Strasbourg, 27 November 2009                                                               LR-FS(2009)10

                                                                                                                         

EUROPEAN COMMITTEE ON LOCAL AND REGIONAL DEMOCRACY

(CDLR)

COMMITTEE OF EXPERTS ON LOCAL AND REGIONAL

FINANCE AND PUBLIC SERVICES

(LR-FS)

CENTRAL FUNDING OF NEW COMPETENCES FOR LOCAL AUTHORITIES

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

As agreed at the last meeting of the LR-FS Committee (6-7 April 2009), the second meeting could work on the first draft of a set of guidelines on compensation for new competences for local authorities. The idea for developing such guidelines arose from the iscussion of the report the LR-FS prepared for the CDLR on the evolution of local government resources. An initial draft for possible guidelines in the form of a discussion paper has been prepared by the consultant expert Jørgen Lotz (Denmark) and appears overleaf.

Action required

Members are invited to study the discussion paper contained in this document and to prepare for a discussion of the points it raises. Members are, of course, free also to raise other issues for discussion.

Following this discussion, the Committee is invited to decide whether to take forward the developments of guidelines along the lines suggested and, if so, to decide on the organisation of this work.

Discussion paper: Text proposals for recommendations for central funding

of new competences for local authorities 

Considering

• The Committee of Ministers[1] in 2005 have agreed on the following guidelines for the funding of local costs resulting from new central rules for local competences: “Higher-level authorities whose decisions impose additional costs on local and regional authorities should ensure that these costs are covered by new financial resources such as additional fiscal resources, evolving financial transfers or other fiscal means”.
• A recent report by the CDLR[2] reported that nearly all countries follow policies of funding local costs resulting from new competences.
• The CEMR[3] states that “consultation procedures have been established in the majority of European countries, but in very different contexts”. Also the CDLR study revealed a variety of designs for rules of compensation for new local competences.
• The CDLR study showed that the local governments in most case have own financial powers to finance the new competences. But compensation schemes serve to fulfil the generally approved principle that financial consequences should be borne by the same political unit as the one that make the expenditure decisions.
• It has been the experience of several countries that compensation to and consultations with local governments foster accountability at both levels, and results in better legislation and implementation. The following recommendations are based on best practice among the member states. 

I. Compensation for new competences

Discussion point 1

It need to be decided whether the recommendations can address also the relationship with regions, and the application for federal states needs to be clarified. 

For discussion 1. “Local authorities”

The following text uses the terms “local governments” or “local authorities” to include all levels of sub central government in federal as well as in unitary countries.

Discussion point 2

The principle that those who take the decisions have to pay for them is derived from the idea of accountability and is the prime argument for central funding of new competences for local authorities, or loss of local revenues, caused by changes in the binding rules introduced by the centre.

But accountability is not always a clear guide. The centre may initiate local spending pressures in non-binding ways that may or may not, from an accountability view, need to be compensated.

One example of cases that need closer consideration is when a minister uses new regulations. If this is done to change the interpretation of existing legislation on which the calculation of the original compensation was made, compensation is clearly called for. But if the new regulation is only a more exact interpretation of existing rules, no compensation is needed.

Another example type of mixed case that of non-binding, but publicly expressed, central complaints that the local service level is found to be unacceptable. On the one hand, this may result in spending pressures that local governments cannot easily resist. Local costs following directly from such spending pressures should, from an accountability point of view, be compensated. This will have a preventive effect on ministers in the centre making such declarations. On the other hand, the right of the centre to initiate political debate must be accepted without (immediately) having to consider compensation.

For discussion 2. Clear rules for compensation for new competences

Costs for local authorities, or loss of local revenues, caused by act of the central government should be compensated by the centre. If the centre causes the obligations of the local authorities to be reduced, or local revenues to be increased, a negative compensation of a corresponding magnitude is justified. Clear and explicit rules for compensation should be formulated so that all levels of government can take compensation into account in their budget planning.

Discussion point 3

Compensation should be paid for effects of introduction of new local competences, but compensation is also needed when functions are transferred from one level to another.

