Local Tax Policy

The 2007 amendments to the Constitution of the Republic of Bulgaria introduced Article 141 that empowered municipal councils to determine rates of local taxes under conditions, by a procedure and within the frames, established by the law. Through these amendments, municipalities in practice received taxation powers for the first time. At the end of 2007, the relevant changes were also applied in the Local Taxes and Charges Act, providing such powers to municipal administrations.

The new provisions did indeed provide municipal authorities with the powers to set the rate local taxes, but within a certain range, while in the early years it was very restrictive and did not allow any major differences in taxation. At the beginning, they were given an opportunity to increase certain tax rates, with the minimum levels being actually the 2007 baselines. In other words, the lack of confidence in tax policies at local level was more focused on the possibility of taxes being cut to an excessively low level rather than on the risk of over-taxation.

Revenues to Municipal Budgets

The legal thresholds of taxation adopted by local authorities have widened somewhat in recent years, allowing also for a reduction in tax rates. It has already helped establishing an actual tax policy and even competition between municipalities, but the effect on the level and breakdown of revenues was not great. Of course, the crisis has also had an impact on local revenues and it's possible that some of the potential positive developments of tax policy at local level have remained hidden. As a whole, however, the general picture over the past years did not change dramatically: municipalities continue to rely heavily on government transfers, then on non-tax revenues (charges and income from real property), with tax revenues coming last on the list.

Graph 1: Municipal Budgets – Revenues and Transfers (BGN, mln)

Source: Ministry of Finance, IME

Basically, municipalities' own revenues (tax, non-tax and state aid) continue to be less than transfers from the central budget, and it means that their fiscal autonomy is still only a wish. This trend continued despite the transfer of the license tax to municipalities (2008) and the introduction of the new tourist tax (2011) – these are only small steps with negligible impact on municipal revenues.

The graph also shows the decline in revenue in the municipal budgets after 2008; signs of recovery were not observed. The slight uplift in 2011 was achieved precisely due to own revenues while the size of transfers remained unchanged. In this case, the condition of public finances and the high dependence of municipal budgets on central transfers predetermine freezing of municipal revenues.

Deficit and Municipal Debt

During the "hard years", municipalities also started accumulating larger deficits; in 2009 and 2010 deficit exceeded 15% of their own revenues: a total of over BGN 500 million in deficit for the two years for all municipalities. In the last year, the deficit accumulated by municipalities shrunk to BGN 60 million (2011), with funding being mostly from domestic sources, i.e. banks.

Municipalities' smaller revenues and budget deficits understandably led to an increase in municipal debts and problems in some municipalities; there were extreme cases of freezing of accounts and temporary closure of municipal services. In early 2009, municipal debt was less than BGN 500 million, most of it domestic debt. At the end of 2011, the amount of debts already doubled, reaching BGN 950 million, with external debt slightly larger than the domestic one.

Graph 2: Municipal Debt (BGN, mln)

Source: Ministry of Finance, IME

It is important to note that half of all municipal debt is held by the Sofia capital city Municipality. Its debt is entirely external, undertaken through municipal loan agreements, and represents almost the entire external municipal debt in the country. Practically all other municipalities in the country only have domestic debt.

Currently, the amount of municipal debt is about 60% of the municipalities' so-called "own revenues" which may seem stable, but there are two factors that should not be overlooked: the rapid growth of municipal debt in recent years, and its distribution. Cumulative municipal debt is an important and interesting indicator, but the actual problems and payments are divided into 264 municipalities. The debt of the capital city is an example of just that. There are quite a few municipalities with no accumulated debt at all and this issue is simply not on their agenda: at end- 2011, 75 municipalities in the country had no municipal debt.

The largest debtors in absolute terms are shown in the table below. Compared to own revenues and the adjustment subsidy, at the end of 2011 municipal debt was largest in the municipalities of Kyustendil, Varna, Peshtera, Hissar, and Simitli. In these municipalities, the size of debt exceeds their own revenues and the adjustment subsidy.

