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significant reform efforts in civilian public sector would call for some redistribution of funds across expenditure categories within the consolidated budget: apportion of savings from staff attrition in the civilian public sector may be used for providing additional funds to support core government administration.

2.105 Our simulations also suggest that it is desirable for both components of the reform - pay adjustment and administrative changes - to be synchronized. Although de-linking the reform components with employment adjustment implemented before the completion of pay increase would cut the expenditures associated with the reform in the earlier years, completion of the pay adjustment would call for an accelerated increase in consolidated budget expenditures that may be politically and fiscally difficult to afford. As a result, the sustainability of the reform achievements would be at risk.

2.106 It should be noted that, although the estimated budget costs of the civil service reform implementation are very significant if compared to the 2002-03 levels of financing of respective expenditures, the expected fiscal outcomes do not look prohibitively high when considered in the international context. This Chapter argues once again that public administration reform in Russia cannot be cheap, especially in the environment of a rapidly growing economy and real wages. Otherwise the objectives of reform could not be achieved and sustained.

2.107 The estimated fiscal costs depend significantly on the private sector real wage dynamics, and more specifically on the change of the share of real wages in GDP. The higher is the growth rate of real wages as compared to GDP growth, the higher is the additional fiscal pressure on the budget system. This introduces a significant factor of uncertainty in the costing out future reforms, because future growth in private sector wages is largely outside of the government control. Moreover, given the low share of wages in GDP at the moment, there are reasons to believe that in the medium term growth in real wages would be higher than GDP, which would push the reforms costs towards the higher end of the estimated range.

2.108 Because of the magnitude of core government administration and civilian public sector restructuring required, this Chapter argues that such reforms are not likely to be implemented within a mid-term time frame (i.e., 200406) and would require a longer period of time - five to seven years. This is especially important given the fact that the success of the civil service reform would significantly depend on its coordination with budget management reforms aimed at introduction of performance budgeting principles, including delegation of greater expenditure autonomy to spending units and significant increase in their accountability for the results. Thus, advancing budget management reforms would create additional incentives for reforms in the public administration.

2.109 Implementation of civil service reform is a complex task entailing multiple risks which, if not controlled for, may result in significant fiscal implications. For instance, a failure to synchronize civil service reform in core government administration with similar reforms in the civilian public sector may result in significant growth of budget expenditures (about percent of GDP a year in 2010). A failure to account properly for regional labor market conditions when determining future pay increases for federal deconcentrated employees may also cause significant extra costs (up to 0.5 percent of GDP in 2010).

2.110 The results of our simulations should be interpreted and applied with caution. For instance, the estimates of net public-private compensation gap used for the simulations are quite rough and could be improved based on the results of regional comparative pay and compensation surveys. These surveys would also allow to better measure the actual value of in-kind benefits received by the core government employees of federal deconcentrated units, as well as regional and municipal servants.

2.111 It should be also noted that some of the financial resources needed for reform implementation could be derived from other reform actions that have not been cost out in our simulations. Given the market prices for real estate in the largest Russian cities, more efficient use of federal, regional and municipal property may provide additional funding (however, it is unlikely that these gains would be sufficient to cover the total reform costs)45.

There may also be important productivity gains from the introduction of more efficient business processes and automation of routine procedures, adoption of more transparent procurement practices, etc.

2.112 Overall, the above arguments suggest that broad reforms in the core government administration and in the civilian public sector at large may be implemented within five to seven years but should be differentiated by the scope of pay adjustment in various sub-sectors of civilian employment, closely monitored for non-wage expenditure growth, and complemented by significant employment adjustments in the civilian public sector as well as by at least some staff reductions in the core government administration. However, even under the most optimistic assumptions, the residual pay gap between public and private sectors may remain considerable.

We agree that, based on introduction of new budgeting mechanisms and improved incentives, a more efficient utilization of publicly-owned real estate indeed could bring substantial fiscal benefits. However, it is difficult to estimate the magnitude of these savings in advance. Moreover, it seems that most of these savings are likely to be concentrated in Moscow (with some of them representing one-time gains). As a result, these savings could be considerable if compared to the initial costs of reforming the federal executive part of the core government administration, but it is unlikely that those could be a longer-term source of funding for reforms in the entire system of the core government administration. Overall, we do not find it appropriate to reflect these savings in the model in addition to the above mentioned effect of a possibly lower share of non-wage expenditures in the total expenditures on core government administration.

Chapter 3. ACCELERATION OF REFORMS IN THE HOUSING AND UTILITY SECTOR IN RUSSIA: POTENTIAL IMPACT ON THE BUDGET SYSTEM AND POPULATION 3.1 This Chapter analyses potential fiscal and social impact of advancing housing and utility sector reforms in Russia under the different scenarios. It argues that in the current environment of high growth in household incomes, it is affordable by 2006 to attain percent cost recovery in tariff with simultaneous elimination of all quasi-fiscal crosssubsidization and the adjustment in domestic energy prices. Moreover, the reforms in residential housing could be made budget neutral in the medium term, and they would bring considerable savings in the long term. However, high sensitivity of results to income dynamics suggests that the government should establish an efficient monitoring system to track the affordability of tariff increases for population. At the same time, it is estimated that adjustment in domestic energy and utility prices could trigger a fiscal gap of 0.4 percent of GDP due to increased utility costs in the public sector.

