Revenue assignment and taxation
Following the analysis of budget expenditure, this chapter will focus on the sources of financing for subnational governments. This key area of local finances is determined by the composition of the four types of local government revenues: own revenue, shared taxes and fees, intergovernmental transfers and loans. Aside from this financial data, the reports available on the countries under study only provide incomplete information about the actual form of fiscal decentralisation, i.e. the degree of revenue-raising autonomy and methods.
Revenue decentralisation and grant dependency
Subnational governments control a significant part of taxes in the more decentralised countries and in the federal countries (Figure 13). In the Scandinavian countries as well as in Germany and Spain, where states/regions have extended responsibilities, subnational taxes represent more than 25% of all government taxes collected (local own-source and shared taxes are reported together). At the other end of the spectrum, there are the less decentralised countries or those that are more dependent on intergovernmental transfers (left-hand side of the chart).
Figure 13 Subnational tax decentralisation, 2010-2020 Subnational taxes as a % of total tax revenue
Responses to the fiscal challenges of the economic crisis differed across the CEMR countries. In countries with higher local tax revenues, the importance of local taxes further increased. Within this group – with the exception of Israel, Latvia and Finland – the ratio of locally collected taxes was higher in 2020 than a decade ago. In the less decentralised countries, those with a lower local tax share were more reluctant to increase own source revenue-raising powers. Consequently, the lower local taxation translates into a further decrease in local taxes.
Local taxation underwent reforms in various ways at different stages of the economic recovery and crisis management (see the cases of Austria and France in Box 14).
For one diverse group of countries, the ratio of intergovernmental transfers and grants in the subnational budgets is high, accounting for more than 60% of subnational budget revenue. Grant dependency, as a symmetrical indicator of local revenue autonomy, is typically high in the smaller transition countries, as well as in the Netherlands, Austria, UK and Italy (Figure 14). This indicates that local revenue autonomy is determined not only by the weight of intergovernmental transfers but that the grant allocation methods can prove critical as well. Inversely, in countries with significant shared revenue, local governments receive less financing through intergovernmental transfers. This is the case with the group comprising Turkey, three of the Western Balkan countries and the Scandinavian and federal countries.
Figure 14 Grant dependency, 2020 and changes between 2010-2020 Grants as % of total subnational revenue
During the past decade, the grant dependency ratio has changed for both groups of countries. However, no discernible pattern was identified in the countries with higher or lower shares of national budget transfers. The reasons behind the changes were different in each country; overall budget restrictions (e.g. Greece), radical centralisation of local functions (e.g. Hungary) or changes in tax policies (e.g. France) may all have contributed to the cuts in intergovernmental transfers.
National budget programmes often target local environmental investments and service management improvements (Box 15). These fiscal transfer programmes exist both in countries with a greater grant dependency ratio (e.g. Estonia, Austria) as well as in those with higher shared revenue (e.g. Turkey). Considering that the environmental impact of subsidised investments extends beyond the boundaries of a beneficiary municipality, these national or often supra-national (European Union) grants and support programmes are warranted.
Differences in local revenue policies
Local tax systems in the CEMR countries are predominantly structured around income (personal, profit) or land and building taxes (Figure 15). According to the OECD tax statistics, in the 16 countries that receive revenue from taxes on income, this source represents more than half of their total local tax revenue (left-hand side of the chart). Personal income taxes can be allocated to the place of origin, where they were raised, or they can be reallocated using a formula. The most progressive income tax-sharing mechanism is the surtax method, whereby subnational governments have the power to set their own rates (e.g. Scandinavia, Germany, Croatia).
Figure 15 Income and property tax-based local tax systems, 2020
The other group of countries (right side of the chart) relies on local property taxation. They are the less decentralised and smaller countries. However, the preponderance of this tax on land and buildings in these countries is due either to tradition, as the only existing main local tax revenue (e.g. UK), or to its introduction during the transition (Kosovo, Albania, Lithuania, Estonia).
Changes in local taxation
The local tax systems underwent minor reforms during the post-crisis period (Figure 16). Two trends can be identified in the CEMR countries. First, in line with the economic policy goals of the time, the local tax burden on businesses and production was reduced. The composition of local taxes shifted towards property taxation in these countries. A tax on buildings and land has a less direct distorting effect on business activities while also being a more stable source of local revenue. Various forms of taxing land value increases are also increasingly being developed (see Box 16).
The second trend can be seen at the opposite end of this chart (Figure 16) with the countries that have moved away slightly from property taxation, experimenting either with income-based taxes (income, profits, capital gains) or taxes on products (sales, excise, motor vehicle, etc.). It should be noted that the tax on land and buildings includes not only recurrent taxes on immovable property, but the property transaction tax as well.
Figure 16 Restructuring local taxation 2010-2020: a) from tax on products towards property tax b) from property tax to income taxation
Countries reliant on local income taxation pursue diverse policies (Figure 17). In countries where it already constitutes the major source of local tax revenue (Austria, Israel), the weight of taxes on income (wages) was increased further. The countries who had previously been less dependent on income taxes moved in the direction of an income-based local own source revenue system in the Balkans (Bulgaria, Romania, Montenegro) and in Turkey and Spain. Thus, within this group of countries, some convergence of their local tax systems can be detected.
Figure 17 Experimenting with tax on income
Property taxation exists in almost all the CEMR member countries. The majority of countries with a high share of taxes on land and buildings in the local tax pool increased their property tax revenue (left side of Figure 18, with France as an outlier). Countries which were less reliant on local property taxes did not fit into any clear pattern in this respect.
Figure 18 Move towards tax on land, buildings
Local tax reforms have also targeted environmental objectives, such as the tax incentives for municipal waste reduction introduced in France (Box 18).
Local tax autonomy
Subnational tax autonomy is measured not only by the ratio of tax revenue in the local budget, but by the local government’s power to levy and collect them. The OECD has developed an indicator, which classifies all local tax revenue according to a six-unit-typology (OECD, 2020). Each tax is categorised using a scale ranging from high autonomy, such as being able to set tax rates, reliefs and tax sharing methods, to low tax autonomy, whereby the central government sets the tax rates and allowances. These 12 forms of local tax autonomy have been further distilled into four categories for the purposes of studying this matter in the CEMR countries that are covered by the OECD revenue statistics (Figure 19).
Most of the countries have high local tax autonomy. Local governments enjoy discretionary authority in setting tax rates and reliefs for almost all the local tax revenue. (Regional (state) governments’ taxing powers have been measured separately.) However, there is another distinct group of countries that typically employ tax sharing schemes. The method of revenue split will determine how stable and certain this source is, in light of whether the sharing arrangement can be changed by the central government only with the consent of local governments (high autonomy) or unilaterally through budget legislation (limited autonomy). The remaining countries fall somewhere in the middle, with local governments only responsible for tax collection while the tax base, rate and reliefs are set at the central level (e.g. Austria, Israel).
Figure 19 Autonomy in setting the majority of local government taxes, 2018
During the past decade the level of tax autonomy remained stable. There were only three countries in the OECD report where tax autonomy increased significantly by 2018. The share of taxes with local discretion on rates and reliefs was higher in Slovakia, Greece and Italy than at the beginning of the period. Reforms were responsible for major changes in these countries even though they started with a relatively low base at the beginning of the decade. In France, the locally significant municipal housing tax is gradually being replaced with revenue-sharing schemes (see Box 19).