UNH Guide Municipal Finance

8/4/2019 UNH Guide Municipal Finance

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Guide to

MunicipalFinance


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S1:i

Nr, 2009

Guide toMunicipalFinance


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Te Human Settlements Financing ools and Best Practices Series

Guide to Municipal Finance

First published in Nairobi in 2009 by UN-HABIA.

Copyright United Nations Human Settlements Programme 2009

All rights reservedUnited Nations Human Settlements Programme (UN-HABIA)P. O. Box 30030, 00100 Nairobi GPO KENYAel: 254-020-7623120 (Central Oce)

www.unhabitat.org

HS/1146/09E

ISBN: 978-92-1-132113-5ISBN(Series): 978-1-132027-5

Disclaimer

Te designations employed and the presentation o the material in this publication donot imply the expression o any opinion whatsoever on the part o the Secretariat othe United Nations concerning the legal status o any country, territory, city or areaor o its authorities, or concerning the delimitation o its rontiers o boundaries.

Views expressed in this publication do not necessarily reect those o the UnitedNations Human Settlements Programme, the United Nations, or its Member States.

Excerpts may be reproduced without authorization, on condition that the source is indicated.

Cover design : Andrew Ondoo/UN-HABIACover photos: Xing Quan Zhang/UN-HABIA

Acknowledgements:

Director: Oyebanji Oyeyinka

Principal Editor and Manager: Xing Quan Zhang

Principal Author: Enid Slack

English Editors: Eric Orina and Cilla Ng

Design and Layout: Andrew Ondoo


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iii

table of CoNteNts

chapter 1 Denition o Mnicipa Finance and Obecties o the Gide 1

Diio o Muiil Fi 1Obis o guid 1Ouli o guid 2

chapter 2 Mnicipa Finance Isses, Chaenges, and Trends 3

S o Muiil Fis 3

Issus d llgs 10r ds i Muiil Fi 14

chapter 3 Principes o Mnicipa Finance 17

rol o lol gom i oom 17Mo uios o muiil goms 18t b modl o lol gom 18publi iils 19

chapter 4 Mnicipa Reenes 21

Sous o muiil u 21cisis o good lol 22ts 23Us s 33Igoml ss 35ts o ss 35riol o ss 36Dsig o ss 38poblms wi ss 38Imlmio d mgm o muiil us 40

chapter 5 Financing Capita Ependitres 41Fuds om oig us 41Igoml ss 42Mobilizig i il 42Muiil boowig 43publi-i sis 44Dlom gs 45t im ig 50Ld lu u s 54


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chapter 6 Mnicipa Bdget, Financia Reporting and Aditing 56

edius lol ll 56Muiil budgig 56aouig sdds 61aouig os 62

audiig 63pom-bsd msum 63

chapter 7 Mnicipa Borrowing and Access to the Capita Market 65

rol o muiil boowig 65cil mks 66poolig muiil db 66Boowig isums 67cdi igs 68

chapter 8 Concding Comments 71

REFERENCES 78APPENDIx 78


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list of tables ,fiGuRes aNd boxes

Tabes

tbl 1 Disibuio o Muiil edius, Sld OecD couis, 2006 (%) 4

tbl 2 Disibuio o Muiil edius, Sld couis icl d es euo, asi, ai, d Li ami, 2006 (%) 5

tbl 3 Disibuio o Muiil rus, Sld OecD couis, 2006 (%) 6

tbl 4 Disibuio o Muiil rus, Sld couis icl d es euo, asi, ai, d Li ami, 2006 (%) 7

tbl 5 Lol Gom edius s pg o GDpd tol Gom edius 9

tbl 6 Ub poulio b Mo a, Sld piods, 1950-2050 10

tbl 7 pg Ub b Mo a, Sld piods, 1950-2050 11

tbl 8 Sous o Muiil Oig rus o Sld ciis 22

tbl 9 Bs o po ts 27

tbl 10 ts o Igoml Fisl tss 36

tbl 11 Dlom cgs, G tooo a, 2007 49

tbl 12 t Ss i cil Budg 58

Figres

Figu 1 publi Db, Sdig d Isms rol o Lol Goms (2000) 15

Figu 2 Di Fiig tools o Di Sis 18

Figu 3 clulig t Im 53

Figu 4 Ss i Budg poss 59

Boes

Bo 1 publi Fi piils 20

Bo 2 cisis o Good Lol t 22

Bo 3 how po t cilizio Woks 23

Bo 4 rod piig i Sigo 34

Bo 5 publi Fi piils o Dsigig Fisl tss 39

Bo 6 ts o publi-pi psis 44

Bo 7 clulig Dlom cgs 47

Bo 8 Imlmio o t Im Fiig 50

Bo 9 Ss o t Im Fiig 52

Bo 10 ciiz Iolm piio Budgig i poo alg 60

Bo 11 Muiil Fi d Mgm Iiii i G 67

Bo 12 Illusio o t-F Bod 67


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abbReViatioNs aNd aCRoNYMs

CBD Central Business District

ERPS Electronic Road Pricing System

GDP Gross Domestic Product

IMF International Monetary Fund

IPSAS International Public Sector Accounting Standards

IU In-vehicle unit

GAAPs Generally Accepted Accounting Principles

MDGs Millennium Development Goals

OECD Organisation or Economic Co-operation and Development

PAYG Pay-as-you-go

P3s Public-Private Partnerships

IF ax Increment Financing

VA Value added tax


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Te global housingcrisis, especially inthe developing world,is getting worse bythe day making theright to adequateshelter a quest that is

becoming more andmore dicult to meet,despite the targets set

by the Millennium Development Goals.

Such is the rate o urbanization the inux opeople into towns and cities, and their naturalgrowth that the world has now reached apoint where or the rst time now, hal theglobal population lives in towns and cities.

By the year 2050, six billion people two-thirds o humanity will be living in townsand cities. And as urban centres grow, the locuso global poverty is moving into towns andcities, especially into the burgeoning inormalsettlements and slums, o the developing world.In the developing world, this is happening soast that slums are mushrooming in what istermed the urbanization o poverty.

Tis makes it imperative that we use everymeans at our disposal to ensure that we at UN-HABIA, and our partners, keep applyingourselves to arget 11 o the Goals to achievesignicant improvement in the lives o at least100 million slum dwellers, by 2020.

And or this, we need innovative governance,and local thinking and reporting i we areto bring hope to the urban poor. Equallyimportantly, we need to support our townsand cities, indeed our countries, to adopt pro-poor policies and strategies that will obviatethe need or urther slum creation.

It is against this background, that the HumanSettlements Financing ools and BestPractices series ocuses on the developmento know-how, knowledge and tools in humansettlements nancing, rom which MemberStates can learn in delivering afordablehousing to the poor.

Anna ibaijuka,Executive Director, UN-HABIA

Under-Secretary-General othe United Nations,

foReWoRd


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1

DeFInItIOn OF MUnIcIpaL FInanceanD OBjectIveS OF the GUIDe

defiNitioN of MuNiCipal fiNaNCe aNdobjeCtiVes of the Guide

CHAPTER 1

Interest in cities around the world is on the rise,in large part, because more and more peopleare living in cities in both developed and lessdeveloped countries. Te rapid increase in theurban population has put pressure on localgovernments to provide a range o servicesrom water and sewer inrastructure to socialservices and housing. o meet the risingdemands o urbanization, municipalities need

adequate revenue tools to pay or services andinrastructure.

DEFINITION OF MUNICIPAL FINANCE

Municipal nance is about the revenueand expenditure decisions o municipalgovernments. It covers the sources o revenuethat are used by municipal governments

taxes (property, income, sales, excise taxes),user ees, and intergovernmental transers.It includes ways o nancing inrastructurethrough the use o operating revenues andborrowing as well as charges on developers andpublic-private partnerships. Municipal nancealso addresses issues around expendituresat the local level and the accountability orexpenditure and revenue decisions, includingthe municipal budgetary process and nancial

management.

OBJECTIVES OF THE GUIDE

Te objective o this Guide to MunicipalFinance is to introduce government ocials,policy makers, proessional practitioners, civilsociety, and academics in UN member statesto the current issues in municipal nancein countries around the world. Te Guideemphasizes the important role that municipal

nance plays in local service delivery,particularly in the context o globalization,decentralization, and a ocus on sustainabledevelopment. It highlights some o the newtrends in nancing services that are beingused in diferent countries around the worldsuch as increased reliance on the privatesector to invest in inrastructure and services.Finally, an important objective o the Guideis to provide policy makers with some basic

economic tools and a ramework or analyzingpublic nance issues and evaluating diferent

ways o nancing both operating and capitalexpenditures at the local level.

Given the length o the Guide, it is notpossible to delve into all topics in depth andsome topics, such as the governance o citiesand metropolitan areas, are not included atall. It is also only possible to provide examples

o municipal nance techniques rom a ewselected countries. For this reason, reerencesare provided throughout the Guide or those

who seek more inormation on specic topicsor specic countries.


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GUIDe tOMuNiCipal fiNaNCe

OUTLINE OF THE GUIDE

Te Guide has eight chapters. Chapter 1 givesa denition o municipal nance and sets outthe objectives o the Guide. Chapter 2 providessome background on the state o municipalnance with reerence to expenditures andrevenues at the local level in a number ocountries around the world. Although itis dicult to nd global statistics on localgovernment revenues and expenditures,some inormation rom the IMF GovernmentFinance Statisticsgives an indication o the widevariation in local government expendituresand revenues around the world. Te chapter

also sets out the issues and challenges thatcities ace and some o the recent trends thatare emerging in municipal nance.

