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Report No. 30741-RU DRAFT RUSSIA: FISCAL COSTS OF STRUCTURAL REFORMS February 25, 2005 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Document of the World Bank CURRENCY AND EQUIVALENT UNITS Exchange Rate Effective as of October 31, 2004 Currency Unit = Ruble US$1 = 28.77 Ruble FISCAL YEAR January 1 December 31 ACRONYMS AND ABBREVIATION CEE Central and Eastern Europe CIS Commonwealth of Independent States CPI Consumer Price Index DDO Deferred Drawdown Option EU European Union FFP Fully Funded Pillar FFRFR Federal Fund for Regional Fiscal Reforms GDP Gross Domestic Product Gosstroi Russian Government Committee for Construction and Housing Policy HBS Household Budgetary Survey HUS Housing and Utility Sector IET Institute of Economic Transition IFIs International Financial Institutions IMF International Monetary Fund INDEM Information for Democracy Foundation IUE Institute of Urban Economy MOEDT Ministry of Economic Development and Trade MOF Ministry of Finance NDC Notional defined contribution NOBUS National survey of household budgets and participation in social programs NPV Net-present Value OECD Organization for Economic Cooperation and Development PAYG Pay-as-you-go PIT Personal income tax RLMS Russia Longitudinal Monitoring Survey Roskomstat Russian State Committee for Statistics SIGMA Support for Improvement in Governance and Management SOE State Owned Enterprise SRF Structural Reforms Fund TACIS Technical Assistance for the Commonwealth of Independent States USA United States of America USAID U.S. Agency for International Development USE Unitary State Exams UST Unified Social Tax VAT Value Added Tax Vice President: Shigeo Katsu Country Director: Kristalina I. Georgieva Sector Director: Cheryl W. Gray Sector Manager: Asad Alam Task Team Leader: Lev M. Freinkman ii TABLE OF CONTENTS EXECUTIVE SUMMARY............................................................................................... xii Chapter 1. Principles of Structural Reforms Financing............................................... A. Recent Fiscal Trends, 1998-2003............................................................................. B. Fiscal Costs of Key Structural Reforms................................................................. C. Costs of Structural Reforms: Examples of Reforms in the Civil Service, Pension System, and Residential Housing................................................................................... D. The Challenge of Financing Structural Reforms: Can Fiscal Rules Help..........E. Implications for Fiscal Policy.................................................................................F. Conclusion..............................................................................................................Chapter 2. Fiscal Costs of Civil Service Reform in the Russian Federation...............A. Employment and Financing of Core Government Administration and the Civilian Public Sector....................................................................................................B. Civil Service Reform Priorities and Progress to Date...........................................C. A Framework for the Assessment of Reform Impact...........................................D. Data Sources and Key Assumptions......................................................................E. Civil Service Reform Scenarios..............................................................................F. Outcomes of Civil Service Reform in Light of Cross-Country Comparisons......G. Summary of Simulations: Analysis of Selected Reform Scenarios.......................H. Overview of Risks Associated with Reform Implementation...............................I. Conclusions and Recommendations......................................................................Chapter 3. Acceleration of Reforms in the Housing and Utility Sector in Russia:

Potential Impact on the Budget System and Population...........................................A. Background............................................................................................................B. Summary of the Earlier Reform Efforts in the Housing and Utility Sector.........C. Government Involvement in Financing Residential Housing...............................D. Recent trends in housing and utility tariffs...........................................................E. Aggregated costs structure in residential housing................................................F. Model for Simulating Budget Implications from Increases in Housing Costs.....G. Reform Scenarios Identified for Simulations........................................................H. Assumptions on Future Utility Costs.....................................................................I. Main Simulation Results........................................................................................J.

