The local government financing model needs to change

Toomas Mattson | 4/3/2017 | 11:25 AM

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TALLINN, 3 April 2017 – The National Audit Office analysed the financial information of local governments for recent years and found that although the government plans to increase local government financing by 2020, giving them more money alone will not help to solve problems in the local governments whose financial resources are considerably smaller than those of other local governments. Local governments have little influence on their income and the majority of it (83%) is decided by the state. Although the state distributes money to local governments on a uniform basis, it actually divides unevenly across the local governments.

The report indicates that if the state continues with the present local government financing model, the various gaps in the capabilities of local governments may not disappear after the administrative reform. The analysis indicates that the present redistribution of money via the Equalisation Fund cannot even up the financial resources of local governments to a reasonable extent, the balance of expenses considered in the Equalisation Fund is based on the expenses of the local governments at the turn of the century, and does not consider regional characteristics or investment needs. However, a partial reform of the basis of distributing the main source of income of local governments, i.e. the personal income tax, which has been discussed in the Ministry of Finance, could have a stronger impact on the establishment of more even opportunities. This solution would not reduce the money paid to any local governments, because the income of local governments would be evened up gradually on the account of income tax.

Although the state must compensate local governments for the expenses related to the performance of public functions, this has still not been done in the case of some functions. When local governments are not compensated for the expenses of public functions, this also has an impact on other functions, as the local governments have to incur the expenses of public functions on the account of performing their own functions. Many local governments have voluntarily started performing the state’s functions that people need, but that the state is unable to perform itself on a satisfactory level throughout Estonia. Since the local governments have received no compensation from the state for this, they’ve had to demand it in court. There are cases where the court has ordered the payment of compensation to a local government for the performance of a public function, but the state has not voluntarily paid the similar expenses of the remaining local governments, continuing to waste time and money on court cases instead. One of the causes of this situation is that the functions of local governments have still not been analysed in a manner that would allow for all public functions to be identified.

At present, the Government of the Republic or the Riigikogu have not yet decided what the functions of local governments will be like and how they will be financed in the future.

The main conclusions made by the National Audit Office are as follows:

  • The money distributed to local governments on the basis of the same principles, the use of which can be freely decided by the local government and that is not tied to a specific purpose, i.e. the primary income, divides unevenly between local governments on a per resident basis.
  • The principles of distributing the money mean that the primary income per capita of a few local governments (37 or 17%) is higher than the average, but the primary income per capita of the majority of local (176 or 83%) governments remains below the average.
  • The financial resources per capita of local governments whose primary income is above average are exceed the resources of the remaining local governments by almost a half (45%).
  • The expenses per capita of local governments whose primary income is above average are exceed the resources of the remaining local governments by almost a fifth.
  • If the local governments will be financed in the same manner after the administrative reform, the gap between the financial resources of local governments will remain large also in the new local governments. For example, the investment capacity of the local governments whose primary income is higher than average would be ca three times as high as that of others.

During the preparation of the overview, the National Audit Office carried out a survey of local governments to find out their opinions of the problems in financing local government and hear about their expectations. It became evident that:

  • the majority of local governments are not satisfied with the negotiations concerning the financing of local governments held between the state and the representatives of local governments;
  • local governments would like to have more money. Above all, they want extra money for roads and education. However, these are the areas that have received the most support from the state, but the money given for these fields can only be used for the specific purposes. This may suggest that giving specific-purpose support deprives local governments of the possibility to use their money flexibly and does not motivate them to add money from their own income to the support;
  • local governments whose primary income is higher than the average would like to get extra money more than the others, as they find that they don’t have enough money for the performance of their mandatory functions. When we compare the extra amount that local governments with a higher primary income claim to need for the performance of mandatory functions with the average amount they spend on the performance of voluntary functions, we see that the latter would cover the majority of the need for money;
  • the opinions of local governments about changing the arrangement of financing were different – the majority of them were in favour of the distribution of personal income tax by regions. Only a few of them were in favour of distributing income tax between the local governments of a person’s place of work and residence, or several places of residence. More than half of all local governments would like to change the principles of distributing money from the Equalisation Fund – they would like the Equalisation Fund to consider peripheral local governments and the actual needs of local governments. Only a little over a third of all governments supported the reorganisation of the Equalisation Fund in such a manner that this money would be distributed to local governments via income tax and the Equalisation Fund, as they feared that would be getting less money. The opinions of local governments about changing the principles of the land tax paid into the local government budget were also different – about half of them would turn it into a local tax and replace the public incentives established for residential land with local ones.


Toomas Mattson
Communication Manager of the National Audit Office
+372 640 0777
+372 513 4900
[email protected]
[email protected]

  • Posted: 4/3/2017 11:25 AM
  • Last Update: 4/7/2017 10:50 AM
  • Last Review: 4/7/2017 10:50 AM

Primary income of local governments formed as a result of the administrative territorial reform per capita in comparison with the local government average based on the data for 2014 to 2015 and 11 months of 2016 if the financing model is not changed.

National Audit Office

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