Fiscal Federalism and Governance in the European Union

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Project on 21st Century City Governance | September 2017 Fiscal Federalism and Governance in the European Union

TERESA TER-MINASSIAN BERNARD SOULAGE NICOLAS LÉTÉ CAROLINE CONROY MARIAMA SOW THE AUTHORS

Teresa Ter-Minassian is a senior consultant to the Global Economy and Develop- ment program at the Brookings Institution. She is the former director of the Fiscal Affairs Department of the International Monetary Fund.

Bernard Soulage is a professor of economy and the secretary general of the Climate Chance Association. He is the former vice president of the Rhône-Alpes region and its representative for Europe and external relations and a former member of the European Parliament.

Nicolas Lété is a policy advisor for the cabinet of the president at European Com- mittee of the Regions. He is a former representative of the Auvergne Rhône-Alpes Region (France) to the European Union in Brussels.

Caroline Conroy is a research analyst in the Global Economy and Development program and the Centennial Scholar Initiative at the Brookings Institution.

Mariama Sow is a research analyst in the Global Economy and Development program at the Brookings Institution.

ACKNOWLEDGEMENTS

This paper was prepared for the Project on 21st Century City Governance, a collaborative effort of the Brookings Institution’s Centennial Scholar Initiative and the Global Economy and Development Program. Alaina Harkness, fellow for the Project on 21st Century City Governance, provided overall editorial guidance.

The Brookings Institution is a private non-profit organization. Its mission is to conduct high-quality, independent research and, based on that research, to provide innovative, practical recommendations for policymakers and the public. The conclusions and recommendations of any Brookings publication are solely those of its author(s), and do not reflect the views of the Institution, its management, or its other scholars. CONTENTS

Local Finances in Italy ...... 1 Teresa Ter-Minassian

Fiscal Decentralization and 21st Century Cities in France ...... 23 Bernard Soulage with Caroline Conroy and Mariama Sow

Fiscal and Federal Structures in Germany ...... 42 Caroline Conroy

Features of Territorial Goverance in Europe ...... 68 Bernard Soulage with Nicolas Lété Local finances in Italy1

TERESA TER-MINASSIAN

INTRODUCTION by the aftermath of the global and subsequent Eu- taly has a complex system of intergovernmental ropean financial crises, reflected a shift toward re- Irelations. It has three basic levels of government: centralization. a national one (the Central Government, or CG); a regional one, composed of 15 “ordinary statute” This paper, which has been prepared for the Brook- regions and five “special statute” ones;2 and a local ings Project on 21st Century City Governance, be- one, comprising 100 provinces, 10 metropolitan gins in Section II with a brief overview of the ebbs cities, and 8,100 municipalities. Broadly speaking, and flows of the decentralization process in Italy the national and regional levels share normative in recent decades, highlighting the main institu- and policy functions, as well as the delivery of tional changes affecting all the subnational levels public goods and services in their respective areas of government and relating them to the evolving of responsibility, while the local level is primarily political, economic, and fiscal trends of the period. responsible for the delivery of local services. The subsequent sections focus especially on the lo- The system of fiscal relations among the three lev- cal level of government, analyzing the current state els of government has been in a state of flux for of affairs regarding: decades. After a phase during the 1990s of enthu- siasm for fiscal decentralization, a constitutional • Governance arrangements and spending amendment was enacted in 2001 calling for an responsibilities (Section III). expanded role in spending and increased revenue autonomy of the subnational governments • Own sources of revenues, in particular the (SNGs). However, the necessary implementing central government-induced travails of the legislation was delayed until the end of the decade, local property tax and their cost for the and subsequent reforms, being largely influenced municipal finances (Section IV).

1 The author wishes to acknowledge gratefully the useful comments received from Kemal Derviş, Giorgio Brosio, Bernard Soulage, Alaina Harkness, and Caroline Conroy. 2 The regions with special statutes (Aosta Valley, Trentino-South Tyrol, Friuli-Venezia Giulia, Sicily, and Sardinia) were created in the aftermath of World War II with the new Republican Constitution, to recognize ethnic, linguistic, or other historical distinguishing characteristics of these regions. These regions have traditionally received larger CG transfers than the ordinary ones, although the gap has been shrinking in recent years.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 1 • The system of intergovernmental trans- procedures; and the main existing mecha- fers, in particular the innovative system of nisms for vertical and horizontal intergov- equalization transfers introduced in recent ernmental cooperation. years (Section V). • Entrepreneurial activities of local govern- • The constraints imposed on the local financ- ments, including through municipal en- es by the past Internal Stability Pacts and the terprises and public-private partnerships national legislation implementing the EU (PPPs) (Section VII). Fiscal Compact of 2012, and their implications for local investments (Section VI). The paper concludes in Section VIII with a discus- This section also discusses the problems of sion, in the light of the analysis of the previous sec- hidden debts and arrears of municipalities, tions, of priorities for further reform of the local past bailouts, and municipal bankruptcy finances in Italy.

2 Fiscal Federalism and Governance in the European Union A BRIEF HISTORICAL REVIEW OF ernmental transfers. Specifically, Article 117 of the THE DECENTRALIZATION PROCESS new Constitution substantially expanded the leg- IN ITALY3 islative power of the regions in key areas, such as he decentralization process in Italy over the last health, education, energy, transport, environment, Tfew decades has been all but linear. The 1970s and regulation of markets. and 1980s witnessed various waves of spending decentralization, with the devolution of import- However, most of these functions were defined as ant expenditure responsibilities to the newly cre- areas of concurrent responsibility between the CG ated Regioni a Statuto Ordinario, as well as to the and the regions, leaving to subsequent national local authorities (provinces and municipalities). legislation a precise determination of respective The spending decentralization was not accompa- competencies in each area. Since such implement- nied, however, by a devolution of revenue-raising ing legislation was substantially delayed by politi- responsibilities. As a result, the SNGs financed cal wrangling, ample scope arose for jurisdictional their expenditures mainly through transfers from conflicts around the extensive areas of overlap in the CG. This contributed, along with inadequate spending responsibilities, which often were esca- controls and poor information on subnational ac- lated up to the Constitutional Court. counts, to significant local deficits and accumula- tion of arrears, and to repeated bailouts by the CG. When a framework law on fiscal decentralization (Law 42/20094) was finally enacted, it still left most Against a background of national focus on fiscal of the reform specifics to subsequent government consolidation as precondition for Italy joining the decrees, which were to focus on: the enhancement euro during the 1990s, concern grew over these of regional and local revenue autonomy; the rede- trends, as did political pressures for greater fiscal sign of the system of intergovernmental transfers, autonomy, especially by the richer northern re- to base them on standardized measures of fiscal gions. That led to the assignment to the SNGs of capacity and spending needs; the harmonization significant own sources of revenues, specifically of accounting standards across levels of govern- health contributions, a motor vehicles tax, and a ment; and the improvement of intergovernmental tax on the value added of enterprises (IRAP) to the coordination mechanisms. regions; surcharges on the personal income tax to both regions and municipalities; and a new prop- However, by 2010, in the aftermath of the global erty tax to the municipalities. financial crisis that took a serious toll on the public finances, and with the onset of the euro crisis, poli- This decentralization phase culminated in the cy imperatives shifted to fiscal adjustment, and the passage in 2001 of a constitutional amendment, subnational finances were required to make a large which, among other things, substantially re- (some believe disproportionate)5 contribution to duced the areas of exclusive competency of the the adjustment. The latter included substantial CG and affirmed the principle that SNGs should cuts in CG’s transfers to the SNGs and a tightening be financed mainly through own revenues and of constraints under the so-called Internal Stabil- non-earmarked, equalization-oriented intergov- ity Pacts6 (see Section VI). The toll was especially

3 For a more detailed account of the history of decentralization in Italy in recent decades, see Piperno, 2013, and Ambrosanio and others, 2016. 4 The lawDelega al Governo in materia di federalismo fiscale, in attuazione dell’articolo 119 della Costituzione, available at www.parlamento.it/ parlam/leggi/09042l.htm. 5 The total cuts in non-interest spending of the CG (including the social security system) over the period 2008-2012 amounted to 5.3 percent of such spending; those in subnational spending to 12 percent (Piperno, 2016). Cuts are defined in relation to projected spending on unchanged legislation. 6 The Internal Stability Pacts are agreements between CGs and SNGs setting limits on the latter’s deficits or spending. They have been used by a number of EU countries (including Italy), with varying degrees of success, to promote compliance with the EU’s fiscal rules. A review of experiences with these pacts can be found in Ter-Minassian, 2016.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 3 pronounced on subnational investments, which issues, including major reforms of the intergov- fell by 34 percent in nominal terms between their ernmental relations system.7 The reform—which peak in 2009 and 2014. was approved by both ouses of Parliament in April 2016 with a less than two-thirds majority and was In such a “fiscal emergency” context, structural therefore subject to ratification by a popular ref- reforms of the intergovernmental relations system erendum—aimed to strengthen the CG’s powers took a back seat to the fiscal consolidation imper- vis-à-vis the regions, in particular through the ative, and progress in the implementation of the abolition of concurrent responsibilities and a sig- framework law remained uneven. Indeed, the del- nificant expansion of the functions assigned to the egation by Parliament to the government to leg- CG, including regulation of the production and islate the pending reforms by decree was allowed distribution of energy, strategic infrastructures to expire before the completion of the agenda set and transport networks, labor protection, and di- by Law 42. The main steps forward related to the saster preparedness, among others. local level of government and included: a revamp- ing of the system of transfers to the municipalities Moreover, the reform provided that, in case of (see Section V); a new 2014 law (Law 56/2014, the conflict between central and regional legislations, so-called legge Delrio), which significantly reduced even in areas assigned to the regions, the former the role of the provinces and created metropolitan should prevail if “the national interest is at stake” cities (see Section III for details); and legislation (the so-called supremacy clause). The reform also to standardize accounting norms for all levels of proposed to eliminate any reference to the prov- government. In contrast, little progress was made inces in the Constitution, thereby paving the way in increasing subnational fiscal autonomy, and, as for their eventual abolition. explained in more detail in Section IV, some recent changes in property taxation can be viewed as a Voters, however, rejected the reform in a Decem- step backward in this area. ber 2016 referendum, leaving the status quo described in the following sections unchanged for In the meantime, the government proposed a the time being. It is too soon to say, at the time constitutional reform to modify the bicameral of this writing, whether new legislative initiatives parliamentary system and transform the Senate will be taken by this or future CGs to reduce the into a sort of regional Chamber, with a much re- scope of concurrent functions, or at least to better duced number of members chosen by the regional delineate respective responsibilities of the different councils and with jurisdiction limited to very few levels of government in those functions.

