Fiscal Design Surveys Across Levels of Government (Oecd Tax Policy Studies, 7)

TAXATION OECD Tax Policy Studies

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OECD Tax Policy Studies

Fiscal Design Surveys across Levels of Government The relationship between different levels of government is one that is continually under review. Policy-makers ensure the expenditure and revenue functions of each tier of government with a view to balancing efficiency, equity and democratic considerations. Over the last decade, the tendency in a number of countries has been to decentralise both expenditure and revenue functions to lower levels of government. Greater autonomy in raising revenues has been given to intermediate and local levels of government. Setting up of local fiscal systems and intergovernmental financial relations involves multiple and often conflicting economic and political objectives. Practically, it is one of the most complex reform processes in the area of public finance and one that is permanently on the political agenda of both OECD countries and economies in transition. Yet there is no international, comparative set of information available to support this process. The international comparable statistics on revenue of local autonomy and the design of national fiscal control are either lacking or insufficient.

Fiscal Design Surveys across Levels of Government TAXATION

This study summarises the overall substantial and methodological framework of a project on fiscal design, which has been carried with the OECD. The results and comparative findings of the OECD Fiscal Design surveys are reported too. The surveys took place in six countries in Central and Eastern Europe: three OECD Member countries, the Czech Republic, Hungary and Poland, and the three Baltic States, Estonia, Latvia and Lithuania. The full country reports are available through SourceOECD, www.SourceOECD.org, and the Internet site of the OECD Centre for Tax Policy and Administration, www.oecd.org/daf/ctpa

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Tax Policy Studies No. 7

Fiscal Design Surveys across Levels of Government

ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT

ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT Pursuant to Article 1 of the Convention signed in Paris on 14th December 1960, and which came into force on 30th September 1961, the Organisation for Economic Co-operation and Development (OECD) shall promote policies designed: – to achieve the highest sustainable economic growth and employment and a rising standard of living in Member countries, while maintaining financial stability, and thus to contribute to the development of the world economy; – to contribute to sound economic expansion in Member as well as non-member countries in the process of economic development; and – to contribute to the expansion of world trade on a multilateral, non-discriminatory basis in accordance with international obligations. The original Member countries of the OECD are Austria, Belgium, Canada, Denmark, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The following countries became Members subsequently through accession at the dates indicated hereafter: Japan (28th April 1964), Finland (28th January 1969), Australia (7th June 1971), New Zealand (29th May 1973), Mexico (18th May 1994), the Czech Republic (21st December 1995), Hungary (7th May 1996), Poland (22nd November 1996), Korea (12th December 1996) and the Slovak Republic (14th December 2000). The Commission of the European Communities takes part in the work of the OECD (Article 13 of the OECD Convention).

Publié en français sous le titre : Conception budgétaire et niveaux d’administration N° 7

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FOREWORD The relationship between different levels of government is one that is continually under review. Policy-makers ensure the expenditure and revenue functions of each tier of government with a view to balancing efficiency, equity and democratic considerations. Over the last decade, the tendency in a number of countries has been to decentralise both expenditure and revenue functions to lower levels of government. Greater autonomy in raising revenues has been given to intermediate and local levels of government. Setting up of local fiscal systems and intergovernmental financial relations involves multiple and often conflicting economic and political objectives. Practically, it is one of the most complex reform processes in the area of public finance and one that is permanently on the political agenda of both OECD countries and economies in transition. Yet there is no international, comparative set of information available to support this process. The international comparable statistics on revenue of local autonomy, or what some have called local democracy, are either lacking or insufficient. In accordance with decisions made by the FDI, the OECD has initiated surveys on fiscal decentralisation in a number of Central and Eastern European economies, for the purpose of providing international comparisons on the design of fiscal systems across levels of government. The FDI is a joint initiative of the OECD, the World Bank, USAID, the Council of Europe, The Open Society Institute, UNDP and OECD Member countries to assist transition economies in Central and Eastern Europe in carrying out intergovernmental fiscal reforms. This publication summarises the overall substantial and methodological framework of the project and the results and comparative findings of the OECD Fiscal Design surveys which were carried out during 2000. The surveys took place in six countries in Central and Eastern Europe: three OECD Member countries, the Czech Republic, Hungary and Poland, and the three Baltic states, Estonia, Latvia and Lithuania. The study was prepared by the OECD Centre on Tax Policy and Administration, in co-operation with governments in the survey countries. The project was led by Leif Jensen of the OECD Secretariat. The study is published under the responsibility of the Secretary-General.

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TABLE OF CONTENTS 1.

Introduction – Background.......................................................................................................................................

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The structure of the publication ........................................................................................................................................

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2.

Fiscal Design Surveys – Substantial and Methodological Framework.............................................................

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2.1. Fiscal Design across Levels of Government – General policy issues .................................................................. 2.2. Specific design issues to address ............................................................................................................................. 2.3. Subnational finance statistics – Levels of government ..........................................................................................

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3.

Subnational Government Finance – Comparative Findings ...............................................................................

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3.1. 3.2. 3.3. 3.4. 3.5. 3.6.

Introduction ................................................................................................................................................................. Profiles on subnational revenues.............................................................................................................................. Profiles on tax and revenue autonomy of subnational governments................................................................... Summary of regional fiscal design in Latvia ............................................................................................................ Profiles on subnational expenditure ........................................................................................................................ Further information on “education” and “housing” expenditures of subnational governments ......................

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4.

The Balance between National Fiscal Targets and Subnational Financial Discretion .................................

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Introduction ................................................................................................................................................................. The framework of government size and expenditure assignments...................................................................... Evaluation of the subnational finance framework................................................................................................... Some comparative findings on the balance between local autonomy in financial decision-making, central control and fiscal discipline .......................................................................................................................... 4.5. Concluding remarks on the fiscal design surveys ...................................................................................................

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Annex 1. Summary of Country Reports .............................................................................................................................

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Czech Republic..................................................................................................................................................................... Estonia................................................................................................................................................................................... Hungary ................................................................................................................................................................................. Latvia ..................................................................................................................................................................................... Lithuania ............................................................................................................................................................................... Poland....................................................................................................................................................................................

46 49 51 54 58 62

4.1. 4.2. 4.3. 4.4.

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Tables 2.1. 2.2. 3.1. 3.2. 3.3. 3.4. 3.5. 3.6.

4.1.

Classification of grants ................................................................................................................................................ General framework for sector – specific descriptions of local discretion in providing public services........... Profile of subnational revenues: Composition by revenue source....................................................................... Classification of local taxes by tax base (in %), 1999............................................................................................... Tax autonomy at the subnational government level: degrees of control given as percentages out of all tax categories............................................................................................................................................... Profile of grants to subnational governments (in %) ............................................................................................... Local government........................................................................................................................................................ Current subnational expenditures by function, as a percentage of subnational government expenditure (A) and as a share of consolidated general government expenditure by expenditure issue (B) (1999) ................................................................................................................................ The distribution of municipalities by size ...............................................................................................................

16 18 21 22 23 24 25

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Figure 4.1. Main elements in relation to the subnational government system .....................................................................

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1.

INTRODUCTION – BACKGROUND

In November 1997, the Fiscal Decentralisation Initiative (FDI) together with the Council of Baltic Sea States held a conference in Copenhagen, Denmark. The theme of the conference was political and fiscal decentralisation in the countries around the Baltic Sea. The overall aim of the conference was to support the Baltic Sea states in contributing to a viable development of structural reforms and democracy. In the recommendations for future initiatives, it was stated that: “Fiscal decentralisation and indeed local governance are to some extent perceived in various ways across Europe. This has become evident when discussing transfer of experience and know-how, and even more when collecting data material for comparative analysis. At the same time, the need for uniform notion of local governance is becoming more and more evident as the Eastern European countries has undertaken considerable administrative reforms. The conference suggests that the Fiscal Decentralisation Initiative should be encouraged to launch an initiative aimed at establishing a framework for comparative local government analysis. This in order to identify a set of operational indicators for assessment of the development of local self-government. Obviously, this would require a set of flexible and adaptable indicators based on internationally recognised definitions.” Economies in Central and Eastern Europe are carrying out a number of activities to complete local and regional government reform initiatives aiming at a decentralised political-administrative structure which will allow for the development of a strong local democracy and viable local and regional government institutions. The experience of other economies – in CEE as well as western countries – are invaluable sources of information on the situation of different local government systems and as a comparative basis for assessing local government development in individual countries. Following up on the recommendations from the conference a number of pre-study activities took place in 1998. Two working seminars were held: one in Copenhagen on March 30, arranged by FDI and USAID, and one in Paris on 31 August-1 September, arranged by the OECD, with the purpose of identifying and specifying the overall framework for the project. In 1999, a number of development activities took place. At an FDI seminar in Paris, March, 1999, the OECD presented an overall framework paper for the project, including new concepts on local discretion in financial decision-making and national constraints on subnational fiscal policies. The paper was agreed on as the general framework for the further development of the project. During May-September 1999, the OECD developed and tested a draft questionnaire for the survey on Fiscal Design across Levels of Governments. The test activities took place in Denmark, Hungary and Latvia. In relation to the Annual FDI Steering Committee held in Strasbourg, February 2000, a summary report was presented, including the results of the three pilot studies. Based on the report, the Steering Committee approved the overall framework for the Fiscal Design surveys and agreed on initiating surveys in six countries: the Czech Republic, Estonia, Latvia, Lithuania, Hungary and Poland. Carrying out Fiscal Design surveys as part of the Stability Pact Programme for the Balkan region was also considered. To support the preparation of the specific country surveys, an FDI grant was approved. In April 2000, the OECD held the opening meeting with the six countries who all agreed on joining the surveys. The surveys in the countries were carried out between April 2000 and January 2001, by representatives from the ministries and agencies responsible for subnational finance issues. The surveys were written in response to a questionnaire and follows the structure outlined therein. © OECD 2002

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Fiscal Design Surveys across Levels of Government

During April-May 2001 the OECD Secretariat received the final versions of country reports from all six countries. The structure of the publication The full version of the country reports for the 2000 surveys, together with the 1999 pilot report on Denmark are presented on the CD-Rom, attached to the publication. In Annex 1 to the publication, a brief summary of each of the surveys is given. Government representatives from the countries joining the surveys have prepared the reports and the summaries. In Chapters 3-4 in this publication, the comparative results and findings from the surveys are presented and discussed, while Chapter 2 brings the main contents of the framework of the project on Fiscal Design surveys, as carried out during 1999-2000.

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© OECD 2002

2. FISCAL DESIGN SURVEYS – SUBSTANTIAL AND METHODOLOGICAL FRAMEWORK 2.1. Fiscal Design across Levels of Government – General policy issues It is generally agreed that fiscal decentralisation results in a number of economic welfare gains. Local needs and preferences for public services are believed to be best met by local, rather than national, governments. Letting local needs for services be tested by willingness to mobilise local revenue is assumed to be the most efficient way, in terms of allocation, of organising public finance. Seen from the national perspective central governments can re-address demands for additional public services to the subnational governments. Under the proper arrangements, the devolution of expenditures can take away local pressure on the national government’s budget and stabilise public finances in general. With efficient local tax administrations the devolution of revenues to subnational governments might further enhance the likelihood of successful results in the macroeconomic fields, due to the fact that the subnational levels have had their “basis of accountability” enhanced. Bringing the positive political and economic effects of fiscal decentralisation into reality, however, requires a number of prerequisites. The match between responsibility and competence within the jurisdiction of the subnational government is a fundamental condition. This means that the authorities are vested with real and powerful instruments for setting expenditure targets and making priorities within these targets, just as the revenue sources must be sufficient for covering the fiscal needs. Careful consideration of the mix of expenditure and revenue capacities that are assigned to the subnational levels is needed. Seen from the subnational perspective, a double set of conditions has to be met. As part of the fiscal objectives, targets are set on public expenditure and general government finance. The national government must – as the first condition – implement measures on fiscal discipline and constraints for the subnational governments, just as the relevant mix of revenue sources must be reserved for the national government. Depriving central government of broad and powerful revenue sources and/or expenditure responsibilities structurally diminishes the scope for political manoeuvre for the government, especially in the context of regional groupings where the supranational authority constrains fiscal sovereignty. National government must also provide subnational governments with the proper background for the local political and economic processes to be put into operation. Schemes for the equalisation of differences in tax bases and expenditure needs are just two examples. This obligation for the national government also includes the establishment of institutional arrangements for ensuring the allocation efficiency at the subnational level. Incentives for expenditure competition between the jurisdictions, and measures for improving transparency and responsiveness of local operations vis-à-vis the constituencies, are examples in this field. From the national perspective, the targets for macroeconomic stability and sustained growth imply a need for fiscal consolidation, including disciplined public finance, for all levels of government. This circumstance is often intensified by the economic fluctuations which characterise economies in transition. Regarding transfers, even objectively, well-founded, general transfers have a tendency to cause overspending and loss of financial responsibility. Central governments need of a degree of discretionality in setting the amount of transfers. © OECD 2002

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Fiscal Design Surveys across Levels of Government

When designing the distribution of tax sources across levels of governments, sufficient tax instruments have to be reserved for the national governments, due to redistribution objectives, tax efficiency objectives – the optimum exploitation of revenue sources – and the need for financing national policy objectives and national expenditure. A number of factors should be considered when deciding which revenue sources are appropriate for subnational governments. Among factors to be avoided are: mobile tax bases; redistributive taxes; unevenly distributed tax bases; taxes subject to economies of scale; and taxes subject to cyclical fluctuations. The design of transfers constantly needs to be evaluated in order to encourage revenue mobilisation and cost-efficiency in spending activities, at the subnational levels. For example, special and conditional grants – with the primary objective of promoting programmes with a national interest – may take into account measures of expenditure competition and indicators on performance. Finally, the administrative aspects must be considered. A process of capacity-building is needed at the subnational level, since a lack of brand professionals will prevent the full benefits of fiscal decentralisation materialising, for example, the collection of devolved revenue might be lower than scheduled, endangering, at the same time, the preconditions for subnational governments and the targets for public finances. For the CEE economies in transition, this must be seen in connection with the fact that revenue collection in its present form is in its initial phase of implementation. 2.2. Specific design issues to address More specifically, fiscal decentralisation as a reform process involves a comprehensive range of considerations: – Efficient design of fiscal decentralisation: Which functions of expenditures and sources of revenues could advantageously be devolved. – Match between locally managed expenditures and the corresponding revenues. The acceptable level of vertical imbalance, ensuring at the same time local accountability and fulfilment of the national financial policies. – The institutional arrangements for ensuring fiscal discipline and budgetary constraints. – Design of the intergovernmental fiscal relations – the balance between the need for local autonomy and the national targets on equity, and policy standards for locally provided services. – Profile of subnational revenues – composition of revenue base. Taxation vs. user charges. – Profile of subnational expenditures – local vs. national public services. National standard setting vs. subnational discretion in provision of public services. – The administrative design – for optimal collection and exploitation of revenues and for costefficiency of the provided services. – Arrangements promoting political accountability – Transparency and predictability of the local political processes. There is obvious no single or standard solution to these questions. The actual design of local finance and intergovernmental fiscal relations varies from country to country, reflecting actual decisionmaking processes and distributions of political power. The country’s physical and political geography, and historical and cultural traditions are strong structural determinants of actual design of subnational governments’ responsibilities and competencies. Not to mention the configuration of the political system per se – fiscal decentralisation typically varies between federal and unitary political systems.

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The surveys on “Fiscal Design across Levels of Government” are addressing this balance between the subnational and the national/federal financial interests and considerations, within the context of country-specific characteristics and features. © OECD 2002

Fiscal Design Surveys – Substantial and Methodological Framework

2.3. Subnational finance statistics – Levels of government In setting up the framework of definitions and classifications for the surveys, the main purpose has been to be in a position to identify subnational payments and receipts on as disaggregated a basis as possible. Consequently, the framework had to be based on two sets of classification systems: the IMF classifications are preferred when setting up classifications on expenditure, non-tax revenue and grants, whilst tax revenue is based on the OECD definitions and classifications. It has also been considered necessary to draw on both sets of classifications for practical reasons, since a number of countries in this survey will report data to the IMF but not to the OECD. Generally speaking, the OECD statistical publications on Annual National Accounts and Revenue Statistics, and the IMF Statistics on Government Finance are all formulated within the same conceptual framework as the United Nations, A System of National Accounts (SNA). The latest version of SNA (1993) was revised jointly by the United Nations, the IMF, the World Bank, the EU Commission (EUROSTAT) and the OECD. The relevant definitions and classifications are stated in the following publications: the IMF, A Manual on Government Finance Statistics 1986 (GFS) and the OECD, Revenue Statistics 1965-97. As far as tax revenue is concerned, the IMF definitions and classifications are consistent with those of the OECD, cf. Revenue Statistics, Part II, VII. In relation to expenditure, non-tax revenue, grants and accounts on capital items, the general classifications of the OECD National Accounts (based on SNA93) and the IMF Government Finance Statistics are identical, although the actual reported data may differ due to differences in the accounting bases of the two systems. A central issue in the evaluation of policies and practices on fiscal design across levels of government is the identification of subnational autonomy or discretion on expenditure and revenue affairs. In this chapter a framework of concepts and definitions is developed, in relation to the general government finance statistics and to the evaluation of subnational autonomy, by the following categories: levels of government, revenues, intergovernmental financial relations, borrowing, expenditure and finally on administrative affairs. 2.3.1. Activities and institutions constituting “general government” According to the GFS Manual, “The principal function of government is to carry out public policy through the production of non-market services primarily for collective consumption and the transfer of income, financed mainly by compulsory levies on units in other sectors. Thus government performs primarily the functions of supplying public goods and services and fulfilling certain public purposes not for commercial or financial reasons, or, if of a commercial or financial nature, not on a major basis or not primarily for a profit.” This functional definition indicates that units or institutions (public enterprises) selling industrial or commercial services or goods to the public on a large scale or a corporate one, fall outside the general government classification. However, a number of borderline cases arise when government institutions perform, in addition to principal functions, minor, subsidiary functions, which are in character primarily commercial. Examples of such activities include departmental enterprises, and the sale of goods and services, which are regulatory in nature. 2.3.2. Levels of government According to the OECD Revenue Statistics terminology, Central government includes all governmental departments, offices, establishments and other bodies, which are agencies or instruments of the central authority whose competence extends over the whole territory, apart from the administration of social security funds. State, Provincial or Regional Government consist of intermediate units of government and includes all units of government exercising a competence independently of central government in a part of a country’s territory encompassing a number of smaller localities, apart from state, provincial or regional © OECD 2002

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Fiscal Design Surveys across Levels of Government

administrations of social security funds. Intermediate units of government are at present identified in federal countries only, the revenues of regional governments in unitary countries being included with those of local governments. Local government includes all other units of government exercising an independent competence in part of the territory of a country, apart from local administrations of social security funds. It encompasses various urban and/or rural jurisdictions (e.g., local authorities, municipalities, cities, boroughs, districts, etc.). These classifications are set as the general guideline for the survey on fiscal design. However, some form of clarification and specification was sought, in order to supplement the classification. The classification might seem too general when measuring financial autonomy at the various levels of subnational governments. As an example, a clear distinction between regional, intermediate and local level is missing for unitary countries. For federal countries, the same problem exists when considering tiers below the “state level”. This discussion is particularly relevant when focus is on democracy and political development. The local level of government is naturally closest to the citizens and as such of greatest interest while the existing classification, however, primarily is representing a top-down perspective. In designing the surveys it was necessary to ascertain whether the separate levels of government can be considered to exist – whether they have sufficient discretion in the management of their own affairs to distinguish them as separate from the administrative structure of another government. The GFS Manual set up the following negatively-defined criteria for identifying separate tiers of government activities: “A dependent government of some broader governmental unit exists where: – They depend for all or a substantial portion of their revenue on appropriations or allocations made at the discretion of another government. – They lack their own officers. – They must submit budget estimates to another governmental entity which may in turn raise or lower the submitted estimates. A separate existence is not precluded, however, by review of budgets by agencies of higher levels of government or review of government budgets in connection with administration of tax limitations imposed by another level of government. – Important aspects of their administration are controlled by another governmental entity (e.g. requirements for approval of plans and sites, approval of contracts, supervision of personnel administration, determination of scope and scale of activities and the like). Supervision by a higher level of government is to be distinguished from control by higher levels.” Within these criteria, however, a range of subnational governments may exist in each country, expressed by variations in functional responsibilities, economic resources and the size of the governments. Considering each level of government – regional and local levels – a number of different governments may, in this way, exist at the same horizontal level and they may be vertically connected by supervisory arrangements and tax-sharing or grants systems. 2.3.3. Taxes In the OECD classification the term “taxes” is confined to compulsory, unrequited payments to general government. Taxes are unrequited in the sense that benefits provided by government to taxpayers are not normally in proportion to their payments. Data are generally reported on a cash basis, reflecting the actual amount of revenue that is available for the government in the considered period. This is different from the accrual principle where the revenues are summarised by receipts that are accrued in the period considered.

