Strasbourg, 11 June 2010                                                                      LR-FS(2010)4

                                                                                                                         

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

The LR-FS Committee discussed at the meeting on 10-11 December 2009 a first draft of a set of guidelines on compensation for new competences for local and regional authorities prepared by the consultant expert, Mr Jørgen Lotz (Denmark). Time did not permit the Committee to have a full discussion and it was agreed that members would after the meeting mail any comments they had to the Secretariat.

A second draft for discussion at the present meeting of the LR-FS Committee has now been prepared by the consultant expert, Mr Jorgen Lotz and the Secretariat, based on the discussion in the Committee and comments received subsequently (these appear overleaf).

Action required

The Committee is invited to review the guidelines with a view to sending them to the CDLR for approval at its meeting in October 2010.

Members are invited to conduct any domestic consultations they deem appropriate in advance of the meeting.

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

• General considerations

• The Committee of Ministers (in Recommendation (2005)1) adopted the following guidelines for the funding of local costs resulting from new central rules for local and regional 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 CDLR study (CDLR(2008)48) revealed a variety of designs for rules of compensation for and consultations on new local competences. A CEMR study found that “consultation procedures have been established in the majority of European countries, but in very different contexts”.
• In order to reduce the pressure on local taxes it is a generally agreed principle in multilevel public finances that financial consequences should be borne by the same political unit as the one making the expenditure decisions. For the implementation of this principle of accountability higher level authorities must compensate for additional net local costs as consequences of higher level decisions. 
• It has been the experience of several countries that compensation to and consultations with local governments foster accountability at all levels and results in better legislation and improved implementation.
• National policies of compensation often include many detailed guidelines. The following guidelines include only the most central issues and are based on best practice among the member states. 

I. Compensation for new competences, accountability and pressure on local taxes.

Discussion point 1: Compensation for new competences.

Decisions made by higher levels of government can have consequences and impose additional net costs for local government. To avoid that this results in unwanted pressure on local finances it is generally agreed to follow the principle of accountability which entails that those who take the decisions should also pay for them. Application of this principle makes it difficult for the higher level of government to make popular decisions on new government expenditure and let the local level of government pay for it, and it reduces the pressure on local taxes. This is the prime argument for funding of the net costs of new competences for local authorities, or compensation for loss of local revenues when caused by decisions by higher level authorities.

New competences to be compensated include decisions by the higher level authority of new duties for local governments. It also includes net costs because the higher level creates expectations of new local or better services. Also new powers create new burdens to be compensated; governments do not generally provide powers unless they expect them to be used, and local authorities will come under pressure to make use of the new powers they have been given. The size of the net costs to be compensated will in this case have to be based on estimates of how widely the new competence will be used by the local authorities. A new burden can also arise from changes causing local authorities to lose income.

Changes in the rules resulting in reduced local spending obligations, or open for new ways of local savings not possible before the change, should give rise to reverse compensation from the local to the higher level.

In such cases when the new competences have been requested by local governments the principle of accountability could justify consultations on sharing of the net costs between the local government side and the lead ministry permitting some pressure on local taxation. 

Draft guideline 1. Compensation for new competences.

i.  Higher-level authorities should compensate local authorities if they make decisions on new local duties and powers, or create expectations that impose additional net costs on local authorities. In this document such cases are referred to as new competences.    

ii. The estimates of the extent to which the new competences will be used by local authorities should be negotiated with the local government side.

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 should be transferred to the higher level authority.

v. Such negative compensation is even justified in cases where realisation of the savings requires initiatives by the local authorities. The degree to which the new possibilities for savings may be expected to be taken up should be negotiated with the local government side.  

vi. Charging local authorities for services currently provided without charge should be compensated.

vii. Compensation should also be given for the local net costs when the higher level government introduces restraint on fee levels that are charged by local authorities, or exemptions from such fees or charges for certain categories of persons.

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Discussion point 2: Regulation for over- or underestimated costs.  

Subsequent reviews may reveal that net costs turned out to differ from the original cost estimates. In such cases the question arises of 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, subsequent regulation should be limited, for example by it being allowed only in cases of substantial amounts, or where subsequent regulation has been explicitly foreseen when the original compensation was decided upon.     

Draft guideline 2. Regulation for over- or under-estimated costs.  

Subsequent reviews may reveal that net costs turned out to differ from the original cost estimates. Rules limiting the number of items with subsequent regulation should for administrative reasons be introduced.

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Discussion point 3: Compensation for transfer of competences.

The effects for net costs when competences are transferred from one level of government to another should be compensated. The calculation of the size of the net costs for the two levels of government raises some particular questions, among these are pension rights and transfer of assets.  

Draft guideline 3. Compensation for transfer of functions.

i. The economic effects of transfer of a competence from a higher level to local authorities without intent of changing the level of service to the user should be compensated. Compensation should be based on estimates of the expected net cost of the competence .

ii. The earned pension rights of any staff transferred should be included in the compensation.

iii. The value of buildings, land and other assets necessary for continued delivery of the service should, as a main rule, be transferred without compensation. Debt should follow the assets and not be included in the net costs if it has been caused by acquisition, construction or necessary improvement in the asset. The net costs for improvements to buildings necessary to meet applicable standards should be compensated.