Own Municipal Revenues

The overview of municipal budgets shows serious differences vis-à-vis fiscal independence or dependence on state transfers. In Sofia, for instance, own revenues exceed transfers and reach up to 60% of all budget revenues. Varna is also close to 60%, while in Plovdiv and Burgas the rate is about 50%, i.e. half the revenue is from own revenues and the other half is from transfers.

In Gabrovo, the municipal own revenues are about 35% of the total revenues while tax revenues account for only 10% of the municipal budget. In smaller settlements like Kotel, own revenues account for just 15% of the budget, and tax revenues are such small amounts, nearly negligible. The picture in most cities in Bulgaria resembles the one in Gabrovo and Kotel. Own revenues in the 28 largest cities account for 30-40% of the budget, while in smaller towns they are in the 15-20% range. Resort municipalities along the Black Sea coast and in mountains are an interesting case in point: the proportion of own revenues there is significant and sometimes exceeds the figures for the capital city. In Bansko for example, own revenues are over 75% of the budget. This is largely determined by the profile of municipal revenues, primarily tied to the value of the real property because property tax and the garbage collection charge depend on the size of property and its value. In places with active construction developments and high demand, respectively the high value of real property, and municipal revenues are sizeable and achieve greater fiscal independence.

Graph 3: Revenues of Selected Municipalities (2011)

Source: Ministry of Finance, IME

In general, some degree of financial independence has been achieved in the largest cities and resorts where the value of the real property is highest. Even there, however, tax revenues account for no more than 20-30% of municipal budgets, which is illustrative of the challenges the financial autonomy of Bulgarian local government is yet to face.

In the great majority of municipalities, i.e. outside the largest cities and resorts, the situation is even more revealing. About 1 out of each 10 BGN in the budget comes from local tax. Even where own revenues account for a larger portion of the budget, if these are mostly generated from charges and fees, we can hardly speak of financial independence. Local policies and the competition between municipalities can happen in the fullest extent if it relies on the tax policy, respectively on the revenue from taxes.

Local Taxes and Fees

The new powers of municipalities obviously did not automatically result in financial independence, but nevertheless municipalities already have their own taxation policies in place. Let us look at developments in several specific taxes and charges over the past years: tax on real estate for legal entities, tax on vehicles, license tax and household waste collection fees for non-residential company property.

Immovable Property Tax for Legal Entities

The tax on real estate owned by companies attracts the greatest amount of interest from the point of view of local taxation. Municipalities’ policy-making in this regard has been relatively active since 2007, which means that tax competition is in place at local level. The chart below shows the tax rates in 198 municipalities across the country - both for the current year 2012 and the baseline 2007. The year 2007 was taken as a baseline as it was the last year in which the tax rate was the same for all municipalities under the Local Taxes and Charges Act.

It is worth noting that, given the limits set by law from 0.1 to 4.5 per mil (as of 2012), the tax rate is usually within the range of 1 to 2 per mil. There are occasional examples of higher rates, with the highest rate being in Nikopol (4 per mils) and in Elin Pelin (3.5 per mils). The only rate below 1 part per thousand is in Hissarya - 0.6 ppt, which a record-low level for the country.

Interestingly, local tax policy is relatively sustainable, with no significant changes during the years. For example, last year saw only isolated cases of changes in real property taxation, which could be due to the on-going financial problems for both businesses and the municipality.

Graph 4: Immovable Property Tax for Legal Entities (‰)

Source: IME

In the case of real estate, the tax base is very important, i.e. the value of the property the tax rate is charged on. Years ago, local tax on real estate was determined on the basis of the "tax evaluation" for natural persons (residential property) and the book value for companies (non-residential property). The difference is that in the first case the rate is fixed by the tax authorities – „depending on the type of property, its location, area, structure and physical amortisation”, while in the other, the property's book value (or historical price) is being taken. The difference between the two tax bases can be quite significant both for old buildings whose book value is often lower than the possible tax evaluation, and for newly built property, where the tax evaluation could be much lower than the book value.

New provisions which came into force in early 2011 state that for real estate owned by companies, the higher value will be taken into account when choosing whether to use the carrying value or the tax evaluation. This change caused much debate because it is entirely in favour of the taxation authority: it does not define which evaluation is right (correct) but simply which one is higher. To some extent, this was taken into account by municipalities; over the past two years there were almost no cases of increasing property tax rates for businesses because the higher base was offset by the unchanged rate. The result was still an increase in revenue from property tax by about 12 per cent in 2011, probably resulting from the new provisions on the tax base.

