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3.125 Moreover, lgoty is a fairly non-transparent policy instrument. At the federal government level, there is no single regulatory and legal framework to govern its allocation and financing. The existing system of lgoty is quite complicated because of the dozens of government resolutions (some of them more than 60 years old) that have introduced different eligibility criteria for potential beneficiaries.56 As a result, there are no reliable statistics on the actual budget and overall costs of providing lgoty. The most commonly used source of information on lgoty (deriving from RoskomstatТs Form 26-ZhKH) is believed to be somewhat unreliable because it is filed not by lgoty recipients but by providers of HUS (see Annex 3.2 on other issues related to the availability of the data).

3.126 On the basis of the 2000 RoskomstatТs data for six regions Misikhina (2002) estimated that about 40 percent of Russian households benefit from various housing payment privileges.

Pensioners and budget sector employees have been the primary beneficiaries. Posarac and Rashid (2002), on the basis of the 2000 RLMS data, also show that low income households receive a much smaller share than higher income households of having privileges.

3.127 The conventional Roskomstat report, based on Form 26-ZhKH, suggests that in about 43.4 million persons (29.9 percent of the entire population) benefited from different housing payment privileges. This is a 13 percent decline since 2002, which was a result of the decision made in May 2002 to monetize housing lgoty for military servicemen. About half of all current beneficiaries receive their lgoty on the basis of the Law on Veterans, which grants considerable non-cash benefits to most Russian individuals with an extended employment history. An additional 30 percent of beneficiaries claim their lgoty on the basis of the Law on Social Protection of People with Disabilities.

3.128 As reported by Roskomstat, the total costs of lgoty in 2003 amounted to about 0.percent of GDP (see Table 3.2, above). The average per capita value of the monthly benefit amounted to Rbl 93.8 or about US$3. However, as was shown in the earlier section, traditionally, lgoty have been under-financed. In 2002-03 the average level of their actual financing was about 70 percent. Thus, the lgoty operate as an implicit tax on sector providers (World Bank, 2003a).

3.129 This Chapter uses newly available information on lgoty from the NOBUS survey, undertaken in the spring of 2003. NOBUS is believed to be a more reliable source of both the incidence and the costs of lgoty (see Annex 3.2 on different sources of data). According to NOBUS the share of individuals benefiting from lgoty was 33.3 percent of the population (i.e., their overall number was 11 percent higher than in Roskomstat reports). Moreover, the The analysis by the IUE identified the list of government decisions that had established various housing privileges, which is more than 30 pages long.

share of households that benefit from lgoty is even higher - 41 percent. This is because the number of beneficiaries is higher among smaller families, such as pensioners.

3.130 More important, the region-by-region comparison of the results from the two sources shows a systemic bias in the Roskomstat data set: this set gives much higher shares of lgoty recipients for poor regions (such as various Russian national republics) and underestimates the number of recipients in wealthier regions (regions of the European center). This is an important bias from the perspective of the impact analysis of reforming the system to phase out the lgoty and provide cash compensation to vulnerable households: simulations that are based on the Roskomstat data would produce a much higher demand for cash compensation for the existing lgoty recipients. This is the reason why this report employs the NOBUS data for the simulation of the fiscal and social effects related to the elimination of lgoty.

3.131 The Russian Government has initiated reforms in the lgoty system in 2004. It intends to define more precisely the sources of financing of the privileges, and it intends to shift the responsibility for financing a relatively large part of them to the regional administrations.

Moreover, the regional governments would be allowed to terminate specific privileges if they could not afford their funding. However, to date the government has made only those decisions that provide for the phasing out and partial monetization of privileges in public transportation and medical services. There is no agreed timetable as yet for the reforms of existing lgoty in the HUS.

Reform scenarios that assume the elimination of non-cash housing privileges3.132 Table 3.21 presents the results of simulations of reform scenarios that combine policies reflected in the scenarios in Table 3.20 with the elimination of housing lgoty (privileges). The results suggest that the elimination of lgoty would have a very modest impact on the vulnerable group of households. This reflects the fact that lgoty are concentrated in middle-income and high-income groups, and that, therefore, phasing out lgoty would not make housing unaffordable for too many of their current beneficiaries.