Chapter 3 provides the theoretical rameworkor discussing issues in municipal nanceby starting with a description o the role olocal government in the economy and thebenet model o public nance. Te benetmodel states that, as much as possible, localgovernment services should be paid or onthe basis o the benets received rom thoseservices. Te last part o the chapter sets outa series o public nance principles to designmunicipal nance tools.

Chapters 4 and 5 turn to ways localgovernments pay or services Chapter4 is concerned with nancing operatingexpenditures; Chapter 5 deals with nancingcapital investment. Chapter 4 provides an

extensive discussion o taxes property,income, payroll, consumption, and excisetaxes. Te ocus o this part o the chapter ison the property tax because o its widespreaduse around the world and its appropriatenessas a local government tax. From an eciencypoint o view, user ees are an importantsource o revenue or local governments andare discussed in Chapter 4.

Finally, because local governments in manycountries, particularly transition and developingeconomies, rely heavily on intergovernmentaltransers, Chapter 4 devotes a air bit o timeto issues around the rationale and design o

transers. Overall, the chapter stresses theimportance o local governments raising theirown revenues as much as possible to ensureecient service delivery and accountability tocitizens.

Chapter 5 looks at nancing capitalexpenditures. Local governments oten useoperating revenues or capital purposes and,in some countries, borrow to meet capital

requirements. More recent trends show somelocal governments turning to the private sectoror unds through charges on developers,public-private partnerships, and land valuecapture taxes such as tax increment nancingin the United States and land value incrementtaxes in parts o Latin America.

Chapter 6 turns to the expenditure side o thebudget and looks at municipal budgeting. It

emphasizes the importance o the municipalbudgetary process or accountability andhighlights the participatory budgeting processused in many Latin American countries.

Chapter 7 ocuses on municipal borrowingand access to the capital market. It stressesthe important role that borrowing can playin nancing capital expenditures at the locallevel while noting that municipal borrowingis restricted in many countries. It describesdiferent borrowing instruments and stressesthe importance o credit ratings or localgovernment borrowing.

Finally, chapter 8 provides a brie summary othe issues o municipal nance and how theyhave been addressed around the world. It alsoprovides some concluding comments on theimportant principles to ollow in municipalnance.


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MUnIcIpaL FInance ISSUeS,chaLLenGeS, anD trenDS

CHAPTER 2

MuNiCipal fiNaNCe issues,ChalleNGes, aNd tReNds

Local governments make expenditures on avariety o services including transportation,policing, re protection, water and sewers,garbage collection and disposal, housing,health, recreation and culture, education, andsocial expenditures. Tey und these servicesand the inrastructure associated with themrom a variety o sources. Tis chapter looksat the state o municipal nances in selected

countries and identies issues, challenges, andtrends.

STATE OF MUNICIPAL FINANCES

Comparative statistics on local governmentexpenditures and revenues around the worldare dicult to nd. ables 1 to 4 providesome inormation or selected countries rom

the IMF Government Finance Statistics, whichis the only source that provides a breakdowno local government nance inormation orboth developed and less developed countries.Te countries in these tables were chosen romthe countries in the IMF statistics becausethey were the only ones or which inormation

was available on a disaggregated basis orlocal government expenditures and revenues.For most o the countries in these tables, the

data are or 2006 but or some countries, theinormation is or earlier years. Te years otherthan 2006 are listed in the notes to the tables.

It is dicult to draw conclusions rom theinormation on expenditures in ables 1and 2. Tere appears to be wide variationin the expenditure responsibilities o localgovernments around the world. For example,education expenditures represent a largeproportion o expenditures at the local level inmost central and eastern European countriesin the tables but the proportion varies among

OECD countries. Expenditures on socialprotection account or a large proportion oexpenditures in Nordic countries but appear tobe less important in the other countries in thetables. Housing expenditures as a proportiono total local government expenditures are,on average, larger in central and easternEuropean countries than in other countries inthe tables.


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4


GeneraPbicSerices

P

bic

Or

der,

Sa

fety,

De

fense

Economic

Affairs

Tota

Eniron

menta

Protect

ion

Hosing&

commnity

amenities

Heath

Recreation,

c

treand

re

igion

Edcation

Socia

protection

Tota

ependitres.

Publicdebt

transactions

Total

Transport

Australia

1.6

24.4

2.6

21.5

26.7

9.5

13.7

1.2

15.7

0.4

5.8

100

Austria

0.5

16.9

2.1

n.a.

14.2

2.6

2.8

16.3

7.1

16.7

21.3

100

Canada

2.7

8.7

9.2

11.6

13.2

5.9

7.8

1.5

6.9

41.2

5.5

100

CzechRe

public

0.7

14.5

1.8

18.9

21.4

7.3

9.1

2.2

7.5

27.5

8.7

100

Denmark

0.5

6.1

0.3

2.8

4.7

0.9

0.4

20.4

2.7

12.9

51.5

100

Finland

0.6

14

2.1

4.1

6.1

0.7

0.4

28.4

4.6

20.5

23.3

100

France

1.4

19.2

2.8

n.a.

13.1

6.9

15.2

0.6

10.2

16.2

15.8

100

Germany

3.2

17.4

5.4

n.a.

13.5

6.8

7.7

2.3

n.a.

7.2

39.7

100

Hungary

0.5

19.3

1.2

n.a.

5.7

3.9

6.9

15.4

4.8

29.9

12.8

100

Iceland

3.1

10

0.9

11

11.7

2.4

4.5

0.8

17.3

37.2

15

100

Ireland

0.9

11.4

3.2

n.a.

23.8

8.7

22.7

0

4.1

20.7

5.4

100

Italy

1.6

14.6

1.5

n.a.

14.8

4.6

4.7

43.9

3

8.3

4.5

100

Luxembourg

1.3

20.9

1.7

n.a.

15.9

12.1

7.6

0.3

13.1

24.6

3.9

100

NewZ

ealand

2.9

18.3

0.5

29.7

35

21.3

7.3

0

12.1

0

5.5

100

Norway

2.7

10.7

1

4.9

6.5

3.6

4.2

15.2

4.8

28.4

25.6

100

Poland

0.8

9.4

1.8

13

14.8

4

5.6

15.3

5.2

29.6

14.2

100

SlovakRe

public

0.7

17.5

1

11.3

15.9

6.2

9.9

0.3

7.1

35.4

6.6

100

Spain

1.3

33.4

7.8

9.8

14.5

10

9.6

1.2

10.9

4.5

8.1

100

Switzerland

3.3

14.3

5.2

7.3

8.7

5.3

2.5

20.5

5.6

21.7

16.2

100

taBLe1

:DISTRIBuTIONOFMuNIC

IPAlExPENDITuRES,SElEC

TEDOECDCOuNTRIES,20

06(%)

Notes:Sub-categoriesogeneralpublicservicesincludepublicdebttransactionsandgeneraltransersbetweenlevelsogovernment.Sub-categoriesoeconomicaairsinclude

agriculture,

orestry,shing,andhunting;uelandenergy;minin

g,manuacturingandconstruction;transport;andcommunications.Sub-categorie

sohealthincludeoutpatientservices,ho

spitalservices,and

publichealthservices.Publicdebttransactionsinclud

einterestpaymentsandoutlaysorunderwritingandfoatinggovernmentloans.Sub-categoriesoeducationincludepre-primaryandprimary

education;secondaryeducation;andtertiaryeducation.

InormationorCanada,CzechRepublic,Denmark,N

ewZealand,Norway,andSlovakRepublicarepreliminaryestimatesor2006.InormationorFrance,Hungary,Ireland,Italy,

andSwitzerlandare

or2005.InormationorFinlandandSpainarepreliminaryestimatesor2005.

Source:In

ternationalMonetaryFund,GovernmentFinanceStatistics,Yearbook,20

07,Table7andIMFStatisticsDepart

ment,GovernmentFinanceStatistics

Manual,2001.


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GeneraPbic

Serices

PbicO

rder,

Safety,D

efense

EconomicAffairs

Enironmenta

Protection

Hosing&

commnity

amenities

Heath

R

ecreation,

c

treand

r

eigion

Edcation

Socia

protection

Tota

ependitres.

Pbicdebt

transactions

Tota

Transport

Tota

Centra

andEasternErope:

Belarus

0.2

7.1

2

5.2

13.3

0

16.8

21.3

5.1

28.5

5.9

100

Bulgaria

0.3

11.5

3.1

9.5

12.1

-6.7

26.3

4.7

5.3

35.7

8

100

Croatia

0.5

16.8

2.6

9.8

13.4

3.5

18.6

4.6

13.2

20.1

7.2

100

Georgia

0.6

9.2

2.1

0.1

-0.3

0

59.7

2.7

8.9

8.7

9

100

Kazakhstan

0.1

16.6

3.9

7.7

12.9

0.4

13.5

18.6

4.4

26

3.8

100

Kyrgyz

Republic

0

13.3

1.9

0.6

1.7

0

10.6

5.2

4.3

58.4

4.7

100

Latvia

0.8

13.5

1.4

7.5

8.1

n.a.

