Coordinating Central and Local Governments Policy in Iceland · Share of sub-central government expenditure in total government expenditure 0% 10% 20% 30% 40% 50% 60% 70% 80% a k

Coordinating Central and Local Governments Policy in Iceland

Björn Rúnar Guðmundsson

Head of Economic Department

Ministry of Economic Affairs

A bird´s eye view: Municipalities in Iceland

Overall number of municipalities in Iceland is 77 with an average number of inhabitants just over 4.100.

In reality it makes more sence to look at the larger capital-area on one hand and the rural areas on the other hand.

Strong centralication trend.

About 75 per cent of the population lives in the 15 municipalities in the larger capital-area.

Population development in Iceland, 1990 - 2008

0

50.000

100.000

150.000

200.000

250.000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Larger capital-area The rural areas

Average rate of growth 1.9%

Average rate of growth -0.2%

Source: Statistics Iceland

Autonomy of local governments is very high in Iceland.

• By international comparison icelandic municipalities enjoy a high degree of freedom in the public financial area.

• Number of municipalities has decreased rapidly, but is still very high.

• There is a politicial consensus in Iceland that the role of municipalities in providing public services should be increased.

• Article 61 of the Local Government Act requires that municipalities revenues match expenditure “as far as possible”. This loose phrasing can invite difference in interpretation.

• The three-year plan stipulated by the Local Government Act is not perceived as binding restrictions in all municipalities.

Main expenditure categories of local governments in 2008.

7,9%

2,1%

2,5%

4,0%

4,2%

7,6%

11,0%

12,4%

48,5%

0% 10% 20% 30% 40% 50% 60%

Other

Construction and planning

Environment

Traffic and transportation

Culture

Mutual cost

Social Service

Youth and sports

Education and child care

Source: The Association of Local Authorities in Iceland

Total public investment, % of GDP

Source: Statistics Iceland

0,0%

0,5%

1,0%

1,5%

2,0%

2,5%

3,0%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Local governments Central government

0,0%

2,0%

4,0%

6,0%

8,0%

10,0%

12,0%

14,0%

16,0%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Local governments Central government

Current division of public spending between levels of government.

Public consumption, % of GDP

Poor overall performance in the last three decades

Since 1980 local government sector has only had positive income balance 8 times (central government 12 times).

Both local and central government show a clear pro-cyclical behaviour.

In 2008 the income balance of the central government is shown and calculated without large takeover of lost claims from the Central Bank.

Including these items central government deficit amounts to 13.6 per cent of GDP.

-6

-4

-2

0

2

4

6

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

Income balance of central gov., % of GDP

Income balance of the local gov., % of GDP

Central government average -0.46%

Source: Statistics Iceland

Local governments average -0.33%

Correlation between the output gap and the income balance of central and local governments (% of GDP)

Source: Statistic Iceland and the Ministry of Finance

y = 0,8732x - 0,6324R² = 0,6865

-4

-3

-2

-1

0

1

2

3

4

5

6

-4,0 -2,0 0,0 2,0 4,0 6,0

y = 0,0961x - 0,5534R² = 0,1843

-2

-1,5

-1

-0,5

0

0,5

1

-4,0 -2,0 0,0 2,0 4,0 6,0

Output gap (x-axis),

Income balance of local governments (y-axis)

Output gap (x-axis), Income balance of the central government (y-axis)

Evolution of local governments revenues and expenditures,% of GDP

2000 2001 2002 2003 2004 2005 2006 2007 2008

Total income 11.5 11.8 11.8 12.1 12.1 12.7 13.8 14.2 13.1

11 Taxes 8.7 8.8 8.7 8.9 8.9 9.3 10.1 10.2 9.5

13 Grants 1.0 1.1 1.1 1.2 1.1 1.1 1.2 1.3 1.3

14 Other revenue 1.9 1.8 2.0 2.0 2.1 2.4 2.5 2.7 2.3

Total expenditure 12.0 12.4 13.1 12.9 12.9 12.6 13.5 13.6 14.0

2 Current expense 10.5 10.5 11.5 11.9 11.3 11.3 11.4 11.6 12.1

31 Nonfin. assets 1.4 1.9 1.6 1.0 1.6 1.3 2.1 2.0 1.9

Income balance -0.4 -0.6 -1.3 -0.8 -0.8 0.1 0.3 0.6 -0.9

Source: Statistics Iceland

Main income and expenditure components of local governments operations 2008.