3.133 In the base case (column 10), the elimination of lgoty increases the number of allowance recipients by one-third, bringing their total number to 12 percent of the population.

In other words, only every tenth beneficiary out of the current lgoty beneficiaries (the number of which is close to 30 percent) would become eligible for housing assistance through allowances. This would provide the budget with considerable savings through the elimination of lgoty: the costs of additional housing allowances (0.06 percent of GDP) amount to only percent of the costs of eliminated lgoty.

3.134 In the case of 100 percent cost recovery (column 11), the above-mentioned proportions hold: the elimination of lgoty increases both the number of allowance recipients and the total cost of the allowance program by about one-third, while generating considerable budget The alternative set of simulations to assess the potential impact of the elimination of privileges was undertaken for the Russia Poverty Assessment (World Bank, 2004). Our modeling reflects two important differences relative to this earlier work. First, it uses 2002 (not 2000) as a base year for the analysis. As a result, our estimates reflect a major recovery in household incomes that took place in 2001-02. Second, we stimulate the phased-in reforms with tariff increases being expanded through three years, which provides household incomes with additional room to catch up with incremental costs. Overall, our estimates suggest that the elimination of the lgoty would generate an even smaller increase in the demand for housing allowances than was reported in the Poverty Assessment.

savings. Overall, the scenario for the 100 percent cost recovery and fully removed housing lgoty in 2006 sounds quite affordable: the share of the population that would receive allowances is only 15 percent, and the average household pays about 14.5 percent of its income for HUS.

3.135 Our interpretation of the latest set of simulations is as follows: if the current trend of high growth in household incomes continues, then the elimination of housing lgoty in about 2006 should not be a social/political problem. This is even more so if, as currently planned, the government would succeed in advancing other structural reforms, including those in public administration, pensions, and the social services, which would result in an additional growth in public sector wages, old age pensions and child benefits58.

3.136 With respect to sequencing the necessary reforms, this report argues that, given the sensitivity of the lgoty issue, the entire set of reforms could be divided into two main groups:

1. 2004-06: Accelerate tariff and financing reforms to increase tariffs, make the financial flows in the sector more transparent, and increase the accountability of sectoral players, including municipalities and service providers. As a part of this process, the Government should make a major effort to monetize the lgoty to transform them into explicit budget subsides and link them directly with the new system of individual social accounts that would track all benefits and entitlements for which households are eligible.

2. 2006-07: Eliminate lgoty (probably with a partial cash compensation to particular categories of recipients). The specific strategy for phasing out lgoty would depend upon the actual progress in housing and other reforms, the basic proportions between the prevailing levels of household incomes and housing costs, and the capabilities of the social assistance system. Additional modeling of housing affordability would be justifiable at that stage.

Yasin (2003) provides a detailed discussion of linkages between changes in public sector wages and benefits and affordability of tariff increases in the HUS.

