The challenge of fiscal decentralisation in transition countries.
Dabla-Norris, Era
JEL Classifications: E62, H20, H30, H40
INTRODUCTION
A number of developed and developing countries have undertaken
comprehensive reforms of their intergovernmental fiscal systems over the
past two decades, and this trend has extended to the transition
countries in Eastern Europe and the Former Soviet Union (FSU) as well.
Several countries in the region are already in the process of
considering or implementing far-reaching 'second-generation'
reforms in this area. (2) However, persistent macroeconomic instability in some, and the entrenched legacy of socialism and central planning in
others, have generated additional challenges which are complicating the
design of an effective decentralised system.
The virtually global trend towards devolving service implementation
to lower levels of government is based on the wide acceptance of the
subsidiarity principle and on the view that it results in improved
efficiency in the delivery of public services and, hence, a more
efficient allocation of resources in the economy. (3) The current
movement towards democratic forms of governance is also closely
associated with the demand for decentralised government. (4) At the same
time, increased fiscal decentralisation, in itself, is seen as an
important means of increasing democratic participation in the
decision-making process, thereby, enhancing accountability and
transparency of government actions. In yet other countries, the trend
towards greater autonomy for subnational levels of government is driven
by the need for national coherence in the face of ethnic or regional
centrifugal forces or conflicts. In many transition economies, the
political and economic failure of autocratic, highly centralised socialist regimes may have provided an impetus to the subsequent
decentralisation initiatives.
Whatever the precise background and the motivation in different
countries, it is generally acknowledged that the manner in which
decentralisation is carried out can have a significant impact on
macroeconomic management and performance. A common view in the
literature is that decentralisation may aggravate fiscal imbalances,
thereby, endangering overall macroeconomic stability, unless
sub-national governments are committed to fiscal discipline and the
decentralisation package includes incentives for prudence in debt and
expenditure management. (5) Empirical evidence on the relationship
between decentralisation and macroeconomic instability is mixed. Shah (1998) and King and Ma (2001) find that a decentralised fiscal systems
have a better record in controlling inflation and deficits. However,
Fornasari et al. (2000) and DeMelo (2000) find that increases in
subnational spending and deficits lead to an increase in spending and
deficits at the central level.
Recent studies suggest that the design and implementation of a
multi-tier system of government can significantly affect overall
resource allocation in the economy and, hence, economic efficiency,
growth, and welfare {Davoodi and Zou, 1998; Martinez-Vazquez and McNab,
2003; Akai and Sakata, 2002). A central argument for fiscal
decentralisation leading to improved resource allocation rests on the
assumption that fiscal decentralisation increases local influence over
the public sector. However, in theory, there is an equal possibility
that fiscal decentralisation simply transfers power from national to
local elites and that improved access of local elites to public
resources increases opportunities for corruption (Bardhan and
Mookherjee, 2000). (6) In general, the impact of fiscal decentralisation
on corruption depends to a large extent on the quality of the supporting
institutional framework and in particular, the degree that subnational
governments and/or officials can be held accountable.
In light of the possible effects--that depend on the institutional
design --of fiscal decentralisation on economic growth, macroeconomic
management and corruption, a key challenge for many transition economies
has been to reap the economic benefits of decentralisation while
maintaining control over public expenditures and borrowing, restoring
growth and improving accountability of local governments and officials
to limit corruption.
In retrospect, for many former socialist countries, the combination
of efforts aimed at consolidating macroeconomic stabilisation during the
early years of the transition, together with the fundamental structural
changes in the economy, in some cases strong centrifugal forces, and
political and ethnic conflicts, created an extremely complex setting for
fiscal decentralisation. This goes a long way in explaining why the
fiscal decentralisation process in many transition countries has been
rapid, haphazard and largely nontransparent, with the emerging system of
intergovernmental relations having important implications for budgetary
developments.
In recent years, there has been progress in efforts to reform
intergovernmental relations in many of the transition economies.
However, this progress has been uneven across countries and across
various components of intergovernmental fiscal relations. It is widely
agreed that the Czech Republic, Hungary, Poland and the Baltics have
been the more active reformers in many of the key aspects of
intergovernmental fiscal relations. They have made considerable progress
in carrying out fiscal decentralisation and have promoted institutional
settings and processes that allow for the articulation of interests and
policymaking based on consensus building. However even in these
countries, there remain challenges and areas for needed progress. Many
other countries, including Russia, Ukraine and the Central Asian States
still need substantial reforms of the incentive structures that govern
intergovernmental fiscal relations in order to obtain an efficient and
well-functioning multi-tier system of government.
Bird et al. (1995) provided a comprehensive comparative assessment
of the decentralisation in early years of transition. A recent study by
Wetzel and Dunn (2001) examined the uneven progress on fiscal
decentralisation and key challenges to effective decentralisation in the
transition economies of Europe and Central Asia. They adopt a
traditional approach that focuses on different structural elements that
together make up a system of intergovernmental fiscal relations (the
legal and institutional framework, expenditure and revenue assignments,
transfers and subnational borrowing). Our paper differs from theirs in
that we provide a more systematic framework to identify and assess key
adverse incentive mechanisms inherent in the design of the system of
intergovernmental fiscal relations in these countries. In this respect,
our paper is similar to Dabla-Norris et al. (2000), which analysed key
disincentives in intergovernmental fiscal systems in a smaller subset of
transition countries, namely, Russia, Ukraine, and Kazakhstan. Our paper
provides a simple analytical framework to examine areas where key
principles of sound fiscal decentralisation have been breached with
their potentially negative impact on the effectiveness of service
delivery as well as macroeconomic performance. This includes an
assessment of the strength of institutions pertinent to the
intergovernmental financial relations, relevant laws, regulatory
frameworks and other incentive structures that may facilitate or
undermine effective fiscal decentralisation in transition economies. In
the section following the next, we identify three critical principles of
sound decentralisation which are then contrasted with actual policies
and practices in select transition countries. Finally, the last section
concludes.
OVERVIEW OF FISCAL DECENTRALISATION
Initial conditions
To set the stage for the discussion that follows, some of the
essential characteristics of the fiscal adjustment that occurred during
the early years of transition is presented. During the initial years of
transition, fiscal imbalances quickly emerged as output collapsed due to
structural dislocations with concomitant loss of revenues, particularly
for the transfer-dependent states of the former Soviet Union. The
negative impact on growth from structural dislocations was further
aggravated by high inflation resulting from price liberalisation and the
monetisation of large fiscal deficits to sustain output and employment
(Tanzi and Tsibouris, 2000; Alam and Sundberg, 2001; Valdivieso, 1998).
Significant progress has been made towards achieving fiscal and
macroeconomic stabilisation since the transition in most
countries--progress which has importantly changed the environment in
which the decentralisation process is taking place. There has, however,
been substantial variation in the nature and pace of reforms across
countries. In general, the Eastern European and Baltic countries, the
most advanced reformers, have made rapid progress. The intermediate
reformers--the South-Eastern European countries of Albania, Bulgaria,
and Romania, and the BRO countries of Russia, Ukraine, Moldova,
Kazakhstan, and the Kyrgyz Republic, and the slow reformers--Armenia,
Azerbaijan, Belarus, Georgia, Tajikistan, Turkmenistan, Uzbekistan have
been less successful in establishing fiscal institutions, controlling
fiscal imbalances, and redefining the role of the state (see EBRD, 1998;
Valdivieso, 1998).
The adjustments that took place in the context of economic
stabilization represented only the first phase of a more substantial
fiscal reform process. A key remaining challenge for these countries is
to implement reforms aimed at improving the quality and efficiency of
government, including improvements in institutional arrangements that
underpin fiscal policy, and to enhance transparency and accountability
at all levels of government. The reform of the structure of
intergovernmental relations remains an important element of this reform
agenda.
Decentralisation experiences
A common feature of almost all transition economies is that they
began from a legacy of a highly centralised system of public finances
with subnational governments acting mainly as administrative units with
little independent fiscal responsibility. While originating from the
similar economic structures and political systems, these countries have
chosen very different routes and approaches to decentralisation, with
some countries being considerably more centralised than others. In
addition, progress with implementing intergovernmental fiscal reform has
varied across the region.
One difficulty in comparing the degree of decentralisation to date
across the various countries is that fiscal decentralisation is a
multidimensional phenomenon, involving not only the assignment of
expenditure and revenue responsibilities among different levels of
government, but also the extent of subnational policymaking autonomy.
