value-added tax revenues were set within a range of

8
1~100% for the first quarter of 1992. The shares were set at 20% across the board for
the second quarter of 1992 and at 20%, 25%, or 30% for the third and fourth quarters of
that year. Although the shares for 1993 and the first quarter of 1994 were in principle
set at 20% (excluding value-added tax on imports), it was actually applied to only 24 of
the 89 regions (subjects composing the Federation). The rate for 57 other regions was
set at 50% and for the remaining 8 regions at 22~48%. This differentiation in
distribution share meant federal government’s financial assistance to regional
governments and was a legacy of the system during the Soviet era, under which
transaction tax revenues were distributed in varying rates to each
federation-composing republic and region.
The regional governments’ shares of value-added tax revenues were set at 25%
across the board for the second quarter of 1994 as a result of the introduction of the
regional financial assistance fund that uses value-added tax revenues as its financial
source. The distribution rate of 75% to federal budgets and 25% to regional budgets
was kept until the end of the first quarter of 1999, and was changed to 85% vs. 15% for
the second quarter of the same year. In 2001, 100% of value-added tax revenues are to
be distributed to the federal budget and none to regional budgets.
[4] Excise tax
Items subject to the excise tax are divided into two groups: luxury goods and oil/gas.
Luxury goods include alcohol, automobiles, gasoline, and other sophisticated consumer
goods. Judging from these items, it can be said that the excise tax is the successor to
the transaction tax during the Soviet era. The excise tax was introduced in the
beginning of 1992. Although the tax rate was changed frequently, there is no big
change in the items subject to the tax. As to the excise tax on exports and imports, the
same system was adopted and the same problems occurred as in the case of the
value-added tax.
The excise tax on oil and gas is viewed as a kind of differential rent. Therefore, its
system and rate were revised frequently in close connection with the movement of
export prices and export duties on oil and gas. During 1997~1999, about 60% of excise
tax revenues came from oil and gas.
The excise tax on oil was introduced in September 1992, with the rate set at 18% ad
valorem. But, in November the same year, different rates were set for different oil
exploration companies by taking their production conditions, etc. into account. That a
different rate is set for a different company is a big characteristic of the excise tax on
oil and it was basically maintained until the end of 1999.
The excise tax rate on oil was revised frequently. This was mainly because Russia

9
was under pressure from international financial institutions, etc. to abolish export
duties, including those on oil. The excise tax on oil was raised to make up for
decreasing revenues from the export duties that were scheduled to be lowered
gradually and abolished ultimately. The rate was first raised by an average 30% in
September 1993 and then switched to specific duty and set at average 14,750 rubles
per ton in June 1994. However, as it was vulnerable to inflation and fluctuations of
dollar-denominated export prices, it was decided to index the price every month by
taking ruble’s exchange rate against the dollar into account. This indexation method
was in place until the end of 1996. Meanwhile, the specific duty was raised to average
39,200 rubles per ton in April 1995. At the same time, it was decided to introduce a
system to raise the excise tax by 3,400 rubles every time the export duty is cut by 1
ECU. As the export duty on oil was lowered drastically in April 1996 and abolished in
July the same year, the excise tax on oil was set at an average 55,000 rubles per ton in
April 1996 and at 70,000 rubles in July and was thereafter to be indexed every month.
In response to the devaluation of the ruble after the financial crisis of 1998, export
duties were again introduced in the beginning of 1999. Since export duty on oil was
also introduced as will be described later, the tariff rate was raised sharply in line with
a steep rise in oil prices. Meanwhile, the excise tax on oil was unified and set at 55
rubles per ton in January 2000 and raised to 65 rubles per ton in January 2001.
The excise tax on gas was introduced in August 1993, with the rate set at 15% ad
valorem. Although the rate was revised later, it remains as the uniform ad valorem tax.
The rate was raised to 25% in March 1995 and to 30% in September 1995. In response
to the gradual cut of the export duty on gas and its abolition in April 1996, the excise
tax on gas was raised as in the case of oil. But, since the export duty on gas was not set
at a high level as compared with oil, its revenue was smaller than the revenue from the
excise tax on gas.
After the financial crisis of 1998, though the excise tax on gas was cut to 15% in
January 1999, the rate on gas bound for exports (except that to Belarus) was kept at
30%. The cut was designed to reduce the cases of unpaid or back taxes as well as to
lessen the tax burden on corporations. That there was no difference in excise tax rate
between that on gas for domestic use and that on gas bound for exports has something
to do with the fact that export duty on gas was not introduced again. In other words,
the excise tax on gas bound for exports is playing the same role as the export duty on
oil. Incidentally, as from January 2001, the tax rate of 15% is being applied to exports
not only to Belarus and other CIS countries as well.
The distribution rates of excise tax revenues to federal and regional budgets are as

