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Local Government Financial Viability

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					                   LOCAL GOVERNMENT FINANCIAL VIABILITY
                               (Regional paper)

Vera Kamenickova

Content
   I.       Introduction
   II.      Fiscal decentralization
   III.     Financial viability
   IV.      Local budgets revenues and expenditures
   IV. a.   Revenues
   IV. b.   Expenditures
   V.       Other aspects
   VI.       Proposed changes
   VII.     Conclusion


   I.       Introduction

Local government sector is always a part of the national economy, so its financial situation
and financial management should not be viewed independently of the general economic and
financial potential of the country as a whole. Generally speaking, the financial arrangement of
local government is primarily influenced by the volume of per capita gross domestic product,
the size of public sector, the relation between the centrally and locally collected incomes, and
distribution of the total public receipts between central and local budgets.

Armenia, Azerbaijan and Georgia are countries, which have been devastated by warfare since
each of them declared independence in 1991. They have only limited experience to run their
own affairs at all levels. Not only are their economies almost entirely based on a few core
commodities but also to a certain degree they are still sensitive to fluctuations of Russian
economy. The overall situation is therefore not very stable.

The lack of any tradition of self-government in the western sense forms further significant
feature, which is reflected in the election process, formation of local property, local revenue
assignment and local expenditure discretion. To sum up, there is only a minimal experience in
decentralization of public finance, which influences the overall situation of local self-
government in this region.

The foundation of a system of local self-government is one of the most urgent tasks faced by
the country in the ongoing process of democratization. How difficult this task is can be seen
from the fact that no precedent for a comprehensive system of local self-government can be
found in the history of these three countries, although different elements have existed at
various points. Under the Soviet Union, local government was exercised solely through local
soviets and executive committees as part of the state administration.

In general, the constitutional provisions on local self-government and the legislation on
municipalities comply with principles stated in the European Charter of Local Self-
government. However, the functioning of local government at present is still not without
defects and shortcomings that will have to be rectified. Contradictions in legislation and
inadequate financial support prevent local self-governments from enjoying the autonomy
assigned to them by law. The state retains sweeping powers in the sphere of local self-
government, especially as the ability to determine community property is concerned.

A problem also arises from the fact that local self-government is regulated by laws, while
central and regional governments are regulated by presidential decrees. It brings among others
volatility into the system. Although guarantees of local self-government exist, there is a gap
between legislation and practice and this has adverse impacts on local self-government
functioning making its environment even less stable and uncertain.

All three countries presented here are unitary countries. Their government has a two-tier
structure, with most of the administrative powers exercised by the central government. The
regional units do exist but they are sub-divisions of the state administration rather than a
separate tier of public administration, as they lack elected representatives or bodies. Heads of
regions are appointed by central government and implement central government policies
under almost no discretion.

Presently, these countries are still in a process of finding their own path for public sector
democratization and construction of a sound public finance management system. As far as the
per capita GDP is concerned, they belong to the group of poorer countries.

At the same time there are significant inequalities among local governments in these
countries, especially between urban and rural municipalities and between capitals and other
localities. Usually no equalization system is applied; therefore there is no tool available, how
to improve the situation of less developed municipalities. The stress on local taxes makes this
matter even more difficult.

Given an unclear division of functions among central government and various tiers of local
governments, the situation is even worse. Municipalities must often perform their function in
co-operation with central and territorial bodies of state administration. The same applies for
preparing and implementing local programs. Division of competencies is not always followed
by proper funding assignment. There is a plenty of local taxes, however, their yield is rather
low and the collection is not very cost effective.

Due to lack of data it is almost impossible almost any calculations, which should serve as a
basis to improve intergovernmental transfers and local tax design. Unclear distinction
between public and private sectors further complicates the task. The three countries under
review also suffer from the lack of formal assignment or concurrent assignment among levels
of government. Mechanism for coordination is usually very week and mechanism for conflict
resolution is missing entirely. It is therefore not very clear, how to design and implement
measures for improvement.

The knowledge, on what the municipal financial viability looks like, is not commonly spread.
Therefore only a very limited numbers of people are involved in the process of improvement.

