## wp17265

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### 3.1 Background — Institutional and fiscal context, data, and revenue composition
- Institutional and fiscal context:
  - Russia is a federal state with three levels of government—federal, regional, and local—with the local level further subdivided into a hierarchy of municipalities, which in total count more than 22,000.
  - A complex system of intra-government transfers (mostly flowing from the federal government) ensures that spending of most regions, territorial EBFs, and federal EBFs remain broadly financed.
  - A large network (counting more than 65,000) of budgetary, extra-budgetary, unitary enterprises, and joint stock companies (most of which operate at the regional level) adds to complexity.
  - The Budget Code states that each of the three levels is autonomous and should be financially self-sustained, but de facto the federal government plays a significant role through tax centralization and transfers.
  - Russia’s fiscal constitution is characterized as relatively centralized with a relatively centralized tax authority and a complex system of federal transfers.
- Data and scope of analysis:
  - The econometric analysis uses panel data for 79 regions.
  - The data spans the period 2000-16, although some variables are available for shorter time periods:
    - regional fiscal data for 2005-16,
    - GRP for 2000-15,
    - GRP composition for 2004-15.
  - A cross-sectional dataset is constructed in which each observation represents a bilateral interaction between two regions (e.g., difference in growth rates, level differences, or correlation) for a given variable.
- Composition of regional revenues and transfers:
  - Regional revenues include own revenues and federal transfers.
  - The share of federal transfers in regional revenue varies widely across regions, ranging from about 10 percent to 90 percent.
  - Federal taxes (most importantly personal and corporate income tax) are the largest source of regional revenue, representing on average about 70 percent of own revenues.
  - Tax sharing (primary distribution) allocates tax revenues among different levels of government; it is performed directly in the regions where taxes are collected on a tax-by-tax basis at predetermined rates and is governed by the Budget Code and, for corporate income tax, by the Tax Code.
  - Regional excises’ shares are determined by the Budget Code with horizontal re-distribution; rates tend to be adjusted frequently.
- Magnitude and targeting of federal transfers:
  - Consolidated federal transfers, either from the federal budget or from federal extra budgetary funds (EBFs) to the regions (including territorial medical EBFs) amounted to 3.5 percent of GDP in 2016, or about 65 percent of federal oil and gas revenues.
  - Transfers financed a large share of regional fiscal spending (e.g., almost 70 percent in the North Caucasus Federal Region, or about 40 percent in the Far Eastern Federal Region).
  - If territorial medical EBFs are considered, the sub-federal share in general government spending is about 40 percent.
  - Transfers from the Federal Medical Insurance Fund (a federal EBF) to Territorial Medical Insurance Funds (regional EBFs) represented 1.7 percent of GDP in 2016 (about 40 percent of these transfers are financed by contributions to the Federal Medical Fund from regional budgets on behalf of the non-working population).
  - Equalization grants constitute about 50 percent of federal government transfers.
  - In per capita real terms:
    - equalization grants flow mostly to regions with both lower per capita income and lower own fiscal revenues;
    - subsidies and subventions in per capita real terms are allocated to regions with higher per capita income.
- Regional spending responsibilities (2016 shares):
  - 95 percent of general government expenditure for housing and utilities was regional.
  - 80 percent for education and cultural activities was regional.
  - around 85 percent for health including spending by territorial extra-budgetary medical funds was regional.
- Stylized empirical facts:
  - Primary distribution of taxes results in a large cross-regional dispersion of fiscal revenues (horizontal disparity).
  - Regions with lower per capita real GRP have lower per capita real own revenues.
  - Regions with a larger public sector share in GRP tend to have lower per capita real fiscal revenues.
  - Per capita fiscal revenues are positively associated with the share of mining in GRP and negatively associated with the share of agriculture in GRP.
- High-level empirical conclusions:
  - Federal transfers to regions contributed to reducing disparities arising from heterogeneous regional tax bases and fiscal revenues.
  - Transfers allowed regions with initially lower per capita income to increase human and physical capital at higher rates.
  - There is little evidence for transfers contributing to increased cross-regional growth synchronization.
  - Federal transfers did not significantly improve regional fiscal sustainability, supported by the lack of convergence in per capita real income across Russian regions in the last two decades.

