Viorel Girbu, Congress of Local Authorities from Moldova, NALAS – Network of Associations of Local Authorities of South-East Europe
Relevance of the Practice
General purpose transfers represent one of the major sources of freely disposable income for local authorities. For 2018, they constitute about 10 per cent of total local revenues. The current system of allocation of general-purpose transfers across local authorities in Moldova can be characterized as been two-fold. Specific regulations are applied for Local Public Administration level 1 (LPA1) and level 2 (LPA2). We intend to assess how this practice influences development and autonomy at local level and whether current settings of the system are sensitive enough to existing differences between large and small localities in Moldova and how it affects the urban-rural divide and interplay.
General purpose transfers are particularly important for smaller and more rural communities, and therefore they play a crucial role in the ability of such municipalities to provide services to citizens. The general-purpose transfer provides for differentiation of the financing of local governments based on their fiscal capacity.
Description of the Practice
The new legislation adopted in 2013 introduced significant changes to the allocation of transfers to local governments. The new system is focused on incomes at the level of locality, although little has been done since the introduction of the new system in order to empower local authorities with improving their constituencies’ income opportunities. The principle of balancing local expenditures to a certain minimum level, established nationwide, was replaced with a new formula focusing on local fiscal capacity, measured by the actual per capita revenues generated in each locality by the wage tax solely. On the other hand, local governments’ powers over taxes on economic activities, (income and wage taxes), have been removed, eliminating local governments’ interest and incentives on improving the business enabling environment at the local level.
The size and the method of distribution of the general-purpose transfers to local governments is prescribed by law, which makes the system immune to subjective political involvement, and in theory, also more predictable over time, although the changes in the macroeconomic and fiscal environment and the income tax policies may generate vulnerabilities.
Simulations based on 2018 data show that the revenues received by smaller (and more rural) communities from the general-purpose transfer are up to 63 times higher than the revenues they receive by the shared tax revenues that are allocated directly to them. On average, revenues that small communities with population up to 2000 inhabitants, constituting more than half of the localities in the country, receive from the general-purpose transfer are about 7 times higher than the revenues they receive from the shared taxes allocated directly to them. The described situation is a consequence of the concentration of economic activities in the capital city of Moldova, Chisinau municipality and other larger and more urbanized local governments. About 62 per cent of the wage tax is collected solely in the Chisinau municipally and is partially redistributed to the rest of the country through the general-purpose transfers system.
The allocation system does not make direct differential treatment to urban or rural localities. However, in relative terms, considering that smaller and more rural local governments have smaller fiscal capacities (and therefore smaller direct revenues from the shared wage tax), on average, they are ‘compensated more’ than the other medium to larger sized municipalities through the general purpose transfers. Chisinau and Balti municipalities are excluded from the system and so is the autonomous region. Still, reference to just one dimension in part related to determination of the fiscal capacity per inhabitant looks simplistic and is questionable.
Assessment of the Practice
The purpose of the financing system is to assign to local governments sufficient financial resources so that they may comply with their obligations. The method of determination and allocation of general-purpose transfers in Moldova seems not to be able to respond to this major objective. The main reasons are the following. First and foremost, the size of general-purpose transfer is simply inadequate, when compared to the expenditure needs and functional responsibilities of local governments in Moldova, as compared to their counterparts in South-East Europe.[1] Secondly, the way in which the size of the general-purpose transfer is determined, as a residual of the revenues of a single tax, does not guarantee the stability and predictability of funds, necessary for local governments to plan and implement effectively local services. Instead, it increases the vulnerability of local governments to the slightest change in both internal and external factors affecting the revenues from the wage tax. Thirdly, the allocation system is designed over criteria such as population and territory that in theory ‘measure’ local governments needs and actual per capita revenues from the wage tax, which in theory ‘measures’ fiscal capacity. The fact that fiscal capacity is measured on the results of a single tax only is a major weakness of the system. Ultimately, the system of allocating general purpose grants produces high disparities across local governments, when compared to the revenues that local governments receive directly from shared taxes. In this respect, the system can be regarded also as disincentivizing the development of localities with existing economic potential and providing a quasi-irrelevant financial incentive to vulnerable localities which are assisted to ‘survive’ but that are not able to develop. [2]
There are also huge disparities and inequalities in the revenue options for autonomous region. In fact, with reference to Local Budgets, in the Republic of Moldova there are practically two parallel local budgetary systems. The autonomous region can benefit from an enlarged list of shared taxes that include also income tax, VAT and excise, although are not covered by general purpose transfers. From this perspective, the autonomous region benefits from more revenue raising options, which are denied to the other local governments in the country. The evolution of revenues compared to 2014 clearly shows that the income formation system for Gagauzia (autonomous region) is more advantageous than that applied in the rest of the country as it provides a broader fiscal base for the local authorities, specifically with respect to the taxes on economic activity. A direct link is created in this respect between the effort to economically develop a locality and subsequent potential financial benefits for the local authorities.
Finally, shared taxes represent a major source of income for the small municipalities in Moldova. Nevertheless, the system presents numerous shortcomings that refer mainly to its simplicity, disconnection from the realities of the municipalities, specifically small ones and inability to provide incentives to local governments and strengthen the link between efforts to improve the business enabling environment and actual financial benefits.
References to Scientific and Non-Scientific Publications
Legal Documents:
Law no 397/2003 on Local Public Finances
Scientific and Non-Scientific Publications:
Budianschi D, ‘Autonomia financiară în Republica Moldova: evoluția veniturilor bugetelor locale’ (Expert Group Centru Analitic Independent 2019) <https://www.expert-grup.org/ro/biblioteca/item/1835-autonomia-financiara-in-republica-moldova-evolutia-veniturilor-bugetelor-locale&category=184>
NALAS, ‘Fiscal Decentralization Indicators of South East Europe’ (9th edn, 2019)
[1] NALAS, ‘Fiscal Decentralization Indicators of South East Europe’ (9th edn, 2019).
[2] Dumitru Budianschi, ‘Autonomia financiară în Republica Moldova: evoluția veniturilor bugetelor locale’ (Expert Group Centru Analitic Independent 2019) <https://www.expert-grup.org/ro/biblioteca/item/1835-autonomia-financiara-in-republica-moldova-evolutia-veniturilor-bugetelor-locale&category=184>.