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In evaluating local autonomy, the essential question concerns the separation of tax revenues across levels of government. This is particularly the case for shared taxes and grants. The OECD Revenue Statistics identifies a system of “Attribution of tax revenues” with the following principles for distribution of revenue between the collecting and the beneficiary government. © OECD 2002

Fiscal Design Surveys – Substantial and Methodological Framework

“As a general guide tax revenues are attributed to non-collecting beneficiary governments: – when they have exercised some influence or discretion over the setting of the tax or distribution of its proceeds; or – when under provisions of the legislation they automatically and unconditionally receive a given percentage of the tax collected or arising in their territory; or – when they receive tax revenue under legislation leaving no discretion to the collecting government. A number of more specific rules may be set down as guidelines for the attribution of tax collection among collecting and beneficiary governments. – The revenue of taxes is not distributed to any government other than that collecting it should be shown as tax revenue of the collecting government. – The revenue of taxes which a government collects and unilaterally earmarks at its discretion for distribution to another government should be shown as tax revenue of the collecting government. – The revenue of taxes which a government collects on behalf of another government with the beneficiary government unilaterally determining the amount of the tax or distribution of its proceeds, should be shown as tax revenue of the beneficiary governments. – The revenue of taxes collected by one government and transferred to another with the amount of the tax or distribution of its proceeds decided upon jointly by both governments, or on the basis of the tax collected or arising in the territory of the beneficiary government is to be shown as tax revenue of the ultimate beneficiary government. – If a central or regional government authorises or requires local collection of a particular tax, a part or all of which is automatically retained by the collecting government, the local share is shown as tax revenue of the collecting government.” With the purpose of solving a number of these problems of classification the Working Party No. 2 of the Committee on Fiscal Affairs at the OECD has taken an initiative to develop a new system of classification regarding own taxes of subnational government (SNG). Taxes of subnational governments are subdivided into categories of decreasing tax autonomy and then ranked by decreasing order of control, that the SNG’s can exercise over this revenue source: (a) (b) (c) (d)

SNG sets tax rate and tax base; SNG sets tax rate only; SNG sets tax base only; SNG sets tax base for SNG and central government tax(es);

(e) (e.1) (e.2) (e.3) (f)

revenue sharing arrangements; revenue-split can only be changed with consent of SNG; revenue-split fixed in legislation, may unilaterally be changed by central government. revenue-split determined annually by central government as part of the budget; central government sets rate and base of SNG tax.

For further information on the system of classification, please address OECD Revenue Statistics 1965-98, the chapter on “Special features”, and “Taxing Powers of State and Local government” OECD Tax Policy Studies, No. 1, 1999. The main distinction of the classification is between “a-d” on the one hand and “e-f” on the other. By revenue sharing, the assessment and collection is undertaken by the national level of government and the distribution of the yields is made across different levels of governments on a predetermined basis. Alternative arrangements for changing the distribution can be identified – cf. e.1-e.3. Revenue sharing is to some extent similar to transfers – collected tax revenue is made available for subnational governments by another level of government. Unlike transfers, however, revenues from shared taxes are traditionally of a (quasi-)permanent nature, with the entitlement to a share in the revenue set by law or even the constitution (typically federal states) and the proportion of the revenue is set as a fixed percentage. © OECD 2002

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Fiscal Design Surveys across Levels of Government

Regardless of the specific arrangements, shared taxes weaken the political accountability of subnational governments. Governments not being allowed to set own tax rate or tax base do not have the incentive of balancing local needs and revenue mobilisation, although the extent of this weakening depends on the political process in play. The composition of the revenues, by type. In the OECD Revenue Statistics the classification of receipts is generally governed by the base on which the tax is levied: – Income, profits, and capital gains. – Social security contributions. – Payroll taxes. – Taxes on wealth and property. – Taxes on consumption. – Other taxes. In the context of subnational governments taxes on personal income, property and consumption are in a number of countries considered as proper types of subnational taxes. 2.3.4. Non-tax revenues The IMF definition covers on a gross basis receipts of fees and charges paid in exchange for noncapital goods and services which are not of an industrial nature and receipts from departmental enterprise sales to the public whose costs are not separately identifiable. This category includes both payments in exchange for goods and services of a non-regulatory nature and compulsory payments for regulatory services. Fees and charges out of all proportion to the cost or distribution of government services provided to the payer are classified as taxes rather than in this category. The classification of non-tax revenue is determined by the nature of the base on which the tax is levied, or the kind of action which creates the liability, for example sale or income: Entrepreneurial and property income – Cash operating surpluses of departmental enterprise sales to the public with a surplus. – From non-financial public enterprises and public financial institutions. – Other property income. Administrative fees and charges Fines and forfeits Contributions to government employee pensions and welfare funds within government – Employees. – Employer contributions from other levels of government. Other non-tax revenues As seen from the classification, a number of economic relations to non-government activities are included. An annex to the questionnaire provided a further classification of institutions (departmental enterprises and public enterprises) and the registration of the economic relations in connection with these organisations.

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Fiscal autonomy in relation to non-tax revenue. Subnational governments often have the choice of charging users for the provision of the service. It is generally agreed that user charges represent a very favourable “institutional characteristic” – the charge is setting the price for the service and thus testing the local demand or need of it. On the other hand, a number of cases exists where the – unrestricted application of – user charges is undesirable, due to the redistributive effects and/or the merit aspects of public subnational services. © OECD 2002

Fiscal Design Surveys – Substantial and Methodological Framework

When evaluating local discretion revenues (gross and net), they will be classified according to the legal regulation on charges in relation to subnational service production. Such groups are basically: A. Activities where the user charge is supposed to match the expenses for the service. The net revenue of these activities must be supposed to be insignificant. B. Activities where the charge or the rate is calculated to cover a smaller part of the expenditures. (Services with social benefits, where subnational governments are deficit-financing – subsidising – the activities). C. Activities which aim at creating a commercial surplus for the subnational government. For public-owned enterprises the central question is whether these enterprises operate on (forms of ) market conditions or on “monopoly” conditions. 2.3.5. Intergovernmental financial relations Insofar as deficit-financing is not allowed the vertical imbalance is covered by grants from the national government. In the IMF, Government Finance Statistics, the concept of grants covers non-repayable unrequited payments received from other governments or international institutions. Grants encompass reparations and gifts given for particular projects or programmes, for general budget support or for any other purpose. The term grants is utilised here to refer to transfers between governments or international institutions. It may include transfers of the proceeds of taxes levied by one level of government and transferred to other levels of government. This category would also include block grants, all-purpose grants or matching grants which are not given for purposes of fixed capital formation. Grants are distinguished from loans by the absence of an obligation to repay. Classification of grants in relation to local autonomy. The main distinction is between general grants and specific grants. Within each category, different arrangements can be identified, related to varying policy mandates and objectives from national government and the specific form of distribution of the grants (degree of discretionality). The classification is as follows:

– General purpose grants are those which can be used as if they were the receiving subnational government’s own tax revenues. Their use is limited only by the possible distinction between capital and current uses. Sometimes they may be of a capital nature, but they are not meant for specific investment projects for sectors. Shared taxes are not included in this category. Specific grants, which are earmarked for certain purposes, but the amount of which is so small that they can in no case cover the local expenditure completely and which are distributed according to objective criteria are to be included under this heading. Related to objective criteria, means grants which are distributed according to some measures of taxable capacity and/or expenditure needs. Also this heading covers grants which have historically been distributed in a certain way and id the case of which legal or administrative limits or established custom are seen as preventing governments from changing the distribution of the grant very much from year to year. Grants related to the recipient’s own tax effort are not included here, but under the following heading. Related also to own tax effort are grants related to objective criteria and to an authority’s own tax effort in such a way that an increase in the level of local taxation for a given authority results in an increase in the amount of grant for that same authority. 15

© OECD 2002

Fiscal Design Surveys across Levels of Government

– All other grants are classified as specific grants. Conditional grants are those where the amount of grant (seen as revenue for each authority) depends on the expenditure of that same authority. They may be typically a predetermined percentage of the authorities’ own expenditure. Note that grants whose overall amount, seen as central government expenditure depends on total local spending are not for this reason to be classified as conditional. At standard costs means that the percentage refund only covers a certain standard cost or some similar amount. If local expenditure exceeds this amount a reduced grant, or no grant at all, is given. At actual costs, no limit as to standard costs or the like exists. Not that this included 100 per cent grants. Sometimes such a 100 per cent grant is given because the local authority acts only as an administrative agent carrying out a precisely defined function on behalf of central government. Under the heading of discretionary grants are included grants which the government may or may not distribute, and which are distributed at the discretion of the government according to the particular circumstances of he authority in question. Normally, there would be no general criteria for the distribution of such grants.

The indicators are summarised in Table 2.1: Table 2.1. Classification of grants Specific Grants

Country

Level of government

General Purpose Grant

Current or both

Objective criteria Total

Capital

Conditional Standard costs

Actual costs

Not conditional

Without own With own tax tax effort effort

Discretionary

It should be noted that design of grants arrangements as an instrument of national policy setting must be evaluated closely together with assignment of expenditures. Instead of using specific grants or discretionary grants national governments might obtain the same objectives by setting standards for local services or through other means. Cf. sections on expenditures below. 2.3.6. Borrowing Borrowing for financing investment outlays has certain advantages as a method of subnational finance. Subnational governments normally have limited fiscal capacity. Distributing the costs of the capital investments over a number of years imply that the taxpayers benefiting from the services are “fairly” contributing, year by year. The central issue is the national governments regulation on borrowing – Regulation on purpose (current expenditures and/or capital installations), on criteria and control mechanisms, on admission to alternative structures of loan-raising, etc. Key design questions on local autonomy regarding borrowing are: – Legal restrictions: • Authorisation by central government, provincial government or other bodies? • Purpose and scope. Current expenditures? Capital installations? Restricted to specific sectors? 16

• Guidelines/restrictions on terms of loans. The form of redemption, the interest pattern, the term, annuity vs. serial loans, etc. © OECD 2002

Fiscal Design Surveys – Substantial and Methodological Framework

• Admission to loan markets? National and/or abroad? Special municipal finance institutions? • Provision of security. National liability? State/provincial guarantees? – Measures for national control on subnational governments with financial problems: • Supervisory administration: Forms of bailouts for governments in economic crisis?, Can local governments go bankrupt? • Tax increase? Moratorium? Etc. – Figures on borrowing and debt by subnational governments: • For each year: gross and net long-term borrowing; gross and net short-term borrowing; capital revenue, including proceeds from the sale of assets. • For the end of latest year: long-term debt; short-term debt; and financial assets. 2.3.7. Expenditures In the surveys, expenditures are distributed by function and economic category. Expenditures by function. The expenditures are characterised by the traditional COFOG classification from the System of National Accounts, and used by the OECD in the Annual National Accounts, and by the IMF in the Government Finance Statistics. The 14 major groups of function may be broken down into subgroups, reflecting the means or programmes by which the general objectives of government are implemented. Such 2- or 3-digit classifications would be able to report data by level of policy programme or subprogramme. When completing the standard templates the countries were asked to report the data figures on as disaggregated a level of function as possible, according to data availability and validity. As a guideline, the most significant fields of expenditure for the level of government in question should preferably be broken down into the functional level of “subgroup”/the level of policy programme. This indicates that a minimum of 6-8 disaggregated functions should be presented. With a view to providing an introductory overview of the general distribution of responsibilities and powers across levels of government, the countries were asked to include a written description which takes into account the legal basis for the subnational activities. The presentation was to be based on aspects such as: – Which level is competent. Overall competence/competence shared with other levels. – General indications on competence e.g. direct or indirect exercise of responsibility; mandated vs. “omnipresent” competence. In the preceding sections, a number of indicators on fiscal autonomy have been described in relation to revenues of subnational governments. Strong local revenue performance probably tends to be positively correlated with local discretion in control of expenditures, but no such relation can be taken for granted. Similarly, it may be assumed that a large share of subnational government in total government spending is associated with decentralised responsibilities and competencies. Such a relationship can, however, not be assumed to exist automatically or proportionally, since “share of expenditures” not per se is equivalent to local control and responsibility. Indicators on subnational vs. national control over subnationally executed expenditures must be based on descriptions of the political and administrative framework for the local services, sector by sector. A first general overview of these conditions can be arranged within the following two headings. To be comparable, however, the descriptions need to be developed specifically for each sector of subnational activities: Public transportation, refuse collection, local libraries, fire fighting, primary education, public health and hospitals as examples (cf. also Table 2.2). © OECD 2002

17

Fiscal Design Surveys across Levels of Government

Table 2.2.

General framework for sector – specific descriptions of local discretion in providing public services Subnational discretion

National control

Arranging the service – Policy formulation

• Admission to set level of and composition • Mandated activities: Rules and standard of services ? setting for coverage and service levels. • Discretion in contracting goods and services. General or specific orientation. • Budget co-operation: Setting general budget frames or specification on targets/sectors.

Provision of the services

• Control by performance- or input indicators. • Clearly delineated responsibilities, in relation to other tiers of government. • Design of expenditure competitions: • Ownership of enterprises. Mechanisms for outsourcing, for example. • Discretion in recruitment and pay • Rules of economic management: of personnel. Standardisation of budget- and accounting • Admission to negotiate agreements system, as an example. and settlements on wages and employment conditions.

2.3.8. Subnational administration and accountability As mentioned the subnational administrative capacity and subnational governments accountability vis-à-vis their constituencies make two main prerequisites for the positive outcome of the devolution of spending responsibilities and revenue sources to subnational levels. Design issues to be addressed will be: – Identification of the measures taken to ensure the appropriate administrative structures and capacities. – Measures for fiscal transparency: Public information on government fiscal decisions and activities. – External, independent control – Auditing and similar procedures. – Systematic measures for public participation in the delivery of the services, including client surveys. – Measures from central government to encourage to administrative development for leaning the services – Self-regulatory mechanisms and market testing of the services, as two examples. 2.3.9. Summing up – The overall framework of the Fiscal Design surveys As appears throughout Chapter 2 the framework on specific design and arrangements of subnational finance and intergovernmental financial relations are set up on two “levels”: – Level 1: Basic government finance statistics for the subnational levels, covering comparative figures on subnational government revenue, including grants and expenditure. The figures are based on existing international definitions and classifications. Different to existing international statistics figures are sought distributed by additional levels of government and by additional information on the functional distribution of government finance issues. – Level 2: Qualitative country statements on the specific mode of subnational financial decisionmaking. By examples, the subnational discretion in financial decision-making and issues of the national fiscal control policies.

18

The two levels are also reflected in the layout of the surveys and in the structure on this publication. On the latter topic, in Chapter 3 the Level 1-data from the surveys are presented while Chapter 4 brings and discuss the qualitative issues on national control and local autonomy in the six survey countries. © OECD 2002

3. SUBNATIONAL GOVERNMENT FINANCE – COMPARATIVE FINDINGS 3.1. Introduction In this chapter, main findings on the level and composition of subnational expenditure and revenue are presented for the six survey countries: The Czech Republic, Estonia, Latvia, Lithunia, Hungary and Poland. The findings cover specifically the following dimensions: – Profiles of subnational revenues. – Profiles of the tax and revenue autonomy of subnational governments. – Profiles of subnational expenditure. In the surveys, the countries were asked to report the figures in two main levels of government: regional and local. In the absence of a regional tier of government, and if capitals and/or urban areas had functions/responsibilities which differed from “local governments”, such areas could be identified separately and included as one of the two tiers. The six countries reported data across the following subnational tiers: – The Czech Republic, Lithuania and Estonia identified one tier of subnational government: local (municipal) government. All three countries have got an intermediate regional level between the central government and the municipalities. They have reported, however, that the “regions” do not have self-government functions, and are therefore not considered to be an independent government level. The intermediate regional level is treated as part of the central government. It is to be noted, however, that according to the Czech report, regional Czech governments started operating at an independent government level this year, 2001. In the Czech Republic and Lithuania, the municipalities are the only level of local government, whilst in Estonia, the local government sector consists of towns and rural municipalities (with the same set of responsibilities) which again can be divided into municipal districts with a limited right to self-government. According to the Hungarian report, the Hungarian system is characterised by a one-tier subnational local government. “In terms of type, a local government may be a municipal government (that of a village, town, county-rights town, the capital city and its districts) or a county government.” – Latvia identifies three tiers of subnational government: rural municipalities and towns, local urban governments (called Republican cities or big cities) and regional governments. The regions are considered a separate tier of government, according to the classification: own separate and independent budgets, with an indirectly elected political Council and nearly 100% financed by state grants. In this survey, Latvia has aggregated its subnational fiscal data from three levels into two, i.e. rural municipalities and towns and local urban governments have been aggregated to represent the local government level, although strictly speaking their functions are not identical: Rural municipalities which govern the less developed areas in the countryside have got fewer functions to accomplish than their urban counterparts. – In Poland, subnational government has comprised three levels of subnational authority, since 1999: gminas and poviats as two levels of local government, and voivodships representing regional government. No subordination exists between these three administrative tiers. © OECD 2002

19

Fiscal Design Surveys across Levels of Government

According to the Polish report, GFS-compatible data for local and regional levels have only been produced since 2000. Therefore, Poland has not been able to aggregate its three subnational levels into two but instead has aggregated the data of all the subnational governments into one level (“local government”). – In the Danish test report from 1999 two tiers were identified: regional and local government. The capital city authorities have the status of both regional and local governments but, for a mixture of reasons, it was more convenient to classify these as local governments. With regard to the data reporting, only Latvia has been able to report data on two tiers, whilst in the other countries where two tiers of subnational self-government exist, reporting on one level was the only feasible solution, primarily for technical reasons. In this chapter, for comparative reasons, data are presented and discussed on “subnational levels of government”. This means that the Latvian figures on regions have been added to the Latvian local government figures. 3.2. Profiles on subnational revenues

20

Table 3.1 summarises the revenue profiles of the six countries. With regard to the size of subnational governments – indicated by share of subnational revenue out of GDP in 1999 – the countries seem to fall into two groups. Latvia, Hungary and Poland are centred around 11-12% of GDP, while the subnational revenues in the Czech Republic, Estonia and Lithuania make up about 7.3-8.6% of GDP. When considering total subnational revenues out of consolidated government revenues, the same pattern appears. By this proportion of subnational revenues out of GDP, Latvia, Hungary and Poland are just in the average of OECD unitary states (1997) where 11.5% of GDP was attributed to subnational governments. Interpretation of the latter information, however, should be made cautiously. Due to the ongoing transition of the public sector in CEE countries, public expenditure and revenue make up a relatively large share of GDP compared to OECD countries. There seems to have been some development in fiscal decentralisation for the period considered. In Poland, the subnational proportion of total government revenues has expanded by more than a third, for the Czech Republic and Estonia, there has been an increase of 10 percentage points, whilst in Hungary, the proportion remained unchanged during 1997-1999. Lithuania, however, reported a decrease in the proportion of local revenues out of total revenues. The composition of subnational revenues varies a great deal between the six countries, and also compared to the unweighted average for OECD unitary countries. The latest reported profiles from 1999 show that Lithuania and, to a lesser extent, Estonia focus primarily on tax revenues for the financing of subnational government. The proportion of the overall revenues in 1999 make up 91% and 68% respectively, compared to 48% in the Czech Republic, 56% in Latvia, 25% in Poland and 33% in Hungary. The OECD average is 43% (for 1997). On non-tax revenues, compared to the OECD average, the Czech Republic is somewhat above, with Poland, Latvia and Hungary on levels close to the average, and Lithuania and Estonia somewhat below the average. In relation to grants, about half of the revenues in Poland and Hungary are made up of grants, which is somewhat above the OECD average of 38%, whilst the rest of the countries report proportions well below the average. The distribution of the country reporting with regard to the composition of local tax revenues by tax base is shown in Table 3.2. With regard to 1999, Lithuania, Estonia and the Czech Republic reported a biased focus on one tax base with 90% and more of local taxes based on taxes on income, profits and capital gains. This is more than double the OECD average of 41%. When taking into consideration the information in Tables 3.1 and 3.2, it can be said that more than 80% of all revenues of local governments in Lithuania is based on this tax base. Taxes on property (category 4000) are traditionally considered as an important and valuable local tax base. Almost 40% of the tax revenue for subnational governments in Poland is based on this source, which is well above the OECD average of 33%. For the other five countries, the share of local taxes from property is much lower than the average. In the Czech Republic, the revenue from this tax base makes up about 1% of overall tax revenue. © OECD 2002

© OECD 2002

Table 3.1.

