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Last week, Ministry of Finance informed the Government on the start of a reform geared towards strengthening the fiscal decentralization in the country. It envisages implementation of many activities and measures which, at the same time, are to strengthen the fiscal capacity of the municipalities and the control as regards cost-effective, transparent and accountable operations. A comprehensive process of public consultations with the Association of Local Government Units (ALGU), the international development partners, the academicians, the business community and other stakeholders is planned to commence so as to reach otpimal solutions through an inclusive and transparent process.

Local elections are schedules for this year. At the same time, we are undertaking activities to overcome the consequences of the COVID crisis on the economy and get the economy back to the pre-crisis trajectory. This article will address the topic why this reform is given priority right now. I believe it will be an interesting read about the significance of building a successfully functioning decentralized system aimed at improving the quality of public services and accelerating the economic growth and development a country.

Building a well-established public finance system is an extensive process, comprising many segments. Fiscal decentralization is among them, as one of the priorities arising from the Accession Partnership of the Republic of North Macedonia with the European Union. Further decentralization is also one of the priorities set in the 2021 – 2024 Government Program. Benefits from decentralization, as a process in general, are further democratization, exercising the competences as close to the citizens and their needs as possible, thus offering more efficient and more cost-effective services to them. Many academic studies show correlation between the higher degree of decentralization and the higher economic development, which I will elaborate below.

 

Chronology of Fiscal Decentralization 

Like many transition economies, Republic of North Macedonia has taken up the process of transfer of part of the competences related to collection of public revenues and execution of public expenditures to the local government units.

In 2002, Law on Local Governemnt was adopted, defining the municipal competences, i.e. the municipalities to be able to independently regulate and perform activities of public interest of relevance to the local authorities. Among other principles and rules, authors at that time were led particular by the so-called principle of subsidiarity, i.e. any action that can be taken more efficiently and more effectively at local level for the citizens, such action to be transferred to the local authorities – a principle which has been accomplished neither by the expected volume nor by the envisaged dynamics unitl today, even two decades later. Decentralization process is implemented in several stages. In “stage zero”, the municipalities provided the minimum necessary capacities for financial management. The first stage included taking over the property and assuming the liabilities from the decentralized competences. As regards the second stage, the municipalities took over the decision-making competences pertaining to the functioning of the budget users.

Fiscal decentralization was also carried out in several stages in which transfers from the Budget and the Funds’ budgets were made simultaneously with the transfer of competences, in line with the Law on Local Government and other laws in the respective areas. The process was carried out according to the “finance follow function” principle. A serious step forward in the fiscal decentralization area in the country was made in July 2005, with the amendments and modifications to series of laws in the field of financing – Law on Property Tax, Law on Untility Fees and Law on Administrative Fees. Municipalities were transferred certain competences in the fisrt stage of fiscal decentralization, while they were financed mostly through transfers from the central governemnt. The model of transfers (block or earmarked) from the central government is more like a deconcentration, rather than decentralization. In fact, transfers from the central governemnt Budget serve more for a vertical, rathen than horizontal, balance in the development. Second stage of fiscal decentralization commenced on 1st July 2007. Municipalities were to meet certain criteria, such as staffing and strengthening the financial capacity so as to be eligible to move to the second stage, which envisages competences in the field of culture, social protection, primary and secondary education and primary health care. All municipalities, except for one rural municipality, entered the second stage.

Sources of municipal revenues are diverse, with the own revenues on the basis of local taxes, such as property tax, tax on inheritance, tax on transfer of real estate, local fees and charges and revenues on the basis of ownership, being the most important one. Other types of revenues are grants and transfers from the Central Budget, such as 4.5% of collected VAT and block grants for financing the transferred competences in the area of culture, education, social protection and child care. Shared taxes fall within this group as well, i.e. 3% of the PIT revenues collected from individuals with permanent place of residence in the municipality and 100% PIT collected on the basis of craftsmanship.

Many measures were adopted in the past years, aimed at increasing the municipalities’ own revenues. Such are the distribution of revenues from sale of construction land with 20%:80% ratio in favour of the municipalities, distribution of revenues on the basis of concessions for mineral raw materials with 22%:78% ratio in favour of the municipalities and additional revenues on the basis of fee for generation of energy from fossile fuels – eco-fee. Starting 2013, revenues have been allocated as follows: 50%:50% ratio applies for both revenues collected by the municipalities on the basis of fee collected for issuing concession for using water resource for electricity generation and revenues from lease of agricultural land owned by the Republic of North Macedonia allotted to the municipalities.