14.6

2.8

7.8

44.1

7.8

100

Lithuania

0.2

5

0.7

1.8

7.1

2.3

5.9

21.9

5.4

40.5

11.2

100

Moldova

0.5

12.7

3.1

2.8

9.6

0

17.7

1.7

5.1

45.9

4.1

100

Romania

0.4

10.7

1

14.6

16.7

2.8

18.9

0.7

5.6

30.9

12.8

100

RussianF

ed.

0.4

10.7

1.7

2.7

3.4

0.2

19

14.1

4.2

38

8.7

100

Slovenia

0.1

9.5

1.4

8.4

13.2

4.5

5.1

11.8

8

42.5

4

100

Ukraine

0.4

9.9

0.2

4

10.6

0.6

10.3

20.9

4

28.7

14.9

100

Asia,AfricaandlatinAmerica:

China,

PR

0.1

21.3

6.0

1.3

39.7

4.4

0.4

3.4

1.6

12.4

10.8

100

Kenya

0.2

32.7

0.0

9.4

45.6

0.0

6.3

6.6

0.0

6.7

2.1

100

Mauritius

0.2

30.9

0

22.4

30.2

0

17.7

1.7

5.1

45.9

10.2

100

SouthAfr

ica

0

4.9

0.7

4.5

7.1

0.5

3.1

20.8

0.9

34.9

27

100

Uganda

0

24.4

0.8

n.a.

10.8

0.4

3.2

14.1

0.3

44.6

1.3

100

Bolivia

2.1

12.9

1

14.5

21.5

7.3

20.4

11.5

6.9

16.3

2.1

100

taBLe2


IPAlExPENDITuRES,SElEC

TEDCOuNTRIESINCENTR

AlANDEASTERNEuROPE,ASIA,

AFRICA

,ANDlATINAMERICA,2006(%)

NotesandSources:SeeTable1.Also,inorma

tionorUgandaispreliminaryor20

06.InormationorRomania,China,

andKenyaisor2005.Inormationor

SouthAricaisor2004.


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6


Taes

Socia

contribtions

Grants

Oth

er

reene

Tota

reenes

Individual

income

Corporate

income

Payroll

Property

Goodsand

services

Excise

Other

Totaltaxes

Australia

0

0

0

38.6

0

0

0

38.6

0

13.5

47.9

100

Austria

14.6

3.7

10.3

5.5

1

2.1

4.4

4.8

55.3

4.6

13.9

26.2

100

Canada

0

0

0

37.8

0

0

2.1

39.9

0

41.8

18.3

100

CzechRe

public

13.2

13.5

0

1.4

1

8.8

0

1.3

48.2

0

39.9

11.9

100

Denmark

46.4

1.1

0

3.4

0

0

0

50.9

1.6

39.1

8.4

100

Finland

40.8

3.8

0

2.4

0

0

0

47.1

0.1

28.6

24.2

100

France

0

0

3.1

33.7

0

3.7

4.1

44.6

0.2

29.1

26.1

100

Germany

15.8

0.2

0

5.4

1.8

0

18.8

42

1.3

33.8

23

100

Hungary

15.8

0

0

4.5

1

3.1

0

2

35.5

0.2

48.4

15.9

100

Iceland

53.1

0

0

10.5

0

0

9.4

72.9

0

8.8

18.3

100

Ireland

0

0

0

9.4

0

0

0

9.4

3.5

59.6

27.6

100

Italy

7.9

0.7

0

5.7

2.2

2.7

25.3

44.5

0.6

43.4

11.5

100

Luxembourg

0

28.6

0

2.2

0

0

0.7

31.4

0.2

46.6

21.7

100

NewZ

ealand

0

0

0

54.5

0

0.5

0

55

0

11.2

33.8

100

Norway

40.1

0

0

4.1

0

0

0.9

45.1

0

36.1

18.8

100

Poland

14.7

4.3

0

9.4

0

0

3.9

32.5

0

50.6

16.9

100

SlovakRe

public

38.5

0

0

6.4

0

0

6.8

51.8

0.6

35.1

12.6

100

Spain

7.5

2.3

0

16

1

3.3

3.1

10

52.2

0.5

34.5

12.8

100

Switzerland

33.8

5.2

0

7.1

0

0

0.1

46.3

0

16.3

37.4

100

taBLe3


IPAlREvENuES,SElECTED

OECDCOuNTRIES,2006(%

)

Notes:Socialcontributionsareactualorimputedreceiptsromeitheremployersonbehalo

theiremployeesorromemployees,sel-e

mployed,ornon-employedpersonsontheirownbehalthat

secureentitlementtosocialbenetsorthecontribu

tors,theirdependents,ortheirsurvivors.Thecontributionsmaybecompulsoryorvoluntary.Grantsarenoncompulsorytransersreceivedby

governmentunitsromothergovernmentunitsorin

ternationalorganizations.Grantsmaybe

classiedascapitalorcurrentandcanbe

receivedincashorinkind.

InormationorCanada,CzechRepublic,Denmark,F

inland,Ireland,NewZealand,Norway,andSlovakRepublicarepreliminaryor2006

.InormationorSpainisor2004ando

rSwitzerland2005.

Source:In

ternationalMonetaryFund,GovernmentFinanceStatistics,Yearbook,20

07,Table1andIMFStatisticsDepart

ment,GovernmentFinanceStatistics

Manual,2001.


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7


Taes

Socia

contribtions

Grants

Oth

er

reene

Tota

reenes

Individual

income

Corporate

income

Payroll

Property

Goodsand

services

Excise

Other

Totaltaxes

Centra

andEasternErope:

Blus

17.9

10.5

0

9.2

21.4

1.1

7.2

67.3

0

30.2

2.5

100

Bulgi

0

0

0

20.1

0

0

0.1

20.3

0

69.9

9.9

100

coi

39.5

15.5

0

3.5

0.4

0

2.3

61.2

0

12.3

26.5

100

Gogi

50

2.1

0

11.1

0

0

3.7

66.9

0

28

5

100

Kzkhs

17.2

0

24.6

5.9

0

3.3

5.3

56.3

0

43

0.6

100

Kygyzr

ubli

9.2

7.5

0

7.8

11.1

2.4

1.7

39.8

0

45.8

14.4

100

Lvi

48.4

0

0

6.5

0

0

0.8

55.6

0

31.3

13.1

100

Lihui

30.2

0

0

4.1

0

0

0.9

35.3

0

57.9

6.8

100

Moldov

23.4

13.8

0

4.9

0.8

0.1

4.9

47.9

0

45.2

6.9

100

romi

38.6

0.2

0

7.8

31.4

0

3.7

81.7

0

8.4

10

100

russi

Fdio

19.2

4.2

0

3.6

0

0

3.7

30.7

0

58.2

11.1

100

Slovi

24

0

0

7.2

0

0

2.8

34.1

0

47.5

18.5

100

Uki

32.9

1.4

0.2

2.3

0

0.1

5

41.8

0

47.9

10.3

100

Asia,AfricaandlatinAmerica:

chi,p

r

2

5

0

2.4

18.4

0

2.2

30

13.3

28.9

27.9

100

Ky

0

0

0

15.6

0

0

5.9

21.4

0

32.8

45.8

100

Muiiu

s

0

0

0

11.9

0

0

13.9

25.8

0

67.1

7.2

100

Souha

fi

0

0

0

16.8

0

0

2.8

19.7

0

24.9

55.4

100

Ugd

1.2

0

0

2.8

0

0

0.9

4.9

0

91.3

3.8

100

Bolivi

0

8.2

0

18.6

18

24.5

3.1

72.3

0

17.6

10

100

NotesandSources:SeeTable3.InormationorSouthAricaandUgandaarepreliminaryor2006.

InormationorChinaandKenyaisor2005.InormationorRomaniaisor2004.

taBLe4


IPAlREvENuES,SElECTED

COuNTRIESINCENTRAlA

NDEASTERNEuROPE,

ASIA,A

FRICA,ANDlATINAMERIC

A,2006(%)


17/90

8


ables 3 and 4 provide a breakdown o localgovernment revenues in selected countries. As

with expenditures, the dependence on variousrevenue sources is diferent rom country tocountry. Property taxes, or example, are levied

by local governments in all o the countries inthe tables but only provide a signicant sourceo local revenue in Australia, Canada, NewZealand, and France. Property taxes are alsoan important source o revenue in the UnitedKingdom which is not included in these tables.Income taxes are more important at the localgovernment level in Nordic countries wheresocial expenditures are also signicant at thelocal level. For all local taxes, the extent to

which local governments have the autonomyto set their own taxes is not clear rom thesetables but, in many countries, local tax ratesetting does not exist or is limited.

Dependence on intergovernmental transers bylocal governments is widespread but the extento that dependence varies in the diferentcountries. For example, government transersare still the most signicant revenue source or

local governments in many countries but theyhave been decreasing in many North Americanand European jurisdictions. Finally, thecomponents o the other revenues categoryare not set out but likely include user ees,nes, and other miscellaneous local revenues.Tese revenues appear to be less signicantin central and eastern Europe than in othercountries.

