What Affects the Propensity to Subsidize : Determinants of Budget Subsidies and Transfers Financed by the Russian Regional Governments in 1992-1995

Making certain federal transfers conditional on reform could indirectly influence the pattern of regional subsidy financing in Russia. Subsidies funded by Russia's regional governments represented about 5.2 percent of GDP in 1995, almost triple the 2 percent of GDP in subsidies funded by the federal government. Regional policies vary greatly, influenced more by local factors than by the federal government. To find out what affects the regional governments' propensity to subsidize, Freinkman and Haney examined available data for 1992-95, asking: How great is the variation across regions in the incidence of subsidies, and what are recent trends in such variation? What are the relative influences of supply and demand factors in shaping the current levels of subsidy? How do federal budget transfers affect regionally funded subsidies to local enterprises? To what extent are federal transfers distortionary, encouraging subsidies and postponing the liberalization of local markets? Their findings: Regional wealth and federal budget transfers to regional governments are two of the most important determinants of regional propensity to subsidize. Even when regional budgetary wealth is controlled for, depressed regions (those affected most by industrial decline and unemployment) tend to spend less on subsidies than regions with more favorable economies. Federal budget transfers are quite distortionary, that is, they encourage regional governments to continue subsidy policies and postpone structural reforms. In fact, federal transfers tend to be concentrated in regions with the most distortionary policies. Housing receives the lion's share of total regional subsidies, and there are greater disparities in housing subsidies than in agricultural subsidies. Housing and transportation subsidies are strongly counter-equalizing: Households in wealthier regions receive more in housing subsidies and rural populations have less access to those subsidies, so up to 30 percent of regional subsidies are questionable in terms of equity. Federal transfers have less effect on regional subsidies in agriculture, which are influenced more by the region's own tax base and its share of rural population or by such factors as the political influence of local interest groups. To accelerate structural reforms, the federal government might consider reducing the number of recipients of federal budget transfers and changing the rules of allocation of the transfers, in particular by introducing conditional transfers linked to increases in cost recovery. This paper is a product of the Country Operations Division 2, Europe and Central Asia, Country Department III