7 See Bilancia and Scuto, 2015, for a detailed discussion of the implications of the proposed reform for the intergovernmental relations system.

4 Fiscal Federalism and Governance in the European Union GOVERNANCE AND EXPENDITURES of local public employment; a superimposition of OF LOCAL GOVERNMENTS different levels of spending authority, often with conflicting interests, and consequent delays in The changing structure and functions of the approval of public investment projects; lack local governments of economies of scale in the provision of essential As mentioned above, the local level of government public services; and increased risk of adverse spill- in Italy encompasses three types of jurisdictions: overs from uncoordinated actions of small munic- municipalities (comuni), provinces, and metropol- ipalities on their neighbors. itan cities. An approach that has been increasingly used to Municipalities are very diverse, ranging wide- reduce the costs of the excessive fragmentation of ly in size and population. About 70 percent of the municipal level has been the creation since the them have fewer than 5,000 inhabitants. They are early 1990s of consortia of small municipalities responsible for a range of local public services, (unioni di comuni) to provide jointly one or more including management of the territory, social as- public services. Both the CG and the regions have sistance, local transport, water and sanitation, promoted the formation of such unions, including pre-primary education, building and maintenance through financial incentives. As of 2014, 2,090 mu- of local schools, and the promotion of local eco- nicipalities had joined permanent unions, which nomic development. numbered over 400.9 In addition, many municipalities and unions have stipulated limited-term The provinces cover larger geographical areas, en- cooperation agreements (convenzioni) for the de- compassing a number of municipalities. They also livery of specific services. There is, however, little vary significantly in size and population. Their analytical evidence so far on the effectiveness and main functions have traditionally been regulatory, efficiency gains from these forms of association in in areas such as environmental protection, territo- the delivery of local public services. rial planning, and labor markets. Their responsibilities have also included the construction and man- There has been less success in promoting the agement of secondary schools and provincial roads. merger of small municipalities. Initial attempts to require the transformation of unions into larger Metropolitan cities are a recent creation, whose func- municipalities (Law 142/1990) were abandoned in tions and governance are discussed further below. 1999. TheDelrio law of 2014 included steps to consolidate the municipal level, by requiring the asso- Clearly, the local government level is quite fragment- ciation of small municipalities into unions and by ed, compared with many other advanced countries, fostering mergers through the maintenance for the a fact that has long historical roots. Moreover, the new larger municipality of the same financial in- number of local governments has been increasing centives provided to the merged municipalities or over the years, driven by the quest for transfers from to their unions. However, since 2014, only 57 small the CG and by pressures to create well-remunerated municipalities have merged into 24 larger ones. positions for local politicians.8 TheDelrio law also introduced important changes Such proliferation of local governments has a in the governance and role of the provinces. Such number of significant costs, including a bloating changes had been called for by many experts of

8 It is interesting that, while only 17 percent of the Italian population lives in municipalities with fewer than 5,000 inhabitants, mayors and council members of these towns account for 55 percent of local elected officials (Ambrosanio and others, 2016). 9 Arachi, Di Liddo, and Giuranno, 2015, provides a detailed analysis of municipal consortia in Italy.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 5 intergovernmental fiscal relations in Italy for reallocation of the corresponding human and bud- years, but had been blocked by affected interests getary resources, a task that is still in process. and by the political weakness of previous national governments. A further important innovation enacted by the Delrio law was the creation of metropolitan cit- Specifically, the law abolished the direct popular ies. Although legislation since 1990 and the 2001 election of the provincial presidents and councils, constitutional reform had already envisaged the who are now chosen by the mayors and coun- creation of such institutions, no concrete steps had cilors of the constituent municipalities among been taken in this direction until 2012, when an themselves.10 More importantly, it significantly attempt by the government to define the proce- curtailed the functions of provincial governments, dures to set them up through a decree was inval- which now maintain only some basic responsibil- idated by the Constitutional Court, which judged ities (funzioni fondamentali), including territorial the decree to be an inadequate legal basis for such planning and the building and maintenance of an important institutional change. provincial roads and schools. TheDelrio law established nine metropolitan cities The Delrio law left the distribution of the remaining (plus the Capital City of Rome) to replace the cor- functions among regions, metropolitan cities, and responding provinces. It also allowed regions with other municipalities to subsequent national and re- a special statute to set up additional metropolitan gional legislation, in the respective areas of responsi- cities in their own territory, if they considered it bility. According to the law, this distribution should appropriate. To date, the regions of Sicily and Sar- aim to increase efficiency in the delivery of the cor- dinia have done so, bringing to 14 the total. Table responding services through better exploitation of 1 provides an overview of some salient character- economies of scale. An intergovernmental conference istics of these cities. set out some basic principles, subsequently incorpo- rated in a CG decree, to guide the redistribution. The law also expanded the responsibilities of metropolitan cities compared with those of the provinces So far, only six regions have enacted legislation to they replaced. These responsibilities now include define the allocation of the different functions. In territorial planning, the organization of area wide the other regions, legislation has been proposed by network for such public services as transport, util- the respective executives but not yet approved by the ities, and telecommunications, and the promotion regional parliaments. These actual or proposed leg- of the metropolitan area’s economic development. islations show significant differences. Some regions, Moreover, regions can delegate additional functions in particular, Lazio, Liguria, Lombardy, Marches, to metropolitan cities, upon mutual agreement. Puglia, Tuscany, and Umbria, have taken over many functions of the provinces (albeit delegating some The law requires the mayor of the metropolitan city of them to the metropolitan cities in their respec- to be that of the main municipality in the province tive territories); others have maintained some of replaced (capoluogo della provincia). Its governing the functions with the provinces, or shifted them to council is chosen among the mayors and council- metropolitan cities or to unions of municipalities.11 ors of the constituent municipalities. There is also a The transfer of functions is to be accompanied by metropolitan assembly (conferenza metropolitana)

10 Provincial presidents and councilors (as well as the presidents and councilors of the new metropolitan cities) receive no additional compensation for the exercise of these functions. 11 For a more detailed discussion of the differences in the regional legislations, see Legautonomie, 2016. For an analysis of the case of the Lombardy region, see Nordi and Rizzo, 2016.

6 Fiscal Federalism and Governance in the European Union Table 1. City characteristics

Number of Population municipalities Population density Date of Metropolitan city Region included (millions) (Pop./km2) inception Rome Lazio 121 4.34 811 1/1/2015 Milan Lombardy 134 3.20 2030 1/1/2015 Naples Campania 92 3.12 2663 1/1/2015 Turin Piedmont 316 2.29 336 1/1/2015 Palermo Sicily 82 1.28 255 1/4/2016 Bari Puglia 41 1.27 331 1/1/2015 Catania Sicily 58 1.12 312 1/4/2016 Florence Tuscany 42 1.01 288 1/1/2015 Bologna Emilia- 56 1.00 271 1/1/2015 Romagna Genoa Liguria 67 0.86 469 1/1/2015 Venice Veneto 44 0.86 349 8/31/2015 Messina Sicily 108 0.65 198 1/4/2016 Reggio Calabria Calabria 97 0.56 175 8/7/2016 Cagliari Sardinia 17 0.43 345 4/11/2016 Source: Author research

composed of all mayors and councilors of the con- ments12 refer to 2014 and therefore do not reflect stituent municipalities, with consultative powers the impact of the changes introduced by the Delrio only. These provisions aim to prevent the creation law. Nevertheless, they provide useful insights into of a new bureaucratic structure superimposed on the level and structure of the local governments’ the municipal ones, with attendant fiscal costs. budgets, and are therefore briefly reviewed here. Table 2 presents some summary indicators of the The creation of metropolitan areas has the potential spending performance of provinces and munic- to promote a more efficient delivery of local services ipalities in 2013-2014. Charts 1 and 2 depict the through coordination and economies of scale, but functional composition in 2014 of municipal and is also seen by many as part of the overall strategy provincial spending, respectively. to reduce the role of the regional level of government mentioned in Section II. The metropolitan The table shows that, even before theDelrio re- cities started operating in 2015, and the experience forms, expenditures of municipalities far exceeded with their functioning is therefore still too limited those of the provinces, not only in absolute but also to draw firm conclusions about their benefits. in per capita terms, reflecting their broader set of responsibilities. The table also points to a composition largely skewed in favor of current spending. The structure of local spending Unfortunately, the latest available consolidated Within each level of government, there were sub- data on expenditure and revenues of local govern- stantial differences across the national territo-

12 These data were published by the National Institute of Statistics (ISTAT) in July 2016 and are available athttp://www.istat.it/it/archivio/188871 .

