- Municipal finances seem to be pressurised around the world. New local policy initiatives, fiscal evaluations and even blog articles dealing with local politics all acknowledge at one point or another that local resources are limited.
- For twenty years, external contributions and partnerships to deliver local policies have become commonplace amidst the growing scope of the services municipalities are expected to deliver.
- This briefing explores the historical context for local finances around the world and summarises the recommendations made by the Covenant of Mayors for Climate and Energy in Europe and UN-Habitat to strengthen municipal budgets.
Briefing in full
Since 2013, Detroit has become an example of all the things that can go wrong in after decades of austerity, disinvestment and mismanagement: deficient infrastructures, lack of public transport, subpar municipal services, local bankruptcy. Often framed as the result of rapid deindustrialisation, the story of Detroit’s finances in 2013 represent constraints faced by local authorities around the world: municipal finances characterised by a decreasing volume of intergovernmental transfers, highly reliant on real estate taxes and private investments to fund municipal services. There are historical reasons why local finances seem to be broken after the financial crisis of 2008, and suggestions made by international organisations e.g. UN-Habitat committee aims to prevent other cities from becoming the next Detroit.
Local financial perspectives and shared problems
Benchmarking municipal finances around the world is difficult for two main reasons: the lack of comparable data, and the wide diversity of powers that local authorities can exercise depending on their constitutional circumstances. Until 2008, the Government Finance Statistics from IMF were the only global source on municipal budgetary data but it also had reliability problems due to the lack of accurate reporting of local data by national governments. International municipal associations, UCLG, recognised this lack of data as a major handicap to allowing learning from peers at the municipal level and monitoring the local implementation of the Sustainable Development Goals (SDGs). To circumvent this disadvantage, local authorities from 101 different nationalities got together to support the creation of the Global Observatory on Local Finances (GOLD) which produces periodical reports on the general trends of municipal finances around the world, based on self-reporting by local authorities, allowing professional researchers and universities to use the data to produce interesting cases of study. GOLD reports feed directly to the UN library dedicated to supporting the implementation of the SDGs by 2030.
While reliable datasets are under construction, there is broad consensus amongst urban practitioners and local authorities: municipal finances are still too dependent on cash transfers by central and regional authorities, and global urban trends such as the increasing demand for municipal services and the growth of urban sprawl posing a real threat for the economic sustainability of most municipal governments, regardless of their geographic location. Municipal governments around the world have seen responsibilities increase since the 1980s, either by the decentralisation of services by national governments (in areas such as education and public health) or because of the growing expectations of populations that are in general more wealthy and better educated than in any other point of human history.
In the early 1900s, most municipal authorities were understood as a compromise between the local elites and the elites represented by the national governments. As such, local elites were for the most part free to defend their interests and pursue their own personal and dynastic political agendas through the governance of their towns and cities, in so far as they collaborated with the central authorities in the maintenance of public order and strategic national infrastructures. However, by the mid-1900s, expectations for universal development became ever-present in the dialectic competition that was the Cold War. Even in non-democratic regimes, states were expected to react to popular demands and provide equal levels of wellbeing for all their citizens within the technical means of the era. In this new context, local authorities became tools for the delivery of centrally mandated infrastructures and services making earmarked intergovernmental transfers a central part for local budgets during this period.
Between the 1940s and 1980s, local authorities acquired responsibility over additional services and functions but not the legal mandate to adapt such services to their local circumstances, nor the capacity to raise additional taxes to pay for them. Local budgeting in this period became highly reliant on the ability of municipal representatives to mobilise their contacts in the central administration to attract intergovernmental transfers, public investment and the relocation of large industries within their municipal limits. Local authorities located in colonised territories and in countries with weak central governments had to face severe limitations to pursue this funding strategy, which according to some scholars explains why their local budgets became dependant on quid pro quo corporate investments and sporadic acts of charity that are both unsustainable and undemocratic.
The constitutional arrangement for local authorities changed how they experienced this development, and varied greatly. In Francoist Spain, local governments were appointed by the central government through their regional delegations dividing the local councillors into three equally sized groups: one third for the representatives of the national workers union, one third for representatives of local business and associations, and the last third elected. In the US “marble cake federalism”; an attempt of involving all levels of administration in the solution of local problems using intergovernmental grants (mostly earmarked investments) and categorical grants (financing for services that had attached certain conditions by the federal government).
