Finance, Accounting and Business Analysis Volume 2 Issue 2, 2020 http://faba.bg Trends and Determinants of Municipal Fiscal Disparities in Bulgaria Nenkova Presiana Department of Finance, University of National and World Economy, Sofia, Bulgaria Info Articles Abstract History Article: The purpose of this paper is to examine the trends of municipal fiscal disparities in Submitted 30 May 2020 Bulgaria and to analyze the causes of the existing inequalities. One of the most Revised 27 June 2020 challenging issues of fiscal decentralization process is the choice of proper policy Accepted 27 June 2020 response to the existing fiscal disparities among local governments. The identification of fiscal inequalities at local level and its determinants is a starting Keywords: point in developing an equalizing mechanism that has a potential to reduce these Fiscal decentralization, fiscal inequalities. Hence, with this study we aim to contribute to a better understanding disparities, inequity about horizontal fiscal imbalance in Bulgaria. Municipal fiscal disparities are measured in terms of differences in municipal own revenue, i.e. local tax revenue, user fees and charges, and other non-tax revenue. The analysis of horizontal fiscal imbalance covers the period 2007-2018 and uses several statistics measures to yield a complete picture of the trend of municipal fiscal disparities. The main findings suggest that disparities among municipalities in terms of own-source revenue were smaller at the end of the period than those at the beginning of the period as measured by the maximum-to-minimum ratio and the coefficient of variation. Regardless, municipal fiscal disparities are still considerable with very few rich municipalities which level of own-source revenue per capita is in sharp contrast to the rest of the municipalities. Address Correspondence: E-mail : [email protected] 72 Nenkova Presiana et al. / Finance, Accounting and Business Analysis 2 (2) 2020 INTRODUCTION Until 1990 Bulgarian public sector operated within a centralized financial and administrative structure. Following the collapse of the old system, decentralization has become a key part of the country’s transformation thrust. Despite the increasing pressure to decentralize public finance, the implementation of fiscal reforms in the vertical public sector and the designation of fiscal roles among the various levels of governance were not seen as central on the agenda in the early years of transition. As in the case to other economies in transition, in the period following the political transformation, the priority was to shift away from an administrative command system to a free market economy, focusing on setting up a legislative and an institutional framework necessary to ensure the proper functioning of the new economic system, dismantle state ownership, restructure the financial system, liberate prices, etc. In the late 1990s, several different policies were implemented, for the purpose of promoting local autonomy and increasing local governments financial capacity. A second wave of reforms emerged in mid- and late 2000, when local tax administrations were set up and local government authorities were delegated discretionary powers to set local tax rates, within a range established by law. Alongside such ongoing reforms in the area of local finance, Bulgaria has seen an upsurge in the number of analyses examining the development and effects of the fiscal decentralization process. These studies explored and discussed opportunities to achieve sound financial management, the development of municipal debt capacity and the possibilities to expand the financial autonomy of local government authorities, and subsequent steps towards fiscal decentralization (Stoilova 2009, Kalcheva 2017; Zahariev 2017). Interpreting issues related to the horizontal fiscal imbalance does not have an ample track-record in Bulgaria and more research is needed to systematically examine the distributional effects of fiscal decentralization reforms, since they could result “in different regions having differing abilities to provide given levels of public goods and services”(Boadway 2004). The heavy persistence of central government grants in municipal budgets in Bulgaria shows that the expenditure assignment was not supported by an adequate revenue assignment between levels of governments, meaning also high levels of vertical fiscal imbalance. At the same time, the transfer scheme applied throughout the years with the aim to reduce differences in local governments fiscal capacity and expenditure needs had a rather mild disparity reducing effect (Nenkova, 2019). If not properly addressed, municipal fiscal disparities will continue to lead to an unequal access of citizens to main local public services. Moreover, the existing inequalities could also be deepened by the growing concentration of population and economic activity in few local territorial units. Not at least, the sudden and extensive economic impacts of coronavirus pandemic could also contribute to municipal divergence. The purpose of this study is to analyze the trends of municipal fiscal disparities in Bulgaria and to identify the causes of those disparities. The identification of the determinants of fiscal inequality at local level is important since it would suggest the right direction in equalization policy design. Therefore, the current paper aims at contributing to a better understanding about municipal fiscal disparities in Bulgaria – did they narrowed or widened during the period under review, and what factors cause the inequality at local level. The analysis of the horizontal fiscal imbalance in Bulgaria covers the period 2007-2018 and fiscal disparities among local governments are measured in terms of differences in municipal own revenue per capita. Municipal own-source revenue is in fact an appropriate disparity measure of municipal fiscal differences, since its level reflects objective factors such as population size, economic base and fiscal effort of local governments. The trends in municipal fiscal disparities is traced and illustrated with descriptive statistics including minimum, maximum, mean, the range, coefficient of variation and maximum to minimum rate. The article is organized as follows. The next section presents in brief municipal finance and municipal revenue structure in Bulgaria for the period 2007-2018. Section 3 traces and explains the trends of fiscal disparities among local governments. Determinants of municipal fiscal disparities are studied in Section 4. The final section summarizes the findings and addresses policy implications. Bulgarian municipalities and their finances Municipalities are the only level of subnational government in Bulgaria’s two–tier public sector vertical structure. The administrative and territorial reform of 1998 set up 264 municipalities, with one more autonomous municipality established in 2015, bringing their total number to 265. Local governments are in charge of providing a wide range of services: administrative services, local transport, public parks and amenities, street lighting and cleaning, child and elderly care, garbage collection and disposal, heating, water supply and sewerage. Besides provision of these services, municipalities are also in charge of investments at the local level, including both local government activities and state delegated activities financed through municipal budgets. Municipal spending is funded by own-source revenue, as well as central government grants. A major 73 Nenkova Presiana et al. / Finance, Accounting and Business Analysis 2 (2) 2020 reform in the area of local finance aimed to expand the revenue base at the local level and the financial autonomy of local government authorities was implemented in 2003, enabling local government authorities to decide autonomously what services are to be provided against payment, set fees and service charges, offer reduced rates to certain users, and collect revenues from fees and service charges. In fact, that change marked the onset of revenue decentralization in Bulgaria, and user fees became a major own source of revenue for local governments for quite some time. Later on, the powers of local government authorities were further extended, and municipal tax administrations were set up in 2006, to collect receipts from local taxes and fees. The conferral of taxation powers to municipalities at the beginning of 2008 is one of the most significant steps towards strengthening the financial autonomy of local government authorities – local governments were granted the power to set local tax rates at their own discretion, within a certain range, with the floor and ceiling defined by law. The only tax revenue in the municipal budgets is that generated through local taxes. About 95% of municipal tax revenue is accumulated through property tax, property transactions tax and vehicle tax. In 2008 the package of measures for expanding the revenue base at the local level was further enlarged by transferring the powers to levy the patent tax to municipalities. That tax is an alternative to personal income tax; it is levied as a lumpsum and is payable by individuals, including sole proprietors engaging in any of the business activities taxable on the territory of the respective municipality and having a turnover of up to BGN 50 000 in the previous year. Another tax that was new to municipalities was adopted in 2010, tourist tax. Despite that new source of revenue, the volume of tax revenue at the local level as a whole