Local government finance: a comparative study

The Local Democracy Research Centre has commissioned experts at the University of Northumbria, led by Dr Kevin Muldoon-Smith, to look at how local government is funded in different countries around the world.

The research takes a whole-system approach, considering local government finance as a system operating within varied national contexts, including the constitutional and legal framework, politics, expectations, roles and responsibilities. This is an original contribution to the Local Government finance debate, particularly in England, across international jurisdictions where system wide analysis is difficult to obtain because of its cross disciplinary and fragmentary nature.

This research will compare local government finance systems in four countries: England, Germany, Italy, and Japan.

The countries have been selected for two reasons. First, all feature local authorities with broad responsibilities, a wide range of revenue-raising powers, and an established role within the territorial governance of the state. Elements of practice within those countries are frequently presented as options for change in the UK and Irish context. Second, these countries are all non-Anglophone. Local government and local government finance systems in Anglophone countries have a common ancestor in English practice and share many historical similarities. These include local revenue consisting primarily of property taxes; a lack of constitutional protection; limited functions; and more restrained legal or financial supervision by central officials.

By providing an in-depth analysis of these different systems, we will enhance our understanding of the options available for running local government in different ways and better understand the context of local government finance pressures. Examples of isolated practices that can be seen in each of the case studies have featured at points in the debate on local government financing across each and, of course, in the case of the local government systems in the UK and Ireland. For instance, tax powers and shared revenues in Japan, and redistribution in Germany.​​ However, there has been little analysis of how these options operate in practice.

This paper provides a short summary of key points in the forthcoming research. A full report on each of the countries studied will follow shortly, enabling comparisons between England and the German, Italian and Japanese systems. A final report will then draw conclusions from the research, indicating key system differences between England and the comparator locations – drawing out how these local government finance systems have evolved and what this means for potential change in England. We are then planning follow up work looking at the Scottish and Irish local government systems.

Full country reports

1. The limitations of local government finance in England: A system wide perspective

The financing of English local government is a source of sustained dissatisfaction within the sector. There are four key reasons for this:

1. English local government funding from the central government has been significantly reduced since 2010. The overall spending power of local governments has reduced by 50% from 2010/2011 to 2020/2021.
2. Local governments are unable to make medium or long term plans in the context of short-term and often competitive funding settlements.
3. Local governments have little control over the means by which they can raise revenue. The two main revenue-raising taxes – council tax and business rates – are tightly regulated by the central government.
4. A promised review of local government finances – the “fair funding review” has been paused indefinitely.

Structure of local government in England

The Local Government Act 1972 introduced a two-tier local government structure across England, which remains the primary way local government is organised to this day. The act split responsibilities between county councils, responsible for large-scale public services (education, adult and children’s social care and transport), and district councils, responsible for smaller-scale services (housing, the environment and waste). In other areas, there is a single ‘unitary’ authority taking on responsibility for all local services.

Today, there are 318 councils in England.

• 21 County Councils (upper-tier)
• 164 District Councils (lower-tier)
• 32 London Boroughs (unitary)
• 36 Metropolitan Boroughs (unitary)
• 63 Unitary authorities (unitary)
• 2 Sui Generis authorities – City of London Corporation and Isles of Scilly (unitary)

There are also parish and town councils with limited funding and powers at the lowest level of local governance, and there are mayoral combined authorities across a minority of key areas which operate over multiple councils with respect to a small number of strategic functions.

Local government responsibilities in England

Local government responsibilities can be split into three broad camps:

1. Statutory:  parliament has imposed a legal duty for local governments to provide the service. These are often subject to statutory requirements or subject to national monitoring regimes.
2. Mandatory: services the local government only has a general duty to provide but must provide up to a certain standard or risk legal challenge.
3. Discretionary: services a local government may choose to provide, such as leisure centres.

Levels of funding of local government in England have no legal or institutional link to local authority functions. This means that these three responsibilities are not funded using parallel or proportionate financial arrangements. There are examples where local authority spending is defined from the centre (known as ring-fencing), such as in the funding of schools or public health. However, this is increasingly rare and local authorities have cut discretionary spending on rational grounds following the overall reduction in revenue.

Germany has three levels of government, the central government, 16 Länder (federal states) and, at the local level, 400 districts and over 10,000 municipalities. As a federal republic, local and central levels of government share power as equal stakeholders through a written constitution. Amendments to the constitution must be approved by both levels of government.

In Germany, municipalities have two areas of responsibility: their own area of responsibility – tasks they undertake autonomously, although may be mandatory by federal law or voluntary – and transferred responsibilities – tasks which are administered at the lowest level of government but with supervision from the state, such as security.

Meanwhile, responsibilities are assumed to be completed at the lowest level and only moved to a higher level of government when the lower level cannot complete them, a ‘bottom-up’ approach. In England, on the other hand, functions are allocated to local governments from the centre by Acts of Parliament.

German municipal governments have three main sources of revenue:

1. Rates, Contributions and Concessions: rates are the foundation of the system and are charged for services such as water, wastewater, refuse collection and landfill and street cleaning. They are obligatory payments and are calculated to the extent that they may only cover the cost of the services provided.
2. Local Taxes (minor municipal taxes and impersonal taxes): Minor municipal taxes are separate taxes levied by the municipality, and the most common include Dog Tax, Entertainment Tax, Beverage Tax / Liquor Licence Tax and Secondary Residence Tax. Impersonal taxes form the backbone of municipal taxation, and the two major taxes are local business tax and property tax.
3. Joint Taxes: revenue sharing between all three levels of government entitles municipalities to a share of joint taxes to supplement their revenue.