One o the reasons or diferences inexpenditures and revenues at the local levelaround the world is that the importance o localgovernment overall varies. able 5 shows localgovernment expenditures both as a percentage

o Gross Domestic Product (GDP) and as apercentage o total government expenditures(including all levels o government) or mosto the countries in ables 1 to 4. able 5 showsthat local government expenditures accountor a signicant portion o GDP and ototal government expenditures in the Nordiccountries (especially in Denmark and Finlandand to a somewhat lesser extent in Norway andIceland). Local governments are also signicant

in some central European countries (such asKazakhstan and Ukraine) and in China. Localgovernments account or a very small portiono GDP and total expenditures in Australia

where the state governments perorm manylocal unctions. It is also very small in Kenya.


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9


loca goernmentependitres as % o GDP

loca goernment ependitresas % o tota goernmentependitres

Seected OECD Contries:

Astraia 2.4 6.7

ausi 7.9 15.9

cd 7.3 18.5

cz rubli 11.9 27

Dmk 32.9 62

Fild 19.7 39.3

F 11 20.4

Gm 7.3 15.6

hug 12.8 25.7

Ild 13.2 30

Ild 6.7 19.8

Il 15.4 32

Lumboug 5.4 12.5

nw Zld 4.1 10.8

now 13.1 30.7

pold 13.2 30.4

Slok rubli 6.8 18.2

Si 5.9 15.5

Swizld 9.9 25.9

Centra and Eastern Erope:

Blus .. ..

Bulgi 5.9 15

coi .. ..

Gogi 6.3 28

Kzks 10.6 40.4

Kgz rubli .. ..

Li 9.5 26.3

Liui 8.3 24.2

Moldo .. ..

romi 7.1 21

russi Fdio 6.3 19.8

Sloi 9 19

Uki 12.6 37.8

Asia, Arica and latin America:

ci, pr 13.7 74.6

K 0.06 1.3

Muiius .. ..

Sou ai 5.1 16.9

Ugd .. ..

Bolii 11.3 26.6

taBLe 5: lOCAl GOvERNMENT ExPENDITuRES AS A PERCENTAGE OF GDPAND TOTAl GOvERNMENT ExPENDITuRES

Source: United Cities and Local Governments, Local Governments in the World,Basic Facts on 82 Selected Countries, 2007 Edition prepared CGLU and DEXIA.


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10


ISSUES AND CHALLENGES

Te challenge or local governments is to keepcities economically viable by delivering a highlevel o services and, at the same time, keepingtaxes suciently low so as not to discourageindividuals and businesses rom locating intheir jurisdiction. Over the past two decades,local governments have aced a number o

issues and challenges that have put stress ontheir ability to meet this objective.

Rapid uRbaNizatioN

Te urban population has been increasingrapidly and is expected to continue to do soover the next 40 years. Te urban populationin the more developed regions o the worldis projected to reach 1.07 billion (or 86percent o the total population) in 2050; theurban population in less developed regions isprojected to increase to 5.3 billion people (or67 percent o the total population) in 2050(United Nations, 2008a). Overall, the urbanpopulation is expected to be 70 percent o the

world population in 2050.

able 6 shows the urban population by majorarea or selected years rom 1950 and theaverage annual rate o change. able 7 showsthe percentage urban population by majorareas or selected periods rom 1950 to 2050and the rate o urbanization. Tese tablesshow that, historically, the process o rapidurbanization occurred in the more developed

countries. Over the next 40 years, however,the level o urbanization is expected to increasein all major areas o the developing world. Inparticular, the urban population is expected totriple in Arica and double in Asia.

Ub poulio (millios) aul g o g (%)

1950 1975 2007 2025 2050 1950-975 1975-2007 2007-2025 2025-2050

ai 33 107 373 658 1,234 4.76 3.9 3.15 2.52

asi 237 574 1,645 2,440 3,486 3.54 3.29 2.19 1.43

euo 281 444 528 545 557 1.84 0.54 0.18 0.08

Li ami & cibb

69 198 448 575 683 4.21 2.55 1.38 0.69

no ami 110 180 275 337 401 1.98 1.33 1.11 0.7

Oi 8 15 24 30 37 2.6 1.44 1.17 0.89

Wold 738 1,518 3.293 4,585 6,398 2.89 2.42 1.84 1.33

taBLe 6: uRBAN POPulATION By MAjOR AREA, SElECTED PERIODS, 1950-2050

Source: United Nations, Department o Economic and Social Aairs, Population Division (2008) World UrbanizationProspects: The 2007 Revision, Executive Summary, New York: United Nations, p. 3 and 5.


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11


pg ub r o ubizio (%)

1950 1975 2007 2025 2050 1950-1975 1975-2007 2007-2025

2025-2050

ai 14.5 25.7 38.7 47.2 61.8 2.28 1.28 1.1 1.08asi 16.8 24 40.8 51.1 66.2 1.42 1.66 1.24 1.04

euo 51.2 65.7 72.2 76.2 83.8 1 0.29 0.3 0.38

Li ami& cibb

41.4 61.1 78.3 83.5 88.7 1.56 0.78 0.36 0.24

noami

63.9 73.8 81.3 85.7 90.2 0.58 0.3 0.29 0.2

Oi 62 71.5 70.5 71.9 76.4 0.57 -0.05 0.11 0.24

Wold 29.1 37.3 49.4 57.2 69.6 0.99 0.88 0.82 0.59

taBLe 7: PERCENTAGE uRBAN By MAjOR AREA, SElECTED PERIODS, 1950-2050

Source: United Nations, Department o Economic and Social Aairs, Population Division (2008) WorldUrbanization Prospects: The 2007 Revision, Executive Summary, New York: United Nations, pp. 4 and 5.

Te growth o the urban population hascreated and will continue to create seriouschallenges or municipal governments in bothdeveloped and less developed countries interms o air and water pollution, transportationgridlock, shortage o afordable housing,

inadequate waste collection, deterioratinginrastructure, mounting violence and crime,and income polarization. Local governmentsare required to provide transportation andcommunications networks, water and sewers,re and police protection, parks, recreationalacilities, cultural institutions, social services,social housing, and public health. Teseservices and inrastructure are, in many cases,already over-stretched and rapid population

growth, combined with limited undingor inrastructure, has put urther strainon local governments to maintain existingservices and meet uture demands. Te resultis an inrastructure decit that is large andgrowing.

ChalleNGes foR laRGeMetRopolitaN aReas

Not only is the world experiencing rapidurbanization but the number o mega-cities(cities with more than 10 million people) isalso on the rise. Whereas in 1950, there were

only two mega-cities (New York and okyo),there were 20 mega-cities in 2005 and thenumber is projected to increase to 22 by 2015.Developing countries will have 17 o the 22mega-cities in 2015 (United Nations, 2008a).

Large cities and metropolitan areas arediferent than smaller urban or ruralmunicipalities, in large part, because o thesize o their population, the high degree

o concentration o population, and thepresence o a heterogeneous population interms o social and economic circumstances(Freire, 2001). In many countries, large citiesalso serve as regional hubs or people romneighbouring communities who come to shopor to use public services that are not availablein their own communities (Slack, 2007a).For example, Rio de Janeiro is surroundedby heavily populated municipalities that

house most o the low income amilies in themetropolitan area.


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12


Te population outside o the city usesservices in the city that are not available inthe periphery with resulting impacts on waterpollution, trac, crowding o hospitals andpublic schools, and crime rates (Rezende,

1998).

From a municipal nance perspective,the unique characteristics o large citiesand metropolitan areas are reected in themagnitude and complexity o the expendituresthat local governments in those areas arerequired to make on municipal services. Tesecharacteristics are also reected in their abilityto pay or services. Generally, large cities and

metropolitan areas have greater scal capacitythan smaller municipalities and rural areas,both in terms o greater responsibility or localservices and greater ability to levy their owntaxes and collect their own revenues.

Rarely are large cities treated diferently,however, in terms o their taxing authority orthe intergovernmental transers they receive.One possible exception is the German structure,

which distinguishes among governments odiferent sizes giving broader responsibilities tocity-states (Berlin, Bremen, and Hamburg)and allowing other large municipalities toassume responsibilities o counties.

GlobalizatioN

Globalization is another challenge acingmunicipalities. o be globally competitive, cities

need to provide the supportive inrastructureto attract business and they need to providea wide range o services: transportation,

water, sewers, garbage collection and disposal,police and re protection, parks, recreationand culture, afordable housing, and socialassistance. Cities must also provide servicesto attract and retain highly trained humancapital.

Te knowledge workers who increasinglyhold the key to economic success are attractedby such quality o lie actors as diversity,tolerance, a lively arts scene, recreationalopportunities, high quality public schools,

strong neighbourhoods, and saety rom crime(Florida, 2002).

Globalization also afects the ability o localgovernments to raise revenues. Te taxationo non-residential properties, or example,is afected by the mobility o industries ina globalized environment. Businesses aremore mobile in this context and respondto diferential property taxes in diferent

locations (Kitchen and Slack, 1993). Localgovernments have to be aware o the impacto their tax policies on businesses. Cities alsohave to manage their nances responsibly toattract private investors and to access capitalmarkets (Serageldin et al., 2008).