For instance, the share of subnational spending in total government
spending, which is a common measure of decentralisation, on average
about 25 per cent among the transition countries, has varied from 15 per
cent in Albania and Macedonia to over 50 per cent in Russia and
Kazakhstan (Wetzel and Dunn, 2001). This standard, however, fails to
take into account the effective decision-making authority of subnational
governments. It also does not take into account whether subnational
governments have the financial resources required to meet their assigned expenditures.
The uneven nature of the degree of decentralisation as well as the
extent and scope of intergovernmental fiscal reform among the former
socialist states largely reflects, among other things historical,
political, ethnic, geographic, and demographic differences (see Table
1). For instance, countries with larger populations or geographic areas
(such as Russia, Kazakhstan, and Poland) require a greater
decentralisation of public service provision to subnational governments
as compared to smaller countries like Moldova and the Kyrgyz Republic.
Similarly, ethnically diverse countries such as Russia also would have
fairly high need for fiscal decentralisation compared to other, smaller
and ethnically more homogeneous transition economies (such as Slovenia).
At the same time, political factors such as the accession to the EU can
be seen as providing an impetus for reform in countries like the
Baltics, the Czech Republic, Poland, and Hungary. In countries such as
Croatia and Bosnia and Herzegovina, ethnic conflict may have played a
significant role in shaping the nature of fiscal decentralisation that
has evolved. Differences in institutional, economic and political
development can also be expected to influence the extent of
decentralisation across these countries. (7)
These factors not only have influenced the observed degree of
decentralisation across the region, but also whether decentralisation
policies are effective and have had their desired impact. At the same
time, macroeconomic and fiscal policies adopted at the outset of
transition have had an impact on the system of intergovernmental
relations that has evolved in many countries. Many of the more advanced
reformers, with more stable macroeconomic conditions, including low
overall public sector deficits, have made considerable progress in
carrying out fiscal decentralisation and, in particular, have promoted
institutional settings that are supportive of effective
decentralisation. However even in these countries, weaknesses in
existing systems have prevented them from fully exploiting the potential
public finance and service delivery benefits from decentralisation. In
countries that are regarded as intermediate reformers in the broad
fiscal arena, the current design and structure of the intergovernmental
systems contains many inappropriate incentive structures that are
adverse to the sound working of the fiscal system and, hence, to overall
macroeconomic performance. Among the slow reformers, both in terms of
the timing and actual implementation of fiscal reforms,
intergovernmental fiscal relations preserves many features, patterns and
structures of the Soviet system.
PRINCIPLES FOR SOUND AND EFFICIENT DECENTRALISATION
The importance of the relationships between decentralisation and
macroeconomic performance underscore the need of identifying the factors
that would ensure a sound and efficient decentralised fiscal system. We
outline three basic principles that capture some key aspects of the
incentive mechanisms needed for sound and effective decentralisation.
Throughout the paper we use the term sound fiscal decentralisation with
regard to the extent it is conducive to macroeconomic stability. The
term efficient fiscal decentralisation refers to the extent it enhances
microeconomic efficiency in the input and output mix of public service
delivery.
Clarity, transparency, stability and well-defined rules of the game
are paramount for achieving accountability that efficient and sound
decentralisation requires. Given the interdependence among the various
components of the system of intergovernmental relation, this requires a
clear and effective delegation of functions by central government, with
revenue assignments that are transparent, unambiguous, and commensurate with subnational governments' expenditure responsibilities. It also
requires transfers that are based on stable principles and specified by
legal formulas that support hard budget constraints.
A measure of autonomy for subnational governments on the
expenditure and revenue side is crucial for realising the efficiency
gains of decentralised government and supporting macroeconomic
stability. On the expenditure side, this requires subnational budget
flexibility to decide--within limits --expenditure priorities and the
choice of both the output mix and techniques of production. On the
revenue side, this requires that subnational governments have the
authority to own-finance locally provided services at the margin. More
complete revenue autonomy requires a minimum of authority to set tax
rates and an assignment of at least one significant tax source.
Achieving meaningful and sustainable autonomy at the subnational
level and avoiding an inequitable geographical reallocation of resources requires a 'level playing field' such that local and regional
councils can provide relatively uniform service levels at reasonable
levels of tax effort. Such equalisation of fiscal disparities is
possible only when effective sizeable and well-designed equalisation
transfers are put in place.
While autonomy should be explicit and well-defined, it must also be
circumscribed with respect to the access to borrowing by subnational
governments in order to support hard budget constraints and reduce moral
hazard. In particular, subnational borrowing in the absence of both
market discipline and a sound, effective and strictly enforced
regulatory framework (as seen in some transition economies) can
undermine achieving fiscal targets for the general government and hence
pose a risk to macro-fiscal stability. (8) For instance, if central
governments lack credibility with regard to not bailing out subnational
governments with debt servicing problems, given the implicit moral
hazard, it cannot solely rely on the market to enforce sufficient fiscal
discipline on subnational governments (Ter-Minassian, 1997a; Rodden et
al., 2003). As a result, the framework for subnational borrowing
requires an appropriate balance of market discipline, rules-based
controls, and administrative oversight and supervision.
Institution building is the last of the three pillars. A
prerequisite for successful decentralisation is that subnational
governments possess the administrative and technical capacity required
to effectively carry out their assigned responsibilities. Supporting
institutions, including democratic representation, sound budget
processes, local government revenue collection capacity, and mechanisms
to ensure coordination and cooperation between different levels of
government--both at the political and the technical level --are crucial
for the functioning of a multi-tier system of government. In the
remainder of this section we provide an overview from a broad range of
transition economies to illustrate instances where these principles are
lacking, with potentially adverse impacts on economic efficiency,
macroeconomic stabilisation, and growth.
Clarity of roles
Legal and institutional structure
In many transition countries, the evolution of the legal and
institutional framework has been subject to a fairly continuous series
of revisions, reversals, and shifts in focus and has reflected political
compromises rather than consistently applied rules and principles. The
degree to which the legal and institutional framework supports a
well-defined system of intergovernmental fiscal relations, however,
varies. Countries like Hungary, the Czech Republic, and Poland have
pioneered reforms in the legal and institutional framework required for
decentralisation, and have had considerable success in defining the role
of intermediate levels of government. However, current legislation in
these countries has set the stage for the fragmentation of
municipalities into entities of inefficient sizes. (9) Some countries in
Central Asia (eg, Kyrgyz Republic, and Tajikistan) still lack a
well-specified legal and institutional basis for decentralisation.
Other countries (Russia, Ukraine) have made significant progress in
recent years to clarify the legal and institutional framework for
decentralisation between the centre and regional (oblast) governments as
well as subprovincial governments. (10) In other countries (eg,
Kazakhstan) the distribution of functions to local governments remains
ambiguous, with important gaps in the legislation arising from the lack
of well-defined criteria to determine the assignment of functions and
powers across regional and local governments. In some countries (Belarus
and Azerbaijan), the practice of resolving contradictions between the
various legislation in an ad hoc manner, with crucial provisions often
decided in the annual budget laws, has imparted a measure of
unpredictability and instability to the system of intergovernmental
relations. In addition, overlapping and poorly defined roles, and
unclear divisions of power between different levels of government has
created confusion about the functions and modes of interaction of
different parts of government.
Expenditure assignment
In recent years, but to varying degrees, progress has been made in
clarifying expenditure assignments. While actual assignments often
broadly correspond to the principle of subsidiarity (Table 2), further
progress is needed in a number of countries. The ambiguity stemming from
shared responsibilities between the centre and subnational government
needs to be reduced. There is also a wide variation across countries
with respect to the distribution of specific expenditure
responsibilities. In most countries, regional and local governments bear
a substantial portion of expenditures on education and social insurance
and health services. This figure is higher for the Baltics and the
Central Asian countries, reflecting, in part, differences in physical
and demographic characteristics, institutional capacities, political
preferences and the degree of centralisation. In other countries, local
governments are routinely mandated to fund and provide redistributive
social services, funding for which could be more effectively provided by
the central government.
