CNS Programs: NISNP

April, 2002

The nuclear closed cities (ZATO) of Russia are often described in terms of location, production and U.S. national security implications. Yet the system of nuclear closed cities also can be seen as a fiscal archipelago that weakens Russia's ability to become a true federation. This chapter examines the public finances in the nuclear ZATO before, during, and after the 1998 macroeconomic crisis. New budget data combined with pre-1998 summary data provided by the Ministry of Finance permits analysis of how the closed cities have recovered from the 1998 macroeconomic crisis and reveals trends in revenues and expenditures over the entire 1996-2000 period. The analysis covers 11 cities (10 Minatom and one MOD), and is benchmarked to fiscal trends at the all-Russia level and compared to trends in Krasnoyarsk krai.

Fiscal Federalism

• The typical economic geography rationale for locating a city, such as a transportation hub, historical place for settlement or existence of a natural resource, does not apply to the formation of the ZATO.
• The federal government retains almost exclusive revenue authority, but expenditure responsibility is decentralized across Russia. The result is a fiscal imbalance with many unfunded mandates. Regional and local governments must constantly negotiate upward for funds needed to cover even the most basic expenditures, such as education and housing needs.
• ZATO budgets are similar to those of other Russian cities, relying on fewer local taxes compared to Western cities. Like other Russian cities, the ZATO retain substantial expenditure responsibility.
• Unlike typical Russian cities, however, the large role of the regional government in ZATO public finance appears to be missing. If a ZATO loses its closed city status (e.g. Yubelenyy in Moscow region), a difficult transition to more dependence on the regional government must be made.
• Until 2000, ZATO kept all taxes that were collected on their territory unlike typical cities, and constituted "off-shore" zones where federal taxes did not apply. This provided de facto local revenue authority to support the closed cities. While Putin's reforms repealed the "off-shore" legislation, they have not altered the overall fiscal ZATO picture.

Budgets (sample table)

Revenues – Trends and Individual Taxes

• ZATO revenues come from a combination of direct federal grants, tax revenues, and non-tax revenue sources.
• ZATO rely on direct federal grants much more than do typical Russian cities.
• Real revenues (taxes and direct grants) fell precipitously in 1998 because of the macroeconomic crisis. In short, the Russian government was unable to protect the ZATO from the financial crisis.
• Two ZATO, Leninsk and Lesnoy, suffered a permanent loss of revenue after 1998. Four ZATO (Sarov, Novouralsk, Trekhgorniy and Snezhinsk) increased their revenues beyond the pre-crisis level, as was the case for typical Russian regions and cities. The remaining ZATO bounced back to pre-crisis levels.
• Several ZATO (Zarechniy) exhibited property tax revenues that were higher than the three traditionally largest tax revenue sources-- VAT, profit and personal income taxes (PIT)-- although this distinction vanished by 2000.
• "Wildcat" taxes were used to compensate for the lack of independent revenue authority by all ZATO.

Expenditures

• Prior to the 1998 crisis, ZATO expenditures resembled trends in other cities and regional budgets. The line items of education, housing and communal services, and health and social policy dominated allocations.
• After being cut in half in 1998, aggregate expenditures for all nuclear ZATO, and average expenditures for an average ZATO in 2000, exceeded 1996 overall and average expenditures. The result was a general U-shape rebound from the 1998 crisis.
• Unlike a typical Russian city, ZATO had budget surpluses in all three years, 1996, 1998, and 2000.

Employment – Population and Standard of Living

• The population of the 11 cities for 1996-1998 shows a slight overall increase, despite evidence of declining budget revenues and a more difficult quality of life. This contrasts with the general trend in Russia and with the situation in many remote regions.
• All ZATO, with the exception of Trekhgornyy, had lower per capita revenues and expenditures after the August 1998 crisis with some ZATO exhibiting very large declines of more than 50%.
• Unemployment in the ZATO appears to be rising, although the net flow of people into the ZATO is beginning to subside.
• Annual income within the ZATO, using indirect estimates from 1996 tax data, is approximately $2000 per year with the exception of Zarechniy ($950). Non-wage income could double this figure. Incomes, however, fell during 1998.