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The former option seems to be the most attractive one, but hard to imple ment. While Art. 288 of the Tax Code of RF (below referred to as TC of RF) reads that the organization is bound to deduct a part of its profit to regions where it car ries out its operations according to the formula 0.5 (a+b), where a is the proportion of the residual value of the organizations capital assets in a given region, while b is the proportion of salaries and wages or the number of its employees in the region, because of drawbacks of Art. 40 and 20 of TC of RF, formally independent corpo rations not only can conceal a part of corporate profit tax, but even easily move their profit from one region to another. But today, from the perspective of tax ad ministration, it appears impossible to solve the problem of transfer pricing.

It is therefore appropriate to once again consider the problem of introduction to the RF tax law of the concepts of consolidated taxpayer and corporate profit tax, which suggests identification of the tax base of this particular tax on the whole by all the taxpayers that form a holding, with a consequent redistribution of tax revenues between budgets of the RF Subjects in the territories wherein the said taxpayers operate. But in all likelihood such a consolidation of legal entities for the sake of payment of corporate profit tax will be voluntary. Hence, the institution of consoli RUSSIAN ECONOMY IN trends and outlooks dated taxpayer will unlikely to fully solve the problem of migration of the tax in question.

The other option is to abolish the 4% regional benefit by corporate profit tax.

This would bridle the businesses eagerness to declare profit in certain regions, thus affecting the other ones. But as noted above, today regions mostly entice large taxpayers employing administrative means, rather than tax benefits.

Numerous corporations (such as, for instance, Gasprom and Transneft) ac count a great deal of their assets (pipelines) in the balance sheet of their head companies headquartered in the capital cities. Accordingly, once their corporate profit tax payments are distributed, the regions wherein the said assets are actually located, loose considerable revenues. Thus, it seems fair to distribute corporate profit tax not only between regions where just separate divisions of such organiza tions reside, but to include regions where their assets are located. This should help make the tax in question less mobile, especially in such sectors as oil and gas transportation. However, again, from the perspective of tax administration, this op tion also appears hard to implement.

Thus, in the short run it appears unlikely that one would be able to modify the tax law in such a manner, so that to radically lower the mobility of corporate profit tax. Hence, it is imperative to have the budgetary system adapted to prompt and considerable migrations of the tax bases. The only rational way to damp sharp fluc tuations in regional budgetary revenues is to create regional stabilization funds, as most instruments the federal center so far has employed to this effect have been less efficient47.

The year of 2006 has become the third straight year of an aggregate surplus of consolidated budgets of the Federations Subjects. In 2006, the surplus ac counted for 0.52% of GDP, while the rise in the surplus of consolidated budgets of the RF Subjects accounted for 0.26 p.p. of GDP vs. the 2005 index.

The analysis of quantitative characteristics of the financial aid from the federal budget to the RF Subjects ones (Table 23) evidences that the volume of the fed eral financial resources transferred gratis in favor of the subnational budgets dropped insignificantly (at 0.08 p.p, or 3.6% of GDP, vis vis 2005).

Once compared with the recent situation, the 2006 federal budgetary expen ditures on provision of financial aid to the RF Subjects and municipalities have un dergone certain modifications. Thus, the tendency towards cuts in funding from the Fund for Financial Support of Regions, which had started in 2003, was reversed the subsidies earmarked from FFSR grew from 0.88% of GDP in 2005 up to 0.94% of GDP in 2006. But, because of the procedure of the annual adjustment of FFSR with account of CPI, it can be forecasted that in the future the tendency should be renewed. Under the same share of public expenditures in GDP, economic growth in real terms should result in a rise of public expenditures at a pace greater than that Nazarov V.S. Nuzhny li regionalnye stabilizatsionnye fondy. M.: Bankovskoye delo. No. 2, 2007. P. 40Section Monetary and budgetary spheres of CPI. Furthermore, one can project a rise in public expenditures at a pace advancing that of the economys growth. It is also possible to suggest that interbudgetary transfers would grow, at least, at a pace equal to that of the federal budget expenditures. Accordingly, the FFSR growth rates should be lagging far behind the growth rates of other interbudgetary transfers. The 2007 federal budget law, which will be considered in a greater detail below, proves the accuracy of the above assumptions: it is envisaged that the overall volume of interbudgetary transfers should grow from 2.17% of GDP in 2006 up to 2.51% of GDP in 2007, while the volume of FFSR should slid from 0.94% of GDP to 0.83% of GDP.