The advanced reformers, (Czech Republic, Hungary, Poland, Estonia,
and Lithuania), have developed clear assignments of expenditure
responsibilities. However, the efficiency of service delivery is often
compromised due to the excessive fragmentation of municipalities in
countries such as Hungary and the Czech Republic, as many small local
governments are required to provide a broad range of services. In
addition, local governments are frequently given greater flexibility in
providing certain voluntary services with the option of passing this
responsibility to a higher level of government. (11)
In a number of countries, such as Albania, Moldova, Georgia,
Romania, and Azerbaijan, the distribution of spending responsibilities
remains ambiguous. In Russia, for instance, ambiguity in the assignment
of the authority to regulate and issue declarative norms and the
resultant proliferation of unfunded mandates, until recently,
compromised subnational budgetary positions (Litwack et al., 2002). In
general, the lack of clarity and stability in expenditure assignments
have detracted from accountability at all levels of government and
undermined the efficiency of public expenditures. Moreover, in many
countries, it has reduced incentives to prioritise budgets, lower costs
of service delivery, eliminate excess physical capacity, and properly
maintain capital infrastructure at the subnational level. (12)
Subnational governments in Russia, Ukraine, and other countries
have also been slow to rid their budgets of private market
interventions, with subsidies for housing and communal services,
including public utilities, accounting for a large proportion of their
expenditures. For instance, subnational governments in Russia spend
close to one-third of their total resources on subsidies to consumers
and in Kazakhstan the relevant figure was 10 per cent (Dabla-Norris et
al., 2004) Among the more advanced reformers, such as Hungary, Poland,
and the Baltics, subnational governments have been more successful with
privatisation and contracting out of service provision. For other
countries with limited private sector capacity and a weak legal and
institutional environment for private providers, the private sector
response has been marginal.
In many cases, the problem of unclear expenditure assignments has
been especially acute at the regional-local level, with regional
governments enjoying a high degree of discretion, with the result that
they exert a certain arbitrariness over expenditure assignments to their
subordinate local governments. For instance, local governments in
Georgia and Kazakhstan lack a formal assignment of expenditure
responsibilities which may negatively affect the accountability of both
regional and local governments to taxpayers and subject local
governments to added budget uncertainty.
Tax assignment
While progress to varying degrees has been made in recent years in
many countries in the region (eg, Hungary, Poland, the Czech Republic,
the Baltic's, and Russia, and to a lesser extent in Kazakhstan,
Kyrgyz Republic, and more recently Ukraine) to make revenue assignment
more transparent and predictable by formalising revenue sharing arrangements and adopting stable and uniform sharing rates at the
central-regional level, in other countries, revenue assignments continue
to rely on the 'regulating approach.' Under this approach, the
formal basis for setting tax sharing rates is the central government
estimates of each region's 'minimum' expenditures needs.
This practice has resulted in customised and yearly changing sharing
rates and compensations through non-transparent transfers to fill the
subnational budget gaps as well as assignments being ad hoc and
negotiated with individual regions through bilateral bargaining.
As seen in Table 3, subnational governments in most transition
economies are assigned income taxes as the most important type of shared
revenue with consumption taxes trailing far behind and generally being
more important at the central government level. Property taxes, which
are widely recognised as an important source of finance for local
governments, are still a small and underutilised revenue source locally,
often reflecting lags in regularising the property market as a basis for
taxation.
The lack of clearly defined, stable and uniform revenue assignments
between the centre and subnational governments inherent in this approach
has weakened budgetary management at the subnational level and created
perverse incentives for subnational governments to either hide locally
mobilised revenue sources in extrabudgetary funds (eg at the municipal
levels in Ukraine, and at the regional level in many Central Asian
countries), or to simply reduce their efforts to mobilise revenues
locally. Evidence from Bulgaria, Georgia and other countries suggests
that central governments routinely revise tax sharing rates on an annual
basis in face of political and economic pressures. (13) Punitive 'extractions' by higher level governments in the form of
clawing back any additional revenues raised by lower level governments
through reduced sharing rates have also created perverse incentives for
revenue mobilisation, at the local levels in many countries. (14) In
Albania, while there has been improvement in recent years, local
governments' efforts to improve revenue collection in the past were
discouraged since they were not free to determine the spending
allocation of funds collected under the local (independent) budget. This
led to surplus funds being trapped in the treasury system and captured
by the central government by the end of the year. The resultant
non-uniformity in revenue sharing and the absence of stability
undermined sound fiscal management at the local level (Banks and Pigey,
1998).
Transfers
In most transition economies--the Slovak Republic, Poland, Hungary,
and the Baltics are among the exceptions--transfers among the various
levels of government remain discretionary, and negotiated, with
transfers largely unconditional and determined ad hoc by the central
government, often changing with each annual budget. Other countries,
including Bulgaria, Croatia, Romania, Georgia, Russia, Kazakhstan, and
more recently, Ukraine have moved towards more transparent formula-based
systems, although weaknesses remain. While most formulas include
indicators of expenditure needs and tax capacity, in Bulgaria and
Estonia for instance, formulas continue to incorporate a fiscal gap
component, creating negative incentives for revenue mobilisation (Table
4). In many countries, transfer formulas are undermined through end-year
negotiated transfers that serve to soften budget constraints.
The gap-filling nature of the transfers between central and
regional governments in many transition countries and between regional
and local governments in most countries, however, provides negative
incentives for revenue mobilisation by subnational authorities and the
efficient provision of public services as any increase in regional own
revenues or budgetary savings in the provision of public services
triggers, often commensurate reductions in the level of transfers. This
practice is seen in Albania, Bulgaria, Belarus, Moldova, Ukraine, and
all Central Asian countries.
Apart from equalisation transfers, other types of grants and
transfers are used across the region. Matching grants for funding
centrally mandated services in the areas of education, health or social
spending are used widely in Croatia, the Kyrgyz Republic, and Poland,
and for investment purposes, in the Czech Republic and Hungary. In
Russia and Ukraine, however, the use of other ad hoc and non-transparent
transfers, such as mutual settlements, which accounted for over 75 per
cent of all non-equalisation transfers in Russia in 1998, provided a
soft budget constraint environment at the subnational level. In recent
years, however, have witnessed significant improvement in the design and
implementation of intergovernmental transfers (Martinez-Vazquez et al.,
2004).
The use of specific or conditional grants (ie, earmarked for
specific purposes) is also common. For example, in the Czech Republic
all grants are specific, covering a number of delegated responsibilities
(state administration and environmental protection) and own
responsibilities (education, social care, and cultural activities). In
Poland, the widespread use of specific grants has been criticised on the
grounds that it provides negative incentives for local governments to
exert tax-effort (OECD, 2001f). Other countries (Russia and Kyrgyz
Republic) provide conditional grants on a per capita basis, while
Armenia, Hungary, Kazakhstan, and the Baltics do not provide conditional
grants for current expenditures.
A measure of autonomy
Expenditure autonomy
Sound and efficient decentralisation requires a close
correspondence between responsibility and decision-making authority.
However, effective expenditure autonomy at the subnational level has
been limited in most transition economies. Norms and regulations (for
instance with regard to quality and scope of service provision)
emanating from central government agencies have interacted with explicit
spending priorities set by the central governments, including spending
mandates to severely constrain the authority of subnational governments
to adjust current expenditures. For instance, in Bulgaria about 90 per
cent of actual local expenditure in 1999 were not under the control of
local authorities (McCullough et al., 2000) and in Albania this figure
was 90-95 per cent (Banks and Pigey, 1998). Hence, the outcome in most
transition economies has been considerable burdens imposed on
subnational budgets.
This is in contrast to the situation in Hungary, Poland, Estonia,
Latvia, and the Czech Republic, where subnational governments are
granted greater flexibility in service delivery, backed by law. In
Hungary, local governments are entitled to determine the ways and modes
for service provision, depending on the requirements of the local
population and their financial resources. Mandatory duties of service
provision can only be imposed by law approved in Parliament and with the
required funding provided by Parliament (OECD, 2001c). In Latvia, local
governments face no output controls on their service provision. They are
free to provide services according to law and norms in certain sectors
(education, welfare, and environment), to structure the provision of
services and, in general, and to decide the service level (OECD, 2001d).
In the Czech Republic, local governments decide on the structure of
local expenditures and the quality and quantity of the services to be
provided (with exception of some earmarked activities financed by
specific grants). However, in some areas such as education a
considerable share of the local costs is determined by the central
government while in other areas the local governments have considerable
discretion (Oliveira and Martinez-Vazquez, 2001). While many of the
expenditure norms developed by central government agencies in transition
countries are merely indicative in nature, other regulations directly
affect the expenditure positions of subnational governments. For
instance, local governments in Armenia and Kazakhstan have little
flexibility in setting wages, or the wage fund of public employees. The
lack of effective autonomy over expenditures combined with weak capacity
for budgetary management has encouraged the accumulation of payments
arrears by subnational governments as a means of deficit financing, and
eroded fiscal discipline and accountability. Even among the more
advanced reformers, central government mandates on local governments
with respect to employment and salaries often constrain budgetary
autonomy of local governments (Ebel and Yilmaz, 2002). However, unlike
in the intermediate and slow reformers, local government associations in
these countries typically play an important role in negotiating mandates
with the central government.
