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This Budgetary Address has been prepared pursuant to Article 170 of the Budget Code of the Russian Federation and contains the main areas and guidelines for budget policy in 2004.

1. The main results of the budget policy in 2002 and early 2003

Significant positive results were achieved last year in implementing the budget policy.

The federal budget is formed and implemented with a surplus that makes it less dependent on foreign economic conditions. Extra revenues of the federal budget have made it possible to establish a financial reserve in the amount of about 230 billion roubles, thus substantially reducing budgetary risks.

Real steps have been taken towards medium-term financial planning.

The implementation of the tax reform that will reduce the tax burden on the economy and improve tax collection has continued. The tax system is becoming more rational, the number of taxes is being cut and so are the tax rates.

The new edition of the Customs Code of the Russian Federation adopted in 2003 will make customs procedures more transparent and provide an incentive for reducing the flow of “grey” imports and for proper payment of customs duties and levies.

Federal budget expenditure is financed at a more regular pace. For the first time budget recipients were given the limits of budget commitments for the next fiscal year in advance.

The wages in the public sector have registered noticeable growth. They will grow by another 33% in 2003. As a result of the recalculation of the size of pensions in accordance with the new system of pension provisions, about 12 million people have already seen their pensions significantly increased.

The salaries of servicemen and members of the law enforcement bodies have been substantially reviewed. Discounts when paying for housing and utilities and communications fees have been replaced with cash benefits. The Government debts under defence orders of previous years have practically been paid in full.

The budgetary process has been tied to the work to revise the level of regulated tariffs of natural monopolies. Early steps have been taken towards taking decisions at the stage when the draft federal budget for the next fiscal year is being formed.

Reform of interbudgetary relations continues. The bulk of the financial assistance to the regions of the Russian Federation is distributed according to uniform objective criteria. The status of regional budgets of the Russian Federation has improved.

The burden of Government debt has been substantially reduced and the international credit rating of Russia was raised in 2002. Investor trust in the internal borrowing market has been restored and loans are incurred for longer terms and at lower prices than before.

2. The main outstanding problems

It is impossible to consolidate the achievements of budgetary policy without addressing some acute problems.

Federal budget revenues are to a large extent formed due to the extraction and export of commodities. In connection with this, the financial system depends heavily on the state of international markets.

The tax system has not yet been fully geared to the goal of long-term economic growth and financial stability. The drafting and adoption of some chapters of the Tax Code of the Russian Federation have been unduly delayed. Complicated tax registration remains a problem.

The quality of tax laws submitted to and passed by the State Duma leaves much to be desired. This necessitates the introduction of numerous amendments. Frequent changes of tax legislation and the timeframe for the adoption of tax laws prevent businesses and the tax authorities from preparing to implement them in advance.

Budgetary allocations are distributed mainly on the basis of earlier proportions without a visible link to the effectiveness of budget spending.

The Government procurement of goods and services often dispenses with the practice of tenders. This is not only the result of outdated approaches. The procedure of Government procurement itself is outdated and is in need of serious modernisation.

The share of long-term sources of revenue for regional and local budgets remains extremely low. This is a disincentive for the relevant government bodies to develop the economies of the regions under their jurisdiction.

The spending commitments of the budgets of various levels are still not delimited. The regional and local government bodies are obviously lacking authorities to manage public finances. “Unsupported federal mandates” have become widespread. The total volume of spending commitments of the consolidated budget of the Russian Federation under the law is 6.5 trillion roubles, which is almost double the available financial resources.

As a result the population loses confidence in the Government and newly passed laws, and the government bodies of various levels tend to blame each other for improperly carrying out their functions, including populist measures that are not backed financially.

3. The main tasks of budgetary policy for 2004 and in the medium-term

The main tasks of the budgetary policy remain improving the wellbeing of the population and sustaining economic growth on the basis of the stable functioning and development of the budget system. In connection with this, budgetary policy must help improve the quality and accessibility of budgetary services, form a favourable business climate, make the national economy more competitive, reduce the scale of poverty, and ensure social stability on the basis of the simultaneous growth of the incomes of both public and private sector employees.

Budgetary policy must be forward-looking, proceed from a clear awareness of the potential of the federal budget and spending priorities, and ensure predictable conditions for the formation of the budgets of all levels. The federal budget for 2004 should not become hostage to electoral ambitions, lobbies or pledges that are impossible to fulfill.

