Too much of a good thing? Local Government Own Revenues and the Current Political Crisis in Albania Tony Levitas Urban Institute January 20, 2011

Too much of a good thing?Local Government Own Revenues and the

Current Political Crisis in AlbaniaTony Levitas

Urban InstituteJanuary 20, 2011

Levitas/Urban Institute 2

Structure of Presentation• A little general theory: Own Revenues and

Decentralization as Normative Ideal

• A little general practice: Dilemmas of own revenue generation in developing countries

• A thumbnail history of Albanian decentralization and the pitfalls of stunning success.

• Take home messages for Albania and beyond

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Decentralization as a Normative IdeaDecentralization as a virtuous circle:• Democratic accountability should produce better

public sector performance• Better public sector performance should

strengthen democracy.

The literature lays out 3 preconditions for the virtuous circle:• political, administrative and financial

independence

Making local governments financially independent has proven particularly difficult.1/20/2011


Decentralization as a Normative Idea• My argument is that the literature and our

practices overemphasize own revenues as the key to local government financial independence.

• Instead, we should focus more on making sure that transfer systems a adequate, equitable, and predictable.

• (Adequacy + predictability = “independence”)

• Before illustrating the argument by looking at the Albanian story, let’s look a little at the problem of own revenues in general.

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Dilemmas of Own Revenues• The fiscal federalism literature recognizes that the

cost of the functions we want to assign local governments often exceed what we can expect them to raise from own revenues.

• It also recognizes that there are only two robust taxes that can reasonably be assigned to local governments– The ad valorem property tax– Local Income Tax Surcharge

• Explicitly rejects giving local governments the right to impose special levies on businesses

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Dilemmas of Own Revenues• Nonetheless, both the literature (and our practices)

often ignore how hard it is to give local governments “good” own revenues.

• For many reasons, implementing ad valorem property taxes has proven difficult.

• While national governments have been willing to share PIT revenues, they don’t like giving local governments income tax powers.

• Own revenues do little to help poorer jurisdictions, particularly in countries where the tax base is heavily skewed towards (capital) cities.

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Dilemmas of Own Revenues• Even giving local governments control over user

fees and charges can be difficult in countries that don’t have the technologies to measure the consumption of public goods.

• Indeed, despite the normative literature’s stress on the importance of own revenues, their share in total municipal revenues --even in OECD countries-- is typically between 15 and 40%.

• More than half of these own revenues often come from non-fiscal sources (asset income)

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Short history of Albanian Decentralization

• Between 1999-2002, Albanian reformers aided by USAID develop and implement a National Decentralization Strategy through a remarkable consensual process.

• The process bridges the deep divide between the Socialist and Democratic parties.

• Results in the Law on the Organization and Functioning of Local Governments (2000) the Law on Local Tax Systems (2002), and laws governing property devolution

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Short history of Albanian Decentralization

These laws radically increase the financial independence of local governments by:

• Converting conditional grants into a single unconditional transfer that can be freely spent by local governments and which is allocated by formula.

• Substantially improving the local government own revenue powers by– Expanding their ability to tax small business;– Creating a new Impact Fee– enhancing an area based property tax; – Allowing them to set user fees and charges

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Short history of Albanian Decentralization• Between 2002 and 2005 local government own

revenues double and come to constitute more than 50% of all municipal income

• New functions are transferred to them.

• Albania becomes the World Bank’s poster child for decentralization in a poor and messy country.

• Donors shift focus away from national policy issues and towards capacity building.

• 2005 Democratic Party wins control over national government and things begin to unravel.

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Short history of Albanian Decentralization• 2006 – Government halves the base of the small

business tax, significantly reducing the own revenues of urban jurisdictions.

• 2006 – Creates new conditional grants designed to increase revenues of rural jurisdictions.

• 2007- Further reduces the base of the small business tax.

• 2009 - Amends the Law on Local Tax Systems in an effort to cap the growth of local taxes fees and charges, completely blurring the distinction between user fees and taxes. 1/20/2011


Short history of Albanian Decentralization• Actions reopen the divide between the Socialist

and Democratic Parties.

• The Municipal Association and the Association of Communes cease to function as bipartisan organizations.

• Socialist-led urban jurisdictions form a new association.

• Complete breakdown of dialogue and roll-back of many of the reforms

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What went wrong?• Could be that the deep divide between (small

town) Democrats and (big city) Socialists simply reemerged to swallow up the gains of the previous period.

• Or it could be that a preference for “own-revenues” over transfers among domestic and international reformers encouraged the (Socialist-led) government to “overshoot the mark” in 2002 in a way that almost guaranteed the backlash.

• The graph on the next slide tells the story.

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00 01 02 03 04 05 06 07 08

0

5000

10000

15000

20000

25000

30000

35000

2,957 4,012 5,2247,414

8,75511,115 10,206 10,037 11,125

3,643

4,870

9,500 6,3006,277

7,300 8,300 9,000

10,500

4,714

4,619

1,8051,588

2,646

1,999

5,9007,970

10,118

The Composition of Local Government Revenue 2000-2008 (in mln lek)

Own Revenues Unconditioned transfer Conditional Transfers

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The fiscal story• In 2002, the “big bang” year of reform, the

revenues of local governments rise because of new General Grant.

• Own revenues also begin to increase.• Reformers see this growth and cut back on the

General Grant in the name of encouraging fiscal responsibility.

• The cuts hit rural jurisdictions hardest.• Urban jurisdictions make up the loss by

aggressively collecting their new own revenues, many of which they impose unfairly on businesses. 1/20/2011


The political story• The Democratic Parties seize on this as political

issue. • They argue that local governments are unfairly

taxing (small) businesses and that rural local governments are underfunded.

• Respond by attacking the tax and fee powers of local governments and returning to conditional grants directed towards the countryside.

• These attacks have now completely polarized the local government community in Albania and put the whole reform process at risk.

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Lessons for Donors• Making transfer systems adequacy, equitable and

predictable is probably more important than increasing local government own revenue powers at the beginning of a decentralization process.

• Local government financial independence –as a precondition for decentralization’s virtuous circle– should be based more on the adequacy and predictability of transfers than on own revenues.

• Rapidly expanding the own revenue powers of local governments in developing contexts is likely to work against local economic development goals

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Lessons for Donors

• Intergovernmental Fiscal Reform (and dialogue) is a fragile process and needs steady, long term support even after it appears that major battles have be won.

• In contexts where the technical ability to measure the consumption of public services is lacking the line between a user fee and an arbitrary and poorly regulated tax can be very blurry.

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Lessons for Albania• Conditional Transfers should once again be put

into the General Transfer.

• The size of the General Transfer should be anchored to a % of the state budget or the GDP.

• Equalization should be strengthened.

• The Small Business Tax should be eliminated since the extension of the VAT and PIT systems make it unnecessary (while also inviting abuse)

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Lessons for Albania• The PIT system should be put on a residency of

employee basis.

• Local governments should be given a share of PIT on an origin basis.

• This will compensate them for the losses that will come with the elimination of the small business tax.

• It will also create a direct incentive for local governments in increasing local economic activity.

• Finally, it will make it possible to ground the equalization system in an objective measure of the relative wealth. 1/20/2011

For more information:Tony Levitas

[email protected] Urban Institute

2100 M St NWWashington, D.C. 20037

www.urban.org

mailto:[email protected]

Documents

Too much of a good thing? Local Government Own Revenues and the Current Political Crisis in Albania Tony Levitas Urban Institute January 20, 2011