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Discussion point 4: Cases of general regulation. 

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 the higher level should make it clear that the purpose of the cut is to reduce local spending.

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.

It could, in parallel to this, be argued that no compensation should be given for costs imposed on local governments by new legislation on improved working conditions or on social conditions for private as well as public employees. Against this view it could be argued that the purpose of such legislation is to implement a desire by the higher level to improve conditions for clients or for local employees and that, from the point of view of accountability, it should be subject to compensation. It may be concluded that if such new demands have a disproportionate effect on the local government sector compensation is called for. 

Draft guideline 4. Cases of 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.

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, unless theyhave a disproportionate effect on local authorities.

iii.  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. 

II. Legal framework

Discussion point 5: The legal framework.

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 causing changes in local net costs without compensation. Different methods may serve this purpose in different ways and to different degrees. In one country it is required that assessments 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.

Draft guideline 5. The legal framework

The legal framework of the rules for compensation to local governments 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.

III. The kind of compensation

Discussion point 6: Grants or own financing.

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, in other cases compensation has been made by permission to introduce user-charges.

Accountability requires that it is the same authorities that take decisions on spending policies that also face the citizens when it comes to financing. For some services, where user-charges are usual, the issue does not arise. But when new competences are for tax financed services grants should be used to place the ultimate responsibility of financing at the proper level of government. The ultimate responsibility would be blurred if compensation took the form of allowing local authorities to raise new taxes.

Draft guideline 6. Grants or own financing.

i. Compensation pertaining to tax financed services should be made in the form of  grants.

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

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

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Discussion point 7: Compensation with earmarked or general grants?

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

In several countries compensation is made by adjustments to general grants. The experience of these countries demonstrates that in the long run those who face a loss in one case of compensation are likely to win in another.

To use earmarked grants would not be in keeping with the provisions of the European Charter of Local Self-Government[2].

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. However, several countries that use matching grants usually do so for a specified period only, after which they are consolidated into the general grants.

Draft guideline 7. Compensation with earmarked or 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.

iii.           Earmarked grants should be used only when

·         the new local competence is relatively costly, and

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

·         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. 

IV. Placement of the responsibility for compensation.  

Discussion point 8: Better responsibility at the higher level government.

Introduction of a system of compensation for new competences 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. In order to further such internal discipline several countries have introduced budget rules obliging the lead ministry, when making decisions that impose net costs for local authorities, to finance the compensation out of it’s own budget. And when the lead ministry makes decisions that result in local government net savings, and grants are subsequently reduced, such decisions should be rewarded with corresponding increases in the budget of the lead ministry. However, the practicability and design of such internal rules depends on the budget system applied at the higher level.

Though not directly called for by accountability concerns, net costs imposed by new local competences resulting from legislation initiated in Parliament (e.g. private members’ proposals) should be compensated by the lead ministry closest to the decision. 

Draft guideline 8. Better responsibility at the higher level government.

i.  Where the budget system of the higher level permits such procedures, any higher level ministry that introduces new local competences resulting in increases in local government net costs should finance the compensation from its budget

ii. If a ministry introduces changes in local competences that result in local net savings this should be rewarded by transferring the savings to the budget of the ministry concerned.

iii. Net costs imposed by new local competences emanating from Parliament should be compensated by the lead ministry.  

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Discussion point 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. 

Draft guideline 9. Precedent effects

Local costs arising from decisions by courts, complaints boards, or other independent bodies and setting precedents for other cases should be compensated by the higher level.

*

Discussion point 10: Responsibility for EU regulation.

In member States that are also member of the EU much national legislation and regulation concerns the implementation of EU regulations and directives. Such implementation may result in increases 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 the local authorities usually have had even less influence. 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.

Draft guideline 10. Responsibility for EU regulation

In EU 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. 

V. Consultations with the local government level.

Discussion point 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 estimations are needed. The following box gives some examples of where interpretation and estimations are needed.

Examples of cases where interpretation of new competences are needed. ·         “The costs for necessary improvements of the standard of buildings should be considered for possible compensation.” Here the question of what is “necessary” needs interpretation. ·         The question to which extent new powers will be used needs to be estimated. ·         The question of whether new decisions 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. ·         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 pressures on local taxes that local governments cannot easily resist. Local costs following directly from such spending pressures should be compensated and introduce a preventive effect for ministers of the higher level from 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.

When an interpretation is needed of the magnitude of the net costs for local government the compensation it should be calculated in consultation with the local level.

But also in cases where there is limited room for estimations and interpretations consultations between the levels of government has its 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 compensations 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 compensations. 

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

Draft 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. 

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Discussion point 12: Organisation of consultations.

There is a wide variety between countries in how consultations between the centre and the local governments are organised (CDLR, 2008). But they frequently include a permanent political body representing both sides, often served by a technical joint committee to prepare the cases. Decisions on how to best organise consultations need to take into account the administrative costs of different ways of organisation, and the setting of a minimum threshold for compensation of new competences is recommended for administrative reasons.  

 For discussion 12. Organisation of consultations

i. Consultations with the local level should preferably take place at set times during the year. They should take place 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 their involvement.

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

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. CDLR(2008)48.

-          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.