News

Yavor Aleksiev

The trend of rising local taxes, established in recent years, continues also in 2018. The Bulgarian municipalities are increasing key local taxes in order to secure the funds they need, but in some cases to also fulfill their commitments to the Ministry of Finance resulting from interest-free loans received in recent years. This development is not surprising given the stalled process of fiscal decentralization, though higher local taxes cannot address the structural problems of the municipal budgets.

What the data shows

Between 2012 and 2018, IME conducted 7 separate annual surveys on local tax levels as part of the Regional Profiles: Indicators for Development initiative. The data was collected through applications under the Access to Public Information Act (APIA) to all municipalities in the country, as well as online tax rate checking. We looked at four of the key local taxes:

• real estate tax - non-residential property of legal entities;
• tax on transport vehicles and passenger cars with engine power between 74 kW and 110 kW;
• annual patent tax for retail trade up to 100 m² commercial area;
• transfer of ownership tax.

The results obtained are unequivocal: the number of increasesin the observed local taxes issignificantly higher than the number of reductionsin the local taxes, the trend being particularly noticeable in 2016 and 2017, just after the entry into force of the so-called „Rehabilitation of municipalities mechanism”.

We see that:

• The trend inincreasing key local taxes continues in 2018. IMEregistered 37 increases compared to 2017, while reductionswere only 4 - a record low for the period.
• For the period between 2013 and 2018, there were 254 registered cases of increase in local taxes, while the cases of reduction were nearly five times lower.
• Two-thirds of the increases were recorded in the last three years.
• Most often, the annual property tax was increased, followed by the tax on property gains and taxes on transport vehicles.

Why increasing local taxes will not help

According to the latest comparable Eurostat data, local governments’ revenues in Bulgaria amounted to only 7.3% of GDP in 2017, which is more than two times lower than the EU average of 15.4%. Although raising the level or collection of key local taxes may lead to some improvement in the state of municipal budgets, the problems with their structure remain.

• Bulgarian municipalities remain highly dependent on transfers from the central government, which account for nearly 2/3 of all their revenues. This ratiocreates not only theoretical but also real political dependencies and cannot be overcome within the existing local tax framework.
• The enforced channels for securing funds (mainly from property taxes) provide limited fiscal space and do not create a real opportunity for tax competition. Given the fact that the relative share of local taxes in the total tax burden of citizens and businesses is insignificant, changes in both directions have no particular effect on the decisions of the economic agents.
• With very few exceptions (large cities, resort municipalities, and municipalities with large concessions), municipal budgets do not reflect what is happening in the local economy.
• The low share of own revenues leads to the inability to implement local policies, even if there is a public and political consensus at the local level, which in some places leads to a senseless democratic voting process.

The simplest and most easily applicable method for changing this status quo is to remit some of the proceeds from the personal income tax to the municipalities based on the principle "money follows the ID card". Assigning one-fifth of the revenues coming from income tax on natural persons projected for 2018 will increase municipal revenues by nearly 675 million leva (i.e. nearly a third) and will create real incentives for local authorities to work to attract investment and opening new jobs. The necessary steps to achieve a real change in the structure of the municipal budgets were discussed by IME in the study "The Road towards Fiscal Decentralization", published in April 2018, where an estimate of potential revenues to be received by each municipality upon adoption of this step was also provided.

The road towards fiscal decentralization

The transfer of part of the revenues from the income tax for individuals to the municipalities cannot and must not be an isolatedand unconditional change on its ownin the structure of the tax system. In order to ensure its success, further steps need to be taken, including:

• Moving towards an effective program budgeting system at the local level, which is to lead to greater efficiency and transparency of local finances;
• Improving the efficiency and transparency of finances and the management of municipal enterprises and municipal property;
• Territorial-administrative reform to ensure long-term sustainability of spatial planning;
• Sharing the income tax with municipalities also implies changing the democratic model by enhancing political responsibility at the local level and actively involving civil society in the process of local policy making.

Sharing the proceeds from the income tax for individuals with municipalities, and eventually assigning authorities to determine this tax within a given range, will result in:

• Enhancing the fiscal autonomy of the municipalities and better linking the budget revenues with the social and economic processes taking place on their territory;
• Reducing the existing political dependencies of the local government;
• Creating incentives to maintain a good business environment and attract investment to increase employment, thus increasing revenues from the personal income tax in the local budget;
• Restoring the lost link between taxation and political representation at local level and increasing the capacity of civil society to participate in the formulation of local policies;
• Creating an environment promoting real tax competition at local level in the future when municipalities are given the right to set the personal income tax rate in a wider range.