Strasbourg, 23 September 2010                                                             CDLR(2010)30

Item 3.6 of the agenda

                                                                                                                         

EUROPEAN COMMITTEE ON LOCAL AND REGIONAL DEMOCRACY

(CDLR)

CENTRAL FUNDING OF NEW COMPETENCES

FOR LOCAL AUTHORITIES

For adoption

Secretariat Memorandum

prepared by the Directorate General of

Democracy and Political Affairs

Directorate of Democratic Institutions


This document is public. It will not be distributed at the meeting. Please bring this copy.

Ce document est public. Il ne sera pas distribué en réunion. Prière de vous munir de cet exemplaire.

Introduction

The LR-FS Committee has had two discussions of the draft set of guidelines on compensation for new competences for local and regional authorities prepared by the consultant expert, Mr Jørgen Lotz (Denmark). The first discussion took place at its meeting on 10-11 December 2009, the second at the meeting on 28-29 June 2010. LR-FS has now agreed on the present text.

Action required

The Committee is invited to approve the guidelines and to decide on any further action.

Draft guidelines for the funding by higher level authorities of new competences for local[1] authorities. 

Guideline 1. Compensation for new competences, the principle of accountability.

i.        When higher-level authorities make decisions on new local duties and powers, or create expectations that impose additional net costs on local authorities, the principle of accountability justifies that compensation be given to local authorities. In this document such cases are referred to as new competences.

ii.       The local government side should be consulted on estimates of the extent to which local authorities will use the new competences.

iii.      When new competences have been requested by local government, such competences represent a new pressure on local taxes, but some sharing of the new net costs could be justified by the principle of accountability. 

iv.      When higher-level decisions reduce the net costs for local authorities, the principle of accountability also justifies that the local savings be transferred to the higher level authority. Such negative compensation is even justified in cases where realisation of the savings depends on the initiative of local authorities. The degree to which the new possibilities for savings may be expected to be taken up should be the subject of consultations with the local government side. 

v.       Charging local authorities for services currently provided without charge should be compensated. Compensation should also be given for the local net costs when the higher level government introduces restraints on the level of fees charged by local authorities, or grants exemptions from such fees or charges to certain categories of persons.

Guideline 2. Regulation for over- or under-estimated costs.  

Subsequent reviews may reveal that net costs differ from the original cost estimates. Nonetheless, for administrative reasons rules should be introduced limiting the (type and number of) cases in which discussions on compensation may be re-opened.

Guideline 3. Compensation for transfer of functions.

i.         The economic effects of transfer of a competence from a higher level to local authorities not aiming to change the level of service to the user should be compensated. Compensation should be based on estimates of the expected net cost of the new competence. The cost of the transfer of staff, including  the estimated wages and working conditions, should be included. The cost of obligations resulting from acquired pension rights of staff transferred should also be included in the compensation.

  

ii.  The ownership of property of buildings, land and other assets necessary for continued delivery of the service, should be transferred. The debts associated to them in as far as they stem from the (reasonable) cost of purchase and/or improvement should also be transferred and the debt-servicing compensated for. If it is deemed (subject to consultation) that improvements are needed to meet applicable standards, the local authority should be compensated for the reasonable costs of improvement (see 3) but whether the improvement is financed by drawing on its cash reserves by or borrowing has no effect on the compensation.

Guideline 4. No compensation for general regulation. 

i.     Compensation is not required when the higher level reduces grants, caps on local tax rates, or shares of tax sharing revenues with the purpose of reducing spending by local authorities for macro policy reasons. But in such cases the purpose to reduce local spending should be made clear by the higher level authority, which should take political responsibility for it.

ii. Compensation is not required for changes in local net costs because of changes in general taxation or employment legislation with similar effects for the private sector as for the local authorities, unless theyhave a disproportionate effect on local authorities.

ii.     Changes in the distribution of grants to individual local authorities should not be compensated when there is no change to the amount being given as a whole. 

Guideline 5. The formalisation of the framework compensations.

The framework of the rules for compensation to local authorities should be formulated in such a way as to ensure that the higher level is committed to compensate local authorities fully and properly for the local net costs of the new competences. Preferably this commitment is provided for by law.

Guideline 6. Methods of compensation.

i.     Compensation may be given in the form of changes in other competences with an opposite, neutralising effect on local net costs.

ii.    Compensation will not be needed for services normally funded from user-charges.

iii.   In all cases pertaining to tax financed services compensation should be given in the form of grants.

iv.   Compensation by allowing local governments to raise new local taxes should be avoided as it blurs the responsibility and weakens accountability.