### 3.2 Federal transfers and public goods’ supply disparities — associations with social spending, human and physical capital, and growth correlation
- Overview (period 2005-16):
  - The distribution of cross-regional per capita real expenditure is situated to the right of the distribution of per capita real own revenues, implying lower income regions can afford higher public real per capita spending than warranted by their own regional revenues.
- Transfers and per capita social spending:
  - Higher average federal transfers in 2005-16 (per capita real terms) are positively associated with larger increases in per capita real annual spending in health and education.
  - This association helps lower income regions to partially close the gap with richer regions in per capita social spending.
- Human capital accumulation:
  - Larger federal transfers are positively associated with stronger human capital accumulation.
  - Human capital measures follow Hall and Jones (1999)-style construction with five education categories: basic, secondary, secondary technical, university, post-graduate; decreasing returns assigned to these categories.
  - Human capital measures grow at higher rates in regions receiving higher average transfers (in GRP terms); result is partially driven by cross-regional differences in labor supply.
- Physical capital and investment:
  - Investment-to-GRP ratios and physical capital accumulation are generally higher in regions receiving larger federal transfers.
  - Regional capital stocks (perpetual inventory) show faster physical capital accumulation in regions with initially lower per capita income that receive larger transfers.
  - Observed very high investment ratios (in some cases as high as 50 percent of GRP) suggest initial capital stocks in lower income per capita regions were likely very low compared with richer regions.
  - Public sector finances a relatively large share of regional investment in regions receiving larger transfers; public sector investment is larger in regions receiving larger transfers.
- Federal transfers and cross-regional growth correlation — econometric specification:
  - Estimated equation: ρ_{i,j}^{y} = α + β θ_{i,j}^{ft} + γ X_{i,j} + ε_{i,j}
    - ρ_{i,j}^{y}: correlation coefficient between per capita real GRP growth of region i and j.
    - θ_{i,j}^{ft}: correlation coefficient between growth rate of per capita real federal transfers of region i and j.
    - X_{i,j}: controls (pairwise differences, including distance, GRP structure, footprint of the state, and international trade).
- Main empirical findings (selected reported coefficients across eleven specifications; observations = 3,023; robust standard errors; significance: * p<0.1, ** p<0.05, *** p<0.01):
  - Aggregate transfers — "Per capita real federal transfers growth corr. β": 0.065 0.051 0.047 0.034 0.021 0.023 0.025 (across relevant specifications).
  - Per capita real grant growth corr. β: 0.013 0.005 0.002.
  - Per capita real subsidies growth corr. β: 0.264 0.209 0.209.
  - Per capita real subventions growth corr. β: 0.356* 0.356* (reported with significance).
  - Constant α across specifications: 0.514*** 0.530*** 0.524*** 0.561*** 0.566*** 0.562*** 0.559*** 0.566*** 0.374* 0.149 0.149.
  - Selected controls (examples): Initial per capita real GRP g: -0.071 -0.069 -0.142*** -0.124** -0.104 -0.101 -0.102 -0.096 -0.085 -0.085. Common border g: 0.126 0.086 0.088 0.096 0.097 0.098 0.088 0.070 0.070. Share of public sector in GRP g: -1.218*** -0.784 -0.814 -0.853 -0.854 -0.807 -0.813 -0.812. Footprint of state g: -0.090 -0.097 -0.095 -0.096 -0.096 -0.083 -0.083. Urbanization rates g: -0.155 -0.132 -0.132 -0.148 -0.189 -0.189. Foreign trade g: -0.043 -0.043 -0.041 -0.054 -0.054.
  - Goodness-of-fit (R^2 / Adj. R^2 across columns 1–11): R^2 = 0.003 0.030 0.038 0.136 0.160 0.164 0.166 0.166 0.177 0.209 0.209; Adj. R^2 = 0.003 0.029 0.037 0.135 0.159 0.163 0.164 0.164 0.175 0.207 0.207.
- Interpretation and caveats:
  - Aggregate transfers do not have a strong or robust association with bilateral cross-regional growth correlation.
  - Per capita real subventions growth rates show somewhat significant positive coefficients in some specifications (0.356*), but caution is warranted due to potential endogeneity.
  - Positive association between GRP growth correlations and subventions growth correlations can be desirable or not depending on whether federal fiscal policy amplifies or lessens the severity of overall economic cycles.
  - Historical evidence for Russia suggests federal fiscal policy has been somewhat pro-cyclical (Erbil, 2011).

### 3.4 Federal transfers and the sustainability of regional budgets — methodology, empirical findings, and policy implications
- Methodology:
  - System of simultaneous equations estimated to allow feedback among endogenous variables (equation (2)).
  - Endogenous matrix Y includes:
    - long-term change in the revenue-to-expenditure ratio (proxy for fiscal sustainability),
    - cumulated per capita real GRP growth,
    - long-term percentage change in the share of public sector in GRP,
    - long-term average of federal transfers in percent of GRP.
  - Exogenous matrix Z includes:
    - level of initial per capita real GRP,
    - share of mining in GRP,
    - population size,
    - population density,
    - common border (time-invariant dummy),
    - footprint of state.
  - Identification imposes exclusion restrictions (Table 2). Estimation methods: SUR, 2SLS, 3SLS, FIML, GMM.
  - Public sector defined as sum of shares of public administration; military security; social insurance; education; health care and social services; and other communal, social, and personal services.
- Main empirical findings:
  - Federal transfers did not significantly improve regional fiscal sustainability.
  - Channels and net effects:
    - Direct effect: regions receiving larger federal transfers grew faster (accumulation of factors of production).
    - Indirect effect: regions receiving larger federal transfers experienced a comparatively larger expansion of the public sector (10-year cumulative increase), which subtracted from per capita real GRP growth.
    - Net effect: the negative indirect impact more than offset the positive direct impact, implying no improvement in the own revenue-to-expenditure ratio through transfers.
  - Representative quantitative associations:
    - One-standard deviation difference in the level of federal transfers (about 17 percent of regional GRP) is associated with:
      - a negative cumulative bilateral difference in per capita real GRP growth (over 2005-15) of around 1.2 percentage points,
      - an increase in the bilateral share of public sector in GRP of around 1.5 percentage points,
      - no improvement in the (own) revenue-to-expenditure ratio.
    - Around one third of Russia’s regions (28 out of 79 in the sample) receive federal transfers higher than the average by between one and three standard deviations.
  - Selected estimated coefficients (SUR column unless otherwise noted):
    - β12 (effect of change in share of public sector on per capita real GRP growth): 0.280***.
    - β23 (effect of per capita real GRP growth on change in share of public sector): -0.320***.
    - β24 (effect of federal transfers as share of GRP on change in share of public sector): 0.011.
    - β32 (effect of change in share of public sector on per capita real GRP growth in alternative equation): -1.360***.
    - β34 (effect of per capita real GRP growth on federal transfers as share of GRP): 0.083**.
    - Selected exogenous effects: g22 (initial per capita real GRP on change in share of public sector): -0.010***. g33 (share of mining on per capita real GRP growth equation): -0.053**. g42 (initial per capita real GRP on federal transfers): -0.058***. g44 (population on federal transfers): -0.046***. g47 (footprint of state on federal transfers): 0.033.
    - Constants (SUR): α1 = 0.002, α2 = 0.001, α3 = 0.002, α4 = 0.022*.
- Robustness and complementary analysis:
  - Total factor productivity (TFP): For pairs of regions, TFP expanded at lower annual rates in regions receiving relatively higher levels of federal transfers; distance in productivity levels between low- and high-income regions increased over the last 15 years.
  - Convergence tests (1998-2015): No evidence of convergence in real per capita income across Russian federal regions in 1998-2015, except some convergence in the Far-Eastern Federal Region at the 10 percent significance level.
    - Selected panel unit-root test statistics (Table 4): Full sample: Im, Pesaran, and Shin (2003) = 840.105; Maddala and Wu (1999) = 195.050. Central Federal Region: Im, Pesaran, and Shin = 194.075; Maddala and Wu = 15.456. Far-Eastern Federal Region: Im, Pesaran, and Shin = 10-2.863*; Maddala and Wu = 43.252*.
  - Population concentration: Population of the city of Moscow increased by more than 30 percent since 2000; Saint Petersburg increased by 10 percent; other less densely populated regions experienced population decreases of 15-20 percent.
- Policy implications and recommendations:
  - Overall assessment:
    - Federal transfers were effective in supporting factor accumulation in lower per capita income regions but were ineffective in supporting self-sustaining per capita real GRP growth and productivity increases.
    - Transfers expanded government services without a long-term increase in the share of the private sector in GRP, leaving large cross-sectional differences in own fiscal revenues and dependence on federal transfers.
    - Transfers flow more heavily to regions where the footprint of the state is larger, suggesting a potentially self-sustaining pattern of dependence.
  - Recommended actions:
    - Strengthen strategic direction of transfers to increase growth effectiveness; consider limiting open-ended transfers that weaken incentives to enlarge regional tax bases.
    - Include a stronger measure of sustainability in grant allocation formulas alongside equalization objectives; establish realistic transition periods to achieve sustainability.
    - Use appropriate federal macroeconomic and tax policies to support development of regional tax bases and accountability of regional authorities.
    - Expand use of personal property taxes:
      - Personal property taxes currently represent only 0.4 percent of the consolidated own revenues of regions.
      - In 2016, 28 regions started a transition to market value-based taxation of property; city of Moscow projecting a five-fold increase in property tax collections by 2020 (with tax collection increasing by 55 percent in 2016).
    - Consider increasing the use of horizontal transfers at the margin to limit excessive concentration and support lower per capita income regions.
    - Implement a credible fiscal rule to avoid stop-go cycles caused by terms of trade shocks, promote a more stable real exchange rate, and smooth national and regional economic cycles—beneficial for expansion of regional tax bases.
    - Rebalance domestic taxes to tax labor less heavily to reduce informality, especially in low per capita income regions.
    - Simplify and increase transparency of transfers:
      - Streamline number of transfers (especially subsidies for agriculture development, housing and utilities, and education).
      - Allocate subsidies one-to-one to government programs (or subprograms).
      - Transform and consolidate “other transfers” into subsidies.
      - Regulate budget loans, which are increasingly used because of concessional interest rates.
  - Additional notes:
    - Complete elimination of regional dispersion is unlikely; equalization grants will likely keep their leading role. Sudden decreases or reallocations could create disruptions, especially in the most financially dependent regions.
    - There may be room to gradually improve the primary distribution of corporate income tax (CIT); an ongoing redistribution of one percentage point of CIT to finance equalization grants is an example of horizontal transfers in the margin.
    - Consideration should be given to modify incentives with the aim of limiting concentration and supporting improved human and physical capital levels in lower per capita income regions.

