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Moral Hazard in Fiscal Decentralization

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					 The Reluctant Public
Sector Transition in the
  Slovak and Czech
      Republics

  Phil Bryson and Gary Cornia
 The Public Sector Under
    Central Planning

• All public goods and services
  provided under central
  government and its ministries.
• No traditional subnational
  governments, all decisions
  pertaining to taxation and
  public services made by central
  government.
 The Public Sector Under
    Central Planning


• The only subnational activities
  were “state administration,”
  the implementation of the
  central plan for local
  governments by agents
  answering to the central
  government.
• Czechoslovakia began the
  attempt to decentralize its
  fiscal system immediately after
  the transition began in 1990. It
  established a taxation and
  budget system of a more
  western-European type.
Fiscal decentralization in the
Czech and Slovak Republics has
only begun to establish local
autonomy.
The “Velvet Divorce” of
1993 set the new Czech
and Slovak Republics on
independent
development paths.
In Slovakia, unusual
politics resulted in sparse
revenue transfers, but
somewhat greater fiscal
independence for
municipalities through the
property tax.
The Czech Republic, more
generous to its
municipalities, has not let
local governments develop
autonomously.
Property tax, the best
vehicle for generating
independent funds,
remains largely symbolic,
as under central planning.
The Decentralization Conflict
  Why Decentralization is Essential
    for developing democracy
  • It makes the decisions of public
    servants more transparent,
  • It permits citizens to participate
    in self-government at local level
  • They participate at low cost,
    and more effectively (Oates,
    1998).
The Decentralization Conflict
    Drawbacks of decentralization:
  • Some local governments are
    small and poorly endowed with
    resources
  • Municipalities tend to reduce
    funding when service benefits
    spill over into contiguous areas.
    Local governments will respond
    in their narrowly-perceived self
    interest by under-providing
    those services.
Need for Property Tax Revenues
  • Administrative and Practical
    Problems of the property tax
  • The property tax is highly
    visible and transition country
    politicians find it threatening.
    The citizenry of transition
    countries are not accustomed
    to visible taxation and can be
    expected to oppose it.
Need for Property Tax Revenues
• Other independent sources of
  revenue for subnational
  governments are insufficient:
  needs are great.
• Revenues from local user fees
  collected for public services
  and the proceeds from
  privatization, for example, help,
  but are insufficient.
Need for Property Tax Revenues
  • Administrative and Practical
    Problems of the property tax
  • The difficulty of establishing
    market-oriented property values
    in the absence of a functioning
    real estate market (Bertaud and
    Bertrand, 1994)
  • The uneven distribution of the
    property tax base (Netzer,
    1966).
Need for Property Tax Revenues
  • Administrative and Practical
    Problems of the property tax

  • the property tax remains
    critically under-used (Dunn and
    Wetzel, 2000).
  • Especially in the transition
    countries, this can be an
    impediment to successful
    decentralization.
Need for Property Tax Revenues


• The municipalities in transition
  countries remain poorly
  financed.
Advantages of the Property Tax


• It is immobile, stable,
  potentially neutral, and (as a
  direct tax) visible to taxpayers.
Positive Property Tax Attributes


  • The property tax is stable (it
    provides fairly constant
    revenues independent of the
    business cycle).
Positive Property Tax Attributes


  • The property tax is immobile
    (taxpayers can’t evade it by
    engaging in transactions just
    beyond a relevant political
    border).
Positive Property Tax Attributes


 • This tax is potentially neutral.
   Its imposition does not cause
   changes in the utilization of the
   services of taxed properties.
Positive Property Tax Attributes


 • The tax falls on taxpayers who
   presumably have the means and
   the ability to pay (they are home
   owners and property holders).
Positive Property Tax Attributes



   Excise taxes, for example, can
   be regressive, representing a
   larger portion of lower than of
   higher incomes.
Positive Property Tax Attributes

  • As local public services improve
    and increase property values,
    the beneficiaries are required to
    pay for the increased value.
Positive Property Tax Attributes



  • As a direct tax, the property tax
    is visible to taxpayers.
• The tax’s moral hazard
  problems become apparent in
  comparing Czech and Slovak
  local budgets.
• Because of greater fiscal need,
  the Slovak municipalities have
  demonstrated what can be
  achieved through greater
  property tax collection effort.
                               Table 1
                Number of Subnational Government Units
                    Selected Transition Economies

