Transfer of Part of Profit Tax Will Not Strengthen Municipalities’ Financial Autonomy

At present, according to available information, a list of assignments is being prepared for the Presidential Executive Office and the RF Government, based on the results of the RF President’s meeting, on 8 November, with the delegates of the All-Russian Congress of Municipal Formations. Among other issues, they discussed the possibility of introducing changes in the powers of local authorities to dispose of their budget revenue and expenditure.

The proposals put forth in regard of taxes may include, among other things, the disposal of profit tax revenues. More specifically, part of profit tax paid by a company within the period of one to three years since its creation can be left at the disposal of local budgets. The feasibility of such a measure, however, is highly disputable both from the point of view of the theory of fiscal federalism and traditional Russian practices.

Profit tax is mobile and, in theory, must be consolidated only at the federal – not regional - level. The current distribution of consolidated powers – an arrangement whereby the revenues generated by profit tax at the rate of 2% are transferred to the federal budget, while those subject to the 18% rate are transferred to regional budget (in this connection, its rate may be reduced to 13.5%), represents a sort of compromise between the well-substantiated theoretical stipulations and the desire, in actual practice, to create incentives for subnational authorities to boost business activity in their subordinated territories. Besides, it is obvious that, if only the revenues generated by that tax within the first few years of a company’s existence are left with local authorities, the resulting effect, in terms of boosting the revenue base of local budgets, is going to be minimal because, in a normal situation, the process of launching a business in its initial phase can generate only minimum profit, or may even be fraught with losses.   

Another factor that must not be forgotten is that profit tax is one of the most volatile taxes. Now, in conditions of a declining rate of economic growth and receding profitability of Russian enterprises, the amount of regional budget revenues generated by profit tax over the first 9 months of 2013 dropped by 22% in real terms on the corresponding period of last year. All these developments clearly indicate that an attempt to redistribute part of revenues generated from profit tax in favor of local budgets cannot be regarded as an instrument genuinely capable of increasing the autonomy of Russian municipalities. As an alternative, it is necessary to consider the issue of levying taxes on real estate (residential and non- residential, including the cadastre value of land plots). The transfer of part of revenues generated from taxes levied on non- residential property can indeed create incentives for local authorities to encourage the development of businesses in their territories. Besides, tax on real estate is significantly less mobile than profit tax.

A package of measures designed to reduce the spending obligations of municipal budgets has already been adopted at the federal level. Thus, from 2012 onwards, all municipal powers in the field of healthcare have been transferred to the regional level. From 2014, in accordance with Federal Law of 29 December 2012, No 273-FZ ‘On Education in the Russian Federation’ (as amended on 23 July 2013), powers in the field of pre-school education, with the exception of the cost of upkeep of buildings and utilities, will also be delegated to the level of RF subjects (the situation will become similar to that in the field of general education).

We believe it necessary to prepare more detailed and accurate estimations of the revenue to expenditure ratio in the budgets of municipalities. The policy aimed at minimizing the volume of powers delegated to the lowest (settlement) level may be fraught with significant problems for big and medium-sized cities, among which only a certain number enjoy the status of an urban district. In this connection, it should be borne in mind that local authorities are operating under constant pressure on the part of prosecutor’s offices, and any attempt to execute powers beyond their jurisdiction as outlined by federal legislation may be treated as non-targeted use of budget funds.

Thus, as far as further development of local self-government is concerned, any uniform decisions in that field may do more harm than good. Truly beneficial solutions to the issue of spending powers may result from introducing more flexible mechanisms of delegating powers, which will work not only vertically, but also horizontally (and from cooperation between municipalities as well).

А.A. Mamedov – Researcher, Budget Federalism Department