### Appendix A — Further details about fiscal federalism in Russia (limits, revenue sharing, and spending responsibilities)
- Limits imposed by federal government on regional budgets:
  - Monitoring, reporting, and transparency standards are high; sanctions for violations may include adjustments in the size of transfers (excluding subventions).
  - Budget balance requirements:
    - the deficit or regions cannot exceed 15 percent of their own revenues (excluding grants).
    - Rules are stricter if federal grants exceed 40 percent of the consolidated region budget revenues (excluding subventions).
  - Tax limits:
    - Sub-federal governments can set tax rates and reliefs for regional and local taxes.
    - For the CIT, regions can set rates for the regional part of the tax within limits set by the Tax Code but not reliefs.
    - Excise taxes on gasoline and alcohol are shared annually between regions and federal government.
    - The Tax Code does not allow regions to legislate on PIT, fees and charges, rates and reliefs, which constitute the remaining 40 percent of their revenues.
  - Expenditure limits:
    - Regions with federal grants exceeding 10 percent of consolidated revenues (excluding subventions) cannot assume and execute expenditures assigned by Constitution and federal laws, and cannot exceed federal norms for budgetary sector wages and regional government activity financing.
    - Similar restrictions exist for municipalities getting equalization grants from regions.
  - Borrowing constraints:
    - Domestic borrowing is not directly restricted.
    - New foreign borrowing (for deficit financing or refinancing) is allowed only for regions that do not receive federal equalization transfers, do not have debt arrears, and have proper credit ratings from at least two international agencies.
    - Regions receiving federal equalization transfers can borrow externally to refinance existing external debt if no debt arrears and credit rating requirements are satisfied.
    - Total yearly borrowing of regions and municipalities is bound by deficit financing and debt amortization.
  - Debt levels and service:
    - Debt is not allowed to exceed own annual revenues (excluding grants).
    - Rules are stricter if federal grants share exceed 40 percent of consolidated region budget revenues (excluding subventions).
    - Debt service (interest payments) should not exceed 15 percent of total expenditures (excluding subventions).
    - Escape clauses introduce flexibility (budget credit financing, privatization, use of regional precautionary saving funds).
    - Debt ceilings can be exceeded for an amount equal to federal budget credits.
- Revenue sources and tax/non-tax sharing (selected entries; shares reported in source):
  - VAT18 (concessional rate 10 percent): 100.
  - PIT: 1308515.
  - CIT: 1/201090.
  - MET (Oil and Gas): Formula-based depending on oil price: 100.
  - Equalization notes: Regions authorized to adjust regional portion of CIT down, but no more than to 13.5 percent (12.5 percent in 2017-20). For 2017-20, the federal government will receive an additional 1 pp to be redistributed via equalization grants.
  - Personal property tax: reported range 0.1 - 2 and share accruing to 100.
  - Personal property taxes currently represent 0.4 percent of consolidated own revenues of regions.
  - Gasoline and diesel oil excise revenues attribution: 38.3 percent in 2017, 42.6 percent in 2018, and 39.8 percent in 2019 to the federal budget; remaining portion to regional budgets (shares suspended for 2017-2020 by law 409-FZ of 30 November 2016 in some cases).
  - Notes clarify statutory specifics and distribution rules as given in the Tax Code and Budget Code.
- Spending responsibilities and jurisdiction (high-level):
  - Exclusive federal jurisdiction: federal property, regulation of social and economic development, federal energy systems, national defense and security, international relations, law enforcement; meteorology and statistics.
  - Joint federal-regional jurisdiction: public safety and law enforcement; administrative, labor, family, housing, land, subsoil, forest, water relations; environmental protection; emergencies and natural disasters; education, science, culture, sports; public health, social security.
  - Exclusive regional jurisdiction: other responsibilities beyond federal and joint jurisdictions as stipulated in regional constitutions and legislation.
  - Local governments' jurisdiction: urban/rural settlements; utilities; roads; municipal housing; public transport; waste management; local culture and recreation; local education and limited public health tasks.
  - Delegated federal responsibilities supported and unsupported by federal subventions are listed (selected examples provided in source).
  - Legal bases: Constitution of Russian Federation (Article 71-73, 130-133), Federal Laws N184 FZ and N131 FZ, and other decrees and laws cited in the source.