In conjunction with the division of powers between the levels of the budgetary system and the federal centers eagerness to fund its mandates in full, the volume of funds allocated from the Compensations Fund has grown dramatically from 0.17% of GDP in 2005 up to 0.3% of GDP in 2006. After a rapid growth of the Fund for Co Financing of Social Expenditures (from 0.04% of GDP in 2004 up to 0.12% of GDP in 2005), which is explained by the monetization of benefits (with subsidies for a partial compensation for the costs of implementation of measures of social support to veterans and other individual categories of citizens), in 2006, the volume of subsidies from the Fund declined insignificantly, to the level of 0.11% of GDP.

Plus, subsidies on ensuring measures on maintenance of balanced regional budg ets likewise slid only slightly from 0.24% of GDP in 2005 to 0.16% of GDP in 2006.

As a year before, a vigorous employment of this mechanism of financing has ag gravated the problem of soft budgetary constraints. The volume of financing from the Fund for Development of Regions and the Fund for the Regional Finance Re form have remained unchanged, each accounting roughly for as much as 0.01% of GDP. Among negative results of the 2006 development of interbudgetary relations one should note a considerable rise in mutual settlements, which forms one of the most non transparent instruments of interbudgetary relations: they grew from 0.01% of GDP in 2005 up to 0.05% of GDP in 2006.

The period between 2004 and 2005 saw some attempts to ensure a greater transparency in the interbudgetary relations area. Thus, it was 2005 when for the first time ever the FFSR and FC resources were distributed according to the meth odology approved by the RF Governments Resolution. The formation and use of the Fund for Co Financing of Social Expenditures, the Fund for the Regional Fi nance Reform and a part of subsidies on support of measures on ensuring bal anced budgets of the RF Subjects were exercised on a formalized basis. Despite the reform attempts, distinguishing features of this particular kind of the federal budget expenditures still remain considerable amounts of funds distributed according to interbudgetary regulation procedures, without any methodological and financial, and economic justification. The proportion of the 2006 financial aid assigned on a formalized basis in the total volume of transferred resources ac counted for less than 60%.

A characteristic feature of the period between 2003 and 2006 became the re vision of the budget law and an increase of the originally allocated amounts of fi RUSSIAN ECONOMY IN trends and outlooks nancial aid to regions (in 2006 alone, at RUR 32 bn.). Notwithstanding that the vol ume of the additional, i.e. not provided for at the beginning of the financial year, aid to regions was reduced more than twice vis vis its 2005 volume, the mere fact of the existence of a significant source of soft budget constraints compels one to question the efficiency of the completed reform of distribution of financial aid be tween regions.

To exemplify the current procedures and fundamentals of distribution of addi tional financial aid, suffice it to note that:

- subsidies to ensure balanced regional budgets were increased from RUR 25 bn to 40 bn, or at 62% over 2006;

- subsidies to budgets of the RF Subjects on diesel fuel consumed to complete seasonal agricultural works were increased from RUR 5 bn up to 12.5 bn (2.times);

- subsidies to budgets of the RF Subjects on compensation for teachers out of class activities in the designated by the RF Government types of public and mu nicipal educational institutions were raised from RUR 7.7 bn up to 11.7 bn (1.times);

- subsidies to budgets of the RF Subjects on monetary compensations to medical staff at local medical attendants and obstetric offices, doctors, medical atten dants and nurses employed in the ambulance service were raised from RUR 4.bn up to 5.1 bn (at 10%).

The above witnesses that launched in 199798 process of the interbudgetary relations reform, has recently displayed clear signs of deceleration. As the most re cent practices show, the reform of fundamentals of distribution of the federal fi nancial aid is still remains in the governments ordre de jour, as the current system remains insufficiently transparent. It does not therefore allows any conclusions on its efficiency and suggests it may contribute to the rise of negative incentives for regional, as well as local, administrations budgetary policies. Below we are going to consider changes in characteristics of interbudgetary relations triggered by the 2006decisions in the fiscal federalism and subnational finance areas.