The long-term financial plan and “enlarged government” budget approved by the Government of the Russian Federation must provide the guidelines for the federal budget of the next fiscal year. The plans to ease the tax burden, to assume new obligations, and implement structural reforms in the economy must be tied to the basic forecast of the budget system parameters.

In the medium-term, dependence of the Russian budgetary system on the foreign market dictates the necessity to create a stabilisation fund.

Continued work to improve the tax system and progressively ease the tax burden remains a priority of the budget policy.

The course for limiting the growth of non-interest bearing expenditures of the budget system must be continued. The aim is to have these expenditures grow more slowly than the rate of economic growth.

The reduction of the amount of financial resources redistributed by the Government must be backed up by effective measures to optimise budgetary spending, to introduce modern methods of performance-related budgeting that stimulate the government bodies of various levels and budget organisations to use budget assets in the most effective way possible.

The Government must abandon the cost-estimate financing of the budget network and direct delivery of many budgetary services in favour of payment for these services in accordance with the results that society gets. It is necessary to continue developing new ideas in this area.

The formation of the financial basis for implementing the ongoing reform of federative relations and local government that envisages broader budgetary independence and greater responsibility of regional and local government bodies remains a priority task for 2003–2004.

4. Guidelines of tax policy

Reducing the tax burden, above all in the processing industries and services, will remain a priority in 2004. That will give a fresh impetus to investment activities, provide incentives for increasing profits and giving up shadow economic activities, stimulate innovation and the development of high technologies. Thereby the necessary conditions will be created for diversifying the structure of the economy and for its further growth.

To this end, the overall value-added tax rate could be reduced from 20 to 18% in 2004. If the financial situation remains favourable a flat 16% VAT tax rate could be introduced starting in 2006.

Beginning in 2005, simultaneously with measures regarding pensions, medical and social insurance, the effective rate of the Single Social Tax may be substantially reduced, which would encourage legalising wages which are currently concealed from taxation.

The system of taxing property must be drastically changed in 2003–2004. Property taxes must provide a serious source of revenue for regional and local budgets, and the principles of collecting them must stimulate the effective use of property.

Measures to upgrade tax administration, notably through the introduction of information technologies, will be an important area of the tax policy. Improvement in tax administration is not only a potential reserve for further tax cuts, but is necessary to provide a level playing field for all the good-faith taxpayers.

The period of drastic changes of the tax system is drawing to a close. The task that is gradually coming to the fore is to keep the tax system stable as a factor that promotes the legalisation of business and tends to increase overall tax collection. Individual amendments introduced in the legislation on taxes and levies must increasingly be aimed at making laws clearer and free of ambiguities in terms of their application by taxpayers.

The work of tax inspections must be streamlined, the time tax payers spend on keeping tax documentation, preparing and handing in tax forms, especially in the sphere of small business, must be minimised.

Consequently, the costs incurred by taxpayers and the state to ensure the functioning of the tax system should begin to diminish.

The positive effects from the tax reform can only materialise if it is synchronised with other economic transformations, including the reform of the budgetary sphere, currency and technical regulation and upgrading of the antimonopoly policy.

5. Main ways of enhancing the effectiveness of budgetary spending

The need to reduce the tax burden and ensure stability of the federal budget calls for more effective spending of budgetary money in line with clearly defined priorities.

Registers of expenditure commitments stipulated by earlier decisions of government bodies must be created at all the levels of Government and work must be organised to introduce amendments to these decisions to prevent federal and local government bodies from assuming obligations for which financing is not available (“unfunded mandates”).

An inventory must be made of the organisations in the public sector. All of them must be thoroughly checked to see if their functions and tasks correspond to the needs of the state. Those that fail to meet these criteria must be deprived of budget funding and privatised or liquidated. Wherever possible the cash flow of budget money must be transferred from the producers to the consumers of budgetary services.

During the course of the reform of the education system, within the framework delimitating jurisdictions and terms of reference between different levels of Government, the training of university-level professionals will be concentrated mainly at the federal level. Federal budget spending for these purposes must be planned with due account of the forecasted demand for corresponding specialities in various labour markets. It is necessary to continue work to optimise the network of higher education institutions, for example by combining them into university-type complexes that comprise educational institutions of different levels.

In reforming the public health services, pride of place must go to modernising the system of compulsory medical insurance for the population, including pensioners and disabled people. Medical institutions that do not fulfill government assignments must be removed from the roster of state-funded institutions.