Compared to 2005, when the process of transferring competences commenced and fiscal decentralization was incentivized, municipal revenues have increased by more than six times in nominal terms, i.e. if revenue performance in 2005 amounted to Denar 5.9 billion, revenue collection in 2019 amounted to Denar 37 billion. Tax revenues, which the municipalities are authorized to collect, have increased by more than twice during the same period. Analyzed by share in GDP by current prices, if total municipal revenues accounted for 1.9% of GDP in 2005, they accounted for 5.4% of GDP in 2019, meaning that relative share in GDP experienced threefold increase. Thus, Republic of North Macedonia falls within the group of countries with medium degree of decentralization, whereby it is worth mentioning that EU-27 average is significantly higher, i.e. 10.6% of GDP, in average higher by almost twice compared to our country.

 

Projects Supporting Municipal Capacity Building

In addition to the support as regards the transfer of competences for collection of part of the public revenues, as well as the Central Budget transfers, support to building municipal capacities is also implemented through projects of the central governemnt funded by international financial institutions.

Among the major ones is the Municipal Services Improvement Project (MSIP), implemented by the Ministry of Finance with support from the World Banka and the EU. The Project commenced a decade ago, its total funds exceed EUR 100 million and it is aimed at improved municipal services through loans and grants for the municipalities to realize capital projects as watersupply, sewerage and waste water treatment, energy efficiency (street lighting, insulation of municipal facilities, etc.), local road infrastructure (street and road modernization and reconstruction), utility services (procurement of vehicles for the public utility enterprises), as well as other municipal services and competences (construction of kindergartens, green markets, infrastructure in the industrial zone, etc.).

Under the Local Roads Connectivity Project, which is part of the ongoing Country Partnership Framework, implemented by the Ministry of Transport and Communications, EUR 70 million is intended to be disbursed to all 80 municipalities for construction and rehabilitation of local roads and streets, as well as other road infrastructure in local government units. Such direct support in the amount of EUR 500,000 up to EUR 2 million per municipality (depending on the project they apply for) provides for improved local infrastructure in the municipalities.

Another major project implemented in the past ten years, aimed at improvement of the municipal infrastructure, is Water Supply and Wastewater Collection Project, funded by the European Investment Bank (EIB), the World Bank, KfW, IPA and budget funds, implemented by the Ministry of Transport and Communications. Funds in the amount of EUR 100 million are provided to all minucipalities, supporting the construction of better watersupply infrastructure and wastewater treatment plants. This Project will continue in future as well through the Ministry of Environment and Physical Planning, with additional funds unlocked for supporting the local infrastructure improvement.

Throughout the years, as well as now, there are number of other projects for supporting the municipal development and strengthening their capacities. Such projects are implemented through several Line Ministries with credit lines from the World Bank, the European Bank for Reconstruction and Development (EBRD), EIB, KfW, Council of Europe Development Bank and other financial institutions and development partners (UNDP, USAID, etc.) and EU Funds.

 

Positive Correlation between Decentralization Degree And Economic Development

Building sound and functioning public finance system is the cornerstone for sustainable economic growth. Fiscal decentralization process is part of that system. As mentioned above, many reviews show positive correlation between the degree of fiscal decentralization and the level of economic development. Average degree of fiscal decentralization in the developed countries is higher in relation to the one in the developing countries. Economic development in most of the transition countries is also usually linked with the increase of the degree of decentralization. However, this positive correlation is also conditional upon the institutional, i.e. the fiscal capacity of the local government, which, in the case of our country, can be an inverse factor as well to this positive correlation without having the matching local government’s capacities. Nonetheless, there are exceptions, as well as different models of fiscal decentralization, which also depend on the levels of government, Besimi wrote.