In a number of transition economies, local autonomy has also been
constrained by the shifting down of subsidies and social services to
local governments since the beginning of the transition. Minimum
expenditure requirements for social services imposed by the central
governments impinge upon the budgetary autonomy of local governments. In
Bulgaria, municipalities have to fund 50 per cent of social welfare
payments from their own revenue which results in significant disparities
among municipalities in residual spending on other services (McCullough
et al., 2000). In Russia, until recently, this problem was compounded by
the existence of regional norms and regulations in conjunction with
federal norms and mandates, and the failure of local governments to
distinguish between funding for each (Litwack et al., 2002).
Overall, there is considerable spending autonomy in the Central and
East European countries such as the Czech Republic, Hungary, Poland, and
the Baltics whereas in Ukraine, Albania, Bulgaria, the Kyrgyz Republic,
and Moldova the local spending level and priorities are mainly
determined by the central government.
Revenue autonomy
Granting effective subnational revenue autonomy--the authority for
subnational governments to determine tax rates and/or bases-remains a
critical challenge for most transition countries. As seen in Table 5,
only the advanced reformers have devolved limited revenue autonomy to
subnational governments, although they still rely on the central
government for the bulk of their revenues. (15) In the Czech Republic,
the Slovak Republic, Hungary, and Poland the share of 'own'
revenue (over which they have policy control and collect themselves)
ranges from 33 to 40 per cent. In the Czech and Slovak Republics most of
this revenue is non-tax revenue; in the former local governments have
very limited tax authority. In Lithuania, legislation giving
municipalities greater discretion in setting tax rates and fees accruing
to local budgets--including a real estate tax of up to 1.5 per cent of
assessed property values--is under consideration for 2002.
A few countries among the intermediate reformers also appear to
have fairly high shares of 'own' revenue (Romania (33 per
cent), Ukraine (31 per cent), and Russia (43 per cent)). In the
remaining transition countries, subnational revenue autonomy remains
virtually nonexistent. Even among the Baltics, that have made
significant progress in other areas of intergovernmental finance, only a
very small share of subnational revenue is controlled by subnational
governments, which depend almost entirely on transfers from the central
government.
The generally low level of revenue autonomy, particularly among the
intermediate and slow reformers, reflects, in part, weak subnational
administrative capacity, political constraints, pre-emption of the local
tax base by central governments, and central limits on subnational tax
rates. Taxes typically assigned to subnational governments include
property taxes, user charges and a number of 'nuisance' taxes
with little revenue potential. These raise only a small proportion of
the total revenue of local governments even among the more advanced
reformers--around 9 per cent in Estonia, and 6 per cent in Hungary, for
instance (Ebrill and Havrylyshyn, 1999). In Poland and Romania, however,
local taxes account for 26 and 17 per cent of local tax revenues,
respectively.
Closely related to the issue of subnational tax autonomy is the
widespread use of tax sharing arrangements, with revenues from taxes
shared on a derivation basis, whose structures can only be changed at
the central level, accounting for the largest share of regional revenue
receipts. As seen in Table 5, in all transition countries tax sharing
constitutes more than 50 per cent of total subnational tax revenue. Some
of the advanced reformers in Central and Eastern Europe (Poland and
Hungary) have the lowest tax sharing rates, whereas in Russia, Ukraine,
and most Central Asian countries, revenues from taxes shared on a
derivation basis continue to account for well over 60 per cent of
regional revenue receipts. The minimal subnational autonomy to raise
revenues and decide tax policies at the margin and the resultant
mismatch between expenditure responsibilities and the real tax base, has
important implications for accountability and responsibility at the
subnational level. In many countries, limited formal revenue autonomy
has encouraged the widespread use of informal revenue generating
mechanisms, such as tax offsets and extrabudgetary funds.
Transfers
Countries in Eastern Europe and Baltics generally have relatively
sound equalisation transfer systems (see Table 4). While the Czech
Republic does not use equalisation transfers, it does however have
formula-based features in its tax sharing system. However, the existing
system has been criticised for being unwieldy, unstable, and
nontransparent (Wetzel and Dunn, 2001). In a number of countries the
equalisation transfer system, however, suffers from weaknesses that
prevent if from achieving its goal of reducing the gap in fiscal revenue
per capita across municipalities and intermediate level governments. For
instance, in Romania the equalisation transfer system suffers from
relying on an unpredictable pool of transfer funds, a formula that does
not target funds to local councils with inadequate revenues to provide
basic services; and lack of accountability at the county level for
distributing funds according to published criteria. In Armenia, for
example, equalisation transfers are supplemented by gap-filling
transfers with associated drawbacks.
While a significant number of countries in the region have moved
towards the increasing use of equalisation transfers, the actual volume
of funds involved is either small or equalisation transfers only account
for a small share of total transfers. For instance, given the relatively
large fiscal disparities existent in Russia, the on-going level of
funding for equalisation transfers in Russia (1.1 per cent of GDP in
1998) appears to be insufficient to bring about a significant level of
equalisation. Although the overall funding for equalisation transfers is
also quite limited in other countries such as Ukraine, Estonia, and
Croatia, they have less pronounced fiscal disparities at the subnational
level. In Hungary and Poland, where transfers account for half of local
revenues, the overwhelming reliance on transfers is viewed as
circumscribing local autonomy.
Gap-filling transfers, however, remain the norm in most FSU
countries. This provides disincentives to local revenue mobilisation and
cost savings through increased efficiency in delivery of services. In a
number of countries (Bulgaria and most Central Asian countries), the
allocation of transfers, in practice, has remained uneven and
subjective, with a tendency for transfers to not get implemented as
budgeted or, if they do, the actual flows have been unpredictable and
subject to long delays.
Subnational borrowing
In recent years, subnational governments in a number of transition
countries have been borrowing from a variety of sources, including, (i)
the central government, (ii) subnational or national financial
institutions (often regional institutions), and (iii) tapping domestic
or international financial markets, by issuing domestic bonds or
Eurobonds. However, there appears to be a wide variation in the
subnational borrowing practices of countries and in the strictness of
administrative controls over borrowing, largely reflecting the extent of
development of financial markets and progress in other areas of
intergovernmental fiscal relations (see Table 6). In many countries,
while the overall level of subnational borrowing remains low, there has
been an increasing trend towards greater subnational deficits,
accumulation of debt, and loan guarantees.
In countries with relatively undeveloped financial markets
(Belarus, Bulgaria, Moldova, and all Central Asian countries),
subnational borrowing generally takes the form of central government
loans. In many of these countries (such as Bulgaria and Albania), the
market for municipal debt is underdeveloped because of the failure of
municipalities to establish creditworthiness, which is a precondition for access to private credit. The limited revenue and spending autonomy
in these countries and associated problems is reflected in the
overwhelming reliance on the central government for financing
subnational deficits. As a result, on the margin there is little
difference between central government loans and transfers. One important
threat to subnational budgetary discipline in all these countries is the
moral hazard or impression of a soft budget constraint created by the
practice of the central government granting loans that are eventually
forgiven (Rodden et al., 2003).
Subnational borrowing from subnational or national state-controlled
financial institutions, on the other hand, also poses significant
macroeconomic risks. For instance, in Russia, commercial bank debt has
become an important source of deficit finance, particularly since
promissory notes (veksels) were disallowed since 1997. Subnational
governments in Ukraine have also used veksels or bills of exchange as
important means of financing. In 1998, over 16 per cent of all
subnational tax collections in Ukraine were in the form of veksels and
17 per cent were collected in the form of tax offsets. However, these
transactions are often non-transparent, subject to abuses and in many
cases the loans are procured from commercial banks owned by regional
governments.
A number of countries have gained access to private domestic and
international sources of finance (such as the Czech Republic, Hungary,
Poland, Russia, Ukraine, and Estonia). While liberalisation of
subnational borrowing in Hungary, the Czech Republic, and Poland has
been accompanied by relatively effective institutional and regulatory
frameworks and increasing reliance on market-based discipline, in many
countries such frameworks are virtually nonexistent. Other countries
(such as Russia, Kazakhstan, and Estonia) have enacted legislation
limits on overall debt as well as limits of the budget deficits of
regions and require control and supervision of all subnational bond
issues. However, the lack of effective monitoring and enforcement and
the general absence of adequate municipal bankruptcy procedures (with
the sole exception of Hungary) and financial emergency controls for
defaulting governments pose important risks. For instance, while the
regulatory framework in Estonia for municipal borrowings is sound,
borrowing regulations are often ignored, there are no effective
sanctions of violators and lenders may still perceive that there is an
implicit sovereign guarantee. This has led to rapidly growing
indebtedness of many municipalities with the potential need for future
bailouts. In the Czech Republic there is no ex-ante control on local
borrowing in place but the existing legislation states that the central
government is not responsible for local debt. At the same time,
determining the actual level of local indebtedness is often difficult
due to the existence of contingent liabilities and other forms of
off-budget operations (Oliveira and Martinez-Vazquez, 2001).
