1. LEARNING EXPERIENCE ON FINANCING OF LOCAL GOVERNMENT General Remarks September 2004 Vera Kamenickova Czech Republic

2. 2 1.Introductory notes 2.Administrative structure 3.Self-government 4.Revenue Composition 5.Sharing principle 6.Function Distribution 7.Local Property 8.Debt Regulation 9.Other issues 10.Conclusion

3. 3 1. Introductory Notes about the Czech Republic Relatively small country spread over slightly more than 78 thousand square km and populated with 10 million citizens; Unitary country – central government plus two tiers of self-government at the municipal and regional levels; Country, which is still under the process of changing from very centralised form of regulation towards decentralised ones; A new member of the European Union – accession date May 2004;

4. 4 1. Introductory Notes about the Czech Republic (cont.) Fiscal decentralisation does not have a long history; Public expenditure to GDP ratio – slightly over 40 %; Local government share on GDP – 12.5 %; Prudent financial policy in the past, the present the level of total public debt is still less than 30 % of GDP; With a mixture of centralised and decentralised features;

5. 5 1. Introductory Notes about the Czech Republic (cont.) New law on municipalities adopted at the beginning of nineties;

6. 6 2. Administrative Structure More than 6 000 municipalities; Increase by almost 50 % at the beginning of nineties; Very disintegrated municipal composition – 90 % of municipalities have less than 2 000 citizens; Fourteen self-government units at the regional level (established 2001, also differ in size substantially); Eight NUTS 2 regions for EU funds drawing;

7. 7 2. Administrative Structure (cont.) Health Insurance Companies (public entities) collect health care insurance premiums and finance the majority of health care; Central government includes social security system; National Property Fund – collects privatisation receipts and finances among other environmental damages occurred under the previous regime, assisted the bank sector privatisation by compensating their “bad” loans;

8. 8 2. Administrative Structure (cont.) Other off budgetary funds – Land Fund (participating in land restitution), Transport Infrastructure Fund and Housing Fund;

9. 9 3. Self-government Renewed after more than forty years of the socialist regime; 1990 – new Municipal Act defining local government responsibilities, revenue and property; 1993 - overall tax reform accompanied by local budget reform; 1996 – introduction of tax sharing principle; 2001 – change of tax sharing bringing more equalisation in the system; 2001 – installation self government at the regional level, gradual shift of functions from the central level; 2004 – looking for a better financial arrangement for regions

10. 10 4. Revenue Composition Tax system composes of: personal and corporate income taxes, value added tax, excises, custom duties, real estate tax, tax on property transfer, gift and inheritance taxes, road tax, and local fees; No local taxes, only local fees exist at the municipal and regional level of self-government; Tax administration is the responsibility of the central level; All taxes are decided at the central level (tax base and rates, tax exemptions, deductions and so on);

11. 11 4. Revenue Composition (cont.) Central budget exclusive tax revenues: excises, custom duties, road tax inheritance and gift tax, and tax on property transfer; Municipal exclusive tax revenue: real estate tax (influence on rates) and local fees; Local fees – the list of them and upper ceilings are determined by the law; Types of local fees: on dogs, on recreational stay, on ticket on cultural events, on the use of public space, on entry to the historical parts of a city;

12. 12 4. Revenue Composition (cont.) Local fees – less than 5 % of local government revenue; Regional exclusive tax revenue – none at the moment;

13. 13 4. Revenue Composition (cont.) Grant system: about 20 % of local government revenue only specific central government transfers - further limit on expenditure part of the budget; both operating and capital grants; operating grants are mandatory, capital grants are ruled by programs; examples of operating grants: per pupil in primary and secondary schools, per bed in homes for elderly, contribution for delegated functions;

14. 14 Table 1: Municipalities´ revenues (in bill. CZK) 20022003 Total revenues208.2244.0 - Tax revenues99.5107.5 -- Shared taxes87.093.4 --Local taxes and fees12.514.1 - Non-tax revenues23.822.8 - Capital revenues11.612.0 - Grants73.3101.6

