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More on the issue of budget conservatism In the 19th century it was an axiom that increasing budget expenditure must be backed by increased taxes. To the British financial authorities of that time it could never have occurred that a law on budget liabilities might be voted for without specifying exactly which taxes would have to be increased in order to provide the necessary funding.

Two fundamental innovations were introduced in the 20th century: the idea of a budget that must be balanced with due regard for the cyclic fluctuations on the market and for the current economic situation, and the idea that the decisions con cerning new expenditures, to be borne by those who would form a future govern ment, could be an element of an efficient economic and political tactics. These rep resented a departure from the rigid logic of the 19th centurys financial conservatism. However, the general rules of the game have remained unchanged.

Just like a family budget, the state budget in a long term perspective must be drawn so as to match expenditure and revenue. Even in the 1950s and 1960s, in a situation of expanding public financial, it was an axiom that the government lead ers, when intending to increase expenditure, had first to think which taxes would have to be raised in order to back such a decision.

The crisis of public finances, which was felt more and more strongly since the 1970s, changed the situation. The political problems caused by cuts in public ex penditure, in face of the unpopularity of growing tax rates, made fashionable the Introduction Key directions of economic policy idea that budget revenue could be boosted by lowering taxes, instead of increasing them. It has been known at least since the publication of the classical work by Adam Smith, Wealth of Nations, that high rates of taxes may result in declining budget revenues. For its author, the issue of tax burden was equivalent to that of state ex penditure.

Since 1970s 1980s, there appeared another version of the interpretation of the relation between the rates of taxation and public revenue. The thesis that it was possible, by lowering tax rates, to compensate for the budgets potential losses through discouraging tax evasion, became quite widespread. This, indeed, seems to appeal to common sense. The State, when it tries to extract too much from the economy, may diminish the scope of legal economic activity. However, no one has ever succeeded in reliably tracing the connection between the levels of taxation and the levels of revenues from specific taxes in countries where such studies were undertaken.

The experience of tax reforms accumulated during the past decades has made it possible at least to imagine, if not to exactly forecast, the succession of re sulting events in the sphere of public finances. When reform results in decreased tax rates and in the elimination of their progression, and the tax system becomes simpler, with fewer tax exemptions, then the outcome may be an increased tax col lection, with a high degree of probability. But this is a hypothesis that each time has to be tested by practical experience.

In 2000 2002, such reform took place in Russia. Its elements were the intro duction of a flat income tax rate, a regressive social tax, the abolition of turnover taxes and the sales tax, a lower rate of the profits tax, and reduction in the scope of tax exemptions. Resulting was increased budget revenue. A by region analysis of the revenues from the income tax confirmed that the reform became a factor of growing budget revenue23. But is would be a gross mistake to draw on this basis the conclusion that the lowering of tax rates is a guarantee of tax collection growth.

In the history of finance, reforms resulting in a combination of lowered rates of taxes and growth of public revenue represent rather an exception from the general rule that the general rule itself. It is far from evident that Russia, after the reform of 2000 2002, still has some potential left for further growth of revenue through im plementing such a strategy. For any hope for the success of tax innovations aimed at lowering the rates to be realized, the determination will be needed to make some serious steps in the direction of tax regime unification and the elimination of its specific exemption elements, such as the taxation regimes in free economic zones or simplified systems of small business taxation. These measure are fraught with conflict. There is no convincing evidence that the Russian authorities are indeed prepared to follow this line. This means that it is time for resorting once again to common sense in the financial policy.

Sinelnikov Murylev S., Batkibekov S., Kadochnikov P., Hekipelov D. Otsenka resultatov reformy podokhodnogo naloga v Rossiiskoi Federatsii [An estimation of the results of reform of the income tax in the Russian Federation]. Nauchnye trudy [Scientific Works] No 52R. M.: IET, 2003.

RUSSIAN ECONOMY IN trends and outlooks Once a countrys leadership has chosen a course towards increasing the share of public revenue in gross domestic product, there is little sense in continu ing the talk of the lowering of the rates of the basic taxes, or in the discussion as to the rate of which tax it would be better to decrease VAT or SST, or if it would be worthwhile to abolish VAT altogether and to replace it by the sales tax. It is far better to discuss the source of financing for the programs aimed at increasing public ex penditure namely, the rates of the specific taxes to be raised, which must be the one least dependent on the situation on the oil market.

*** Now let us draw some conclusions. The dynamic economic growth, which oc curred after the post socialist recession, the success of the tax reform of 2000 2002, the changes on the oil and gas market, and the increased revenue of the Russian budget have created appropriate conditions for a rapid (by the standards of financial history) rise in public revenue. The growth of the States potential re sulted in the expansion of its liabilities. This has long term consequences. The problems created by the decisions once made will be determining the alternative to be faced by the Russian financial policy for decades to come.

The key problem of the Russian finances is the need to ensure the stability of the national pension system, to preserve the habitual ratio of the average annuity to the average salary in a situation of ageing society, when one worker has to support a growing number of pensioners. Coupled with the liabilities assumed in other spheres, this has given rise to the trend of a growing share of public expenditure in GDP. Russias specificity is that these problems emerge in face of the trend of a declining share in GDP of the revenues from the oil and gas sector. This is the main challenge to this countrys financial stability.

