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Experts from all over Spain warn of the precarious state of local finances and discuss possible solutions: increasing tax burden, merging municipalities, and streamlining institutions

In the IEB’s Second Report on Fiscal Federalism in Spain, professors and researchers analyse the situation of town and city councils and propose a series of measures

The IEB’s Second Report on Fiscal Federalism in Spain analyses the worrying situation of local government funding and debates possible solutions. Experts on Spain’s economy propose a range of measures, including raising tax burden and merging municipalities. They argue that cities like Barcelona and Madrid should receive compensation for the costs they have to bear as capitals of Catalonia and Spain respectively, and note that Catalan city councils spend three of every ten euros on services that they are not in fact obliged to provide. The IEB also analyses the funding problems of city councils at international level in its second World Report on Fiscal Federalism, with contributions from researchers from Denmark, Switzerland, Canada and Italy.  

The Barcelona Economics Institute, a centre of research in Applied Economics at the University of Barcelona, publishes an annual Report on Fiscal Federalism, with articles by experts from the IEB itself and from other universities, research centres, and government bodies. This year’s edition includes the following studies:  

City councils must raise local tax burden to overcome an unsustainable situation (Javier Suárez Pandiello, University of Oviedo)

Javier Suárez Pandiello, Professor of Public Economics at the University of Oviedo, argues that the current local funding systems and government structures are no longer sustainable. Nonetheless, he states that city councils do not make full use of their tax capacity; to avoid unpopularity, they do not apply the maximum tax rates that they are legally authorized to levy in areas under their jurisdiction. The lack of flexibility of the tax bases means that when faced with increased spending needs, as in the current recession, local governments cannot increase their tax income without adopting discretionary measures.  The author warns that the only option available to city councils is to take these discretionary measures, despite the current economic situation, in order to raise local tax burden. Suárez Pandiello advocates a new tax on business activity and considers the practical elimination of the Tax on Economic Activities (IAE) in many municipalities as a grave mistake. He also favours the study of charging users for specific services (without a redistributive component), and increasing local tax areas by the introduction of shared taxes. Capacity in the area of income tax would endow local governments with an instrument for personalizing tax revenues which would improve the current situation.  

Time to end small-scale municipal organization and to simplify municipal institutions (Roberto Fernández Llera, University of Oviedo)

The author argues in favour of measures such as the merger of local institutions (either promoted by financial incentives or imposed from above), to put an end to the piecemeal style of municipal organization in Spain and to make the system administratively and financially viable. He calls for the streamlining of institutions and the abolition of insolvent and inefficient offices, and advocates mergers between bodies with similar or complementary powers. Fernández Llera argues for an internal stability agreement to reinforce joint responsibility and coordination both between levels of government and inside local government itself. These measures would “federalize” budget stability, making it automatic, and would obviate the need for drastic, improvised measures and cutbacks in times of recession.  The author stresses the need to strengthen control and transparency, budgeting according to objectives, management indicators, and selective sanctions. In his view, it must be made clear that generalized bailouts for municipalities will not be permitted. Fernández Llera calls for a new model of local funding to allow local entities to cooperate fully in the reduction of the public deficit by 2013.  

Barcelona should receive an additional 150 million euros to offset the cost of its capital status (Núria Bosch – Marta Espasa – Daniel Montolio, Barcelona Economics Institute)

Being the capital of Spain costs Madrid 384 million euros, and being the capital of Catalonia costs Barcelona 150 million euros. Madrid and Barcelona are followed by Seville (87 M€), Alicante (46 M€) and Valencia (46 M€) in the ranking of Spanish cities which, according to the authors, should receive compensation for the cost of being provincial capitals. Calculating the gross compensation per capita, the city council of Madrid should receive 119€ more for each resident, and the city council of Barcelona should receive 92€. These compensations are gross figures, because they do not take into account the possibility that capital or large city status may generate more income. These are some of the conclusions regarding the estimation of the costs of centrality and capital status in Spain in this study carried out by three IEB researchers. The main cost of centrality identified by the study is the flow of non-residents, which may overload the municipal services, accentuate social problems, and raise levels of congestion and density. The principal cost of capital status is the loss of tax revenue due to the fact that most government activities are tax-exempt, and that these activities predominate in any city that is the capital of an autonomous community.  The study concludes that cities with more than 75,000 inhabitants should have a funding system that compensates them for these costs, and that it should be separate from the system that finances the rest of municipalities. The authors also argue that this differential funding should be established via compensatory transfers from the autonomous or central governments or through special tax formulae, such as a tourism tax based on overnight stays or an increase in the taxes on consumption. In the UK, London receives compensation for its capital status. 

Catalan city councils spend three of every ten euros on services that they are not obliged to provide (Maite Vilalta – Barcelona Economics Institute)

The services in question are in the area of culture (23%), public safety (20%), education (11%) and social programs (10%) – services promoting culture, sport, heritage, kindergartens, and employment. It is municipalities with populations below 5,000 inhabitants that have the highest volume of non-obligatory spending per capita, with a mean figure of 136€. In the smaller municipalities, the greater part of non-obligatory spending goes on culture, and in larger municipalities the greater part is allocated to public safety.
 Part of the funding of these non-obligatory services is covered by special discounted prices paid by the residents who use them (8.5%) and by transfers from other government offices (17.1%). But by far the greatest part of this spending – 70% – is funded by taxes that come under the city councils’ tax jurisdiction and through “no strings attached” transfers they receive from other government offices. These figures highlight the poor distribution of the resources and powers between the three levels of government. The author calls for the definition of a clear jurisdiction for local government and stresses the need to strengthen the relations between treasuries at local and autonomous level.  In addition to the obligatory services, current legislation allows municipalities to provide other services to cater for the needs and aspirations of their residents. In addition, the law specifies which services the municipalities are obliged to provide, depending on their size. The IEB’s Second Report on Fiscal Federalism in Spain also includes reflections by experts on the problems of municipalities with a high level of tourism, the possibility of introducing a local environmental tax, the relationship between urban development and local funding, and the role of general subsidies in municipal funding in the country as a whole.  The Barcelona Economics Institute is a research centre in Applied Economics at the University of Barcelona which promotes, develops and publishes economic research. In 2008 the IEB Foundation was set up along with the Chair in Fiscal Federalism of the University of Barcelona, with the cooperation of the Institute of Autonomous Community Studies, the ICO Foundation and the Institute of Fiscal Studies. 

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