Vehicle Tax

Tax on vehicles is another key source of revenue for municipalities. In this case, we will focus on cars with a capacity between 74 kW and 110 kW. The law is quite strict on this count: BGN 1.10 to 3.30 per 1 kW. Actually the lower limit is equal to the base level from 2007, i.e. no option was provided to cut this type of tax. Below are the rates for the „base” year 2007 and the current year 2012:

Graph 5: Vehicle Tax (BGN per kW)

Source: IME

Most rates do not exceed BGN 1.50 per 1 kW, with many municipalities keeping down to the minimum. These figures and the experience with property taxation shows that the lack of opportunities to reduce the tax to the "base" 2007 levels certainly stops some municipalities from reducing that rate. The highest rate is in the municipality of Ruzhnitsi, with the change introduced as early as in 2008. The question remains why the legislature keeps the minimum at the base levels when experience with other types of tax has identified no problems.

Annual license tax for retailers

The annual license tax was only recently (2008) ceded to municipalities and its development is another interesting point. In this case, we are looking into the license tax for retail trade on up to 100 square metres of shopping area. Figures for the year 2012, as well as the legal minimum and maximum, are shown below.

Graph 6: Annual License Tax for Retailers (BGN/sq.m.)

Source: IME

By law, the limits for this type of tax vary from BGN 2 to 20 per 1 sq.m. Figures show that most municipalities have set rates at the lower end of the specified range, mostly between BGN 5 and 10 per sq.m., but there are also examples of extremes: the maximum rate is set in municipalities such as Varna, Blagoevgrad, Haskovo and Sofia capital city, while the minimum rate is applied in municipalities such as Varbitsa, Maritsa, Makresh, Medkovets, and Yakimovo. In this case, differences are traditionally predetermined by the size of the municipality and have remained unchanged since before the amendments to the Constitution and the new powers given to municipalities. This type of tax is rarely changed; the vast majority of municipalities have kept it at familiar levels over the past several years.

Annual Waste Collection Charge for Properties of Legal Entities Annual waste collection charge is a key revenue source for municipalities forming a significant part of the so-called "non-tax revenue". In this case, we are looking into the waste collection charge for non-residential property owned by companies because it is most relevant to the economic processes in municipalities.

Graph 7: Annual Waste Collection Charge for Properties of Legal Entities (‰)

Source: IME

In this type of charge, there are no minimum and maximum rates set – a fact that predetermines large discrepancies. The so-called "garbage charge" rate is the highest in the municipality of Kocherinovo, followed by Godech and Svilengrad. Among the district centres, the garbage charge is the highest in Pazardzhik – 14 per mil of the tax evaluation, while the lowest rate is in Sliven – 1.4 per mil, followed by Gabrovo – 3.1 per mil, and Varna – 3.9 per mil. Where garbage charge is concerned, there have been significant changes in recent years, with rates reduced in most places.

The garbage charge, similarly to property tax, is determined in proportion to the property evaluation when the quantity of household waste cannot be determined. Here, municipalities are free to determine the base themselves: either book value or tax evaluation. In some municipalities, the property tax model was adopted. For example in Razgrad, the higher value of either tax evaluation or the book value is used for the garbage charge, as well. The figures show that changes in the tax base had a significant impact on the per-mil charge in many municipalities: district centres saw a decrease in the garbage charge rate over the past 1-2 years. In Razgrad, the per-mil charge was changed from 11.5 to 6.5 because of the changed base.

Conclusions, Developments and Recommendations

Changes in recent years have shown that municipalities are already implementing a more active taxation policy, but this did not lead to changes of the structure of revenues and setting a greater degree of autonomy. Municipal own revenues do not have much in common with the economic developments in the respective area: real property is being taxed while profits and incomes barely affect local budgets. In practice, the arrival of a major investor does not automatically generate benefits for the local budget, instead it even takes away incentives encouraging local authorities to work for a better business environment. It is the lack of development incentives that is the leading argument for more powers and responsibilities at local level.