Building institutions for fiscal decentralisation
Effective implementation of fiscal decentralisation requires the
presence of a comprehensive institutional framework. This holds in a
number of important respects.
While local governments in a number of transition economies (eg,
Hungary, Poland, the Czech Republic, the Baltics, and Russia) are led by
democratically elected councils and governors/mayors, the heads of
regional governments continue to be appointed by the central governments
(eg, in Ukraine, Georgia, and all Central Asian states) (Table 7).
Belarus, Azerbaijan, and Turkmenistan have no elections for subnational
governments. The lack of democratic representation at lower levels of
government may importantly affect the responsiveness of these
governments, since conflicts between policies implemented and the
preferences of local taxpayers are politically inconsequential. In cases
of weak local influence on local officials decentralisation could simply
lead to a transfer of power from national to local elites. With improved
access of local elites to public resources this could increase
opportunities for corruption. Furthermore, a system of appointed
officials may imply that central political or other interests dominate
local policy making, again adversely affecting the responsiveness of
subnational governments to the interests of local citizens. Ultimately,
the objective of enhanced accountability of regional and local
governments is negatively affected.
International experiences have shown that a basic requirement for
efficient multi-tier governments is the presence of intensive
cooperation between the main stakeholders--the different levels of
government. Countries have chosen very different ways of securing the
required cooperation, but common experiences seem to indicate that an
efficient system is characterised by transparent, regular, and
comprehensive exchanges of information and discussions, and that
cooperation must take place at the political as well as the technical
level. Very few BRO countries have established such consultation
mechanisms or cooperative bodies, with Estonia and Latvia being
important exceptions. Other Eastern European economies, such as Hungary,
Poland, and the Czech Republic also have such coordinating institutions
in place.
At present, there is a clear lack of interaction and coordination
between central government agencies (ministries of finance and line
ministries) and regional government agencies (finance departments and
sectoral departments) in many BRO countries. This lack of dialogue has
occasionally led to unrealistic regulations, the proliferation of
unfunded mandates, ineffective supervision and weak support and absence
of performance evaluation of subnational programmes. More generally, it
has encouraged conflicts and frictions in intergovernmental relations.
The lack of a modern tax administration has hampered both the
day-to-day implementation of revenue assignments, and adversely affected
general government revenue collections in many transition countries (eg,
in Russia). In most BRO countries, the tax administration is a central
government agency exclusively responsible for collecting taxes at all
levels of government. Regional and local governments do not have their
own tax administrations. However, the lack of effective control over the
regional and local offices of the central tax administration and the de
facto dual subordination of tax administrators to the central tax
authorities and to subnational government officials has had an important
impact on tax collections at all levels of government. Regional and
local officials may be more interested in preserving the economic
viability of local enterprises which provide employment and a tax base
for subnational taxes than ensuring that federal taxes get paid. They
may, therefore, pressure tax officials to be selective in their
collection efforts. Furthermore, subnational officials may press tax
administrators to employ more resources to the collection of subnational
taxes than the low yield of these taxes may warrant. Even among the more
advanced reformers, local capacity in tax collection is generally low,
which reduces the effectiveness of tax collections (Ebel and Yilmaz,
2002).
With the exception of the more advanced reformers, budget process
at the subnational level remain deficient in most transition economies
and strengthening institutions for fiscal management remains a key
challenge. Formulating budget objectives in a clear, transparent and
realistic manner, strengthening budget execution, monitoring, and cash
management at all levels of government, to varying degrees, are on the
policy agenda of many of the intermediate reformers. However, progress
in many of these areas has been slow.
CONCLUSION
Progress in reforming intergovernmental relations in the last
decade has been uneven across the group of transition economies and
across various components of intergovernmental fiscal relations. The
nature and extent of decentralisation to date has been shaped in large
measure by political, historical, and ethnic realities, and its
effectiveness influenced by the institutional design and capacities of
the various levels of government. In many countries, much has been
accomplished in putting sound foundations in place, while, in others
decentralisation reforms have been carried out without institutional and
legal support mechanisms and appropriate intergovernmental fiscal
arrangements to support a decentralised system.
In this paper we have provided an overview of key aspects of the
ongoing decentralisation process in transition economies to illustrate
instances where certain broad principles for sound and effective
decentralisation are breached. To this end, it is important to note that
there is no unique design or optimal degree of decentralisation that is
'appropriate' for all countries. The institutional context for
decentralisation, including the overall level of economic development,
ongoing economic and political reforms, existing technical and
administrative capacity of subnational governments, geographic,
demographic and other factors determines the design of intergovernmental
fiscal system and ultimately affects the outcome of the fiscal
decentralisation reform process. In general, institutional reforms that
minimise adverse incentives and promote transparency, predictability,
and accountability are key to an effective decentralised system.
However, in the absence of strong institutional capacity and firm and
transparent rules that regulate intergovernmental relations, forcing
subnational governments to provide an adequate level of services and
maintaining a sustainable decentralised system can pose a formidable
challenge.
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(1) The author wishes to thank John Norregaard and Valerie
Mercer-Blackman for sharing an early version of their dataset and
participants at the OECD conference on Fiscal Decentralization in Russia
for useful comments.
(2) See Bird et al. (1995), Wallich (1994), and Ter-Minassian
(1997b) for a discussion of fiscal decentralisation experiences during
the early years of transition.
(3) This principle suggests that provision of any given public
service should be assigned to the lowest level of government that allows
for the full internalisation of the costs and benefits associated with
that service.
(4) The 1999 World Development Report notes that the proportion of
countries with some form of democratic government rose from 28 per cent
in 1974 to 61 per cent in 1988 (World Bank, 2000) partly as a response
to the ongoing globalisation and integration of national economies with
increasing circumscription of the powers of nation-states that it
entails.
(5) See Prud'homme (1995), Tanzi (1995), and Ter-Minassian
(1997a). McLure (1995) and Sewell (1996), among other, however, have
questioned the validity of the adverse link between decentralisation and
macroeconomic stability. Qian and Weingast (1997) stress the need for
market-preserving federalism--a system of intergovernmental relations
that is conducive to private sector development--as key to the
relationship between decentralisation and sound macroeconomic
performance.
(6) Fisman and Gatti (2002) report a strong negative relationship
between expenditure decentralisation and corruption, Gurgur and Shah
(2002) find that decentralisation results in greater public sector
accountability and lower corruption in unitary rather than federal
countries. However, Treisman (2000) does not find any significant
relationship between fiscal decentralisation and corruption.
(7) Ebel and Yilmaz (2002) note that high-income OECD countries
tend to be more decentralised than others, as measured by indicators of
subnational share of revenues and expenditures.
(8) The experiences of Argentina, Brazil, and India with extensive
borrowing by subnational governments illustrate clearly this problem. In
these cases, the absence of effective limits on borrowing by subnational
governments greatly complicated achieving overall fiscal tightening.
(9) The average size of Hungary's municipalities is 3,200
people and over half of the municipalities have a population below 1,000
(Wetzel and Papp, 2003). In the Czech Republic, 86 per cent of the
municipalities have fewer than 1,500 inhabitants, and 42 per cent have
fewer than 300 inhabitants (Oliveira and Martinez-Vazquez, 2001).
(10) In Russia, recommendations of the Kozak Commission have
brought significant improvements in regional-local relations by
mandating a uniform two-tier structure of local government and further
clarifying assignments (Martinez-Vazquez et al., 2004). In Ukraine, much
needed clarity was introduced in regional-local relations in the
2000-2001 Budget Code.
(11) For instance, the Law on Local Government in Hungary specifies
certain potential responsibilities for local governments (urban
development, housing, and waste management) that leave a degree of
ambiguity in the system as local governments can 'pass up' a
voluntary responsibility to a higher level if unable to meet the costs
of providing that service (Wetzel and Papp, 2003).
(12) A closely related issue for transition countries has been
budgetary management and control at different levels of government,
including the way the budget is prepared and presented, its coverage,
and the way the budget is executed. In many countries, weaknesses in
budgetary management have interacted with opaque expenditure assignments
to further constrain the effectiveness of expenditures.
(13) Dabla-Norris et el. (2004) and Wetzel and Dunn (2001).
(14) See Martinez-Vazquez and Boex (2000) and Zhuravskaya (2000)
for the case of Russia.