MilleNNiuM deVelopMeNt Goals

In 2000, leaders rom 189 countries set out

a vision in the UN Millennium Declarationto eradicate poverty and increase the welareo the worlds poorest by 2015. o provide aramework to measure progress towards thisvision, they established eight goals, 18 targets,and 48 indicators. Te UN MillenniumDevelopment Goals (MDGs) include:eradicate extreme poverty and hunger; achieveuniversal primary education; promote genderequality and empower women; reduce child

mortality; improve maternal health; combatHIV/AIDS, malaria, and other diseases; ensureenvironmental sustainability; and develop aglobal partnership or development (UnitedNations, 2008).


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13


Te challenge o achieving these goalsis placing an increased burden on localgovernments, in particular, because they arethe level o government that is responsibleor delivering basic services such as water and

sanitation, housing, primary health care, andeducation. In order to deliver these services,local governments need adequate resources,local autonomy, and increased capacity (Dirie,2005: 4).

Costs of uRbaN spRaWl

Along with rapid urbanization, manymunicipalities ace the mounting costs o

urban sprawl which is generally characterizedby relatively low density, development thatexpands in an unlimited and non-contiguous(leaprog) way outward rom a solidly built-up core o a metropolitan area (CRP, 1998:6). Sprawl consumes exurban agriculturallands as well as environmentally sensitiveareas. Uncontrolled growth (or urban sprawl)threatens the sustainability o both localeconomies and the environment.

Sprawl is the result o land use policies andnancing decisions that have providedincentives or low-density developmentsoutside the urban core, such as over-investment in highways and road transportin North American cities and the lack ourban acilities in the peripheral areas in manyLatin American countries, or example (Stren,2001). Urban sprawl signicantly increases

the cost o services, in particular the cost oinrastructure: when neighbourhoods arespread out at low density, they require more

water, sewer pipes, power lines, and roads(OMeara, 2001: 346).

Te nancing tools used to pay or growth(or example, property taxes, user ees, anddevelopment charges) can provide incentivesor sprawl. I these nancing tools charge the

same amount or services in all developmentsregardless o the costs incurred, there is noincentive to locate near existing services wherethe costs would be lower (Slack, 2002).

iNadequate ReVeNues to MeetexpeNdituRe Needs

Te amount o unding available to localgovernments is an important determinant othe quantity and quality o services that they

will be able to provide. Where locally raisedrevenues are limited, urban governmentexpenditures sufer (Bahl and Linn, 1992).Over the last twenty years, a number ocountries have increased the powers andresponsibilities o local governments but theyhave not matched those responsibilities withrevenues at the local level: ew countriespermit local governments to levy taxescapable o yielding sucient revenue to meetexpanding local needs (Bird, 2000: 114).

In short, revenues at the municipal level havenot kept pace with the increased expenditurerequirements (Montgomery et al., 2003;OECD, 2006). Not only do local governmentsdepend heavily on intergovernmental transers,their own revenue sources are inadequate.In most countries, municipal own-sourcerevenues are generally based on property taxes

and user ees and not the more lucrative taxessuch as income, sales, and uel taxes. In manycountries, intergovernmental transers are notreliable.

Local governments in less developed countriesace even greater challenges when it comesto raising revenues (Dirie, 2005). First, thelocal government revenue base is oten weak,especially when compared to the revenue base

o the central government. Second, they haveew own-source revenues, lack incentives togenerate their own revenues, and do not usethe existing revenue potential rom thesesources. For example, property taxes aredicult to administer and collect (Bird andSlack, 2004). Tird, they oten have little orno control over the tax rates they can levy.Fourth, central government transers arenot stable and predictable and the design o

transers is oten not transparent.


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14


Fith, most municipalities in developingcountries are either not permitted to borrow ortheir borrowing is restricted by senior levels ogovernment. Each o these issues is discussedurther in the remainder o this Guide.

RECENT TRENDS IN MUNICIPALFINANCE

Recent trends in municipal nance result, inpart, rom the need to nd ways to pay or theexpenditures which local governments have tomake to meet local demands or services andinrastructure. In many cases, these trendsrelate to the nancing o capital expenditures.Tere are also some new trends in nancialmanagement to address the demands oraccountability and transparency at the locallevel.

fisCal deCeNtRalizatioN

An important trend in municipal nanceis scal decentralization which has meant

the transer o nancial responsibility romcentral governments to local governmentsorcing local governments to deliver and undan increasing number o services. Althoughmany industrialized countries have a longhistory o decentralization, it is much newerin less developed countries. Since the 1980s,as many as 75 countries have implementeddecentralization policies as a means o ensuringmore ecient public service delivery and

addressing poverty issues (Ingram and Hong,2007).

Figure 1 shows the role o local government inpublic debt, spending, and investments or 15

Western European countries in 2000. Localexpenditures as a percent o total governmentexpenditures range rom less than 5 percent inGreece to almost 60 percent in Denmark.

Local investments as a percent o total publicinvestments range rom approximately 20percent in Greece to over 70 percent in Italy.Local debt, on the other hand, is a muchsmaller percentage o total debt in most

countries when compared to expenditures andinvestment.

In many countries, decentralization has meantthat national and provincial/state governmentshave downloaded responsibilities onto localgovernments. In some cases, the downloadingis part o an overall scal decentralization

whereby the central or provincial/stategovernment passes budgetary authority to local

governments to make taxing and spendingdecisions. Te intention is to provide servicesin a more ecient and efective manner butoten the taxing authority is not part o thedecentralization process. In other cases,devolution has been a way or senior levels ogovernment to shit their debt burden ontomunicipalities by reducing their transers anddirecting responsibilities downward (Ebel andVaillancourt, 2001).

Te downloading o expenditureresponsibilities to local governments withoutadequate revenue sources (sometimes reerredto as ununded mandates) compromises theability o local governments to provide servicesand puts pressure on municipal nances.Regardless o the reasons or decentralizationor how much is decentralized to localgovernments, the revenues under their direct

control rarely match their expenditures (Bird,2001b). Te exceptions are a ew countries inwhich local governments have ew expenditureresponsibilities or in a ew countries (such asthe Nordic countries) where local governmentshave substantial access to large and elastictax bases such as the income tax (Bird andVaillancourt, 1998).


24/90

15


Uid

Kigdom

80%

70%

60%

50%

40%

30%

20%

10%

0%

Lol db s % o ol ubli db

Lol dius s % o ol ubli dius

Lol isms s % o ol ubli isms

ausi

Swd

Si

pougl

n

hlds

Lu

xmboug

Ily

Ild

Gmy

F

Fild

Dmk

Blgium

G

FIGUre 1: PuBlIC DEBT, SPENDING AND INvESTMENTS THE ROlE OF lOCAl GOvERNMENTS (2000)

Source: Dexia (2000) Local Finance in Eleven Countries o Central, Eastern and Baltic Europe (Paris) as reproducedin Swianiewicz, P. (ed.) (2004) Local Government Borrowing Risks and Reward, A Report on Central and EasternEurope, Budapest: Open Society Institute, p. 17.

eMphasis oN laNd aNd pRopeRtYtaxatioN

As already noted in the discussion o revenuesources in ables 3 and 4, almost all countriesaround the world rely, at least to some extent,on property taxes. Recently, many developingand transition countries have become moreinterested in land and property taxes (Birdand Slack, 2007). China, or example, hasbeen considering the role o land and propertytaxation in its rapidly growing urban areas(Bird, 2005).

Property tax is regarded as an important toolor raising revenue at the local level. Te tax is

also oten used to shape urban developmentpatterns and to oster rural land reorm. Somecountries, or example, are turning to landvalue capture taxes to pay or inrastructure(such as tax increment nancing in U.S.

jurisdictions and valorization contributionsin Latin American countries) and to capturerevenues rom increased land values arisingrom government actions that change landuses (or example, plusvalia or land value

increment taxes in Colombia).


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16


Land and property taxes thus have a role inproviding revenues and a role in afecting landuse (Slack, 2002). Property taxes are discussedmore ully in Chapter 4; land value capturetaxes are described in Chapter 5.

publiC-pRiVate paRtNeRships

In many countries, municipalities haveturned to the private sector to deliver andund public sector services through explicitpublic-private partnerships. Te rationale orprivate involvement in the delivery o localpublic services is to improve the eciencyand efectiveness o delivery. Municipalities

also turn to the private sector, in some cases,because they are not permitted to borrowon the capital market or are not willing toborrow. An enhanced role or the privatesector has been most evident in areas such astransportation, water supply, and solid wastemanagement.

A principal advantage o public-privatepartnerships is that they relieve municipalities

o the nancial responsibility or up-rontcapital costs (assonyi, 1997) and allowthem to build acilities without incurringmunicipal debt. Te operation o acilitiesand programs by private operators reducesmunicipal operating expenditures and mayenable additional revenue to be collected.Moreover, such operations permit the publicsector to draw on private sector expertise.Tere are risks associated with public-private

partnerships, however, and these are discussedurther in Chapter 5. Te details o how sucharrangements are structured and how therisks are shared will determine whether or notthey will be successul rom a public policyperspective.

aCCouNtabilitY iN budGetiNG

Democratic local governance has resultedin increased demands or accountabilityand transparency at the local level. In somecases, increased accountability has meantthat municipalities are making the efort toinclude the public in important decisionson how revenues are raised and how undsare spent. One example is participatorybudgeting, which began in Porto Alegre in1989 and has spread to other municipalitiesin Brazil and around the world. Bringingthe public into budgetary decisions ensuresthat residents are represented in the decision-making process and that municipal ocialsare held to account or budget decisions (bothin the previous year and in the coming year).It also increases transparency in the budgetaryprocess. Participatory budgeting is discussedin Chapter 6.

iMpRoVed fiNaNCial MaNaGeMeNt

Increased participation on the part o the

public, combined with limited resources atthe local level, has increased pressure on localgovernments or better municipal nancialmanagement. Te imbalance betweenexpenditures and revenues at the local levelmakes it critically important that cities spendthe resources they have as eciently andefectively as possible (Bird, 2001b).