   II.     Fiscal decentralization

Compared to Central and Eastern European countries, the public expenditure to GDP ratio is
rather low – less than 21 %, while in European countries it is between 40 – 50 %. Local
government’s share on GDP is also tiny - up to 3 %. In European countries it varies between
15 - 30 %. Low tax quota is also influenced by insufficient tax collection. Tax arrears and tax
avoidance are not a negligible phenomenon in this region.

As a result, local government revenues are insufficient and there are also fewer opportunities
for transfers from central government to local budgets. Moreover, the state treats its transfer
as an element of its influence over local government actions. In some cases, the issue of local
government property – an important element of decentralization - is not very clear.

Unclear function division among particular tiers of government is accompanied by such a
division of competencies, which is not always and fully followed by the proper funding
assignment. Moreover, central government steps into local government functioning is quite
frequent.

Intergovernmental process involves rather negotiations instead of the application of a concrete
formula, rules of the game are often changed and instability is the norm. There is a weak
equalization mechanism in place, though differences among municipalities are huge.

Table 1: Expenditure to GDP ratio (in %)

                                 2002                   2003
Armenia - total                           20.6                   20.6
- Local level                              1.3                    1.3
- Central level                           19.3                   19.3
Azerbaijan - total                        15.9                   17,8
- Local level                              0.2                    0.2
- Central level                           15.7                   17.6
Georgia - total                           14.1                   13.9
- Local level                              0.5
- Central level                           13.6
Source: National reports


          Figure 1: Expenditure to GDP ratio, local level
                             (in %)

  1,4
  1,2
    1
  0,8                                                             2002
  0,6                                                             2003
  0,4
  0,2
    0
            Armenia          Azerbaijan          Georgia


   III.    Financial viability
Financial viability represents an important feature when evaluating the overall situation of the
municipal sector. Usually it tells about how is the reason for local self-government existence
significant. The quality of financial management and the sustainability financial arrangement
of municipalities are important in this respect. This term tries to describe municipalities´
ability to manage their budgetary resources so that they can fulfil the legislative requirements,
in particular to provide basic local services defined in law. In quantitative terms it may be
expressed as sustainable budget balance in the long term. Long-term perspective is important
in this sense, as budget deficit itself is not necessarily a sign of breaking financial viability. To
a certain degree a lack of money is also not the main restriction for reaching financial viability
at local level.

The principle of local autonomy is embedded in Constitution of a particular country, which
defines municipal governments as independent self-governing institutions separate from the
system of state administration bodies. Judicial protection to municipalities is also granted by
the law as well as guarantees that additional municipal expenditures caused by state decisions
shall be reimbursed. Municipal property is a legal category of property and its protection is
guaranteed.

There are certain preconditions that help to achieve financial viability. Clear division of
functions among levels of government as well as proper and stable funding arrangement and
balance between local government resources and its functions belong among the most
important. Sound and prudent public finance management in a country plays a prominent role,
while it has a positive influence on local government economy. Municipalities should have
the right to decide on at least a part of local budget revenue and discretion over local
expenditures. It means that they should have the right to impose local taxes, fees and charges.
Otherwise it is not very meaningful to speak about local government decision-making and its
influence on financial viability.

Well-defined control mechanism stated in a law represents a counterpart to local government
discretion. It includes an independent audit with clear mission and rules, how to deal with
audit reports, trained staff in financial management and precisely defined responsibilities and
functions of local officials.

In case that local government borrowing on the market is allowed, a certain local debt
regulation should be in force. The reason is that local officials do not have to be necessarily
experts on financial operations and a loan may have longer maturity than local
representatives’ term in office.

Another important element is a clear delineation between state and municipal property. It
should be evident, which tier of government owns what. Local government should posses its
property in full with all ownership rights.

Sufficient size of municipalities, transparent handling of local affairs and long term
budgeting, particularly in case of capital projects and borrowing, are further aspects important
for financial viability belong also the. Unified and well defined budget classification helps to
understand properly the budget execution as well as ongoing analyses.

