1 Public Expenditure Conference Public Expenditure Conference Applying Subsidiarity Principle in the Transition Context: Lessons from South East Europe

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Public Expenditure ConferencePublic Expenditure Conference

Applying Subsidiarity Principle in the Transition Context:

Lessons from South East Europe to Guide the Diagnosis in BIH

Sarajevo,

March 4-5 2003

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Principle of SubsidiarityPrinciple of Subsidiarity

The general aim of the principle of subsidiarity is to guarantee a degree of independence for:

lower authority in relation to a higher bodylocal authority in respect of a central authority

It involves the sharing of powers between several levels of authority

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Subsidiarity has three primary, generally accepted applications:

Philosophical

Legal

Technical

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The idea of subsidiarity is entrenched in the process of European integration

1951: Article 5 of ECSC Treaty• The Community should exert direct influence on

production only when circumstances require it

1987: Article 130r EECT of Single European Act• Subsidiarity criterion included, but not expressly

defined

1988: Article 5 of European Charter of Local Self-Government

• Public responsibilities should be exercised by those authorities that are closest to the citizens

1992: Article 5 of Treaty on European Union

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Application of this principle has expanded into many areas:

EconomicPoliticalSocialEnvironmental

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Application of the principle to intergovernmental relations requires two strong pillars:

Lowest denominator – municipality, canton, local government

Highest denominator – power that can resolve problems that cannot be solved at the lower levels

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Subsidiarity in the SAP CountriesSubsidiarity in the SAP Countries

No explicit mentioning of subsidiarity in the SAP or accompanying CARDS ProgramPrinciple behind key objectives of SAP

Democratic StabilizationBuilding the Institutions of the StateSupporting Development of Civil Society and its InstitutionsPublic Participation in Policy Debate and Accountability of GovernmentRegional Cooperation and Key Sectors (e.g. Infrastructure)

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Macroeconomic and Public Finance Macroeconomic and Public Finance Aspects of DecentralizationAspects of Decentralization

The concerns

Decentralization of government functions raises challenges for macroeconomic control at the national level

• Local accountability involves the transfer of financial competencies, together with municipalities’ right to borrow

• Uncontrolled access to capital markets and mismanagement of budgets by local governments could destabilize the economy

Decentralization and creditworthiness could be conflicting goals

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Macroeconomic and Public Finance Macroeconomic and Public Finance Aspects of DecentralizationAspects of Decentralization

Trade-offs

Local budgets typically subject to central control, monitoring preferable over direct controlCentral governments discharge own responsibilities to lower tiers: proper co-funding an issueChanges in state regulations, budget processes, social policies essential, predictability, however, a challenge for lower tiers

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Building Blocks of DecentralizationBuilding Blocks of DecentralizationThe RulesThe Rules

Expenditure and Revenue AssignmentLocal revenue is the cornerstone of fiscal decentralization, however, expenditure assignment has to precede revenue assignmentObjectives of expenditure and revenue assignments

• National equity• Efficiency of the internal common market• Economies of administration and transaction costs

– Grouping of congruent services at local, regional and national level

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Building Blocks of DecentralizationBuilding Blocks of Decentralization

Criteria for Tax Assignment

Tax Assignment Level

Custom Duties State

VAT State

Corporate Income Tax

State

Sales Tax Sub-national, above municipal

Personal Income Tax

Any level, e.g through surcharges

Property Tax Local government

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Intergovernmental Transfers

Whatever local system is established in a country, there will be a need for grant or revenue sharing because local expenditure needs typically tend to outstrip local resources

• Hence, design of a grants system is of a prime importance

In general, intergovernmental transfers should be based on rules that are:

• Stable• Transparent• Non-arbitrary• Universal• Non-negotiable

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Stabilizing Municipal Budgets and the Working of the Transfer System

The grants/revenue-sharing system is sensitive to variations in the business cycle, with negative impact on the creditworthiness of municipal governments

Therefore need for a stable source of revenue (e.g. property tax)

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Municipal DebtCreditworthiness measured by the size of deficit of municipal budgets relative to their resource flow Recurrent spending very high in municipal budgets Borrowing for current expenditures to be avoided

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The PreconditionsThe Preconditions

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Essential Principles to Support Essential Principles to Support thethe Building BlocksBuilding Blocks

The Political Side

Necessary Conditions Desirable Conditions

Elected Local Council Freedom from Excessive Central Expenditure Mandates

Locally Appointed Chief Officers Unconditional Transfers from Higher-level Governments

Significant Local Government Discretion to Raise Revenue

Borrowing Powers

Significant Local Government Expenditure Responsibilities Budget Autonomy A Hard Budget Constraints Transparency

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Essential Principles to Support the Essential Principles to Support the Building BlocksBuilding Blocks

Finance Follows FunctionStrong Central Ability to Monitor and Evaluate DecentralizationTransfers of Significant Taxing Power to Local GovernmentNot Change the Rules Half Way ThroughIntergovernmental Transfer System to Match the Objectives of the DecentralizationHard Budget Constraint

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There Must be a Champion for Fiscal There Must be a Champion for Fiscal DecentralizationDecentralization

