In its III IEB Report on Fiscal Federalism, the Barcelona Economics Institute warns that the current crisis threatens the very sustainability of local services, but at the same time the situation provides an opportunity to carry out far-reaching reforms of the system.

The III IEB Report on Fiscal Federalism published by the Barcelona Economics Institute (IEB) proposes taking advantage of the current crisis to reorganise local government and reform its system of financing. The changes proposed would involve downsizing local administration, promoting the merger of small municipalities as a cost-saving measure and implementing urgent reforms of the local financing system. The reforms, aimed at creating a more just finance system and at cutting the severe municipal deficit, would involve first and foremost a clear-cut division of powers and the reform of taxes, such as local rates (IBI) and the tax on commercial and professional activities (IAE).

The Barcelona Economics Institute, the University of Barcelona’s Applied Economics research centre, publishes an annual IEB Report on Fiscal Federalism, with contributions from experts at both the IEB and at universities around the world. This year’s report, coordinated by the professors of public finance and IEB researchers, Núria Bosch and Albert Solé, seeks to contribute to the urgent debate on the grave financial situation currently faced by the municipalities with the opinion and analyses of leading economists. The IEB is home to the University of Barcelona’s Chair in Fiscal Federalism, which, with the support of the ICO Foundation, the Institute for Fiscal Studies and the Institute of Autonomous Studies, undertakes the writing and publication of this report together with a wide research program on Fiscal Federalism.

Proposals for the reorganization of local government

Merging of municipalities with less than 5,000 inhabitants The report concludes that most of Spain’s municipalities are administratively unviable, and considers their merger essential in any process of strengthening local government. In the case of Spain, establishing a minimum size of 5,000 inhabitants would represent a major step forward, bearing in mind that 85% of the municipalities are currently below this threshold. The benefits to be gained from such a merger would be: § to reduce administration costs, while guaranteeing the improved administrative capacity of the municipalities § to facilitate the reform of the local finance system, reducing the dependence of the municipalities on higher tiers of government and improving the fiscal responsibility of each municipality § to improve the efficiency of municipal investment policies (reducing the dependence of the small municipalities on higher tiers of government) and avoiding the duplication of service provisions. § to facilitate municipal financial control (currently impeded by their size and sheer number) and the design of policies tailored to their needs (e.g., fiscal stimulus; aid in extreme financial situations, etc.). The reform would need to be accompanied by improvements to the systems of citizen participation to guarantee that all citizens (including those in the small merged municipalities) have the capacity to play a role in the decisions that affect them.

Strengthening of intermunicipal cooperation

The report argues in favour of strengthening intermunicipal cooperation to exploit scale economies, especially when a merger is not feasible or in the case of services for which there is greater potential for cooperation. In solid waste collection, for example, the study points out that in the municipalities of Catalonia that cooperate the cost is 19% lower than it is in the non-cooperating municipalities. And if we only consider municipalities with fewer than 10,000 inhabitants, the mean cost is 22% lower. To date, however, in many instances cooperation via supramunicipal levels of government has been expensive and has led to a duplication of administrative costs.

Elimination of supramunicipal levels of government

The report considers self-evident the potential for simplifying the State’s administrative structure (Provincial councils; comarca district councils; cabildo administrative councils; local councils; Metropolitan Entities, etc). And it identifies as the first possibility designing a structure of asymmetrical supramunicipal governments, maintaining them in rural zones to guarantee the provision of certain services and eliminating them in urban zones. A second option is the replacement of all supramunicipal governments with more flexible institutions, similar to the voluntary associations of municipalities that exist in France and Finland. Their successful operation could be ensured by providing adequate financial incentives and an institutional design that facilitates decision-taking. As for the metropolitan areas of the big cities, the report calls for the coordination of service provision and the sharing of costs through the establishment of cooperation agreements or by creating metropolitan entities. In the case of Barcelona, a simplification of the administrative organization in the metropolitan area seems necessary, eliminating other levels of government such as the comarca district councils.

