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. Last Updated: 07/27/2016

Cash Benefits Put Regions in Fiscal Bind

In 2005, Russia resolved to cast off yet another socialist relic, namely the universal provision of welfare assistance in the form of in-kind benefits. This decision was made at the federal level, though previously many benefits -- specifically, free housing, utilities, transportation and phone service -- were funded from regional and local budgets. Benefits reform might have been postponed for many a year, had it not been for recent reforms defining the responsibilities of federal, regional and municipal levels of government.

The moment the federal government took on the responsibility of not only mandating but also financing social measures for various categories of beneficiaries, it was inevitably forced to cover the shortfalls of the regional and municipal enterprises providing free services to the public in accordance with federal law. Companies valued their losses from free service provision and sent a bill to the local authorities to cover them. Yet no one made any objective calculations, no one counted up the number of beneficiaries using a service, and no one separated losses due to free services from those incurred as a result of rates cuts or mismanagement.

Regional and municipal authorities, who previously were responsible for guaranteeing free services and benefits, somehow or another -- though in an extremely opaque manner -- finessed their financial interactions with state-owned companies. The federal authorities, however, were not capable of mastering this problem on a national scale. It proved far easier to give each consumer the possibility to determine their relationship to service providers independently. In other words, it was simpler to replace in-kind benefits with cash.

Monetizing benefits was a logical step in the reforms to define government jurisdictions. However, the implementation of these reforms was complicated by another problem. When all the state's social obligations were tallied up, it became clear that the budget could only fund half of all the benefits guaranteed by federal law. To divide up the responsibility for benefits, it was first necessary to make them match the state's actual income. Thus, the law actually distributed the necessary spending among the authorities at various levels, and reduced the size of benefits. This reduction came by either completely eliminating a certain benefit or handing it down to the jurisdiction of officials a level below. By doing so, the question of coordinating income and spending was passed on to the regional and local levels. This also applied to welfare programs for certain categories of beneficiaries that were given over completely to the regions.

Does the legislation changing welfare benefits contradict the Constitution, which forbids the government from reducing the rights and freedoms of Russia's citizens? The number of rights on paper has indeed been reduced compared to what it once was, yet has the amount of services provided by the government actually fallen? Half of the promises previously made by federal law were not funded, which means the government never delivered on them. To make sure the reforms abide by the Constitution, the transitional phase of the law on monetization requires regional governments to provide and fund social welfare packages -- regardless of whether they remain in-kind or are converted to cash -- at levels equal to the actual benefits provided in 2004.

Because of this requirement, monetization has inevitably led to significant increases in government spending. The law states that all citizens in certain categories have a right to welfare. However, in the past, only those with access to particular services -- for instance, to central heating, public water, telephone service and public transportation -- could take advantage of in-kind benefits. Now that benefits have been converted to cash, the government is forced to give the same amount to all citizens who qualify. In addition, payments by law must be large enough to allow those who previously used discounted services to acquire the same amount of paid services. Consequently, state spending has increased exponentially.

When dividing up tax income among the various levels of government, federal authorities halfheartedly took these additional needs into account. However, in the rush to write and pass the law, they did not manage to estimate the precise amount needed to compensate everyone who once took advantage of in-kind benefits. Estimates were further complicated by the widely varying prices for services provided by various companies in various regions under various conditions.

Despite the many complexities and variations, according to law the amount of cash compensation must be the same regardless of region, even though the cost of living in "expensive" areas is as much as three times greater than in "cheap" ones. The cost of housing and utilities is 20 times greater. As a result, the funds designated in the federal budget for benefits reform proved insufficient, and the government could not pay all beneficiaries. This is precisely why the federal government has recently decided helter-skelter to spend more federal money on solving the problem.

But what is happening in the regions? The law does not require regions to convert in-kind benefits into cash. However, the federal center began to insist that the regions follow the federal government's example. It should not have handed over responsibility for social policy to the regions, if only because they have lost almost all ways to get more funds to local coffers. In 2004, the government did away with one of the few regional taxes, the sales tax. In 2005, profit taxes, oil production taxes and water taxes were centralized. Nonetheless, despite their limited resources, as the vertical structure of state power continued to gain strength, regional leaders were not able to resist the temptation of making their future bosses happy. As a result, they went over to cash.

The federal authorities also gave leaders another incentive. The Finance Ministry budgeted 15 billion rubles for 2005 to help finance the reforms in regions that voluntarily went over to cash payments. This meant that many regions monetized in hopes of getting more money from the center. Their leaders in effect closed their eyes to the inevitability of higher costs. But federal funding covered only 12 percent of the total cost of implementing reforms, even though the monetary compensation recommended by the federal government was inordinately low, 200 to 300 rubles. This is exactly what the majority of regions decided to pay.

These decisions led to an extreme disparity in the amount and form of social guarantees to various categories of people in various regions. The regional budgets are coming apart at the seams, and former beneficiaries, unable to figure out whose jurisdiction they fall under, have focused all their rage on regional leaders.

In response to the public outcry, the government began to roll back the reforms willy-nilly. Several regions, such as the Moscow and Vologda regions, simply abandoned their earlier monetization decisions. The federal authorities have even discussed digging into the stabilization fund in a desperate attempt to plug the holes that have formed in regional budgets. In the ensuing chaos, the issues of federalization and redistributing government powers have been sadly left in the dust.

Galina Kurlyandskaya is director of the Center for Fiscal Policy in Moscow. She contributed this comment to The Moscow Times.