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Wednesday, November 01, 2006

Russia's Regional Income Gap Spells Disaster

In his Moscow Times column, Nikolai Petrov, scholar in residence at the Carnegie Moscow Center, exposes the horrifying income gap between Russia's various regions, which threatens to bring the country to the verge of civil war.

The way in which a civil servant's income is determined today is largely a holdover from the Soviet nomenklatura system. Then, as now, this consisted of a relatively small base salary and a much larger set of payments and benefits granted by management. This is a way of guaranteeing a bureaucrat's loyalty to his superiors.

Budget relations between the three main levels of power -- federal, regional and municipal -- operate on much the same principle. Fiscal federalism and the need to improve inter-budgetary relations have been talked about for many years, but the degree to which regional budgets depend on the federal budget and, in turn, municipal budgets on regional budgets is higher than ever. This is particularly evident at present as budgets for 2007 are being worked out at all levels.

Seventy of Russia's 88 regions receive subsidies from the federal budget, meaning that only one region out of every five is a net contributor. Unlike the federal budget, which is running a surplus, a large number of regional budgets are weighed down with large deficits, and the load is only increasing in many cases. The draft budget recently submitted for the Kemerovo region, for example, forecasts a deficit of 13 percent, despite the fact that the deficit has been dropping steadily in recent years and is running at 3 percent this year. The reason for this is a fall in profit tax revenues from companies whose bottom lines have been hurt by climbing electricity and fuel prices.

Analysts have warned that inequality between regions will only increase as gross domestic product continues to grow. A report by Krasnoyarsk Governor Alexander Khloponin to a recent session of the State Council noted that "the gap between regions in terms of per capita GDP, by which the figure for the richest regions was 64 times that for the poorest in 2000, approached a factor of 300 in 2005!"

Budgetary revenues for the 10 richest regions were three times those for the poorest regions in 2005. The 10 richest regions accounted for more than half of the total regional debt, which was 460 billion rubles ($17.2 billion) at the end of last year. So economic differences between the regions are growing against a backdrop of constantly increasing volumes of income transfers. Whereas federal transfers to the regions accounted for 9 percent of total federal spending in 1999, the figure was more than 18 percent in 2001 and about one-third of all spending in 2005.

The situation is even worse at the municipal level. Recent data from the Audit Chamber show that 40 percent of all budget projections call for deficits and that the average budget income in 2006 dropped by almost 44 percent from the 2005 figure. This was due to a redistribution of revenue sources between the different levels.

Federal economic systems are generally characterized by subsidy systems, where lower levels are only given powers and made responsible in areas they can actually fund. Responsibility for areas they can't afford to fund is transferred upward. In Russia, unfortunately, it works the other way around: Those powers and responsibilities the federal or regional levels are either unable or unwilling to fund are transferred downward. The money to cover these areas is transferred down either too late or not in full.

The problem with regional budgets that are heavily subsidized yet still run deficits is twofold: There is a shortfall in revenue sources to cover the governments' mandated responsibilities and the resources that are at hand are used inefficiently. The Kremlin generally ignores the first problem and tries to solve the problems by focusing exclusively on the second. In this it is acting in the only way it knows -- by increasing federal control and replacing one set of administrators with another.

Beginning in January, the administration of subsidized regions will be transferred to an external administrator in Moscow. The government will recommend administrators to be appointed for a term of one year by the Supreme Arbitration Court in regions where total debt exceeds the region's revenues by more than 30 percent, or where regional revenues consist mainly of federal transfers. The external administrators will perform an analysis of the regional budget and draft a plan for escaping the crisis. The list of regions that will end up with this external financial administration has not yet been published, but the most likely candidates are those in the Southern Federal District, where transfers comprise up to 70 or 80 percent of budget revenues.

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