10
follows and they remain almost unchanged from the beginning: federal budget receives
100% of the tax revenues from oil, gas, automobiles, oil products, and ethyl alcohol,
federal and regional budgets receive 50% each of the revenues from vodka and liquors,
etc. and regional budgets receive 100% of the revenues from other items.
[5] Export/import duty
Since Russia is a big exporting country of oil, gas and other mineral resources and
since there was a big difference between foreign currency-denominated export prices
and ruble-denominated domestic prices, taxes on exports were always a big source of
revenues for the state budget. During the Soviet era, such revenues were automatically
transferred to the state coffers, as the state set prices and monopolized trade. These
revenues were called special trade revenues and acquired by the Trade Corporation
(the state organization that monopolized trade) that worked intermediary of trade
between domestic corporations and foreign corporations. In the case of exports, the
Trade Corporation purchased goods from domestic corporations at domestic prices
(ruble) and sold them to foreign corporations at trade prices (foreign currency). In the
case of imports, the Trade Corporation purchased goods from foreign corporations at
trade prices (foreign currency) and sold them to domestic corporations at domestic
prices (ruble). The balance of these transactions calculated in the ruble became a
special trade revenue. Since the Russian domestic market was cut off from the world
market and since there was a significant discrepancy in pricing system between the
two, the Trade Corporation was able to reap a huge amount of profits from trade. After
1970, in particular, the corporation was able to boost revenues from energy exports
that were increasing year after year. The special trade revenues are included in
“Revenues from foreign economic activity” of Table 3.
The mechanism that automatically transferred such revenues to the state coffers
disappeared as a result of the liberalization of prices and trade in 1992. In its place,
export duties and import duties were introduced. The figures of “revenues from foreign
economic activity” of the Table 3 for 1996 onward do not include export/import duties.
But, when export duties increased sharply due to a steep rise in oil prices in 2000, the
export/import duties amounted to about 3.3% of GDP, or about half the level before the
transition to market economy. Since all of the export/import duties become revenues of
the federal government, however, they accounted for about 20% of the federal budget
revenues in 2000, the second largest revenue source next to the value-added tax.
Although export duties are extremely unusual taxes by world standards, they were
introduced on many export items in the beginning of 1992 as they were expected to fill
the gap in difference between domestic and foreign prices that existed even after the

