Elton Stafa, NALAS – Network of Associations of Local Authorities of South-East Europe
Relevance of the Practice
The general-purpose unconditional grant funds more than 50 per cent of the budget for 70 per cent of municipalities in Albania. From this perspective it is the single most important financing mechanism for the vast majority of local governments. The allocation formula of the grant treats differently densely populated municipalities and municipalities with a population density below the national average. By the same token, local governments with ‘lower than average fiscal capacity’ are compensated, by ‘taxing’ more those municipalities that have ‘higher than average fiscal capacity’. The practice directly addresses some of the key questions of report section 3 on local finances, in particular the differentiation of the financing system to take into account the size and fiscal capacity of local governments. The practice responds directly to the challenge of increasingly depopulated rural local governments and commuters from suburbs.
Description of the Practice
The concept of the general-purpose unconditional grant for local governments was introduced in 2001, providing local governments with freely disposable funding that they could use for the implementation of their own and shared functional responsibilities. The funding was allocated to local governments according to a formula whose criteria and coefficients were stipulated in the annexes of the annual budget law. The formula provided for a differentiated treatment of urban and rural local governments, through coefficients that provided extra revenues to mountainous rural local governments or economically distressed municipalities. The formula also included a differentiated treatment for the Capital City of Tirana, which incurred additional costs in providing services for large numbers of populations that migrated to Tirana – but that were not officially registered in Tirana (as taxpayers) and to commuters from neighboring municipalities that put additional pressure on service provision and infrastructure in Tirana.
Changes in the political landscape in 2005 had a huge impact on the way in which the formula was allocated to local governments. The most relevant change was the elimination of the differentiated treatment of the capital city Tirana, on the grounds of an ‘equal treatment’ of local governments; and the frequent changes of the weights of the criteria and coefficients used for the allocation of funding. Nevertheless, the major weaknesses of the general-purpose unconditional grant in Albania were its historical underfunding, when compared to other counterparts in the region whose local governments had a similar bundle of responsibilities as in Albania;[1] and the downward instability and unpredictability over time. All these changed between 2015 and 2017 when the government of Albania adopted a new formula for the allocation of the general-purpose unconditional grant to local governments, and a new law on Local Self-Government Finance. [2]
Currently, the general-purpose unconditional grant for local governments is regulated by the Law on Local Self-Government Finance and the annual budget law annexes. This law constitutes a major milestone for Albania’s path towards decentralized government. For the first time, the criteria and coefficients used for the allocation of the unconditional grant to local governments are incorporated in a permanent piece of legislation. Before the adoption of the law, the rules were written and explained only in the annexes of the annual budget laws, where the government and parliament had significant room to change them from year to year, with adverse consequences to the planning and implementation of local services.
The new formula allocating the unconditional grant to municipalities follows three criteria. First, up to 80 per cent of the total pool is allocated to local governments on the basis of their resident populations, as measured by the last Census and corrected with 30 per cent of the difference with the population data of the Civil Status Register data; The ‘consolidation’ of the population number utilized for the allocation of funding was necessary to ensure a rationalization of funding to where the needs for local services actually ‘are’, supposedly better captured by the CENSUS, and not where the need is ‘registered’ – which is what the Civil Status Register provides for. It should be considered that Albania is not the only country in the region to utilize different population numbers when allocating funds to local governments.
Second, up to 15 per cent of the total pool is allocated on the basis of population density, reflecting differences in service delivery costs among local self-government units; Territorial consolidation changed reality by making most local government units similar in size, with a central city that should be capable of supporting new functions. From this perspective the former ‘surface area’ criteria of the former formula introduced in 2002 is no longer relevant, as there could be municipalities of similar territorial size but with different populations.
Third, no less than 5 per cent of the pool is allocated on the basis of the number of enrolled pupils in the pre-university education system; chosen because of the importance of education as a function, and also to compensate for potential inaccuracies in the number of resident populations.