The updated Decentralisation Strategy (2006 - 2015) clearly states that „The general trend in Europe is to transfer services, powers and resource from central to regional and local levels of government, according to the principle of subsidiarity”. However, the revised strategy and its implementation programme contain few development incentives in terms of financial independence and taxation policies at the local level. The idea of going in that direction is generally supported but even if applying all practical measures, the plan is to achieve approximately ½ of the municipal revenues to be its own, i.e., ideally, we will have achieved a partial financial autonomy.

With regard to tax policy at local level, the measures discussed in the Strategy could be grouped as follows:

• Introduction of new local taxes: license tax became local, and in 2011 a new "tourist tax" was introduced;
• Allowing more freedom in establishing local taxes: the range has already been extended ;
• Increase of revenue from property tax: changes in the tax base (tax evaluation or book value, whichever is higher) have already been applied;
• Restructure the taxation system: the focus is on income taxes, but there hasn't been any development in that area.

The above shows that most measures have already been implemented but no major impact in terms of real financial autonomy is evident. License tax and tourism tax are not large revenue sources. Municipalities have leeway to set rates and they do have active policies but it has failed to result in higher taxes and larger revenues. If the rates of „central” taxes remain unchanged, this would result in increasing the effective tax burden on businesses and citizens. The changes applied to the tax base will result in more income, yet it is not a sustainable long-term solution. It takes us to the concept of restructuring the taxation system as key aspect of achieving financial independence.

"Restructuring" should be understood as transferring to municipal existing taxes (or portions of taxes) currently collected by the central government. They may include direct taxes – income and corporate tax, or for instance a portion of VAT. The topic has been widely discussed over the past years, and there have been all sorts of proposals. The most feasible option at present, and as stated in the Programme for the implementation of the Decentralisation Strategy (2010-2013), is for a portion of the personal income tax to be transferred to local taxes. Although it has been listed as a measure in the Implementation Programme, putting it to practice in the short term is highly unlikely because there will be both political and administrative obstacles and issues hindering this process.

Municipalities will find it difficult to win greater fiscal decentralisation if they fail to improve their budget effectiveness and transparency or the way municipal companies and property are currently managed. A lot of effort is needed in this direction. If good results are shown, any demands for more powers and resources will be more successful and convincing.

It would involve at least the following two measures:

• Transition to an effective programme-based budgeting at local level: it results in greater effectiveness and transparency, yet currently it is not adequately implemented;
• Ensure the improved transparency of municipal budgets and the budgeting process, to increase cost-effectiveness. Furthermore, without achieving minimum levels of budget transparency, it would be difficult to persuade citizens and politicians that greater fiscal autonomy is indeed justified.

It would open the way to financial decentralisation and greater financial independence, with some possible changes in this direction such as:

• Parliament would no longer set limits to local taxes; the decision and the responsibility would entirely fall with local government;
• At least one direct tax would become local – for instance, personal income tax. Direct taxes are not at all central government's main source of revenue, so transferring them to the closest government to the citizens would not be an illogical step;
• Municipalities would receive a "share" of economic growth – i.e. a proportion of the revenue from as many types of taxes as possible, particularly those associated with local economic activities (f.e. a percentage from the revenue from profit tax, VAT, excise duties);
• Municipal revenue collection and spending powers would be balanced so they are no longer dependent on the state budget, creating a fiscal asymmetry;
• Open and transparent privatisation of municipal assets;
• The powers of municipalities in the area of economic and social policy would increase.

Municipal councils and mayors are fully responsible for the development of the municipality and it is perfectly normal that they should have the right to set tax rates applicable to local residents. It would allow for all types of policies to be developed at local level, including social programmes and investment in infrastructure. It would be a decision made by local government officials and by voters themselves. If residents in a given municipality do not want massive public spending, let setting low local tax rates. On the other hand, if people from another municipality believe that local government should take matters into its own hands and provide funding for various policies, then let local tax rates be high. It would be an expression of a different approach and of real competition between municipalities. But the fact is that the presence of tax competition protects citizens from over-taxation while at the same time it compels even those who levy high taxes to spend the money collected in a more efficient manner.