    IV.     Local budgets revenues and expenditures
Although the basic composition of local government revenue systems is similar in all three
countries, due to the same former setting under the former Soviet Union, some differences can
be observed. The weakness of local government in financial terms can be observed in all three
countries as well as a certain degree of instability. Among the common features can be also
listed the prevailing conviction that adoption of a piece of legislation itself solves a problem.
The frequency of legislative changes is relatively high. Under these conditions it is impossible
that new legislation is based on rigorous analysis of bottlenecks, which are to be overcome.
Another reason of the lack of analytical activities is the insufficiency of data.

In all three countries local governments are granted the power to form their budgets and to
manage independently their financial resources. The budgetary system is regulated by a law
and is based on general principles of a unified budgeting and budget classification. However,
due to several circumstances, long-term budgeting is still missing at local as well as national
levels. Independent audit of budget execution has not become the common practice.

Assuming the level of financial autonomy, the degree of decentralization is rather low.
Strengthening financial sustainability of local government is a major challenge in all three
countries. However, from the proposals it is not very clear, how this goal is to be met.

IV A. Revenues

From the legislative point of view, taxes and rates in all countries are defined in laws. The
majority of general government revenue is collected by the central government bodies. The
collection rates are significantly low. In some cases there is a proposal to pass the
administration of some taxes to local governments. However, this solution hat its limits while
not many local authorities have enough skilled staff and proper equipment to meet all
requirements of tax collection.

Legislative basis of local finance in all three countries is highly unstable. There have been
several amendments to relevant laws. This instability greatly diminished the actual level of
local autonomy.

Own revenues

In Armenia localities decide only rates of local duties within limits given by law. The total
local government revenue splits into own revenue, official transfers and borrowing. Own
revenues are further classified as tax revenue and duty and non-tax revenue. Tax revenue
together with duties represent a predominant share of own revenues. Tax revenue includes
land and property tax levied on land and property located within the administrative border of
municipalities. Land and property taxes are currently the only community tax revenues. One
hundred percent of each tax is paid to local governments. The law envisages also deductions
from income and profit taxes, as well as environmental fees, but they do not take place
nowadays.

Three main sources of revenue exist also in Azerbaijan, namely local revenue, transfers, and
fees. Local tax revenue is generally considered to play an important role in local government
financial management. It represents almost 50 % of the total local government revenue. Local
tax revenues include personal land tax, personal property tax, corporate mining tax and
income tax paid by municipal enterprises (legal entities). The first one is the most important
revenue source.
Similarly to Armenia, also Georgian local representative bodies may introduce five local
taxes and decide their rate within margins determined by the Tax Code. Local taxes in
Georgia are levied on economic activities, gambling establishments, resorts, hotels and
advertisement. The total yield of local taxes is rather low as they form on average less than 5
% of local government revenues, which than represent a serious limit on the degree of fiscal
autonomy.

Table 2: Local taxes

                                              ARMENIA           AZERBAIJAN GEORGIA
Property tax                                      x                 X
Land tax                                          x                 X          x
Mining tax                                                          X
Income tax from local enterprises                                   X          x
Tax on gambling                                                                x
Tax on resorts and hotels                                                      x
Advertisement tax                                                              x
20 % of profit tax                                                             x
Share on small business tax                                                    x
Tax on environmental pollution                                                 x
Tax on use of natural resources                                     x          x
Enterprise profit tax                                               x
Hotel tax                                                           x
Source: National reports

Non-tax revenue in Armenia consists above all of land rentals, real estate rentals, and local
fees. Communities are entitled to levy ten types of duties and three types of local fees. Local
duties include permission to launch construction of a new facility, permission for
reconstructions of existing buildings, licensing sellers of alcoholic beverages and tobacco
products, users of open air sales, and permissions to gambling facilities, lottery games, saunas
and public catering, pet duties in urban communities, placement of outdoors advertisement.
Duties for taxi services and provision of document copies belong also in this group of local
government revenues. Capital budget revenues are of minor importance and many localities
do not have capital revenues at all.

