Local government finance: a comparative study

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Introduction

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

Why are we doing this?

This project aims to provide a more in-depth understanding of local government finance, but also to help develop practical alternatives to move the local government debate forward.

English Local Government has seen continual discussion of how its financing works in recent years. Particular attention has been devoted to options for fiscal devolution; funding shortages, originating in the UK Government’s ‘austerity’ policy of the early 2010s; and controversies over large-scale borrowing, resulting in a small number of English local authorities experiencing severe financial difficulties. This is less the case for Ireland where Government focus has been on institutional shifts such as the introduction of elected mayors. Finance remains largely a limited area for central government consideration, notwithstanding the strength of national public finances.

Analyses of these situations typically focuses on a single element of the finance system, rather than a wider connected system approach to local government finance. For example, considerations of the local authority, without consideration of its relationship with central government or local government autonomy without considerations of equalisation. The wider system perspective in this study includes the functions of local authorities; capital finance and its regulation; audit and budgeting practice; funding redistribution to take account of economic variations; and the often-uneven culture of central-local relations.

The reports, as they issue, will be useful for policymakers, practitioners and academics, across the LGIU Jurisdictions, seeking to understand the different ways local services are financed internationally, and for those considering how different local government approaches could be usefully applied in democracies across the world. It is also hoped that examining the operation of these alternative systems will provide useful contextual information for future proposals to reform the Local Government finance system in England and, potentially, Scotland and Ireland.

Research methodology

About the Local Democracy Research Centre

Research to solve key challenges facing our local democracies everywhere.

The LGIU’s Local Democracy Research Centre (LDRC) has an international programme that engages local authorities and universities in original research. We develop new ideas and approaches for governance, municipalism and citizen participation.

Do you want to work with us on projects, collaborations, research, fellowships, exchanges and PhDs for the future of local democracy? The opportunity to be involved and make your views known is a key part of LGIU membership. Get in touch: [email protected]

The research is cross-disciplinary, blending insights from policy, territorial, governance, finance, and real estate studies.

The first research stage included scoping interviews with subject experts in academia and practice followed a semi-structured interview format in each international location. This provided context for the research and direction towards relevant resources and information on practice within the local government finance system in England.

The research then examined information from secondary academic literature, government documentation and legislation regarding the legal structures underlying local government finance systems in Germany, Italy, and Japan. Obtaining detailed and accurate information on the operation of local government finance systems was not straight forward, with sources providing contradictory information at times. The second stage involved cross-referencing and sense-checking of evidence with subject experts in the respective study locations which led to a process of draft refinement and gap analysis.

The third stage of research gathered additional empirical data on each international system and a final panel meeting with experts in each country to form consensus around key research findings. This final research stage involved sense checking and opportunity identification with a steering group of experts in England. This stage ran throughout the project, designed to review, and revise the research objectives, to highlight opportunities for dissemination and to consider how the international findings could be applied in England. As noted previously we envisage a similar approach in our proposed research for Scotland and Ireland.

Background to the debate in England

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.

Local government finance in Germany

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.

Local government finance in Italy

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 government finance in Japan

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.

Conclusions

A more in-depth set of conclusions will follow in the analysis reports, due to be published soon. There are some findings that are worth highlighting, however, as they provide some useful points of comparison that will be fleshed out.

Our comparison of international local government finance systems shows that radically different scenarios are possible, though they would require much more than tinkering with finances to bring them about. What is clear is that different systems have significantly different outcomes.

Germany, Japan and Italy all have clear constitutional roles, responsibilities and protections for local government, which has enormous implications for funding, autonomy and power at the local level.

The fact that the German Basic Law, which was designed in part by the British, enshrines subsidiarity and no additional responsibility for municipalities without funding attached, is particularly striking. 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. That local government in Italy has a much wider range of tax-raising powers than local authorities in England demonstrates that this is possible, too. Councils possess the ability to establish and set tax rates in line with the constitution.

Whether this leads to greater trust of local government in these countries is another question, however, but it does clearly demarcate roles, responsibilities and resources. This in turn helps to enable a greater sense of partnership and a shared approach to tricky questions like equalisation between areas. In short, municipalities are treated like adults in the room.

By exploring the different systems for funding local government and providing practical alternatives, we will drive forward the debate on local government funding. This unique system-wide perspective will be useful for practitioners, policymakers and academics seeking to understand the different ways local services are financed in democracies across the world.

If you wish to discuss the project, if you have any questions, or if you have suggestions about how the research can progress in a way that is helpful for you, please contact or [email protected].

LGIU@40

This research is part of a body of work that is informing our campaign LGIU@40: For the future of local government.

Together with our members and the wider sector we will be establishing a set of new ideas about how local government could work better and how we can build the firm foundations we need to navigate a turbulent and uncertain future.

We are exploring five key questions and this research speaks directly to the first of those.

  1. What if local government was funded properly?
  2. What if central government trusted local government to do its job?
  3. What if people trusted democratic institutions again?
  4. What if people really participated in local democracy?
  5. Why is local government the answer?
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