Profile of subnational revenues: Composition by revenue source Share of national government revenue and GDP, 1997-99 Composition of subnational revenues (%)

Tax revenues

Non-tax revenues

Share of total subnational revenues in consolidated national government revenue

Grants

Share of total subnational revenues in GDP (tax revenue)

1997

1998

1999

1997

1998

1999

1997

1998

1999

1997

1998

1999

1997

Czech Republic

54.9

55.6

47.7

26.4

26.8

36.3

18.7

17.5

16.0

18.0

18.3

20.8

Hungary

28.1

30.6

33.0

18.1

18.0

17.0

53.7

51.3

50.0

26.6

27.4

26.7

Poland

37.6

36.4

24.5

28.0

27.8

24.2

34.3

35.8

51.3

21.1

21.6

28.8

Estonia

64.6

67.7

68.4

12.9

9.3

9.1

22.5

23.0

22.5

20.0

21.0

22.1

Latvia

53.9

54.0

56.0

20.7

21.4

20.4

25.3

24.6

23.6

25.3

25.3

26.0

Lithuania

65.7

74.1

91.0

4.7

4.0

4.8

29.6

21.8

4.1

24.2

25.8

22.8

OECD. Unweighted average Unitary states

43.4

–

–

21.7

–

–

38.3

–

–

–

–

–

7.15 (3.9) 11.3 (3.2) 9.4 (3.5) 7.8 (5.0) 9.9 (5.3) 7.5 (4.9) 11.5 (5.0)

Source:

1998

7.2 (4.0) 11.5 (3.5) 9.3 (3.4) 7.7 (5.2) 10.5 (5.6) 8.3 (6.2) –

1999

8.6 (4.1) 11.1 (3.7) 12.0 (2.9) 7.8 (5.4) 10.8 (6.0) 7.3 (6.6) –

Revenue Statistics, 1965-1999, Paris 2000.

Subnational Government Finance – Comparative Findings

21

Fiscal Design Surveys across Levels of Government

Table 3.2.

Classification of local taxes by tax base (in %), 1999

Czech Republic

1000 Taxes on income, profits and capital gains 2000 Social security contributions 3000 Taxes on payroll and workforce 4000 Taxes on property 5000 Taxes on goods and services 6000 Other taxes Total Source:

Hungary

Poland

Estonia

Latvia

Lithuania

89.4 – – 5.6 4.9 0.1

45.0 – 0.3 13.9 – 40.8

56.7 – – 39.6 3.6 0.1

90.7 – – 8.6 0.7

77.4 – – 21.0 1.6 –

91.3

100.0

100.0

100.0

100.0

100.0

100.0

8.7

OECD unweighted average for unitary countries, 1998

40.8 – – 32.5 16.3 10.3 100.0

OECD benchmarks: Revenue statistics, 1965-1999, Paris 2000.

3.3. Profiles on tax and revenue autonomy of subnational governments As referred to in Chapter 2, the issue on local discretion in financial decision-making is a central theme in the questionnaire for the survey. The country data on this issue are summarised under the following three headings: – Own tax revenue, Table 3.3. – Classification of grants in relation to subnational autonomy, Table 3.4. – Overall presentation of own revenue sources, Table 3.5. 3.3.1. Own tax revenue In identifying own taxes of subnational governments, the essential question concerns the separation of tax revenues across levels of government. The OECD has taken the initiative of developing a new system of classification regarding own taxes of subnational government (SNG). Taxes of subnational governments are, here, subdivided into categories of decreasing tax autonomy and then ranked by decreasing order of control that the SNG’s can exercise over this revenue source: (a) SNG sets tax rate and tax base; (b) SNG sets tax rate only; (c) SNG sets tax base only; (d.1) SNG determines revenue-split; (d.2) revenue-split can only be changed with consent of SNG; (d.3) revenue-split fixed in legislation, may unilaterally be changed by central government; (d.4) revenue-split determined annually by central government as part of the budget; (e) central government sets rate and base of SNG tax. In cases (a) – (c), the subnational government has total or significant control over its taxes. In the remaining cases, involving tax-sharing arrangements, its tax autonomy is very limited or non-existent.

22

With reference to the results in this survey – Table 3.3 – when considering “own taxes” – categories a-c where local government has control over the tax base and/or tax rate – Hungary and Poland report a very large share of local taxes under these headings, for 1999. In Hungary, 50% of the tax revenue is characterised by local control over the tax rate and tax base, whilst in Poland, 40% of the tax revenue covers taxes with local discretion on the tax rate. For Hungary and Poland, the local tax revenue as a proportion of total government tax revenue equalled 10% and 8%, respectively. The Czech Republic and Estonia can be “classified” in a second category, reporting 10% of local taxes as own taxes, while the remaining 90% are dealt with as a tax-sharing arrangement with central government. For Latvia and Lithuania, no own tax revenue is given, since the tax rate and tax base are 100% set by central government. © OECD 2002

Subnational Government Finance – Comparative Findings

Table 3.3.

Tax autonomy at the subnational government level: degrees of control given as percentages out of all tax categories

Subnational government taxes as % of total tax revenue

a

Czech Republic 1997 1999

10.8 11.1

2.2 2.7

Hungary 1997 1999

8.9 10.4

Category

b

c

d.1

d.2

d.3

d.4

e

6.0 5.6

– –

– –

– –

91.8 91.7

– –

– –

43.5 49.2

– –

– –

– –

– –

– –

56.0 50.8

Poland 1997 1999

9.1 8.3

– –

39.3 41.9

0.7 0.6

– –

– –

60.0 57.6

– –

– –

Estonia 1997 1999

14.6 16.2

– –

9.8 9.2

– –

– –

– –

90.2 90.8

– –

– –

Latvia 1997 1999

15.7 17.1

– –

– –

– –

– –

– –

– –

– –

100 100

Lithuania 1997 1999

16.7 22.0

– –

– –

– –

– –

– –

– –

– –

100 100 100

The publication, Taxing Powers of State and Local Government (OECD Tax Policy Studies, No. 1, 1999), reports the results of a survey of 19 OECD Member countries (including the Czech Republic, Hungary and Poland), based of the same classifications as in this survey. No distinct pattern across states can be identified. The profile of Poland and Hungary is, to some extent, parallel to the situation for local governments in Portugal and Germany (a federal country), whilst the design of local taxes in Latvia and Lithuania seems not to have a parallel in OECD survey countries. 3.3.2. The system of grants in relation to subnational autonomy In the questionnaire for the survey, the main distinction is set between general grants and specific grants. Within these categories, different arrangements can be identified relating to varying policy mandates and objectives from national government, and the specific form of grant distribution (degree of discretionality). General-purpose grants are those which can be used as if they were the receiving subnational government’s own tax revenues. Within this category, grants related to objective criteria are those which are distributed according to some measure of taxable capacity and/or expenditure needs, whilst grants also related to own tax effort are those related to objective criteria and to an authority’s own tax effort in such a way that an increase in the level of local taxation for a given authority results in an increase in the amount of grant for that same authority. Under the heading, Specific grants – conditional grants are those where the amount of the grant (seen as revenue for each authority) depends on the expenditure of that same authority. At standard cost means that the percentage refund only covers a certain standard cost or some similar amount. If local expenditure exceeds this amount, the grant is reduced or not given at all. At actual cost, there is no limit as to standard or similar limits but this does not include 100 per cent grants. Sometimes, a 100 per cent grant is given because the local authority acts only as an administrative agent carrying out a precisely defined function on behalf of central government. Discretionary grants, on the other hand, include grants which the central government may or may not distribute and which are distributed at the discretion of the government according to the particular circumstances of the authority in question. Normally, there are no general criteria for the distribution of such grants. © OECD 2002

23

Fiscal Design Surveys across Levels of Government

Table 3.4.

Profile of grants to subnational governments (in %)

Specific grants

General purpose grant

Current

Total

Grants as proportion of total local revenue

100 100

18.7 16.0

3.7 3.4

100 100

53.7 50.0

63.1 60.6

100 100

34.3 51.3

64.4 59.8

100 100

22.5 22.5

Objective criteria

Conditional

Without own tax effort

Total

Total

41.2 37.2

46.0 46.8

100 100

95.0 94.2

1.7 0.6

0.6 1.8

97.3 96.6

Poland 1997 1999

12.5 14.3

24.4 25.1

Estonia 1997 1999

35.6 40.2

35.6 40.2

Latvia 1997 1999

87.2 90.0

87.2 90.0

12.7 10.0

12.7 10.0

100 100

25.3 23.6

Lithuania 1997 1999

57.0 12.7

61.6 45.2

38.4 54.7

38.4 54.7

100 100

29.6 4.1

Actual costs

Czech Republic 1997 1999

12.8 16.0

Hungary 1997 1999

4.6 32.5

36.9 39.4

With own tax effort

Discretionary

Not conditional

Standard costs

0.6 0.6 63.1 60.6 64.4 59.8

2.1 2.8

Parallel to the findings in Table 3.3, the reporting of the countries in Table 3.4 can be “grouped” into three types: for the Czech Republic and Hungary, almost 100% of the grants are reported as specific grants. In Hungary – where the grants make up about 50% of the overall subnational revenues – 95% of all grants are given as conditional, specific grants, based on standard costs. For the Czech Republic, the specific grants are distributed with approximately 50% as conditional grants and 50% as unconditional grants. For Latvia and Lithuania, in 1997, 60-65% of the grants are classified as tied resources i.e. as specific grants, whilst the remaining part is distributed as general purpose grants. For Lithuania, in 1999, however, a large part of the grants was “generalised”, leaving a proportion of 45% as specific grants. In Latvia, the opposite trend was seen, in 1999. In Estonia and Poland, the distribution of grants seems tied to central government to a lesser extent than for the other four countries. 60% of the grants are distributed as general purpose grants, and 40% as specific grants. It should be noted that grants make up a relatively large share of subnational revenues in Poland (about 50%), whilst in Estonia, the proportion is at an “average” level of 20-23%. With the changes from 1999, as mentioned, Lithuania is also close to the profile of these two countries. However, as illustrated in Table 3.1, in Lithuania, the proportion of grants out of total revenues is disproportionately small. 3.3.3. Overall presentation of own revenue sources The findings in Tables 3.3 and 3.4, together with other information on subnational revenues (Table 3.1), are summarised in Table 3.5. The total subnational revenue is classified into the categories “own revenues”, “other free revenues” and “tied revenues” – cf. Table 3.5.

24

There does not seem to be an overall pattern of “revenue autonomy” across the countries. The profile of revenue sources across the subnational revenue base differs to a large extent, just as the deciding power for setting the base and rate of taxation and the grant designs, is very unevenly distributed across the countries. © OECD 2002

Subnational Government Finance – Comparative Findings

Table 3.5.

Local government

Summary of profiles of current revenue, 1999 % of financing Czech

Republic1

Hungary

Poland

Estonia

Latvia

Lithuania

I. Own revenues Own taxes, category a – c Non-tax revenue

40.2 (3.9) (36.3)

33.3 (16.3) (17.0)

35.2 (10.6) (24.6)

15.4 (6.3) (9.1)

20.4 (0.0) (20.4)

4.8 (0) (4.8)

II. Other free revenues General grants Tax sharing , category d – e

43.8 (–) (43.8)

18.5 (1.7) (16.8)

44.9 (30.5) (14.4)

75.5 (13.4) (62.1)

58.4 (2.4) (56.0)

93.3 (2.3) (91.0)

III. Tied revenues Specific grants

16.0 (16.0)

48.2 (48.2)

19.9 (19.9)

9.1 (9.1)

21.2 (21.2)

1.9 (1.9)

100

100

100

100

100

100

Total

1. The proportion of non-tax revenue out of total revenue was extraordinarily high in 1999. For the figures on 1997-98, please refer to Table 3.1.

However, when referring to the findings in Table 3.5, there do seem to be some common features. In the Czech Republic, Hungary and Poland, own revenues make up a large proportion of total revenues, unlike in Estonia, Latvia and Lithuania. For the former three countries, the proportion is between 33% and 40%, whilst in Estonia, Latvia and Lithuania, own resources make up 15%, 20% and 5%, respectively. The profile of own revenues, however, seems very different across the first group of countries. In the Czech Republic non-tax revenues make up about 90% of own revenues, as against to about 66% in Poland and approximately 50% in Hungary. The major part of subnational revenues in Estonia, Latvia and Lithuania are classified in the next category, “other free revenues”. Tax sharing arrangements or taxes set wholly by central government make up between 56% and 91% of the overall revenues in the three countries. Poland and the Czech Republic report about 45% under this category, whilst less than 20% of the revenues for subnational governments in Hungary are raised under this category. Finally, when considering “tied revenues”, Hungary reports approximately half of the revenues as tied revenues, whilst Lithuania, at the other extreme, reports 2%. In between, in the four remaining countries, this part of subnational revenues makes up 10% to 20%. To summarise Table 3.5, from an overall perspective, Poland and the Czech Republic seem to have parallel profiles, as do Estonia and Latvia. The own revenues profile of Hungary and Lithuania seems to deviate from that of the rest of the countries, on more basic terms. 3.4. Summary of regional fiscal design in Latvia As mentioned at the beginning of this chapter, Poland and Latvia are the only countries with a regional self-government level. However, only Latvia was able to report data on regional government finance. The profile of regional revenue sources in Latvia is summarised in Tables 3.1 and 3.5 of the Latvian country report. Seen across the three reported years, some fundamental change in the composition of the revenues seems to have taken place. Regional governments depend largely on grants, which made up 73.1% of all their revenues, in 1999 this proportion is almost double that of 1997. 83.9% of all grants are reported as specific grants. In 1998-99, no tax revenue was assigned to regional governments. This trend of continued deprivation of “own” revenues is accompanied by a sharp decrease in regional revenues: their proportion of consolidated government revenues dropped by 80% to a minor share of 2.0%, in 1999. The same pattern appears when looking at the share of GDP which, in the same year, made up only 0.8%. © OECD 2002

25

Fiscal Design Surveys across Levels of Government

3.5. Profiles on subnational expenditure As referred to in the presentation of the revenue profiles, the level of decentralised expenditures – seen as the proportion of total government expenditure of which subnational authorities dispose – is somewhat higher in Hungary, Latvia and Poland than in the three other countries: the figures are almost 24%, 24% and 28%, for Hungary, Latvia and Poland, respectively, whilst in the Czech Republic, Estonia and Lithuania the proportion is 18%, 20% and 20%, respectively (see Table 3.6). There are some distinct differences in the composition of expenditure, by policy sector, across the countries (Column A). In the Czech Republic, more than 60% of subnational expenditure is divided between the three sectors of “Housing”, “Transportation and communication” and “General public services”. Such an expenditure profile to some extent reflects the transitional tasks subnational governments are given as part of the Czech Republic’s overall economic transition policies. For further information on this issue, please refer to the sections below on “housing expenditures”. A similar concentration of expenditure, but in relation to quite different policy areas, is found in Lithuania. Almost two thirds of total subnational expenditure is divided between the welfare service fields of “education” and “social security and welfare”. The same pattern, but to a lesser extent, is followed by Estonia. In Poland, Hungary and Latvia, there is a more diversified composition of subnational expenditure. Only in Hungary does health expenditure make up a relatively large part of subnational activities. When considering this area, Hungary seems to have a similar concentration to Lithuania on welfare services, with the proportion of total subnational expenditure to education, health and social security and welfare making up 66-67%. In all countries apart from the Czech Republic, education seems to be an important local policy sector. Education expenditure represents from 33% in Poland and Hungary to 50% or more in Latvia and Lithuania. As shown in Column B of Table 3.6, in these countries, subnational governments dispose of a large proportion of general government expenditure: from 50% in Estonia to 71% in Poland. The same level of subnational proportion of overall government expenditure is found in the “Housing” sector. Although it makes up a minor part of the expenditure for most countries (apart from Poland and the Czech Republic), for all countries, the local proportion of the overall expenditure on housing is between 80% and 100%. In two sub-sections below, a further presentation is given on the fiscal design in these two sectors of “housing” and “education”. Parallel figures from Denmark – one of the survey pilot studies carried out in 1999 – have been added to Table 3.6. For a number of reasons, comparisons between the OECD profiles and the profiles for the six economies in transition should be made with some caution. It appears, however, that in Denmark subnational governments make up a somewhat larger share of total government expenditure than is found in any of the six countries. At the same time, expenditure is even more concentrated on the sectors of welfare service, education, health and social services than in the countries in the year 2000 survey. 3.6. Further information on “education” and “housing” expenditures of subnational governments 3.6.1. Education

26

The Czech Republic has a very distinctive subnational expenditure pattern in comparison with the other five countries. This is particularly obvious in the field of education. Whilst the other five countries have reported education as being amongst the most important subnational policy sectors, in the Czech Republic, education only makes up 10% of local expenditures. The local contribution to overall expenditures in the field of education (18%) is also far below the average of the other five countries (66%). © OECD 2002

© OECD 2002

Table 3.6.