Besides local taxes local government in Georgia has also the right to collect local levies. They
are defined as an obligatory payment made by natural and legal bodies for the right to carry
out certain activities, for example trade, public advertisement, parking, construction or for the
use of restricted public areas. This amount of revenue for local budgets is also negligible.
However these levies have the potential to be used more effectively.

There is also a rather great set of local fees and charges in Azerbaijan. However, they do not
yield much - about 5 %. Far more important is income from privatization or leasing municipal
property (one third of the total). Municipalities have the right to select a number of local taxes
and duties and decide upon their rates within the list of taxes and duties enumerated in the
Law on Municipal Finance. Local residents may also decide to create an ad hoc local public
fund, either by local referendum or at citizens´ assembly, for the purpose of resolving local
problems.
Apart from local taxes and levies own local government revenues in Georgia include the rent
for state or municipal property and dividends from partially or fully owned municipal
enterprises. At the end of nineties municipalities also obtained receipts from the privatization
of state or municipal property, although the privatization process is nowadays almost
finalized.

The most important part of local government budget (almost two thirds) in Georgia comes
from tax sharing. Several state taxes are shared - VAT, excises, custom duties, profit tax, land
tax, tax on the use of natural resources, tax on environmental pollution, tax on the transfer of
property and surprisingly also property tax.

Table 3: Local fees, charges, levies and duties

                                             ARMENIA           AZERBAIJAN GEORGIA
Fee to advertise in public areas                 x                 x          x
Fee for open-air trade activities                x                 x          x
Tourist and sanatorium service fee                                 x
Parking fee                                                        x          x
Stamp duties                                        x
Permission for gambling                             x
Fee on use of public space                                                               x
License to construct or renovate buildings          x                                    x
Pet duties                                          x
License to sell alcohol or tobacco                  x
products
License to operate a passenger taxi                 x
Source: National reports

Georgian central government allocates very little grants from the state budget. To compensate
this, municipalities may apply for loans from the Georgian investment market after submitting
the necessary information to the State Chancellery and receiving presidential approval. In
reality, municipalities use this tool only very rarely and for minor sums. Also municipalities
do not very frequently use the practice of issuing guarantees on large commercial loans.

Table 4: Other revenues

        ARMENIA                        AZERBAIJAN                         GEORGIA
Land and real estate rentals    Grants from international       Privatization receipts
                                organizations
Loans, credit, bond issues      Voluntary contributions         Rents and dividends
Receipts from selling           Income from lotteries           Loans from the central
municipal property                                              budget
                                Compensation from the state
                                for expenses incurred due to
                                state decisions
                                Receipts from privatization
                                or lease of municipal
                                property
Source: National reports
Transfers

State official transfers in Armenia, which make slightly more than 20 % of the total local
government revenue, have been extremely irregular. This single fact makes the budget
preparation and decision-making very difficult, not speaking about long term budgeting. The
main role of the official transfers is to compensate localities in worse climatic and natural
conditions or those experiencing adverse demographic and socio-economic development.
These subsidies are provided in accordance with the Law on Financial Equalization and the
use of these means is for local government discretionary. However, these transfers are passed
to localities in many cases at the end of a year, when they cannot be utilized and therefore
they result in budget surplus. The central government may also allocate subventions to local
government for the implementation of concrete projects.

Only less than 9 % of local budgets in Azerbaijan represent financial aid and subventions
from the state budget. Not only is this amount insufficient for a country, which exhibits great
differences across municipalities but also the volume of state grants is very volatile.
Moreover, there are also huge differences among budgeted and realized figures. Therefore,
state grants do not support much the stability of local budgets. The same applies to
privatization incomes as these are time-limited. Municipal budgets receive also, though it
represents only a small fraction, a financial assistance from legal and natural entities.

Transfers from the central budget, which are usually an important part of the local budget, are
not very meaningful in case of Georgia. These transfers have been tending to diminish. This
trend is considered to be an indication of progress in developing local financial autonomy.
Municipalities should be capable of balancing their budgets with own revenues independently
on the central government. Assistance from the central government should be devoted to
mountainous regions and to units with problems due to natural, social or migratory
circumstances that are too great to be resolved solely with local government own revenues. In
practice, however, majority of municipalities do receive transfers from the central
government.

