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Monetary and budgetary spheres 34,8% 26,7% 347,348, 4,2% 273,249,2 258,200 239,2002 2003 Envisaged by the law on the federal budget approved prior to the end of financial year Envisaged by the law on the federal budget approved prior to the beginning of financial year Source: The laws on the federal budget for years 2002, 2003, and 2004, different versions.

Fig. 13. The excess of financial aid envisaged by the law on the federal budget approved prior to the end of financial year over the amount of financial aid envisaged by the law on the federal budget approved prior to the beginning of financial year There may be several factors behind this phenomenon. First, there may be responsi ble the financial planning of insufficient quality; for instance, in the beginning of the year such indicators as the revenues of the federal budgets and needs of regions as concerns financial resources were underestimated. Second, it is highly probable that the federal au thorities deliberately kept significant amounts of financial resources for the purposes of distribution of these resources during the financial year among the regions, which due to economic and (or) political reasons are in need of additional financing. Third, such a situa tion might be determined by the circumstance that the planning of the revenue and expen diture indicators of the federal budget proceeded from a conservative forecast of external business situation, while favorable developments on the world markets of raw materials resulted in higher amounts of additional revenues, part of which could be distributed among the regions in the form of financial aid.

Notwithstanding the possible reasons (most probably, all three are valid to a certain degree), the present situation has a very negative impact on the incentives of regional au thorities as concerns the pursuit of efficient budgetary policies. In the world literature, the situation, where the federal authorities do not adhere to the principles announced in ad vance and provide additional financial aid to the regions experiencing financial difficulties is defined as the situation of soft budgetary constraints10. As it is demonstrated by the in ternational experience, soft budgetary constraints on subnational authorities result in a whole number of negative economic effects, including both the excess over the efficient See, for instance, Fiscal Decentralization and the Challenge of Hard Budget Constraints. Rodden, Jonathan, Gunnar Eske land and Jennie Litvack (eds). Cambridge: MIT Press, 2003.

Rub. billion RUSSIAN ECONOMY in trends and outlooks level of budgetary expenditures, and effects of a more general nature (creation of barriers to the growth in private investment and increase in the number of inefficient investment projects involving higher risks).

In practice it means that in the situation, where regional authorities can justifiably ex pect additional financial aid as compared with the amounts made public initially, there may be observed several types of negative effects. First, regional authorities may assume higher risks both in the course of implementation of budgetary programs and as concerns borrowings. Second, the probability to receive additional financing permits regional au thorities to assume additional obligations in the form of creditor indebtedness and to re frain from taking of measures aimed at the improvement of the efficiency of budgetary ex penditures in the region. Third, basing on the experience of past years, regional authorities may surmise an approximate list of indicators on the basis of which the federal authorities will distribute additional financial aid among regions, regional authorities can influence the respective indicators (for instance, the level of creditor indebtedness in the region, the level of wages and salaries arrears in the public sector, the level of indebtedness of public institutions as concerns payments to public utilities, etc). As a result, the seemingly favor able for the residents of the regions receiving financial aid decision about the provision of additional financial aid may have consequences producing negative effects not only on the residents of concrete regions, but the country at large (the state of its public finances). At the same time, the probability of such negative effects increases in the cases, where addi tional financial aid is distributed on the regular basis.

A factor facilitating the softening of budgetary constraints on Russian regional au thorities is not only the increase in the total amount of financial aid envisaged in the law on the federal budget. The amount of financial resources made public already prior to the be ginning of the financial year remains rather high, however the powers concerning the deci sions on the concrete methods of the distribution of these resources are vested with the Government, which takes respective decisions during the financial year. As a result, re gional authorities have no information about the methods of distribution of certain financial resources, what creates incentives for origination of soft budgetary constraints, as well as for the wish of regional authorities to receive additional financial aid.

Thus, in 2004 about 25 per cent of the financial resources in the form of the grants aimed at the balancing of regional budgets were not distributed among regions on the ba sis of the law on the federal budget: the grants provided to the budgets of RF subjects for support of the measures aimed at the balancing of budgets of RF subjects in amount of Rub. 15 billion 194 million 335 thousand were redistributed in accordance with supplement No. 36 to the law on the federal budget, while the procedures governing the distribution and amounts of grants provided to the budgets of RF subjects with the purpose to ensure the balance of the budgets of RF subjects, which amounted to Rub. 4.965 billion, were set forth by the Government of the Russian Federation.

The creation of the reserves without having in place clear procedures of distribution in the beginning of the financial year may also have a negative impact on the fiscal behavior of regional authorities (expressed in attempts to receive yet undistributed financial re serves of the center in stead of optimization of own financial resources), and on control over the distribution and utilization of the said funds.

The same practices persist in 2005. In Fig. 14, there are presented the dynamics of grants for stabilization of regional budgets proceeding from the methodology of distribu tion of these funds and distribution of these funds at the Governments discretion.

Section 2.

Monetary and budgetary spheres 75,4% 73,4% 24,6% 26,3% 2004 The procedure governing the distribution of grants is set forth in the law on budget The procedure governing the distribution of grants is set forth by the RF Government Fig. 14. The dynamics of amounts and shares of grants for stabilization of regional budgets proceeding from the methodology of distribution of these funds and distribution of these funds at the Governments discretion (Rub. billion) As it is demonstrated by the data presented in Fig. 14, the share and amount of grants for the support of the balances of regional budgets provided under procedures set forth by the Government were significant both in 2004, and 2005. The share of these finan cial resources makes about one fourth of the total amount of grants provided for the sup port of the balances of regional budgets.