Table 3.21: Results of Simulations for the Third Year of Reforms: Scenarios with the Advanced Reforms in Housing, Utility Tariffs, and the Elimination of lgoty (as % of GDP) 100% + 100% + 100% + 100% + Cost recovery in tariffs Capital Capital Capital Capital 90% 100% Repair 90% 100% Repair 90% 100% Repair 90% 100% Repair 1 2 3 4 5 6 7 8 9 10 11 Total housing costs, % of GDP 9.1 9.Budget spending on allowances 0.47 0.65 1.07 0.20 0.29 0.52 0.52 0.70 1.15 0.23 0.32 0.Budget subsidies on tariffs 0.76 0 0 0.76 0 0 0.75 0 0 0.75 0 Budget compensation for lgoty 0 0 0 0 0 0 0 0 0 0 0 Budget spending on capital repair 1.51 1.51 0 1.51 1.51 0 1.50 1.50 0 1.50 1.5 Total budget costs 2.74 2.16 1.07 2.47 1.80 0.52 2.77 2.20 1.15 2.48 1.82 0. as % of total housing costs 30.1% 23.7% 11.8% 27.1% 19.8% 5.7% 30.8 24.50 12.8 27.5 20.6 6.Max number of hhs that are recipients of allowances, mn 10,610 12,458 15,932 5,151 6,441 9,069 11,353 13,262 16,760 5,660 7,024 9, as % of population 22.6 26.5 33.9 11.0 13.7 19.3 24.2 28.3 35.7 12.1 15.0 20.Number of regions with the share of recipients > 25% 36 52 68 7 11 22 44 56 73 10 14 Share of population that resides in these regions, % 33.1 51.9 77.8 5.9 9.6 17.2 43.4 60.6 87.4 9.2 10.9 22. K. CONCLUSIONS AND POLICY RECOMMENDATIONS 3.137 Despite more than 10 years of reform efforts, the housing and utility sector remains among the least reformed segments of the Russian economy. It is increasingly becoming a bottleneck in the countryТs overall development strategy. The HUS is too dependent on government support, too costly to the budget, and too politicized and non-transparent, while the quality of the provided services remains low.

3.138 At the same time, when compared with the previous decade, the current economic environment in Russia is much favorable for advancing the HUS reforms. This is the case for the following reasons:

- RussiaТs macroeconomic performance is much stronger and it provides all major players with an additional income space for addressing the potential short-term costs of reforms.

- Recent improvements in cost recovery indicate that a significant portion of the entire task of phasing out inefficient housing subsidies has already been accomplished; what remains is a much more manageable tariff increase relative to what was a major challenge in 2000.

- RussiaТs federal government has a much stronger influence over subnational developments and could be more proactive in setting up proper incentives for regions and municipalities to advance the HUS reforms.

- RussiaТs private sector has shown for the first time a real interest in entering the housing sector.

3.139 Our analysis suggests that the acceleration of the HUS reforms in the current macroeconomic environment is not supposed to bring any significant incremental fiscal costs.

From the fiscal perspective, the main immediate challenge of the reforms in housing is not about changing the current level of budget financing of the sector but is about the radical restructuring of the existing financing mechanisms in the direction of the following:

- A reduction in government involvement in the HUS operations and financing - Improved transparency in the residual government commitments in the sector - A strengthening of the accountability of the government for the full financing of its commitments - Improved transparency of the financial flows in the sector - A strengthening of the accountability of both municipalities and service providers for the use of budget funds and the quality of services - Improved targeting of budget support to vulnerable households and depressed regions 3.140 Our estimates suggest that, as a result of tariff adjustments and other reforms, the real unit cost in the HUS would increase by about 90 percent relative to the prevailing 2002 level.

This would bring the annual costs of operating residential housing to 9 percent of GDP. At the same time, given considerable tariff adjustments that already took place in 2003-04, much a smaller additional growth in tariffs (of about 40 percent) is needed to reach the levels that cover full economic costs in the sector.

3.141 This Chapter argues that in the current environment of high growth in household incomes, it is affordable (both politically and financially) to attain, by 2006, a policy target of 100 percent cost recovery in tariffs with the simultaneous elimination of all quasi-fiscal financing (cross-subsidization). In addition, in the wealthier regions it could be possible to incorporate capital repair charges in tariffs. In such a scenario, households are expected to pay 6.5 percent of GDP, a major increase relative to 2.5 percent in 2002. Government budgets would pay the residual 2.5 percent of GDP (which is roughly the same level of budget spending as in 2003).

3.142 The simulations also suggest that, in the current environment, with high growth in household incomes, advancing reforms in the residential housing could be easily made budget neutral in the medium term, and this would bring considerable savings in the long term.

However, if household income growth slows down, this may generate incremental budget costs of 0.4-0.5 percent of GDP per annum in the medium term, which would be mostly related to the additional financing of housing allowances.

3.143 Overall, the analysis revealed a high sensitivity of the results to income dynamics.

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