### Appendix B — Data definitions (selected variables)
- Change in the share of public sector in GRP: Change in the share of public sector in GRP in 2004-15 (percent) *.
- Common border: Dummy identifying regions sharing a common border *.
- Federal transfers as a share of GRP: Average federal transfers-to-GRP ratio in 2005-15 (percent) *.
- Footprint of state: Ln of number of per capita budgetary and non-budgetary state institutions *.
- Foreign trade: Average Exports plus Imports over GRP for 2009-15 (percent) *.
- Initial per capita real GRP: Ln of real per capita GRP in 2003 *.
- Per capita real federal transfer growth correlation: Bilateral regional corr. of real per capita federal transfer growth for 2005-15 (excluding transfers to territorial EBFs).
- Per capita real GRP growth: Annual average growth rate (Ln difference) of real per capita GRP in 2004-15 *.
- Revenue-to-expenditure ratio: Annual average change of the revenue-to-expenditure ratio in 2005-15 (percent) *.
- Share of mining in GRP: Average share of mining in GRP in 2004-15 (percent) *.
- Share of public sector in GRP: Average share of public sector in GRP in 2004-15 (percent) *.
- Urbanization rates: Average urbanization rates for 2005-15 (percent) *.
- Notes: Variables marked by * refer to the bilateral difference between any two regions.

*Source: wp17265 - 3.1–3.4, Appendix A–B (IMF working paper content as provided in source content).*

### 3.1    Background  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  . 

### 3.1 Background

### Institutional and fiscal context
- Russia is a federal state with three levels of government—federal, regional, and local—with the local level further subdivided into a hierarchy of municipalities, which in total count more than 22,000.
- A complex system of intra-government transfers (mostly flowing from the federal government) ensures that spending of most regions, territorial EBFs, and federal EBFs remain broadly financed.
- A large network (counting more than 65,000) of budgetary, extra-budgetary, unitary enterprises, and joint stock companies (most of which operate at the regional level) adds to complexity.
- The Budget Code states that each of the three levels is autonomous and should be financially self-sustained, but de facto the federal government plays a significant role through tax centralization and transfers.
- Russia’s fiscal constitution is characterized as relatively centralized with a relatively centralized tax authority and a complex system of federal transfers.

### Data and scope of analysis
- The econometric analysis uses panel data for 79 regions.
- The data spans the period 2000-16, although some variables are available for shorter time periods:
  - regional fiscal data for 2005-16,
  - GRP for 2000-15,
  - GRP composition for 2004-15.
- A cross-sectional dataset is constructed in which each observation represents a bilateral interaction between two regions (e.g., difference in growth rates, level differences, or correlation) for a given variable.

### Composition of regional revenues and transfers
- Regional revenues include own revenues and federal transfers.
- The share of federal transfers in regional revenue varies widely across regions, ranging from about 10 percent to 90 percent.
- Federal taxes (most importantly personal and corporate income tax) are the largest source of regional revenue, representing on average about 70 percent of own revenues.
- Tax sharing (primary distribution) allocates tax revenues among different levels of government; it is performed directly in the regions where taxes are collected on a tax-by-tax basis at predetermined rates and is governed by the Budget Code and, for corporate income tax, by the Tax Code.
- Regional excises’ shares are determined by the Budget Code with horizontal re-distribution; rates tend to be adjusted frequently.

### Magnitude and targeting of federal transfers
- Consolidated federal transfers, either from the federal budget or from federal extra budgetary funds (EBFs) to the regions (including territorial medical EBFs) amounted to 3.5 percent of GDP in 2016, or about 65 percent of federal oil and gas revenues.
- Transfers financed a large share of regional fiscal spending (e.g., almost 70 percent in the North Caucasus Federal Region, or about 40 percent in the Far Eastern Federal Region).
- If territorial medical EBFs are considered, the sub-federal share in general government spending is about 40 percent.
- Transfers from the Federal Medical Insurance Fund (a federal EBF) to Territorial Medical Insurance Funds (regional EBFs) represented 1.7 percent of GDP in 2016 (about 40 percent of these transfers are financed by contributions to the Federal Medical Fund from regional budgets on behalf of the non-working population).
- Equalization grants constitute about 50 percent of federal government transfers.
- In per capita real terms:
  - equalization grants flow mostly to regions with both lower per capita income and lower own fiscal revenues;
  - subsidies and subventions in per capita real terms are allocated to regions with higher per capita income.

### Regional spending responsibilities
- Regions and municipalities are largely responsible for social policies and some regional infrastructure.
- In 2016, regional spending represented:
  - 95 percent of general government expenditure for housing and utilities,
  - 80 percent for education and cultural activities,
  - around 85 percent for health including spending by territorial extra-budgetary medical funds.

### Stylized empirical facts and relationships
- The primary distribution of taxes results in a large cross-regional dispersion of fiscal revenues (horizontal disparity).
- Several steady relationships are observed:
  - Regions with lower per capita real GRP have lower per capita real own revenues.
  - Regions in which the public sector’s share in GRP is high tend to have lower per capita real fiscal revenues.
  - Per capita fiscal revenues are positively associated with the share of mining in GRP and negatively associated with the share of agriculture in GRP.
- These patterns imply that regional tax bases are positively associated with per-capita GRP and the share of mining in GRP, and negatively associated with the share of agriculture and that of the public sector.

### High-level empirical conclusions (from the paper)
- Federal transfers to regions contributed to reducing disparities arising from heterogeneous regional tax bases and fiscal revenues.
- This allowed regions with initially lower per capita income to increase human and physical capital at higher rates.
- There is little evidence for transfers contributing to increased cross-regional growth synchronization.
- Federal transfers did not significantly improve regional fiscal sustainability, a conclusion supported by the lack of convergence in per capita real income across Russian regions in the last two decades.