Draft guideline 7. Compensation preferably with general grants

i.     Compensation should preferably be made with general grants from the outset.

ii.    Earmarked grants should, as a general rule, not be used for compensation because they limit the freedom of the local authorities to act in the most cost-efficient way. Earmarked (matching) grants should be used only when

iii.   a) the new local competence is relatively costly, and

     b) the net costs are very unevenly distributed across local authorities, and

     c) no objective indicators that match the allocation of the costs well enough are available.

iv.  When earmarked grants are used it should be under the explicit condition that they will be replaced by general grants after a defined period of a few years. 

Guideline 8. Better responsibility at the higher level of government

i)     The principle of accountability could be broadened to apply at central government level. Any higher level ministry that introduces new local competences resulting in increases in local government net costs should finance the compensation from its budget, and if a ministry introduces changes in local competences that result in local net savings it should be rewarded by the transfer of the savings to its budget.

ii)    Where applicable, net costs imposed by new local competences emanating from Parliament should be compensated by the relevant lead ministry.

 

Guideline 9. Precedent effects

The original estimates of the net cost of a new competence may become inadequate because of subsequent decisions by courts, complaints boards or other independent bodies setting precedents. In such cases the additional cost should be compensated by the higher level authority.

Guideline 10. Responsibility for EU regulation

In EU and EEA member states compensation for new local competences introduced to implement EU rules and resulting in additional net costs for the local authorities should be paid by the higher level as if it were the level responsible for introducing the new competence. 

Guideline 11. Consultations with local government level

i.     Consultations with the local level should be held on all issues of allocation and size of compensation for new competences.

ii.    Consultations should be held as early as possible in the drafting phase of the new competence and the local representatives should be given reasonable time to consider fully the likely net costs. 

Guideline 12. Organisation of consultations

i    Consultations with the local level should preferably take place at set times during the year in a permanent structure with the participation of political representatives from both levels of government.

ii.   Consultations may be initiated between the lead ministry and the local side, but it is desirable that the local level has a possibility of recourse to the ministry responsible for overall issues of economy and accountability if agreement cannot be reached without its involvement.

iii.    Any proposal to Parliament on new competences for local authorities should be accompanied by information on whether agreement on compensation has been reached with the local government side.

iv.   It is recommended that a minimum amount is introduced as a threshold for the compensation of new competences.

Comments

General considerations

Comments  to par. 1. Compensation for new competences, the principle of accountability.

Ad i) Decisions made by higher levels of government may have consequences for and impose additional net costs on local government. To avoid that this results in unwanted pressure on local finances it is generally agreed that the principle of accountability should be followed which entails that those who take the decisions should also pay for them. Application of this principle makes it difficult for a higher level of government to take popular decisions on new government expenditure whilst leaving it to the local level of government pay for them and it reduces the pressure on local taxes. This is the prime argument for compensating local authorities for the net cost of new competences, or for loss of local revenues caused by decisions of higher level authorities.

New competences to be compensated for include decisions by the higher level authority to establish new duties for local governments because governments do not generally provide powers unless they expect them to be used and local authorities will come under pressure to make use of any new powers they have been given. Also cases where the central government creates expectations of new or better local services call for compensation. Finally a new burden can also arise from changes causing local authorities to lose income.

Ad ii) In the case of new powers or new expectations the amount of the net cost to be compensated will have to be based on estimates. Such estimates should be the subject of consultations with the local level.

Ad iii) In cases where new competences have been requested by local government, the principle of accountability could justify consultations on the sharing of the net costs between the local government side and the lead ministry, thus permitting some pressure on local taxation. 

Ad iv) Changes to the rules resulting in reduced local spending obligations, or opening ways of local savings not possible before the change, should give rise to reverse compensation from the local to the higher level. This is also the case where realisation of the savings requires initiative to be taken by local authorities, but in this case the net costs to be compensated should be subject of consultations between the levels.

Ad v) Charging local authorities for services currently provided without charge impose a net burden in the same way as a new competence and should be compensated. The same is the case for the local net costs where the higher level government introduces restraints on the fee levels on charges by local authorities, or introduces exemptions from such fees or charges for certain categories of persons.

Comments to par. 2. Regulation for over- or under-estimated costs.     

Subsequent reviews may reveal that net costs differ from the original cost estimates. In such cases the question arises whether the higher authorities should make good the local losses resulting from under-estimation and have the right to recoup benefits resulting from over-estimation. In order to avoid that the system of compensation becomes overburdened and considering that the annual number of new compensations may be substantial, subsequent regulation should for administrative reasons be limited, for instance being allowed only in those cases where substantial amounts are at stake and cases where subsequent regulation has been explicitly foreseen. In the latter such cases the uncertainty should be clearly circumscribed (i.e. does it pertain to the number of users or the the cost per unit) at the time of deciding the initial  compensation.