11
liberalization of prices. Initially, the export duties were ECU-denominated specific
duties. When the number of items subject to export duties was increased in July 1992,
some of the new items were taxed ad valorem. But, after November 1993, the number
of the items was reduced and tax rates were lowered, apparently in response to
international financial institutions, etc. that raised objection to the export duties from
the standpoint of promoting trade liberalization. As a result, export duties were
imposed only on a handful of items, including oil and gas, in 1996 and ultimately
abolished on July 1, 1996.
The discrepancy between domestic and export prices widened again as a result of
the sharp depreciation of the ruble during the financial crisis of 1998 and this
prompted the restoration of the export duties in the beginning of 1999. Compared with
the previous export duties, however, the items subject to new export duties are limited
to only major export items. Among them are oil and oil products and their duties were
raised sharply during 1999~2000 in response to steep rises of their prices in the world
market. Export duties are not imposed on gas, another major foreign currency earner
along with oil. Under the current system, export duties are imposed on exports of oil
and excise taxes are imposed on exports of gas.
Import duties were first introduced in July 1992. There were no import duties in the
first half of 1992 because prices of imported goods were extremely high as a result of
the sharp depreciation of the official rate caused by the transition to market economy
(but, it was possible to import at lower prices, as multiple exchange rates, in effect,
existed in around 1992 and 1993). The import duties that were introduced in July 1992
were 5% in principle, 10~25% on alcohol, home electric appliances, automobiles, etc.
and foods and medical supplies were exempted from the duties. However, they were
revised immediately in August the same year and set at 15% in principle and 20~50%
on alcohol, home electric appliances, automobiles, etc. Thereafter, the duties were
revised almost every year. This reflected domestic producers’ demand for higher import
duties on one hand and the need to lower the duties in connection with Russia’s desire
to join the WTO on the other. Therefore, the direction of the revisions was not constant
and varied from one item to another. But the mainstream of the direction, especially in
and after 1998, is toward lowering the duties.
Export/import duties are not applied to all trade. Import duties are not applied to
trade with the CIS bloc. Export duties were not applied to exports to CIS countries
during 1992 but began to be applied in February 1993. When export duties were
re-introduced in the beginning of 1999, initially they were not applied to exports to CIS
countries but, from mid-1999 began to be applied to CIS countries except customs

12
union members. The customs union members are Russia, Belarus, Kazakhstan,
Kyrgyzstan, and Tajikistan.
[6] Personal income tax
A new personal income tax system was introduced in the beginning of 1992, which
is basically modeled on the Russia-era personal income tax system that was
implemented in July 1992. A system of a basic rate of 12% and a progressive tax rate
that differs according to income group was in place until 1998. But, there were
revisions almost every year as to the number of income groups and the tax rate for
each group. Up to 1998, personal income tax revenues were in principle treated as
income of regional budgets. Only during 1995~1996, 10% of the personal income tax
revenues were allotted to the federal budget as an upkeep of the social field facilities
and housings that were transferred to the regional authorities in 1994.
Under the system that was applied in 1999, a fixed rate of 3% and progressive tax
rates ranging from 9% to 42% were introduced, with the revenues from the former
allotted to the federal budget and those from the latter allotted to regional budgets.
But, the original system was restored in 2000 and under which the basic rate of 12%
and progressive rates for three different income groups were applied. The revenue
distribution rates to federal and regional budgets were set at 16% and 84%,
respectively. In 2001, a radical revision was made in accordance with the Vol. 2 of the
Tax Code. The progressive tax system was abolished and a uniform 13% tax was
applied. The revision has something to do with the fact that although many Russians
have more than one job, they pay income tax for only one job. The government
apparently thought the even if the tax rate was raised, tax revenues would increase.
The distribution rates to federal and regional budgets were set at 1% vs. 99%.

(3) Problems in tax collection

The following four points can be sited as the main reasons that made nonpayment
of taxes common and prevented tax revenues from increasing.
[1] Inadequate tax system
In view of the fact that many taxes that are completely new had to be introduced in
a short period time, this cannot be avoided.
[2] Inadequate tax-collection system
During the Soviet era, state budget and state enterprises were under unsystematic
management and the practice of collecting taxes from enterprises and individuals did
not exist. Given these facts, it was difficult to establish a tax collection system in a
short period of time in terms of organization, system and personnel, etc. Even now, a

13
considerable portion of tax revenues comes from estate enterprises and joint stock
companies in which the state has a major stake. The tax collection rate from private
enterprises, especially small enterprises, remains low.
[3] Recession and liquidity shortage
Since the economy was in recession throughout the 1990s, tax in arrears increased.
This generated a vicious cycle of a revenue shortfall, an increase in fiscal deficits, fiscal
restraint, and prolonged recession. A liquidity shortage caused by fiscal austerity also
made it difficult for corporations to pay taxes. As a result, paying taxes in bills, goods,
etc. other than ruble became pervasive. This was related to the fact that fiscal spending
was overdue, which in turn prompted frequent offsetting of tax payment and fiscal
spending.
[4] Deliberate tax evasion
This contains two phenomena: one of them is that tax revenues cannot be expected
from activities in the second economy, and the other is that corporations and
individuals try to avoid tax payment by understating their income. But, they overlap
each other. Paying taxes for one’s main business but not for side jobs is a common
behavior pattern of Russian enterprises and individuals.