Income Expenditure

54,8%

13,3%

4,6%

9,7%

17,6%

111 Taxes on income and profit

113 Taxes on Property

114 Taxes on goods and services

13 Grants

14 Other revenue

Source: Statistics Iceland

40,3%

28,3%

3,6%

4,0%

1,9%

3,4%

4,7%13,5%

21 Compensation of employees

22 Use of goods and services

23 Consumption of fixed capital

24 Interest

25 Subsidies

27 Social benefits

28 Other expense

31 Nonfinancial assets (Investment)

Share of sub-central government expenditure in total government expenditure

0%

10%

20%

30%

40%

50%

60%

70%

80%

Can

ada

Den

mark

Un

ited States

Ko

rea

Spain

Germ

any

Swed

en

Belgiu

m

Finlan

d

Czech

Rep

ub

lic

Ireland

Au

stria

Neth

erland

s

No

rway

OEC

D average

Po

land

Italy

Iceland

Un

ited K

ingd

om

Hu

ngary

France

Slovak R

epu

blic

Luxem

bo

urg

Po

rtugal

New

Zealand

Greece

State or regional level Local level OECD average

Iceland

Source: OECD National Accounts. All functions, average 1995 – 2005, except; Korea (2000 – 2005), Hungary (2001 – 2005) Poland (2002 – 2005), New Zealand (2003 – 2005) and Slovak Republic (2003 – 2004). For the US, National Accounts do not provide a breakdown between state and local governments.

Economic consequences of local government autonomy

One obvious consequence of small municipalities is administrative inefficiencies.

Administrative cost in the smallest municipalities are up to 150.000 ISK per inhabitant in 2008 but down to 25.000 in the largest municipalities like Reykjavík and Kópavogur.

0

20.000

40.000

60.000

80.000

100.000

120.000

140.000

160.000

180.000

0 5.000 10.000 15.000 20.000 25.000 30.000 35.000

Per-Capita administrative cost and size of municipalities

Source: The Association of Local Authorities in Iceland. Reykjavík is not included.

Economic consequences of local government autonomy

Icelandic local authorities borrowed considerably in foreign currency giving them a significant exposure to fx risk which has had negative balance sheet effects for many municipalities.

The share of foreign debt ratio in 2008 was 42 per cent in long term debt which amounts to 111.6 bn. ISK, 7.6% of GDP...

...but 28 per cent in 1998.

Off-balance sheet debts amount to 52 bn. ISK in 2008. About 80 per cent of this debt is held by the municipalities in the larger capital-area.

Another issue relates to competition among local authorities which under certain circumstances can lead to ineffective distribution of resources. Recent housing boom is a case in point. 0

20.000

40.000

60.000

80.000

100.000

120.000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Debt in millions of ISK Debt in foreign currency

Source: Statistics Iceland

Currency composition of local gov. long term debt in 2008

Local government budget framework has to be strengthened

Local governments are currently required to „led revenues match expenditure as far as possible“. This should not be seen as a „soft budget“ regime. At the same time it can hardly be seen as a „hard budget“ condition. It is somewhere in between.

During 2002-2008 period 30 municipalities have negative overall balance...

...up to 16 per cent of income.

One municipality had a negative result each year during the seven year period.

During the last few years off-balance sheet items have increased dramatically.

Current regulatory framework needs to be strengthened.

0

2

4

6

8

10

12

14

16

Years 7 6 5 4 3 2 1 0

Source: The Association of Local Authorities in Iceland.

Number of years with negative balance

Nu

mb

er o

f m

un

icip

alit

ies

Coordination between central and local government needs to be increased.

• From an economic policy point of view the central government has to have a lever on overall public sector fiscal position.

• This is particularly important in a crisis situation. In general, however, effective fiscal policy is crucial, particularly should Iceland join the EU.

• Accountability in relation with transfer of services from central to local governments has to be strengthened. As new tasks are assigned to local governments, funding has to be secured.

Re-inventing the wheel is unnecessary –Adopting international best-practice.

• A framework for policy coordination has already been put in place and there is a genuine understanding at both local and central government level for the need to increase policy coordination among different levels of government.

• Studies are under way looking into which setup will be most useful for Iceland.

• A mixture of legal reforms, budgeting rules and increased enforcement mechanism is needed in order to enhance policy co-ordination between different levels of government.

• The time to implement significant reforms in this area has probably never been better than right now.