Current subnational expenditures by function, as a percentage of subnational government expenditure (A) and as a share of consolidated general government expenditure by expenditure issue (B) (1999) Czech Republic

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

General public services Defence Public order and safety Education Health Social Security and Welfare Housing and community amenities Recreational, cultural and religious affairs Fuel and energy Agriculture, forestry, fishing and hunting Mining, manufacturing and construction, except fuel and energy Transportation and communication Other economic affairs Other functions Total

Total current government expenditure. Consolidated % of GDP Total current subnational government expenditure. % of GDP

Hungary

Poland

Estonia

Latvia

OECD-benchmark Denmark 1996

Lithuania

A

B

A

B

A

B

A

B

A

B

A

B

A

B

13.5 0.05 2.5 10.0 1.1 9.3 31.7

42.9 0.2 9.8 18.1 1.3 5.1 79.1

14.3 0.05 1.2 32.6 18.6 16.1 8.6

47.2 0.6 7.6 66.2 43.8 11.1

8.8 0.02 5.1 33.9 2.5 10.9 22.8

44.0 0.2 32.6 71.2 7.0 6.8 88.5

13.5 0.02 0.3 40.8 1.2 12.5 10.4

37.5 0.2 0.9 49.2 1.5 7.5 97.7

13.0 – 1.6 49.5 1.1 8.7 10.4

42.2 – 6.3 73.2 2.6 4.9 80.1

4.6 0 0.8 56.3 0.5 16.1 7.9

20.8 0 2.6 68.0 0.7 8.7 100

5.2 0 0.3 16.2 21.5 43.9 0.7

29.0 0 9.3 52.3 98.1 48.8 22.0

6.8 0.04 0.6

54.6 1.8 5.1

4.6 – 0.7

46.5 – 5.2

5.1 – 2.2

74.4 – 32.5

9.0 1.0 0.07

40.6 100 0.6

5.6 0.06 0.1

47.1 50.0 0.6

4.9 3.1 0.01

36.2 94.3 0.02

3.5 0 0.04

57.0 0.2 4.8

0.2 17.7 0.6 5.7 100

9.3 43.7 3.5 42.9 18.3

0.07 1.2 1.0 0.8 100

12.7 12.2 10.6 1.0 23.7

0.6 7.1 0.3 0.6 100

28.0 64.0 18.0 2.3 27.6

– 5.5 1.7 3.8 100

– 18.4 39.4 26.8 19.7

– 4.5 0.2 5.1 100

– 23.0 4.2 39.0 23.1

– 3.4 0.04 2.2 100

– 15.4 1.8 6.2 19.6

0.1 4.6 2.7 1.2 100

12.9 48.0 35.5 4.3 43.9

1

43.0

44.0

43.6

36.2

41.4

32.1

7.9

10.4

12.1

7.1

9.5

6.3

27

Subnational Government Finance – Comparative Findings

B-column: current local expenditure as % of current government expenditure. 1. Social security contributions are included in the figures, but not consolidated. Data is therefore not compatible. Source: FDI 2000, Danish country report.

Fiscal Design Surveys across Levels of Government

Expenditure assignment on education in the Czech Republic In the Czech Republic, education is a shared function between the central and local governments. The responsibilities of each municipality are divided between own responsibilities and delegated responsibilities. Education belongs to the realm of own responsibilities of municipalities. Local governments are responsible for providing children with pre-school education and a 9-year compulsory education. However, teachers are employees of central government which is also in charge of paying their salaries and buying a proportion of school textbooks. In addition, central government supports compulsory and pre-school education through a per-pupil grant, calculated as a percentage of the average operating costs of these schools. A small grant is also assigned to the capital costs of school building renovation. Central government is also responsible for providing higher education and running special schools for handicapped and mentally-retarded children but some big cities also run these. Some local governments provide vocational education facilities, such as music and painting schools, which are partly financed through fees. When a child up to the age of 15 from one municipality attends a school in another municipality, the municipality in which this child resides pays a proportion of the school running costs. Contrary to the Czech profile, Latvia and Poland report the most decentralised assignment of responsibility: – In Latvia, subnational governments assume comprehensive expenditure responsibility for education. They contribute almost three-quarters of national expenditure. Table 3.6 of the Latvian country report clearly shows the distribution of expenditure responsibilities across levels of government: subnational governments are almost exclusively responsible for the provision of primary and secondary education, whilst central government is exclusively in charge of providing higher (tertiary) education. Subnational expenditures for primary and secondary education make up 82% of general government expenditure, the large majority of which (87%) is being paid by local authorities (republican cities, rural authorities and towns). The regions are mainly responsible for the further education of pedagogical staff and for deciding on teaching methodologies. – In Poland, where subnational governments hold an equally high share in national expenditures on education (71%), education is also the most important subnational policy task, making up 34% of regional and local expenditures. Although central authorities and all three levels of subnational government share responsibility in this policy field, it is increasingly a subnational policy domain. The ratios are the result of a significant growth process over the years 1997-99 when subnational expenditure on education rose by 64.7 per cent (nominal growth). Although nominal growth has been seen in almost all areas of local expenditure, it has been highest in the field of education. Self-governing voivodships are responsible for higher vocational schools, poviats for the establishment and operation of special high schools, special secondary schools, high schools and sports schools, whilst gminas are empowered to manage kindergartens, primary schools and secondary schools. The central state, however, merely holds the financial and operational responsibility for state schools, art schools and tertiary education establishments. 3.6.2. Housing

28

The data in Table 3.6 show that housing is clearly a subnational policy field, although its importance locally seems to be relatively small. Only the Czech Republic and Poland report above average ratios. In the Czech Republic, housing and community amenities is the most important local policy sector, in Poland it is the second most important. In the Czech Republic, the sector represents nearly one third of local expenditures, whilst in Poland, the local share is 23%. However, the share of overall expenditures covered by the regional and local governments is even higher in Poland, at 90%, than in the Czech Republic, at 80%. © OECD 2002

Subnational Government Finance – Comparative Findings

A closer look at the two countries shows that the high local proportion is due to the transfer of formerly central state-owned housing to local levels which became almost entirely responsible for the ongoing privatisation process. The high proportion seems to indicate that, compared to the other four countries in transition, the local governments in the Czech Republic and Poland seem largely to have maintained the former state-dominated structure of housing provision. Expenditure assignment for housing in the Czech Republic and Poland Generally speaking, in the Czech Republic, local governments are responsible for housing. Municipalities were transferred almost all housing facilities which were built by the state prior to 1990. However, since there are no national mandates or standards for the provision of subnational services, it is entirely up to each municipality to decide how they want to distribute their funds across the functions. As stated in the Czech report (p. 18), the municipalities have dealt with this newly-enlarged responsibility for housing and community amenities in different ways: Some have rented the housing facilities out, some have sold them. It was up to them which part of the housing stock to keep and which one to sell, and under what conditions. Hence, the situation differs significantly across the country. Flats in municipal houses were sold predominantly to the occupiers of the time. For state-owned houses, there is rent regulation with central government setting the maximum increase in rent, each year. The regulation does not concern the newly built flats financed without central government assistance. In Poland, all the housing stocks that are not in the hands of the State Treasury and are not in private or collective ownership, are owned by gminas. Accordingly, gminas are responsible for most of the maintenance for these state-owned housing stocks, making the repairs and renovations detailed in the Act on Renting Premises and Housing Allowances, of 2nd July, 1994. As the owners of apartments, gminas are also able to sell them.

29

© OECD 2002

4. THE BALANCE BETWEEN NATIONAL FISCAL TARGETS AND SUBNATIONAL FINANCIAL DISCRETION 4.1. Introduction In addition to the overall government finance indicators on subnational governments, as presented in Chapter 3, the country surveys cover a number of matters to do with the specific mode of subnational financial decision-making, including the specific design of intergovernmental financial relations. This chapter describes some of the main findings in the surveys on these issues. The questions on the mode of financial decision-making are compiled under the overall heading of “Setting the balance between local discretion and autonomy in financial decision-making on the one hand, and macroeconomic control and fiscal discipline on the other”. Setting the balance in the power distribution across levels of governments is, of course, at the focus of reform considerations in all countries – in OECD Member countries just as in countries in transition. Indeed, the surveys show that a certain amount of consideration has been given to policy and a number of policy decisions have been taken in the six countries. Reforms are taking place in all the countries, though there are still some outstanding problems and gaps in efficiency. As indicated in Chapter 2 it is generally acknowledged that fiscal decentralisation results in a number of allocative efficiency gains. Local priorities and preferences regarding local public services are best met by allowing for local decision-making on the amount and standard of the services, and the local mobilisation of the relevant revenue sources. In economies in transition, however, political considerations on allocative efficiency should be taken in close connection with overall targets on stabilisation policies for the economy. This also includes political decisions on structural reforms, like labour market reforms, privatisation programmes, etc. Such structural reforms may require a strong central lead of the reform processes, which may, at the same time, imply a halt to furthering the fiscal decentralisation processes. In this survey, for obvious reasons, focus is restricted to the prerequisites for making the allocative gains of fiscal decentralisation a reality. Do central governments impose a “package” of hard budget constraints on subnational governments, to ensure political accountability for local government affairs and overall national fiscal discipline? What kind of regulations and agreements surround the decentralised expenditure and revenue powers, in order to ensure that the positive benefits of economic decentralisation come through, and that the overall national targets on expenditure and financial control policies are met? In the questionnaire and, more specifically, as set out in the sections below, the following questions and issues were raised, in order to identify the country-specific “balances” or designs:

31

© OECD 2002

Fiscal Design Surveys across Levels of Government

Taxation Measures on overall fiscal co-ordination and policy coherency. What kinds of measures are there to ensure co-ordination between central and local tax policies? Are there any national restrictions on local autonomy: targets for each local government on total revenue from a specific source; targets for the range (min./max.) of the specific tax rate; exemptions from the tax bases set centrally; etc.? – Are subnational governments free to decide whether to impose taxes, or are taxes mandatory? – Are they combined with minimum rates (cf. above)? National measures for revenue-efficient local tax administration. Central assistance in general capacity-building of local tax administrations, including central systems in support of local administrations. Central assistance in optimal exploitation of subnational tax sources, e.g. national systems of valuation. Non-tax revenue What kind of overall measures are set up to restrict and control subnational government revenue from non-tax sources? Are subnational governments generally allowed to deficit finance with non-tax revenues? Grants What overall measures are set up to avoid national budgetary pressures from subnational government? How are the annual overall amounts for grants determined e.g. automatically (as set out in substantial law); as a share of current revenue (identity of the revenue e.g. by base); or set as discretionary in the national budget law? How are the grants allocated – cf. the categories identified in the tables. Have reforms taken place due to insufficiencies in the overall design of the system of intergovernmental relations, i.e. the lack of stable, reliable, transparent, well-documented and formulabased relations and procedures? Borrowing Procedures on the bail-out of subnational governments. To what extent can subnational fiscal imbalances be passed back to the national government? Does central government set conditions for helping subnational governments in deficit? Expenditure Is there clear assignment of expenditure responsibilities across levels of government? What is an appropriate size of unit for the cost-efficient operation of subnational government services? Macroeconomic control of local governments – Budget co-operation (expenditure) between central and subnational levels. Main characteristics of the instruments for the central control of expenditure Institutions and procedures for expenditure control. The decision-making processes.A summary of recent reforms of central-local relations. Background and objectives. Have there been reforms due to insufficiencies in the overall design of the systems of budget co-operation: the lack of stable, reliable, transparent, well-documented and formula-based relations and procedures? Specific budget co-operation. Compensation when new activities are assigned to subnational governments: according to which principles is the compensation calculated?

32

The survey replies to these questions are summarised in the following subsections 4.2-4.3. Section 4.2 deals with the issues on subnational government size and the expenditure assignments to subnational governments. Section 4.3 summarises the situation of the framework on subnational finance. © OECD 2002

The Balance between National Fiscal Targets and Subnational Financial Discretion

4.2. The framework of government size and expenditure assignments 4.2.1. Subnational government size With regard to the size of municipalities, one substantial result from the six survey countries is the problem of fragmented government (see Table 4.1). Apart from Lithuania, in the other five countries, most local expenditure responsibilities are carried out by a large number of local governments, often with a small unit size. This is the case in the Czech Republic where almost 80% of the municipalities (1999) comprised no more than 999 inhabitants, and also in Hungary (53.7% of the municipalities in 2000). Latvia also shows a very fragmented picture of territorial administration with more than two thirds of the municipalities (71.4%) having less than 2 000 inhabitants. In Estonia, in 85% of the municipalities, the population does not exceed 5 000 inhabitants. Poland and Lithuania show a somewhat different territorial government structure, their municipalities being bigger. According to the Polish report, two thirds of the municipalities have less than 10 000 inhabitants. In Lithuania, the structure is indeed very different from the rest of the countries, with the most concentrated local government structure: populations of less than 10 000 people are only to be found in 3.3% of the municipalities. Cost-efficient operation of local services does require municipalities of a certain size. As an example, municipalities smaller than 6 000-8 000 inhabitants are traditionally considered too small to run their own schools and facilities in relation to primary education. All countries except Lithuania, will apparently have severe problems in assigning precise and sole responsibilities to subnational governments to carry out decentralised tasks. Please refer to Section 4.2.2 below on these issues. The distribution of municipalities by size

Table 4.1.

Various years Proportion of municipalities (A), proportion of population (B) Number of inhabitants

–999 –1 999 –4 999 –9 999 –49 999 –99 999 > 100 000

Czech Republic (1999)

Hungary (2000)

A

B

A

B

79.6 90.0 95.8 97.9 99.7 99.9 100

16.8 25.6 36.2 45.3 66.8 79.0 100

53.7 74.7 91.0 95.5 99.3 99.7 100

7.5 16.7 31.5 40.9 63.6 71.1 100

Poland (2000) A

Estonia (1999)

B

23.4

5.9

66 96 98.2 100

25.4 61.9 100

}

Latvia (2000)

Lithuania (2000) A

B

3.3

0.3

66.6 91.6 100

32 60 100

A

B

A

B

10 49 85 94 98 99 100

1 11 30 40 52 64 100

32.3 71.4 91.1 95.5 99.1 99.6 100

5.6 18.2 31.5 38.8 54.2 62.9 100

}

In the Estonian country report, there is some evidence to indicate that smaller local government units have a smaller administrative capacity at the level of public service provision and infrastructure conditions. Research has been carried out on the local government socio-economic situation, stating that under-performance in some local government tasks in some of the smaller municipalities is mainly due to scarce financial resources. Such research and study results were not reported in the other country surveys. 4.2.2. The assignment of expenditure responsibilities across levels of government All six countries reported on overlapping and shared tasks between the tiers of government. They reported a number of outstanding problems and issues that constitute major obstacles in ensuring overall efficiency and local political accountability. In Latvia, local and regional governments are carrying out compulsory tasks (of a permanent or temporary nature) and voluntary tasks. The allocation of these tasks is often not explicitly allocated to a particular level of government. The Latvian contribution states that “the necessary standard of tasks is © OECD 2002

33

Fiscal Design Surveys across Levels of Government

not demarcated in detail in the law and the minimum national standard service level very seldom is stipulated”. To this is added, “the division of these tasks (…) depends on the abilities of the regional and local governments in the region and personal initiatives from politicians and administrative employees”. A municipal government can also give up certain functions by transferring them, by mutual agreement, to another municipal government. The Hungarian contribution points out a very sub-divided structure of local government: for more than half of the local governments (54%), the population is less than 1 000. Within this structure, however, all local governments, irrespective of their size, are in principle attributed the same set of rights and duties. There is no specific regulation concerning the public services that the “smallest” local governments have to supply. “All the local governments have equal rights meaning that the soviet-type system of subordination and superordination was terminated”. As far as duties are concerned, “a local government is entitled to determine the ways and modes for the performance of the various duties – depending on the requirements and demand of the local population and its financial resources”. Similar to Latvia, local governments can make arrangements to transfer certain services to other local governments. In Poland, ipso iure competencies of local and regional authorities are specified by legislation. A distinction may be drawn between compulsory and optional tasks. Under the Act of 8th March, 1990, all public matters of local importance not assigned to other authorities by law fall within the competence of the municipalities. The poviats perform supra-municipal local tasks, while voivodships frame regional development strategies. In the Polish contribution, there is a clear indication of the role and mandate for local and regional governments in each policy sector, as set out by law. The principle governing the division of power is the principle of subsidiarity. As stated in the Polish report, the main problem seems to be that the decentralisation of functions to local and regional levels has not been accompanied by a sufficient decentralisation of own subnational revenues, “A considerable part of the given tasks, especially those realised by poviats and voivodships, is still financed by means of transfers from the state budget”. In the Czech Republic, the responsibilities of local governments are divided between own and delegated responsibilities. Delegated responsibilities include the local contribution to the performance of administrative state tasks like keeping the birth, marriage and death registers. However, “not every municipality meets all the tasks included in delegated responsibilities”. Only 6% of the municipalities assume these duties, whilst the remaining 94% have delegated the functions to larger municipalities. Only housing and community amenities are the exclusive duty of local government. All the other local government functions are functions shared between state and local levels. However, in the field of recreational, cultural and religious affairs, local governments have the main responsibility for the service. Contrary to most states, social security and welfare functions, as well as health, are fields substanially in the hands of the central government. Contrary to the Czech Republic, in Estonia “most local government responsibilities are full and exclusive, but there are some tasks shared between the municipalities and the central government”. An example of the latter is health care. There seems to exist a rather clear indication of the role and mandate for local governments for each policy sector, set out by law. Apart from their own functions, municipalities can also carry out some central government tasks “which can be passed on by a contract between an authorised central government body and a specific local government unit” (p. 18). In Lithuania, public duties are carried out by central and local administrative governments. The regional governments, who exercise devolved central state authority, have also been prescribed their own duties, competencies and responsibilities. Only housing and community amenities are exclusively local functions, attributed by law. An untypical pattern of responsibility-sharing exists in relation to the fuel and energy policy where local governments have been assigned the overall competency.