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 7 ry. For example, the ratio of personnel spending tended to be higher in the smallest and largest to current revenues (an indicator of the weight municipalities, reflecting at one end of the distri- of these expenditures in the local governments’ bution the lack of economies of scale, and at the budgets, as well as of the rigidity of these bud- other end both larger spending needs13 and reve- gets) showed a wide regional variance around the nue-raising capacities. municipal and provincial national averages. Sim- ilar ranges of regional variation could be found The charts indicate that the average composition around the national means as regards the shares of expenditures was fairly similar between prov- of expenditures on various functions (e.g., general inces and municipalities. For both levels of gov- administration, environmental protection, trans- ernment, the two largest components were general port, education, and social assistance), reflecting administration and the management of the terri- differences in local preferences as well as in demo- tory and the environment, followed by spending graphic and geographic characteristics. on roads and transport, and on education. Munic- ipalities had a larger role than provinces in social Data not reported in the table also showed a assistance, while the reverse was true for spending U-shaped pattern in per capita spending, which on promoting local development.15

Table 2: Italy: Selected indicators of level and structure of local expenditures, 2013-2014

2013 2014 Expenditures of provinces/expenditures of municipalities (%) 13.5 12.5 Average current expenditure per capita (in euros) Provinces 126 120 Municipalities 962 911 Current expenditures/capital expenditures (%) Provinces 370 520 Municipalities 430 430 Personnel expenditures/current revenues (%) Provinces National average 24.3 25.6 Regional maximum 44.8 47.1 Regional minimum 18.4 18.3 Municipalities National average 23.8 23.6 Regional maximum 32.9 32.3 Regional minimum 20.4 20.7 Source: ISTAT, 2016. Data are on commitment basis

13 From the observation that many public goods—such as zoos—are indivisible, Oates and Schwab (1988) put forward the idea that the range of public goods should increase with localities’ size; this is called the zoo effect. For an empirical investigation of this effect for French municipalities, see Frere and others, 2011. 14 The assertion that municipalities play a larger role in social assistance than provinces is demonstrated when comparing Chart 1 and Chart 2.

8 Fiscal Federalism and Governance in the European Union Figure 1. Italy: Functional composition Figure 2. Italy: Functional composition of municipal expenditures, 2014 of provincial expenditures, 2014

General administration General administration Territorial administration and environment Territorial administration and environment Roads and transport Roads and transport Social assistance Social assistance Education Education Citizen security Economic development promotion

Source: ISTAT, 2016. Source: ISTAT, 2016.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 9 LOCAL REVENUE AUTONOMY The 2015 budget framework law called for the cre- ince the 1990s, Italian municipalities have ation of a new “local tax” to replace most existing Sbeen assigned significant sources of own rev- ones, with the aims of simplifying the whole prop- enues, defined here as revenues for which they erty tax regime and reducing its compliance cost. can set rates (at least within a range ) and possibly This reform, however, has not been enactedso far. have some autonomy in defining the base. These Instead, in 2016 property taxes on households’ revenues include a surcharge of up to 0.8 percent- principal homes were abolished, a move that re- age points on the national personal income tax, duced the revenue autonomy of municipalities, a property tax (IMU), an additional property tax and could not really be justified in terms of verti- to cover the cost of indivisible local services, a tax cal equity, since its benefits to the owners increase for waste collection and disposal (TARI), a tax on with the value of the house. Moreover, the 2016 hotel occupancies for touristic localities (tassa di Stability Law froze the rates of all local taxes (with soggiorno), other user fees, and fees for building the exception of the TARI). Municipal property permits and other licenses. In addition, munici- taxation remains in need of substantial reform, es- palities receive a share of a number of national tax- pecially an early updating of the cadastre, which es related to real estate, including on the transfer of is very much out of line with market valuation of properties and on rents.15 existing properties.

Provinces have traditionally had more limited rev- Charts 3 and 4 depict the composition of municipal enue autonomy, their main source of own revenues and provincial revenues, respectively, in 2014 (the being the taxation of insurance policies for motor last year for which consolidated data are available vehicles. They have also shared in the revenues of for each level of government). They show the lesser some national and regional taxes. Even before the dependence of municipalities than of provinces on Delrio law took effect, in 2014, provincial own rev- national and regional transfers. They also suggest a enues were equivalent to less than 14 percent of greater availability of sources of own non-tax reve- municipal ones. nues for the municipalities than for the provinces. Both levels of government appear to have made lit- Local taxation has been the object of frequent in- tle use of property sales (a potential source of rev- terventions by the CG, responding to short-term enues, especially for the municipalities, to finance fiscal or political motivations with little regard for investments in local infrastructure). local autonomy and with detrimental effects on the capacity of both the local governments and Per capita municipal tax revenues in 2014 av- their citizens to plan and budget. This has been eraged 652 euros, but with substantial variance especially the case with the municipal property ranging from 443 to 931 euros. The lowest values tax, repeatedly modified in recent years regarding were recorded in municipalities located in the spe- its coverage, rate structure, and relation with the cial-statute regions and in the South, reflecting a abovementioned taxes to finance local services. mixture of lower revenue-raising capacity and ef- Between 2011 and 2014 there have been some 10 forts. Correspondingly, the degree of dependence modifications of municipal property taxation.16 from transfers from higher levels of government also varied significantly among municipalities,

15 Tax revenues shared with higher levels of government (tributi compartecipati) are not stricto sensu own revenues, because subnational governments have no control over either their base or their rate structure, although they can choose how to use them without CG’s constraints. Nevertheless, in the statistics they are often included in the category of own revenues. 16 For a detailed account of the travails of municipal property taxes, see Revelli, 2016.

10 Fiscal Federalism and Governance in the European Union Figure 3. Italy: Composition of Figure 4. Italy: Composition of municipal revenues, 2014 provincial revenues, 2014

Tax revenues Tax revenues Transfers Transfers Non-tax revenues Non-tax revenues Property sales Property sales

Source: ISTAT, 2016. Data are on a cash basis. Tax revenues include Source: ISTAT, 2016. Data are on a cash basis. Tax revenues include ones shared with other levels of government. ones shared with other levels of government.

ranging between near zero and 11 percent. The For provinces, per capita revenues averaged 96 degree of dependence tended to be U-shaped, be- euros, also with substantial variance around the ing higher for both very small (up to 5,000 inhab- mean. Similarly, the dependence of provinces from itants) and largest (over 60,000 inhabitants) local- transfers ranged between 0.5 percent and 13.6 per- ities, reflecting, for the former, lower own-raising cent, and was substantially higher in the southern capacities and traditionally higher CG transfers regions of the country that traditionally have re- per capita, and for the latter, the effect of greater ceived more generous grants by the CG and have access to special purpose grants. generally smaller own revenue bases.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 11 INTERGOVERNMENTAL TRANSFERS Its main features can be briefly summarized as fol- he system of intergovernmental transfers lows. Tin Italy has traditionally been very complex, resulting from the superimposition of There is an equalization fund for municipalities many different pieces of legislation that changed (Fondo di Solidarietà Comunale, or FSC) and one frequently until the end of the last decade.17 for provinces and metropolitan cities. Both are fed The system could be characterized as a mixture by transfers from the CG, but the FSC also receives of origin-based revenue sharing; some equaliza- a portion of the local property tax, the IMU. tion transfers, based in principle on indicators of relative per capita income and demographic A distinction is made between “fundamental” and characteristics, but in practice on the historical “non-fundamental” local functions. For the mu- distribution of local spending; and a number of nicipalities, fundamental functions would include special-purpose grants, to finance specific spend- general administration, local police, education, lo- ing programs. The weights of the different types of cal transport, management of the territory and of transfers have been changing over time, in reflec- the environment, and social assistance, altogether tion of shifting priorities given by the legislators accounting for about 70 percent of municipal cur- to their different objectives. Obviously, this made rent non-interest spending. For the provinces, they more difficult an orderly budgetary planning by would include the functions defined as fundamen- local authorities and arguably weakened the bud- tal by the Delrio law. get constraint on them. For the fundamental functions, standard spending The framework law on decentralization, Law needs are calculated taking into account demand 42/2009, set out the broad lines of a revamped (e.g., population and demographic structure) and transfer system, privileging equalization based on cost (population density, remoteness, and other standardized indicators of spending needs and rev- geographic characteristics) factors outside the lo- enue-raising capacity. The system is intended to be cal authorities’ control, which are econometrically applied to both the regions with ordinary statute estimated to affect local spending on the function and their provinces and municipalities. However, in question.19 Thus, municipalities with similar so far the necessary implementing framework has characteristics in terms of these factors are at- been developed only for the local level of govern- tributed the same standard spending needs. ment. The distribution of CG’s transfers to the regions remains largely shaped by historical patterns. The differences between actual and standardized spending may reflect differences in the priority The equalization framework for transfers to local attributed by each municipality to the function in governments covers only general-purpose ones. question, different revenue-raising capacities, or There still remain special-purpose grants, includ- different levels of efficiency.20 To correct for the im- ing capital transfers for investments. Subsequent pact of differences in fiscal capacity, standardized decree laws have defined more specifically the fea- revenues have also been calculated for the main tures of the system, which began to be operational municipal taxes, based on the legislation prevail- in 2015.18 ing in 2014. The gaps between standard needs and

17 A summary of these changes can be found in Piperno, 2013. 18 Since the new system was expected to involve substantial changes in the distribution of transfers among localities, Law 492 contemplated a gradual transition to it. A transition was also required for the complex technical task of estimating standardized spending needs and fiscal capacities. 19 The econometric estimates used a vast data panel of municipalities’ responses to a detailed questionnaire prepared by the national Ministry of Economy and Finance and the National Association of Italian Municipalities (ANCI). 20 See IFEL, 2014.