(15) It is important to note that cross-country comparisons of
subnational revenue autonomy as seen in a number of reports can in
general be misleading. This is because such comparisons are based on GFS data for the share of subnational revenue in total general government
revenue across countries. GFS data only measures the quantity of revenue
that eventually ends up as being used by local governments and does not
capture the extent of discretion or control by local governments
associated with each type of revenue collected (Ebel and Yilmaz, 2002).
ERA DABLA-NORRIS (1)
IS 3-1600, International Monetary Fund, Washington, DC 20431, USA.
E-mail: edablanorris@imf.org
Table 1: Structural aspects of fiscal decentralisation, 2001
Country Number of Number of Average
subnational top tier population
tiers (regions/
province/
oblast)
Armenia 2 11 336,000
Azerbaijan 2 71 107,000
Belarus 3 7 1,454,000
Estonia 2 15 96,000
Georgia 2 12 450,000
Kazakhstan 3 14 978,000
Kyrgyz Republic 3 7 (b) 645,000
Latvia 3 33 (d) 71,527
Lithuania 2 10 371,000
Moldova 2 11 390,000
Russia 3 89 1,652,000
Tajikistan 2 3 1,967,000
Ukraine 3 27 2,058,000
Uzbekistan 3 14 1,721,000
Albania 3 12 275,000
Bulgaria 2 9 921,000
Croatia 3 20 230,000
Czech Republic 39 14 740,000
Former Yugoslav 2
Republic of
Macedonia
Hungary 1 3,177 3,200
Poland 3 16 2,419,000
Romania 2 41 548,780
Yugoslavia 2
Country Number of Average
lowest tier population
(town/
municipality)
Armenia 930 3,970
Azerbaijan -- --
Belarus 133 58,000
Estonia 247 6,000
Georgia ~1000 5,400
Kazakhstan 258 (a) 60,000
Kyrgyz Republic 549 (c) --
Latvia 541 2,219
Lithuania 56 66,000
Moldova 911 4,300
Russia 2337 63,000
Tajikistan 70 84,000
Ukraine 937 (e) 59,000
Uzbekistan 1749 14,000
Albania 374 (f) 9,000
Bulgaria 255 33,000
Croatia 423 10,900
Czech Republic 6292 1,700
Former Yugoslav 123 (h) 16,500
Republic of
Macedonia
Hungary 3177 3,200
Poland 2483 16,000
Romania 2948 (i) 7,632
Yugoslavia 187 55,500
Source: IMF country economists
(a) 173 rural rayons and 85 towns of rayon status.
(b) One independent city (Bishkek) functions as an oblast.
(c) 72 rayons, 19 towns and 458 village centres.
(d) 26 districts and 7 republican cities.
(e) 490 rayons and 447 municipalities.
(f) 65 communes and 309 municipalities.
(g) District offices have been phased out from January 2001.
This phase-out will be completed by the end of 2002.
(h) The number of municipalities may be reduced during 2002
to about 85.
(i) 2948 municipal councils (2686 communes, 182 towns and 80
municipalities).
Table 2: Structure of expenditures for each level of government,
most recent year (percent of total within each level of government)
Level General Defense Social
public and insurance
services public and health
order services (a)
Azerbaijan (1998) C 6.3 21.1 31.9
R&L 4.3 0.0 22.7
Belarus (2000) C 4.6 8.5 41.7
R&L 2.8 1.3 20.8
Estonia (2000) C 7.2 12.2 47.9
R&L 11.2 0.3 12.1
Georgia (2000) C 7.4 12.6 35.4
R&L 9.8 3.7 11.2
Kazakhstan (2000) C 6.6 14.2 42.6
R&L 3.5 5.1 22.2
Kyrgyz Republic (2000) C 14.9 16.0 20.5
R&L 9.4 1.5 28.4
Latvia (2000) C 5.4 9.5 52.8
R&L 10.5 1.3 9.2
Lithuania (2000) C 4.2 11.4 52.5
R&L 4.8 0.8 15.1
Moldova (2000) C 3.7 5.7 43.6
R&L 9.4 3.5 26.0
Russia (2000) (c) C 7.6 17.8 32.5
R&L 25.6 2.8 19.2
Tajikistan (2000) C 20.5 20.0 20.9
R&L 10.2 3.0 18.2
Ukraine (2000) C 11.1 14.0 22.8
R&L 4.0 1.4 34.7
Albania (1998) C 5.8 9.4 23.9
R&L 10.4 0.0 33.5
Bulgaria (2000) (d,e) C 7.5 14.0 40.6
R&L 7.4 0.7 36.0
Croatia (2000) C 3.7 12.9 55.0
R&L 22.4 0.8 3.9
Czech Republic (2000) C 2.9 9.8 54.3
R&L 15.4 3.9 16.6
Hungary (1999) C 4.9 5.5 32.3
R&L 12.6 0.9 27.1
Poland (2000) C 4.0 7.5 51.9
R&L 7.2 4.1 32.0
Romania (1999) C 4.1 9.1 43.4
R&L 13.2 1.8 8.1
Level Education Culture
and
recreation
Azerbaijan (1998) C 3.5 1.5
R&L 60.2 4.4
Belarus (2000) C 3.9 1.6
R&L 26.5 3.1
Estonia (2000) C 10.2 4.0
R&L 38.9 11.4
Georgia (2000) C 3.6 2.9
R&L 31.8 7.7
Kazakhstan (2000) C 3.6 1.2
R&L 23.6 4.3
Kyrgyz Republic (2000) C 19.5 2.9
R&L 45.0 3.4
Latvia (2000) C 5.6 2.1
R&L 45.5 6.4
Lithuania (2000) C 5.8 1.9
R&L 58.9 4.6
Moldova (2000) C 4.0 1.0
R&L 38.2 2.7
Russia (2000) (c) C 2.3 0.7
R&L 17.8 3.5
Tajikistan (2000) C 3.2 3.3
R&L 39.8 2.5
Ukraine (2000) C 7.7 0.7
R&L 23.3 3.5
Albania (1998) C 1.9 0.9
R&L 41.6 2.6
Bulgaria (2000) (d,e) C 4.3 1.6
R&L 31.0 2.8
Croatia (2000) C 7.9 1.2
R&L 11.9 14.3
Czech Republic (2000) C 9.4 1.1
R&L 7.5 7.0
Hungary (1999) C 7.7 1.6
R&L 23.1 4.3
Poland (2000) C 4.7 0.5
R&L 27.5 3.7
Romania (1999) C 9.8 1.0
R&L 8.4 4.3
Level Other (b) Total
Azerbaijan (1998) C 35.7 100.0
R&L 8.4 100.0
Belarus (2000) C 39.8 100.0
R&L 45.5 100.0
Estonia (2000) C 18.4 100.0
R&L 26.0 100.0
Georgia (2000) C 38.1 100.0
R&L 35.7 100.0
Kazakhstan (2000) C 31.7 100.0
R&L 41.3 100.0
Kyrgyz Republic (2000) C 26.2 100.0
R&L 12.3 100.0
Latvia (2000) C 24.5 100.0
R&L 27.1 100.0
Lithuania (2000) C 24.3 100.0
R&L 15.8 100.0
Moldova (2000) C 42.0 100.0
R&L 20.2 100.0
Russia (2000) (c) C 39.1 100.0
R&L 31.1 100.0
Tajikistan (2000) C 32.2 100.0
R&L 26.1 100.0
Ukraine (2000) C 43.6 100.0
R&L 33.1 100.0
Albania (1998) C 58.1 100.0
R&L 11.9 100.0
Bulgaria (2000) (d,e) C 32.0 100.0
R&L 22.2 100.0
Croatia (2000) C 19.3 100.0
R&L 46.7 100.0
Czech Republic (2000) C 22.5 100.0
R&L 49.5 100.0
Hungary (1999) C 48.0 100.0
R&L 32.0 100.0
Poland (2000) C 31.2 100.0
R&L 25.5 100.0
Romania (1999) C 32.6 100.0
R&L 64.3 100.0
Sources: IMF country economists, Government Finance Statistics (IMF)
(a) GFS categories 'Health' and 'Social Security and Welfare.
(b) GFS categories 'Housing and Community Amenities,'
'Agriculture, Forestry, Fishing and Hunting; 'Mining,
Manufacturing and Construction; 'Transportation and
Communication; 'Other Economic Affairs and Services'
and 'Other Expenditures:
(c) Central government transfers to extrabudgetary funds
are included. General government includes wages and salaries.
(d) Some small contributions to Defense and Education by
both governments are included in the 'other' category.
(e) General government services comprises 'Wages and
Salaries' and 'Maintenance and Operations.'