The unconditional grant allocation formula provides also for the fiscal equalization between local self-government units that have different fiscal capacities. Fiscal equalization in Albania is based on:
- the fiscal capacity of every municipality, calculated as the total actual revenues that local governments have received in the former year from shared taxes;
- the equalization threshold, calculated as the national average revenues of local governments from shared taxes, above or below which the municipality benefits from or contributes to the equalization fund of the unconditional grant;
- the equalization coefficient calculated as the amount that municipalities with per capita revenues from shared taxes above or below the equalization threshold should give or receive in terms of equalizing funds;
- the equalization fund calculated as the amount of funds necessary to ensure that all municipalities arrive at in the chosen equalization threshold. Local self-government units, with fiscal capacity lower than the equalization threshold are compensated as per the pre-set equalization coefficient and the available equalization fund resulting from the contributions of those municipalities which have a fiscal capacity above the threshold. In practice the equalization fund is created by taking funds from local governments that have higher than average per capita revenues from shared taxes, through specific calculations, explained in detail in annual budget laws.
The new Law on Local Self-Government Finance made possible also for the first time in Albania, the anchoring of the annual size of the unconditional grant to a macroeconomic variable, a practice adopted frequently at international and regional level. In fact, according to this law, the size of the unconditional grant can be no less than 1 per cent of the GDP and no less than the total amount that was allocated the previous year. This wording creates a double safety for local governments. Firstly, the size of the grant is more stable and predictable and it also increases with the economy over time; and secondly, being a novelty also on public finance theory, the size of the grant cannot be lower than the amount allocated the year before – which literally means that even if the economy goes down, the size of the unconditional grant cannot be lower than the amount that was allocated the former year.
The main institutions involved in the determination and allocation of the general purpose unconditional grants to local governments are: the Ministry of Finance and Economy, responsible for the implementation of the formula for the allocation of unconditional grants to local governments, the development of the annual budget law that explains in details how the formula works, the development of the macroeconomic projections of the GDP; the General Tax Administration, that collects the national taxes whose yield is shared with local government; the Council of Ministers and Parliament that shall approve the allocation and amounts of grants for local governments as part of the approval of the annual budget law. However, it has to be specified that over the past three years, the Economy and Finance Committee of Parliament has made ad hoc decision to add some additional funding to select local governments. The logic behind this practice is not explained in the budget law annex or justification reports, nor in any other official public document. The lack of transparency has been accompanied by concerns over political favoritism of select local governments.
Legally speaking, there is not any differentiation in terms of urban and rural municipalities in Albania. Municipalities incorporate both the urban center and the rural areas (former communes that were amalgamated with the urban center with the Territorial and Administrative Reform TAR) around it. However, local governments are differentiated in an indirect manner. The first type of differentiation is done through the implementation of the population density criteria, where local governments that have a population density below the national average are treated preferentially. In fact, the lower the population density of a municipality, the better it is treated by the formula. The rationale for such treatment is the assumption that larger municipalities which have fewer people face higher costs in service delivery (because of the lack of economies of scale and the large territory to be served). Larger municipalities with few inhabitants, in particular in the aftermath of the territorial consolidation reflect also those municipalities that have incorporated large rural and mountainous areas. On the other hand, those municipalities that have a population density above the national average, not only do not receive any preferential treatment, but they do not receive any funding at all from the second component of the unconditional grant formula – population density. In fact, 15 per cent of the overall size of the unconditional grant is allocated to 39 out of 61 municipalities. Municipalities with small or average territory and large population numbers have higher opportunities to reach economies of scale, and therefore, it is assumed that they have lower service delivery costs. However, this assumption does not reflect at all the additional costs imposed on service delivery and infrastructure of more urban municipalities from commuters from suburban areas or internal migration movements of people that formally continue to be registered in their hometowns but have chosen to live in the capital city – without becoming a taxpayer of the capital city. Indeed, public finance theory and research show that service delivery costs follow a U-shaped pattern with regards to population, where municipalities with few inhabitants have higher costs to serve them because of the lack of economies of scales and municipalities with too many inhabitants have higher costs because of significant pressure on infrastructure and on services from commuters or other persons that use their services and infrastructure without contributing through taxes.
The second type of differentiation is performed through fiscal equalization. In practical terms, those local governments that have a lower tax base and fewer taxpayers – in most cases coinciding with municipalities that have a smaller urban center and large rural areas with few taxpayers – receive some equalizing funds which are paid by those local governments that have ‘higher than average’ fiscal capacity, – which in most cases are municipalities with larger urban centers hosting more economic activities and therefore more taxpayers.
