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Section The Monetary and Budget Spheres The foregoing dynamics refers in general to tax revenues of the consolidated budget of the constituent territories of the Russian Federation. However, it would be reasonable to make analysis by region, because the constituent territories of the Russian Federation differed largely in the depth of recession and the degree of economic recovery. It should be noted that differentiation of tax revenues between regional budgets decreased in 2009, but then increased again in 2010. The relevant variation of per capita tax revenues adjusted for the budget expenditure index stood at 87.2% in 2008 (75.0% in 2009), increased to 91.3% in 2010, but decreased to 77.7% in 2011. The following factors were responsible most to this dynamics. It was the economically developed regions that were hit hardest (they experienced a deeper recession) by the crisis, which resulted in a decrease in the interregional differentiation. From the end of 2009, the Russias economy began to recover, but the constituent territories of the Russian Federation differed largely in the degree of such recovery and, consequently, growth rates of tax revenues, which resulted in increase of differentiation of per capita tax revenues. In 2011, the differentiation declined as a result of a certain equalization of recovery rates in the economies in different groups of regions.

Tools which allow profit tax revenues to be distributed more evenly among the constituent territories of the Russian Federation, began to work from 2012 in order to reduce differentiation of tax revenues in various regions. This refers to the amendments to the Tax Code of the Russian Federation which concern the control of transfer pricing and introduction of the concept of consolidated group of taxpayers1. The amendments imposed a higher degree of control among related companies in order to create extra obstacles against using transfer pricing for the purpose of moving the profit center through various regions. However, the amendments allow taxpayers to form a consolidated group thereby allowing them to make special consolidated reports. The advantage of this approach is that corporate profit tax is to be paid on the basis of financial performance results of the consolidated group of taxpayers. In doing so, profit tax is to be accrued and tax revenues are to be distributed between various regions in which companies within the consolidated group operate pursuant to the regulations set forth in Clause 6, Article 288 of the Tax Code of the Russian Federation. A share in the profit of a specific company is to be measured as an arithmetical mean of a share of the average number of workers (wage costs) of the company and a share of depreciation value of amortizable assets in relevant values for the entire consolidated group. The amount of profit tax itself is to be measured on the basis of a tax rate applicable in the constituent territory of the Russian Federation where a certain member (and/or its stand-alone unit) of the consolidated group is located. Therefore, the aforesaid regulations allow the profit tax base to be more evenly distributed among the regions of Russia.

However, legislative regulations concerning transfer pricing and consolidated group of taxpayers, which have been in effect since 2012, impose strict requirements to such consolidated group. This is why the number of companies, i.e. potential members of consolidated groups of taxpayers is not going to be large, up to 4050, in the short-term period. It should be emphasized that it will be Moscow which will incur most losses from the application of the new regulations vs. other regions, because head offices of most of large Russian companies are located in Moscow. However, considering high fiscal capacity of this region (3,232 in Federal Law No. 321-FZ, dd. November 16, 2011 On the Amendments to Part 1 and Part 2 of the Tax Code of the Russian Federation Due to the Creation of the Consolidated Group of Taxpayers; Federal Law No. 227-FZ, dd. July 18, 2011 On the Amendments to the Selected Legal Acts of the Russian Federation Due to Perfection of the Pricing Principles for the Purpose of Taxation.

RUSSIAN ECONOMY IN trends and outlooks 20111), there is no point to expect any significant deterioration of its revenue potential, which disputes the need for large-scale compensatory arrangements. It should be understood that the larger the scale and longer is the duration of such compensations, the lesser the equalizing effect of taken measures will be in the short-term period.

Let us examine in detail the situation with tax revenues by constituent territory of the Russian Federation. Table 20 presents a breakdown of Russias regions by change in tax revenues in the period between 2008 and 2011.