34

To sum up on the assignment and “size” issues, the fragmented subnational government structure experiencing the “too many municipalities and too small” problem undoubtedly explains some of the problems on the opaque and dispersed task assignments. A number of special assignments, exemptions, etc. have to be in place in order to compensate for the fact that not all municipalities have © OECD 2002

The Balance between National Fiscal Targets and Subnational Financial Discretion

the capacity to deal with the assigned tasks. Arrangements are set up to allow for (voluntary) transfer of tasks to other types or levels of government, just as the sector-specific laws and regulations have to be prepared with very weak or even absent standard requests for the local services to be provided. These facts put a strain on the possibilities of ensuring local political accountability, including local provision of cost-efficient services whilst at the same time ensuring tight targets in the overall national expenditure policies. 4.3. Evaluation of the subnational finance framework This section summarises the country surveys on the subnational finance framework. The findings are given, country by country, primarily by quoting from the relevant sections of the country reports. The summaries have been prepared with direct reference to the questions structure presented in Section 4.1. For further presentation of each country, please refer to the annexes to the publication. For a complete presentation of the country systems of finance framework, please refer to the full country reports, brought on the attached CD-Rom to this publication. 4.3.1. Lithuania Tax revenues. In accordance with Lithuania’s legal system, only central government can set the local government tax rate and base which are assigned to the tax revenues. This is done on a multiannual basis. Local governments have the right to set the tax base and rate for local levies and for municipal budgetary revenue obtained for the services rendered. The two types of revenue comprise up to 10% of all the non-tax revenue of the local governments. The amount of general grants is determined according to the amount of expenditures expected for the planned years of all municipalities minus the expected amount of tax and non-tax revenues of all municipalities and minus special grants planned to be assigned from the state budget. Borrowing and bail out. The municipal councils approve the budgets. The budgets should be approved as deficit-free, balanced budgets. If a municipality intends to re-borrow or make a guarantee or to give bail, it has to get permission from the Ministry of Finance. The Ministry of Finance controls municipal borrowing limits. Expenditure and budget co-operation. The overall volume of expenditures of all municipal budgets is determined as a percentage of total expenditure of state and municipal budgets. Basic indicators determining the volumes of municipal budgets and equalisation degrees are planned for a three-year period in order to help municipalities achieve stable forecasting of their own activities, priorities and investments, and a better supply of services. Central Government together with the Municipal Association presents these indicators to Parliament for approval for the three-year period. The evaluation of the fiscal needs of a municipality is based on the calculated need of expenditures determined on a three-year basis. Compensation for new tasks. Together with the proposed new laws, government resolutions and other legal acts concerning government institutions and municipalities, all new tasks presented must include an evaluation of their financial cost and of their impact on revenues and expenditures. No explicit guarantee of actual compensation for the increased local government expenditures seems to be given here. 4.3.2. Latvia As in Lithuania there are no municipal taxes in Latvia. All taxes are set and collected by central government. Part of the revenue is allocated to the local government budgets. In relation to personal income tax (the main tax revenue source for subnational governments), the tax base and the tax rate of personal income tax are set by central government without the influence of local governments. The local authorities are guaranteed the central government prognoses of the tax revenue. © OECD 2002

35

Fiscal Design Surveys across Levels of Government

The Ministry of Finance forecasts the total amount of non-tax revenues for the fiscal year, using preferential macroeconomic developmental tendencies. This forecast is included in the annual Dispute and Settlement agreement between the Cabinet of Ministers and the Union of Local Governments. Local governments plan their own non-tax revenues and also administer these non-tax revenues. There are no controls on the amount of this revenue. Grants. The volume and purpose of both earmarked and general grants are set annually in the national budget law. Earmarked grants are mainly for salaries, investments and development issues, whilst general grants are assigned inter alia to the local government equalisation fund and, since 1999, allocated to municipalities for the implementation of the territorial reform. As mentioned in the Latvian report, the most severe problem in the present grant system seems to be the calculation of the total expenditure needs of one year before the next financial year arrives. The framework on borrowing was strengthened in 1996-97, with a detailed regulation introducing a yearly cap on borrowings and guarantees, to be determined by the annual State Budget Law. The annual debt level for the municipalities is limited, and set in the annual law on the national budget. In 1996, a local government borrowing supervisory body (“Board”) was set up, based on a Regulation from the Cabinet of Ministers. The Latvian State Bank, the Government and the Union of Local Self-Governments are members of the board. All local government borrowing and guarantees have to be approved by this Board. The Board has considerable powers of regulation and supervision of local government borrowing and guarantees, including approval of these, which is delegated from the Cabinet of Ministers. There is a special stabilisation fund for local authorities with severe economic problems that need bailing out. The bail -out procedures are regulated by law. There are no strict limitations on further local government borrowings. Budget co-operation. The total financial envelope i.e. the total financing of local government expenses for the coming year, is set after negotiations between the central and local governments in the yearly protocols. These protocols contain the total local government expenses, revenues, state grants and revenue composition. Municipalities independently prepare, approve and manage their budgets, as well as make decisions on the expenditures. However, the municipality’s budget expenditures in the financial year shall not exceed the total amount of estimated revenue for the respective budget year plus the balance of previous year funds. According to law, local governments are compensated for new tasks or changes in the task portfolio. The sources of state financing to cover the increase in expenditure or decrease in revenue of the local government budget must be indicated in any new law or Cabinet Regulation. In practice, these procedures are not always followed. National standards on expenditures. In general, there are no output controls of local government service provision. Local governments are free to provide services in accordance with the law, structure the provision of services, etc. Some sector areas e.g. education, welfare and environment, have very few norms, and, in general, the service level is decided by the local government. 4.3.3. Estonia

36

Utilisation of own tax sources. The amount of tax revenue from own taxes is marginal. In Tallinn, for example, only three of the potential municipal taxes have been levied: on advertising, on closing roads and streets, and on motor vehicles. The total revenue generated by local taxes only constituted 2.3 per cent of Tallinn’s total gross revenue, in 1999. Out of all local taxes in Estonia, this revenue constituted about 85%. Several taxes (head tax, local income tax and entertainment tax) have not been imposed by any of the local authorities during the last few years. According to the Estonian report, some of the main reasons behind this are that: the financing system as such does not favour local taxes; local taxes are difficult to administer due to a lack of own local tax authorities; and municipalities prefer fees as a revenue source because imposing local taxes is considered unpopular, locally. In Estonia, local governments are quite free to finance their expenditures through non-tax revenues. There is no special regulation for local government non-tax revenues. There is a regulation for property income (as for revenues on natural resources), fees and fines but the regulation covers general government. © OECD 2002

The Balance between National Fiscal Targets and Subnational Financial Discretion

The global amount and annual allocations of the general grants are worked out during negotiations between the government and the “co-operative assembly” created by local government associations. Borrowing. Local budgets have to be in balance (outflows equal to projected inflows). In only a few cases has central government helped local governments in debt, by providing them with additional loans, and only one municipality has been bailed out so far (in 2000). No uniform regulation on bail-out has been prepared yet. Expenditure and budget co-operation. Local governments are independent in their budget formation. There are no targets set for local expenditure. The central government has determined the normative level of the provision of certain public services but it has not attached any financial targets to this or any other field of local expenditure. Central government does, however, control local government expenditure by fixing the tax rate of state taxes and by allocating grants: Allocations to the Support Fund and setting the rate of special purpose allocations. Financing additional tasks set by law always receives special attention. Local government units, however, claim a higher budget for tasks set to them by law, and feel that transfers from the support fund in order to fulfil these tasks are not in proportion with national requirements on standards set for service provision. 4.3.4. Czech Republic Taxation. Central government bodies in the Czech Republic administer most of the local taxes, including collection and revenue assignment. Only small – from a fiscal point of view – taxes and fees on specific goods and services are completely administered by local authorities. Municipalities are free to set tax rates on goods and services, respecting upper limits indicated by central law. They are also free to define the tax base through exemptions and various reliefs. Municipalities collect taxes and exclusively benefit from the revenues. As far as frequency of facultative implementation of the above-mentioned local taxes on goods and services is concerned, about 90% of municipalities use their right and impose at least one tax. The tax revenues obtained by municipalities will be changed from 2001. In general, all tax revenues will be centralised, and partly distributed back to the municipality’s budget. Lack of local government discretion over tax rates, the tax base, the collection process, and their share in the revenue, would ordinarily make personal income tax on wages and salaries, personal income tax of unincorporated individuals, and corporate income tax and levies on the withdrawal of land, central government taxes. Only the fact that the proceeds of personal income taxes and levies on the withdrawal of land are distributed in the area in which they are collected, makes them close to the “own taxes” of local government. Local tax administration will be similar to the present local fee administration. There will be no national system of valuation or setting up of revenue benchmarks. There are no national limits on deficit financing through non-tax revenues. Deficits may be financed with tax- as well as non-tax revenue and by debt. The only exception is that some central government grants provision includes as a criterion that a municipality deficit/operating revenue ratio does not exceed 15%. Municipalities, when providing local services, are mandated to set the price themselves. The obligatory grants (mainly operating grants) are calculated each year when preparing the central government budget. Capital grants to local government are provided according to the approved central government budget. The system of grants is not designed in a way to avoid national budgetary pressures from local government. Grants to local government are not only distributed from the state budget but also from extra-budgetary funds, the most important being The State Environment Fund. The Czech country report sees the grants system reform as overdue, in the light of overcoming the lack of stable, transparent, well-documented and formula-based relations and procedures. There is no control on local borrowing, at present. Local government may borrow any amount, from any institution (even abroad) for any reason, at any terms of interest rate, maturity etc. Legislation says that central government is not responsible for local debt. There has not yet been a case in which central © OECD 2002

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government has been called upon to assist a municipality in financial difficulty. One reason is that, through the tax sharing principle, each local government is granted a certain amount of money regardless of its activities. No rules on bail-out have been prepared. Expenditure and budget co-operation with central government. There is no overall budget target for local government set by general budget frames or specified by sector or output targets. Local government is limited in its expenditure policy by law and by specific grants only. When new activities are assigned to local government, the proportionate increase in expenditure is reflected in the increase in grant. The compensation is calculated by central government. There are no national mandates for arranging subnational services. There are no standards of local services, no targets for local capacity. There are no expenditure norms and standards, no part of the budget is earmarked for specific activities, except central government grants. The choice between own production of services and contracting out is up to each municipality. The recruitment of personnel is also for the municipality to decide. The payment of personnel is ruled by a law valid also for state administration personnel. 4.3.5. Hungary Local tax revenue. The Constitution in Hungary provides that a local government is entitled to raising its own revenues – for the performance of its law-defined duties – and that it is also entitled to state subsidies that are proportionate to such duties. A local government is entitled to establish the types and rates of local taxes within the limits specified by law. A local government is not under obligation to introduce and collect local taxes. The act on local taxes establishes the possibility of taxation. According to the Hungarian report, local governments exercise their taxation right in a carefully planned way, in view of the local conditions, taking into account the taxpaying capacity of the local population. Local taxes have been collected for some ten years now as part of the Hungarian taxation system. The number of local governments collecting local taxes and their revenues have been steadily increasing. In 1999, 93 per cent of all local governments applied local taxes. Local taxes accounted for some 18 per cent of all current revenues of logos in 1999 – to be compared with the mere 3.5 per cent in 1990 when “council taxes” were collected. No direct central measure has been taken in order to increase local governmental revenues. In an indirect way, however, a local governmental tax authority is helped by the fact that – subject to statutory limitations – they may ask for and may be given information by the central tax administration on the taxpayers operating in their areas of competency. Non-tax revenues. The rules on the establishment of service charge type fees are specified by decrees issued by the Government and line ministries concerned. In some cases these also specify the mandatory allowances to be applied by local governments. The expected annual revenue on non-tax sources appear not to be taking into account when estimations on needed state revenues to local governments are identified on the Budget bill to Parliament. The system of grants from central government to subnational governments, as presented in details in Chapter 3 in the country survey, allocate resources by a very comprehensive set of subsystems, based on a number of normative criteria. The system seems to weaken the possibilities for efficient local decision-making on the level and the standard of the locally provided services, and as such appears to be a significant barrier for political accountability at local levels. The system of grants seems difficult to administer in straightforward manners, just as the normative criteria apparently to some extent are subject to negotiation and as such potentially may be changed annually. 38

In the following textbox the grant system in relation to education matters is highlighted, to illustrate some of these issues. © OECD 2002

The Balance between National Fiscal Targets and Subnational Financial Discretion

Financing profile of subnational education services in Hungary “The costs of the provision of public education services are financed from the contributions from the central budget, the revenues generated by the institutions themselves, the payments made by the users of the services and the funding sources of the organisations in charge of maintaining the institutions. The contribution by the central budget is comprised of normative state contributions for discretionary utilisation, normative contributions for specific purposes and other contributions for specific purposes and the contributions provided from the chapter of the Ministry of Education, primarily for specific priority professional purposes. Normative contributions are provided on the one hand for the various phases of education and teaching and for other services of public education (basic arts education and provision of student hostel services) (basic contributions). On the other hand, for supplementary services of public education (daytime care for children, teaching to help catching up) and to provide for requirements of specific conditions of public education (education and training in small municipalities, providing services for commuters from other municipalities etc.) (supplementary normative contributions). Part of the normative subsidies for specific purposes provide funding for specific benefits (for the procurement of technical literature and books by teachers, textbooks by students), another part provides funding for the performance of district type responsibilities (including for instance the subsidies to public foundations for public education constituting one of the bases for the implementation of the above mentioned “development plan” or the subsidising of special professional pedagogy services). Furthermore, contributions for specific purposes may be applied for in order to provide support to the further training of teachers”.

As appears, in the operation of local educational institutions, local governments will have four sources of income. One of these sources, the grants from central government, comprises four elements and is allocated by two different central authorities. Most of the grants are provided for, and allocated for specific aspects of the activities connected to carrying out education services. Borrowing and bail-out. Local governments are allowed to take out loans and issue bonds. However, they have to respect certain restrictions on borrowing. According to the Local Government Act, the ceiling of a local government’s annual debt commitment equals the adjusted current own revenues of that local government (i.e. 70% of the local government’s net own revenues – from local taxes, duties, interest, fines, etc.) in that year. In general, the state does not assume liability for a local government. There is a debt settlement procedure for local government insolvency, which is set by law, as a separate regulation. Expenditure – budget co-operation. The Parliament specifies – by passing the Budget bill – the share of local governments of centrally regulated taxes and duties, the titles and amounts of the normative central budgetary contributions of local governments and the earmarked and targeted and other subsidies and grants to be provided for local governments. The funding is specified on a yearly basis. Along with the submission of the budget bill to Parliament central government makes available for local governments the data and regulatory proposals pertaining to them, for their preparation of the local budget proposals. The possibilities of spending on local public services are determined, ultimately, by the amount of the funds from the central budget and the funds earned by municipal governments for discretionary spending. No overall consolidated targets on local revenue and expenditure out of total public finance seem to be set in Hungary. The local governmental act provides that where a mandatory duty and/or power is imposed on or assigned to a local government the Parliament is to provide the necessary funding for the performance and exercising of such tasks and power, deciding on the amount and mode of the budgetary contribution. © OECD 2002

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4.3.6. Poland Local taxes are deemed the basic revenue of gmina (local government) budgets in Poland, since they are fully administered by local self-governments; and local authorities are able to affect the taxation rate. (The voivodships and poviats are not covered by the following text on tax revenues.) The statutory tax authority, however, is quite limited and only covers non-uniform functional powers. In most cases, it entails the possibility of reducing, to the extent laid down in statutes, upper rates of individual taxes (i.a., real estate tax, agricultural tax, and forest tax). The upper tax rates are determined and updated on an annual basis, by the Finance Minister, within the framework of the general tax policy of the state. It also covers the possibility of granting reliefs, deferment and remission of taxes that make up the gmina’s revenues and are directly paid to the gmina’s account. The same power is exercisable in the form of a waiver, if any, of collection of such taxes. Local governments do utilise these instruments of tax authority. In 1999, they granted reliefs, deferments and remissions of taxes and reduced upper rates of taxes that make up gmina revenue totalling ca. 3.2% of total receipts, including reducing real estate tax receipts that were in excess of 78% of the whole amount of reliefs decided by gmina councils. This meant that gmina revenue from that tax was reduced by 18.1%. The Ministry of Finance assists in the optimal exploitation of local revenue sources. There is general supervision of tax liabilities, which covers the uniform application of tax regulations by tax authorities, and the official interpretation of tax regulations. As part of the surveillance of local revenues, local governments are responsible for the preparation and submission of quarterly budget reports on, inter alia, budget revenues, and semi-annual and annual reports on the generation of basic revenue from taxes. The reports relating to the revenues from taxes, charges and other non-tax budget duties, must cover: information on planned revenue projections; receipts less returns made; the difference between revenues that a gmina could have got by applying ceiling tax rates and the revenues that it actually raised through the application of lower rates adopted by the gmina council; and finally, amounts reflecting the effects of reliefs, remissions, concessions and waivers of taxes and charges. The legal system of rules setting out the construction and functioning of non-tax revenues of Polish local government is made up of several statutes of varying significance and character. There do not seem to be any co-ordinated measures on the central management and control of subnational government revenue generation from these sources. The systems of grants, in Poland, seem relatively complex, with the possibility of some weak budget constraints on local governments, for example, general grants are distributed annually within three sub-sectors: basic, educational and fiscal equalising. The total amount of the sector-specific general grant on educational subsidy is allocated to individual gminas in accordance with the rules laid down in a regulation issued by the Minister responsible for education, following consultations with the representation of the units of local self-government. Specific grants are set on an annual basis, for the financing or partial financing of own duties in the areas of social welfare; higher education; and “other duties”. The design of the specific grants to some extent reflects efforts to overcome problems on the fragmented structure of local government and the redistribution of expenditure responsibilities to the newly-created regional governments.

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Borrowing and bail-out. Borrowing limits are set by law, indicating that the total amount repayable during the budget year cannot exceed 15% of the revenue projection for that budget year, for that unit, and the total amount of debts at the end of the budget year cannot be more than 60% of the unit’s aggregate revenue during the relevant budget year. Local governments are supposed to cover any budget deficit themselves. The measures that may be applied towards covering such a deficit are set by law. In the case of temporary financial difficulties, loans may be extended from the state budget in the course of rehabilitation proceedings. The conditions of such loans are considered individually for each municipality. © OECD 2002

The Balance between National Fiscal Targets and Subnational Financial Discretion

Expenditure and budget co-operation. In general, the central authorities do not have any influence on the level of local revenue or expenditure. The amount of revenue transferred from the state budget i.e., subsidies and specific grants, are implemented according to law. Neither are central authorities able to influence the amounts spent from local budgets since the sole supervisory criteria is the correctness of implementation of duties assigned to individual levels of local self-government. Some indirect influence on the local budget level and composition seems, however, to exist in relation to the competencies of the regional clearing chamber. Prior to the adoption of the draft budget resolution, local governments have to submit their proposal to the regional clearing chamber for its review and comment. The chamber is a government authority for the supervision and control of local financial management. Its opinion covers, i.a., the amount of planned debt. There does not seem to be any overall budget consolidation of government finance. On the other hand, there is comprehensive economic reporting from subnational government on the status of expenditures and revenues. However, the information from the reporting does not seem to lead to the formulation of overall expenditure and revenue targets for the public sector as such, including the subnational sub-sectors. 4.4. Some comparative findings on the balance between local autonomy in financial decision-making, central control and fiscal discipline This section highlights a number of comparative findings on the specific mode of subnational financial decision-making across the countries, and is based on the presentation in Sections 4.2-4.3. Due to the complexity and comprehensiveness of the subnational finance systems in the countries, there cannot be a genuine comparative presentation and discussion across the countries in this section. As mentioned in Chapter 2, the main purpose of the surveys has been to provide each country with updated information on the status of fiscal design in similar countries, and by this means; to assist national policy discussions and considerations on further reform steps. As stated in Section 4.1, the questionnaire focused on issues related to the framework of subnational finance. These issues, however, have to be presented and discussed within the context of the overall subnational government system: the structure of local governments, including the size of the units and the expenditure assignments to the separate tiers of governments. This is illustrated in Figure 4.1. Figure 4.1.

Main elements in relation to the subnational government system

Fragmented structure

Weak subnational finance framework

Blurred assignment of expenditure responsibilities

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Fiscal Design Surveys across Levels of Government

As mentioned in Section 4.2, the combination of a fragmented structure and incomplete expenditure assignments raises a number of problems and constraints on the overall possibilities of ensuring an efficient local government system with extensive subnational political accountability. Territorial reform is being considered in most countries. The creation of a regional level of government in Latvia, Poland and, recently, the Czech Republic can partly be seen as a way of solving the problems of the fragmented local levels of self-government. Considerations in Hungary on setting up regional governments – in combination with other territorial restructuring – have the same kind of objectives. As another example, to further the process of amalgamation of small local governments in Latvia, a lump sum grant has been set up. The grant is allocated to those municipalities that have decided to amalgamate or co-operate for the implementation of their functions. Undoubtedly, the framework on subnational finance may be seen in this perspective. As an example, in some countries, the design of the grants system reflects the fragmented structure and the incomplete assignment of subnational tasks in a number of ways. The near absence of a finance framework and the extensive use of specific grants in the Czech Republic may partly be explained by the very fragmented local government structure, whilst the system in Lithuania, with consolidated multi-annual public sector targets and the absence of specific grants may be an example of the opposite situation. In relation to the finance framework as such, some major findings across the countries can be highlighted: – Some countries, Poland and Hungary notably, have implemented support systems for assisting subnational government in the optimal exploitation of local tax sources. However, undertaxation of local sources, as reported in Estonia for example, seems to be frequent, in any case, in the countries with evolving local taxing powers. – Frameworks on bail-out are set by law in Latvia, Poland and Hungary. In other countries, explicit procedures have been prepared and are to be carried out by the government. – In some countries, e.g. Latvia, the principle of full financing for additional tasks to subnational governments is set by law. In other countries, it is an issue that “receives special attention” or “a calculation has to be presented with an evaluation of additional costs”. In the Latvian case, however, it is stated that even within this framework “these procedures are not always followed”. – In some cases, e.g. Lithuania, the overall budget on public finance, by expenditures and revenues, are consolidated and planned from a multi-annual perspective. Budget targets are set and announced by revenue source and sector of expenditure. In most other countries, estimates are set on part of the subnational revenues and expenditure, typically on an annual basis. In most countries, as referred to in the Polish and the Hungarian reports, there is a comprehensive set of financial reporting from the subnational levels to central government. The reporting, however, does not seem to be used directly in relation to setting the budget estimates. – In some countries, e.g. Hungary, Poland and Latvia, the grant systems seem relatively complicated, with too large a number of sub-specifications, “sub-grants” and allocation criteria. This situation, as mentioned already, seems to reflect other deficiencies in the local government system. Reforms, aimed at simplifying and “generalising” the system of grants, are to a large extent restrained by these factors.