                    Type                              Country         Municipalities per
  Country        Government          Number          Population            10,000
Albania          Municipality           356           3,400,000              1.05
Bulgaria         Municipality           255           8,900,000               .29
Czech            Municipality          6234           10,300,000             6.05
Hungary          Municipality          3148           10,300,000             3.06
Poland           Municipality          2459          38,400,000               .64
Romania          Municipality          2948          22,700,000              1.30
Russia           Municipality          2000          149,000,000              .13
Slovakia         Municipality          2781           5,300,000              5.25
Ukraine          Municipality           619           52,100,000              .12
Source: Calculated from Bird, Ebel, and Wallich. See also respective statistical yearbooks.
                               Table 1
                Number of Subnational Government Units
                    Selected Transition Economies

                    Type                              Country         Municipalities per
  Country        Government          Number          Population            10,000
Albania          Municipality           356           3,400,000              1.05
Bulgaria         Municipality           255           8,900,000               .29
Czech            Municipality          6234           10,300,000             6.05
Hungary          Municipality          3148           10,300,000             3.06
Poland           Municipality          2459          38,400,000               .64
Romania          Municipality          2948          22,700,000              1.30
Russia           Municipality          2000          149,000,000              .13
Slovakia         Municipality          2781           5,300,000              5.25
Ukraine          Municipality           619           52,100,000              .12
Source: Calculated from Bird, Ebel, and Wallich. See also respective statistical yearbooks.
                                        Table 4
                  Moral Hazard: Property Tax Policy and Administration

                                POLICY DEVELOPMENT

                       Central Government               Sub-National Government
                       Complete centralization          Sub-national governments have
                       benefits from resources,         substantial input on policy
    Central
                       technical support, and policy    issues but there is less chances
    Government
                       experience. There is little      to monitor the behavior of the
                       incentive to improve             administrator of the property
                       administrative outcomes.         tax. The potential for moral
                       The result is a lagging effort   hazard problems is moderate.
                       on the part of central
                       administrators. Discovery
                       and audit are especially
ADMINISTRATION
                       underdeveloped. Likelihood
                       of moral hazard problems is
                       high.
                       Centralization of policy         Complete decentralization
                       facilitates development of       diminishes the uniformity
   Sub-National        policy. Local governments        between taxing jurisdictions,
   Government          benefit directly in the          creates potential for tax wars,
                       outcomes of the                  and has uneven resources
                       administrative processes.        assigned to policy. To overcome
                       Revenues collected can be        potential policy problems
                       used by the local                administrators rely on strong
                       government. The potential        administrative responses that
                       for moral hazard problems        only exacerbate the problems of
                       is low.                          the tax. Likelihood of moral
                                                        hazard problems is high.
                                     National and Local Budgets:
                                     Czech and Slovak Republics
                                       SLOVAK REPUBLIC


                             1993      1994      1995     1996     1997     1998    1999     2000
Local Budgets*                19.5         19       21      21.5    23.5     22.7     21.3     24.8
Local as % of National
Budget                       12.97      13.65    12.88      13.2   13.37    12.68     11.9    11.07
State Grants to Local
Budgets*                       1.5         1.1      1.2      1.3      1.8    2.08     2.24     2.77
Total Local Revenues*          21        20.1     22.2      22.9    26.7     25.9     24.2     27.4
Local Budget Expenditures*    19.3        19.1    18.9      21.9    25.3     25.8     23.9     26.5
Real Estate Tax*               1.6       1.79     1.73      2.14     2.61     2.4     2.72     2.87


                                         CZECH REPUBLIC
                             1 993     1994      1995     1996     1997      1998   1999     2000
Local Budgets*                91.1        111     129.1   161.72   145.3    157.2    187.7    181.8
Local as % of National
Budget                       25.45      28.43    29.34      33.5    30.3     30.8     30.9     32.6
State Grants to Local
Budgets*                     27.03      29.25    33.28     59.44   35.87    37.39    41.43    46.05
Total Local Revenues*          101        111      129       162     147      162     188       181
Local Budget Expenditures*    90.1       112.1   132.3     171.1   150.5      158     173      190
Real Estate Tax*             3.021      3.808    3.799     4.018   3.943    4.108    4.248    4.437
                                     National and Local Budgets:
                                     Czech and Slovak Republics
                                       SLOVAK REPUBLIC


                             1993      1994      1995     1996     1997     1998    1999     2000
Local Budgets*                19.5         19       21      21.5    23.5     22.7     21.3     24.8
Local as % of National
Budget                       12.97      13.65    12.88      13.2   13.37    12.68     11.9    11.07
State Grants to Local
Budgets*                       1.5         1.1      1.2      1.3      1.8    2.08     2.24     2.77
Total Local Revenues*          21        20.1     22.2      22.9    26.7     25.9     24.2     27.4
Local Budget Expenditures*    19.3        19.1    18.9      21.9    25.3     25.8     23.9     26.5
Real Estate Tax*               1.6       1.79     1.73      2.14     2.61     2.4     2.72     2.87