Proposals for a new local financing model

The proposal for a new local financing model, included in the report and presented by Professor Maite Vilalta, seeks to lay the foundations of a more just and equitable system that would reduce the municipal deficit. According to the authors, the reform would, inevitably, require a clearer distribution of powers and an increase in the financial autonomy of the municipalities, endowing them with regulatory capacity over the taxes that contribute a major part of their resources. (Today, municipal income derived from taxes and the rates stands at 43%, while in 2001 it was 48.9%)

Objective: greater financial autonomy

a)Changes in local municipal taxes (rates, tax on commercial and professional activities, vehicle tax, taxes on building work and on increase in urban land value), with the aim of making them more efficient, flexible and transparent:

Property tax/Rates (IBI):

• § Assess rateable values on the basis of their market value § Review rateable values more frequently § Increase maximum ceiling on tax rates § Study application of higher tax rates to property used for business purposes and give more favourable treatment to principal residences § Apply a surcharge on permanently unoccupied property

• Tax on commercial and professional activities (IAE):

  § Reform the tax so that the quota payable is tied closely to the business value § Abolish it and offset the losses with an alternative tax Vehicle tax : § Introduce environmental variables linking payments to the level of vehicle contamination § Improve the relation between the value of the vehicle and the taxable quota § Analyse the links with vehicles used for business activities § Raise the tax rate and eliminate the tax on certain means of transport (CCAA)

• Tax on constructions, installations and building work (ICIO):

  Extend the payment of the ICIO and make it compulsory in all situations, not just when a licence is required.

• Tax on the increase in value of urban land (IVTNU)

  § Modify the way in which the tax base is calculated so that the increase in value that is assessed is real and not estimated, as is currently the case § Possibility of integrating the IVTNU and the transfer tax and dividing the tax rate between the Autonomous Communities and the municipalities

• Changes in taxes in which only large municipalities (more than 75,000 inhabitants) can participate:

  § § Study the possibility that all the municipalities (not just those with more than 75,000 inhabitants) receive part of income tax (IRPF). The economic argument is that the municipalities provide services linked to the welfare state and not just to land and buildings § Examine the possibility that the municipalities, at least those of a certain size, might have some regulatory capacity over income tax (IRPF) c) To study the introduction of new taxes in the municipal tax basket: § Introduce a (voluntary) tax to be levied on tourists (overnight stays) § Raise public rates and prices for given services § Provide incentives for the use of special tax contributions § Modify the tax regime of companies supplying services in the public domain and reconsider recognition of Telefònica’s special tax regime

• Objective: greater vertical and horizontal equilibrium

  The study laments the imbalance between the distribution of powers and the distribution of potential income between central, intermediate and local governments. This imbalance has become more marked of late, among other reasons, because of the fall in fiscal capacity (many of the taxes levied by the municipalities depend on the property sector) and the increase in municipal costs from their having to provide services that correspond to other levels of government. According to this study, the solution to this imbalance involves an increase in the resources that the State should be injecting into the municipal finance model. A further proposal made by the report and drawn up by Professors Francisco Pedraja and José Manuel Cordero is that the local finance model should distinguish more clearly between small and large municipalities. The authors also stress the need to establish more just distributive formulae, based on indicators of need (population with weightings) and capacity (index based on IBI). The aim of such a reform would be to link resources to capacities, a situation that does not occur with the application of the current formula. All the proposals contained in the III IEB Report on Fiscal Federalism are based on the analyses of prestigious researchers, including Maite Vilalta (University of Barcelona and IEB), who describes the basis for financial reform; Germà Bel (University of Barcelona), who evaluates scale economies in different points of the State; Francisco Pedraja and José Manuel Cordero (University of Extremadura), who argue for the reform of the grants system; Anti Moisio (Government Institute for Economic Research in Helsinki), an expert in the municipal cooperation formulae used by Nordic countries; Guy Gilbert (École Normale Supérieure de Cachan), analyst of the French case; and Enid Slack (University of Toronto), who undertakes an analysis of financing in metropolitan areas.

• Read the III IEB Report on Fiscal Federalism