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– Some countries present a comprehensive set of agreements and involvements of subnational government associations when setting the overall revenue and expenditure envelopes, and, in some cases, as part of the implementation of the subnational government framework. Latvia provides an example of the latter case, where the subnational government associations is a member of a local government borrowing supervisory body (“Board”), where all local government requests on debts and guarantees are approved. In other countries, the associations are involved to a somewhat lesser extent. © OECD 2002

The Balance between National Fiscal Targets and Subnational Financial Discretion

4.5. Concluding remarks on the fiscal design surveys Economies in transition need methods for monitoring and evaluating their ongoing reform processes of government finance, including fiscal design across levels of government. As mentioned in the opening sections, international data to compare decentralisation policies across countries seem to be insufficient or even non-existent. Economies in transition do not have internationally consolidated data on fiscal autonomy and the actual design of fiscal relations to look to for policy guidelines and inspiration for reform processes. Guidance for these countries on where to concentrate their reform efforts, to a large extent, must be based on national figures and reform experiences. The substantial framework and the methodological design of the survey, as presented in Chapter 2, identify relevant international statistics to assist fiscal reform processes. Central aspects of fiscal design across levels of government are presented on a comparative basis: government finance statistics, distributed by further levels of government and by policy sectors (Level 1), and concepts and definitions on expenditure and revenue powers of the subnational governments (Level 2). The substantial results, as presented in Chapters 3-4, demonstrate the comprehensiveness of the survey design. Comparative data are given on general design issues like the chosen fiscal mix across levels of government, and the distribution of tasks and expenditure responsibilities across tiers of government. Comparative data and country evaluations on local autonomy are also distributed by policy sector and by the relevant government authorities, making international data available for considerations on reforms on the health sector, the environment sector, education services, etc. It is envisaged that the comparative results can support the policy dialogue and the considerations on fiscal design reforms that are currently taking place in most of the six countries.

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Annex 1

SUMMARY OF COUNTRY REPORTS Table of Contents Czech Republic....................................................................................................

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Estonia..................................................................................................................

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Hungary ................................................................................................................

51

Latvia ....................................................................................................................

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Lithuania ..............................................................................................................

58

Poland...................................................................................................................

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CZECH REPUBLIC

1.

Main features of local finance and the inter-governmental relation

The Czech Republic has a unitary status. Up to 2001 there were only two tiers of government – central government and local government at municipal level. Local government covers more than 6 000 municipalities. The autonomy of local government is granted by the Constitution and the Act on Municipalities. The local government budget is separated from the Central government budget. The only link is given by the grant system. All municipalities regardless their size enjoy the same rights and obligations. Each municipality represents a legal entity. Its responsibilities are divided between own and delegated ones. The own responsibilities include among other tasks in education, welfare services, housing, health care, culture, public safety, street cleaning, water, electricity and gas supplies, sewerage system. Among delegated responsibilities can be found: birth, death and marriage registers and building permissions. Different tasks in environmental protection, sanitation, statistics and so on belong also to this group. The basic reform of local government system took place in 1993 together with the overall tax reform. Since that the local finance system underwent several minor changes. The radical change took place only in 2001 together with regional government installation. The most important source of local budgets is tax revenue. There are no local taxes, only local fees at present. Municipalities participate on personal income tax and corporate income tax. They also receive the total yield of real property tax collected within their territory. As concerns the tax on buildings, the base is given in the form of physical parameters, the usage plays also a certain role. The income tax sharing was up to 2000 including as follows. Municipalities were granted 20% of the total yield of corporate income tax. The municipal share was distributed on the base of population of each municipality. The personal income tax has three parts in the Czech Republic. First, it is the wage tax, which was distributed among municipalities according the district collection. Municipality, in which employers’ office was registered , received 10% of the collected amount, 20% was distributed according the number of citizens in each municipality within a given district, and the rest was assigned to the central government. The unincorporated income tax yield was allocated to the municipality, in which the particular entrepreneur had his permanent home address. This above described system led to growing disparities among municipalities of different size and location. It was seen injustice as any municipality could influence this revenue only very little. It also led to a special competition among municipalities concerning the location of employers’ registered office and permanent home addresses of entrepreneurs. It was a competition, which had noting to do with building up a bigger tax base. Moreover, some additional cost was involved, which then lowered the tax revenue for municipal sector. The change applicable since 2001, however, did not solve the problem of a rather small municipal discretion over their revenue. A certain room for own decision of local government is provided only by local fees. In this case local government also administers this revenue source. The law sets the list of local fees and their upper limits. Some of local fees are planned to be transmitted into local taxes. The fee on operated gambling machines, on recreational units and the fee on use of public space are examples of local fees. The system of central government grant consists of mainly operating subsidies, which are decided each year when preparing the central budget. They do not take into account the revenue level of any municipality as they are calculated as a certain amount per pupil in pre-school facilities and primary schools, per bed in social care facilities, as a contribution to the tasks of state administration provided by local government and so on. Capital grants are as well decided when preparing the central budget on ad hoc base. Once started projects have the priority.

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All grants transferred to local government are specific grants in the sense that their provision does not allow local government to allocate them according their discretion. The precise use of grants is defined by the central government. In case that a municipality does not succeed to spend the grant amount in the given year and for the given purpose, it must return this amount back. All municipalities, which received a grant, must make an annual statement for these grants.

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Annex 1

2.

Major empirical findings With reference to the Czech country report: – Table 2.2 Municipalities by size (December 31, 1999); – Table 3.2 Classification of taxes of sub-central governments. Local Government, 1997-1999 (in millions of CZK); – Table 3.4 The profile of central grants to local governments, 1997, 1998 and 1999, in millions of CZK; – Table 4.1 Expenditure assignment – actual status of the legal framework.

3.

Main problems in the fiscal design

Some problem of the tax sharing system valid up to 2000 were already removed by the change in 2001. At present there is a necessity to change the tax sharing system in the way, which would enable to introduce a link between the municipality effort and its tax revenue. Generally, all taxes in the Czech Republic are decided by the central government fixed in legislation, central government also collects and administers all taxes. Local government in the Czech Republic has only very limited tax authority. At present, the local government control over tax rates, tax bases and collection is not significant – less than 3% of total municipal tax revenue could be called as actually own taxes of local government. Municipalities have a certain room when deciding rates of real property tax and local fees rates (with restricted discretion over fee base). Local taxes installation is almost an evergreen in the policy debate on local finances in the Czech Republic. The apparent fear that local government would radically increase the tax burden is still to strong to introduce local taxation or anyhow increase the influence of a municipality over its revenue. Nowadays local government has only very limited power to decide its revenue. That makes them too dependent on sharing taxes and grants and receipts from sale of their property. Relatively low yield of the property tax and its decreasing share on the total local government revenue are other issue to be solved soon. The new property tax should be based on market prices and give municipalities more discretion over this revenue. Also numeral exceptions, which exist at present, should be reduced. The whole system of regional government finances is under consideration only. At present regional elected representatives often complain that they have almost no way how to get funds to manage their office and tasks properly. To prepare a new schedule might be very difficult due to the fact, that particular regions will be given different facilities and therefore have different needs of funding. This complicate the introduction of the unified system of their financing. What to do with district office is another task to be solved. At present they provide a wide range of state administration tasks as well as many services, which do also municipalities. In many cases these functions were left to them because of the very small size of prevailing municipalities. The present consideration includes that district offices should be abolished by year 2002. Yet, there is no mechanism, how to transfer some of their functions to the regional level of government. 4.

The status of policy reform consideration

The overall public sector reform is just proceeding. It has several tasks. First of all it is the establishment of regional self-government. First regional election took place in November 2000 and this way the local councils for 13 regions were elected. Prague, which is a municipality as well as region, will held first election together with municipal election in 2002. Financial terms and responsibilities will be provisional for first two years of their existence. In this period they will be under close control of the central government and will be financed mainly through central government specific grants. Their present responsibilities, as given in a special law, include among others regional development, environmental protection, some roads, regional transport, secondary education, social care facilities, museums, and big libraries. Particular facilities needed for carrying out these tasks will be transferred during this year. In the year 2001 a new system of tax sharing was established. The sense of this change was to bring more justice into the system. The underlying condition was not to change the relation of the proportion of central budget and local budgets tax revenue. Into the sharing system now belong not only income taxes, both personal as well as corporate ones, but also value added tax. Within the personal tax not only wage tax is shared, but also the unincorporated income tax. All shared taxes are allocated among municipalities on the base of the total yield collected and according the number of citizens of each municipality. There are some coefficients involved that make the sharing more favourable for bigger municipalities (new sharing rules could affect the amalgamation process, but in January 2001 the number of municipalities increrased by seven). The further improvement of this sharing principle is still under consideration. It should connect in a better way the effort of a municipality with its tax revenue. The public sector reform follows following tasks: – improvement of the overall efficiency of public sector; – stress on transparency of funds spent and on the stability of the finance system;

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Fiscal Design Surveys across Levels of Government

– increase of the control mechanism; – introduction of medium term financial planning, and – local taxes installation. As the main tool of the improvement of the overall efficiency of public sector is considered further transfer of functions from the central government to lower tiers of the government. Standards of the accessibility and quality of public services are being worked out and are supposed to improve the public services provision. Similar role is seen in building up an unified information system for the whole public sector and in using modern management methods, tools, and forms. The transparency should be improved by the existence of clear rules and responsibilities split within the general government, by clear definition of the government sector towards private one, by availability of reliable and understandable set of information, and by including all necessary items into the relevant budget. The unified government account will be established, which enable the integration of all public information systems and the link among expenditure and cash management. This single government account should also bring some savings as far as the borrowing cost is concerned. The establishment of the State Treasury is under preparation. It will monitor and check public funds operations also (at lower levels of government and in case of extra-budgetary funds will check the flows from the central budget), provide public debt management, management of EU funds, and prepare medium term financial outlook. The new budgetary law adopted in 2000 introduced besides ex post control also ex ante control and the division of management and control functions. Medium term planning should include not only expected revenue and expenditure items in needed composition for a given period of time, but also the assessment of impacts of today’s decisions for future revenue and expenditure. Local tax installation should increase the local government discretion over its revenue. It is also supposed to introduced more accountability into the local government spending.

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Annex 1

ESTONIA 1.

Main features of local finance and intergovernmental relations

The basic provisions concerning local government level in Estonia are laid down by the Constitution of 1992. The Constitution recognises the principle of local government and states that all local issues shall be resolved and managed by local authorities, which shall operate independently pursuant to law. Estonia is currently divided into 247 local government units. Estonia has had a one-tier local government system since 1994. Among the 247 local governments, there are 42 towns and 205 rural municipalities. Towns and rural municipalities are equal in their legal status. As there is no regional government level in Estonia, the co-operation of municipalities within a county is of great importance to municipalities both in their relations with central authorities and in co-ordinating their own activities. Local authorities have a constitutional right to form associations or establish joint institutions. Associations of local authorities within counties carry out tasks set by the central government as well as by local authorities. The basic functions of local government include the organisation of social services, welfare services for the elderly, housing and utilities, the water supply and sewerage, the provision of public services, physical planning, public transport, and the maintenance of local roads and streets. Local authorities maintain pre-school childcare institutions, primary and secondary schools, libraries, community centres, museums, sports facilities, shelters, care homes, health care institutions and other agencies and institutions founded and/or owned by the local government. Most local government responsibilities are full and exclusive, but there are some tasks shared between the municipalities and the central government. In addition to local functions, municipalities carry out a few central government administrative tasks which can be passed on to local authorities by a contract between an authorised central government body and a specific local government unit. 2.

Major empirical findings

In Estonia, general government revenues consist mainly of taxes – the share of taxes is approximately 90%. The Estonian tax system has been relatively stable since 1994. The share of local government revenues in general government revenues has been above 20% during recent years. Personal income tax – 56% of which is local government revenue – amounts to about 60% of local government total revenues. Amongst taxes, land tax also forms quite a significant share. With regard to local government non-tax revenues, property income and sales have traditionally been important. In Estonia, local governments rely somewhat on grants from central governments but not very much – the share of these has been 22-23% of local government total revenues, over the last few years. Personal income tax constitutes, on average, ninety-one per cent of the total tax revenue paid to municipal budgets. There are considerable differences in the income per capita between municipalities. The receipts from personal income tax per capita differed by about 11 times between the richest and poorest municipalities, in 2000. The trend is for income to grow faster in those municipalities which are located closer to Tallinn. Revenue from local taxes only represents a small share of the local budget. The total proportion of municipal taxes does not exceed one per cent of local government revenues. Several taxes have not been imposed by any of the local authorities during the last few years and thus remain only theoretical. There is no special regulation for local government non-tax revenues. The most considerable part of non-tax revenues comes from the so-called own revenues, which are used by the institutions collecting these. Although most of the own revenues have been included in the budget there are still some local governments which do not show all of their revenues in the budget. By law, all revenues should be included in the budget. The financial resources allocated from the central government budget for the support of local budgets are called the Support Fund. The amount of the support fund in a draft central government budget, and its distribution, are determined during the negotiations between the representatives of the associations of local authorities and the Government of the Republic. There have been lots of ideas lately on changing the principles for the distribution of the support fund. There have been discussions to increase the importance of local taxes and on taking more precisely into account the expenditure needs of local governments distributing the support fund.

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In addition to the Support Fund, there are allocations intended for specific purposes. The number of specific grants is changing from year to year. Local authorities also fulfil several tasks which are, in principle, the ones of central government but can be executed more effectively by municipalities. The funds for financing these tasks are transferred to local budgets through the budgets of ministries. 3.

Major problems in the fiscal design

Local government expenditure has made up about 20% of general government consolidated expenditure in recent years. Most of local government expenditures have been made in education – about 40% of total expenditures. Since the beginning of 2001, the importance of local governments has been growing, in this regard, as the Estonian government has decided to move all costs of primary and secondary schools over to the responsibility of local governments. This sees the share of local educational expenditures grow to more than 50% of total local expenditures. Altogether, there are hundreds of local functions, most of which have to be carried out by all local governments. Certainly there are differences in the costs of covering these functions, based on more or less objective reasons. But because, on one hand, no comprehensive analysis has been done, and, on the other, not a single local government admits that financing is high enough, it is hard to speak about efficiency and effectiveness in municipalities. In general, the differences in costs are not very big. One exception is certainly in general public services. Expenditures on these services represent around half of total current expenditures in the smallest local governments, whilst the average is only about 13%. Of course, the size of government is crucial in other spending areas, as well, but this is not so clear as in general public services. In education, for example, even people in the smallest local governments are used to having their “own” schools. There have been thoughts on mapping the functions of local governments for some years, already. At least this would help to find out what the exact tasks of local governments are, and what the costs of fulfilling these tasks have been. In practice, nothing has been done so far. The general government deficit and the official debt burden have been relatively small in Estonia. Similarly to general government, the local government budget has been close to balanced – even though always in slight deficit over recent years. Accordingly, gross debt has been at the very low level of about 2.5% of GDP, and net debt at around 1.5-2% of GDP. Central government has, in few cases, helped local governments in debt by providing them with additional loans, and only one municipal government has been bailed out so far. In this regard, no uniform regulation has been worked out yet. 4.

Status of policy reform consideration

During recent years, no finance reforms have been carried out in Estonia. Discussions are held on the necessity of financial, territorial and organisational reforms in the field of local government. As a part of natural development, sixteen local government units have amalgamated into eight units and one local government unit has been divided into two, recently. Since 1996, no changes in the local government budget formation have been carried out. There is some evidence that smaller local government units have smaller administrative capacity in the level of public service provision and infrastructure conditions. A lot of research has been carried out on the local government socio-economic situation. They state under-performance of some local government tasks in some smaller municipalities, mainly due to scarce financial resources. Some local government units have been faced with problems in fulfilling their financial duties e.g. in relation to the burden of loans on the budget, or buying public services from other municipalities. In order to improve local administrative capacity, an administrative reform is being prepared in Estonia. There is political consensus on the fact that reforms to improve the efficiency and administrative capacity of local government units are necessary. There is an unavoidable need to reduce the number of local governments. It is obvious that almost all functions are relatively more expensive in smaller local governments. However, this does not necessarily mean that bigger ones are more effective. At the same time, central government is planning a reform whereby additional tasks will be delegated to the local level of government to order the division of tasks between central and local government. The additional tasks will have to be financed from the central government budget. Central government will affect local expenditure by determining the mechanism for financing the additional tasks. Also, the central government is planning a reform of the mechanism of local government budget equalisation. 50

The reforms are still under discussion and no final political decisions have been taken yet.

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HUNGARY 1.

Main features of local finance and intergovernmental relations

In line with the principles of deployment of powers laid out in the Constitution the act on local governments specifies the detailed rules on the types of local governments, their mandatory responsibilities and the economic foundations of their operation. The Hungarian system acknowledges only local governments as the base of the one-tier subnational local government system. In terms of type a local government may be a municipal government (that of a village, town, county right town, the capital city and its districts) or a county government. These, however, do not constitute a hierarchy, for the distribution and controlling functions of the former county councils have been terminated. It should also be noted that the system established in 1990 is excessively fragmented. A total of 1 600 councils were replaced by 3 115 local governments – one for each settlement. Over recent years the number of local governments continued to increase through separation of some formerly integrated municipalities and this process has not yet come to an end. On 1 August 2000 a total of 3 177 municipalities were operating. In the case of more than half of the total of almost 3 200 municipal governments the population is below 1 000, while in almost 300 municipalities the population is below 200. Along with the fragmented structure of the local government system, local governments perform and exercise a very wide scope of responsibilities and powers. Local governments perform functions in almost all areas of the state responsibilities. Despite all local governments have almost identical rights and responsibilities, in a large number of municipalities the number of inhabitants and financial resources are not sufficient for the efficient and economical performance of the services required by the population. 2.

Major empirical findings

The year 1990 was something of a milestone in the regulation of the funding sources of local governments since an entirely new regulatory system was introduced. Former funding regulation system was a centrally controlled, so-called expenditure oriented financial regulation system which was based on the establishment of the expenditures on an individual bargaining basis. State subsidies were determinated as the difference between the amount of spending and the local revenues. In 1990 it this was replaced by a so called resource oriented regulation system where the potential spending of a local government for the provision of public services is determined on the basis of the disposable resources (funds) realised by local governments. Instead of the earlier practice, the basic principle of the new resource regulation is that the central budget contributes to the performance of the mandatory duties specified in the act on local governments and the sectoral laws for which local governments also have to involve their own revenues. This system is aimed to incent local governments and their institutions to perform economical financial management – whilst complying with the standards specified in the sectoral laws. In order to ensure a balanced economic growth reduction of income concentration is one of the key points of the Government’s fiscal policy. The proportion of the operating revenues of the general government system had dropped from the 44.2 per cent of GDP in 1996 to 41.6 per cent by 1999. In line with the reduction of the share of the general government system as a whole local governmental revenues had decreased from 11.8 per cent of GDP in 1996 to 11.1 per cent by 1999. Tax revenues represent 82-85 per cent of the operating revenues of general government. These revenues has dropped over four year period from 36.8 per cent to 35.5 per cent of GDP. Some 8-10 per cent of tax revenues of the general government are booked among the current revenues of local governments representing 33 per cent of their total revenues. Despite the reduction of the centralisation of incomes in the general government system the share of local governmental tax revenues has increased from 3 per cent to 3.7 per cent of GDP during the same period. Tax revenues of local governments fall into two large categories: shared taxes and duties, and local taxes.