Comments to par. 3. Compensation for transfer of functions.

i)     The effects for net costs when competences are transferred from one level of government to another should be compensated. The calculation of the amount of the net costs raises some particular questions. Regarding the staff transferred to a new authority the compensation should include the wages to be paid by the new authority, any agreements on future working conditions, and the costs resulting from acquired pension rights.

ii)  The ownership of property of buildings, land and other assets necessary for continued delivery of the service, should be transferred. The debts associated to them in as far as they stem from the (reasonable) cost of purchase and/or improvement should also be transferred and the the debt-servicing compensated for. If it is deemed (subject to consultation) that improvements are needed to meet applicable standards, the local authority should be compensated for the reasonable costs of improvement (see 3) but whether the improvement is financed by drawing on its cash reserves by or borrowing has no effect on the compensation.

Comments to par. 4. No compensation for general regulation.     

i)      Changes in general grants are in some cases introduced for reasons of macro economic control with the intention that local governments reduce spending. In such cases no compensation should be given, but to clarify that this is not a case of accountability the higher level should make it clear that the purpose of the cut is to reduce local spending.

ii)    This also applies to changes in general taxation with similar effects for the private sector as for the local government (such as increases in social security charges), or of general employment legislation (such as a change in minimum wages). Compensation is called for in  these cases only when they have a disproportionate effect on local authorities.

iii)   Changes in the grants for individual authorities without changes in the overall amount of grants, as is the case with reforms of the equalisation system, cannot justify compensation.

Comments to par. 5. The formalisation of the framework for compensation.

There are several ways to formalise compensation procedures such as constitutional or legal requirements, cooperation agreements, government and/or parliamentary rules, or commitments based on good practice. Decisive for the choice of method is how well it discourages the higher level from making changes to local net costs without compensation. Different methods may serve this purpose in different ways and to different degrees. One such method is that estimates for net local costs are signed off by the top official of the lead ministry. Publication of the rules is another way to discourage deviations. The most clear-cut way for the higher level to be committed to the practice of compensation is for the principles of compensation for local government to be laid down by law or in the constitution.

Comments to par. 6. Methods of compensation.

i)      Compensation can be given by introduction of other changes in local competences with opposite, neutralising effects.

ii)    For services which are paid for from user-charges, the issue of compensation does not arise.

iii)   In other cases compensation should be paid in the form of grants. Grants financing has been shown to be the usual way of compensation in member countries (CDLR, 2008).

iv)   Ultimate responsibility for changes would be blurred and accountability weakened if compensation took the form of allowing local authorities to raise new taxes.

Comments to par. 7. Compensation preferably with general grants

Where compensation is to be paid with grants, decisions have to be made as to what kind of grants to use.

i)     As a rule, compensation, when made by grants, should be made through the adjustment of general grants. The experience of several member countries has demonstrated that in the long run those local authorities facing a loss in one case of compensation are likely to win in another.

ii)    Compensation through earmarked grants should be avoided. To use earmarked grants would not be in keeping with the provisions of the European Charter of Local Self-Government[2] (except for investment grants).

iii)   Nonetheless, the CDLR 2008 report[3] suggests that most countries use earmarked matching grants because such grants best allocate compensation to those local authorities where the extra net cost for the new competence is highest. The use of general grants often fails because it is difficult to identify objective indicators that allocate the grant to those authorities with the extra net costs. It may therefore be difficult to avoid entirely the use of earmarked grants for compensation, but their use should be restricted to cases where the following three conditions are met: the new local competence is relatively costly, the net costs are very unevenly distributed across local authorities, and no objective indicators are available to ensure the allocation of the costs well enough through general grants.

iv)   The use of such earmarked grants should be for a limited period only which is to be specified from the outset, after which they are replaced by adjusted general grants.

Comments to par. 8. Better responsibility at the higher level government

Introduction of a system of compensation for new competences as described in paragraph 1 will improve the accountability of local councils as they can no longer blame the higher level for any excessive levels of taxation they might seek to introduce. But improved internal discipline may also improve the accountability of the higher level.

i)     In order to further such internal discipline at the higher level, member countries could introduce budget rules obliging the lead ministry, when making decisions that impose net costs for local authorities, to finance the compensation out of its own budget. And when the lead ministry makes decisions that result in local government net savings such decisions should be rewarded with corresponding increases of the budget of the lead ministry. Several member countries have already introduced such rules though their practicability and design depend on the budget system applied at the higher level.

ii)    Though not directly called for by accountability concerns, net costs imposed by new local competences emanating from Parliament should, where applicable, be compensated by the relevant lead ministry closest to the decision. These cases would, if no compensation were to be given, result in unwanted pressures on local taxation.

