4 There are some country-specific arguments in support of a possible positive link between regional decentralization and regional growth in Russia. Recent experience of the most advanced countries in transition demonstrated that economic recovery and growth is primarily concentrated in the largest cities (urban municipalities) which is associated with more favorable industrial structure, better access to infrastructure and human capital in metropolitan areas. But in Russia, local governments in urban areas of potential economic growth, face economic disincentives that derive from excessive and discretionary centralization of fiscal gains that such a growth may bring.

Under current fiscal arrangements, the rules of tax sharing between the local and regional governments are negotiated annually-or sometimes several times a year. The shares tend to be differentiated sharply across municipalities, with a few largest industrial centers often contributing large shares of main taxes, while rural rayons keep 100 percent and also receive most of regional budget transfers. The sharing rates vary not just between urban and rural districts within the same oblasts, but also between urban districts in different oblasts. In 1993, the city of Tver was permitted to keep 3 percent of profit tax revenues, 4.3 percent of VAT, and 5 percent of personal income tax collected in the city. The rest went to federal and regional budgets. The corresponding rates for the city of Yaroslavl, however, were 12, 10 and 80 percent. (Institute for Local Government, 1994) Research suggests that urban municipalities are punished for better revenue performance by having their tax shares lowered. One study of the budgets of 35 large cities in 29 Russia's regions in 1992-97 found that for every ruble that a local budget's own revenues increased in a given year, about 90 kopecks were taxed away by reductions in the transfers and tax shares that the superior regional government allowed (Zhuravskaya, 1998). Thus, any increase in the effectiveness of tax collection or increase in local revenues due to growth-promoting policies would be unlikely to make the local governments better off than before.

Analysis of the trends in tax sharing rates for rayon budgets in Yaroslavl oblast in 1994-98 also suggests that urban municipalities are the most affected by the existing system (World Bank, 1998). As in most other Russian regions, all the 12 rural rayons are recipients of transfers within the regional budget system and always have been getting maximum possible tax shares. In contrast, all urban rayons are facing a gradual decline in their tax share. The rate of this decline is not monotonic, influenced by bargaining power of specific municipal leaders, and hardly could be predicted in advance by municipal authorities.

Overall, these examples may suggest that large urban municipalities in Russia are the main beneficiaries from decentralization of regional budgets. Decentralization brings them more resources and more incentives to use them more efficiently. While we believe that in Russia, as in other countries in transition, an average rate of return of budget spending is much higher in urban centers, then decentralization may support growth through simple reallocation of resources from less to more efficient users.<sup>3</sup> For further justification of this argument, it is necessary to look at differences in the structure of budget spending at various government levels. Different combinations of investment, subsidies, and social spending have a different impact on economic growth. From this perspective, there is an evidence that it is regional governments who are responsible for most enterprise subsidies remained in the Russian fiscal system (Freinkman and Haney, 1997). These subsidies are a serious barrier for restructuring of recipient enterprises, which are usually the largest local companies with a sufficient lobbying power to

> 3 By the same reason, decentralization, by reducing redistribution, may lead to an increase in fiscal inequality across local govermments, especially between urban and rural municipalities.