A. BACKGROUND 3.2 The Russian government has been pursuing reforms in the housing and utility sector (HUS) since the early 1990s. To date, these reforms have been only partially successful, and the sector remains one of the major parts of the economy that still operates on predominantly non-market principles. The share of the governments involvement in both ownership and management of the sectoral entities is excessive, while the institutional framework to support market-based development is rather weak. As a result, the housing stock is deteriorating, the quality of utility services is low, and the sector is the single largest recipient of government subsidies.

3.3 In 2003 the government made a new commitment to accelerate reforms in the housing and utility sector aimed at its market transformation, the phasing out of budget subsidies, and the mitigation of social risks. This policy priority has been driven by the multiplicity of problems that have accumulated in the sector as well as by the demands coming from parallel reform efforts in public administration and the energy sector that call for both the rationalization of budget spending and an increase in domestic energy prices.

3.4 There are several channels through which reforms in the energy and utility sectors, which are expected to take place as a part of the governments medium term reform strategy, would have a major impact on the costs of operating the housing stock and thus would affect both household and government budgets. These channels include the following:

A direct increase in utility and housing maintenance tariffs, aimed at increasing cost recovery under the existing cost patterns A substantial increase in domestic energy prices, which would affect the costs of services both directly (direct electricity and gas consumption) and indirectly (use of electricity and gas for heat generation and water supply) An additional increase in utility tariffs to incorporate a capital repair component The phasing-out of the existing cross-subsidization in utility tariffs.

3.5 Overall, the reforms are expected to change considerably the current proportions in the financing of the existing housing stock: the share of the consolidated budget is expected to decline, the share of the population would increase, while the current financing by the enterprise sector through cross-subsidization is intended to be fully phased out. In addition, the budgets should be able to collect additional taxes from the energy sector, primarily the gas industry. However, while budget subsidies and total government spending on housing would decline, budget expenditures on social support to the poor are likely to increase, at least in the initial period that would follow the tariff increases.

Objectives of the Chapter 3.6 The overall objective of the Chapter is to estimate the potential fiscal impact of the expected changes in energy prices and utility tariffs, based on the series of simulations of different reform scenarios. The reform scenarios aim to reflect changes in the governments fiscal and social policies intended to reduce budget subsidies to the sector, increase the overall efficiency of government expenditures in housing and utilities, and, at the same time, help to mitigate the impact of tariff increases on vulnerable groups of households. The reform analysis follows the approach suggested by Yasin (2003), which emphasizes a reform strategy that closely links future tariff increases in the energy and housing sectors with structural reforms in these sectors, as well as with adjustments in both public sector wages and pensions.

3.7 Important factors to be reflected in simulations of the various reform scenarios include:

Existing cross-regional variations in the main underlying factors, such as actual utility costs, access to utility services, and household incomes Projections for future dynamics in domestic energy prices and their likely impact on utility prices Expected trends in the real dynamics of household incomes Elimination (phasing out) of cross-subsidization in the utility sector Elimination (phasing out) of privileges (lgoty) in housing and utilities Actual participation rate of households eligible for housing allowances.

3.8 More specific objectives of the Chapter include:

a. Costing out potential medium term reform scenarios in the housing and utility sector.

b. Estimating an overall demand for budget financing related to the reforms in the sector that would cover (i) residual subsidies during the transitional stage (for the periods when the full cost recovery will remain below 100 percent), (ii) the costs of social mitigation programs, and (iii) additional utility costs of budget sector entities (in health, education, etc.), caused by the increased utility tariffs.

c. Developing estimates of budget revenue impact associated with an increase in housing and utility tariffs and improved tax yield.

3.9 The projections developed in this Chapter are based on a flexible imitational model, which could be used for the simulation of different reform scenarios in Russias housing and utility sector. An improved government capability to analyze and forecast the consequences of the respective sectoral reforms is critical to designing adequate mitigation policies, reducing the risks of social tensions, and avoiding an excessive budget burden in the course of reforms. To become a practical tool for policy analysis, the model explicitly takes into account several features of the housing situation that are Russia-specific, such as the considerable cross-regional variation in the main parameters and specific characteristics of Russias housing allowance program.

B. SUMMARY OF THE EARLIER REFORM EFFORTS IN THE HOUSING AND UTILITY SECTOR3.10 The reforms in the housing and utility services (HUS) were identified as a major structural reform challenge fairly early in Russias transition. Despite this, the HUS were not a part of the original Government of Russias economic liberalization program of early 1992.

Instead, the Governments decisions of 1992-93 provided for the gradual attainment of full cost recovery in the sector (supported by considerable market transformation) by 1998.

However, later these reform targets were adjusted and made considerably less ambitious. In particular, in 1999 the Duma adopted an amendment to the Law on the Foundations of Federal Housing policy which set 2008 as a target for attaining full cost recovery in housing.

3.11 Overall, reforms in the HUS to date have produced three main achievements:

Divestiture of enterprise housing (which in the early 1990s accounted for about percent of the housing stock) to municipalities is practically completed.

Cost recovery in tariffs has been radically increased, with the current federal benchmark set at the level of 90 percent, while collections remain high.

A new system of targeted means-tested social assistance housing allowances has been established by almost all municipalities and has proved to be an efficient tool for protecting vulnerable households.

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