*Discussion themes
♦ How should tax reform be implemented?
♦ What form of tax system is desirable? In other words, to what tax should
importance be attached? On what factor should such decision be based?
♦ How should the tax collection rate be raised?

4. Fiscal deficits

(1) Factors behind fiscal deficits

In the beginning, a huge amount of expenditures was the main factor behind fiscal
deficits, but later the fact that revenues do not increase became a more important
factor. If revenues do not increase (See 3 (3)) under the circumstances where
expenditures cannot be reduced drastically (See 2 (2)~(4)), then it increases fiscal
deficits (See Table 1). Most of the fiscal deficits are federal budget deficits. In the case
of Russia, the problem was that fiscal deficits show no signs of declining. The ratio of
fiscal deficits to GDP rose consistently from 3.2% in 1995, to 4.4% in 1996, to 5.2% in
1997 and to 5.8% in 1998.

14
(2) Financing fiscal deficits
Fiscal deficits were at first financed by direct lending from the central bank. But it
became one of the big factors that caused inflation (See Table 4).
From 1995, fiscal deficits came to be financed by government bonds and borrowings
from international financial institutions. As for government bonds, short-term
government bonds (GKOs) with maturity of less than one year and federal bonds
(OFZs) with maturity of one year or longer were issued in large quantity and they
carried extremely high interest rates. Since the official discount rate stood at above
100% until the first half of 1996, the interest rates on government bonds were set at
above 100% per annum (the growth rate of consumer prices was 22% in 1996). Even in
1997, the interest rates on government bonds stood at 20~30% (the growth rate of
consumer prices was 11% in 1997).
Loans from international financial institutions carried various conditions
concerning reform of the Russian economy. Some of the conditions (for example, in the
field of exchange and trade) were not beneficial to the development of the Russian
economy (in particular, the real economy). From around 1997, measures to finance
fiscal deficits through the issuance of Euro and other foreign currency bonds were
taken in order to curb the issuance of government bonds.
The government bond purchase by foreigners that had initially been restricted was
gradually approved in order to curb interest rates on government bonds. As of the end
of 1997, foreigners held more than 30% of the outstanding government bonds. Some
Russian private banks borrowed foreign currencies on the international financial
market to purchase government bonds. Behind these moves lied the existence of stable
exchange rates and a favorable relationship between international financial
institutions and the Russian government. Around 1997~1998, 70~80% of fiscal deficits
were financed by foreign funds (loans from international financial institutions, etc. and
government bond purchases by foreign investors).
As a natural consequence of these policies, however, the debt-servicing cost
increased, accounting for 18% of the state budget expenditures and 5.5% of GDP in
1998 (See Table 2). Due to high interest rates on government bonds, the expenditures
necessary for redemption and interest and principal payments began to exceed the
revenues from new bond issues around the end of 1997 (in other words, government
bonds had to be issued for the sole purpose of redeeming previously issued debt paper).
Moreover, private funds were used only for the purchase of government bonds,
resulting in crowding out private investment.
This structure of government bond issuance collapsed as a result of the Asian

15
currency crisis and government bond transactions and foreign exchange transactions
were suspended in August 1998. The government bonds frozen at that time amounted
to 280 billion rubles, or about $40 billion if converted by the then official rate. The
government bond market has yet to recover from that time.
Thanks to economic boom, fiscal deficits shrank sharply in 1999 and the
government posted a fiscal surplus in 2000. The problem of financing fiscal deficits
disappeared at least for now. However, the problem of repaying debts to international
financial institutions remains as a big financial burden on the government.

*Discussion themes
♦ Do you think that there should be no fiscal deficits?
♦ How should fiscal deficits be financed?