                                         CZECH REPUBLIC
                             1 993     1994      1995     1996     1997      1998   1999     2000
Local Budgets*                91.1        111     129.1   161.72   145.3    157.2    187.7    181.8
Local as % of National
Budget                       25.45      28.43    29.34      33.5    30.3     30.8     30.9     32.6
State Grants to Local
Budgets*                     27.03      29.25    33.28     59.44   35.87    37.39    41.43    46.05
Total Local Revenues*          101        111      129       162     147      162     188       181
Local Budget Expenditures*    90.1       112.1   132.3     171.1   150.5      158     173      190
Real Estate Tax*             3.021      3.808    3.799     4.018   3.943    4.108    4.248    4.437
                                                   TABLE 5

                                    National and Local Budgets:
                                    Czech and Slovak Republics
                                         SLOVAK REPUBLIC


                                 1993     1994       1995     1996     1997     1998    1999     2000
Local Budgets*                    19.5       19          21     21.5    23.5     22.7     21.3     24.8
Local as % of National
Budget                           12.9     13.65      12.88     13.2    13.37 12.68       11.9    11.07
State Grants to Local Budgets*     1.5       1.1        1.2      1.3      1.8    2.08     2.24     2.77

Total Local Revenues*              21       20.1       22.2     22.9    26.7     25.9     24.2     27.4




                                          CZECH REPUBLIC
                                 1 993    1994       1995     1996     1997      1998   1999     2000
Local Budgets*                    91.1       111      129.1   161.72   145.3    157.2    187.7    181.8
Local as % of National
Budget                            25.45 28.4         29.34     33.5    30.3     30.8     30.9     32.6

State Grants to Local Budgets*   27.03    29.25       33.28    59.44   35.87    37.39    41.43    46.05
Total Local Revenues*              101       111        129      162     147      162     188       181
       Local Property Taxes and Transfers from Central
         Governments: Czech and Slovak Republics

       Property Tax as % of Local          Fiscal Transfers as % of Local
       Budget                              Budget
Year    Czech Republic   Slovak Republic    Czech Republic   Slovak Republic


1993            2.99            7.62             29.67               7.69
1994            3.43            8.91             26.35               5.79
1995            2.95           7.79              25.77              5.71
1996            2.48           9.34              36.75              6.05
1997            2.68           9.78              24.68              7.66
1998            2.53           9.27              23.79              9.16
1999            2.26          11.24              22.07             10.52
2000            2.44          10.47              25.33             11.17
       Local Property Taxes and Transfers from Central
         Governments: Czech and Slovak Republics


       Property Tax as % of                Fiscal Transfers as % of
       Local Budget                        Local Budget
Year    Czech Republic   Slovak Republic    Czech Republic   Slovak Republic


1993            2.99            7.62             29.67               7.69
1994            3.43            8.91             26.35               5.79
1995            2.95            7.79             25.77               5.71
1996            2.48            9.34             36.75               6.05
1997            2.68            9.78             24.68               7.66
1998            2.53           9.27              23.79              9.16
1999            2.26          11.24              22.07             10.52
2000            2.44          10.47              25.33             11.17
The EU Demands Democracy
and Democracy Implies
Fiscal Decentralization
EU membership requires that a
  country achieve:
• stability of institutions
  guaranteeing democracy, the
  rule of law, human rights and
  respect for and protection of
  minorities;
EU membership requires that
a country achieve:
  • a functioning market economy
    as well as the capacity to cope
    with competitive pressure and
    market forces within the Union;
  • the ability to take on the
    obligations of membership and
    adhere to the aims of political,
    economic and monetary union.
The EU Commission on
Czech Accession ignored
the local autonomy issue
In the 2000 Regular Report
  the Czech Republic was
  praised and censured for
  rather trivial fiscal
  conditions and situations
• The more serious, long-term failure
  to enable or promote the
  development of local autonomy
  was not mentioned by the EU as a
  subject of concern.

 (2000 Regular Report by the
 Commission on the Czech
 Republic’s Progress towards
 Accession)
  The Reform of Public
    Administration
• For the past few years both the
  Czech and Slovak Republics
  have been responding to an EU
  challenge to prepare for
  admission by reforming their
  systems of public
  administration.
  The Reform of Public
    Administration
The reforms of public
  administration have included
• the addition of regional
  governments (Kraje) between
  the center and the
  municipalities, and
  The Reform of Public
    Administration
The reforms of public
  administration have included
• the transfer of additional
  responsibilities to some of the
  municipalities.

But…
  The Reform of Public
    Administration

The reforms of public
 administration are like
 redefining the powers of agents
 without providing independent
 financial resources to enable
 them to implement their own
 decisions.
  The Reform of Public
    Administration

In other words, reforming public
 administration and fiscal
 decentralization are related as
 complements, not as
 substitutes.

				
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