12 Fiscal Federalism and Governance in the European Union standard revenues are used as coefficients of distri- resources from smaller to larger municipalities. bution of growing portions of the FSC, starting at This could provide an incentive to fusion of small 20 percent in 2015 and rising progressively in the municipalities. following years to 55 percent by 2018. The estimated standard needs and fiscal capaci- Current legislation has not yet defined the crite- ties for individual municipalities are available to ria that should eventually guide the distribution the public through the website OpenCivitas (www. of a portion of the FSC to help finance non-fun- opencivitas.it). They will need to be revised to take damental functions of municipalities with be- into account the important changes that have been low-standard fiscal capacity. In the meantime, the introduced with the Delrio law, in particular re- rest of the FSC continues to be distributed on the garding metropolitan cities and the recent changes basis of the historical level of transfers to individ- in local taxes, and to update the econometric esti- ual municipalities. Even at its initial level, the new mates on the basis of more recent data. system has involved a significant redistribution of

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 13 FISCAL RULES, LOCAL spective municipalities. The latter are also allowed GOVERNMENTS’ DEBT, AND to lend or borrow among themselves any imbal- INTERGOVERNMENTAL FISCAL ances they might have. The flexibility clause was COOPERATION intended to allow localities to borrow from each ince 2001, local governments have been sub- other’s (or their region’s) temporary surpluses to Sject to the so-called Internal Stability Pacts fund lumpy public investments. However, little use setting targets for their fiscal balances and, in some has been made of this clause. years, limits on the nominal growth of their expenditures. These pacts were customarily discussed The tightening of financial constraints on local within the various forums for intergovernmental governments has been reflected in some improve- cooperation (see Box 1), but were ultimately de- ment of their fiscal balances—with municipalities cided by the CG. Small municipalities (those with recording near balance and the provinces small fewer than 5,000 inhabitants) have been generally surpluses in recent years—and in some a decline excluded from the pacts. in their debt, as percent of both GDP and of the total public debt (Chart 5). Since 2003 the pacts have included various types of sanctions for non-compliance, mostly in the form of cuts in transfers from the CG and freezes Figure 5: Aggregate debt of provinces on hiring, but the application of such sanctions has and municipalities been uneven. In the more recent years, monitoring 4 of compliance by the national Ministry of Econ- 3.5 omy and Finance (MEF) has been strengthened 3 regarding both timeliness and enforcement. As a result, compliance has improved. In 2013-14 only 2.5 1.5 percent of municipalities subject to the pact 2 did not comply with its provisions. The majority of 1.5 non-complying municipalities were concentrated 1 in some southern regions and in Sicily. 0.5 0 2009 2010 2011 2012 2013 2014 The combination of tightening of constraints, including on total spending, under the pacts and Local debt as percent of GP of cuts in CG’s transfers to the local governments Local debt as percent of total public debt during the recent crises has had a strong adverse Sources: IFEL, 2015, and ISTAT impact on the local governments’ investments, which fell by more than 50 percent between 2007 and 2012 (Ambrosanio and others, 2016). An unfortunate side effect of the tightening of constraints under the Internal Stability Pacts has been With a view to arresting and ultimately reversing a growth of both off-budget debts (debts not prop- this trend, the national law implementing the EU erly recorded according to accounting rules) and Fiscal Compact has introduced a degree of flexi- of arrears of local governments. Estimates by the bility in the fiscal rules for local governments. Spe- Supreme Audit Institution (Corte dei Conti) put cifically, it has given regions the power to use part the amount of off-budget debts of municipalities or all of their surpluses to offset deficits of their -re in 2013 at over 1.5 billion euros,21 involving nearly

21 See Corte dei Conti, 2014.

14 Fiscal Federalism and Governance in the European Union Box 1. Intergovernmental cooperation forums in Italy

Well-functioning forums for intergovernmental fis- • Some vertical executive-level ones: cal cooperation are especially necessary in relatively fragmented systems of multilevel governance, such o A State-Regions-Provinces Conference. as Italy’s. Potential gains from such cooperation include a reduction of adverse spillovers and a fuller o A State-Municipalities Conference. exploitation of positive externalities, synergies from participants’ actions and policies, and economies of o A Unified Conference in which all four scale. Intergovernmental fiscal cooperation can be levels of government are represented, beneficial in different aspects of policy, namely: chaired by the prime minister. Within this broader forum, a standing Confer- • Macro-fiscal management. ence has been in place since 2013 for the coordination of the public financ- • The design and reform of intergovernmental es, charged with reviewing the national fiscal arrangements. and subnational budgets for compliance with the above-mentioned fiscal rules • Sectoral policies, including service delivery. and with promoting dialogue on other aspects of inter-governmental fiscal re- • Subnational revenue and expenditure man- lations. agement. • Parliamentary Committees on inter-govern- A further benefit of intergovernmental fiscal coop- mental fiscal reform. eration is that it facilitates the exchange of relevant information among participant governments, lead- • Horizontal cooperation fora within each ing to a better understanding of respective objectives level of government, with primary advocacy and constraints, as well as the identification of viable functions. At the local level the main such policy synergies and trade-offs that can be taken into forum is the National Association of Italian account in the design and implementation of reform Municipalities (ANCI). packages. This exchange of information and experiences also facilitates the identification of good and • A special mechanism is in place for consulta- bad practices by peers that face similar policy chal- tion with the SNGs regarding EU legislation. lenges. These forums are of a consultative nature but have Intergovernmental cooperation can take different been influential in several cases, especially regarding forms: among different levels of government (in the implementation of legislated reforms (e.g., the vertical forums) or within each level (in horizontal redistribution of functions among the different lev- ones); among executives or parliaments; with deci- els of government ushered in by the Delrio law and sion-making power, or only consultative; through the homogenization of accounting standards across standing bodies, or ad hoc forums; and can cover the whole general government). They could also, in more or less broad ranges of intergovernmental is- a future perspective, play a greater role in promoting sues.* intergovernmental agreement on the vertical distribution of fiscal balances compatible with the con- Italy has a number of intergovernmental coopera- straints of the national fiscal rules. tion forums:

* For a more detailed discussion of the theory and international practice with intergovernmental fiscal cooperation, see Ter-Minassian and de Mello, 2016.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 15 2,000 municipalities. There are no official estimates and council, appointment of a commissioner, in- of the local governments’ arrears, the growth of creases in local taxes and user fees, hiring freeze, which was fostered by the fact that spending limits liquidation of assets, etc.). under the Internal Stability Pacts were specified in cash, rather than accrual, terms.22 The CG repaid Not surprisingly, there has been little use of these in 2014 some 7 billion euros of arrears of provinces bankruptcy procedures. More recently, the Corte and municipalities to private suppliers. dei Conti has been given the power to call for the initiation of bankruptcy procedures for municipal- Legislation has been passed in recent years to facil- ities judged under severe financial stress. Howev- itate an orderly resolution of local financial crises. er, a growing number of municipalities have been The law (modeled on Chapter 9 in the U.S.) allows availing themselves of an alternative procedure municipalities in financial distress to seek protec- allowing those under incipient financial stress to tion from creditors and a restructuring of their prepare multiyear adjustment plans, to be imple- debts, but at the cost of substantial loss of financial mented by the existing local authorities, with en- and political autonomy (dismissal of the mayor dorsement and support from the CG.

22 This has now been modified. The structural balance is calculated with current expenditures on an accrual basis and capital ones on a cash basis.

16 Fiscal Federalism and Governance in the European Union LOCAL GOVERNMENTS’ an additional motivation for such proliferation of ENTERPRISES, PPPS, AND ASSET local enterprises, since outsourced activities would MANAGEMENT not come under such limits, unless the enterprises ecent decades have seen a rapid growth of par- received more than half of their revenues from the Rtial or full ownership of enterprises by Italian local government. municipalities and provinces. Between 2000 and 2007, the number of firms with local government An important source of concern is that a sizable participation rose on average by 400 a year. Even in number of these enterprises record losses, amount- more recent years, their number has continued to ing to some 1.2 billion euros in 2012, and many increase by some 200 a year, to over 6,000 in 2013.23 receive subsidies from local budgets. A significant part of these losses is attributable to the sector of Of these enterprises, 13 percent provide services local transport, which compares poorly with other (information technology, property management, European countries in terms of operational costs catering, etc.) directly to the local governments; and revenues per kilometer.25 about 42 percent provide services to the population (e.g., street lighting, security, maintenance of Moreover, concerns have been raised about the val- cemeteries) paid by the local government; 23 per- ue for money provided by many local enterprises in cent provide network services (e.g., electricity, wa- the delivery of essential public services, particular- ter, transport or waste disposal) partly or wholly ly in water and sanitation, and especially in cities paid by user fees; and the remaining 22 percent are in the Center and South of the country. However, engaged in activities typically undertaken by pri- a rigorous analysis of the efficiency of these enter- vate enterprises (e.g., pharmacies, tourism facili- prises is hampered by the lack of measurement of ties, casinos, even dairies).24 Only some 20 percent standard costs in the production of such services. of these enterprises are wholly owned by the local governments; in more than half, most of the capi- In a 2013 report, the Corte dei Conti expressed seri- tal is in private hands. In some 1,400 of them, the ous concerns about the state of the local enterprise local governments own less than 5 percent. sector and called for increased transparency of its finances and urgent corrective measures. In 2014, the It is difficult to escape the sense that in many cas- Commissioner for the spending review submitted es the decision to enter into such participations (a to the national government a set of recommenda- decision which until recently could not be chal- tions to streamline and improve the performance of lenged by higher levels of government) is motivat- the sector.26 These recommendations included: ed mainly by a desire to create well-paying jobs for local constituents. In this respect, it should be not- • Requiring approval of the national Com- ed that some 1,300 such enterprises have a board petition Authority for the creation of new but no staff, and in 2,000 of them, board members local enterprises in non-core sectors. outnumber employees. • Strictly limiting indirect participations and The limits on local spending and deficits under the requiring the sale of existing “micro-partic- Internal Stability Pacts are likely to have constituted ipations.”