15. 15 Table 2: Municipalities´ revenues (in %) 20022003 Total revenues100.0 - Tax revenues47.844.2 -- Shared taxes41.838.3 --Local taxes and fees6.05.9 - Non-tax revenues11.49.3 - Capital revenues5.64.9 - Grants35.241.6

16. 16 Table 3: Regions´ revenues (in bill. CZK) 20022003 Total revenues37.695.8 - Tax revenues10.211.4 - Non-tax revenues0.71.4 - Capital revenues0.00.2 - Grants26.782.8

17. 17 Table 4: Regions´ revenues (in %) 20022003 Total revenues100.0 - Tax revenues27.111.9 - Non-tax revenues1.91.5 - Capital revenues0.00.2 - Grants71.086.4

18. 18 5. Sharing principle Almost a half of local government revenue some from tax sharing; Concerns individual and corporate income taxes and VAT; The total tax yield is shared; Sharing mechanism is based on the number of population; A set of coefficient is also involved making the system more favorable for bigger municipalities;

19. 19 5. Sharing principle (cont.) Advantages of the system: Total tax burden is decided at one level only; All tax payers in the same situation pay the same amount; Better predictability of local government revenues; More stable local budgets; Tax collection for municipalities is free of charge; Tax yield is distributed relatively equally though in the respect of the population numbers only; Applied form of tax sharing does nor require additional equalization scheme;

20. 20 5. Sharing principle (cont.) Disadvantages: Less accountability of local government; Unfavourable system for control over local budget execution from local citizens; Effects on efficiency as local government spends money coming from somebody else; Local government gains a certain amount of money regardless of its actions and decisions; Little discretion and control over local revenues; Tax sharing in this form is by nature close to central government general grants; Chosen mode of shared tax distribution among municipalities pays respect only to the number of population, which is simple but not always fair;

21. 21 6. Function Distribution defined in State Budget Act, Act on Municipalities and Act on Regions;

22. 22 6. Function Distribution (cont.) Central level: defence; public order and safety; education - tertiary schools; health care - hospitals; social security and welfare - pension scheme, sickness benefits, family and child benefits, unemployment benefits, social net, social assistance; legal environment; economic, fiscal, foreign, social and other policies; postal services;

23. 23 6. Function Distribution (cont.) Municipal level: Autonomy is granted by the Constitution; Each municipality presents a legal entity; All municipalities regardless their size enjoy the same rights and obligations; Fragmented structure of municipalities - over 90 % less than 2 000 citizens; Responsibilities - divided between own and delegated ones;

24. 24 6. Function Distribution (cont.) A.Delegated responsibilities: birth, death and marriage registers; building permissions; different tasks in environmental protection, sanitation, statistics and so on;

25. 25 6. Function Distribution (cont.) B.Own responsibilities: education - primary schools and pre-schools facilities (not teachers wages); welfare services - social aid, homes for elderly and disabled people, social services for elderly citizens; housing - the majority of formerly state housing stock - passed to this level of government - now being privatised mainly to the present tenants, new housing construction; health care - only to ensure the availability of basic health care -not the service provision itself; culture and recreational activities - optional - cinema, theatres, galleries (unless they are private); parks and recreational zones;

26. 26 6. Function Distribution (cont.) B.Own responsibilities: public safety - optional - city police with limited power, street cleaning - may be carried out also by private entities; water, electricity and gas supplies - mainly privatised, municipalities having shares; sewerage system - mainly private entities, municipal supervision; local roads and city transport - privatised - local government decides fares; urban planning;

27. 27 Table 5: Municipalities´ expenditures (in bill. CZK) 20022003 Total expenditures214.3248.5 - operating expenditures145.4177.0 - capital expenditures68.971.5 Balance- 6.1- 4.6

28. 28 Table 6: Municipalities´ expenditures (in %) 20022003 Total expenditures100.0 - operating expenditures67.871.2 - capital expenditures32.228.8 Balance- 2.8- 1.9

29. 29 6. Function Distribution (cont.) Regional Level Functions education - secondary schools (not teachers wages); special school for disabled (mentally or physically) children; roads (not highways); social care - homes for elderly and disabled adults and children, nursery homes, homes for abounded children; cultural activities - galleries, museums, Zoos, scientific libraries; health care - hospitals; environment protection; regional transport; regional development in co-operation with municipalities within a given region.