Table Financial Aid out of the Federal Budget to Consolidated Budgets of the Subjects of the Federation in 19922006 (as % of GDP) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 1. Finan cial aid to 1.8 2.3 2.5 1.6 1.18 1.43 1.79 2.2 1.94 1.7 1.65 1.52 1.budget of other tiers 2007* Section Monetary and budgetary spheres 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 1.1. Fed eral tar geted programs, as well as subsidies to the RF Subjects on support of agricul ture, water 0.05 0.15 0.economy measures, support of small busi nesses, and meas ures on childrens recovery 1.2.Fund for co financing 0.15 0.11 0.04 0.12 0.11 0.of social expendi tures 1.3. Fund for finan cial sup 0 0 0.36 1.17 1.04 1.22 1.12 0.99 0.96 1.14 1.36 1.3 1.05 0.88 0.94 0.port of regions, including:

Subsidies on equali zation of 0 0 0.36 0.86 0.68 0.86 1 0.99 0.96 1.14 1.36 1.3 1.05 0.88 0.94 0.budget sufficiency State support of the 0.06 0.08 0.08 0.07 0.Northern Supply Transfers at the 0 0 0 0.31 0.36 0.36 0.12 0.expense of VAT 1.4. Sub sidies and subven 0 0.02 0.09 0.06 0.09 0.13 0.1 0.06 0.15 0.54 0.28 0.29 0.27 0.36 0.21 0.tions, including:

Subsidies to budg ets on support of measures 0.11 0.24 0.16 0.on secur ing bal anced budgets 1.5.Resou rces of the Fund for 0 0.01 0.01 0.01 0 0.01 0.reforming regional finance 1.6. Other gratis and irrevoca ble trans 0.01 0.01 0.01 0.01 0.08 0.fers (sub sidies and subven tions) RUSSIAN ECONOMY IN trends and outlooks 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 1.7. Fund for financ ing re 0.03 0.05 0.1 0.1 0.15 0.01** 0.01 0.gional develop ment 1.8.Funds trans ferred under 0.61 1.95 2.54 0.42 0.81 0.43 0.36 0.14 0.28 0.05 0.2 0.14 0.12 0.01 0.05 0.mutual settle ments 1.9.Loans and budg etary credits, less loan repay 0.09 0.03 0.02 0.04 0.23 0.64 0.03 0.1 0.08 0.02 0.09 0.01 0.02 0.03 0.04 0.ments to other levels of govern ment** 2. Fund for com 0.37 0.38 0.36 0.34 0.17 0.30 0.pensa tions 3. Other inter 0.18 0.11 0.4 0.45 0.54 0.35 0.33 0.34 0.budgetary transfers Funds ear marked to budgets 1.49 2.7 3.4 1.8 2.3 2.5 1.6 1.36 1.54 2.56 3.03 2.84 2.39 2.25 2.17 2.of other levels of govern ment * By the 2007 budget act.

** Since 2005 budgetary loans only.

2.4.3. The 2007 Federal Budget in the Part of Allocation of Interbudgetary Transfers to Other Levels of the Budgetary System The overall amount of funds planned for allocation in favor of regional and lo cal budgets in 2007 accounts for some RUR 784 bn, or 1.3 times more than the re spective index of the prior year. It is particularly notable, as the general federal budget expenditures are going to rise 1.23 times. Accordingly, because of a faster rise in interbudgetary transfers to other levels of the budgetary system, their pro portion in the federal budget expenditures should grow from 13.5% reported in 2006 up to 14.2%.

The main channel of financial aid to regional authorities is subsidies on equali zation of budget sufficiency from the Fund for Financial Support of Regions.

Their volume should grow at 14.1% and reach RUR 260.4 bn. It should be noted that 2007 should see the renewal of the tendency to contraction in the proportion of the Fund in interbudgetary transfers to 33.2% (vs. 43.1% in early 2006 as per the 2006 federal budget law and 38.2%, as per the same law as of late 2006).

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