23 See ISTAT, 2015. This number is likely an underestimate, because it is based on a survey of the national Ministry of Economy and Finance, and municipalities tend to underreport indirect participations (i.e., participations of their enterprises in other firms). 24 See Cottarelli, 2015. 25 The operational cost per kilometer in 2012 was 3.3 euros in Italy, compared with a 2.8-euro average for France, Germany, Spain, and the U.K. The corresponding figures for revenues per kilometer were 1.4 and 1.9 euros, respectively (Bain and Company, 2012). 26 See the website of the spending review: http://spendingreview.gov.it.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 17 • Closing or privatizing enterprises with a succeed in streamlining the local enterprises’ sec- very small volume of sales or number of tor and ensuring a sustained improvement in its employees. financial performance.

• Forbidding municipalities with fewer than Local governments have also engaged actively in 30,000 inhabitants to hold equity in lo- public-private partnerships (PPPs) since their in- cal enterprises, except through the unions troduction in 1998. Resort to PPPs by all levels of mentioned in Section II. government rose rapidly through 2006, decelerated in the wake of the recession induced by the global • Undertaking urgent studies to measure financial crisis of 2008-2009, and recovered briefly sectoral standard costs and rates of return, in 2010, before falling again during the euro crisis. with a view to identifying significant ineffi- According to a recent study by the national Minis- ciencies of remaining municipal enterpris- try of Economy and Finance,27 PPPs accounted for es and requiring well-tailored adjustment about a quarter of public works in 2013. Munici- programs from them. palities were responsible for over one-third of such PPPs, concentrated in infrastructures for public • Increasing local transport tariffs (especial- transport, social housing, schools, and cemeter- ly monthly tickets) and taking steps to im- ies.28 Municipalities in the North were distinctly prove enforcement on public buses. more active in PPPs than those in the Center and the South. • Ensuring appropriate reassignments, re- training, or unemployment benefits for af- The initial spurt and the subsequent deceleration fected employees. of PPPs are partly related to their treatment in the public accounts. Initially they were largely off the These measures were expected to drastically re- books of the public partner, thus easing budgetary duce over time the number of local enterprises constraints under the Internal Stability Pacts. In (to around 1,000 by 2018) and to produce fiscal more recent years, under the guidance of Eurostat, savings of 2 billion to 3 billion euros a year. The PPPs have begun to be treated as on- or off-bud- government included the reform of local partici- get depending on the distribution of the risks they pations within the broader program of reform of involve (construction, availability, demand, and the public administration, for which a framework other financial risks) between the public and the law was enacted in 2015. private partner. According to the MEF study, over 70 percent of investments financed through PPPs Implementing legislation has introduced by the in 2010-2014 were classified as public. government incorporating several of the commissioner’s recommendations. It requires local gov- PPPs are notoriously complex to negotiate, and ernments to prepare annual reports on the state require a careful evaluation of the risk and their of their enterprises and specific plans to improve assignment to the partner best equipped to bear their performance. It also requires the closure of them. Best practices suggest that decisions to do enterprises with sales or staff under given thresh- public works through PPPs, rather than through olds, and of those that are serial loss-makers. Ex- direct public procurement, should be guided by perience will tell how much these reforms will the preparation of comparative analyses of the

27 Ragioneria Generale dello Stato, 2015. 28 A large portion of PPPs is in the health sector (hospitals and local health care units, which are financed and overseen by the regions).

18 Fiscal Federalism and Governance in the European Union costs and benefits of the two options (the so-called nancial assets.29 Naturally, performances in this public-sector comparators). Most municipalities area vary significantly across municipalities, but lack adequate technical expertise to prepare such there are widespread examples of poor use of the analyses, and there are no national sector-specific land and buildings owned by municipalities. Many guidelines in this area. don’t have even complete lists of all their real estate holdings, let alone of their current market worth. Finally, an area in which most Italian municipali- Many lease them out at prices well below those of ties could make progress in mobilizing resources private comparators.30 for investment is the management of their non-fi-

29 Since 2012, all subnational financial assets have to be deposited with the Central Bank of Italy and the remuneration of these accounts is transferred to the national Treasury (the so-called Tesoreria Unica), to help reduce public debt costs. 30 For example, according to a recent survey, only 16 (less than 0.1 percent) of the 42,000 buildings owned by the municipality of Rome paid rents of over 1,000 euros per month. Almost one-third of the buildings were rented for less than 10 euros per month! See Corriere della Sera, June 21, 2015.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 19 CONCLUSIONS properties (in particular lands and building), by ignificant progress has undoubtedly been completing inventories of such properties, esti- Smade in improving local finances in Italy in mating their market values, leasing them out at re- recent years. In particular, the Delrio law rep- alistic rents, or disposing of some of them through resents an important advance in streamlining the a well-structured program of sales. sector, by reducing the superimposition of different levels of government, promoting various forms Substantial progress has been made in recent of association of small municipalities, and putting years in rationalizing transfers to local govern- the creation of metropolitan cities on a sound legal ments, in particular by setting in place an equal- footing. ization mechanism based on estimates of standard spending needs and revenue-raising capacities. The focus of future reform efforts concerning gov- The phasing-in of this system seems appropriate, ernance and functions of local authorities should to smooth the inevitable gains and losses that the be on the implementation of the law, a further clar- reform entails for individual municipalities. Fur- ification of the role of metropolitan cities and their ther progress is needed in defining appropriate relations with the regions, and strengthening in- criteria for distribution of transfers to finance the centives to the merger of small municipalities. The non-fundamental functions of municipalities, as rejection of 2016 referendum implies that provinc- well as in implementing the equalization reform es will continue to exist, albeit with reduced func- at the regional level. A politically sensitive issue is tions the scope for reform of transfers to municipalities located in the regions with special statute, to which On the revenue side, international comparisons the new equalization system does not apply. suggest that Italy fares relatively well regarding the assignment to local governments of appropriate Probably the biggest challenge for municipalities sources of own revenues. However, there is scope is now how to finance a recovery of local public for improvement in this area. First, it would be investments, while conforming to the constraints desirable that the CG refrains in the future from of the legislation implementing the EU’s Fiscal frequent interventions regarding the definition of Compact. This will likely require a multipronged the base and the rate structure of local taxes. The approach, carefully tailored to local situations, in- recent record in this respect has been detrimen- cluding in the first place actions to increase mu- tal to the ability of local governments to plan and nicipal current surpluses through, in particular: budget, and has increased compliance costs for taxpayers. • Some of the steps mentioned above to raise own tax and non-tax revenues, as appro- Second, it would seem urgent to review and up- priate in individual municipalities’ circum- date property cadastres, to bring them in line with stances. market valuations. This is likely to require substantial efforts and time, a fact that adds to its urgen- • Increased efforts to make local spending cy. Third, there appears to be scope for increasing more efficient, including through better -ex some user fees, notably some public transport tick- ploitation of economies of scale. ets, and to reduce exemptions and special treat- ments in this area. • Reducing subsidies to municipal enterprises and drastically cutting back their num- Fourth, there is clearly significant scope for mu- bers, especially in non-core public services. nicipalities to improve the management of their

20 Fiscal Federalism and Governance in the European Union In addition, it may be worth exploring ways to bet- to support priority local investments through ter use the flexibility provided by the current fiscal matching capital grants or co-financing. Finally, rules, for instance by promoting the development there may be scope for the larger municipalities to of a market backed by interest-bearing securities use well-structured PPPs to exploit the efficiency for the trading (regionally or even nationwide) of gains that an appropriate sharing of risks with pri- temporary fiscal imbalances among municipal- vate partners could bring to the building of major ities. Also, the CG and/or the regions could use infrastructures. available fiscal space under their respective rules

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 21 REFERENCES

Ambrosanio, M.F., P. Balduzzi, and M. Bordignon, ISTAT, 2015. Sintesi dei conti e aggregati economici del- 2016. “Economic Crisis and Fiscal Federalism in le Amministrazioni pubbliche, 1995-2014. Rome. Italy,” in Multi-level Finance and the Euro Crisis: http://www.istat.it/it/archivio/172177. Causes and Effects,edited by E. Ahmad, M. Bor- dignon, and G. Brosio. Cheltenham, U.K.: Edward Legautonomie, 2016. “L’attuazione della Legge Delrio Elgar Publishing. e la riallocazione delle funzioni delle Province.” http://www.legautonomie.it/. Arachi, G., G. Di Liddo, and M.G. Giuranno, 2015. “Co- operazione locale in Italia: le unioni di Comuni,” Nordi, F., and L. Rizzo, 2016. “Abolizione delle province POLIS working paper, Economic Series no. 226. e riallocazione della spesa: il caso della Lombardia.” http://polis.unipmn.it/pubbl/RePEc/uca/ucapdv/ Economia Pubblica. Milan: F. Angeli. polis0226.pdf. Oates, W. E.and Schwab, R. M., 1988. “Economic com- Bilancia, P., and F. Scuto, 2015. La riforma costituzio- petition among jurisdictions: efficiency enhancing nale tra superamento del bicameralismo paritario e or distortion inducing?,” Journal of Public Eco- riordino delle competenze Stato-Regioni. Research nomics, Elsevier, vol. 35(3), pages 333-354, April. paper, Centro Studi sul Federalismo, Turin, Italy. Piperno, S., 2013. La finanza decentrata in Italia. Il Mulino: Bologna, Italy. Brosio, G., and S. Piperno, 2013. “Il difficile cammino dell’autonomia tributaria regionale e locale in Ita- Piperno, S., 2016. “L’attuazione del federalismo fiscale lia: un modello interpretativo.” Rivista italiana di in Italia: si puo’ riavviare il cantiere?” Research pa- politiche pubbliche no. 2, Agosto: 249-281. per, Centro Studi sul Federalismo, Turin, Italy.