5. Regional/local finances

(1) Fiscal relations among central, regional and local governments

During the Soviet era, the state budget was in a nesting-box structure, in which the
budgets of lower administrative divisions were incorporated into the budgets of higher
administrative divisions. Roughly speaking, about half of the state budget was federal
budget, about two thirds of the remaining half was budgets of 15 republics composing
the federation, and the remaining one third was budgets of local administrative
divisions (territory, province, autonomous regions, etc.). As to the process of budget
compilation, the budget of the highest administrative division was first approved, then
the budget of next highest administrative division, and so on downward. However, this
was drastically changed in 1991. The nesting-box structure was abolished and a new
system was adopted, under which the federal budget, regional budget and local budget
were compiled and approved at the federal, regional and local levels, respectively.
The current fiscal relationship of the central, regional (subjects composting the
federation: republics, territory, province, autonomous regions, special cities) and local
(local self-governing bodies; counties, cities, towns and villages) governments is based
on the change made in 1991. Under the three-layered structure, federal, regional and
local budgets are compiled and approved independently. However, in many regions,
there are big economic discrepancies between their main cities and other cities, towns,
and villages and the relationship between regional and local budgets are not uniform.
The relationship varies greatly from one region to another.

16
 As can be seen from Table 1, the revenues and expenditures of the federal budget in
terms of their ratios to GDP were on a downward trend from 1992 to 1998, but those of
regional budget (including local budget) showed no big changes. On the contrary, the
ratios of the expenditures of regional budget to GDP during the same period were
considerably higher than in 1992. This was because the federal government, under
pressure from international financial institutions, etc. to slash fiscal deficits amid no
prospect of revenue increase, forced regional and local governments to take over
expenditures. This was particularly true of expenditures on state enterprises, subsidies
(price-disparity subsidies) and social expenses. Behind this was the fact that many
local cities in Russia were dependent on state enterprises in various aspects of people’s
life. Therefore, expenditures on state enterprises, including tax benefits and budget
outlay-tax payment offsetting, are a big burden on regional and local budgets. If
regional and local governments want to tighten budget constraints on state enterprises,
they have to contrive funds from their budgets for social expenses and subsidies to the
local people in place of the state enterprises.
With regard to the fiscal relationship among central, regional and local
governments, it is a big problem that the distribution of various expenditures to each
level is not well defined. For example, decisions on raising wages and pensions of public
employees are made at the federal level, but the actual payments are made from
regional and local budgets. As to local chapters of federal organs (military, security
organization, statistic commission, etc.), building maintenance costs and part of wages
are provided from regional budgets on the ground that they are not to be paid from the
federal budget.

(2) Sources of regional/local budgets

During 1996~1998, the personal income tax, corporate profit tax and value-added
tax were the three major tax revenue sources for regional budgets (including local
budgets), accounting for about 50% of total revenues. By contrast, the financial
assistance from the federal budget accounted for 10~14%, or merely about 2% of GDP.
However, this is the figure for Russia on the whole. As will be described later, some
regional governments depend much more on the federal budget.
The financial assistance from the federal budget to regional budgets takes various
forms. At present, the regional financial assistance fund that was first introduced in
the second quarter of 1994 is the most important assistance. Until this fund was
introduced, financial assistance to regional budgets were provided in the form of
various subsidies and, as was described earlier, by differentiating the distribution

17
ratios of value-added tax revenues to regional governments. However, the distribution
system was not well defined and depended much on negotiations with the central
government. The regional financial assistance fund was introduced to break down this
situation. Under the system, regions eligible for funds and the amount of funds to be
provided are decided in accordance with a set formula. The formula was revised almost
every year. The outline of the fund is as follows: First, the regions whose per-capita
regional tax revenues (excluding tax revenues from the federal budget) are below the
national average are eligible to receive fund in the amount equal to the difference
between their tax revenues and the national average. Second, the regions that cannot
cover their current expenditures by tax revenues plus the provision of the fund are also
provided with the fund. The basic idea of the fund is to smooth revenues of regional
governments and ensure the minimum amount of financial resources.
In Russia, there are 89 regions (subjects composing the federation), of which about
10 regions do not receive the regional financial assistance fund. Among them are
regions that produce resources, such as oil, gas and non-ferrous metals, main
industrial regions, and the city of Moscow. The rest of the regions receive assistance
from the fund. The ratio of the financial assistance from the funds to total regional
budget varies from one region to another. In autonomous jurisdictions with a small
scale of public finance, the ratio stands above 40%. Generally speaking, the dependence
on the fund is high in the North Caucasus, East Siberia and Far East.
Initially, the source of the regional financial assistance fund was value-added tax
revenues of the federal government. In 1994, 22% of such revenues were allotted to the
fund, and the ratio was raised to 27% in 1995. Starting in 1996, 15% (14% from 1998)
of the total tax revenues of the federal government (excluding import duties) are
allotted to the fund. In 2000, the amount of the fund was specified by the Federal
Budget Law.