Table 5: Central government grants

         ARMENIA                        AZERBAIJAN                     GEORGIA
Law on Financial                Mode of distribution: number No explicit policy on
equalization (operating         of citizens                  subsidies
grants)
Capital grants are not                                           Specific grants for delegated
regulated by law                                                 powers
Differences between planned                                      General grants
and actual volumes
Share on total fluctuates       Share on total fluctuates
between 38 and 56 %             between 11 and 38 %
Source: National reports

IV B. Expenditures

Under the Soviet Union, public service delivery was a responsibility of the state. Although the
transition to decentralized management and a market economy created certain preconditions
for the development of private sector, the burden of public service delivery falls on the state.
The state in all three countries continues to take the lead in public service delivery as it has
the necessary structures and financial resources to do so. According to legislation,
municipalities have an extensive authority in providing public services as well. However, they
are strictly limited by their financial resources, and partly also by lack of experience and
skilled staff. The role of private sector in public service delivery is increasing, especially in
the field of public health care, education, transport, communication and trade.

For local government expenditures in all three countries, the low ratio of capital expenditures
is significant. Another similar feature is that in spite of the fact that the relevant law mentions
many local government functions, quite a number of localities are not able to provide them.
The main reason is the lack of money and in some case a small size of municipalities. The
biggest share of capital outlays exhibits Armenia, where it is around 5 %.

Tasks of local governments in Armenia involve a relatively huge amount of services, but not
all municipalities are able to provide them. They include: water supply, sewerage, irrigation,
gas and central heating systems, landscaping and community improvement, use and
maintenance of community building stock, including residential and non-residential buildings,
maintenance of cemeteries, roads, bridges and sanitation facilities, public transport, waste
collection and disposal. Local governments control kindergartens, specialized schools for art,
music and athletics, cultural halls, libraries, parks, clubs and stadiums.

A trend of decreasing expenditures on education, culture and sport as a share of total outlays
can be observed in the last years in Armenia. Administrative costs increase instead (reaching
up to almost 80 % of total expenditure in some small municipalities) and overstaffing takes
place in many localities. Besides administration outlays the expenditures on education and
household form an important part of local government budget. As mentioned above, Armenia
is the only country, in which capital outlays are not insignificant, although quite a part of
them is devoted to repairs.

Provided that local governments in Armenia have the necessary financial resources, they may
choose to offer services similar to those already offered by regions, such as health care,
primary, secondary a higher education, social services and even social services and
unemployment security. Despite their limited financial capacity, local governments do try to
exercise their voluntary powers.

In theory, municipalities in Azerbaijan have extensive authority to provide public services.
According to legislation, they may adopt programs of public service delivery and create
municipal entities to implement them in the following areas: education, health care, culture,
housing, sanitation, water supply and sewerage, local transport and communication.
Performance of these services must correspond to the standards determined by the state.
Municipalities have complete autonomy in determining the method of public service delivery
and may take local conditions into account in order to determine exemptions and other
specific features.

Local budgets expenditure in Azerbaijan include operational expenses, maintenance of social,
housing, cultural and sport establishments and maintenance of streets, parks and squares.
Local governments may also designate funding for social protection, environmental and
economic development programs.
Municipalities in Georgia are responsible for long-term social and economic plans, creating
housing and construction funds, programs for revitalization and development of community
services, resolving issues concerning education, health care, culture and sports and regulating
social services.

Services shared between central and local governments include especially education and
health care. Control over the most important functions, such as health care, education, public
safety and tax collection retains the central government. Even when services are partially
financed by local budgets, the central government still has the legal and political leverage to
implement its own public service policy.

Economic services (including housing) and education are the main items on the expenditure
side of local government budget in Georgia. The outlays on general administration are also
important. Again, local authorities are involved in providing services in such areas as social
assistance, health care, cultural and sport activities.