The procedures and rules of distribution of grants provided for the support of the measures aimed at the balancing of the budgets of RF subjects in 2004 were elaborated and set forth by the governmental resolution approved in the second half of the financial year. The key feature of the said rules is that they usually base on the reporting indicators of regional budgets, although the use of such indicators was deemed inefficient yet in 1998 in the course of revision of the Methods of distribution of grants provided from FFSR11.

In accordance with the resolution of the RF Government, the right to obtain grants aimed at the balancing of budgets should have the regions, where the ratio between pri mary expenditures of the consolidated budget (expenditures for wages and salaries, charges on the payroll, payments associated with mandatory medical insurance as con cerns non working residents, compensation of the difference between the set level of household payments for public utilities and the economically justified tariffs, capital repairs of the housing fund, payments to the population as concerns subsidies for housing and public utilities expenditures) for the first 5 months of 2004 and the consolidated revenues for 5 months of 2004 (minus the financial reserves of the Compensatory Fund, the Federal Fund of Financial Support of RF subjects transferred in advance, and certain types of grants) made less than 60 per cent.

See the Concept of reform of interbudgetary relations in the Russian Federation in 1999 through 2001 approved by Resolution of the RF Government No. 862 of July 30, 1998.

RUSSIAN ECONOMY in trends and outlooks The amount of the grant provided to individual regions should depend on the amount of the expenditures of the consolidated budget of this region in 2003, the ratio between its primary expenditures and revenues in the first 5 months of 2004, and the level of its budg etary security after the distribution of the FFSR financial reserves in 2004.

Grants are provided in two stages. At the first stage (in September of 2004) the re gions received 30 per cent of the total amount of grants for support of the balance of re gional budgets. At the second stage (in October of 2004), according to the aforemen tioned resolution the regions should receive 70 per cent of the amount of grants, which should be distributed among the regions on the basis of the indicators discussed above with the use of an adjustment coefficient.

This adjustment indicator of the fulfillment of measures aimed at the balancing of the budgets of RF subjects should take into account the activities of sub federal authorities aimed at the improvement of the financial standing of regions.

The adjustment indicator was calculated on the basis of:

1) reduction of the creditor indebtedness of the regional budget as concerns wages and salaries, charges on payroll, provision of state allowances to citizens with children, and payments for public utilities;

2) attrition rate of arrears associated with the regional and local tax on profits (the share due to the consolidated budget of the RF subject);

3) attrition rate of unregulated indebtedness of the RF subject to the federal budget.

Thus, there was made an attempt to compensate negative effects of irregular provi sion of financial aid and to create incentives for regional authorities to use the grants for implementation of measures aimed at the rehabilitation of regional finances.

At the same time, the rationality of the existence of grants for the balancing of re gional budgets proceeding from the reporting indicators and to a certain extent envisaging the targeted nature of the funds received by the region seems to be arguable.

A similar effect could have been achieved, on the one hand, by an increase in the amount of FFSR, and on the other hand, by granting various conditional subventions for rehabilitation of regional finances. Both measures could have been envisaged in the law on the budget for year 2004. All individual and extra requirements with respect to additional financing on the part of regions not related to emergency situations can be met at the ex pense of borrowings in the market sector. These measures could result in more reliable data used by regions in the course of elaboration of their budgets and partially mitigate the urgency of the problem of soft budgetary constraints (in the cases of active use of borrow ings, the problem of soft budgetary constraints may emerge as subnational authorities are granted financial aid for the repayment of borrowings they are unable to pay at the ex pense of own funds).

It appears that it would be more feasible not only to distribute the total amount of planned financial aid to regions via the mechanisms set in place in advance, but also in form regional authorities about the amounts of financial aid targeted for each region even prior to the beginning of the planned period. At the same time, it is necessary either to re frain from granting financial resources in excess of the targets, or envisage the closed list of cases, where additional financial aid may be granted, and the respective procedures in the framework of the federal legislation.

Yet another mechanism of flexibility of the federal budget became the option per mitting to redistribute grants and subventions to closed administrative and territorial enti ties (CATE). In accordance with the RF Government resolution No. 409 of August 12, 2004, the RF Finance Ministry was granted the right to redistribute grants from CATEs, where revenues exceeded 15 per cent, in favor of the CATEs, where the revenues were below the Section 2.

Monetary and budgetary spheres planned level. A similar reduction should be applied to subventions for capital repairs and resettlement, as well as misused subventions.

2.3.3. Distribution of grants for equalization of budgetary security of RF subjects: new methods In accordance with the requirements set forth by the new budgetary legislation, which has entered into force since January 1, 2005, in 2004 there was elaborated and ap proved by the RF Government resolution No. 670 of November 22, 2004, the new Method ology of distribution of financial resource of the Federal Fund of Financial Support of Re gions (FFSR), which took into account the flaws of the preceding methodologies. For the first time since the FFSR has started to operate, the methods of distribution of grants for equalization of budgetary security of RF subjects was fixed in the form of a regulatory and legislative act (prior to 2005, the methodology existed only in the form of information mate rials presented by the Government in the package of documents supplemented to the draft federal law on the federal budget for the next financial year). There may be singled out the following innovations, which make the new principles of distribution of FFSR resources dif ferent from the preceding methodologies.

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