Should one analyze the recent available data of the Organization for Economic Cooperation and Development (OECD) on share of revenues at local level (local government units (LGUs)) in GDP, it can be noted that, as regards Europe, Sweden exhibits the highest share of local revenues in GDP – 16%, followed by Finland and Denmark with 14.79% and 14.12% respectively, Iceland with 11.7% and Norway with 9%. In 2019, share of LGUs revenues as percentage of GDP in the Republic of North Macedonia accounted for 5.4% (according to the data on GDP revised by the State Statistical Office). Compared to the countries in the region, analyzed according to the Report of the Network of Associations of Local Authorities in SEE (as per the preliminary data on RNM, its degree of fiscal decentralization is 4.9%), fiscal decentralization is lower in relation to Bosnia and Herzegovina (4.5%), Albania (3.6%), Turkey (3.5%) and Slovenia (4.7%), but higher compared to Croatia (7.4%), Montenegro (6.5%) and Kosovo (7.7%). On the other hand, share of LGUs revenues in GDP in the case of Western Balkans is 5.6%, being by 5 percentage points lower compared to the EU average (10.6%).

In addition to strengthening the fiscal capacity of the municipalities, activities should be undertaken and geared towards the quality of the operations, in particular increased transparency and accountability. Many activities were undertaken in the past period aimed at announcing the financial reports so as to increase the transparency in terms of the municipalities’ operations. However, improvement can be certainly achieved considering that transparency provides the highest level of oversight over the public finances.

 

Three Pillars of Strengthening Fiscal Decentralization: Fiscal Capacity, Financial Discipline and Transparency and Accountability

For the purpose of strengthening the fiscal decentralization, many activities and measures are envisaged, grouped in three pillars – improved fiscal capacity and increased municipal revenues, strengthened fiscal discipline and transparency and accountability as regards municipalities’ operations.

The first pillar, or improved fiscal capacity and increased municipal revenues, will be implemented through activities which envisage increase of the funds distributed to the municipalities on the basis of collected fees in the Central Budget, increased own revenues of the municipalities and establishment of funds to support the good performance. To that end, revising the methodology on distribution of funds on the basis of taxes and grants by municipality will be discussed. It is envisaged for the percentage of PIT revenues distributed to the municipalities, collected from individuals with permanent or temporary place of residence in the respective municipality, to gradually increase. Furthermore, amount of VAT grants will gradually increase in line with the municipalities’ performance. Two funds are envisaged to be established – Performance Fund and Equalization Fund. Municipalities showing positive results and higher own revenue collection will be awarded funds from the Performance Fund, while municipalities with lower revenues, but also showing fiscal effort and good results in collecting their own revenues, will be awarded funds from the Equalization Fund. Establishing the Performance Fund should be a careful process of transition with a support from the central government institutions in order to strengthen the local fiscal authorities in the municipalities showing significant underperformance as regards this component (not always a fault of their own).

Activities will be also undertaken towards increased municipal own revenues by improving the efficiency of the administration and determining new local revenues in line with the EU good practices on service quality, as well as enhancing the criteria on distribution of funds for transferred competences in the field of primary and secondary education, culture, child care and care for elderly and firefighting.

The second pillar, aimed at strengthening the financial discipline of the municipalities, arrears repayment and cost-effective operations, envisages activities aimed at measures for planning the actual revenues and expenditures of the municipalities, rationalizing the operations and reducing the unnecessary expenditures, regular servicing of arrears, strengthened financial discipline, procedures on declaring financial instability, issuance of municipal bonds and analysis of the existing arrears of both the municipalities and the public enterprises.

For the purpose of increased transparency and accountability, i.e. within the third pillar of strengthening the fiscal decentralization, government oversight will be enhanced, in particular by the Department for Public Sector Financial Inspection in terms of the Law on Reporting and Recording Liabilities and reporting non-compliance with the Law on Financial Discipline, measures will be adopted with respect to increased transparency at the municipalities by announcing the financial reports in a transparent and understandable manner, and activities will be undertaken for the purpose of strengthened accountability when using budget funds.

Public consultations and discussions with ALGUs and the stakeholders on reform proposals will soon follow, in coordination with the Working Group entrusted with the continuation of the decentralization process, established by the Government, with the Ministry of Political System, Ministry of Finance, Ministry of Local Government and ALGUs as its members. One of the governemnt priorities is continuation of the decentralization process to the end of greater democratization, improved (better quality and expanded) public services and intensified local development in the interest of the citizens. In the coming period, municipal development policies, i.e. fiscal decentralization and equal regional development, will continue to be implemented, to the end of strengthening the municipalities’ financial sources, at the same time increasing the accountability and the transparency of their operations to the end of bringing the municipalities closer to the citizens.

Fatmir Besimi, Minister of Finance

Also available in: Macedonian Albanian

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