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Fiscal Decentralization to Local Governments

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Ljubinka Andonoska
September 14, 2019

Fiscal decentralization of local governments, while common in the United States, has not been fully established in other countries. Over the last three decades, however, many developed, transitional, and developing countries have opted for decentralized local governments, triggering decentralization reforms. In essence, fiscal decentralization involves delegation of power from a central (state or federal) government to local governments. It entails full discretion on behalf of the local administrator to make decisions regarding tax collection and service provision without transfers from central government. After three decades of implementation, continued arguments remain on both sides regarding the impact of decentralization on the work of local governments.

Historically, arguments for decentralization focus on the potential to better connect people to their local governments and the political process. Decentralization arguably increases efficient allocation of resources because local governments have more accurate information regarding the preferences of their constituents. As such, local governments are better positioned to provide services to meet the wants and the needs of their residents; residents choose the government that best fits their preferences. Thus, local governments have the incentives to be more fiscally responsible and to provide services more efficiently.  In turn, residents have a voice in the political process and are served by a more transparent government.

However, these arguments have been countered with potential pitfalls. Some of the challenges associated with decentralization are related to economies of scale. Local governments might need to impose higher taxes simply because they are unable to utilize economies of scale. Efficiency of service provision is reduced. Moreover, the quality of local governments has been posited as an important factor in decentralization reforms. Ill-conceived local institutions and poor implementation of reforms could exacerbate disparities in regional development. Local governments with poor institutional capacity not only face the risk of reducing benefits but also may be more vulnerable to corruption. This may be especially true in underdeveloped countries with ineffective accountability mechanisms. Finally, fiscal decentralization reforms triggered by political factors such as tranquilizing ethnic disputes are more likely to fail than decentralization reforms led by the need for greater efficiency.  

The case of Macedonia is an example of decentralization reform triggered by political factors. Although the central government architects of the reforms were careful when designing the processes and tried to insert accountability mechanisms, unfortunately, the results so far are discouraging.

Fiscal decentralization in Macedonia

Macedonia inherited a highly decentralized system of local self-governments in 1991. As a new sovereign and independent country, the first years of democratization in Macedonia were characterized by centralization of most of the previously decentralized municipal functions. In July 2005, Macedonia initiated the process of fiscal decentralization for two political reasons: to comply with European Union (EU) candidate requirements and to end an ethnic conflict. The Macedonian Government prepared a comprehensive legislative framework to meet the requirements of the European Charter on Local Governments and the Ohrid Framework Agreement (OFA), a peace treaty that ended the 2001 ethnic conflict in Macedonia.

The process of decentralization followed a two-stage, top-down approach. The Law on Financing Local Self-Government Units earmarked a tax of 3 percent on the personal income tax of people living in their jurisdictions and 4.5 percent from the Value Added Tax (VAT) in the form of general grant to local governments. At least 50 percent from this grant must be formula-based on a per capita basis.

During the first stage of fiscal decentralization, the national government transferred its authority to collect municipal income tax, drafted methodology for transferring capital, and earmarked grants from central to local governments. During the first stage grants covered only operating expenditures.

The second phase began in January 2007. Municipalities transitioned to this stage after completing an assessment of key local variables, such as staffing. In addition, municipalities prepared regular financial reports and submitted them for approval to the national Ministry of Finance. A separate central government commission, the Phase Commission, evaluated the level to which these conditions were met by local governments. The successful municipalities received block transfers for culture, social welfare and child protection, primary and secondary education and primary healthcare.

Fiscal decentralization in Macedonia did not solve lingering problems in local government. The experience has been widely criticized because of:

  • Lack of funding.
  • Low level of cooperation with the central government.
  • Understaffing of the municipal administration.
  • Inappropriate level of knowledge and skills of the municipal administration.

The major problem, however, has been the allocation of limited fiscal resources across municipalities much to the advantage of the more developed and more densely populated regions. Fiscal decentralization in Macedonia did not bring about the desired level of fiscal autonomy to municipalities to independently collect taxes and make decisions for service provisions. Municipalities are still heavily dependent on the central government’s decisions. The relationship between the local and national political leaders mirrors vertical clientelism, which allows national party leaders to maintain control over state resources by controlling subservient local politicians. Overall, under decentralization, lack of fiscal autonomy and lack of direct political representation have proven detrimental to poorer and less populated regions in Macedonia.


Author:

Ljubinka Andonoska
Assistant Professor of Public Administration
University of Texas at El Paso
Contact phone: 915-747-7132
Contact email: [email protected]

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