Fiscal decentralization has been at the core of Local Government Associations (LGAs) policy advocacy in South-East Europe (SEE) over the past fifteen years. The ninth edition of the NALAS fiscal decentralization report provides an analysis of intergovernmental fiscal relations and local government revenue-raising capacities, highlighting significant developments and challenges faced by local governments in SEE. The report aims to provide guidance to national counterparts in assessing policy options for municipal development. The report is prepared by the NALAS Fiscal Decentralization Task Force, with the support of the KDZ Centre for Public Administration Research, within the BACID III Program funded by the Austrian Development Agency. The Report covers Albania, Austria, Bosnia and Herzegovina, Bulgaria, Croatia, Kosovo, North Macedonia, Moldova, Montenegro, Romania, Serbia, Slovenia and Turkey. This blog post delves into the key findings of the report, highlighting trends and tendencies, regulatory changes and key factors affecting local governance and fiscal autonomy.
A Diverse and Challenging Landscape
SEE presents a complex and varied landscape regarding fiscal decentralization. The region comprises different economies with distinct governance structures, from single-tier systems to those with multiple subnational levels. For instance, the number of 1st tier local governments ranges significantly, from 25 in Montenegro to 3181 in Romania, reflecting the diversity in administrative organization. The average population size of these local governments is 27,679, considerably higher than the EU27 average of 5075. The SEE region follows the European trend of concentration of people in the capital and metropolitan cities. The oversized importance of capital cities causes tensions for the intergovernmental finance system.
Demographic Shifts and Their Implications
Demographic trends pose a significant challenge to fiscal decentralization efforts in SEE. The period between 2012 and 2021 saw a modest population increase of 5.7 million, or 4.4%, primarily driven by Türkiye. In contrast, other SEE economies experienced population declines, averaging 5%, with the Western Balkans seeing a 4% decrease. Migration, brain drain, low birth rates, and an aging population exacerbate the challenges for local governments, affecting the types of services required and straining intergovernmental fiscal relations.
The COVID-19 Pandemic: A Catalyst for Change
The COVID-19 pandemic has profoundly impacted municipal finances in SEE, far surpassing the effects of the 2008-2009 global financial crisis. Before the pandemic, local revenues had grown steadily for a 5-year period, averaging 5% per annum in SEE and 7% in the Western Balkans. However, the pandemic interrupted this growth, causing a decline in local government revenues. In 2020, local government own source revenues fell on average by 7% in SEE and 10% in the Western Balkans (WB), with North Macedonia, Kosovo*, and Türkiye experiencing the most severe declines. This reduction in revenue, coupled with increased service costs, forced national governments to step in and provide financial support to local authorities.
Local Government Revenues: Trends and Challenges
Local government revenues in SEE have been on a volatile trajectory. Over the past 15 years, local government revenues increased in only about half of SEE economies. This seems to be the case for Kosovo, North Macedonia, Austria, Albania, and Bulgaria where local government revenues as a hare of GDP have increased. In the other cases, local government revenues as a share of GDP, are either at the same level as in 2006 or 2009 (Slovenia, Serbia, Romania, Croatia) or lower than that (Türkiye, Bosnia and Herzegovina, Montenegro, and Moldova).
Pronounced Disparities Across SEE Economies and the EU
On average, EU countries have both larger public sectors and have decentralized more revenue to local governments than their counterparts in SEE. In 2021, SEE local government revenue was only 6.1% of GDP, compared to 11.4% in the EU. In per capita terms, SEE local governments have seven times less revenue than their EU counterparts. Within SEE itself, there are wide disparities. For example, Slovenia’s local governments are more than five times richer than those in Moldova, which get only 206 € per capita. The disparities are also evident in how local governments manage education costs. Local governments in Moldova, Kosovo, and North Macedonia pay for teachers’ wages on per capita revenues of less than 316€, while Croatian and Slovenian municipalities that bear little of these costs but dispose of up to 4 times higher per capita revenues.
Fiscal Autonomy is Declining
Fiscal autonomy in SEE has been on a declining trend, with local governments having less control over their budgets. In 2021, only 70% of local budgets were under local authorities' discretion (own revenues, shared taxes and general grants), down from 83% in 2006. The share of own source revenues has decreased by 25%, while the share of block grants and conditional investment grants has increased as increased by 87% and 58%, respectively, over the past 15 years. This shift undermines the ability of local governments to tailor service delivery to local needs, a fundamental aspect of effective decentralization.
Revenue Raising Capacities are Limited
In SEE, local governments’ own-source revenues, on average, make up 33% of their total income, with property tax shares doubling over 15 years. However, there’s significant variation in property tax collection across the region with Moldovan LGs at the lowest and Slovenian LGs at the highest. Revenue sources like new construction taxes are key in Albania, Kosovo, and Montenegro, while Serbia has removed the land development fee. The key challenges facing SEE local governments in revenue generation include the frequent amendments of their tax powers, outdated fiscal registers, weak tax compliance and enforcement.
Borrowing is an Underutilized Tool
Local government borrowing remains relatively underutilized in SEE, with only a few economies exceeding 2-4% of GDP in local government debt. High public debt levels and stringent regulations constrain borrowing, limiting its use for long-term capital investments. However, the COVID-19 pandemic saw an increase in local government borrowing as municipalities sought to address liquidity constraints and support socio-economic recovery efforts.
Education and Healthcare: Key Responsibilities
Local Government in the Western Balkans and SEE manage between 10% and 25% of total public spending. Education is the most significant function for local governments in SEE, with substantial variations in funding responsibilities across the region. In Moldova and Kosovo, education accounts for over 50% of local government expenditures, while in Türkiye, it is funded directly by the state. Social care responsibilities are lower in SEE compared to the EU. The financing and regulation of these decentralized social sector responsibilities remain a complex issue, often blurring the lines between 'own,' 'shared,' and 'delegated' functions.
Infrastructure Needs Require Higher Spending for Capital Investments
Local Governments in the Western Balkans and South-East Europe spend about 24-25% of their budgets on capital investments. However, the share of capital investments spending has been downwardly unstable over the past 15 years. There are also wide disparities in the ability of local governments to spend on capital investments. On average, in the Western Balkans local governments spend about 77 Euro per person on capital investments, versus 142 in SEE. Local governments from EU member states can benefit from substantial investment funding compared to the Western Balkan economies.
Conclusion: Pathways to Enhanced Fiscal Decentralization
The report underscores the importance of continued efforts to strengthen fiscal decentralization in SEE. Despite significant progress, challenges remain in ensuring fiscal autonomy, enhancing revenue generation, better access to borrowing for capital investments, and enabling local governments to become drivers of change in their local communities. Effective decentralization requires a balanced approach, providing local governments with the necessary fiscal tools and autonomy to meet their responsibilities while ensuring equitable and efficient service delivery. By addressing these challenges, SEE economies can foster more resilient and responsive local governance structures, ultimately improving the quality of life for their citizens.
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