*Source: wp17265 - 3.1 Background (IMF working paper, sections and figures as provided in source content).*

### 3.2  Federal Transfers and Public Goods’ Supply Disparities

### 3.2  Federal Transfers and Public Goods’ Supply Disparities

### Overview
- Federal transfers aim to reduce disparities arising from heterogeneous regional tax bases and unequal own revenues.
- The distribution of cross-regional per capita real expenditure is situated to the right of the distribution of per capita real own revenues, implying lower income regions can afford higher public real per capita spending than warranted by their own regional revenues.
- Period referenced for transfer analysis: 2005-16.

### Transfers and Per Capita Social Spending
- Higher average federal transfers to regions in 2005-16 (in per capita real terms) are positively associated with larger increases in per capita real annual spending in health and education.
- This association helps lower income regions to partially close the gap with richer regions in per capita social spending (top panels of Figure 4).
- Notes on graphical analysis: The black dashed lines in Figure 4 represent the linear regression lines.

### Human Capital Accumulation
- Larger federal transfers are positively associated with stronger human capital accumulation.
- Human capital measures constructed using educational attainment and employment data follow a methodology similar to Hall and Jones (1999), which assumes diminishing returns for additional years of education.
  - Education categories used (from Rosstat): basic, secondary, secondary technical, university, post-graduate.
  - The construction assigns decreasing returns to these five categories.
- Result: Human capital measures grow at higher rates in regions that receive higher average transfers (in GRP terms) (bottom left panel of Figure 4).
- Caveat: This result is partially driven by cross-regional differences in labor supply.

### Physical Capital and Investment
- Investment-to-GRP ratios and physical capital accumulation are generally higher in regions receiving larger federal transfers.
- Regional capital stocks constructed by the perpetual inventory method show that physical capital accumulation in regions with initially lower per capita income and that receive larger transfers is faster than in other regions (bottom right panel of Figure 4).
- Observed very high investment ratios (in some cases as high as 50 percent of GRP) suggest initial capital stocks in lower income per capita regions were likely very low compared with richer regions.
- Additional note: The budget finances a relatively large share of regional investment in regions receiving larger transfers, particularly lower-income regions; public sector investment is larger in regions receiving larger transfers.

### Federal Transfers and Cross-Regional Growth Correlation
- Policy premise: A federal policy that smooths aggregate economic cycles and strengthens cross-regional growth correlations should have positive spillovers for the effectiveness of monetary policy.
- Estimated equation for bilateral per capita real GRP growth correlation:
  - ρ_{i,j}^{y} = α + β θ_{i,j}^{ft} + γ X_{i,j} + ε_{i,j}
    - ρ_{i,j}^{y} is the correlation coefficient between the per capita real GRP growth rate of region i and region j.
    - θ_{i,j}^{ft} is the correlation coefficient between the growth rate of per capita real federal transfers of region i and region j.
    - X_{i,j} is a set of control variables (pairwise differences, including proxies for distance, GRP structure, footprint of the state, and international trade).
    - α is a constant; β and γ are coefficients; ε_{i,j} is the error term.

- Main empirical findings (Table 1, eleven alternative specifications):
  - Aggregate transfers: coefficients for "Per capita real federal transfers growth corr. β" reported as: 0.065 0.051 0.047 0.034 0.021 0.023 0.025 (across relevant specifications).
  - Per capita real grant growth corr. β: 0.013 0.005 0.002 (reported values).
  - Per capita real subsidies growth corr. β: 0.264 0.209 0.209 (reported values).
  - Per capita real subventions growth corr. β: 0.356* 0.356* (reported values with significance noted).
  - Constant α across specifications (columns 1–11): 0.514*** 0.530*** 0.524*** 0.561*** 0.566*** 0.562*** 0.559*** 0.566*** 0.374* 0.149 0.149.
  - Control variable examples (selected reported coefficients):
    - Initial per capita real GRP g: -0.071 -0.069 -0.142*** -0.124** -0.104 -0.101 -0.102 -0.096 -0.085 -0.085.
    - Common border g: 0.126 0.086 0.088 0.096 0.097 0.098 0.088 0.070 0.070.
    - Share of public sector in GRP g: -1.218*** -0.784 -0.814 -0.853 -0.854 -0.807 -0.813 -0.812.
    - Footprint of state g: -0.090 -0.097 -0.095 -0.096 -0.096 -0.083 -0.083.
    - Urbanization rates g: -0.155 -0.132 -0.132 -0.148 -0.189 -0.189.
    - Foreign trade g: -0.043 -0.043 -0.041 -0.054 -0.054.
  - Goodness-of-fit (R^2 and Adj. R^2 across columns 1–11): R^2 = 0.003 0.030 0.038 0.136 0.160 0.164 0.166 0.166 0.177 0.209 0.209; Adj. R^2 = 0.003 0.029 0.037 0.135 0.159 0.163 0.164 0.164 0.175 0.207 0.207.
  - Observations: 3,023 (reported for all specifications).
  - Notes: Robust standard errors; significance markers: * p<0.1, ** p<0.05, *** p<0.01.

- Interpretation and caveats:
  - Aggregate transfers do not have a strong or robust association with bilateral cross-regional growth correlation.
  - The same lack of robust association applies for per capita real grant growth rates and per capita real subsidies growth rates.
  - Per capita real subventions growth rates show somewhat significant positive coefficients in some specifications (0.356*), but this should be taken with caution due to potential endogeneity.
  - The positive association between GRP growth correlations and subventions growth correlations can be either desirable or not, depending on whether federal fiscal policy amplifies or lessens the severity of overall economic cycles.
  - Historical context: Evidence for Russia in the last two decades suggests that federal fiscal policy has been somewhat pro-cyclical (Erbil, 2011).

*Source: Authors' calculations.*

### 3.4  Federal Transfers and the Sustainability of Regional Budgets

### 3.4  Federal Transfers and the Sustainability of Regional Budgets

### Methodology
- System of simultaneous equations estimated to allow feedback among endogenous variables (equation (2)):
  - Endogenous matrix Y includes:
    - long-term change in the revenue-to-expenditure ratio (proxy for fiscal sustainability)
    - cumulated per capita real GRP growth
    - long-term percentage change in the share of public sector in GRP
    - long-term average of federal transfers in percent of GRP
  - Exogenous matrix Z includes:
    - level of initial per capita real GRP
    - share of mining in GRP
    - population size
    - population density
    - common border (time-invariant dummy)
    - footprint of state
- Identification imposes exclusion restrictions summarized in Table 2 (coefficients equal to zero represent exclusion restrictions).
- Estimation methods reported in Table 3 include: SUR, 2SLS, 3SLS, FIML, GMM.
- Public sector definition: sum of shares of public administration; military security; social insurance; education; health care and social services; and other communal, social, and personal services. Note: private sector is the sum of the rest of economic activities, including SOEs in those activities.