Table 6: Main expenditure areas

         ARMENIA                      AZERBAIJAN                         GEORGIA
Administration (almost 29%)     Administration (almost 40%)      Administration
Communal and household          Road maintenance (12 %)          Education
services (16 %)
Education (15%)                 Education (3.5 %)                Social assistance
Culture and sport (8 %)         Financial aid (2.1 %)            Health care
Capital expenditure (12%)       Reimbursement of income          Economic services
                                losses (2.8 %)
Debt recovery (9 %)             Debt recovery (4 %)              Housing
Source: National reports

   V.      Other aspects

Community councils are responsible for general monitoring of budget implementation in
Armenia. The option to use an independent auditor is not very utilized in practice. Central
government control is officially restricted to usage of targeted transfers from the state budget.
All municipalities in Armenia, except 12 Yerevan districts, operate on the basis of the same
legislative framework. According to the law, they all have the same amount of functions. In
reality, however, some of them provide only up to 30 % of local functions.

The judicial system is still under development. Local self-government bodies may appeal
against decisions or actions of state authority. Heads of regions often use administrative
methods of control in its relations with local government bodies. Public participation on the
process of preparing and implementing local budget is not very extensive, although public
hearings take occasionally a place.

The Law on Municipal Finance in Azerbaijan regulates among others legal issues concerning
local budget monitoring. It is possible for municipalities to involve independent auditor at
their discretion. Ministry of Justice may also exercise control over compliance with the
Constitution and laws by municipalities and their officials. Within the Ministry of Justice, a
division was formed to provide legal assistance to municipalities, in order to establish close,
permanent working relations between the state and municipalities. Any conflicts that may
emerge between municipal and state government bodies should be settled by legal
proceedings.

 The legality of local budget implementation in Georgia is overseen by an inspection
commission, which is chosen by each local authority. The task of this commission is to
monitor the revenue collection, the legality of expenditures and their correspondence to the
local budget. It reports on its activity to the local council every three months. Report on
budget execution is submitted to the Department of Statistics and Chamber of Control.
Ministry of Finance and the State Department for Social-economic Information determine the
frequency and form of budget reports. The central government has the most effective means
of control at its disposal. Legislative control is exercised by the prosecutor’s office, economic
control and control over specific functions by the relevant ministries, such as Ministry of
Internal Affairs or Ministry of Finance. Courts play a very limited role in resolving conflicts
between central and local governments. In practice, all such cases are decided by the president
of Georgia.

Local council members are obliged to meet their voters at least once every three months and
report on their activities at least once a year. Local council meetings are open to public.
People may request any public information from government agencies. However, they do not
exercise this right in practice.

Table 7: Control mechanism

          ARMENIA                      AZERBAIJAN                        GEORGIA
Local council                   Local council                    Local council
Independent audit is not        Independent audit is not         Independent audit
obligatory                      obligatory
Central government in case      Ministry of Justice controls     State Audit chamber (only
of specific grants, borrowing   over compliance with laws        for specific grants)
and delegated powers            by municipalities
Source: National reports

Local self-governments in Armenia possess substantial authority to manage local property,
including the right to sell the property. Community property consists of registered public
assets (buildings and other facilities) and other resources including financial and other non-
patrimonial properties (for instance bonds). Under community property fall heating, sewerage,
water supply and irrigation systems, kindergartens, specialized schools, clubs, culture halls,
libraries, parks, stadiums, sanitation facilities, administrative buildings and non-privatized
housing stock. Communities also control few enterprises.

Municipal property in Azerbaijan consists of municipal housing, social and cultural
institutions, land, objects of common use of citizens (uninhabited premises, roads, education,
health care, and sports facilities). According to the law, municipalities may rent or
redistribute, enter into contracts using their property as collateral and draw up contracts for
the privatization of municipal services and factories. However, much of the property was state
property, which is now being transferred to municipal ownership, but these transfers have
been delayed. Since the judicial branch is entirely dependent on the executive branch,
municipalities have no opportunity to resolve any conflict with central government fairly.
State and municipal property is not yet clearly differentiated in Georgia, although some steps
have been taken to this end. The Presidential Decree on the Transfer of State Property to
Local Authorities has been in effect since 1999.