Reorms to existing management practices and

the introduction o new nancial reportingtechniques have resulted in improvedaccounting methods and budgeting processes.One example is the use o perormance-basedbudgeting to evaluate how well resourcesare being used and the extent to whichthe municipality is meeting its objectives.Perormance indicators give some indicationo the outputs o local government services(or example, how satised is the public).

Perormance-based budgeting is discussedmore ully in Chapter 6 and Appendix 1.


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17

prIncIpLeS OF MUnIcIpaL FInance

CHAPTER 3

pRiNCiples of MuNiCipal fiNaNCe

Tis chapter provides the theoretical rameworkthat will be used to evaluate municipal nancialtools in subsequent chapters. It begins withthe appropriate role or local government inthe economy, then describes the benet modelo local government nance, and sets out someprinciples o municipal nance.

ROLE OF LOCAL GOVERNMENT IN THEECONOMY

In terms o economic theory, the major roleassigned to local governments is to providegoods and services within a particulargeographic area to residents who are willingto pay or them. Local governments shouldnot do stabilization policy because they donot have access to monetary policy tools and

because capital and labour ow reely acrosslocal jurisdictions. Tey should also notengage in redistribution because local efortsto address income disparities will likely resultin the movement o high-income groups tolow-tax areas and low-income groups to high-tax areas (Kneebone and McKenzie, 2003).

Although local governments do engage insome redistribution through the act o taxingand spending, redistribution should not be

the primary ocus o what they do (Bird andSlack, 1993).

According to the subsidiarity principle(Barnett, 1997), the ecient provision oservices requires that decision-making becarried out by the level o government thatis closest to the individual citizen. As long asthere are local diferences in tastes and costs,there are clear eciency gains rom deliveringservices at the local level. Tis principle goeson to say that expenditure responsibilities

should only be assigned to a higher level ogovernment i it can be demonstrated that itcan carry out the unction more ecientlythan the lower level. With ew exceptions (suchas national deence and services that involveincome redistribution), almost all publicservices should be provided at the local orregional level with local policy-makers makingdecisions about what services to provide, howmuch to provide, and who should pay orthem.


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18


MAJOR FUNCTIONS OF MUNICIPALGOVERNMENTS

Te unctions o municipal governments diferamong countries around the world but generally

include transportation services (includingroads and transit), environmental services(including water, sewerage, and solid wastecollection and disposal), protection (includingpolicing and re protection), recreation andculture, planning and development, economicdevelopment, social services, housing, andhealth. Municipal governments in somecountries also deliver primary and secondaryeducation; in some countries, education is

delivered by school boards or by the province/state level o government.

THE BENEFIT MODEL OF LOCALGOVERNMENT FINANCE

Given this role o local government to providegoods and services, the benets-receivedprinciple is the appropriate starting point ormunicipal nance (Bird, 1994). According to

the benet model o local government nance,local government services, wherever possible,should be paid or on the basis o the benetsreceived rom those services (Bird, 2001a).

Te extent to which municipalities will beable to apply the benets-received principle,however, depends on the nature andcharacteristics o the services they provide.Figure 2 and the discussion which ollows look

at diferent types o municipal services and theappropriate nancing tools.

ServIceS WIth prIvate GOOD

characterIStIcS

For services with private good characteristics(such as water, sewers, garbage collection anddisposal, transit, and recreation), user ees areappropriate to und at least some portion othe costs. In general, user ees are appropriate

where there is a clear relationship betweenthe ees charged and the benets received, thetaxpayer has the choice about the extent to

which he or she uses the service, it is possibleto collect the charge at a reasonable cost,and equity concerns can be addressed (orexample by lowering or waiving ees or low-income users). User ees can play an importantrole in municipal nance by ensuring thatgovernments do what people want and are

willing to pay or.

Priate Pbic Redistribtie Spioers

WSws

Gbgtsi

poliFi

Lol ksS ligs

Soil ssisSoil ousig

rods/siculu

Soilssis

tssUs Fs po t Iom t

FIGUre 2: DIFFERENT FINANCING TOOlS FOR DIFFERENT SERvICES


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prIncIpLeS OF MUnIcIpaL FInance

ServIceS WIth pUBLIc GOOD

characterIStIcs

Services with public good characteristics(or example, police and re protection,neighbourhood parks, local streets, and street

lighting) have collective benets that areenjoyed by local residents but which cannoteasily be assigned to individual beneciaries.Tese services are more dicult to charge orand require some orm o local benet-basedtaxation such as the property tax. Te propertytax allows individuals to express their demandor services where benets are consumedcollectively. In this respect, the property taxcan be considered to be a generalized, or non-

specic, user charge (Kneebone and McKenzie,2003).

ServIceS WIth SpILLOverS

Tere are other services where the benets(or costs) spill over municipal boundaries but

where local provision is still desirable. Positivespillovers (externalities) occur i residents oneighbouring jurisdictions receive a service orree or at less than the cost o providing theservice. For example, major roads constructedin one jurisdiction may be used by residentso another jurisdiction without any charge tothem. Te result will be an under-allocationo resources to that service because themunicipality providing the service would baseits expenditure decisions only on the benetscaptured within its jurisdiction. It would nottake account o the benets to those outside the

jurisdiction. One way to provide an incentiveto the municipality to allocate more resourcesto the service generating the externality is atranser rom the provincial government.

ServIceS that reDIStrIBUte IncOMe

Services that redistribute income should bepaid or by senior levels o government becausethey have a wider range o taxes than localgovernments and they generally have taxes

that are more closely related to ability to pay,such as income taxes. Although the primaryrole o local governments is to provide goodsand services and not to redistribute income,however, many local governments do deliverservices that are redistributive in nature(such as welare assistance, health, and socialhousing). User ees and benet-based taxessuch as the property tax are not appropriateto und these services. User ees deeat the

purpose o redistribution and property taxesare more regressive than income taxes and thusare not appropriate or nancing redistributiveservices. For these reasons, services that have aredistributive component should be undedrom local income taxes or rom central andstate/provincial revenues (which includeincome taxes).

PUBLIC FINANCE PRINCIPLES

Following rom the benet model o localgovernment nance, there are a number oeconomics principles that can be used to designor evaluate municipal nance tools. Teseprinciples are set out in Box 1. Achieving allthese principles at the same time is dicult.For example, a tax system that is designed tobe equitable may not be simple to administer.

Local governments thus have to make choiceson which principles to apply based on theirpriorities.


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box 1: publiC fiNaNCe pRiNCiples

Economic eciencyis concerned with the allocation o resources to the production o goods and serviceswhere society gets the largest possible bundle o goods and services. Economic eciency is achievedwhen the user ee or tax per unit o output o the service received equals the extra cost o the last unit

consumed (the marginal cost). Te tax or ee indicates what consumers are willing to pay or the serviceand the marginal cost measures the cost o resources used up in producing that service.

Fairness (equity) based on benets-received is achieved when those who consume public services payor them, just as someone who benets rom a private good pays or it. Fairness based on ability to paysuggests that those with similar ability should pay similar amounts in taxes and user charges (horizontalequity) and those with diferent ability should pay diferent amounts (vertical equity).

Accountabilitymeans that taxes (charges) and expenditures should be designed in ways that are clear totaxpayers so that policymakers can be made accountable to the taxpayers or the services they deliver andthe costs they incur. Te more direct the relationship between the beneciaries o a government serviceand payment or that service and the less the complexity o the revenue system, the greater is the degree

o accountability.

Adequacy and Stabilityrequires that revenues provide governments with sucient unds to nanceservices on a regular and continuing basis. Revenues should be stable and predictable so thatmunicipalities can budget and plan or uture expenditures.

Autonomymeans that municipal governments have autonomy and exibility to set their own priorities.o do this, they should minimize their dependence on revenues rom other levels o government.

Ease and cost o administration means that the time and resources devoted to assess, collect, and accountor revenues should be minimized. Moreover, costs o compliance on the part o taxpayers should beminimized.


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caSe StUDy OF the BaanManKOnG (SecUre hOUSInG) prOGraM

CHAPTER 4

MuNiCipal ReVeNues

Tis chapter sets out the characteristics o agood local tax and then discusses a numbero taxes and user ees that have been or couldbe used by local governments. Because theproperty tax is levied by local governmentsin many countries, there is an extensivedescription and analysis o this tax. Techapter also devotes considerable time tointergovernmental transers because many

local governments rely to a great extent onthese transers.