Simulations for Phasing out Housing Privileges (lgoty)........................................K. Conclusions and Policy Recommendations.........................................................Chapter 4. Implicit Fiscal Risks in the Russian Pension System: Potential Impact of Reduction in Social Tax Rates and Other Reforms................................................. iii A. Introduction..........................................................................................................B. Background..........................................................................................................C. Reform Scenarios Identified for Simulations......................................................D. Main Macroeconomic and Reform Assumptions................................................E. Demographic Assumptions..................................................................................F. Simulation Results................................................................................................G. Summary and Conclusions..................................................................................References....................................................................................................................Annexes........................................................................................................................Annex 2.1......................................................................................................................Definitions on Civil Service Reform............................................................................Annex 2.2 Categories of Federal Civil Servants in the Russian Federation.............Annex 2.3......................................................................................................................Classification of Civil Servants Rewards....................................................................Annex 2.4......................................................................................................................International Public Sector Pay and Employment Data, 19962000*.......................Annex 2.5......................................................................................................................Assumption on Core Government Administration Attrition Rates...........................Annex 2.6......................................................................................................................Interpretation and Analysis of Results: Impact of Individual Factors......................Annex 3.1......................................................................................................................Macroeconomic Framework Used for the Analysis of Fiscal Costs of Structural Reforms........................................................................................................................Annex 3.2......................................................................................................................Main Data Sources and Data Assumptions.................................................................Annex 4.1......................................................................................................................Sensitivity Analysis For Pension Simulations.............................................................Annex 4.2......................................................................................................................Simulation Methodology..............................................................................................Annex 4.3......................................................................................................................Main simulation results for the pension reform analysis...........................................Annex 4.4......................................................................................................................Summary of pension benefit rules in the current system...........................................LIST OF FIGURES iv Figure 1.1: Public Debt Projections...................................................................................... Figure 2.1: Public Sector Employment in Selected OECD Countries and Transition Economies....................................................................................................................Figure 2.2: Total Fiscal Costs of Selected Scenarios............................................................Figure 2.3: Fiscal Implications of Scenario 20: Core Government Administration and Civilian Public Sector...................................................................................................Figure 2.4: Fiscal Implications of Civil Service Reform: Role of Administrative Adjustments Figure 2.5: Total Fiscal Implications for Scenarios with the De-Linked Implementation of Pay and Administrative Reform Components................................................................Figure 3.1: Housing and Utility Costs to Consumers under Different Scenarios in 2006..........

.....................................................................................................................Figure 4.1: Trends in tax bases for unified social and personal incomes taxes, 2000-03, trillion rubles..............................................................................................................Figure 4.2: GDP Growth by Scenario, Group 1..............................................................Figure 4.3: Dynamics of the Taxable Payroll Share in GDP, Group 1..........................Figure 4.4: Real Growth in Taxable Wages, Group 1 Scenarios...................................Figure 4.5: Economic Activity of Population, Group 1 Scenarios..................................Figure 4.6: Real Interest Rate, Group 1 Scenarios.........................................................Figure 4.7: System Dependence Ratio............................................................................Figure 4.8: Pension Replacement Rate, Group 1 Scenarios...........................................Figure 4.9: UST Rate (Contribution Rate) Needed to Ensure the Replacement Rate of 30 percent, Group 1 Scenarios.................................................................................Figure 4.10: Ratio Between Average Pension and Pensioners Subsistence minimum, Group 1 Scenarios.....................................................................................................Figure 4.11: Balance in the Base and NDC components of the Pension System, Group Scenarios...................................................................................................................Figure 4.12: Pension Replacement Ration, Comparison in Scenarios Groups 1 and 2.Figure 4.13: Ratio Between Average Pension and Pensioners Subsistence minimum.Figure 4.14: System Dependency Ratio, Comparison in Scenarios Groups 1 and 3.....Figure 4.15: Pension Replacement Ratio, Comparison in Scenarios Groups 1 and......Figure A2.1: Total Public Employment in the Russian Federation.....................................Figure A2.2: Civil Servants Rewards Classification...........................................................Figure A2.3: Sensitivity of Civil Service Reform Costs to Real Wage Growth..................Figure A2.4: Sensitivity of Civil Service Reform Costs to Real Wage Growth (for Core Government Administration Only)..............................................................................Figure A2.5: Total Fiscal Costs of Civil Service Reform: Radical versus Moderate Pay Reform...................................................................................................................Figure A2.6: Fiscal Costs of Civil Service Reform: Radical versus Moderate Pay Reform.....

Figure A2.7: Fiscal Implications for Federal and Sub-Federal Budgets for Radical and Moderate Pay Reforms...............................................................................................Figure A2.8: Internal Decompression in Federal Executive HQ-Based Civil Service: Radical versus Moderate Pay Adjustment................................................................................Figure A2.9: Internal Decompression in Federal Executive Civil Service: Radical versus Moderate Pay Adjustment...........................................................................................Figure A2.10: Distribution of Total Fiscal Burden of Civil Service Reform Scenarios, Depending upon Pay Reform Pace..............................................................................Figure A2.11: Distribution of Fiscal Burden of Civil Service Reform Scenarios, Depending upon Pay Reform Pace................................................................................................ v Figure A2.12: Total Fiscal Costs of Civil Service Reform for Different Scenarios of Administrative Reform Implementation......................................................................Figure A2.13: Fiscal Costs of Civil Service Reform in Core Government Administration for Different Scenarios of Administrative Reform Implementation........................................

...................................................................................................................Figure A2.14: Fiscal Costs of Civil Service Reform in Core Government Administration:

Dynamics of Cash Compensation and Non-Wage Expenditure Increase for Different Administrative Reform Scenarios...............................................................................Figure A2.15: Fiscal Costs of Civil Service Reform in Core Government Administration for Different Scenarios of Administrative Reform Implementation........................................

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