   VI.     Proposed changes

In Armenia the main task in fiscal decentralization is seen in providing new powers to local
government. An optimization of administrative and territorial division should be the first step
in this process. It is built on the conviction that Armenian municipalities are rather small to
provide all functions defined in the law. Creating a second level of self-government or
community unions is considered to be crucial to promote further successful decentralization.
It is proposed to improve the financial equalization system, to transform it into a formula
based system. Tax sharing, which is stipulated in the law, should be taken in practice. The
status of capital should be modified and it should be allowed that the city mayor is elected
directly by population.

The main tasks in creating viable municipalities in Azerbaijan is to structure properly the
state power, to improve the role and powers of municipalities in order they are more precisely
defined, to remove delays in the transfer of property to municipal ownership, to improve
subvention allocation and to increase local government budgets.

Next steps in the transition process in Georgia include improvement in conditions for local
government decision making and implementation of the results, to decentralize the governing
system, better to define functions of each tier of the government, to increase the independency
of local budgets by enlarging their revenue base and by establishing long-term standards for
transfers and local budget revenue.

Table 7: Proposed changes

          ARMENIA                       AZERBAIJAN                        GEORGIA
Territorial reform              Code of conduct for             Territorial reform (voluntary
                                municipalities                  amalgamation)
Expansion of powers             Transfer of property (land)     Clear division of functions
Increase the power of local     Legislative form of grant       New equalization procedure
government to collect taxes     system                          based on formula
New taxes for municipalities    Accent on general grants and    Independent local budgets
                                not specific ones
New equalization procedure      Improvement of local taxes      Transfer of property to local
based on formula                collection                      government
Defined shares on centrally     Share on profit tax
established taxes for local
self-government
Improve transparency of
local government activities
Source: National reports

   VII.    Conclusions

It is worth of mentioning that the destruction of the Communist regime in these countries, as
well as in others, led to a weakening of the state, to economic chaos, and deterioration of
public finance system. This negative trend was accompanied by a fall of GDP, high inflation
rates, and growing public budget arrears. Under such situation, the need to make the state
cheaper and more effective was of vital importance. Solving this problem will influence the
stance and financial opportunities of municipalities. It is obvious that problems at the central
level had to be solved first, and the local government solution was postponed. But it is clear
that it cannot be postponed for ever. Many steps have been already taken to improve the local
government situation.

Although drawing up a law might be very difficult, it is the implementation that is usually
even more problematic. In all three countries it might be observed that there are many pieces
of legislation under preparation or intended to be designed. Less attention is paid to the
analysis, of how the present laws work and whether their consequences meet the expectations.
Among all needed aspects, the stability plays inevitable and important role. For long-term
budgeting, for capital project planning and for maintaining efficiency, the stability of local
government setting is crucial. Local governments must have certain discretion over their
revenue to be able to react to municipality needs and local citizens´ priorities.

Making budget procedures transparent and open to public from the very beginning (budget
proposal) may help to increase the citizens’ involvement in public affairs and gain their
support for local government actions.

Insufficiency of data and consequent lack of analyses make the work on improving local
government financial performance and thoughts of financial viability of local governments
very difficult. Regular records of budget execution based on unified budget classification
(operating and capital budgets) are very important. It requires a radical improvement of
budgetary data collection. Analytical activities should be strengthened and supported by
obligatory audit based on well defined audit procedures.

Training of local officials and exchange of best practices among local sector will contribute to
better public service delivery. It is important to keep in mind that equalization mechanism
based on formula requires substantial amount of data and their regular updating. Success of
tax administration done by local officials is undermined by sufficiently trained staff and
access to all needed information. There is often risk of inefficiency in case that there are
plenty of collected local taxes and fees with small yield.

Referred bibliography:

David Tumanyan (coordinator): Communities Financial Viability in Armenia, National paper,
WBI/LGI/UNDP Initiative for Caucasus, Yerevan 2004;

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