Comments to par. 9. Precedent effects

Court decisions – for instance by constitutional courts - that set a precedent can be seen as the expression of a better understanding of the obligations of local authorities. They may be seen as clarifications of existing rules that the higher level previously was not aware of and hence had not taken into account when calculating the original compensation. Such a correction should be compensated as if it were a new local competence. The higher level may also have created other independent bodies whose decisions set precedents. Decisions of such bodies, being the creatures of the higher level, should also be compensated for. 

Comments to par. 10.  Responsibility for EU regulation

In member States that are also members of the EU and EEA much national legislation and regulation concerns the implementation of EU regulations and directives that may result in an increase in local costs. In such cases it is difficult to use arguments of accountability to decide whether compensation should be paid. The higher level may have had only limited influence on the EU rules, but local authorities usually have had even less. The EU is not subject to any obligation to compensate for the costs of the national implementation of EU decisions, and EU regulation presents an accountability problem without clear answers. But since such new competences would result in pressure on local taxes, compensation by the higher level is called for also in these cases.

Comments to par. 11: Consultations with the local government level.

The calculation of the additional net costs from a change in local competences does not always follow directly from the formulation of the new competence. Often some clarification is needed. The following box gives some examples of where clarification and estimations are needed.

Examples of cases where clarification of new competences is needed.

·         Public statements by the higher levels, which are not binding but get media attention, saying that the local service level is unacceptable. On the one hand, this may result in pressure on local taxes that local authorities cannot easily resist. Local costs following directly from such spending pressures should be compensated, thus having a preventive effect on ministers at the higher level making such declarations. On the other hand, the right of higher level political bodies to initiate political debate must be accepted without having to consider compensation. The decision on whether compensation is called for or not depends on the interpretation of the specific case (par.1.i)

·         The question of extent to which new powers will be used needs to be estimated (par.1.ii).

·        “The costs for necessary improvements of the standard of buildings should be considered for possible compensation.” Here the question of what is “necessary” needs clarification (par.3,ii).

·         A further question of clarification is whether new decisions (e.g. by a Court) are only clarifications of existing competences that have already been compensated, or are new competences and result in new costs for local governments qualifying for additional compensation (par.9).


When a clarification (estimate) of the amount of the net cost for local government is needed it should be calculated in consultation with the local level.

But also in cases where there is limited room for estimations and clarifications, consultation between the levels of government has advantages. Decisions are better understood and accepted when the local level is heard and consultations may improve local implementation. Consultations on the size and allocation of compensation may also result in better legislation because it improves the knowledge at the higher level of the factual circumstances. Consultations are therefore recommended as a general rule for all cases of compensation. 

Consultations need to take place as early as possible in the drafting phase, but the timing also needs to take into account that the preparation of new legislation or regulation sometimes requires confidentiality during negotiations in Parliament.

Comments to par. 12. Organisation of consultations

i)     There is a wide variety between countries in the organisation of consultations between the centre and the local government(CDLR, 2008). But they frequently include a permanent political body representing both sides, often served by a technical joint committee to prepare the cases.

ii)    The organisation of consultations should include some level of mediation if agreement is difficult to reach. It is recommended that the consultations are initiated by the lead ministry, but that recourse can be had to the ministry responsible for overall expenditure policy. However, final responsibility should always be with Parliament.

iii)   All proposals for new legislation presented to Parliament should include information on whether agreement has been reached with the local government side on the amount and distribution of compensation so as to give members of Parliament a chance to ask for more information before deciding on proposal.

iv)   Decisions on how best to organise consultations need to take the administrative costs of different ways of organisation into account; the setting of a minimum threshold for compensation of new competences is recommended for administrative reasons.

References:

-          CCRE/CEMR. ”Consultation procedures within European States” Undated.

-          Council of Europe (1985): European Charter of Local Self-Government. ETS 122 – Local Self-Government. Strasbourg 15.X.1985.

-          Council of Europe (2004): Recommendation Rec(2004)1 of the Committee of Ministers to member States on financial and budgetary management at local and regional levels.

-          Council of Europe (2005): Recommendation Rec(2005)1 of the Committee of Ministers to member States on the financial resources of local and regional authorities.

-          CDLR European Practice Report on member States’ Practices for the Funding of New Competences of Local Authorities. CDLR(2008)48.


[1] In this document the term ”local” will be used for all sub-national levels of government including municipalities and regions.

[2] Article 9 paragraph 7 reads: “as far as possible, grants to local authorities shall not be earmarked for the financing of specific projects. The provision of grants shall not remove the basic freedom of local authorities to exercise policy discretion within their own jurisdiction”.

[3] CDLR (2008)48, p.6.