*Discussion themes
♦ How should the independence of regional/local budgets be ensured?
♦ How should the revenue source of regional/local budgets be secured?

18
< Table 1~4 >

(Table 1) State budgets of the Russian Federation/the Soviet Union1)

(Ratio to GDP in %)

1988 1990 1992 1994 1996 1998 2000

Revenue 43.1 46.0 28.0 28.2 26.0 25.5 29.9
Federal budget ⋅⋅⋅ ⋅⋅⋅ 15.9 13.4 13.1 12.1 16.2
Regional budget ⋅⋅⋅ ⋅⋅⋅ 14.1 18.9 15.0 15.3 13.7
Expenditure 52.2 50.0 31.4 37.7 30.4 31.2 26.9
Federal budget ⋅⋅⋅ ⋅⋅⋅ 20.9 23.4 16.6 17.5 12.3
Regional budget ⋅⋅⋅ ⋅⋅⋅ 12.4 18.4 16.0 15.7 14.7
Fiscal deficits (Revenue - -9.2 -4.0 -3.4 -10.7 -4.4 -5.8 3.0
Expenditure)
Federal budget ⋅⋅⋅ ⋅⋅⋅ -5.0 -10.0 -3.5 -5.4 4.0
Regional budget ⋅⋅⋅ ⋅⋅⋅ 1.7 0.5 -0.9 -0.3 -1.0

(Note) 1) Figures for 1990 and before are those of the Soviet Union and figures for 1992
and after are those of the Russian Federation.
(Source) State Committee of the Russian Federation on Statistics, Russian Ministry of
Finance, State Committee of the Soviet Union on Statistics

(Table 2) State budget expenditures of the Russian Federation/the Soviet Union1)

1988 1990 1992 1994 1996 1998 2000

(Composition in %)
Total expenditures 100.0 100.0 100.0 100.0 100.0 100.0 100.0
National economy expenditure2) 5) 52.8 38.5 34.5 27.8 26.0 19.8 8.1
Social/cultural measures3) 32.9 33.1 23.2 24.2 28.9 29.2 28.5
State management expenditure4) 0.7 1.0 5.9 7.8 8.6 9.1 11.0
Defense expenditure5) 4.4 13.5 14.3 12.4 9.8 7.7 10.2
Debt-servicing cost ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ 6.8 17.7 10.2
Others 9.2 13.9 22.1 27.8 19.9 16.6 32.0
(Ratio to GDP in %)
Total expenditures 52.2 50.0 31.4 37.7 30.4 31.2 26.9
National economy expenditure2) 5) 27.6 19.2 10.8 10.5 7.9 6.2 2.2
Social/cultural measures3) 17.2 16.6 7.3 9.1 8.8 9.1 7.7
State management expenditure4) 0.3 0.5 1.8 3.0 2.6 2.8 3.0
Defense expenditure5) 2.3 6.7 4.5 4.7 3.0 2.4 2.7
Debt-servicing cost ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ 2.1 5.5 2.8
Others 4.8 7.0 7.0 10.5 6.0 5.2 8.6

(Note)
1) Figures for 1990 and before are those of the Soviet Union and figures for 1992 and
after are those of the Russian Federation.
2) Figures for 1992~1994 are “Assistance to each economic sector,” those for 1996~1998
are total of manufacturing, agriculture, transportation, and housing/public