Table 3: Structure of tax revenues at
each level of government, most recent year
Country Central/ Total subnational Income
regional tax revenue taxes
& local
Percent Percent
of GDP of total
SNG
revenues
Azerbaijan (1998) (a) C 22 25 40
R&L 4 95 43
Belarus (2000) (b) C 12 41 42
R&L 15 91 31
Estonia (2000) C 16 38 46
R&L 5 83 89
Georgia (2000) C 9 22 62
R&L 4 93 52
Kazakhstan (2000) C 31 8 53
R&L 10 96 51
Kyrgyz Republic (2000) C 18 0 78
R&L 2 75 38
Latvia (2000) C 13 39 46
R&L 5 72 80
Lithuania (2000) C 13 35 51
R&L 6 95 91
Moldova (2000) C 4 30 59
R&L 4 77 55
Russia (2000) (c) C 14 34 37
R&L 11 80 49
Tajikistan (2000) C 3 22 59
R&L 4 94 40
Ukraine (2000) (d) C 24 9 60
R&L 7 86 71
Albania (1998) C 9 18 52
R&L 0 40 0
Bulgaria (2000) C 16 33 48
R&L 3 77 90
Croatia (2000) C 10 34 49
R&L 3 59 85
Czech Republic (2000) C 14 46 36
R&L 5 71 91
Hungary (1999) C 22 35 38
R&L 4 57 45
Poland (2000) C 21 35 42
R&L 6 64 24
Romania (1999) (e) C 18 39 37
R&L 3 84 77
Country Central/ Payroll taxes Consumption
regional and social taxes
& local security
contributions
Azerbaijan (1998) (a) C 3 10
R&L 0 40
Belarus (2000) (b) C 0.0 6
R&L 0 57
Estonia (2000) C 0.0 0
R&L 0 1
Georgia (2000) C 0.0 7
R&L 0 11
Kazakhstan (2000) C 0.3 8
R&L 31 8
Kyrgyz Republic (2000) C 0.0 4
R&L 0 62
Latvia (2000) C 0.0 1
R&L 0 2
Lithuania (2000) C 0.0 1
R&L 0 0
Moldova (2000) C 0.0 7
R&L 0 19
Russia (2000) (c) C 0.3 15
R&L 0 30
Tajikistan (2000) C 1 15
R&L 0 40
Ukraine (2000) (d) C 0.0 7
R&L 0 13
Albania (1998) C 0.4 20
R&L 0 92
Bulgaria (2000) C 0.0 3
R&L 0 0
Croatia (2000) C 0.4 7
R&L 0 4
Czech Republic (2000) C 1 2
R&L 0 5
Hungary (1999) C 1 5
R&L 0 44
Poland (2000) C 0.0 3
R&L 55 2
Romania (1999) (e) C 0.0 6
R&L 0 2
Country Central/ Property Other tax Total
regional taxes revenue
& local
Azerbaijan (1998) (a) C 100 11 100
R&L 6
Belarus (2000) (b) C 100 5 100
R&L 7
Estonia (2000) C 100 0 100
R&L 10
Georgia (2000) C 100 11 100
R&L 26
Kazakhstan (2000) C 100 0 100
R&L 10
Kyrgyz Republic (2000) C 100 0 100
R&L 0.0
Latvia (2000) C 100 0 100
R&L 19
Lithuania (2000) C 100 0 100
R&L 9
Moldova (2000) C 100 0 100
R&L 26
Russia (2000) (c) C 100 11 100
R&L 10
Tajikistan (2000) C 100 6 100
R&L 14
Ukraine (2000) (d) C 100 5 100
R&L 11
Albania (1998) C 100 8 100
R&L 0.2
Bulgaria (2000) C 100 0 100
R&L 10
Croatia (2000) C 100 0 100
R&L 11
Czech Republic (2000) C 100 0 100
R&L 5
Hungary (1999) C 100 0 100
R&L 11
Poland (2000) C 100 0 100
R&L 18
Romania (1999) (e) C 100 2 100
R&L 18
Sources: IMF country economists, Government Finance Statistics
(a) Assumes that unaccounted-for local revenue is split
up evenly between 'other tax revenue' and transfers.
(b) Other revenue of central government includes property
taxes and other tax revenue.
(c) 'Other tax revenue' includes fees and other revenues.
(d) VAT and excises are no longer allocated to local budgets.
(e) Property taxes of subnational government includes land tax.
Table 4: Transfers (grants) from central to
subnational governments, most recent year
Size Type of grant
Percent Percent of General Specific
of GDP total revenue
Azerbaijan (1998) 2.8 42 100 0
Belarus (2000) 3.0 15 100 0
Estonia (2000) 2.0 26 Yes Yes
Georgia (2000) 0.5 10 0 0
Kazakhstan (2000) 1.7 14 100 0
Kyrgyz Republic (2000) 2.6 49 100 0
Latvia (2000) 2.5 26 100 0
Lithuania (2000) 0.7 10 100 0
Moldova (2000) 2.7 34 100 0
Russia (2000) 1.4 9 Most Some
Tajikistan (2000) 1.2 24 90 10
Ukraine (2000) 2.5 23 60 40
Albania (1998) 5.4 96 100 0
Bulgaria (2000) 3.3 43 80 20
Croatia (2000) 0.2 5 Small Most
Czech Republic (2000) 2.3 25 0.0 100.0
Hungary (1999) 6.3 49 69 31
Poland (2000) 6.0 39 60 40
Romania (1999) 0.7 17 Yes Yes
Properties of general grants
Determinants of total amount
Azerbaijan (1998) Gap-filling.
Belarus (2000) Gap-filling.
Estonia (2000) Revenue equalisation.
Georgia (2000) 'Rich' regions make transfers to poor
regions. Not transparent transfer system;
based on negotiations between central and
local government.
Kazakhstan (2000) Gap-filling after revenue sharing.
'Fraternal' system introduced in 1999
budget formulations which determines
subventions to poorest regions and
withdrawals from richest regions.
Kyrgyz Republic (2000) Gap-filling. Since 1998, categorical grants
which fund wage spending for health and
education at subnational level. Poor regions
without sufficient tax revenues receive
equalisation grant. Amount negotiated with
Ministry of Finance.
Latvia (2000) Revenue equalisation; process initiated
by the local governments.
Lithuania (2000) Expenditure needs based on inflation-adjusted
previous year expenditures: 1. Allocated
based on claims at the end of the year;
2. Allocated in order to bring forecast
tax revenues below national average and
close to national average; and 3. Allocated
on 'fraternal system' based relative measure
of need adjusted with demographic coefficient.
Moldova (2000) Gap-filling, based on expenditure norms
and revenue mobilisation capacity.
Russia (2000) Equalisation and gap-filling.
Tajikistan (2000) Gap-filling. Not transparent transfer system;
based on negotiations between central and
local government.
Ukraine (2000) Expenditure needs and population; Conditional
grant.
Albania (1998) Gap filling.
Bulgaria (2000) Specific transfer for capital purposes and
block grants. Transparent transfer system.
Croatia (2000) Equalization grant for specific purposes.
Not transparent transfer system.
Czech Republic (2000) Grants are calculated each year when
preparing the central government budget
or distributed according to a specific
legal frame work. The precise use of grants
is defined by the central government. Typical
criterion is per pupil, per bed etc.
Hungary (1999) Certain degree of equalisation. Dependency
of municipal sector from grants is high.
Poland (2000) Equalisation block grant, capital
expenditures. Equalisation grants bring
localities up to 85% of national average
per capita revenues. Transparent formula
using objective criteria.
Romania (1999) Equalisation grant. Transparent transfer
system.
Sources: Government Finance Statistics (IMF),
IMF country economists; Wetzel and Dunn (2001)
Table 5: Degree of tax sharing vs own financing
of subnational governments, most recent year
Own taxes Own nontax Total own
as % of revenue revenue
total SNG as % of as % of
revenue total SNG total SNG
revenue revenue
(ex grants)
Armenia 0.0 0.0
Azerbaijan (a) -- 8.0 --
Belarus (b) 6.0 4.1 10.1
Estonia 6.3 9.1 15.4
Georgia -- 6.2 --
Kazakhstan 0.0 3.2 3.2
Kyrgyz Rep. -- 12.7 --
Latvia 0.0 16.1 16.1
Lithuania 0.0 4.8 4.8
Moldova 15.4 12.4 27.8
Russia 34.4 9.1 43.5
Tajikistan -- --
Ukraine 30.9 30.9
Uzbekistan (d) -- --
Albania 0.0 1.6 1.6
Bulgaria -- 11.9 --
Croatia
Czech Republic 3.9 36.3 40.2
Macedonia, FYRM
Hungary 16.3 17.0 33.3
Poland (f) 10.6 24.6 35.2
Romania -- 12.6 --
Yugoslavia
Average
Standard deviation
Total Distribution of total
subnational subnational tax revenues
tax revenue
in percent Tax Own-
of total sharing financing
subnational
revenues
Armenia 52.0 100.0 0.0
Azerbaijan (a) -- 55.0 45.0
Belarus (b) 96.0 93.8 6.2
Estonia 62.0 89.2 10.8
Georgia n.a. 95.0 5.0
Kazakhstan 82.0 100.0 0.0
Kyrgyz Rep. n.a. 64.6 35.4
Latvia 55.2 100.0 0.0
Lithuania -- --
Moldova 80.4 80.9 19.1
Russia 86.0 60.0 40.0
Tajikistan 39.4 95.0 5.0
Ukraine 87.0 64.4 35.6
Uzbekistan (d) 88.4 n.a. n.a.
