1 Equalization Formula Ministry of Finance of Georgia Budget Department Tbilisi October 18, 2007

2 Introduction Current Position Current Position Previous Position Previous Position Reason Reason During Formula development process I used to be the Budget Director at the Ministry of Finance of Georgia; the formula was prepared under my direct leadership During Formula development process I used to be the Budget Director at the Ministry of Finance of Georgia; the formula was prepared under my direct leadership A local consultant was hired to develop the formula. A local consultant was hired to develop the formula.

3 Purpose of Presentation Purpose of Presentation Review of the reforms implemented for decentralizing local self-governance in Georgia Review of the reforms implemented for decentralizing local self-governance in Georgia Organic Law on Self-Governance (1997) Organic Law on Self-Governance (1997) Elections for the self-governance units (1998) Elections for the self-governance units (1998) Establishment of the 1072 self-governance units Establishment of the 1072 self-governance units Amendments into the Organic Law on Self-Governance Amendments into the Organic Law on Self-Governance Creating 69 Self-Governance units from 1072 Creating 69 Self-Governance units from 1072 Introduction

4 Self-Governance Unit GOVERNANCE SELF- GOVERNNACESELF- GOVERNNACE SELF- GOVERNNACE SELF- GOVERNNACE SELF- GOVERNNACE SELF- GOVERNNACE SELF- GOVERNNACE SELF- GOVERNNACE

5 Introduction Outcome Outcome Increase in Revenue Increase in Revenue Revenue Simplifying hiring of the more skilled staff Revenue Simplifying hiring of the more skilled staff Increasing the degree of independence for self- governance units Increasing the degree of independence for self- governance units Law on the Budgets of the Self-Governance Units Law on the Budgets of the Self-Governance Units Budget authorities Budget authorities Types of the transfer Types of the transfer Equalization transfer formula Equalization transfer formula

6 Need for New Equalization Formula Existing formula did not meet the requirements Existing formula did not meet the requirements  Amendments in legislation  Average income decline  Did not cover all of the municipalities

7 Goal of the New Equalization Formula Equal financial capacity Equal financial capacity Simplicity Simplicity Inability to manipulate data Inability to manipulate data Comprehensiveness Comprehensiveness

8 Equalization Formula Ti=(E-R)*K where : Ti – shows equalization transfer for local municipality E – shows budget expenditures of local municipality R _ shows revenues of local municipality K – is coefficient of support

9 Expenditure Calculation E=∑ Cn*Pn or C 1 *P 1 + C 2 *P 2 + C 3 *P 3 + C 4 *P 4 + C 5 *P 5 + C 6 *P 6 E=∑ Cn*Pn or C 1 *P 1 + C 2 *P 2 + C 3 *P 3 + C 4 *P 4 + C 5 *P 5 + C 6 *P 6 E (expenditure) = the sum total derived from the multiplication of the statistical data ( Cn ) and equalization coeficient ( Pn ) where : C n i.e ( C 1 C 2 C 3 C 4 C 5 C 6 ) – is a statistical indicator of local self-governing unit (population, pre-school age children, area, number of youth under 7-18, status of the capital, roads of local importance) ; C n i.e ( C 1 C 2 C 3 C 4 C 5 C 6 ) – is a statistical indicator of local self-governing unit (population, pre-school age children, area, number of youth under 7-18, status of the capital, roads of local importance) ; P n i.e Pn (P 1,P 2,P 3,P 4,P 5,P 6.) – Equalization coefficients, which represent interconnection between each category of expense (function) and statistical indicator. Amount of equalization coefficient is calculated through regression analysis, which is then approved by the order of the Minister of Finance for the long-term period (3-4 years); this coefficient is the same for all self-governing units and increases annually consistent with the Consumer Price Index (CPI) identified in the Basic Data and Direction paper (BDD) P n i.e Pn (P 1,P 2,P 3,P 4,P 5,P 6.) – Equalization coefficients, which represent interconnection between each category of expense (function) and statistical indicator. Amount of equalization coefficient is calculated through regression analysis, which is then approved by the order of the Minister of Finance for the long-term period (3-4 years); this coefficient is the same for all self-governing units and increases annually consistent with the Consumer Price Index (CPI) identified in the Basic Data and Direction paper (BDD)