Assessment of the Practice
The reform of the general-purpose transfer introduced by the new Law on Local Self-Government Finance in 2017 aimed at increasing the stability and predictability of the local government finance system in Albania and help local authorities in planning and delivering on their responsibilities through more stable and predictable local budgets. The commitment of the national government in Albania to implement the provisions of the reform and provide local governments with increased transfers (as foreseen by the reform) even in the background of the devastating effects of the 2019 earthquakes and the 2020 Covid-19 crisis needs to be praised as it has helped Albanian municipalities in responding to these crises.
On the effectiveness of the general grants it is important to clarify that they aim to provide local governments with freely disposable –unconditional—revenue for two basic aims: (i) to provide local governments with ‘the difference between the costs of their own responsibilities (expenditure needs) and the revenues they can raise from own sources (fiscal capacity)’ (vertical gap); and (ii) to provide local governments with ‘lower than average fiscal capacity additional funds so they can provide public services of a reasonably equal standard’ (horizontal gaps).[3]
The extent to which the general purpose unconditional grant is able to fill the vertical gap is debatable, in that indirectly, the formula treats in a preferential manner only one of the two categories of local governments that have higher costs of service provision – municipalities that have more rural areas in their territory and fewer inhabitants. From this perspective, it should be taken into account also the additional costs for service delivery and infrastructure maintenance and development incurred by larger and more urbanized local governments, as indicated by other regional and international best practices in financing local governments.
Secondly, the extent to which the grant is able to fit the horizontal gap is debatable too. In practice, fiscal equalization is paid by local governments themselves, reshuffling funds that are provided by the unconditional grant. This is a typical ‘Robin Hood’ system, taking additional resources from ‘more urbanized’ local governments that have higher than average revenues from shared taxes, to allocate them to more ‘rural’ local governments with lower than average fiscal capacity. Ultimately, over the past 17 years, the ‘poorer’ municipalities have been subsidized by only a small group of larger municipalities, where more than 85 per cent of the funds necessary to ‘equalize’ shared tax revenues of local governments came from the Capital City of Tirana and 10 per cent from the second largest city in the country – Durres. From this perspective, 95 per cent of the funds necessary to bring all local governments closer to a predetermined share of the national average of revenues are raised by ‘taxing’ Albania’s two largest cities. Nevertheless, it is important to highlight that the horizontal fiscal equalization component of the general-purpose transfer for local governments in Albania is small, as is the pool against which equalization is calculated. Local governments are equalized on their shared revenues (which constitute less than 5 per cent of local revenues) and the amount of funds that are redistributed to ‘poorer’ municipalities make up no more than 2 per cent of total local government revenues. In short, all municipalities benefiting from the equalization receive only a trivial amount of funds which are not able to account for the significant disparities across local governments as regards their fiscal capacity and territorial development. On the other hand, it is important to highlight also that Albania has a very strong equalization component in the calculation of the expenditure needs of local governments that provides for additional funds for smaller and less dense municipalities which have higher than average costs in providing services and lower than average fiscal capacities.
References to Scientific and Non-Scientific Publications
Blöchliger H and Charbit C, ‘Fiscal Equalisation’ (2008) 44 OECD Economic Studies 1
Kim J and Lotz J, ‘Measuring Local Government Needs’ (The Korea Institute of Public Finance and the Danish Ministry of Social Welfare 2008)
Levitas T and Stafa E, ‘Creating an Equitable, Transparent, and Predictable Unconditional Grant Formula’ (USAID’s Planning and Local Governance Project PLGP 2015) <https://www.plgp.al/wp-content/uploads/2.-Unconditional-Grant-Policy-Paper-September-30-2015-Clean_eng-2.pdf>
NALAS, ‘Fiscal Decentralization Indicators for Southeast Europe, 2006–2017’ (2018)
[1] NALAS, ‘Fiscal Decentralization Indicators for Southeast Europe, 2006–2017’ (2018).
[2] Tony Levitas and Elton Stafa, ‘Creating an Equitable, Transparent, and Predictable Unconditional Grant Formula’, (USAID’s Planning and Local Governance Project PLGP 2015) <https://www.plgp.al/wp-content/uploads/2.-Unconditional-Grant-Policy-Paper-September-30-2015-Clean_eng-2.pdf> accessed 18 May 2019.
[3] Hansjörg Blöchliger and Claire Charbit, ‘Fiscal Equalisation’ (2008) 44 OECD Economic Studies 1 <https://www.oecd.org/norway/42506135.pdf>.