The Discredited Decentralization

anjči || Creative Commons

Just a year after the topic of fiscal decentralization briefly entered the public debate in Bulgaria, the political volition for taking actual steps in this direction seems exhausted. The government stifles to a large extent the initiative of local authorities in two steps:

  1. The successful transformation of the debate of last year’s fall into a debate about higher taxes. After delaying for years the discussion about transferring part of the proceeds from taxes on personal income to the municipalities, Finance Minister Vladislav Goranov made a move that largely discredited the idea of fiscal decentralization. The proposal to maintain the level of taxes on personal income at the national level and to give municipalities the power to additionally “burden” workers with up to 2 percentage points increase of this tax (on the eve of local elections) silenced the local authorities on the topic to a large extent, at least for the 2016 fiscal year, and probably for later on as well.

  2. The adoption of a mechanism for financial recovery of municipalities, which even though provides tools to promote higher collection and optimization of administrative costs for troubled municipalities, makes local finances even more dependent on the central government. Particularly worrying is the possibility of pardoning the accumulated interest-free loans of distressed municipalities from the central budget, in the case of satisfactory results in the recovery of the local finances – an obvious tool for favoritism towards certain mayors.

With the first step, the government managed to make the concept of fiscal decentralization sound unappealing by linking it with a rise in taxes. With the second step, it managed to change the subject completely by diverting the attention of municipalities from the lack of income sources towards their debt problems. In other words, while the supporters of fiscal decentralization were trying to give Bulgarian municipalities the image of a responsible and less dependent local authority, the mechanism for financial recovery managed to portray those same municipalities as fiscally irresponsible.

Despite these steps made by the Ministry of Finance, the public remains enthusiastic about fiscal decentralization, which is why we want to draw attention towards two recent reports published on the National Association of Municipalities in the Republic of Bulgaria (NAMRB): Analysis of the implementation of municipal budgets for 2015 and Indicators for the development of fiscal decentralization in South-East Europe: 2006-2014.

  • There is practically no country in South-East Europe where the debt of local authorities has not grown over the last decade. In general, this fact is explained by the need for higher capital costs and relatively smaller tax powers of local authorities compared to municipalities in Central and Western Europe.

  • The increased indebtedness of Bulgarian municipalities (especially in 2015) is to a large extent a direct consequence of the lack of alternatives for co-financing investments for EU projects. It should be also noted that 2015 was the last year when payments for European projects from the previous programming period (2007-2013) could be made.

  • Revenues of local authorities in Bulgaria as a share of GDP fell from 7% in 2008 to 5.3% in 2015. At the same time, this decrease occurred at a time of a gradually rising tax burden in the economy as a whole. As part of the consolidated budget the revenue for the same period fell from 19.6% to 14.4%.

  • Lacking other opportunities to raise their own funds, Bulgarian municipalities have resorted for the most part to an increase in property taxes. The collection of these taxes, however, remains below 70% in 118 of the 265 municipalities in the country. In addition, these taxes are subject to a number of tax exemptions. Practically, all sudden increases in the revenue are observed in smaller municipalities and are due to one-time proceeds, grants or sales of property.

  • The structure of the municipal revenue collection disallows the use of the budget as a policy-making tool, including debt management. Actually, the last things that depend on local spending policies in Bulgaria are decisions of municipal councils and preferences of local communities.

There exists a problem with municipal debt in Bulgaria, indeed. However, in general, the debt is not created by arbitrariness and fiscal irresponsibility of the local authorities, but by structural problems of the tax policy. In order for a municipality to negotiate first, and then successfully repay the loan, it must manage the bulk of its revenues (i.e. its revenues have to play a significant role) and have more control over their spending. Unfortunately, except for a few major cities and resort communities, most municipalities in Bulgaria have a much lower share of disposable income and rely heavily on transfers from the central governent.

The differences in the capacities of municipalities to generate their own revenues are significant, which is a problem that will not resolve itself with remising a portion of the proceeds from taxes on personal income. However, an improving process should be initiated and the only action that is logical and technically feasible in the medium-term is namely linking the economic processes on the territory of a municipality with its budget.