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Shared taxes and duties. 40 per cent of the centrally imposed and collected personal income tax is transferred to local governments, 15 per cent is redistributed to the place of income generation, while 25 per cent is allocated normatively taken into consideration the local tax potencial. Duties are collected by local governments, a percentage of which is transferred to the central budget. Local taxes. In order to enable local governments to perform public services in line with the local characteristics and requirements and to provide them with means for financial management a system of local taxes was developed in 1990. The state has partially transferred its traditional right of taxation – reserved for Parliament – to local governments within the limits specified by law. Under authorisation by and in accordance with the provisions of the act on local taxes the council of elected representatives of a municipal government may issue decrees imposing local taxes. However local governments are not under obligation to introduce and collect local taxes. The act on local taxes establishes the possibility of taxation. The number of local governments collecting local taxes and their revenues have been steadily increasing. In 1999 a total of 2 970 local governments – 93 per cent of all local governments – applied local taxes. Local taxes accounted for some 18 per cent of all current revenues in 1999 – to be compared with the mere 3.5 per cent in 1990. The most frequently applied locally imposed tax type is the local business tax accounting for some 84 per cent of all local governmental tax revenues. Most of the non-tax revenues of general government are collected in the central budget. The share of local governments of such revenues accounts for an estimated 30 per cent, representing 18 per cent of their total revenues. The rules on the establishment of these non-tax revenues are specified by decrees issued by the Government and line ministries concerned. Charges and fees applied by a local government are established and announced by local governmental decrees. In some cases decrees also determine the mandatory allowances to be applied by local governments. Grants. For the performance of their mandatory responsibilities local governments are entitled to grants from the central budget. The titles and the amount of grants are approved by the Parlaiment annually. Normative contributions represent the massive part (80%) of these grants. Their allocation is based on indicators of concrete tasks. There are some 100 titles of allocations presently. This, however, is not a form of task-financing, because the spending of such subsidies is not subject to restrictions. A local government decides at its own discretion, how much it spends on what tasks. A slight part (12%) of state contributions serve for specific purposes allocated under normative rules. Such subsidies are related to special operational purposes or to development projects of local governments. Another smaller part (8%) of grants is spent also on specific purposes but allocated on individual basis. Mention should be made of an extra support for the performance of mandatory tasks of local governments. This kind of support represents some 1 per cent of all grants and is provided for “local governments in disadvantaged position for reasons beyond their control” having no sufficient revenues. The budget act specifies the normative conditions under which a local government can have access to such subsidy. Its utilisation is linked, of course, to the operating expenditures, but it is not fixed to any specific target. Expenditure. Under the act on local governments a local government is entitled to determine the ways and modes for the performance of their duties – depending on the requirements of the local population and its financial resources. A local government decides whether to make arrangements for the provision of a certain public service itself (through its own institution, a contractual arrangement or purchasing the service) or to co-operate with other local governments. Under the provisions of the act on local governments the tasks of providing for certain public services may be imposed on local governments only by law. The local governmental act also provides that where a mandatory duty is imposed on a local government the Parliament has to provide the necessary funding for the performance and exercising of such tasks and power, deciding on the amount and mode of the budgetary contribution. The largest proportion of the current expenditure of local governments is made up by spending on the performance of education, health and social/welfare responsibilities. In 1999, education, health and the social/welfare area accounted for 33 per cent, 19 per cent and 16 per cent, respectively, of the total current spending of local governments. The expenditure of local governments on education, health and social/welfare functions accounted for 66 per cent, 44 per cent and 11 per cent, respectively, of the total general government spending on the relevant areas. 3. 52

Major problems in the fiscal design

The most substantial problem of the Hungarian local governmental system is that an excessive degree of decentralisation has evolved in the system of scopes of duties and responsibilities.

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The smallest municipalities have almost identical duties and responsibilities as does the capital city. The organisation of the performance of tasks for conurbation areas is not provided for in the system. This has not been yielding efficient solutions because there is little propensity to establish economic associations while there are no means for mandatory association in today’s Hungarian legislation. International and domestic experience also shows that larger associations are not usually established on a voluntary basis. No clear-cut arrangement has been introduced that would assign institutions performing regional tasks. county governments performing territorial functions along with the necessary financial and other operational requisites for such task performance. A persisting problem is that municipalities may unilaterally transfer their institutions performing territorial duties to county governments which are obliged to take over and operate such institutions – and municipal governments may just as unilaterally take back such institutions. Another unsolved problem is that the ownership of assets should be transferred always along with the transfer of the relevant tasks (those who were given ownership rights in 1990 are now obliged to transfer only the right of utilisation, to the new organisation in charge of maintaining an institution). The establishment of a regional level of governance covering several counties has gained importance from the aspect of EU accession as well. This constitutes some of the tasks to be carried out in the near future as part of the reform of the public administration system. A more concentrated scheme of the allocation of tasks may make it possible to replace the current normative subsidy system adjusted to the fragmented regime of task performance with a regulation comprised of a substantially smaller number of elements, based primarily on global subsidies. 4.

Status of policy reform considerations

In the spring of year 2000 the Government decided on the directions for the continued development of the institutional and financial system of general government. According to the Government decision, in order to ensure efficient and transparent utilisation of public moneys, the definition of the range and sub-systems of general government need to be reviewed, along with the general and specific regulation of the tasks of the various sub-systems. To this end, the scopes of responsibilities and powers of the state have to be reduced through the regulation of technical/professional and organisation efficiency requirements on the one hand, while on the other hand there is a need for a perceptible reduction of the number of institutions and for the simplification of their internal organisation structures. The parties in Parliament agree that the current system of the deployment of responsibilities and powers in the local governmental system is not the most appropriate or most efficient solution, but in respect of the mode of its rearrangement one should expect heated debates. Even local governments themselves have different views on the issue. From a professional angle the following distribution of duties seems most reasonable: A conurbation local governmental scope of duties – existing only in respect of a few types of responsibilities in the Hungarian local governmental system – should be established. This means that keeping the number of local governments unchanged, the scopes of responsibilities of towns local governments performing the roles of district centres would be broadened, while those governments of smaller municipalities would be reduced. The tasks that demand increased expertise and resources, including the maintenance and development of kindergartens, nursery schools, schools, the organisation of social/welfare benefits, the maintenance and improvement of roads between municipalities should be involved. Furthermore, the mandatory – regional – roles of county governments should be clearly specified, terminating the permeability between them and municipal governments. This should result in transferring the property to the local government that maintains the given institution. At a regional level it seems justified in a longer run to create elected local governmental bodies. The tasks of maintaining, developing of institutions serving several counties – hospitals, secondary schools etc. – and infrastructure development tasks (e.g. main roads, motorways) should be delegated to this level of local governance. The review of the deployment of responsibilities and powers of local governments is underway. The effort is co-ordinated by the Minister of the Interior and is carried out with the involvement of the line ministries and the associations of local governments. It should be noted, however, that the amendment of the act on local government needs a two thirds majority of votes in Parliament which necessitates a broad political consensus. In co-ordination with the review of the local governmental tasks and the rational deployment of responsibilities and powers the regulation of the resources of local governments also need to be improved, in the course of local revenues should be increased and at the same time increasing of income differences should be restricted.

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LATVIA 1.

Main features of local finance and intergovernmental relations In Latvia there are three types of self-government: – local governments of urban areas – big cities (republican cities); – rural (pagasts) authorities and towns; and – regional governments.

There are 578 municipalities in Latvia, including 7 urban municipalities representing big cities (republican cities), 26 regions (rajons), 73 towns and 472 rural municipalities (pagasts). The resident population are 2 439 445, of which 1 683 556 urban population and 755 889 rural population. There are 1 224 463 population in republican cities, of which 796 732 lives in Riga the Capital of Latvia. The big cities have the functions of both: the rural authorities, towns and the regions (at the same time). The rural authorities and towns (or the big cities) are not subordinated to the regions. The regions have separate functions and structures. The general work principles of these municipal councils, their economy, competence, the rights and obligations of the council its institutions and chairmen, the relations of municipal councils with the Cabinet of Ministers and the Ministries, and the relations with other municipal councils are regulated by the Law “On Local Governments”. The permanent functions of municipalities are specified in law “On Local Governments”. They shall be executed in accordance with the procedure established by respective laws and regulations of the Cabinet of Ministers. The current Law “On local government”, article 15, stipulates 17 permanent tasks for rural authorities and towns and 4 permanent tasks for the regions (Rayons). The permanent tasks of the 7 “republican cities” are both those of the rural authorities and towns and those of the region – in total 21 permanent tasks. Apart from the permanent tasks, the rural authorities and towns are also responsible for a number of temporary tasks (laid down by laws and regulations) and voluntary tasks. Among the most comprehensive temporary tasks are implementation of the land reform, restoration of property rights, and other questions related to privatisation of public properties. Voluntary tasks concern for instance local orchestras or tourism development initiatives. The problem in Latvia, as in many other countries, is that the necessary standard of tasks are not demarcated in details in the law and the minimum national standard service level very seldom is stipulated. To a wide extent, the division of these tasks (e.g. leisure activities for children) depends on the abilities of the regional and local governments in the region and personal initiatives from politicians or administrative employees. Therefore, the current division of these “self government tasks” differs considerably from region to region. Recent new legislation (Law on Administrative Territorial Reform) and reforms of existing legislation (Law On Local Governments) have been aimed at rationalising the number of local governments and improving the distribution of financing at the local and regional level to allow for better provision of services. There is wide consensus on the importance of building institutional capacity at the local level to improve functioning and service provision by the Local Governments and their municipal enterprises, however limited progress has been made in implementing the local government reform agenda. 2.-3.

Major empirical findings. Main problems in the fiscal design

The revenue of Local Governments is generated from the following sources: – Percentages of state taxes: • 71.6% of the personal income tax; • 100% of the real estate tax. – Percentages of state duties. – Duties imposed by local governments. 54

– Grants and earmarked grants allocated from the state budget.

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– Grants from the local government financial equalization fund. – Service fees. Local governments are financed by shared taxes (income tax), inter-governmental transfers (state grants and earmarked grants) and state taxes (real estate tax) and own revenue (duties and fees). Shared taxes and transfers constitute by far the largest share of local government revenue (more than 70 per cent in 1998-1999). Own local revenue is composed of fees and duties that the local governments can administer. In accordance with binding regulations issued by the respective republican city or rural authority, town’s municipal council, local governments may impose duties on the following: – official documents issued by the urban or rural municipal council; – organisation of entertainment in public places; – accommodation of holiday-makers or tourists; – commercial activities in public places; – the keeping of animals, wild or domestic; – driving through special protection zones; – placing advertisements, posters or announcements in public places, containing visual commercial information; – keeping boats, motor-boats or yachts; – use of municipal symbols for commercial purposes. Local governments have the right to collect state duties for issuing special permits (licences) to engage in specific types of businesses. These duties are paid to local government budgets. Local governments receive grants and earmarked grants from the state budget for the fulfilment of specific tasks assigned to them under the Law “On Local Governments” and under other specific laws. The government of Latvia is working on the medium –term budget preparation program, but today there are no binding documents that would stipulate multi– annually the amount of specific and general grants for the Local governments. They are set annually at the national budget law. Local governments still have limited autonomy to raise their own taxes. There are only state taxes in Latvia. Local Governments have a right to collect taxes and this is a real estate tax for all municipalities and in addition three municipalities: Riga, Ventspils, Liepaja collect also personal income tax. Municipalities don’t have a right to set the tax rate, to give tax exceptions etc. All taxes are set by the Central Government. The most significant shortcoming in this important area of intergovernmental fiscal relations has been and continues to be the lack of tax autonomy. This minimum level of autonomy would create better accountability of local officials to constituents, increases the efficiency of public expenditure decisions, and is the best way to address the vertical imbalance between responsibilities and funding sources. Granting some degree of revenue autonomy to local governments has proven to be difficult, but needs to be addressed in the next round of intergovernmental finance reform. Probable together with the implementation of administrative reform we will observe the possibility to give more rights for municipalities to set the real estate tax rate within some limits. The choice of both the personal income tax and real estate tax as the major sources of revenues for local governments, is appropriate because their tax bases tend to be relatively stable during business cycles of the economy. They are not easily exportable, and there tends to be a linkage between the payment of these taxes and the benefits received by taxpayers from local public services. Local governments have taken around 24 per cent of general government revenues for the last three years. The Equalization Mechanism. The current formula-driven Equalization Fund performs well in many respects. It has provided a good measure of objectivity in the determination of the equalization grants, it has provided the intergovernmental finance system with a high degree of equalization, and it has also contributed to increasing the revenue certainty and budgetary stability for local governments. The Equalization Fund implements both revenue capacity equalization and expenditure needs equalization. This is quite proper for Latvia because there are not only significant disparities in revenue availability across local governments, but also different demands on local budgets arising from the demographic profiles and other cost factors. The Rules on Local Governments’ borrowing. The government of Latvia observes strict financial and fiscal policy and the annual debt level for the municipalities is limited and is stated in the annual law on national budget. The ceiling for 1999 was 30 mill. Ls (the same as for 1998). The amount for the year 2000 being 17 mill. Ls where 10 mill. Ls of the total amount was for borrowing (and from that 0.5 mill. Ls was for the stabilisation of local governments finances) 7.0 mill. Ls are for guarantees. Along with the financial resources that are denominated in the national currency, and State Treasury can lend to the municipalities on favourable terms, with comparatively easy and fast

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procedures and without foreign exchange rate risk, the government has arranged credit facilities with the European Investment Bank and with the Nordic Investment Bank for the local government’s long term borrowing purposes. The Local Governments borrowing procedures are strictly observed by the Local Governments Borrowings and Guarantees Board. Without permission from this Board Local Government has no right to borrow. If Local government wants to borrow from other Sources than the State Treasury, special permission from the Minister of Finance is requested. Central Mandates on Economic Management. Municipal councils draft, adopt and implement their budget plans independently. State institutions are not allowed to interfere with the drafting and implementation of local budgets unless prescribed by law. The Minister of Finance has prescribed a standard classification for the recording of local government budget revenue, expenditure and debt, and has established rules for budget accounts. Local government budget plans must always be balanced. In accordance with State Treasury instructions, all the financial activities of the municipal councils are registered in the official local government financial accounts. The local government budget for the current budget year includes all the revenue collected or received by the local government (and its institutions) which is then used by the local government to achieve its goals. Municipalities budget preparation and reporting system is getting better with every year. Local governments’ annual reports have to be audited by the state-sworn auditors before submitting to the State Treasury. The State Audit Office may check the budget accounts for the current budget year submitted by republican cities, regional, or rural authorities and towns’ municipalities councils, concerning the implementation of their basic and the special budgets. 4.

Status of policy reform considerations

Improved clarity of task assignments to municalities. The current Law “On local government”, article 15, stipulates 17 permanent tasks for rural authorities and towns, and 4 permanent tasks for the regions (Rayons), making 21 permanent tasks in total. The permanent tasks of the 7 “republican cities” are those of both the rural authorities and towns, and those of the region. (See Section 4.6, “Local discretion – expenditure”, below.) The problem in Latvia is that the law does not detail the standards to be reached when carrying out a task, and rarely stipulates a minimum national standard. To a large extent, the division of these tasks (e.g. leisure activities for children) depends on the abilities of the regional and local governments, and the personal initiatives of politicians and administrative employees. Therefore, the current division of these “self-government tasks” differs considerably from region to region. A working group has been set up, by the Cabinet of Ministers, to work out proposals for a clear division of functions between levels of government, and, specifically, the division of functions such as education and social welfare. Territorial reforms – Unit size of governments. The existing administrative territorial division of Latvia is a heritage from the Soviet period. Already with the beginning of the 90’s attempts have been made to reform the administrative division, to reorganise it according to the present-day needs, yet no results have been achieved. Although the law “On the Administrative-territorial Reform”, which determines the reform process, was passed, still there are big problems to establish a consistent development of the process, as well as to provide the necessary financial resources. The existing division of Latvia in regions and rural districts does not demonstrate an administrative territorial structure formed historically and representing certain historic principles or criteria, but the reorganisation of the economic management, taking place in the 60’s. During the Soviet times regional territories basically performed the role of economic management unit. The administrative regions were used as the territorial units of economic planning, management and control. Rural district territories were adjusted with the territories of the collective farms. Up to the present moment the local government reform was directed at revisions not involving fundamental basic changes. The rural district and town municipality functions have been added, as well as their independence and responsibility increased, while the municipal administrative territorial division with minor changes has stayed the same from the previous regime. It was formed in the 60’s and 70’s for the centralised administration. It is dominated by territories with small number of inhabitants and, consequently with a weak financial revenue base.

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Such municipalities cannot efficiently execute their functions. Lack of uniformity of the financial resources among the big number of small municipalities and big volume of the interrelated payments provides no possibility for rational usage of the already lacking municipal financial resources, planning and management of the financial resources often is quite weak.

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To execute the municipal functions and provide qualitative services to inhabitants, it is necessary to form qualified, specialised municipal administration, to separate municipal decision-making power from the executive institutions. However, it is not possible for the municipalities with small number of inhabitants due to the relatively big already existing administrative expenses, which results in decreasing of the municipal management effectively and quality of the services provided. Encountering the unstable character of the municipal co-operation, the situations might occur that municipal cooperation associations are formed, which after the implementation of the reform become formal or collapse. Thus the state budget resources would be spent for the reform and much of efforts applied, but the administrative territorial division would stay the same with just few exceptions. Although the administrative-territorial reform cannot be viewed as a magic treatment for improving the municipality situation it will create a better basis for the possibilities to solve many of the urgent problems. When comparing the essential municipal problems and possibilities, one can see that the reform is able to solve the problems, which are connected with the small municipal capacity, discrepancy between the number of municipal employees and the amount of the functions. With other beneficial conditions it might be possible for the territorial reform to solve the issues of budget spending effectively, attracting of investments and intellectual potential, increasing the possibilities of international municipal co-operation. Municipal amalgamation just provides the possibility of the development of the municipality, while all the results depend only on the work done by the respective municipality. To ensure timely and qualitative execution of the activities determined by the law, the implementation of the territorial reform has to be provided with the necessary financial resources. Municipal amalgamation has to be linked with the state investments for ordering and development of the infrastructure. More attention has to be paid to the formation of public relationships for the reform, informing inhabitants, municipal politicians and employees on the aims, objectives and process of implementation of the reform. Equalisation. Although the present system of equalisation of revenue bases and expenditure needs across municipalities represents a clear step forward there are a number of areas with potential improvements. The most severe problem in the present system is the calculation of the total expenditure needs each year before the coming financial year. This figure has a decisive role for the system of equalisation as it is used as the basic for the calculation of the needed grants. There is a lack of detailed calculations of the exact expenditure needs at the local government level. The present criteria should be evaluated in order to have a more updated review of the relationship between the cost area, e.g. costs areas for children between 7-18 years, and the population group. The present weights are based on old figures for the distribution of cost across these expenditure groups. However, also in future there will be both: income and expenditure part equalisation. Reporting system on Local government’s budget data becomes better with every year. The officials from the Ministry of Finance that are responsible for the Equalisation algorithm are ready to recalculate criteria weights of expenditure need (methodology is clear) but the government has an agreement with the Union of Local Self governments not to make any amendments at the law “On equalisation of Local Government finance” for the year 2001. Therefore, there is a plan to re -evaluate criteria weight together with the Union of Local Self Governments for the year 2002 and to make necessary amendments at the law “On local government finance equalisation”. Some local authorities have up to 10 times more revenues from taxes per inhabitant than others before equalisation. This makes it difficult to make a sufficient strong equalisation, especially with the maximum level of equalisation, i.e. 35% of the tax revenues. This is not a problem caused by the system of equalisation itself but will need to be addressed in the aim to develop a local government territorial reform and the related financial reforms, cf. below. A reform of the system of equalisation is needed if and when a territorial reform changes the pre-sent division of tasks considerably. On the other hand an appropriate territorial reform will ease some of the problems mentioned above, e.g. probably some of the huge variations across the local authorities on revenues per inhabitant. The reform of the system will therefore be seen in close connection with this reform, e.g. the future functions and competencies of the regions.

