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In March 2022, the Institute for Market Economics released a film called ”2% in your municipality”, which presents the concept of financial decentralization and investing a fifth of income tax revenues in local economies. A key theme in the film is interregional inequalities and opportunities for compensating those in the proposed new model. Given that the Parliament has finally managed to pass the budget for 2022, one can focus once again on finding long-term solutions to issues in local finances. The big concern regarding financial decentralization, which needs addressing, is the problem of regional disparities.

The proposed local finances model has two main aspects, which are crucial for the regional development of the country. On the one hand, there is the redistribution of a fifth of income tax revenues toward the municipalities (a sum of around 850 million leva in 2021), which would incentivize significantly regional development and would also boost the potential of economic centers throughout the whole country. On the other, there is the reform in the compensatory subsidy (330 million leva in 2020), which would redirect funds from the larger and more prosperous municipalities towards the smaller and less wealthy ones. The increased financial autonomy of municipalities would allow for a genuine reduction of regional inequality.

IME’s paper analyses the effects of existing compensatory mechanisms in the budget relationships between the municipalities and the central government and outlines a clear path towards reforming the compensatory subsidy in the model, which would feature sharing income tax revenues. Calculations show that at least seventy municipalities would not need a compensatory subsidy, should the new model be introduced, as they would collect higher revenues based on their own resources. These include most municipalities with populations above 30 000 people, as well as some smaller ones with higher concentration of economic activity.

For the remaining municipalities, where funds from the subsidy would exceed those received under the reform, additional 115 million leva would be needed to close the gap. This sum would ensure that smaller municipalities with declining populations would receive just as much funding as they do under the current model. In fact, with around a third of the current subsidy, the poorest municipalities could be given the same level of support as they do now. In the paper, the Institute also presents a simplified model, which aims to show that the money saved from the subsidy could be targeted toward closing regional disparities.

An additional proposal is a balancing mechanism, fitted within the reform. It would redistribute up to 20% of revenues gained from the reform towards smaller and poorer municipalities. This balancing mechanism could supplement or partially replace the compensatory subsidy by providing resources for equalizing transfers directly from the sharing of income tax revenues. Such mechanisms exist in other countries in Central and Eastern Europe with experience in decentralizing tax revenues and could boost the financial autonomy of local governments in Bulgaria.

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The economic disruptions caused by the Covid-19 restrictions have affected the various parts of the country in different ways. Data about regional GDP in Bulgaria for 2020 allow for assessing the effects of the pandemic through a single indicator. While most districts remained largely unaffected, those specialized in tourism marked a setback worth many years of growth.

In 2020, Sofia continues to generate almost half of the country’s GDP – 51,3 billion leva, followed by Plovdiv (9,7 billion leva) and Varna (7,4 billion leva). The smallest regional economic centers – Vidin and Silistra – mark outputs of 726 million leva and 892 million leva, respectively. In per capita terms, Sofia is again on top of the list with 38,9 thousand leva per person, which is twice the output per person of Sofia District (17,2 thousand leva) and Vratsa (15,6 thousand leva).

The long-term trend of regional GDP shows that in the past 20 years growth in the country occurred at different speeds. Expectedly, the capital city leads once more with an increase in GDP per capita of 557% between 2000 and 2020. Growth of 410-420% can be seen in Plovdiv, Sofia Province, and Kardzhali, where GDP rises due to local industry. While output in the first two provinces grows smoothly over time, Karzdzhali’s economy expanded rapidly in the past couple of years, driven by the newly opened gold mine in Krumovgrad. In most provinces GDP per capita grows more modestly – within the range of 250% to 350% for the last two decades. The effect of the 2020 crisis is the most pronounced in the long-term trend of Burgas, the economy of which marked the slowest growth up to 2020 – only 159%. This underwhelming performance is solely a result of the Covid-19 setback.

In 2020 most districts enjoy a mild increase in output per person. The common negative trend is driven by Burgas and Varna, which attract most of the tourists in the country during the summer. The annual decrease in Burgas amounts to 17%, while in Varna it is 5%. The more extreme contraction in Burgas is due to the higher intensity of tourism in the province in the years before the Pandemic. Moreover, the economy of Varna is more diversified, including other prominent sectors like manufacturing. Blagoevgrad, where winter tourism suffered from the first wave of restrictions, shows no change in GDP from 2019 to 2020.

One should mention that current GDP per capita data do not reflect the anticipated changes from the census from the end of 2021. Accounting for them would result in a convergence between provincial figures for GDP per capita. The lead of the capital will narrow down after updating the data on its population. Nevertheless, the conclusions from the 2020 data would not change much – the economies of the tourist regions carry the heaviest burden from the Covid-19 downturn, while those of the other provinces continue to grow, albeit more slowly.

Fiscal decentralization is still a far-off concept in Bulgaria, despite the support from all major political parties for transferring tax revenues directly to the municipalities. 

The Institute for Market Economics stands behind the idea of “keeping” 2% of income tax in the municipality of residence of the taxpayer (see http://dvenasto.bg/). According to IME’s calculations, based on the number of employed people and the wage level in each municipality, this small share of tax revenue would amount to 850 million leva in 2021 ( you may find figures for each municipality in the appendix). 

Our observations throughout the years, the many regional analyses we have published (https://www.regionalprofiles.bg/), and the data we have collected (https://265obshtini.bg/) show that due to their specific regional attributes, some municipalities manage to attract people and investors, whereas others remain stuck on their path to development. There are also those municipalities that possess all prerequisites to grow but lack the required resources. Our proposal for fiscal decentralization has several benefits - we present the broader ones here [1].

Decentralization boosts economic growth

Research conducted by the OECD outlines a clear positive relationship between decentralization of revenues and growth. The results show that a 10% increase in tax revenues for the municipalities results in a 0.1% faster growth. 

Decentralization lowers inequality

One of the main motivations behind decentralization is that it reflects the needs and wants of local communities better. Therefore, it is no surprise that decentralization is linked to the improved efficiency of municipal services. Furthermore, decentralizing could yield additional social capital in the form of higher trust in local authorities, resulting from efficiency gains, increased transparency, and the more active participation of the municipality in the distribution of public funds.

Decentralization increases life expectancy

Research shows that healthcare costs fall, and life expectancy rises in the presence of moderate decentralization. However, the trend reverses when decentralization becomes excessive.

Decentralization boosts academic achievements

When it comes to education, data shows that a 10% increase in local tax revenues increases PISA results by 6%, which equals going six places up in the rank list. A similar but weaker connection is observed in the presence of other measures for decentralizing education, like increasing the autonomy of schools.

Decentralization allows for better tending to local needs by boosting competition, convergence, and investment

Higher local fiscal autonomy allows for shaping public services on a local level so that they are more in line with the preferences of communities. Moreover, higher levels of autonomy in municipal budgets allow for higher interregional competition in social services.

Decentralization is also linked to higher public investment – a 10% increase in decentralization (measured through local expenses and the ratio of local revenues to total state revenue) “boosts the share of public investment in total state expenses from 3% to more than 4% on average”. Investment incentivized by decentralization targets human capital, measured through education. This relationship is explained by pressures from interregional competition, which stimulates productive investment since regions strive to draw more workers and firms. 

[1] Source -  Fiscal Federalism 2022 MAKING DECENTRALISATION WORK by the OECD, December 20^th 2022

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