19
management, and those for 2000 are total of manufacturing, agriculture and
transportation.
3) Figures for 1990 and before include science.
4) Figures for 1992 and after are total of state management and peace/security.
5) Figures for 1998 are national economy expenditure plus some defense expenditures.
(Source) State Committee of the Russian Federation on Statistics, State Committee of
the Soviet Union on Statistics

(Table 3) State budget revenues of the Russian Federation/the Soviet Union1)

1988 1990 1992 1994 1996 1998 2000

(Composition in %)
Total revenue 100.0 100.0 100.0 100.0 100.0 100.0 100.0
State enterprise profit deduction 31.6 24.7 ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅
Profit tax ⋅⋅⋅ ⋅⋅⋅ 29.4 28.4 17.3 14.5 19.2
Personal income tax 9.5 10.3 8.1 10.2 10.1 10.4 8.4
Transaction tax 26.7 25.7 ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅
Value-added tax ⋅⋅⋅ ⋅⋅⋅ 37.5 21.7 25.8 24.8 22.0
Excise tax ⋅⋅⋅ ⋅⋅⋅ 4.0 4.3 9.6 10.5 8.0
Revenues from foreign economic 16.5 15.9 8.8 13.6 3.0 2.7 1.8
activity2)
Others 15.8 23.4 12.2 21.7 34.2 37.1 40.7
(Ratio to GDP in %)
Total revenue 43.1 46.0 28.0 28.2 26.0 25.5 29.9
State enterprise profit deduction 13.6 11.4 ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅
Profit tax ⋅⋅⋅ ⋅⋅⋅ 8.2 8.0 4.5 3.7 5.7
Personal income tax 4.1 4.7 2.3 2.9 2.6 2.7 2.5
Transaction tax 11.5 11.8 ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅ ⋅⋅⋅
Value-added tax ⋅⋅⋅ ⋅⋅⋅ 10.5 6.1 6.7 6.3 6.6
Excise tax ⋅⋅⋅ ⋅⋅⋅ 1.1 1.2 2.5 2.7 2.4
Revenues from foreign economic 7.1 7.3 2.5 3.8 0.8 0.7 0.5
activity2)
Others 6.8 10.8 3.4 6.1 8.9 9.4 12.2

(Note)
1) Figures for 1990 and before are those of the Soviet Union and figures for 1992 and
after are those of the Russian Federation.
2) Figures for 1996 and after are only non-tax revenues
(Source) State Committee of the Russian Federation on Statistics, State Committee of
the Soviet Union on Statistics

20
 (Table 4) Financing of Russian Federation budget deficits
(Composition in %)

1994 1995 1996 1997 1998 1999

Total deficits 100.0 100.0 100.0 100.0 100.0 100.0
Central bank loans 73.7 -2.8 -0.3 -0.6 ⋅⋅⋅ ⋅⋅⋅
Short-term government bonds ⋅⋅⋅ 57.3 51.3 39.1 -135.2 -23.2
International financial institution loans ⋅⋅⋅ 68.4 30.3 26.8 8.9 -106.6
Others 26.3 -23.0 18.7 34.8 226.3 229.8

(Source) State Committee of the Russian Federation on Statistics

Bibliography
Kiichi Mochizuki, Shin-ichiro Tabata, Masato Yamamura, “The Slav Economy,”
Kobun-do, 1995
Hiroshi Kimura, “Russia that we want to know more,” Kobun-do, 1995
The Japan Institute of International Affairs, “Current situation of CIS and future
movement,” (Fiscal 1998 research paper consigned by the Ministry of Foreign Affairs)
Masaaki Kuboniwa, Shin-ichiro Tabata, “The Russian economy at a turning point,”
Aoki Shoten, 1999
The Japan Association for Trade with Russia & Eastern Europe, “Outline of Russian
region,” 1999
The Japan Institute of International Affairs, “Current situation of CIS region and
future movement,” (Fiscal 1999 research paper consigned by the Ministry of Foreign
Affairs)
The Japan Association for Trade with Russia & Eastern Europe, “Quarterly ROTOBO
Economic Trend”

21