### Main empirical findings
- Federal transfers did not significantly improve regional fiscal sustainability.
- Channels and net effects:
  - Direct effect: regions receiving larger federal transfers grew faster (accumulation of factors of production).
  - Indirect effect: regions receiving larger federal transfers experienced a comparatively larger expansion of the public sector (10-year cumulative increase), which subtracted from per capita real GRP growth.
  - Net effect: the negative indirect impact more than offset the positive direct impact, implying no improvement in the own revenue-to-expenditure ratio through transfers.
- Representative quantitative associations:
  - One-standard deviation difference in the level of federal transfers (about 17 percent of regional GRP) is associated with:
    - a negative cumulative bilateral difference in per capita real GRP growth (over 2005-15) of around 1.2 percentage points
    - an increase in the bilateral share of public sector in GRP of around 1.5 percentage points
    - no improvement in the (own) revenue-to-expenditure ratio
  - Around one third of Russia’s regions (28 out of 79 in the sample) receive federal transfers higher than the average by between one and three standard deviations.
- Select estimated coefficients from Table 3 (SUR column unless otherwise noted):
  - β12 (effect of change in share of public sector on per capita real GRP growth): 0.280***
  - β23 (effect of per capita real GRP growth on change in share of public sector in GRP): -0.320***
  - β24 (effect of federal transfers as share of GRP on change in share of public sector): 0.011
  - β32 (effect of change in share of public sector on per capita real GRP growth in alternative equation): -1.360***
  - β34 (effect of per capita real GRP growth on federal transfers as share of GRP): 0.083**
  - Selected exogenous effects:
    - g22 (initial per capita real GRP on change in share of public sector): -0.010***
    - g33 (share of mining on per capita real GRP growth equation): -0.053**
    - g42 (initial per capita real GRP on federal transfers): -0.058***
    - g44 (population on federal transfers): -0.046***
    - g47 (footprint of state on federal transfers): 0.033
  - Constants (SUR): α1 = 0.002, α2 = 0.001, α3 = 0.002, α4 = 0.022*
- Additional summary:
  - Own revenues (in levels) are positively correlated with the size of the private sector.
  - Regions receiving larger transfers did not close their expenditures–own revenues gap; own revenues often barely sufficient to finance health and education spending.
  - Federal transfers flowed more heavily to regions with lower initial per capita real GRP and to regions with a relatively larger footprint of the state.

### Robustness and complementary analysis
- Total factor productivity (TFP):
  - For pairs of regions, TFP expanded at lower annual rates in regions receiving relatively higher levels of federal transfers; distance in productivity levels between low- and high-income regions increased over the last 15 years.
  - Approach: neutral TFP levels for 2000-15 recovered using a Cobb-Douglas production function for all regions; regional capital stocks constructed via perpetual inventory method; effective human capital calculated using educational attainment of employed working-age population (corrected for labor utilization).
- Convergence tests (1998-2015):
  - No evidence of convergence in real per capita income across Russian federal regions in 1998-2015, except some convergence in the Far-Eastern Federal Region at the 10 percent significance level.
  - Selected panel unit-root test statistics (Table 4):
    - Full sample: Im, Pesaran, and Shin (2003) = 840.105; Maddala and Wu (1999) = 195.050
    - Central Federal Region: Im, Pesaran, and Shin = 194.075; Maddala and Wu = 15.456
    - Far-Eastern Federal Region: Im, Pesaran, and Shin = 10-2.863*; Maddala and Wu = 43.252*
- Population concentration:
  - Population of the city of Moscow increased by more than 30 percent since 2000; Saint Petersburg increased by 10 percent; other less densely populated regions experienced population decreases of 15-20 percent.
  - Concentration increases per capita cost for federal transfers and contributes to geographically unbalanced development.

### Policy implications and recommendations
- Overall assessment:
  - Federal transfers were effective in supporting factor accumulation in lower per capita income regions but were ineffective in supporting self-sustaining per capita real GRP growth and productivity increases.
  - Transfers expanded government services without a long-term increase in the share of the private sector in GRP, leaving large cross-sectional differences in own fiscal revenues and dependence on federal transfers.
  - Transfers flow more heavily to regions where the footprint of the state is larger, suggesting a potentially self-sustaining pattern of dependence.
- Recommendations:
  - Strengthen strategic direction of transfers to increase growth effectiveness; consider limiting open-ended transfers that weaken incentives to enlarge regional tax bases.
  - Include a stronger measure of sustainability in grant allocation formulas alongside equalization objectives; establish realistic transition periods to achieve sustainability.
  - Use appropriate federal macroeconomic and tax policies to support development of regional tax bases and accountability of regional authorities.
  - Expand the use of personal property taxes:
    - Personal property taxes currently represent only 0.4 percent of the consolidated own revenues of regions.
    - In 2016, 28 regions started a transition to market value-based taxation of property; city of Moscow projecting a five-fold increase in property tax collections by 2020 (with tax collection increasing by 55 percent in 2016).
  - Consider increasing the use of horizontal transfers at the margin to limit excessive concentration and support lower per capita income regions.
  - Implement a credible fiscal rule to avoid stop-go cycles caused by terms of trade shocks, promote a more stable real exchange rate, and smooth national and regional economic cycles—beneficial for expansion of regional tax bases.
  - Rebalance domestic taxes to tax labor less heavily to reduce informality, especially in low per capita income regions.
  - Simplify and increase transparency of transfers:
    - Streamline number of transfers (especially subsidies for agriculture development, housing and utilities, and education).
    - Allocate subsidies one-to-one to government programs (or subprograms).
    - Transform and consolidate “other transfers” into subsidies.
    - Regulate budget loans, which are increasingly used because of concessional interest rates.
- Additional notes:
  - Complete elimination of regional dispersion is unlikely; equalization grants will likely keep their leading role. Sudden decreases or reallocations could create disruptions, especially in the most financially dependent regions.
  - There may be room to gradually improve the primary distribution of corporate income tax (CIT); an ongoing redistribution of one percentage point of CIT to finance equalization grants is an example of horizontal transfers in the margin.
  - Consideration should be given to modify incentives with the aim of limiting concentration and supporting improved human and physical capital levels in lower per capita income regions.