SOURCES OF MUNICIPAL REVENUE

Te sources o revenue or municipalgovernments vary across countries butgenerally include taxes, user ees, andintergovernmental transers. Other revenues

may include investment income, propertysales, and licenses and permits, or example. Interms o taxes, the property tax is levied by localgovernments in many countries. Other localtaxes can include income taxes, general salestaxes, and selective sales taxes (or example,taxes on uel, liquor, tobacco, hotel occupancy,vehicle registration), and land transer taxes(or stamp duties). o meet capital expenditurerequirements, some municipalities charge

developers or growth-related capital costs. Insome countries, particularly in South America,a land value capture tax is sometimes levied topay or inrastructure.

able 8 illustrates the sources o municipalrevenue or our cities Cape own (South

Arica), oronto (Canada), Madrid (Spain),and Mumbai (India). As noted above, citiesgenerally rely on local taxes, intergovernmentaltransers, and user ees or local services butthe dependence on each varies across cities.

All our cities in able 8 levy a property tax;in Cape own and oronto, the property

tax is the only local tax.1 Mumbai levies anoctroi (a tax on the entry o goods into a localarea or consumption, use, or sale). Madridlevies a variety o local taxes (including a taxon land value, vehicles, construction, andbusiness). User charges (or service ees) arelevied by all our municipalities but are mostsignicant in Cape own where they are leviedor electricity, water, sewerage, and cleansing.Dependence on government grants also variesamong municipalities.

1 Starting in 2008, Toronto also levies a vehicle registration tax anda land transfer tax.


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Cape Town 2007-08 Toronto 2007 Madrid 2003 Mmbai 2007-08

% % % %

po ts 25.4 41.5 12 19

O ts 19 46

Sis cgs 40.9 21.8 16 23

Gom Gsd coibuios

25.2 20.9 39 4

O 8.5 15.8 14 8

Total 100 100 100 100

taBLe 8: SOuRCES OF MuNICIPAl OPERATING REvENuES FOR SElECTED CITIES

nos: Mdid is Muiili o Mdid d o commui o Mdid. O s i Mdid iluds o ils, ld lu, osuio, d busiss. O s i Mumbi ilud ooi ( o o goods io lol o osumio, us, o sl s b bolisd i mos s o Idi).Source: Cape Town Budget: (http://www.capetown.gov.za/en/Budget/Documents/Drat_Budget-March_2008/

Budget%202008%202009.pd); Toronto: Ontario Ministry o Municipal Aairs and Housing, Municipal FinancialReturns; Madrid: OECD Territorial Reviews: Madrid, Spain, 2007; Mumbai Budget (http://www.mcgm.gov.in/irj/portalapps/com.mcgm.aaboutus_budgets/docs/E13.pd)

box 2: ChaRaCteRistiCs of aGood loCal tax

Te tax base should be relatively1.immobile so that local governmentscan vary the tax rates without losing a

signicant portion o the tax base.Te tax yield should be adequate to2.meet local needs, increase over time asexpenditures increase, and be relativelystable and predictable.

Te tax should not be one that is easy to3.export to non-residents.

Te tax base should be visible to ensure4.accountability.

axpayers should perceive the tax to be5.

reasonably air.

Te tax should be relatively easy to6.administer.

Source: Bird (2001a)

CHARACTERISTICS OFA GOOD LOCAL TAX

Te characteristics o a good local tax, as setout by Bird (2001a) are listed in Box 2.

o achieve the ull range o desirablecharacteristics set out above would requirethat municipalities have access to a mix otaxes. Moreover, a mix o taxes would givemunicipalities more exibility to respond tolocal conditions such as changes in the economy,evolving demographics and expenditureneeds, changes in the political climate, andother actors. For example, property taxescan provide a stable and predictable source

o revenue but do not increase automaticallywith economic growth in the same way thatincome and sales taxes do.


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Whatever tax or taxes are chosen at thelocal level, local governments need to beable to set their own tax rates. Internationalexperience tells us that the most responsibleand accountable local governments are those

who raise their own revenues and set theirown tax rates (Bird, 2001a: 3). Unless localgovernments can alter the tax rates, they willnot achieve local autonomy or accountability.Moreover, local tax rate setting providespredictability or municipal governments andgives them the exibility to change rates inresponse to diferent circumstances.

TAXESTis section reviews property taxes, personalincome taxes, corporate income taxes, payrolltaxes, general consumption taxes, and excisetaxes.

pRopeRtY taxes

As was evident in ables 3 and 4, almost all

local governments worldwide rely, at leastto some extent, on property taxation. Teproperty tax is historically associated with localgovernment, in part because real property isimmovable, that is, it is unable to shit locationin response to the tax. Although a change inproperty tax may be capitalized into propertyvalues in a particular community (see Box 3or an explanation o how tax capitalization

works), and in the long run may afect where

people locate, these efects are o a smallermagnitude than those that would occur withincome and sales taxes at the local level.

box 3: hoW pRopeRtY taxCapitalizatioN WoRks

Property taxes are capitalized into the valueo a property i, other things being equal, a

higher property tax results in a lower propertyvalue. Because property owners pay propertytaxes each year, estimating the present value othe property tax payments is necessary.

Te present value o a uture ow is theamount that someone would pay today inexchange or receiving that ow in the uture.Te present value o US$1 to be received nextyear is 1/(1+i), where i is the discount rate (thereturn on an investment other than housing).Te present value o a dollar received in two

years is 1/(1+i)2

and so on. Te present valueo avoiding property taxes every year rom nowuntil the expected lietime o the house is 1/(1+i)n, which is closely approximated by 1/i.

As an example, consider two houses, A andB, identical except or the property taxes. Teannual property taxes on house A are $1,000higher than on house B. Suppose that thediscount rate is 5 percent. Te present value othe stream o uture property taxes would thusbe US$20,000 (1,000/.05) higher on house A

than on house B. Property taxes would be ullycapitalized i the market value o house A wereUS$20,000 less than house B. Anything lessthan US$20,000 would mean that the propertytaxes were only partially capitalized.


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Another reason why property taxes areappropriate as a source o revenue or localgovernments relates to the connectionbetween the types o services unded at thelocal level and the benet to property values.

Fischel (2000), or example, has argued thatthe property tax in the United States is likea benet tax because taxes approximate thebenets received rom local services. Underthese circumstances, the property tax promotesecient public decisions because taxpayers

will support those measures or which thebenets exceed the taxes. Both the benetsderived rom local services (or example, goodschools, access to roads and transit, and so

on) and the taxes are capitalized into propertyvalues. Because taxpayers are willing to paymore or better services and lower tax rates,this translates into higher property values.

O course, this analysis is based on a numbero assumptions such as that local propertytaxes do nance services that benet propertyvalues, that the incidence o such taxes is onlocal residents, that both tax rates and service

levels are decided by local residents, thatthose who wish to buy other combinationso services and tax rates are ree to move toother jurisdictions, that impelled by theirsensitivity to property values people willact rationally in response to such signals, andthat local governments do what voters wantthem to do. Te strength and validity omany o these links is obviously suspect in thecontext o many developing countries (Bird

and Slack, 2004). Moreover, this argumentbecomes particularly tenuous when it comes toexplaining the commonly ound phenomenono higher taxation on non-residential property(the over-taxation o non-residential propertyis discussed urther below).

A competing view sees the property tax as atax on capital. For example, Zodrow (2000)argues that the property tax in the UnitedStates results in distortions in the housingmarket and in local scal decisions. According

to this view, the property tax (based on marketvalue) discourages building and results inthe underutilization o land. Te amount ocapital per unit o land is less than what iseconomically ecient.

Both o these approaches have some validity.Te property tax is not purely a benets tax,because homeowners who improve theirhouses will ace higher taxes and will thereore

be discouraged rom doing so. At the sametime, the benets and costs o local programsare reected in local property values.

UnIqUe characterIStIcS OF theprOperty tax

Tere are at least our characteristics o theproperty tax that diferentiate it rom othertaxes. First, the property tax is a highly visibletax. Unlike the income tax, or example, the

property tax is not withheld at source. Rather,taxpayers generally have to pay it directly inperiodic lump-sum payments. Tis means thattaxpayers tend to be much more aware o theproperty taxes they pay. Te exception is wheremortgage institutions include property taxpayments with monthly mortgage payments.Te property tax also nances services thatare highly visible, such as roads, garbagecollection, and neighborhood parks. Visibility

enhances accountability but it restricts theability o local governments to raise or reormthan tax.


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Second, the base o the property tax doesnot increase automatically over time, becauseproperty values respond more slowly to annualchanges in economic activity than incomes.It is said to be an inelastic tax. Furthermore,

very ew jurisdictions update property valuesor taxation purposes on an annual basis. Tismeans that to maintain property tax revenuesin real terms or to raise property tax revenues,

jurisdictions have to increase the rate o thetax. As with visibility, inelasticity leads togreater accountability (taxing authoritieshave to increase the tax rate to increase taxrevenues), but it also leads to greater taxpayerresistance.

Tird, the property tax can be an importantinstrument o local autonomy to the extentthat it is only levied by local governments.o ensure local autonomy, however, tax ratesmust be set locally and not by a senior level ogovernment.

Fourth, the property tax commonly avorssingle-amily, owner-occupied, residential

properties over apartments and commercialand industrial properties in most jurisdictionsaround the world (Bird and Slack, 2004). Inmost transition economies, enterprises tendto pay higher property taxes than individuals(Malme and Youngman, 2000). Favorabletreatment o single-amily residential propertiesis achieved by deliberately under-assessingsingle-amily residential property comparedto apartments and commercial and industrial

property o comparable value; by legislatinglower tax rates on single-amily residentialproperty; and by providing property tax reliemeasures to residential property owners in theorm o tax credits, homeowner grants, or taxdeerrals. Tese measures are not generallyavailable to non-residential properties.