For discussion 3. Compensation for transfer of functions

The economic effects of transfer of functions between levels of government should be compensated. The compensation should be calculated as the costs saved by the level responsible before the change. The pension rights of the staff transferred should be included in the compensation. Buildings, land and other assets necessary for continued delivery of the service should, as a main rule, be transferred without compensation.

Discussion point 4

Also changes in the rules that open the way for local policies that were not possible before should be compensated. [Examples: Removal of central maximum limits on the number of pupils in each primary school class room. Or the introduction of ceilings for the number of pupils in the class rooms.].  

For discussion 4. Compensation also when local initiatives are needed

Negative compensation is also justified when the centre by regulation opens up for new ways for the local authorities to make savings, also if the realisation of the savings requires initiatives by the local authorities.

Discussion point 5

Changes in general grants are in some cases introduced for reasons of macro economic control. When this is the reason of a cut in grants, or of reductions in local revenues no compensation should be given. The same applies to changes in general taxation with similar effects for the private sector as for the local authorities. The local government sector needs to adjust to such changes like the private sector has to.

(Examples: The costs for local government from a change in the rate of the national VAT rate, or in the social security tax rate, do not justify compensation.)

For discussion 5. Compensation when macro policy has effect for local finances

The local authorities are not to be compensated for the effects of macro economic policies that aim at regulation of the national economy.

But local revenue effects of changes in tax sharing arrangements, or other tax measures aimed directly local government, should be compensated.  

 

II. Legal framework

Discussion point 6

There are several methods that may be adopted to formalise compensation procedures: 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 the method helps to discourage the centre from introducing changes in local competences without compensation. Different methods may serve this purpose in different ways and to different degree. The most clear-cut way for the centre to commit itself to the practice of compensation is for the principles of compensation for local government to be laid down by law.

For discussion 6. The legal framework

The rules for conditions for compensation to local governments should be formulated in such a way that the centre commits itself, preferably by law, to an obligation to compensate local authorities for new competences,.

III. The kind of compensation

Discussion point 7

In nearly all cases compensation is paid in the form of grants (CDLR (2008)). Some cases have been recorded where compensation takes the form of permission for local governments to raise new taxes, fees or charges.

Accountability requires that those who take decisions on spending policies should also be the ones facing the citizens when it comes to financing. When compensation is given through grants, the ultimate responsibility of financing is placed with the central government. But the ultimate responsibility may be blurred if compensation takes the form of allowing local authorities to raise new taxes or fees. Accountability will in such cases depend on whether the local authorities are able to convince citizens that the new tax or user charge is a creature of the central government. 

For discussion 7. Grants or own financing

Compensation should be made in the form of grants. The use of other means for compensation– like the introduction of new local taxes, or fees and user-charges - should be used only when the real responsibility for financing the new local competence is clear in the eyes of the citizens.

Discussion point 8

When compensation is given with grants it needs to be decided what kind of grants to use. In many cases earmarked matching grants are used[4].

However, the use of earmarking may not to be in conformity with the legal obligations agreed upon by the member governments in the “European Charter of Local Self-Government” (Council of Europe (1985)), on the design of grants.

The CDLR report suggests that earmarked matching grants are used because such grants are the best way to allocate the grant to those local authorities where the extra cost for the new competence is highest. This may be the case where it is difficult to identify objective indicators to allocate the general grants corresponding to the allocation of the costs. Some countries compensate with matching grants under the condition that they after a period are consolidated into the general grants. But other countries have been able to compensate, in better conformity with the guidelines, by using general grants. The experience of the latter countries demonstrates shows that it is difficult but not impossible to convince the local authorities that in the long run those who face a loss in one case will win in another.

For discussion 8. Compensation with earmarked or general grants

Compensation should preferably be made with general grants. Earmarked grants should, as a main rule, not be used for compensation because they limit the freedom of the local authorities to act in the most cost-efficient way and because they do not allow special local circumstances to play a role. Earmarked grants should be used only in cases where

·         the new local competence is relatively costly, and

·         the costs are very unevenly distributed across local authorities, and

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

When using earmarked grants it should be with the specific condition that the earmarked grants will be replaced with general grants after a defined period of a few years. 