Reforming Russian Army recruitment to replace conscription with a system of recruitment under contract is particularly important. It means new expenditures for the federal budget which must be funded in a targeted way with subsequent reporting of the results achieved to the broad public.

It is necessary to ensure conditions for the total independence of the judicial system. All the expenditures of federal courts must be funded exclusively from the federal budget.

The streamlining of the functions of the federal executive power bodies must be completed by 2004 and preparations must begin for introducing procedures for allocating funds for their upkeep on the basis of financial assessment of the cost of performing corresponding functions. The system of control and supervisory bodies must be reorganised and optimised to eliminate duplicating their functions, totally ruling out their direct or indirect funding through enforced deductions, fines and the rendering of services for a fee.

Legislation pertaining to federal targeted programmes must be updated. It is necessary to introduce procedures of their development and implementation that meet present-day economic realities. The strategic priorities of the state investment policy must be clearly defined and strictly adhered to. It is necessary to work out a mechanism that would make state customers and the corresponding executives responsible for the achievement of the goals of these programmes and determine the ways to ensure that the programmes are matched by resources.

In 2004, it is necessary to pass legislation to seal the main principles for forming the federal targeted investment programme, including the delimitation of authorities to spend budget resources.

To reduce the cost of Government procurement, wider use must be made of the potential of centralised procurement of homogeneous products to fill the needs of several Government customer organisations.

Federal budget spending must become still more regular. Measures are to be taken to make the campaign of signing contracts to deliver products for Government needs more effective and to cut the time period during which it takes place. The resolutions of the Government of the Russian Federation needed to implement the provisions of the federal law on the federal budget must be passed no later than 15 days after its effective date.

The main distributors of the federal budget means must tighten control over the obligations of the organisations and institutions under their jurisdiction. The amount of unsanctioned obligations under which the treasury has to bear joint liability remains inadmissibly large. Every such incident must lead to an internal investigation and the corresponding officials must bear administrative or other liability.

The transition to the technologies of a single treasury account of federal budget spending must be speeded up. It is necessary to take measures to concentrate all the budget assets at the Bank of Russia institutions as much as possible. In practice that can be done by carrying out transactions within the framework of implementing the budgets of the Russian regions and local budgets through the federal treasury system.

6. Improvement of relations between budgets of different levels

A distinctive feature of 2004 will be intensive preparation for the delimitation, beginning in 2005, of the revenue-collecting and spending terms of reference between different levels of the budgetary system of the Russian Federation.

Creating a clear-cut and stable system of delimitating revenue-collecting and spending terms of reference is a necessary condition for harmonising federal and municipal obligations with the resources that are actually available for their implementation. As a result, the federal and local government bodies will be able to perform their functions more effectively, will become more independent in implementing budgetary policy, more responsible for its results, and budgetary services will improve and become more readily available thus creating further conditions for sustained economic growth.

The draft federal laws On the General Principles of Organisation of the Local Government in the Russian Federation and On Introducing Amendments and Additions to the Federal Law On the General Principles of Organisation of Legislative (representative) and Executive Bodies of Authority in the Regions of the Russian Federation submitted to the State Duma provide the basis for solving this strategic task. It is necessary to ensure that these laws are passed in 2003.

The Government of the Russian Federation must prepare and submit to the State Duma draft laws on introducing amendments and additions to the Budget Code of the Russian Federation and the Tax Code of the Russian Federation that are in line with the requirements of the initiated reform of federative relations and local self-government and ensure the implementation of the principles set down in the government Programme of the Development of Budget Federalism in the Russian Federation up to 2005.

By the same token, systematic work must be launched to review in accordance with the new principles of delimitation of the jurisdictions and terms of reference of the whole body of federal laws that require budget funding. Beginning in 2004, the norms that have not been followed over the past years must be declared to be null and void. Decisions must be prepared for optimising the system of benefits for servicemen, law enforcement employees, other federal civil servants, judges and parliamentary deputies.

Assuming new obligations that are impossible to meet is not an option. A great responsibility in this regard falls on the deputies of the State Duma (especially in the pre-election period) and on the deputies of the regional legislatures in the Russian Federation.

The government bodies of the regions of the Russian Federation and local self-government bodies must be vested with real powers to independently determine and restructure expenditure commitments in the spheres which will come under their jurisdiction beginning from 2005, including the wages in the public sector and social protection of the population.