*Source: Authors' calculations.*

### Appendix A. Further Details about Fiscal Federalism in Russia

### Appendix A. Further Details about Fiscal Federalism in Russia

### A.1 Limits Imposed by the Federal Government on Regional Budgets
- Monitoring, reporting, and transparency standards and requirements established by the federal government are high; sanctions for rules violations might be imposed and include, among other, adjustments in the size of transfers (excluding subventions).
- Budget balance requirements:
  - the deficit or regions cannot exceed 15 percent of their own revenues (excluding grants).
  - Rules are stricter if federal grants exceed 40 percent of the consolidated region budget revenues (excluding subventions).
- Tax limits:
  - Sub-federal governments can set tax rates and reliefs for regional and local taxes.
  - For the CIT, regions can set rates for the regional part of the tax within the limits set by the Tax Code but not reliefs.
  - Excise taxes on gasoline and alcohol are shared annually between regions and federal government.
  - The Tax Code does not allow for regions to legislate on PIT, fees and charges, rates and reliefs, which constitute the remaining 40 percent of their revenues.
- Expenditure limits:
  - Regions with a share of federal grants exceeding 10 percent of consolidated region budget revenues (excluding subventions) cannot assume and execute expenditures assigned to regional governments by Constitution and federal laws, and cannot exceed federal norms for budgetary sector wages and regional government activity financing.
  - Similar restrictions exist for municipalities getting equalization grants from regions.
- Borrowing constraints:
  - Domestic borrowing is not directly restricted.
  - New foreign borrowing (for deficit financing or refinancing) is allowed only for regions that do not receive federal equalization transfers, do not have debt arrears, and have proper credit ratings from at least two international agencies.
  - Regions receiving federal equalization transfers can borrow externally to refinance existing external debt if no debt arrears and credit rating requirements are satisfied.
  - Total yearly borrowing of regions and municipalities is bound up by deficit financing and debt amortization.
- Debt levels and service:
  - Debt is not allowed to exceed own annual revenues (excluding grants).
  - Rules are stricter if federal grants share exceed 40 percent of consolidated region budget revenues (excluding subventions).
  - Debt service (interest payments) should not exceed 15 percent of total expenditures (excluding subventions).
  - Escape clauses introduce flexibility for regional budget implementation (budget credit financing, privatization, use of regional precautionary saving funds).
  - Debt ceilings are currently allowed to be exceeded for an amount equal to federal budget credits.

### Revenue sources and tax/non-tax sharing (Table A.1 highlights)
- Federal taxes / Share accruing to (in percent of total):
  - VAT18 (concessional rate 10 percent) 100
  - PIT 1308515
  - CIT 1/201090
  - MET (Oil and Gas) Formula-based depending on oil price 100
  - MET (Other subsoil resources, including diamonds) Ad valorem and specific 4060
  - MET (Commonly occurring subsoil resources) Ad valorem and specific 100
  - MET (Diamonds) 8100
  - Water tax Specific 100
  - Excise tax on ethanol from edible raw material 2/ Specific 5050
  - Excise tax on ethanol from all material excluding edible 2/ Specific 100
  - Excise tax on alcohol-containing products 2/ Specific 5050
  - Excise tax on spirits 2/ Specific 5050
  - Excise tax on wine, beer, other 2/ 3/ Specific 100
  - Excise tax on tobacco 2/ Specific 100
  - Excise tax on cars and motocycles 2/ Specific 100
  - Excise on gasoline and motor oil 2/ 4/ 5/ Specific 1288
  - Excise tax on imported excisable goods 2/ Ad valorem and specific 100
  - Fee (royalty) for exploitation of water biological resources Specific 2080
  - Fee (royalty) for exploitation of animal resources Specific 100
  - Stamp duty 6/ Specific 100100100
  - Stamp duty via public multi-service centers 5050
- Special Tax Regimes / Share accruing to (in percent of total):
  - Single agricultural tax 6100
  - Single imputed income tax 15 (7.5-15) 100
  - Patent 6100
  - Simplified taxation regime6 or 15 100
  - Taxes under Product sharing agreements 2575
- Local Taxes / Share accruing to (in percent of total):
  - Corporate property tax Capped at 2.2100
  - Gambling tax Specific 100
  - Transport tax Specific 100
  - Land tax Capped at 0.3 and 1.5 for diff.types of land 100
  - Personal property tax 0.1 - 2100
  - Retail sales fee (so far implemented only in Moscow) Specific, but no more than patent-based 100
- Federal Non-Tax Revenues / Share accruing to (in percent of total):
  - Property income and earnings from paid services 100100100
  - License fees 100
  - Customs duties and fees 100
  - Forests 100100100
  - Water facilities 100100100
  - Environmental Fee 7/54055
  - Consular fees 100
  - Disposal fee 100
  - Subsoil royalty Formula-based 4060
  - Proceeds from sale/lease of federal land ceded to region 5050
  - Fees for record extracts 100100100
  - Fees for record extracts via public multi-service center 5050
  - Fines and penalties 8/ (distributed in various shares)
- Notes and statutory specifics (selected):
  - 1/ The CIT is the only tax whose rate is split between the federal and the regional levels in the Tax Code (sharing of other taxes is established in the Budget Code). Regions are authorized to adjust their portion of the CIT rate down, but no more than to 13.5 percent (12.5 percent in 2017-20). For 2017-20, the federal government will receive an additional 1 pp to be redistributed via equalization grants. This may result in a financing gap for some regions.
  - 2/ The tax code sets the corresponding rates in Rubles for 2017-19.
  - 3/ As established in the Budget Code (article 56, 2.2). For 2017, the distribution of these revenues shall be governed by the Federal Budget Law.
  - 4/ These shares are suspended for 2017-2020 by law 409-FZ of 30 November 2016.
  - 5/ Gasoline and diesel oil excise revenues shall be attributed to the federal budget according to the following shares: 38.3 percent in 2017, 42.6 percent in 2018, and 39.8 percent in 2019. The remaining portion will go to the regional budgets.
  - 6/ Whenever share of federal, regional and local government is reported simultaneously as 100 it means that each of them receives the full share of the tax revenue in application to its own jurisdiction.
  - 7/ 95 percent in Moscow, Saint Petersburg. The federal 5 percent is planned to be given over to municipalities in 2018.
  - 8/ Numerous fines and penalties are distributed in various shares (including 100 percent) among different government levels.
- Source for table data: Russian Tax Code (articles 13-15; 18; 143-418); and, Russian Budget Code (articles 46, 56-64).

