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Sharing Income Tax Revenues with Municipalities

The last decade was characterised by the reluctance of a number of Bulgarian governments to pursue their strategic commitment to fiscal decentralisation. The last meaningful steps towards higher financial independence of Bulgarian municipalities were taken in the distant 2007, when municipal councils were given the power to determine the size of local taxes and fees within a given range. The period that followed showed that this change was insufficient and has not led to a significant change in the structure of municipal budgets.

• Municipal budgets remain highly dependent on transfers from the central government. About 2/3 of municipal budget revenues come from such transfers, while capital expenditures are almost entirely dependent on EU funds.
• Independent fiscal policy is severely hampered by the lack of own revenues. The deteriorating condition of municipal budgets and the stipulations of the 2016 “Financial recovery procedure for municipalities with financial difficulties” have led to incentives to increase existing local taxes and have created prerequisites for growing political dependence through non-interest-bearing loans and their subsequent "forgiveness" by the Ministry of finance.
• The lack of own revenues limits the role of local democracies and deprives municipalities of the tools needed to form local policies. It is questionable whether the current system allows them to carry out long-term policies in the interest of their own citizens.

The Solution: Fiscal Decentralization

Fiscal decentralisation rests on two basic principles - "local self-government" and "subsidiarity". The first principle relates to the right and the ability of local authorities to manage and be responsible for a substantial part of local public affairs, while the second principle implies that problems are resolved as quickly, easily and efficiently as possible at the lowest possible level of governance.

A real change in the financial autonomy of the Bulgarian municipalities is only possible through the restructuring of the existing tax system. There is a wide consensus that a good first step towards fiscal decentralisation would be to share one-fifth of the revenue from personal income tax with municipalities. If we look at the 2018 budget, which foresees personal income tax revenues in the amount of BGN 3,372 million, the transfer of 1/5 of the proceeds would increase the own revenues of the municipalities by nearly BGN 675 million or by 30.4%.

Sharing income tax revenues with municipalities cannot and should not be approached as an isolated and unconditional shift in the structure of the tax system. In order for such a reform to succeed, additional steps must be taken, among which:

• Transition towards effective program-based budgeting procedures, which can lead to higher efficiency and transparency;
• Improved efficiency and transparency of local finances and the way in which municipal enterprises and municipal property are being managed;
• A reform in the administrative division of the country, which guarantees the long-term demographic and financial sustainability of municipalities.

The process of financial decentralisation also suggest a shift in the democratic model in the direction of increased political accountability at the local level and the active participation of civil society in the policy making process.

Sharing income tax revenues with municipalities (and eventually the delegation of the power to determine the actual tax rate within a given range) will lead to:

• Increased financial independence of municipalities and a better connection between local government revenues and the socio-economic processes at the local level;
• Reduced political dependence from the central government;
• Incentives for local governments to create and maintain a good business environment and to attract investment that can foster employment and, thus – municipal budget revenues;
• Restoring the lost link between taxation and political representation at local level and increasing the capacity of civil society to participate in the local policy debate;
• Creating conditions for real tax competition at the local level, especially when municipalities are given the right to determine the rate of the income tax within wider range.

The full text of the report is available in Bulgarian here.