IV. Internal accountability in the centre and internationally

Discussion point 9

Introduction of a system of compensation for new competences will improve the accountability of local councils. They will no longer be able to blame the centre for excessive levels of spending. It can also improve the accountability of the centre seen as a whole if there is good discipline internally in the centre.

In order to further such discipline many countries have introduced internal budget rules at the centre that oblige a minister, when making decisions that impose costs for local authorities, to finance the compensation to local authorities out of his/her own budgets. Also, when a minister makes decisions that may result in local government savings and grants to local government subsequently are reduced, such decisions can be rewarded with similar increases in the relevant minister’s budget. However, the practicability and design of such internal rules depends on the design of the central budget system.

For discussion 9. The internal central government budget regulations

It is recommended, where the central budget system permits such procedures, that any central minister who makes decisions resulting in increases in local government spending will be faced with financing compensation from his/her own budget. If the minister introduces rules that result in local savings this should be rewarded by budget increases of an amount similar to the local savings.

Discussion point 10

Administrative or court decisions that set a precedent are to be seen as expressions of new understandings of the obligations of the local authorities. They may be seen as clarifications of existing rules that the centre had not been aware of before and had not taken into account when calculating the original compensation. This could be seen as a correction of a failure by the centre, and the local authorities should be compensated as if it was a new central government act. 

For discussion 10. Precedent effects

Local costs following decisions by courts or complaints boards that create a precedent for other cases should be compensated by the centre.

Discussion point 11

For countries member of the EU much national legislation and regulation concerns implementation of EU decisions. Such implementation may result in increases in local costs (examples may be decisions that oblige local authorities to introduce better working conditions). In such cases it is difficult to use arguments of accountability to decide whether compensation should be paid. The centre may have had only fractional influence on the Community rules, but the local authorities have usually have had even less influence. EU regulation presents an unresolved accountability problem. The decision on whether the centre should compensate local authorities in such cases may be resolved by considering that the centre is after all closest to influence EU policies.

For discussion 11. Compensation for implementation of EU regulation

Legislation in EU members countries implementing EU regulations may result in costs for the local authorities. It is recommended that compensation from the centre is made in these cases. 

V. Consultations with the local government level

Discussion point 12

The experience of several countries has been that consultations with the local government level on the size and allocation of compensation results in better legislation and implementation. The timing of such consultation will have to take into account that the preparation of new legislation or regulation sometimes requires confidentiality during the negotiations in Parliament. But to reap the greatest benefit from consultations they need to take place as early as possible in the drafting phase.

The advantages often mentioned of consultation and of reaching agreement with the local level are that it improves the quality of legislation and of the local implementation so that the results conform better to what was intended by the centre. 

For discussion 12. Consultations with local government representatives

Consultations should be held with the local level on the size and allocation of the compensation. These consultations should be held as early as possible in the drafting phase of the legislation or regulation. 

Discussion point 13

There is a wide variety among countries in how consultations between the centre and local government are organised (CDLR (2008)). But it frequently includes a permanent political body representing both sides, often served by a technical joint committee to prepare the cases. Decision on the best organisation should take into account the administrative costs of different ways of organisation.   

For discussion 13. Organisation of consultations

Consultations with the local level should preferably take place in a permanent committee-like structure with elected representatives from both the central and the local side as members. Consultations may be organised between the ministry concerned and the local side, but in such cases it is desirable that the local level has a possibility of recourse to an agent of the centre responsible for overall issues of economy and accountability.

Literature:

-          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 (2009).

-          Kommunal- og regionaldepartementet (2007) “Statslig styring av kommunesektoren” 02/2007. Stockholm. Sweden.

-          Finansministeriet (2007). ”Vejledning om Det Udvidede Totalbalanceprincip (DUT)”. Vejledning nr. 63 af 9. oktober 2007. Denmark.