Table A breakdown of Russias regions by change in tax revenues of the consolidated budget of the constituent territories of the Russian Federation Number of regions in which tax revenues In nominal terms In real terms in 2011 2011 vs. 2010 2011 vs. 2008 2011 vs. 2010 2011 vs. Increased by more than 25% 8 55 4 Increased from 10 to 25% 61 20 20 Increased by less than 10% 12 5 53 Decreased by less than 10% 1 1 4 Decreased from 10 to 25% 0 1 1 Decreased by more than 25% 0 0 0 Source: Federal Treasury, Gaidar Institutes estimates.

The foregoing data shows that tax revenues of the consolidated regional budget increased in real terms in 54 of 822 constituent territories of the Russian Federation in 2011 (the second year of economic recovery) against 2008. The following regions were leading in terms of growth rates: the Republic of Ingushetia, the Karachay-Cherkessia Republic, the Chechen Republic, the Magadan Region, the Chukot Autonomous Area, the Republic of Adygeya. At the same time, tax revenues decreased by 30.41% in the Vologda Region. Comparing the data on 2011 and 2010, one may note that 77 regions saw an increase in tax revenues in real terms.

Furthermore, almost all the regions saw an increase in nominal terms, save for the Republic of Altai. The Tyumen Region and Vologda Region experienced a decrease in nominal terms in 2011 vs. the percentage reported in 2008.

Let us examine the changes which took place in the consolidated budget expenditures of the constituent territories of the Russian Federation. Aggregate expenditures of the consolidated budge of the constituent territories of the Russian Federation increased in nominal terms by 15.6% in 2011 against 2010. However, their growth in real terms was merely 9.0%. The structure of expenditures of the consolidated budget of the constituent territories of the Russian Federation saw certain changes as well (Table 21).

The following should be noted on the basis of analysis of changes in regional budget expenditures by item. A share of expenditures on National Economy and Education increased a bit and stood at 17.1% and 22.5% respectively in 2011 against 16.6% and 21.9% in 2010. On the contrary, a share of expenditures on Social Policy deceased to 15.5% of total expenditures in the same period (17.6% in 2010). Expenditures on National Security and Law Enforcement, Environmental Protection and Culture, Cinematography and Mass Media remained the same vs. 2010.

According to the Method for allocation of grants for fiscal capacity equalization of the constituent territories of the Russian Federation for 2011.

The Arkhangelsk Region and the Nenets Autonomous Area are regarded as the single constituent territory of the Russian Federation.

Section The Monetary and Budget Spheres Table Structure of consolidated budget expenditures of the constituent territories of the Russian Federation in the period between 2008 and 2011 (%) 2008 2009 2010 2011* Nationwide Issues 7.1 7.3 7.3 7.Including State and Municipal Debt Service 0.6 1.0 1.1 1.National Defense 0.0 0.0 0.0 0.National Security and Law Enforcement 4.1 3.9 3.8 3.National Economy 19.6 18.1 16.6 17.Housing and Community Amenities 16.3 13.7 12.6 12.Environmental Protection 0.3 0.3 0.2 0.Education 20.8 21.5 21.9 22.Culture, Cinematography and Mass Media 3.5 3.4 3.4 3.Healthcare and Sports 12.7 12.1 12.0 11.Social Policy 12.2 15.3 17.6 15.Interbudget Transfers 3.3 4.4 4.5 6.*Expenditures in 2011 are presented in a comparable classification which was in force until 2011.

Source: Federal Treasury, Gaidar Institutes estimates.

Expenditures on Healthcare and Sports saw a more considerable change, with a downward trend over the recent four years, from 12.7% in 2008 to 11.1% in 2011. Expenditures on healthcare saw a marked decrease in 2011 basically due to an increase in a share of regional budget transfers to territorial funds for compulsory medical insurance. Examining this dynamics, it should be taken into account that contributions (transfers) for economically enactive population have become standardized and mandatory since 2011, in other words, regions no longer may reduce considerably the amount of such contributions (which resulted in their marked increase also as a result of a certain cut-off in direct regional budget expenditures on healthcare). As a result, the accumulative share of the two items Healthcare and Sports and Interbudget Transfers increased to 17.6% in 2011 from 16.5% in 2010. A share of expenditures on Nationwide Issues decreased by 0.2 p.p. to 7.1% in the last year, and a share of expenditures on State and Municipal Debt Service also decreased a bit from 1.1% to 1.0% of total regional expenditures.

