Earmarked and Block Grants in Macedonia: Options for Reform

In the present report, after reviewing the allocation formulas of earmarked and block grants for decentralized institutions, five major problems of the system are identified:
• Underfunding of local governments in Macedonia (subsection 3.1). Shares of local revenues in terms of GDP are low compared to other Europeans countries, even those who like Slovenia did not entrust to municipalities the responsibility for paying teacher salaries.
• Decentralization is institutional, not functional (subsection 3.2). Back in 2005, Macedonia transferred to municipalities a large selection of public institutions, but the laws, and the financing instruments, indicate that the functions were not in fact transferred.
• Ineffective central control over employment levels (subsection 3.3). Macedonia maintains a strict and costly system of control over local employment, even in cases when an existing employee retires. The system hampers proper functioning of some of the decentralized institutions but allows employment expansion in other sectors.
• Very low local financial involvement in the financing of decentralized sectors (subsection 3.4). Most decentralized institutions, even preschools, are financed almost exclusively from grants from the national budget, with very little local contribution from own revenues. They are not seen as own institutions by most municipalities.
• Debts related to obligatory transport of students of secondary schools (subsection 3.5). For too long has Macedonia accepted without any intervention growing problem of blocked accounts of many secondary schools.
Three general scenarios, described in section 4, are proposed to address the identified problems and to reform the system of earmarked and block grants in Republic of Macedonia:
1. Continuation of institutional decentralization.
2. Introduction of sectoral decentralization.
3. Granting municipalities financial autonomy.
Nine specific recommendations are proposed (section 4) to implement these three scenarios:

1. VAT grant
Macedonian municipalities are relatively underfinanced in comparison to local governments in EU and in the Balkan region. For this reason, Macedonia needs a stronger equalization system. It is recommended (as part of the first scenario) that VAT grant is increased substantially, and that the increase be allocated as an equalization grant. A formula for this new equalization part of VAT grant is proposed in subsection 4.1.
2. Earmarked grant in primary education
Since 2012, only one municipality remains in the first phase of decentralization and receives earmarked grant for primary education (Plasnica). This is a clear anomaly, because it is the only instance of a Macedonian municipality still functioning within phase I of decentralization, 13 years after the start of the process. It is recommended (as part of the second scenario) that this anomaly be corrected, and that the earmarked grant should be discontinued from January 2019.
3. Block grant in primary education
Today the per student allocation formula for the block grant is not functioning well, because the main impact on the allocation is due to upper and lower buffers. It is recommended that Macedonia removes the buffers for block grants for primary education. An immediate effect of such a decision will be that some municipalities, if their local school networks are especially inefficient, may receive allocated subvention lesser than the current (irrational) salary costs. Simulation for this recommendation are presented in subsection 4.2.
A further recommendation is to introduce in Macedonia obligatory co-financing of primary education from own revenues of municipalities. A discussion how this can be done is included in subsection 4.4 (point 4.4.1).
4. Block grant for secondary education
Block grant for secondary education is one grant in the system of Macedonian local government finance which functions well. It is recommended that the allocation formula for this grant should be maintained. Since 2008, when it was introduced for the first time, it underwent only minor corrections. For this reason, it is advisable to analyze, to what extent the coefficients of the formula are aligned with per student costs (see subsection 4.4, point 4.4.2).
5. Block grant for culture
It is recommended to divide all institutions of culture into two categories, national institutions and local institutions. Local institutions of culture should be financed from a relatively small block grant, allocated to municipalities proportionally to their population (with a determined per capita amount). National institutions of culture, which were transferred to municipalities in 2005, should be recentralized to create a simpler and more functional system. However, they may be then delegated to individual municipalities, on a case-by-case basis.
6. Block grant for preschools
The allocation of the blocks grant for preschools is based on a formula, which besides the per student amount and the number of enrolled children uses also a municipality coefficient, separate for each municipality. It is recommended to introduce a true per student allocation formula for the block grant for preschools, by removing any dependence on the number of staff. A simple draft formula is proposed in subsection 4.2, together with simulations.
7. Block grant for houses of the elderly
The block grant for houses of elderly is, similarly to the block grant for culture, is in reality a earmarked grant for concrete activity, because it finances just three institutions across the country. The catchment area (service area) of each of these houses extends far beyond the municipality where it is located. The funds involved are very small, the allocation formula is based in fact on actual costs of the institutions, and the municipal role in the management of houses of the elderly is not helping to manage them efficiently and according to national needs. It is recommended that the three houses for the elderly should be recentralized, and the block grant for them discontinued. However, they may be then delegated to individual municipalities, on a case-by-case basis.
8. Earmarked grant for fire protection
Earmarked grant for fire protection is used to finance units of fire protection, which were transferred to municipalities in 2005. It is recommended to centralize the system of fire protection and to finance it directly from one central agency. This would ensure common technical, training and disciplinary standards, and would avoid current controversies. This recommendation assumes that earmarked grant for fire protection will be discontinued. However, municipalities should retain some measure of influence over the management of state fire brigades located on their territory.
9. Unified grant replacing earmarked and block grants
It is recommended that all the funds transferred from the national to local budgets in the form of earmarked and block grants will be pooled together to form one unified transfer (as part of third scenario). Subsection 4.3 includes an allocation formula proposed for the unified grant and simulations of how this formula will affect Macedonian municipalities.