At the same time, this diferential treatmentdoes not necessarily reect the diferential useo services by diferent property types. Indeed,some observers have suggested that non-residential properties use ewer services than

residential properties, but pay more in taxes.For example, users o nonresidential propertyoten provide their own garbage collection,security, and re protection (Kitchen andSlack, 1993). Moreover, since businessestend to be more mobile than homeowners(in other words, they are more responsive totax changes), eciency arguments lead tothe conclusion that non-residential propertyshould be taxed more lightly than residential

property. For these reasons, some authors havesuggested that the non-residential property taxis not a good tax or local government and haverecommended that it be replaced by a businessvalue tax (Bird, 2001a).

MechanIcS OF the prOperty tax

Te property tax is levied on residential,commercial, and industrial properties. Severalsteps are involved in the process o taxing

real property: identiying the propertiesbeing taxed, preparing an assessment roll thatcontains a description o the property and theamount o assessment, setting the tax rate orseries o rates, issuing tax bills, respondingto assessment appeals, collecting taxes, andaddressing arrears. Tis section o the chapterocuses on property identication, assessment,tax rates, and tax collection. For inormationon the other steps in the process, see Dillinger(1992) and Bird and Slack (2004).


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pRopeRtY ideNtifiCatioN

Te rst step in levying a property tax is toidentiy ownership and assemble a completelist o properties. A scal cadastre requiresinormation on each property: a description,a denition o its boundaries (using cadastralmaps), a notation o ownership, and the valueo land and improvements. Establishing acomplete inventory o all properties andassigning a unique property identicationnumber to each parcel is necessary to permitthe tracking o all parcels. Property identiersalso allow or the linking o assessment, billing,and property transer records. Jurisdictionsmust report the inormation collected in aconsistent way and establish a process orupdating it on an annual basis (Slack, LaFaver,and Shpak 1998).

Te process o property identication is otenmore dicult in developing countries andtransition economies. Examples o some o thetypes o problems that have occurred includethe nonexistence o base maps or propertyidentication, the absence o data on property

ownership because o disputed ownership, theincomplete inormation on improvements,and the poor sharing o inormation onbuilding permits (Dillinger, 1992, Malmeand Youngman, 2000, and Bird and Slack,2004). Further problems include land andbuilding records being maintained separatelyby diferent agencies and not linked, taxrecords being identied by taxpayer and notby property, records being kept secret, andocial prices not being true indicators omarket value.

aSSeSSMent BaSe

Te base o the tax is the assessed value oreal property. Some properties in all countriesare exempt rom the property tax base.Exemptions may be based on ownership,

such as government-owned property; on theuse o the property, such as properties usedor charitable purposes; or on the basis o thecharacteristics o the owner or occupier; suchas age or disability (Youngman and Malme,1994). Exemptions erode the tax base and aredicult to remove.

wo general assessment methodologiesare used or property taxation: area-based

assessment and value-based assessment. Underan area-based assessment system, the tax

jurisdiction levies a charge per square metero land area, per square meter o building, orsome combination o the two. Where bothmeasures o area are included, the assessmento the property is the sum o an assessmentrate per square metre multiplied by the sizeo the land parcel and an assessment rate persquare metre multiplied by the size o the

building. A strict per unit assessment resultsin a tax liability that is directly related to thearea o the land and buildings. With unit valueassessment, the assessment rate per square ootis adjusted to reect location, quality o thestructure, or other actors. Market value hasan indirect inuence on the assessment basethrough the application o adjustment actors.For example, the assessment rate per squaremetre might be adjusted to reect the location

o the property within a particular zone inthe city. Even though the specic location othe property within the zone is not taken intoaccount, properties in diferent zones will havediferent values.


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Value-based assessments use market value(including site value assessment), rental value,and sel-assessment. Market value is denedas the price that would be struck between a

willing buyer and a willing seller in an arms-

length transaction. Market value assessmentestimates the value that the market places onindividual properties. Site value taxation is aspecial case o market value taxation where onlythe land portion o the property is taxed; theassessment base excludes any improvements tothe land.

Under the rental value (or annual value)approach, property is assessed according to

an estimate o rental value or net rent. Onerationale or using rental value is that taxes arepaid rom income (a ow) rather than rom

wealth (a stock), and thus taxing the net rentalvalue o real property is appropriate. In theory,however, no diference should exist between atax on market value and a tax on rental value -

when a property is put to its highest and best

use and this is expected to continue, rentalvalue will bear a predictable relationship tomarket value: the discounted net stream onet rental payments is approximately equal tomarket value.

Sel-assessments require property owners toplace an assessed value on their own property.In some countries, the taxing authority hasthe right to buy the property at the assessedvalue. A system where the taxing authoritycan buy the property will only be credible iit can and will buy property, but this right hasrarely been exercised, partly because o thepolitical impossibility o large-scale purchases

o residences.

able 9 summarizes the diferent bases andprovides examples o countries where they areused.

Ta base Denition Measre sed Eampes o contrieswhere sed

Mk lu pi would bsuk bw willigbu d sll i ms-lg sio

combl sls,did os, oiom mod

ausli, cd, Idosi,j, Uid Ss, Souai

Si lu pi would bsuk bw willigbu d sll i ms-lg sio

comblsls subigimoms lu omol o lu

jmi, K, nw Zld

rl lu vlu i u us n l iom F, Mooo, s oIdi

Ui lu Siz o o dusdo f loio, uli,o o os

Su ms o ldd buildig ,dusd

ami, cz rubli,Isl, pold, russi, Sloki

Sl-ssssm Sls i Dmid b ow oo

pu, tuk

tsiiol o midssms

combiio o dmk lu

Mk-id zoso ld o ld dbuildigs

esoi, Li

taBLe 9: BASE FOR PROPERTy TAxES

Source: Slack (2006a: 206) and updated


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Where it is possible to use market value, it isgenerally regarded as a better tax base (Slack,2006a). First, the benets rom services aremore closely reected in property valuesthan in the size o the property. For example,

properties close to transit systems or parks enjoyhigher property values. Second, market valuehas the advantage o capturing the amenities othe neighbourhood, amenities that have otenbeen created by government expendituresand policies. Under area-based assessment(particularly unit assessment), on the otherhand, two properties o identical size and agebut in diferent locations would pay the sametax even i one is located next to a park and

the other is adjacent to a actory. Tird, area-based assessment results in a relatively greaterburden on low-income taxpayers than high-income taxpayers when compared to value-based assessment because average householdincomes in high-value neighbourhoods arehigher than in low-value neighbourhoods.

A tax on area taxes all properties that are thesame size the same amount, whether they are inhigh-income or low-income neighbourhoods.

Similarly, older houses in a bad state o repairbut with a large oor area will pay relativelyhigh taxes. Furthermore, i a relatively poorneighbourhood becomes richer, there wouldbe no tax change. A tax system that ails totake account o changes in relative values overtime will result in inequities.

Many transition countries employ somevariant o area-based assessment. Unit value

assessment is easier to understand and cheaperto administer than value-based assessmentsparticularly where the real estate market is not

well developed. o some extent, this choiceno doubt reects the nature o the availableinormation on the physical area o buildingand land recorded in the old central planningrecords. Over time, however, as zones becomemore narrowly dened, it seems both likelyand desirable that these systems will evolve

into something closer to a market value system(Slack, LaFaver, and Shpak, 1998).

tax Rates

o determine the tax liability, the assessedvalue is multiplied by the tax rate. Inmost North American jurisdictions, localgovernments rst determine their expenditurerequirements and then subtract non-propertytax revenues available to them (or example,intergovernmental transers, user ees, andother revenues) rom their expenditurerequirements to determine how much theyneed to raise rom property tax revenues.Te resulting property tax requirements aredivided by the taxable assessment to determinethe property tax rate. By contrast, in manytransition and developing economies, thenational government sets the rates or propertytaxes.

Local governments may vary tax rates accordingto the services received. For example, in some

jurisdictions a general tax rate applies acrossthe city and a special area rate or additionalsurcharge applies in those parts o the city thatreceive services provided only to them, orexample, garbage collection, street lighting, or

transit. Special area rates, which are earmarkedor services in those locations, approximate abenet charge.

Local governments may also vary tax ratesby class o property, or example, residential,commercial, and industrial. Variable tax ratesby class o property may be justied on anumber o grounds. On the basis o airness

with respect to benets received, the benets

rom local public services may be diferentor diferent property classes. For example, asnoted earlier, non-residential properties mayuse ewer services than residential properties.

On eciency grounds, some have argued thatproperty taxes should be heavier on thosecomponents o the tax base that are least elasticin supply. Because business capital tends to bemore mobile than residential capital, eciency

arguments lead to the conclusion that businessproperty should be taxed more lightly thanresidential property.


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In reality, however, tax jurisdictions generallyapply lower rates to residential properties.On the basis that higher property taxes onbuildings tend to slow development and thatlower taxes speed up development, a municipal

policy to develop some neighborhoods insteado others would call or diferential taxes indiferent locations as well as or diferentproperty

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