Corte dei Conti, 2014. Relazione sugli andamenti della Ragioneria Generale dello Stato, 2015. “A Focus on finanza territoriale. Analisi dei flussi di cassa. Anni PPPs in Italy.” Paper prepared for the eighth OECD 2011-2012-2013, Volume I, Corte dei Conti, Rome meeting of senior PPP officials. http://www.corteconti.it/export/sites/portalecdc/_ documenti/controllo/sez_autonomie/2014/delibe- Revelli, F., 2016. L’autonomia tributaria dei Comuni e la ra_20_2014_sezaut_frg_vol_I.pdf. “local tax.” Research paper, Centro Studi sul Fede- ralismo, Turin, Italy. Cottarelli, C., 2015. La Lista della Spesa. Feltrinelli: Mi- lan, Italy. Rossi, M., and R. Civitillo, 2014. “Public Private Part- nerships: A General Overview in Italy.” http:// Frere, Q., H. Hammadou, and S. Paty, 2011. “Is There a www.sciencedirect.com. ‘Zoo Effect’ in French Local Governments?” Centre d’Economie et Sociologie appliquées à l’Agriculture Ter-Minassian, T., 2016. “Promoting Stabilizing and et aux Espaces Ruraux, working paper 2011/1. Sustainable Sub-National Fiscal Policies in the Euro Area.” Multi-level Finance. IFEL, 2014. Guida alla lettura dei fabbisogni (e dei costi) standard. Studi e ricerche, IFEL, Rome. Ter-Minassian, T., and L. de Mello, 2016. “Intergovern- http://www.fondazioneifel.it/studi-ricerche-i- mental Fiscal Cooperation: International Experi- fel/item/2176-guida-alla-lettura-dei-fabbiso- ences and Possible Lessons for Brazil.” IDB Tech- gni-e-dei-costi-standard. nical Note TN1048.

22 Fiscal Federalism and Governance in the European Union Fiscal Decentralization and 21st Century Cities in France

BERNARD SOULAGE IN COLLABORATION WITH CAROLINE CONROY AND MARIAMA SOW

ities worldwide are facing growing challenges, forms continue a decentralization process that Cas a result of rising urbanization, citizens’ ex- began in the 1980s. The most recent changes will pectations of better local services, migration, and unfold through 2020 and will be described at environmental concerns, among others. That such greater length in following sections. challenges have to be met in a context of tightening resource constraints adds urgency to the im- There are three levels of local government: the peratives of effectiveness and efficiency in local communal bloc, departments, and regions. spending, and of growth-friendly, sustainable, and equitable generation of local revenues. Cities are The lowest level of territorial governance consists meeting these imperatives in different ways and of complex groupings commonly referred to as the with different degrees of success. communal bloc. In terms of urban territorial classifications, this administrative unit most closely The Brookings Project on 21st Century City Gov- corresponds to the “city” in terms of spatial and ernance explores the norms, institutions, and net- population size. However, this division lacks judi- works that power successful cities in a complex cial and fiscal autonomy. The communal bloc can world. This background paper aims to contribute be further divided into two administrative and to the project by providing a brief, yet comprehen- functional units, each with distinct characteristics sive, overview of local and national fiscal systems and compositions: and governance structures in France. • Commune. This designation encompasses administrative units that vary in size THE VARIOUS LEVELS OF from a hamlet, an entity with a popula- LOCAL GOVERNANCE AND THE tion no greater than several hundred, to DISTRIBUTION OF COMPETENCIES large metropolitan cities. There are about 36,000 communes in France, an important Administrative divisions distinction as French communes account France recently introduced a series of legislative for half of all communes in the European changes to its territorial organization, resulting in Union. The governing assemblies, munic- significant alternations to both physical bound- ipal councils, are elected through direct aries and the division of competencies. These re- universal suffrage via two-round list-ballot

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 23 majority voting (see Box 2). This process directly elected but are often selected from extends to the election of the mayor, who existing officeholders, such as mayors and jointly manages the affairs of the commune city council members. Additionally, there with the local council. The administrative are a number of less formal intercommunal powers of the governing body are uniform, cooperation arrangements, such as city net- regardless of commune size, although the works and agreements. size of the municipal council greatly varies depending on population size. The second level of territorial governance is the department. This administrative level is a tier above • Intercommunalities. These consist of co- the communal bloc in terms of territorial size. operative groupings of communes, the size Structurally, departments are further divided into and scope of which vary drastically. Al- arrondissements and cantons. These units have no though this agglomeration was codified in functional autonomy but are used to effectively 2001, it was fairly common for communes, organize service provision and, in some cases, ad- particularly with smaller populations, to minister elections. There are 95 departments within voluntarily enter cooperative agreements to Metropolitan France (the official territorial designa- facilitate service provision. There are 2,100 tion of continental France, which excludes overseas intercommunalities. Governing assemblies regions, collectivities, and the sui generis collectivity for these bodies are elected through indirect of New Caledonia). Departmental boundaries have universal suffrage. Intercommunalities can not shifted since the 1900s, although the regional take several forms and titles, depending on division was almost abolished in 2014 as part of the the size and location of the communes. national discussion on territorial reform. Govern- ing assemblies, termed departmental councils, are Territorial evaluation and designation are elected through two-round binomial majority voting particularly complex in France. Public es- within cantons. Each department has a president of tablishments for cooperation among lo- the council, as well as departmental advisers, select- cal authorities (établissement public de ed by council representatives. Elections for the two coopération intercommunal, or EPCI) and departmental advisers are unique because of gender official communal groupings are myriad. Of- parity requirements, which ensure that elected ad- ten differentiated by population size, the most visers are of opposite gender. common groupings, listed from smallest to largest, include community of communes The highest level of territorial governance is the re- (communauté de communes), agglomeration gion. Despite their size, regions lack legislative pow- communes (communauté d’agglomération), er, a long-standing point of contention. Regional and metropolis. Not all groupings are subject assemblies are elected through two-round, list-bal- to population thresholds, such as the com- lot majority voting and function much like depart- munity of communes designation, which re- mental councils. In January 2016, a law reduced the quires only geographical continuity. Group- number of regions in France from 22 to 13. ings with higher population requirements tend to be less tightly integrated, although all permutations are governed by a representa- Division of competencies tive council. In the case of communes whose Over the course of the 20th century, a series of population numbers fewer than 1,000 but decentralization reforms and territorial restruc- are part of an intercommunal grouping, the turing created a fairly well-structured system of representatives at municipal boards are not governance. Capitalizing on economies of scale,

24 Fiscal Federalism and Governance in the European Union Box 1. The Metropolis Box 2. French electoral system lexicon In December 2010, France passed a law establishing the creation of metropolises, with the aim of Universal suffrage: The right to vote is granted consolidating the role of large agglomerations as to every citizen who meets the electoral require- a key driver of economic growth. A metropolis ments: age, nationality, moral capacity, and voter is defined as a “public cooperation entity, which registration. groups several communes and promotes economic educational environmental and cultural Direct universal suffrage: Voters directly elect development in order to improve their region’s their elected officials. The French president is competitiveness and cohesion” (General Code elected via direct universal suffrage. on Local Governments). Fourteen metropolises have been created: Bordeaux, Brest, Grenoble, Indirect universal suffrage: Voters elect delegates Lille, Montpellier, Nantes, Rennes, Rouen, Stras- who in turn select the elected officials. The U.S. bourg, Toulouse, Nice Côte d’Azur, Aix-Mar- president is elected via indirect universal suffrage. seille-Provence. The metropolis of Grand Nancy will be created on July 1, 2016, bringing the total Uninominal voting: One candidate is elected. to 15. The French president is elected via uninominal voting. The list of metropolises cited in the paragraph included the following Metropolises: Grand Par- List ballot voting: Voters elect a list of candidates. is and Grand Lyon. The two have a special status The governing assemblies of communes are elect- within France. The Métropole du Grand Paris, a ed through list ballot voting. recently created cooperative structure that over- sees the capital city and surrounding urban area, Majority voting: The winning candidate (or list is a complex entity tasked with the responsibil- of candidates) is attributed all the seats at stake. ities most commonly assigned to the first two tiers of local governments (commune and de- Proportional voting: Candidates are attributed partment). Although the city of Paris has held a seats based on the proportion of votes they re- unique position within the governance structure ceived. of France, legislative reform in 2016 saw the administrative structure of Grand Paris grow to Two-round voting system: When a candidate incorporate communes from three departments. (or list of candidates) fails to obtain an absolute The area is governed by a newly constituted met- majority of votes (more than 50 percent), runoff ropolitan council, and its basic competencies will elections are organized between the two can- include urban planning, housing, and protection didates (or list of candidates) who obtained the of the environment. Additionally, the Metropolis most votes in the first round. of Lyon, or Grand Lyon, like Paris, was granted expanded powers and scope in 2016. This administrative unit replaced the urban community of Lyon and has the competencies of a depart- local governments in France play a central role ment and metropolitan area. The special status of in the distribution of services and tax collection, Grand Lyon will be examined in greater depth in and have a fair amount of influence over social, an upcoming publication. economic, and education policies. Although the Despite their special status, French metropolises division of responsibilities among tiers of local are under the umbrella of the communal bloc; government has undergone significant alterations their finances are reported under the “communal since the second stage of decentralization in 2003, bloc” label. competencies continue to be allocated uniformly across corresponding administrative authorities. This ensures that each level has a consistent set of