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LITHUANIA 1.

Main features of local finance and intergovernmental relations

The essential element of the system of municipal financial resources is municipal budgets. Every municipality has an independent budget. Municipal budgets are approved deficit-free. From 1998, a significant step was made towards the development of a modern, reliable and sustainable system of municipal budget revenues. The system sets the overall volume of municipal expenditures, as well as the principles and procedure for the allocation, calculation and transfer of revenue sources assigned to this volume. The Seimas approved in 1999 the Law on the Methodology of Determination of Municipal Budgetary Revenues based on budgetary co-operation. One of the principles of the law is that the main financial indicators should be established through negotiations between central government (represented by the Ministry of Finance) and the municipalities (represented by the Municipal Association). Another important principle is that the evaluation of a municipality’s fiscal requirement is based on calculated expenditure requirements, which are determined on a three-year basis. The state budget and the municipal budgets make up the national budget of the Republic of Lithuania. The essential criterion reflecting effective macroeconomic control is that the municipal budgets must be balanced prior to approval. The law on the methodology of determination of municipal budgetary revenues defines the ratio of the size of municipal budgets to the size of the national budget. In this case, municipal expenditures are linked with the general state of the state economy and of the national budget revenues. Municipal borrowing is controlled by Central Government and the Ministry of Finance. The use of municipal budget resources is inspected by the controllers of municipalities. In certain cases, the execution of municipal budgets is inspected by the state controller. 2.

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Major empirical findings

By analysing the changes in the revenue and non-tax income of local governments, we can conclude that income tax of natural persons becoming an income source solely for local governments is a positive tendency in forming a base for local government budgets. Compared to 1997, income tax revenues of natural persons in local government budgets increased by 45%. Lithuania’s economy experienced difficulties due to Russia’s financial crisis of 1998. That is why, in 1999, as compared to 1998, the revenues from the income tax of natural persons in local government budgets increased only by 6.4%. Assigning said taxes to the budgets of local governments, knowing that budget revenues will not change, should give more confidence to local government administrations. These conclusions are backed up by the example of the decrease in revenues at other administrative levels, in 1999, partially due to Russia’s financial crisis of 1998. Tax-revenues of municipalities increased constantly (4.93% in 1997, 6.18% in 1998 and 6.63% in 1999 of GDP). Analysing tax clasification, the major part (about 90% in 1999) of the municipal tax revenues consists of taxes on income, profits and capital gains. The rest (about 10% in 1999) consists of taxes on property: as a share of tax revenue, this is decreasing but as an absolute amount, it is increasing. Local governments only have the right to impose a small part of their own taxes. These taxes are assigned to the non-tax revenues. Local governments have the right to set the tax base and tax rate for local levies and for municipal budgetary revenue obtained for the services rendered. The two types of revenue comprise up to 10% of all non-tax revenue of local governments. Grants in total have decreased during the period 1997 – 1999, from LTL 852.6 million to LTL 128.4 million, i.e. by more then 6 times. This was caused due to a considerable decrease in both general and special grants. The amount of the general grants is based on the expenditure volume of municipal budgets and the volume of tax and non-tax revenues assigned to cover such expenditure volume, according to tax laws. During the last two years (1998 and 1999), these revenues have increased more than municipal expenditures, therefore the amount of general purpose grants has decreased accordingly. Basically, it was due to the fact that, from 1998, personal income tax became the basic revenue source for municipal budgets, and revenues from that tax have increased. The decrease in specific grants, to cover standard costs, is noticeable due to the recent Government policy to decrease the amount of such grants. Grants, allocated to cover actual costs, are oriented to state social policy implementation, therefore the amount of grants has remained quite stable. An analysis of the expenditures reveals that the largest portion of municipal expenditures is allocated to social services which include education, health-care, social security and welfare, sports and culture. Municipal expenditures on social services constitute about three quarters of total expenditures (72.6% in 1997, 74.1% in 1998,

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and 77.8% in 1999). Education absorbs the major part of the expenditures, i.e. 49.4% of the total expenditures in 1997, 52.8% in 1998 and 56.3% in 1999. Social security and welfare consumes about 15% of total expenditures. Expenditures on health-care within municipal budgets are quite moderate, because, since the health-care sector reform, in 1997, these services have been financed from the budget of the Compulsory Health Insurance Fund. The number of healthcare institutions funded from municipal budgets was reduced and, as of 1 July, 1997, was very small. In 1998 and 1999, municipal budgets financed primary health-care services only. Another significant part of municipal appropriations (about 10 per cent) is used for housing and community amenities, which are – exceptionally – municipal functions. Services attributed to fuel and energy, as well as transport functions, constitute between 3 and 3.5% of municipal budgets each. Appropriations in these expenditure line items are used to compensate expenses incurred due to application of passenger transport benefits as well as to compensate heating costs for low-income households. The function of public order and public security, for which municipalities spend up to 1% of their budgets, is delegated to municipalities who organise the activities of their fire-prevention agencies. Having analysed the changes in municipal budgetary expenditures in the past few years, we can conclude that the budgetary resources allocated for social services remain stable and are even increasing, notwithstanding the changes in the municipal revenue sources. This increase could be explained by the fact that municipalities are responsible for more and more functions in the sphere of social services and this is also related to the Government’s social policy. An analysis of municipal expenditures shows that they represent the major part of the three basic political sectors, like any other current expenditure of state or municipal budgets for a certain sector. This is, first of all, true of municipal expenditures for such services as pre-school training, general education, sanitation and environment protection, street lighting, other functions in the sphere of housing amenities and public utilities. Funding for preschool institutions and general schools accounts for 83% of the total state expenditures for this sector, while expenditures on sanitation and environment protection, street lighting and other services in the sphere of housing amenities and public utilities account for 100% of the total state expenditures for this sector. This is also related to the fact that these functions are mainly within the competence of municipalities – the division of expenditures between the central government and municipalities is mainly determined under generally accepted principles (municipalities are only responsible for pre-school and general education, and public utilities, for their residents, whilst the central government is responsible for services that are used by all citizens of the country, such as national defence or public order and security). 3.

Main issues in the fiscal design

The main quality of the new Law on Local Self-government is the more precise and clear description of its functions, together with a link to legal and procedural aspects. The new law clearly regulates the powers and rights of municipal institutions. In the old version of the Law, only two types of function were described: autonomous and those delegated by the State. Functions delegated by the State included: civil registration, keeping the register of municipal, state and private enterprises as well as public organisations; carrying out secondary health activities; they may also have managed state parks (national and regional), organised the municipal police, civil security and fire safety, and implemented other functions delegated by law. Autonomous functions were described separately for each part of the internal management system: the Council, the Mayor and the Board. Moreover, autonomous functions included many procedural functions, which were actual rules of internal management and responsibility, and these were not clearly defined, either. This caused co-operation between levels of governments to be ineffective, and created contradictions and difficulties in appraising functions financially (in the budget preparation process). At present, discussions are taking place in Lithuania on state (transferred to local self-government) functions and the funding necessary to implement them. The problem is that there is no existing, unified methodology for the calculation of the cost of the functions, especially when the Government delegates certain functions related to state or public management, the cost of which differs in each municipality. In addition, there are certain inadequacies between implementing functions and municipal budgets. Therefore. some conventional decisions are to be made in relation to the above-mentioned shortcomings, in the near future. The new Law on Budget Structure regulates the implementation of objectives and tasks, and gives a legal basis for budget reform . The Law contains certain basic principles: – Appropriations are defined as resources of the state and municipal budgets, approved by the Law on the Approval of the State Budget and decisions of municipal councils concerning the approval of municipal budgets; and assigned for the implementation of activities and programmes of the state and municipal institutions. – The introduction of the concept of “special programmes”, i.e. whose expenditures are covered not only by the funds of the national budget but also by other funds. – The definition that taxes, obligatory payments, and levies collected in the Republic of Lithuania may only be allocated through the National Budget of Lithuania, the State Social Insurance Fund, the Obligatory Health Insurance Fund, and the Privatization Fund.

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Fiscal Design Surveys across Levels of Government

– The determination of the main duties, rights and responsibilities of the appropriation managers. – The definition of requirements for the publicity of budget information. – The definition of requirements for the adoption of other laws that affect budget revenues and expenditures. – The draft state budget shall be prepared for a period of one budget year and estimated for a period of three budget years. – It is also planned to submit to Seimas performance measures of the appropriation managers’ programme results. – The definition that state budget revenue received in excess, and appropriations that are no longer valid, shall be used for: the repayment of public debt, the financing of carried over appropriations; covering shortfalls in municipal tax revenue, with the exception of cases where the Seimas pass amendments to the current year budget. The annual state budget has to be prepared according to the long-term strategic plan of Central Government and strategic activity plans of ministries and Government agencies. The need to have a strategic plan was formed in order to implement effective reforms in the areas of public administration and the legal system. The Strategic Planning Manual was prepared in order to help ministries, government agencies and other public management institutions to prepare strategic plans, programmes and draft budgets. The manual covers the principles of strategic planning and budget formation. The manual helps to implement the integrated planning and budget system as approved by the Government. Planning and budget reforms can only be implemented successfully when both reforms are carried out together. Strategic priorities are not implemented successfully when they are presented without a reliable financial plan and firm financial obligations. Central Government has recommended that municipalities apply strategic planning principles. Specific training in municipalities has begun. Recently, certain municipalities have introduced these principles. 4.

Status of policy reform considerations

One of the key factors bringing about new aspects of the self-government reform is the Program for 2000 to 2004 of the new Government that was formed after the election to the Parliament in 2000. With the view to limit the power of the central government over municipalities and relying on potential capacities of municipalities to act more efficiently, economically and more understandably to the public, the Government of the Republic of Lithuania has set in its program for 2000-2004 the following measures to be taken: – to detail all functions of the central government and municipalities, to eliminate overlapping of the functions, to specify in as much detail as possible the powers and to limit authority; – to develop an efficient legislative mechanism to ensure that each institution of the respective municipality is observing the laws on its own will; – to give municipalities the power to deal with land-related and land management issues; – to transfer all institutions dependent on regional administrations as well as other bodies to the supervision of those town and regional municipalities, in the territory of which the above-referred institutions and other bodies are located; – to gradually phase-out centralised re-allocation of budgetary resources. To give possibilities for the municipalities to form their budgets from local taxes and levies. To set that both natural and legal persons shall pay two types of taxes – a fixed amount to the state and to the municipality. – to set statutory limits, within which a municipality may itself set the size of taxes due to it; – when changing administrative borders of municipalities, to take account of the opinion of the public and to set the procedure for remuneration of losses; – to give the property, which is not necessary for the needs of the central government and which is not to be returned to its former owners, to municipalities; – not to delegate any functions to municipalities, unless they are appropriately financed; – to promote social housing development in municipalities, to grant state support to socially vulnerable people and young families; – to finance schools by the principle “money follows a student”, to guarantee equal opportunities to nongovernmental and governmental educational institutions; – to implement the principle “money follows a child” in supplementary education field as well.

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In the 1st quarter of 2001, it is planned to draft the methodology for calculation of the need for the resources from the state budget of the Republic of Lithuania to perform the functions delegated to municipalities so that budget proposals to finance central government functions and those delegated to municipalities collected to draft a law of the respective year on approval of financial indicators of the state and municipal budget are well-grounded.

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In the 2nd quarter of 2001, the Law of the Republic of Lithuania on the Methodology for Estimating Municipal Budgetary Revenues shall be amended to adapt it to the provisions of other legislation already applicable (Local Self-Government Law, Law on Budgeting) and to be still adopted (relevant taxation legislation). Quite a significant portion of the expenditures that are currently financed by municipalities will be financed centrally, i.e. by state budget grants. To finance other functions performed by municipalities, the same revenue equalisation mechanisms as provided for in the currently applicable law will be applied, since the differences between tax revenues of individual municipalities per capita are very large. Therefore, it is forecast that both the equalisation of differences in tax revenues and equalisation of differences in expenditure structures among individual municipalities will be further applied. Levels of tax revenue equalisation and demographic indicators to be used to determine the levels of equalisation of differences in the structure of expenditures are planned to be established in a single Methodology Law. It is anticipated that after the fiscal reform of municipalities planned by the Government is implemented, the principle of revenue equalisation will be more applicable to perform independent functions of municipalities, while expenditure setting principles will be applied with respect to functions delegated by the central government, the latter being financed by special grants from the state budget. We can forecast that as a result the ratio of grants within municipal budgets will increase in the coming years.

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POLAND 1.-2.

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Main features of local finance and intergovernmental relations. Major empirical findings

The last stage of local government reform in Poland has begun in 1999, when were established two new tiers of local government – poviats and voivodships. These new tiers were fitted with new financial sources – especially special grants and general subsidy – and also took over new tasks from state government. Much more independent than poviats and voivodships are gminas – the lowest level of subnational government, which have existed since 1990. The gminas have functioned in stable financial environment – significant part of its revenues consists of tax revenues. Units of subnational government receive revenues from three basic sources: 1. From taxes: • local taxes; • share of state taxes. 2. From non-tax revenues, and 3. From grants: • general subsidy; • special purpose grants. After the reform of subnational government, the most important source of revenues has become grants. In 1999 it was over 51 per cent of total local revenues. In comparison in 1998 the share of grants in local revenues was 35.8 per cent and in 1997 it was 34.3 per cent. Such significant growth was influenced from the fact, that new tiers of subnational government (poviats and voivodships) received grants (general subsidy and specific grants) as main sources of revenues. It should be pointed out that existing system subsidising units of local governments are a denial of the self-government idea and do not permit making a decision in an independent and flexible way. The local governments are dependent on government decisions on granting subsidies and their amounts. It is very important in the case of grants for investment, where unforeseen delay in submitting the required money has a negative impact on the effective use of financial resources, completing on time, etc. With respect to these problems, grants should gradually be replaced by increasing own revenues. A parallel decision is required to reduce the quantity of commissioned tasks by state administration and, at the same time, increase own tasks together with accurate financial resources to realise them properly. On the other hand, the share of tax revenues in total revenues fell from 37.6 per cent in 1997 to 24.5 per cent in 1999. The budgets of gminas remain the only budgets that are funded from local taxes and charges that constitute, in their entirety, the own revenue of gminas. The revenues of poviats and self-governing voivodships do not come from any independent tax sources other than a share in state taxes – personal income tax and corporate income tax. During the years 1997 – 1999 the growth of tax revenues of subnational government was insignificant and in 1999 with comparison to 1997 it grew only by 8 per cent. At this time units of local authorities did not received any additional source of tax revenues. That 8 per cent growth was mainly a result from an increase in revenues from real estate tax, which grew during this period by 1503 mln of zlotys – it was equal to 34.0 per cent. Revenues from taxes on income, profits and capital gains did not change significantly during years 1997-1999. The growth of revenues from this source was equal to 5.4 per cent. Unfortunately local authorities have little influence on the development of their revenues from central tax sharing (the role of sharing in direct taxes is primarily fiscal – the provision of funds to the eligible unit of self-government). The statutory tax authority of subnational government is quite limited and brought down to non-uniform functional powers. In most cases, it allows lowering upper rates of local taxes, to the extent laid down in statutes. The upper tax rates are determined and updated on an annual basis by the Finance Minister within the framework of the general tax policy of the state. Another instrument of tax authority used by the units of local self-government is the granting of relief, deferment and remission of taxes that make up the gmina’s revenues and are directly paid to the gmina’s account. The same power can be exercised in the form of a waiver of the collection of such taxes (relevant decisions may solely refer to individual applications filed by taxpayers).

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The responsibilities of the units of local self-government may be divided into duties being their direct responsibility, and responsibilities delegated by the central government administration. Duties are being delegated to units of local government by the central government administration under a number of statutes regulating various areas of public activity. They may also be implemented on the basis of agreements made between unit of local government and a body of the central government administration. Such duties are financed from funds transferred to local government especially for that purpose by the relevant body of central government administration. Funds allocated to the performance of own duties of subnational governments come from own revenues, i.e. from taxes, charges, receipts from assets and the general subsidy. On the other hand, delegated duties are financed from specific grants transferred by the government administration. Public expenditure specified in the self-government’s budget resolution applying to particular year cannot be exceeded as it is capped. During the years 1997-1999, almost all areas of expenditure grew. The relation of total local expenditures to GDP was higher over 2 percentage points in 1999 than in 1997. The most important tasks realised by subnational government embrace: education, social security and welfare, and housing and community affairs. The expenditure on these three sectors covered almost 67.6 per cent of total local expenditures in 1999. There exist, in Polish law, different restrictions in the area of borrowing, bond issue and provision of guarantees. These restrictions are imposed on all local authorities. The total amount repayable during a relevant budget year cannot exceed 15% of the revenue projection for a given budget year of that local authority. Also, the total amount of debts at the end of the budget year cannot be more than 60% of the aggregate revenue of that unit during a relevant budget year. The units of local government may also incur loans and issue securities in order to cover the in-year shortage in the budget of the units of local government. Such debts are repayable or redeemable within the same year as the year of incurring or issuing them. This is due to the irregular inflow of revenue from taxes and other revenue to the budget accounts of the units of local self-government, and the necessity of incurring current expenditure on a regular uninterrupted basis. In addition to that the units of local self-government may also borrow at certain banks and financial institutions on preferential terms. It should be noted that units of local government are independent entities, acting under their own responsibility. Local authorities must cover any budget deficit themselves. On the other hand, in case of temporary financial difficulties, loans for financing deficit may be extended from the state budget in the course of rehabilitation proceedings. The conditions of granting such loans (interest rates, repayment dates) are laid down in the loan agreement. The central authorities influence neither level of local revenue nor expenditure. Even the amount of revenue transferred from the state budget, i.e. subsidies and specific grants, depends on objective criteria laid down in the Acts and, hence, the central authorities are unable to interfere in the amount of this revenue. Neither are these authorities able to exert influence on the amounts spent from local budgets and the sole supervisory criteria is the correctness of implementation of duties assigned to individual levels of local government. The regional clearing chamber fulfils the external control of subnational governments. Regional clearing chamber also fulfils information and training functions, providing the council with professional opinions on the draft budget, information submitted by the gmina council (poviat, voivodship) and concerning the implementation and execution of the budget, and also findings of comprehensive inspections of the financial management of a local government. 3.-4. Major problems in the fiscal design. Status on policy reform considerations The fact of decentralisation, and the new tasks and functions given to all levels of local government, have not entailed an increase in the amount of their own financial resources. A considerable part of the tasks, especially those carried out by poviats and voivodships is still financed by means of transfers from the state budget. This way of financing is considered to be the factor restraining local government reform and reducing their independence by limiting the ways in which tasks are realised and financed. The method of financing described above violates the so-called basic acts such as the Act of gmina government, the Act of poviat government, and the Act of voivodship government. Apart from this, supplying local governments with targeted grants via the national budget does not motivate local governments to obtain their own financial resources or to efficiently manage the money they get. It is also a characteristic of specific grants, which constitute a type of revenue that is earmarked for special purposes and must be returned to the state if not used. Thus, government proposes changes in the types of local government tasks, and the ways of financing them. Government aims at replacing targeted grants transferred to local governments with own source revenues, and transforming commissioned tasks to own tasks. Increasing the financial independence of local communities will require changes in special acts.

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