Economic and ideological developments in 1970s promoted ideas of political decentralisation and economic specialisation. The underlying logic was that centralised decision-making tended to produce standardised and inefficient solutions, and in the case of local authorities, prevented communities from adapting to their own circumstances and taking advantage of their strengths. Central governments developed two main schools of thought on how to approach decentralisation and specialisation: one position was to improve the system of earmarked intergovernmental transfers, making it more participative and tailored to local necessities; and the second was to minimise the intergovernmental transfers as much as possible, freeing local authorities to explore alternative financing arrangements.
Transfers were contested by those believing tailoring grants from the central government would not solve the problems with efficiency or the quality of the local public services, since it was a step towards creating a larger and more complex bureaucracy to deliver local programmes. Also, contested on the basis that it could be politicised and did not prevent the unfair distribution of national resources due to partisan clientelism. The second approach was also criticised, because it opened the door for local representatives to have too much discretion in the management of local services to the point of allowing partial or complete privatisation of some services (with possible cost and transparency issues).
Most national governments reformed local administrations through the 1970s to 1990’s, falling between these two positions depending on their socio-political and historical circumstances. In France decentralisation was uniform but limited in its scope, allowing municipalities the capacity to enter in cross-border agreements with other municipalities and become partners with private investors, but still requiring the petition of approval by the central government in most policy areas. In the US, the constitutional role of states and local governments remained the same, but the Nixon administration began to encourage the reduction of bureaucracy by turning categorical grants into block grants: states were then freer to manage federal grants and have enhanced discretion over local authorities tax collections and spending non-federal taxes.
In 1992, UN Earth Summit in Rio established Agenda 21 for sustainability, and the final declaration encouraged national governments to empower local authorities to develop local objectives to implement the agenda. This was one of the first occasions in which local authorities’ organisations received endorsement by the UN to be an active part in the global policy implementation. Furthermore, this endorsement was also meant as a call to action for all those countries that had not developed legislation to support local administration. From this moment onwards, local government organisations and international organisations (such as the OECD) encouraged local governments to reclaim responsibilities in policy areas such as cultural services, economic development and climate change.
Cities including Detroit, that had historically depended on federal grants and taxes related to the car manufacturing industry, began to suffer acutely in this new context. When the state of Michigan reduced their tax base in the mid 1990s in an attempt to retain the businesses that were closing as a result of the relocation of the large car manufacturers in the area, the city lost a significant part of their grant revenue, while simultaneously having to face a reduction in the resident’s and corporate income tax they were allowed to collect since 1961. The city resorted to re-develop large areas of the city in a set of policies that combined public safety concerns with the prospect of increasing the collection of construction-related and real estate taxes for the municipal coffers. In addition, the local government turned to the financial sector to secure loans and investments for up to $18.5 billion. This last strategy proved to be the undoing of the city after 2008, when the real estate all but collapsed in the area, and the city found itself without the liquidity ($198 million) to re-finance its debt and avoid filing for bankruptcy in 2013.
Good practices and reforms to improve local government revenue
2015, UN-Habitat published a report to help local authorities in developing countries to overcome the challenges associated with increasing responsibility for delivery of transformative policies and quality services. This report, however, includes suggestions and theoretical insights that are applicable to all municipal authorities.
UN-Habitat experts establish five desirable traits that help to identify what makes a good local tax: a) being buoyant, with revenues roughly changing in proportion to the economic base; (b) being horizontally equitable: providing equal treatment to taxpayers in similar circumstances; (c) being relatively efficient, causing low distortions in economic activity; (d) being relatively low in administration and compliance costs; and (e) being politically acceptable.
The report also suggests that other desirable properties that make local taxes more adaptable to the benefit principle might be: (a) being geographically neutral: not distorting the location of economic activity, not interfering with domestic or international commerce, and not exportable so that the burden is not borne by residents of other jurisdictions, unless matched by benefits to non-residents; (b) having evenly distributed tax bases across jurisdictions; (c) having relatively immobile bases; (d) having relatively stable tax bases over the business cycle; (e) being highly visible and transparent, to increase accountability; and (f ) being administratively feasible.
The report also states that instruments including corporation tax and income tax should not be managed locally because local authorities are ill-equipped to enforce them effectively. Other examples of local taxes that end up damaging local development in the long could be inter-municipal taxes for goods, such as octroi tax enforced in overseas French cities, since they are neither cheap to administrate nor geographically neutral. In contrast, good examples of possible municipal taxes could be property taxes and local services fees. reports from local finance systems as different as New Zealand (2012, 2019) and the United Kingdom (2017, 2018) indicate that there is still some scope to reform local strategies to collect fees and charges to increase its policy impact, transparency and cost-effectiveness. The Commonwealth Local Government Forum, the Local Government Association and the Centre for Cities also provide interesting examples and resources that can be used to improve local strategies to generate sustainable income.