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 25 responsibilities and attempts to reduce any redun- dancies in spending and service provision. How- Box 3. Intergovernmental cooperation and consolidation ever, the 2003 Act on Experimentation by Local Governments allows for some variation in the del- The central government has long recognized the egation among government levels. potential pitfalls of a lack of coordination within a highly localized, and overlapping, subnational France is one of the least decentralized European government structure. Colloquially referred to as countries, particularly when compared with larger a mille-feuille, or multilayered and highly bureau- EU countries (i.e., Germany). As it is not a federal cratic, structure, local entities are often controlled and governed by overlapping authorities and ju- state, local governments lack legislative power and risdictions. Coordination among complex local cannot impose their jurisdiction or control outside levels of government can lead to costly redundan- their boundaries. Instead, the central government cies in service division and is often compounded exercises authority and control a posteriori over by the high number of very small municipalities. the actions and finances of local governments. This process is facilitated via the Office of the Prefec- In recent years, the federal government has re- sponded with a series of structural reforms and ture and Sub-Prefecture; federally appointed rep- departmental committees that have sought to resentatives of the national government that op- simplify intergovernmental cooperation and lo- erate within the departments. “Regalian” powers cal government structure. A key example can be (defined as the functions that reflect the sovereign found in the Departmental Commission for In- attributes of the nation-state), such as national de- tercommunal Cooperation (CDCI), which dates fense, lawmaking, health care, and funding for ed- back to 1992, a representative body that draws delegates from the communal, EPCI, general, and ucators and public researchers, are almost entirely regional councils to develop plans for increased endowed in the central government. cooperation and dialogue among local governments. Moving beyond the commission, in 2010 With respect to subnational governance, the com- the Departmental Plan for Intermunicipal Co- munal bloc (communes, intercommunalities, and operation (SDCI) was established to streamline metropolises) is by far the most influential entity. local governments. The SDCI has developed in- depth schemes for departmental cooperation It is the only level of local administration that has which have led to the restructuring of local enti- retained a “general competency” clause that en- ties and the creation of population requirements ables it to intervene in most areas of administra- for certain designations. The most recent adapta- tive activity, excluding the provision of essential tions took place in January 2017. functions related to national sovereignty (justice, national defense, foreign affairs, security, etc.). ing the division of labor between the groupings of Communes, intercommunalities, and metropo- communes and within intercommunalities and lises share functions related to early childhood metropolises, responsibility-sharing arrangements education, roads, urbanism and public transport, vary depending on the size of the associated units culture, sports, after-school programs, housing and agglomeration area. The transfer of resources and accommodation, and economic development from the communes to the intercommunalities is through the economic activity zones.31 Division of monitored and financially incentivized by the cen- labor is a particular concern as these duties often tral government. overlap. Recent legislation, discussed at greater length in Section II, has attempted to reduce ser- Departments are primarily responsible for the im- vice duplication and excess spending by clarifying plementation of social policies: inclusion and so- competencies among local governments. Concern- cial welfare, social aid, care for senior and disabled

31 Economic activity zones in France are zones reserved for the creation of businesses within a given perimeter.

26 Fiscal Federalism and Governance in the European Union residents, public health, youth services, depart- areas: regional transportation (notably trains, civil mental transport, economic development, voca- airports, etc.), professional training, building and tional training, environmental services (including maintenance of high schools, and support staff. waste and water plans), ordinary secondary ed- Additional services also include academic and ucation, social solidarity, and territorial solidar- scientific research, local economic development ity (providing financial assistance to poor com- (often overlapping with departmental activities), munes). exports, sports, culture, tourism, and international cooperation. The regions handle the entirety Despite being the largest local administrative lev- of European Structural and Investment Funds, el, regions have fewer responsibilities and smaller amounting to about 20 billion euros. Recent legis- budgets relative to other tiers of government as lation, examined in Section II, attempted to solid- well as to their European counterparts. Regional ify regional control over fund dispersal and eco- governments are the lead actors in the following nomic growth.

Box 4. Fiscal decentralization and income distribution

At the national level, the central government often ities and services to lower levels of administration argues that the taxation and benefits system is in- (see Table 1, Appendix). These additional competen- herently redistributive and effectively reduces in- cies and corresponding increase in expenditures for come inequality and compensates for differences lower levels of government authority have become in regional wealth distribution. Therefore, there is a growing drain on local resources. This has result- less of a need to implement more aggressive redis- ed in an increase of inequality among territories, tribution policies at the national level. An analysis particularly in smaller communes and departments of the data supports the national government’s claim that lack the institutional support and funding to that its redistribution taxation system and public manage and meet the needs of their constituencies services help compensate for inequality among re- without increased financial and administrative as- gions. A 2014 Organization for Economic Cooper- sistance from adjacent communes and higher levels ation and Development (OECD) study found that of government. France’s system of taxation and transfers created the largest reduction dispersion of poverty rates, Additionally, in early 2017 the Monitoring Com- based on disposable income, of all OECD countries. mittee of the Council of Europe explicitly expressed Despite this claim, the OECD has often found that concern over the state of France’s financial equal- while redistribution and social benefits do help re- ization system, citing fears that the redistribution duce income inequality, these funds are ineffectively of resources among authorities is insufficient to distributed so that the bottom 30 percent of house- compensate for financial disparities. Given signif- holds received slightly less social funding than the icant territorial reforms and steps toward greater average household, while the top 30 percent enjoyed decentralization, the Congress of Local Regional about a quarter more than the average. Authorities has stressed a greater need for consul- tation among levels of government to ensure that A failure to properly redistribute funds based on local authorities, particularly in rural areas, have the economic need and circumstance is increasingly appropriate financing to fulfill their responsibilities worrisome given the trend to devolve responsibil- and properly serve their constituents.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 27 RECENT DEVELOPMENTS through direct universal suffrage by 2020. This wo important laws recently changed the struc- paradigm shift will re-center policy debates on Tture and responsibilities of local governments metropolitan issues and will likely lead to further in France. difficulties as metropolitan councils try to meet the needs of much larger constituencies.

Modernization of Territorial Public Action and the Affirmation of Metropolises32 New Territorial Organization of the Adopted in January 2014, Modernization of Ter- Republic ritorial Public Action and the Affirmation of Similar to MAPTAM, New Territorial Organiza- Metropolises (MAPTAM) attempted to clarify tion of the Republic (NOTRE) seeks to reinforce the competencies of local administrative bodies the competencies of regions. Adopted in August through a structural reorganization of highly in- 2015, this law clarifies territorial organization and tegrated municipal areas as well as the creation of condenses the size of lower tiers of local govern- consultative bodies among communities. It also ment. First, the population requirement for in- established a framework to facilitate the eventual tercommunalities increased from 5,000 residents transfer of responsibilities from the newly incor- to 15,000. This drastically reduced the number porated communes to the metropolitan govern- of intercommunalities to 1,500, forcing over 500 ments, a process slated for completion in 2020. communal groupings to redefine their legal desig- This law is a continuation of the decentralization nation and scope. The responsibilities of restruc- process in France. Although MAPTAM has been tured intercommunalities will increase as respon- in effect only since January 2016, it affirmed the sibilities are transferred from the communes or role of metropolises through the creation of new departments. Second, NOTRE transferred several metropolitan entities and classifications. The -me departmental responsibilities to regional govern- tropolises of Grand Paris, Grand Lyon, and Aix- ments. New regional competencies include land- Marseille-Provence increased in territorial size, use planning, environmental and climate change with the latter two gaining new competencies and issues, professional training, transport, and mobil- influence. Although Paris has had special status ity. The most notable change is the transfer of con- for quite some time, Lyon experienced the great- trol over economic development, which is under est changes as it became the second metropolis in debate, particularly within the metropolises. France. This territorial restructuring decreased the num- Not without controversy, the creation of metrop- ber of regions from 22 to 13, thereby creating larg- olises and cities with special status and competen- er regional governments with greater territorial cies has been the center of ongoing discussions re- scope and responsibilities. The passage of NOTRE garding the division of power among government and MAPTAM laws can be viewed as an attempt levels. This is particularly pressing for the newly to replicate key aspects of the administrative struc- established metropolises, as before MAPTAM they tures of neighboring countries that have strong had cooperative structures as urban communities regions and metropolises. Nevertheless, France (a subdivision of communal bloc) that were up- continues to have a relatively higher number of rooted by new regulations. Moreover, MAPTAM territorial levels and a hazy distribution of respon- affects the local electoral process, as it mandates sibilities. that all metropolitan assemblies must be elected

32 Modernisation de l’Action Publique Territoriale et d’Affirmation des Métropoles.

28 Fiscal Federalism and Governance in the European Union Evolving political divisions among regions Metropolises argue that they elevate the sur- and metropolises rounding areas through “spillover effects.” Recent attempts to simplify the distribution of Alternatively, regions believe they are unique- responsibilities among administrative levels and ly able to prevent polarization caused by the empower regions and metropolitan areas are in- flight of capital and human resources, often dicative of a highly adaptable, and evolving, orga- created by metropolitan areas, emphasizing nizational climate. Due to their recent implemen- examples of territoriality (as seen in the case of tation, it is difficult to draw conclusions about the the Italian “industrial district”) that promoted effectiveness of MAPTAM and NOTRE. Moreover, innovation and economic development. The significant confusion over the implementation of debate continues. that legislation continues to play out in parliamentary debates, creating some issues for first adopt- 3. Public transport and mobility. Tensions re- ers. Two key difficulties should be highlighted: lating to the provision of transportation services arose because of conflicting aspects of 1. Economic intervention. Drawn into conten- the MAPTAM and NOTRE laws. As it ex- tion after the passage of NOTRE, as the law panded the role of metropolitan governments failed to adequately delegate the responsibil- to cover sustainable mobility, which includes ity of economic development to a particular urban transportation as well as parking, administrative level. While the law created streets, and some aspects of regional transit, a generic division of regional competencies, MAPTAM created the Metropolitan Authori- the updated administrative responsibilities ties for Sustainable Mobility. This joint assem- have significant overlap with competencies bly capitalizes on the role of agglomerations assigned to metropolises. As of 2016, both and metropolises in organizing mobility ser- regional governments and communal admin- vices, an arrangement reflective of France’s istrations have the same rights in relation to highly developed urban public transportation economic assistance for the internationaliza- system. Conversely, NOTRE created a trans- tion of local firms and the support of research portation scheme termed the Regional Trans- and development—often the only way to assist port Blueprint, which has the potential to re- private companies within the confines of EU strict and clash with metropolitan authority regulations. and planning. While the blueprint is intended to increase collaboration among the levels of 2. Although the debate over economic develop- local government, there is no indication that ment highlights power rivalries and hostility, harmonization of projects and tariffs will be it symbolizes a deeper divide over the drivers easily achieved. of innovation and economic development.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 29 Box 5. Tensions between metropolises and surrounding territory