10 Calculation of Equalization Coefficient – – State service of common purpose – – Defense – – Public order and security – – Other expenses – – Education – – Economy – – Environment protection – – Housing communal services – – Recreation, culture and religion – – Health protection – – Social Provision Economic activity Health and Social Insurance Administration Culture Education

11 Calculation of Equalization Coefficient AdministrationEducationCulture Economic activity Population Number of pre- school age childrenPopulation Length of the roads Area Number of youth under 7-18 Status of the capital Status of the capital

12 Calculation of Equalization Coefficient Calculating average cost Calculating average cost Calculating average expense indicator based on the forecast expenses of the basic (present) year and actual expenses of the previous two years. Calculating average expense indicator based on the forecast expenses of the basic (present) year and actual expenses of the previous two years. Finding the correlation by individual function between average expenses and statistical indicators through regression Finding the correlation by individual function between average expenses and statistical indicators through regression

13 Equalization Coefficient

14 Calculation of Equalization Coefficient CoefficientNameAdministration Economic activity and housing communal services Recreation, culture and religion EducationIn total P1P1 Population P2P2 Area P3P3 Length of the road P4P4 Number of youth under P5P5 Number of pre-school age children P6P6 Status of the capital 1, , ,

15 Calculating Budget Expenditures of Municipalities Name of the Statistical indicator Equalization Coefficient Calculated Cost Population C1122.1P C1*P13,821.1 Area C216.7P C2*P21.3 Length of Road C3104.1P C3*P34,137.4 Number of youth under 7-18 C424.5P C4*P Number of pre-school age children C58.2P C5*P Status of the capital C61.0P623, C6*P623,973.1 Total Sum 32,975.6

16 Revenues of Local Municipalities R - revenues of local municipality (property tax, non-tax revenues, capital revenues). Revenues for each district are calculated according to the tendency (“TREND”) of current year forecast and previous three year actual indicators. Excel function “TREND” had been used for calculation of revenues. R - revenues of local municipality (property tax, non-tax revenues, capital revenues). Revenues for each district are calculated according to the tendency (“TREND”) of current year forecast and previous three year actual indicators. Excel function “TREND” had been used for calculation of revenues. R=TREND(2004w, 2005w,2006w,2007w)= 15,995.2 Calculating revenues Revenues Batumi1,317.34,649.16, , ,995.2

17 Support Coefficient At the following stage, amount of equalization transfer of the budget of each local municipality is calculated. This transfer is received via multiplying the difference between the expenses and the revenues of the same municipality by the coefficient of support (K), which is approved by the government of Georgia for 4 years. At the following stage, amount of equalization transfer of the budget of each local municipality is calculated. This transfer is received via multiplying the difference between the expenses and the revenues of the same municipality by the coefficient of support (K), which is approved by the government of Georgia for 4 years.

18 Calculating equalization transfer for Batumi Calculating revenues Statistical indicators AmountEqualization coefficientsAmount of expenses Population (thousand men) C P Area per capita (m 2 ) C P Length of the roads (kl) C *P Number of youth under 7-18 (thousand men) C P Pre-school age children (thousand men) C P Status of the capital C 6 1.0P , , Total - E 32,975.2 Note* - length of road = (127*0.9)*0.9 + (127*0.1)*0.1 R=TREND(2004w, 2005w,2006w,2007w)= 15,995.2, If K=0.6 Then T=(E-R)*K=( )*0.6= Revenues Batumi1,317.34,649.16, , ,995.2

19 Issues Encountered in Transition Calculated transfers were not sufficient to offset loss of income tax Calculated transfers were not sufficient to offset loss of income tax Status of the Capital should be revised Status of the Capital should be revised Use indicators that have stronger coefficient (with higher correlation coefficient) Use indicators that have stronger coefficient (with higher correlation coefficient) One Time Revenue fluctuation (including capital revenues) One Time Revenue fluctuation (including capital revenues) Tie transfer pool to GDP, VAT an etc. Tie transfer pool to GDP, VAT an etc.

20 Having been discussed with Parliament and Government the Formula was approved by the “law on self- governance unit” and Instructions for transfer calculation was approved by the Order of the Minister Having been discussed with Parliament and Government the Formula was approved by the “law on self- governance unit” and Instructions for transfer calculation was approved by the Order of the Minister

21 Thank You for Your Attention!