In 2019, the Covenant of Mayors for Climate and Energy in Europe published a brief leaflet highlighting innovative financing schemes to fund locally-owned projects in the framework of their Sustainable Energy and Climate Action Plans (SECAP). Even though the examples are tailored to climate change prevention and energy sector, they offer lessons that can be useful to adapt these schemes to other policy areas such as local infrastructure and housing services.
One of such schemes is issuing municipal bonds to fund long-term projects that have a lasting social impact. These bonds can adopt different forms depending on their final objective, including Social Impact Bonds (SIBs) and Green Municipal Bonds. These tools can produce significant amounts of revenue for local authorities at a low capital cost, as long as the municipal governments have the legal capacity and the technical expertise to issue the bonds in the first place. Local authorities may overcome barriers by partnership with existing investment funds or to use local government funding agencies and arm’s length organisations as proxies to issue the bonds. The project ‘Teens and Toddlers’ in Liverpool is an example of how a local government could use a charitable body (Power2) to deliver educational services funded by SIBs.
One example of successful municipal bonds was the issuing of municipal green bonds by the city of Paris in 2015. Local government-issued bonds for a total of €300 million to renewable energy, low-carbon transport, energy efficiency and climate adaptation projects in partnership with Credit Agricole CIB, HSBC, and Société Générale. They stipulated that if the target was met, the excess capital would be used to fund additional projects that were being developed or that would be developed in the future with the same conditions to return the investment (long term bonds of 17 years, with an interest rate of 1.43%). In less than a week, national and international investors offered €1.2 billion euros on green investments to the city. Local governments can also resort to crowdfunding to accelerate projects that are particularly popular amongst neighbours, as the city of Plymouth discovered in 2016 by raising over £400,000 to support 100 local projects.
There are many examples of revenue-generating schemes supporting local cooperatives to stimulate economic sectors and improve the quality of basic services through encouraging competition. This is the case of Barcelona Energia, a public company funded by the city council in 2017 that provides energy to all municipal buildings in the city area at a fraction of the cost previously paid to private companies. Beyond offering a significant saving to the operating costs of the local council, the company invests in generating renewable energy in the city, provides information campaigns to cities and supports the eradication of energy poverty in low-income households in the city.
US local government decided to take matters in their own hands and bring fast internet to their rural communities, bypassing large telecommunication corporations. To do so, they resorted to the same strategy used to bring electrification to their areas in the 1930s: create an array of inter-connected local broadband cooperatives. This strategy capitalises on the skills and the workforce already present in their communities and allows local authorities to share with citizens and local business the access to faster and more reliable connection to internet while producing benefits for the local corporations.
Lastly, local authorities can decrease the expenses associated with challenges such as urban sprawl and infrastructure adaptation through external efficiency contracting and municipal soft loan schemes. Those strategies should not be conceived as revenue-generating according to the leaflet, but they could be useful to minimise the burden of the investments required by local authorities. For example, local authorities in the region of Wallonia (Belgium) can contract the energy service company RenoWatt to select public buildings that are worthy of being renovated and coordinate the execution of energy-saving and renewable energy interventions. Afterwards, local authorities use the stream of revenue produced by the energy savings to repay RenoWatt the costs of the project.
Local authorities can also encourage individual citizens and companies to make adaptations in their proprieties that would have a positive impact over the community via soft municipal loans, such as updating waste management and energy-saving systems. Even though local authorities have the legitimacy to be the initiators of these processes, the Covenant of Mayors for Climate and Energy recommends them to partner with a technical partner to define the goals and metrics for the individual interventions and also partner with a bank or a fund to manage the loans. One example is the Brussels Green Loan programme, in which the local authority collaborates with a local financial cooperative to offer zero to low-interest loans to homeowners to pre-finance energy renovation work.
Despite the diversity of economic and legal frameworks affecting local government finance, the historical evolution of local finances in the last 200 years has led to a convergence that allows learning from innovative schemes, and from the successes and failures of other cities, regardless of their size or geographic locations. The suggestions and examples included in this briefing speak to the power that collaboration; well defined financial policies and transparency can help to improve the fiscal health of local authorities.
However, examples included in the briefing required the support and hard work of dedicated public leadership that seems incompatible with extreme austerity policies. In the current context of budgetary preparations for Brexit, intergovernmental transfers and business revenue are under continued pressure. Local authorities in the UK and Ireland could take the opportunity to revise policies on local fees and taxes with fresh eyes, and continue debates on diversifying sources of income and savings rather than relying on programme cuts and debt restructure – as Detroit did before filing for bankruptcy in 2013.