Five European Systems of Local Government Finance

Abstract

Local government finance, especially the systems of grants from the national to local budgets, and other revenues streams of municipalities, counties, and regions, are highly specific for each country, as they depend crucially on legislation in force, on recent history, on the political process that takes place between different levels of governance. The five case studies presented in the report identify some of these country-specific characteristics of financing of local governments, tailored to the different needs and serving different allocation of managerial and expenditure responsibilities. None of the reviewed systems can be transposed, in toto or in part, to Republic of Macedonia without a thorough review of required adaptations. At the same time, however, they provide some lessons which may be usefully considered by Macedonian reformers.

• The functioning of most European systems of local government finance is based on high degree of trust in local governments and in other users of public money. This trust, however, does not stop them from using are strict mechanisms of monitoring and control of local public finances. Any reforms considered for Macedonia should always include monitoring mechanisms, as well as procedures to intervene if lower levels of government do not follow prescribed rules.

• Some successful European countries have maintained, similarly to Macedonia, high dependence of municipalities on grants received from the national budget, with relatively reduced revenue from taxes and other sources. This indicates that efficiency of local provision of services is related not only to autonomy in generating local revenues, but also to allocation mechanisms and to effective monitoring. The efficiency and transparency of the Macedonian system may be improved even if grants remain the main revenue of municipalities.

• Every European system of local government finance uses a robust, formula-driven equalization mechanism. These systems attempt to ensure that citizens living in all municipalities may have access to services of the same high quality. In Macedonian conditions the need for strong equalization system is even more apparent than in wealthy countries of the European Union, due to large differences between municipalities. Prior to any reforms of the Macedonian equalization system, reformers should undertake an in-depth review of its strengths and weaknesses. Experience of Sweden suggests that it is better to begin with relatively simple equalization system, so that its formulas and its effects on municipalities are easy to understand and analyze.

• Taxes are an important source of revenues of European municipalities. Specific tax regime is decided differently in every country, it may include taxes on property or income. In every case, however, citizens of municipalities know that their taxes contribute to the operations of their local government, and demand accountability. This link becomes even stronger if local governments have the power, as in several European countries, to set the tax rates (sometimes within the limits specified by legislation). Macedonia should try to strengthen the role of tax revenues in local finances, for example by increasing the land tax. There is also room for introducing new types of property taxes (e.g. for businesses) that could represent an additional source of funds for municipalities.

• European countries have not only instituted strong monitoring regime, but also powers of central government to interfere in cases of local mismanagement. This indicates that in certain cases the central government should be prepared to take decisive unilateral action and intervene. For this, the government must have appropriate tools and measures available to sanction certain municipalities that do not respect good governance principles. Today in Macedonia almost 20% of municipalities have blocked accounts (some for more than 10 years), but the central government still does not take appropriate measures (even those defined in the legislation). Further, with each progress of the decentralization process it is necessary to strengthen the system of monitoring and control, and to build up available policy tools for taking effective action.

• In European countries, including Slovenia, there is intensive academic research concerning the functioning of local governments, the adequacy of financial mechanisms, equity of provision of local services. An important topic for empirical analysis is the equalization system. It seems that lack of such research in Macedonia is one of difficulties of designing reform scenarios and deciding on next steps of reforms. Macedonia should actively try to develop own academic expertise in the area of local public finance, to be able to rely more on local knowledge and experience.

• In some countries, local taxes are collected by the state authorities and are then distributed to the local governments based on geographical location of the tax payer (both personal and commercial). This approach may work well independent of whether the rates of these taxes or their shares that remain at the local level are set locally or nationally. In Macedonia, tax collection is a serious challenge for the mayors of municipalities, who often find themselves in uncomfortable situation when trying to tax their neighbors. In this situation a full or partial centralization of this function could be part of the solution of the problem of low tax compliance.

• Many European countries delegate large autonomy to local governments in important social spheres, such as education and health, allowing municipalities and counties to decide on how to best organize and finance educational and health services. However, these spheres are quite well regulated through different norms and procedures, and a system of oversight of local government finance is present. If Macedonia plans to strengthen autonomy of Macedonian local governments, similar quality standards and monitoring norms should be proposed for each sector, discussed with stakeholders, and adopted.

• As European countries decentralize, they always need to collect more and more data on local governments, on the services they are providing, on the operation of different areas of public sector. Over time, several interlinked databases were developed. The lesson for Macedonia is that increasing autonomy of local actors should be accompanied by increasing knowledge and understanding at the central level of how the system is operating.