Albania 35.7 100.0 0.0
Bulgaria 72.9 90.0 10.0
Croatia 55.8 85.0 15.0
Czech Republic 47.7 91.7 8.3
Macedonia, FYRM 86.4 -- --
Hungary 18.0 67.4 32.6
Poland (f) 40.0 57.7 42.3
Romania 73.7 75.0 25.0
Yugoslavia 71.5 8.0 92.0
Average 82.4
Standard deviation 16.1
Degree of Autonomy
To set To set
tax base tax rate
Armenia None None
Azerbaijan (a) None None
Belarus (b) None Some discretion
over local taxes
Estonia None Some discretion
over local taxes
Georgia None (c) None (c)
Kazakhstan None None
Kyrgyz Rep. None None
Latvia None None
Lithuania None On land tax, up to
4% ceiling.
Moldova None None
Russia None None
Tajikistan None Can set local tax
rates
Ukraine None Very limited
Uzbekistan (d) Very limited Very limited
Albania None None
Bulgaria None None
Croatia Very limited Very limited
Czech Republic Limited Limited
Macedonia, FYRM None Local govt financing
is currently under
discussion
Hungary Some (e) Rate autonomy on
substantial share
of revenue
Poland (f) None Rate autonomy on
substantial share
of revenue
Romania Some (d) Some (g)
Yugoslavia None None
Average
Standard deviation
Source: IMF country economists
(a) Percent of local tax revenue from tax-sharing includes personal
income tax in which local governments' share is 100 percent.
(b) Revenue as a percent of GDP excludes Extrabudgetary Funds.
(c) Over shared taxes. Local governments impose a few minor taxes
and fees, and there is evidence of local governments creating tax
bases outside of the official mandate.
(d) Local authorities have discretion only with regard to granting
tax exemptions, delays and spacing out of tax payments.
(e) Building tax, land tax, communal tax on private individuals
and businesses, tourism tax, and local business tax.
(f) No autonomy with respect to share of income tax, and little
or none on real estate tax.
(g) Local councils can increase or decrease proposed tax and fee
rates within a range of 50 per cent.
Table 6: Borrowing by subnational governments
Borrowing Actual Is there
Allowed? amount regulation
% of GDP for municipal
At home Abroad bankruptcy?
Armenia Yes -- 0 No
Belarus Yes -- No
Estonia Yes Yes 2.6 (a) No
Georgia Yes
Kazakhstan Yes No n.a. No
Kyrgyz Republic Yes No
Latvia Yes Yes 0.40 No
Lithuania Yes No
Moldova Yes n.a.
Russia Yes No No
Tajikistan No Yes
Ukraine Yes Yes 0.9 No
Uzbekistan No
Albania Yes
Bulgaria Yes Yes (b) No
Croatia Yes
Czech Republic Yes Yes No
FYRM Yes No Very
Macedonia limited
Hungary (c) Yes Yes 0.1% Yes
Poland Yes No
Romania Yes Yes No
Slovakia Yes Yes No
Slovenia Yes No
Yugoslavia Yes No
Bosnia No
Sources of financing
Armenia Only from home sources, not
from abroad
Belarus In practice, build up of
arrears.
Estonia Financial markets.
Georgia Can borrow from the central
budget to meet temporary
deficits.
Kazakhstan SNGs can borrow (1) from the
Central Government to repay
local debts; (2) from securities
market for financing local
investment programmes
Kyrgyz Republic
Latvia From central government;
Minister of Finance is
authorised to approve of
another party to the loan
agreement.
Credits guaranteed by the
government; other creditors.
Lithuania
Moldova Arrears to Social Funds and
wage arrears.
Russia Bonds, bank loans and vexels.
Tajikistan Arrears
Ukraine In practice, build up of
arrears. Most widespread:
1. loans from central
government. 2. Short-term
loans from commercial banks.
Uzbekistan
Albania
Bulgaria
Croatia
Czech Republic Local government may borrow
from any institution (even
abroad) at any terms of
interest rate, maturity etc.
FYRM
Macedonia
Hungary (c) Bonds and bank loans
Poland They can borrow from local
market. Not clear if they can
borrow from abroad.
Romania Bonds and bank loans. External
credits guaranteed by the
central government.
Slovakia Bonds and bank loans--both
from local banks and domestic
branches of foreign banks.
Slovenia
Yugoslavia Commercial banks
Bosnia
Source: IMF country economists
(a) Estimate is for 1998. This equivalent to
about 16 percent of local government revenue.
(b) Localities have not borrowed in the past,
except Sofia municipality.
(c) Refers to 2000.
Table 7: Political accountability in selected transition economies
Country Elections at Elections at
regional level? Local level?
Armenia
Executive No Yes
Council Yes Yes
Azerbaijan No (district) Yes
Belarus No No
Estonia
Executive No (district) Yes
Council Yes Yes
Georgia
Executive No Yes
Council No Yes
Kazakhstan
Executive No No (district)
Council Yes Yes
Kyrgyz Republic
Executive No No
Council Yes Yes
Latvia
Executive No (district) Yes
Council Yes Yes
Lithuania No (district) Yes
Moldova No Yes
Russia Yes Yes
Tajikistan
Executive No Yes
Council Yes Yes
Ukraine No Yes
Uzbekistan
Executive No Yes
Council Yes Yes
Albania
Executive No Yes
Council Yes
Bulgaria No Yes
Czech Republic Yes Yes
FYRM Macedonia Local elections
at the municipal
level for mayors
and local council
members.
Hungary Yes (district) Yes
Poland
Executive No Yes
Council Yes Yes
Romania Yes (district) Yes
Country Comments on political
accountability and elections:
Armenia
Executive Central government appoints and dismisses
heads of regional governments.
Council
Azerbaijan Representatives of central government in
lower levels.
Belarus President appoints regional governors, who
then appoint subordinates.
Estonia
Executive County governor appointed by central
government on proposal of Prime minister.
Council Local councils elected, local councils appoint
mayor.
Georgia Top tier in general governed by central
government appointed commissioners.
Executive Two lowest tiers (municipal and district)
have elected councils and executives.
Council
Kazakhstan Oblast akims appointed by president. Local
level akims appointed and removed by
oblast-level. Regional and local councils
elected.
Executive
Council
Kyrgyz Republic President appoints oblast and rayon
governors. Heads of village councils
are elected locally.
Executive
Council
Latvia Local governments are elected and form the
district councils. District councils consist of
lower levels chairs of municipal councils.
Local councils are elected, local councils
appoint mayor. No representatives of central
government in local councils.
Executive
Council
Lithuania Central government appoints and dismisses
governors of regional administrations. Local
councils elected, local councils appoint
mayor.
Moldova Local councils are elected. Executive selected
locally but approved by the President.
Russia Representatives of central government in
lower levels (super-districts).
Tajikistan Executive at regional and local level
appointed by the president. President
can remove local officials, including
locally elected mayors.
Executive
Council
Ukraine Regional governors are appointed. Rayon and
local level elected (but have in past been
removed by the President).
Uzbekistan Regional executives are appointed. Local
leaders selected from 'village elders:
Regional and local councils are elected
but elections influenced by higher level.
Executive
Council
Albania
Executive Representatives of central government in 12
regions replacing districts as administrative
units by law in 2000.
Council
Bulgaria Central government appoints governors of
regional administrations. Local councils and
local leaders (mayors) are directly elected for
4-year terms.
Czech Republic
FYRM Macedonia
Hungary Representatives of central government in
lower levels.
Poland
Executive Vovoidship (regional council) elected, but
head appointed by prime minister.
Council
Romania Representatives of central government in
lower levels.
Source: IMF