Potential Strong Supporters Comments The people and their elected representatives Demand for more participation in governance at

the local level The President Decentralization is a popular policy with the

electorate. However, the President must also be very mindful of stabilization concerns with decentralization, since inflation and unemployment are usually the greatest danger to his/her political standing

The Parliament or Congress Decentralization is a popular policy with the electorate. Parliament would like to identify with specific local projects they could “bring home”, therefore, they will favor a less transparent and less structured system

Urban Local Governments “Give us the autonomy to tax and spend.” Urban local governments are often most concerned with how their autonomy is circumscribed, and how their access to their tax base is limited

External Donors These provide encouragement and some technical assistance to get the process underway, but are no substitute for an in-country champion

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Potentially Weak Supporters Comments Ministry of Finance Would propose strict limits to decentralization in

order to hold the main fiscal tools for stabilization policy purposes

Ministry of Economy Would like to control the type of investment made, as well as the regional distribution of investment. Typically interested in programs with big externalities vs local benefit programs

Line Ministers Would like to control the standards of public service delivery, and often would like to hold an approval or sign off power

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Ambivalent Supporters Comments Ministry of Local Government Would favor a greater guaranteed share for local

governments, but would like to control the distribution of those resources

Weaker Local Government Would like a guaranteed transfer of resources from the urban and wealthier local governments to the rest. More interested in a transfer system than in a local taxing system

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Were do we Stand in BosniaWere do we Stand in Bosnia

Policy Dimensions of the ReformsSignificant progress has been made in reforming and harmonizing indirect tax policies through:

• Rationalizing exemption policies• Lowering rates• Broadening the tax base• Harmonizing the point of indirect tax collection

Similar reforms are now being designed for direct taxes, VAT is being considered as a replacement for the sales taxesExcessively high combined taxes on labor, including wage taxes and social contributions, have been nearly halved from their post-war highs of about 80-90 percent of net wagesThe trade regime is now being further liberalized within the Stability Pact framework for South Eastern Europe

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Were do we Stand in BosniaWere do we Stand in Bosnia

Institutional Dimensions of the ReformInitial steps include the establishment of basic fiscal management capacity and the adoption of legal and institutional frameworks for budget and debt management systemPromoting credibility, transparency and accountability in the public sector management has gained an increasing emphasisA major reform of the payments system has been introduced, involving the re-integration of key public resource management and control functions to those public institutions where the normally belong for the transparent and efficient operation of the public sectorInitial tax administration reforms are also being broadened to improve cooperation between Entity tax administration systems and to effectively introduce anti-tax evasion and avoidance rules

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Were do we Stand in South East EuropeWere do we Stand in South East EuropeLooking forward

The development of a sustainable fiscal stance will take place in all countries of South East Europe in a complex and evolving policy and institutional setting, with many uncertainties along the way If it is not well coordinated, well timed, and kept within the financial constraints, this process could aggravate the present fiscal fragilities Several critical issues will need priority attention concerning:

• Streamlining public administration • Securing own-sourced financing for the State

administration • Formally coordinating public finance policies between

the State and the Entities and within the Entities • Developing mechanisms for balancing revenue and

expenditure assignments between multi-tiered governments against development needs and the need for rationalizing the role of the public sector in the economy

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AnnexAnnex

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BiH: Distribution of MunicipalitiesBiH: Distribution of Municipalities

Under jurisdiction of:

Tiers of government State Federation Republika Srpska

Office of the High

Representative

Total

Central Government 1 1 Entities 1 1 2 Cantons 10 10 Municipalities 80 62 142 Autonomous Districts 1 1 Total 1 91 63 1 156

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BiH: Sub-Entity Total BiH: Sub-Entity Total Public ExpenditurePublic Expenditure

Including Public Funds As a share of: Canton + Municipality Municipalities BiH 55.2% 7.8% Federation + Republika Srpska 56.2% 7.9% Federation 74.8% 7.9% Republika Srpska 8% 8%s

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FYR Macedonia: FYR Macedonia: Distribution of MunicipalitiesDistribution of Municipalities

# of municipalities % of population % of municipalities < 2500 18 1 15 2500 – 4999 28 5 23 5000 – 9999 27 10 22 10000 – 49999 39 41 32 50000 + 11 42 9 Total 123 100 100

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Serbia and Montenegro: Serbia and Montenegro: Distribution of MunicipalitiesDistribution of Municipalities

Inhabitants Number of settlements Distribution (in %) Number of citizens Distribution (in %) < 1.000 na na na na

1.001 – 2.000 na na na na 2.001 – 5.000 4 2.0 17.000 0.2

5.001 – 10.000 6 3.0 44.600 0.4 10.001 – 50.000 126 62.4 3.500.000 33.7 50.001 – 100.000 39 19.3 2.557.000 24.6

100.001 – 1.000000 26 12.9 2.673.300 25.7 > 1.000.001 1 0.5 1.602.200 15.4

Total 202 100.0 10.394.100 100.0

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THE ENDTHE END

Documents

1 Public Expenditure Conference Public Expenditure Conference Applying Subsidiarity Principle in the Transition Context: Lessons from South East Europe