30. 30 Table 7: Regions´ expenditures (in bill. CZK) 20022003 Total expenditures35.894.3 - operating expenditures32.185.0 - capital expenditures3.79.3 Balance+ 1.8+ 1.5

31. 31 Table 8: Regions´ expenditures (in %) 20022003 Total expenditures100.0 - operating expenditures90.090.1 - capital expenditures10.09.9 Balance+ 5.2+ 1,6

32. 32 7. Local Property Huge transfers of property from the central to local level at the beginning of nineties; Municipalities were transferred: "historical" property (land, woods, castles etc. owned by municipalities prior 1948), shares in some not only local firms (for example Czech Savings Bank); former state housing stock; property that is necessary for local services provision (town halls, primary school, pre-school facilities, museums, galleries, theatres, hospitals, social care facilities);

33. 33 8. Local Debt Local debt regulation in place only since 2004; Municipalities are excluded from bankruptcy law and no other legal provisions are in place in this respect; Municipalities may: borrow any amount, at any rate, for any purpose; in domestic as well as in foreign currency; may provide guaranty for a loan of a third party;

34. 34 8. Local Debt (cont.) More than 50 % of municipalities are indebted (the very small ones included); Local debt on total public debt – 13 %; More than 60 % of local debt in hands of four biggest cities; Municipal defaults have not been yet a frequent phenomenon; Financial difficulties concern only up to 80 small municipalities (slightly more than 1 %);

35. 35 8. Local Debt (cont.) Limits applied since 2004 restrict: the debt service ratio – 30 %; guaranty provision for a loan of a third party (individuals as well as corporations) is prohibited; breaking these rules leads to consultations with the Ministry of Finance; no other penalties are involved;

36. 36 Table 9: Local Debt (in bill. CZK) 2000200120022003 Total41.048.355.870.4 Bank credit18.422.627.335.2 Municipal bonds10.113.315.921.7 Others12.512.412.613.5

37. 37 Table 10: Local Debt (in %) 2000200120022003 Total100.0 Bank credit44.946.848.950.0 Municipal bonds24.627.528.530.8 Others30.525.722.619.2

38. 38 9. Other important issues Control over local budget execution relies predominately on audit, Scope of audit is quite limited - not well trained staff and not enough agencies specialising for this activity; Central government control only specific subsidies; Local budget proposal is a public document as well as budget execution report; Public hearings to important issues take occasionally place; Data on local government budgetary results are available via Internet;

39. 39 9. Other important issues (cont.) No systematic comparison of local government functioning has been made; System for capital grants provision is not very well defined – involved bargaining.

40. 40 10. Conclusions Relatively stable finance system; Local taxes introduction is not on the agenda; Only weak attempts to consolidate municipal sector;

41. 41 10. Conclusions (cont.) Fragmentised municipal sector has a number of disadvantages: Small municipalities do not handle all their affairs properly, they lack professionals, have unstable and small budgets; Their existence may be also the explanation, why there is practically no demand for local taxes or any form of widening the limited room for municipal own decisions in order to improve local service provision; They form a certain constraint for further decentralisation; Additional territorial units must be formed in order to draw assistance from EU funds;

42. 42 10. Conclusions (cont.) Growing central government deficit (starting at the end of nineties) underlines the fact that central government should have some tool to influence general government deficit; A few municipalities were forced to sell their property, because of its debt, and that may lead to deepening existing local debt regulation in the near future;

43. 43 Thank you for your attention!