The majority of local tax revenue in Germany is collected from business profits.

According to Article 61 of the German Basic Law, municipalities must plan and manage their budgets in such a way that they can always perform the required tasks. State authorities supervise the local budgets to ensure they remain within state regulation/budgetary frameworks. Because of significant financial equalisation between localities, there is less pressure to maintain a balanced budget on a local level.

Italian local government has four levels:

1. Central government: with responsibility for foreign policy, immigration, currency, and other nation-level policies.
2. Regions: the constitution states that “the Regions have legislative powers in all subject matters that are not expressly covered by State legislation,” including the international and EU relations of the regions, foreign trade, education, and energy policy.
3. Provinces: the role of the provinces has reduced over the last decade, with their powers being transferred to regions or municipalities. Provinces currently have responsibility for the following: protection of the environment, planning for transportation services, and several other tasks within the province, such as supporting local authorities.
4. Municipalities (Comuni): Article 13 of Legislative Decree 267/2000 states that Comuni are responsible for all administrative functions that concern their population territory. These include: social welfare, education, culture, planning and transport.

Decentralisation in Italy has been actively encouraged since the early 2000s. The Italian constitution includes a clear outline of local government responsibilities in a way that is not possible with the English unwritten constitution.

In Italy, the constitution requires the state to define essential levels of service (LEP) for civil and social rights throughout the country.

Local authorities are constitutionally mandated to ensure their budgets are balanced, overseen by the Court of Auditors.

Italian law distinguishes between expenses that affect fundamental rights of citizenship, such as health, assistance, and education and the expenditures related to fundamental functions of local authorities for which full financial coverage is provided. For functions other than fundamental ones, the financing is done through a model of fiscal capacity equalisation.

The main sources of municipal income from taxes are the Imposta Municipale sugli Immobili (IMU), a municipal tax paid on the possession of real estate. The TASI tax finances waste collection and disposal for those who own or hold a premise that produces waste. The IREF surtax is an additional tax levied on top of the already existing income tax system. Other non-tax revenues include revenue from businesses, commercial activities, property ownership, collection of parking fines, financial operations, private sector loans and the issuing of bonds.

Local government in Italy has a much wider range of tax-raising powers than local authorities in England, possessing the ability to establish and set tax rates in line with the constitution.

Equalisation between territories is primarily managed by the Municipal Solidarity Fund. The fund was created by Law 228/2012 and is managed by the Central Direction of Local Finance in the Ministry of the Interior. The central principle of the fund is solidarity; poorer municipalities should receive funds and the richer, more stable municipalities should finance it.

Local autonomy in Japan is constitutionally protected and considered indispensable to democracy. Decentralisation has been actively encouraged since the early 1990s – the Decentralisation Promotion Law was passed in 1995. Chapter 8 of the Constitution contains four articles outlining the nature and guarantee of local autonomy:

• Article 92: outlines the basic “principle of local autonomy” fixed in law.
• Article 93: established legislative assemblies and the direct election of local officials.
• Article 94: details that local public entities shall have the right to manage their property, affairs, and administration and to enact their own regulations within law.
• Article 95: the diet cannot enact a special law that is only applicable to one local government without the majority consent of a local referendum in that location.

Japan has a three-tier system of government, national, regional, and local. The “Local Autonomy Law” specifies two basic types of local authorities: prefectures and municipalities. These are framed within a two-tier system of sub-national government, prefectures as regional government units and municipalities as the basic local government level unit. Prefectures and municipalities operate as independent entities that carry out local public administration within their jurisdictions. Both entities have democratically elected governing bodies and representatives. The system is centred on the comprehensive authorisation principle; prefectures and municipalities act as comprehensive administrative bodies and perform activities considered necessary for their residents.

Central Government is responsible for the following:

1. Affairs relating to Japan as a nation in the international community.
2. Affairs relating to various activities of the people that should be handled in a uniform, nationwide manner.
3. Executing policies and projects that must be performed from a nationwide viewpoint or on a nationwide scale.

The responsibilities of prefectures are as follows:

1. Wide-area affairs (e.g., prefectural roads, harbours, forest and river conservancy, public health centres, vocational training, police)
2. Communication and coordination affairs relating to municipalities (e.g., advice, recommendations and guidance concerning rationalisation of municipal organisation and operations)
3. Supplementary affairs for municipalities (e.g., high schools, museums, hospitals)

The responsibilities of municipalities are as follows:

1. Affairs relating to the fundamentals of residents’ lives (e.g., family registers, resident registration, street addresses)
2. Affairs relating to ensuring the safety and health of residents (e.g., fire service, garbage disposal, water supply, sewage)
3. Affairs relating to the welfare of residents (e.g., public assistance (within the area of cities), nursing insurance, national health insurance)
4. Affairs relating to urban development plans (e.g., urban design, municipal roads, parks)
5. Affairs relating to the establishment and management of various facilities (e.g., public halls, citizens’ halls, day-care facilities, elementary and junior high schools, libraries)

Local governments have full control over their independent financial operations. However, mechanisms exist to ensure balance with central government financial operations and to secure revenue sources.