A special focus should be placed on National Economy. The dynamics here should be examined both for the item as a whole and its sub-items, because this type of expenditures is quite homogeneous vs. other types. After a stable upward trend, a share of expenditures on agriculture decreased for the first time to 3.0% of total expenditures (a max. of 3.4% was reached in 2010). In general, expenditures on General Economic Issues, Fuel and Power Sector, Applied Research in the Field of National Economy saw a decrease against 2010.

Such sub-items as Water Industry (83.4%) and Forestry (69.4%) were leading in terms of growth rate. However, a share of these expenditures still remains insignificant. A special emphasis should be placed on such sub-items as Transport and Road Facilities, which in accounted for 8.3% of total expenditures on National Economy, a growth of 0.4 p.p., 7.9% against 2010 (refer to Section 2.3.4 for more details on the expenditures on road facilities).

In 2011, a combined subnational budget deficit remained unchanged, but its volume decreased to 0.5% of total expenditures, which is much smaller vs. 5.3% in 2009 and 1.5% in 2010. Analyzing the budget deficit value by constituent territory, it should be noted that only 26 of 83 regions saw a surplus of their consolidated regional budget at year-end 2011. As a result, the need for borrowing was maintained at the subnational level. It should be noted that the need for fundraising might have emerged also because of the need for refinancing of the existing debt. The data on volumes of government debt of the constituent territories of the RUSSIAN ECONOMY IN trends and outlooks Russian Federation in the period between 2007 and 2011 and municipal debt in period between 2010 and 2011 is shown in Table 22.

Table Government debt due by the constituent territories of the Russian Federation in the period between 2007 and 2011 and municipal debt in the period between 2010 and 2011 (Rb, billion) Debt amount, Rb, billion as of January 1, as of January 1, as of January 1, as of January 1, as of January 1, 2008 2009 2010 2011 All constituent territories of 456,9 599,6 889,6 1096,0 1071,the Russian Federation including:

Moscow 89,3 121,5 243,1 299,3 263,Moscow Region 92,1 156,1 163,7 146,8 96,Constituent territories 275,4 322 482,8 649,9 712,(net of Moscow and the Moscow Region) Municipalities n/a n/a 134,9 169,8 197,Source: Ministry of Finance of Russia, Gaidar Institutes estimates.

The data on changes in absolute volumes of government debt by constituent territory of the Russian Federation in 2011 show some decrease in borrowings (a decrease of Rb 24,1bn).

However, such a decrease resulted basically from a considerable decrease in volumes of government debt in Moscow and the Moscow Region. In addition, these two regions accounted for more than 30% of total government debt due by the constituent territories of the Russian Federation. Examining the dynamics of regional debt amounts, net of Moscow and the Moscow Region, the picture would be different. The amount of government debt due by the other constituent territories of the Russian Federation increased to Rb 712,7bn by January 1, 2012, a growth of Rb 62,8bn vs. the beginning of 2011. Total municipal debt increased by Rb 27,9bn of the period.

The following should be noted on the basis of the results of the second year of Russias economic recovery. The situation with the fulfillment of subnational budgets in 2011 improved visibly. However, a series of the principal parameters describing the situation with subnational finances remained lower than the pre-recession values. For example, tax revenues decreased in real terms by 4.3% in 2011 vs. the pre-recession values of 2008. No prerecession values were regained for a series of the principal taxes, namely profit tax (a decrease of 12.4%), personal income tax (a decrease of 4.6%). The level of expenditures failed to reach the pre-recession values (a 2.3% cut-off), above all, through a lower level of capital expenditures. At the same time, expenditures on Social Policy (which is ranked third in size after the National Economy and Education) increased in real terms by 24.4% (vs. the percentage reported in 2008). A major part of the regions failed to fulfill their budget without a deficit. As a result, in spite of general easing of the economic situation (growth in GDP and industrial output), a certain tension still remains in place with regard to the budget fulfillment in certain regions.

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