### Spending responsibilities and jurisdiction (Table A.2 highlights)
- General allocation:
  - Exclusive Federal Jurisdiction: Authority on federal property, regulation of social and economic development, federal energy systems, national defense and security, international relations, law enforcement; meteorology and statistics.
  - Areas of joint federal-regional jurisdiction: Public safety and law enforcement; administrative, labor, family, housing, land, subsoil, forest, water relations; environmental protection; emergencies and natural disasters; education, science, culture, sports; public health, social security.
  - Exclusive Regional Jurisdiction: all other government responsibilities beyond those under the federal jurisdiction and joint federal-regional jurisdiction - as stipulated in regional constitutions and legislation.
  - Local Governments' jurisdiction: Urban, rural settlements; electricity, heating, water, gas, fuel supply; roads; municipal housing; public transport; emergencies, fire safety; public amenities, eateries, retail trade; culture (local cultural heritage, folk art and crafts); physical culture, sports, public entertainment, recreation; archives; cemeteries; local resorts; public safety, rescue operations; waste management; support to agriculture and SMEs; terrorism/ extremism prevention; education (less vocational + vacations); public health.
- Delegated federal responsibilities supported by federal subventions (selected examples):
  - National Census and Agricultural Census
  - Prevention of homelessness
  - Housing for disabled, veterans, retired servicemen, etc.
  - Subsidization of housing and utility payments for veterans, disabled, radiation-exposed, etc.
  - payouts to radiation-exposed
  - unemployment benefits
  - maternity and childcare benefits
  - monthly compensation payouts to various categories, e.g. exposed to radiation, blood donors, etc.
  - water and forest relations: management (partial) of federal water facilities and forests
  - animal world, hunting, fishing (partial)
  - protection and oversight of cultural heritage
  - education: oversight, licencing, accreditation (all partial)
  - public health: licensing; procurement of drugs, mandatory medical insurance
- Delegated federal responsibilities unsupported by federal subventions (selected examples):
  - Audit of construction plans and engineering surveys
  - Environmental audit
  - Land relations: provision of plots of land for construction, demolition of real estate, easement
  - R&D management
- Sectoral allocations (concise):
  - Education: Universities (federal); Vocational, primary, and secondary schools (regional/local).
  - Employment: Unemployment benefits (delegated - see above); Employment facilitation (regional/local).
  - Social security: Social support to war veterans, radiation victims (some delegated - see above); Social support to senior citizens, disabled, orphans, labor veterans, low income households; payment of medical insurance contributions on behalf of non-workers.
  - Industry support: For instance, Aviation (federal); Support to agriculture (beyond that from federal programs) and to SMEs (since 2015) (regional).
  - Waste management: Radioactive waste (federal/region); Solid waste (regional/local).
- Notes on legal basis and listing:
  - Responsibilities of regional governments in areas of joint jurisdiction are stipulated in the following legislation/regulations: 114 responsibilities listed in the framework law (184 FZ of 1999); 61 responsibilities prescribed in various specific laws (e.g. 52 FZ On Sanitary and Epidemiological Safety); 20 responsibilities arising from Presidential decrees (in particular decrees of May 2012), e.g. social support to medical workers, their professional development, employment of disabled, housing, increase in salaries for teachers and cultural workers, etc.; 162 responsibilities according to GoR decrees (minor, many of them recommended, not mandated). Regional governments implement 55 federal government programs and federal special-purpose programs - according to GoR resolutions (financed with own funds and subsidies).
- Legal sources cited in the appendix: Constitution of Russian Federation (Article 71-73, 130-133), Federal Laws N184 FZ (10/06/1999 amended 12/28/2016; and, N131 FZ (10/06/2003 amended 12/28/2016 and updated 02/17/2017); list of regional responsibilities (Ministry' of Justice website).

### Appendix B. Data (Variable definitions, Table B.1 highlights)
- Change in the share of public sector in GRP: Change in the share of public sector in GRP in 2004-15 (percent) *
- Common border: Dummy identifying regions sharing a common border *
- Federal transfers as a share of GRP: Average federal transfers-to-GRP ratio in 2005-15 (percent) *
- Footprint of state: Ln of number of per capita budgetary and non-budgetary state institutions *
- Foreign trade: Average Exports plus Imports over GRP for 2009-15 (percent) *
- Initial per capita real GRP: Ln of real per capita GRP in 2003 *
- Per capita real federal transfer growth correlation: Bilateral regional corr. of real per capita federal transfer growth for 2005-15 (excluding tansfers to territorial EBFs)
- Per capita real grant growth correlation: Bilateral regional correlation of real per capita federal grants growth for 2005-15
- Per capita real GRP growth: Annual average growth rate (Ln difference) of real per capita GRP in 2004-15 *
- Per capita real GRP growth correlation: Bilateral regional corr. of real per capita GDP growth for 2005-15
- Per capita real subsidy growth correlation: Bilateral regional corr. of real per capita federal subsidies growth for 2005-15
- Per capita real subvention growth correlation: Bilateral regional corr. of real per capita federal subventions growth for 2005-15
- Population: Ln of population (millions) in 2005 *
- Population density: Ln of population density (people per square kilometer) in 2005 *
- Revenue-to-expenditure ratio: Annual average change of the revenue-to-expenditure ratio in 2005-15 (percent) *
- Share of mining in GRP: Average share of mining in GRP in 2004-15 (percent) *
- Share of public sector in GRP: Average share of public sector in GRP in 2004-15 (percent) *
- Urbanization rates: Average urbanization rates for 2005-15 (percent) *
- Notes: Variables marked by * refer to the bilateral difference between any two regions.

*Appendix A. Further Details about Fiscal Federalism in Russia*

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_Source: https://www.imf.org/-/media/files/publications/wp/2017/wp17265.pdf_