This problem is better to be solved today, and not to be left for a time when the situation may get out of control. We suggest here the following strategic solu tions:

1. To spend the revenues generated by high hydrocarbon prices on the strength ening of the financial base of the funded component of the pension system. This implies that the system should also encompass those Russian citizens who presently have no right to a funded annuity.

2. To implement the program of privatization of state property, and to earmark the resulting revenues for the financing of the funded pension system.

3. To stabilize those tax revenues which are the least dependent on the revenues from the oil and gas sector, to abstain from lowering the rates of those taxes which are the least dependent on the situation on the hydrocarbon market, when it is not backed by the decisions to restrict the budgets spending obliga tions.

It might be feasible to follow the example of Norway and to transform the Sta bilization Funds into a pension fund for future generations of pensioners, thereby guaranteeing the fulfillment of the States principal social obligations independently Introduction Key directions of economic policy from the markets fluctuations for many years to come. Of course, a certain reserve for dealing with emergency situations must also be created within its framework.

While enjoying high oil incomes, it is easy to disregard the existence of long term financial problems. The Soviet Unions experience has clearly demonstrated that such a policy can be very costly.

Section 1.The Socio Political Background 1.1. State policy and state institutions in 1.1.1. The main trends of economic and political development The past year was not marked by any outstanding events in terms of either economics or politics. The authorities continued their course outlined in the previ ous years. There were no remarkable external challenges which could exert signifi cant influence on the economic life of the country and necessitate some special re sponses.

This observation is confirmed by macroeconomic indicators (Table 1). The economy was growing at a steady if not spectacular rate, sufficiently high to ex ceed both the worlds and European average but still too modest to secure the achievement of the recently so cherished goal of doubling the GDP. And this idea has somehow slipped off into the background. Practically none of the important in dicators exhibited any changes either to the better or to the worse.

In terms of economic growth, Russia continued to considerably outpace the most developed countries of the world, but slightly lagged behind the majority of post Soviet countries (Table 2). By comparison with the countries of Central and Eastern Europe, Russian growth rate appears, on the whole, to be satisfactory (with the exception of the Baltic states), thus confirming the regularity that has revealed itself after the completion of the period of transition that the further from Brus sels the higher is economic growth2.

The investments, especially foreign ones, are exhibiting a positive dynamic.

And it is noteworthy that it is taking place in a situation when the State is clearly boosting up its role in economic life by increasing the assets of the state owned enterprises operating in the sectors which are the most attractive ones under the existing conditions (the branches of the fuel and power engineering complex).

The government continued to pursue a cautious financial policy. The re sources of the Stabilization Fund and gold and foreign currency reserves were growing. Although the budgeting policy has become weaker (the federal budgets expenditure rose in nominal terms by more than 20 % on the previous year), and therefore the dependence of the state sector on the situation on the market has in creased, it is still too early to affirm that the conservative budgeting policy has been abandoned, and budgeting populism has come in its stead. It has now become very clear that it is a rather difficult task to avoid populism in a situation when money is in abundance, and throughout the past year the authorities were continuing their quest for arguments and solutions designed to control the torrent of populist de mands and calls. This was especially important from a political point of view, be cause the year was pre electoral.

The author expresses his gratitude to V. Novikov and O. Kochetkova for their help in preparing this section of the review.

For more details, see Oslund, A. `Paradoks evraziiskogo rosta (The paradox of Eurasian growth) // Rossiia v globalnoi politike (Russia in global politics). 2006. Vol. 4. 6.

Section The Socio Political Background The first year or realization of the national projects came to an end. Having been formulated by V. Putin in autumn 2005, these projects became the core of the countrys social and budgeting policy, because they provided a means for signifi cantly accumulating budget expenditures and endowing the governments eco nomic policy with a social accent. To the initially suggested projects (public health care, education, agriculture, and housing), one more issue was now added the need to overcome the demographic crisis.

The national projects have become a reflection of the general tendency of transition toward medium and long tem politics. There emerged a strong demand for programs aimed at the development of the whole country and also of its individ ual regions and sectors of the economy. The development of a ten year socio economic strategy of the country was started. A Summary Report on the results and main areas of activity, containing three year benchmarks for the govern ments activity, was prepared, and similar reports were prepared by ministries and agencies. For the first time in Russias economic history, a switchover to three year budget planning took place: even in conditions of the Soviet planned econ omy, the feat of extending budget planning beyond the limits of one year had never been achieved. The Federations subjects started mapping long term (for 3 years) strategies and medium term (for 3 5 years) programs of their socio economic development. The Government periodically considers strategies for the development of some individual manufacturing and infrastructural sectors.

In the course of the year 2006, the Government continued to actively design and materialize the institutions of development. Special economic zones, con cession agreements, and the Investment Fund became the reality of economic life.

Simultaneously, a lot of intensive effort was devoted to creating the legal and or ganizational foundations of the State Development Corporation (or the Bank of De velopment), which should become the source of investments for large projects supported by the State. Apparently, this work will be finished in 2007, and Russia will then possess an integral system of the so called institutions of develop ment.

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