With the adoption of the MAPTAM law, metropol- The reduction of services to underpopulated areas itan cities within France gained new competencies could bring some benefits. For example, closing and importance. The new metropolitan councils can some of the smaller rural hospitals would allow deliver most services across the city, notably gaining economies of scale and greater investment in new control of social and welfare services. In particular, technologies, which could increase quality of service Grand Lyon significantly increased in size and ad- provision. There has been a general push from orga- ministrative control, assuming powers and control nizations such as the OECD to decrease the powers over areas formerly outside its purview. of communes in order to consolidate and expand the size and responsibilities of higher levels of ad- Territorial reorganization was presented as a means ministrations to both increase efficiency and reduce to ensure that communes, and inhabitants, would losses from overlapping of responsibilities and ex- have greater access to administrative and financing penditures among lower levels of government. sources to support economic growth and cohesion. There has been some localized pushback from the This tension is also reflected within metropolitan host regions as well as the surrounding departments areas, where many view outlying towns and de- and intercommunal areas that are now part of, or partments as being “free-riders” that benefit from border, the metropolises. Citizens from surrounding substantial wealth transfers and knock-on benefits departments and communes, particularly in more without financially contributing to the city. This has rural or sparsely populated areas, have begun to become a particular issue for Grand Lyon, which view the growth of metropolitan areas as detrimen- transfers substantial amounts to surrounding de- tal to the economic and social health of their cities partments and its regional government. Large met- and towns. Citing a “desertification” of resources ropolitan areas often view themselves as the drivers and skills, departments and communes outside the of economic and social growth for their regions, periphery of large metropolises view urban growth stating that the benefits of increased innovation, coming at the expense of small and medium-sized public spending, and economic growth will often towns as funding, services, and businesses leave less flow down to surrounding cities and departments. populated areas.

30 Fiscal Federalism and Governance in the European Union LOCAL GOVERNMENT SPENDING cal governments drive 74 percent of public investment in France. The growth and diversification of local expenditure These figures and trends demonstrate the increas- The overall analysis of local government spending ing influence of the communal bloc, particularly as a percentage of GDP and as a percentage of total with intercommunalities, which represent about public spending demonstrates the growing fiscal half of all spending within the communal bloc. importance of the local governments. Since the Conversely, the sum of spending by the regions in first decentralization laws of 1982, subsequent leg- relation to total government spending continues islative reforms have continued to strengthen the to be small in comparison with neighboring EU role of local governments and increase the scope countries. of service provision and responsibility of local administrations. This trend is also reflected in the Figure 2. Local government rapid increase of the local to central government expenditures by level (%) spending ratio. Additionally, a recent study by the 100% Bank for Official Deposits demonstrates33 that lo- 90% Figure 1. Local and central government 80% expenditures, as a percentage of total 70% public spending (excluding social 60% security expenditures) 50% 40% 60 30% 20% 50 10% 0% 40 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

30 Region epartment Communal bloc Source: Direction générale des Finances publiques (DGFiP) 20 Expenditure across the levels of local 10 government The distribution of resources and competencies 0 among the tiers of local government has led to significant variations within local public expendi- 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 tures. The provision of public goods and services Local Government Expenditures (as a % of can be examined as follows: total public Expenditure) Central Government Expenditure (as a % of • Direct operating expenditure. This cat- total public Expenditure) egory encompasses all the expenditures Source: Institut national de la statistique et des études économiques necessary for service delivery by local (Insee)

33 “2012-2015: Observatoire de l’évolution de la commande publique,” Assemblée des communautés de France, February 2016. http://www.adcf. org/files/Finances-et-fiscalite/2Commande-publique-note-AdCF-fevrier-2016.pdf.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 31 governments. These expenditures are re- Figure 3. Breakdown of budgetary curring and account for about two-thirds of expenses, by governmental level total local government spending. Operating 100% expenditures include staff salaries, utilities (water, telephone, electricity, etc.), allow- 90% ances for elected officials, fees related to the 80% interest on debt repayment, and spending 70% related to maintenance and stationaries. 60% Additional expenditures include operat- 50% ing expenditures for “intervention,” such 40% as subsidies to associations, human capital 30% investment, public services (e.g., transpor- 20% tation), and assistance to senior citizens. 10% These are applicable to regions and depart- 0% ments as both are responsible for social security. 2009 2011 2013 2010 2012 2009 2011 2013 Region epartment Communal bloc

• Investment expenditure. This reflects the Investment Expenditures Operating Expenses

appreciation or depreciation of the value Source: DGFiP of the assets held by the local governments. Covered expenditures include the purchase Figure 4. Breakdown of investment of durable materials, the construction and expenditures, by governmental level maintenance of buildings, infrastructure de- 100% velopment, real estate acquisition, debt re- 90% imbursement, etc. Investment expenditures 80% account for about one-third of total spend- 70% ing. These are accrued at all levels of local governance with a stronger weight in com- 60% munes and intercommunalities. Local gov- 50% ernments are the largest public investors in 40% France. This is driven, in large part, by struc- 30% tural investment such as public transport.34 20% 10% Investment expenditure has been dominated by 0% the communal bloc, which accounts for almost 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 two-thirds of all investment by local governments. Annual variations in spending levels are almost Region epartment Communal bloc nonexistent, and the department and region Source: DGFiP spending represent 20 and 16 percent, respectively, of all investment by local government. Fig- bloc), while departments and regions supplement ures 3 and 4 illustrate that the bulk of investment the projects and investment plans undertaken by spending occurs at the most local level (communal communal or national actors.

34 “Les dépenses des collectivités locales,” Vie publique, Direction de l’information legale et administrative (DILA), last modified February 8, 2016. http://www.vie-publique.fr/decouverte-institutions/finances-publiques/collectivites-territoriales/depenses/comment-repartissent- depenses-collectivites-territoriales.html.

32 Fiscal Federalism and Governance in the European Union LIMITED REVENUES redistributive efforts at the national level. For example, a recent analysis of taxation in Paris and Operating revenues and the realignment Lyon has demonstrated that, despite a relatively weak tax system, revenues from these local house- Independent fiscal structures hold taxes strongly contribute to the financing of Historically, local fiscal governance and funding public services throughout the country and across were the responsibility of the respective local ad- administrative levels. ministrations. Local revenues are overwhelmingly collected from respective local communities. This However, this topic is relatively difficult to address system helps to create and reinforce important dis- quantitatively and is the subject of ongoing debate. parities among local governments. The differences This issue will be discussed at greater length in a among communes, departments, and regions can be forthcoming paper on Lyon. attributed to the political decisions regarding the level of service provided to residents, as well as wealth Reassertion of central controls disparities (or fiscal potential) among constituencies. In recent years, the central government has ex- Income distribution is a particular concern within pressed an interest in decreasing the overall tax and among urban areas and has been exacerbated by burden. As part of this process, efforts have fo- the sheer number of communes in France .As a re- cused on reforms at the local level, resulting in the sult, it is not unusual for residents from neighboring abolishment of key local taxes, including the oc- communes to be subject to very different tax rates, cupancy tax (taxe d’habitation), an important sub- because of different tax effort, even though their -ad sector of household taxes, and the professional tax ministrative governments bear similar expenditure (taxe professionnelle). A system of compensation burdens and provide comparable services. was created to help local authorities recoup the loss of tax revenue. However, the new compensa- In the past, government expenditure was financed tory process has undermined the fiscal autonomy via an even balance between business and house- of local governments, as the proposed transfers are hold taxation. Now, local government revenue in- evaluated by the central government on an annual creasingly draws on private households through basis and do not fully compensate local authori- indirect taxation. Prime examples include taxes ties for loss of tax revenue. Therefore, an important on gas and automobiles, which are collected at percentage of local revenue is determined at the the regional level, and estate taxes, which are en- national level, where an identical tax rate across forced by departments. Additional measures have local governments is set. Revenues from local tax been adopted that bolster the ongoing horizontal collection are ultimately transferred to the Nation- realignment within local governments, including al Treasury before any redistribution, which is also the transfer of jurisdiction over business taxation determined at the national level. from the intercommunal to the national level. Other revenues These structural changes have made France’s ad- Often called “estate” revenues, this income is made ministrative structure more closely resemble its Eu- up of user fees from public services. Overall, these ropean neighbors, where disparities in competency revenues make up a negligible portion of local distribution are less prevalent. But recent reforms government budgets (with the exception of the ought to be examined within the context of the commune level, where they make up 20 percent of French system, which is notable for concentrating operating revenues35) for two main reasons:

35 Figure estimated by B. Soulage.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 33 1. Most public services—such as preschools, seen negative growth (about negative 9.2 and 2.7 public lectures, roads, and public spaces—are percent, respectively) while expenses continue to free. grow at a higher rate than total revenue for local governments.36 2. When these services have associated fees, the generated revenues do not cover their costs. Investment revenue can be divided into four components:

Investment revenue 1. Gross savings. Before addressing this topic, it is important to note that by law local governments are not allowed to 2. Subsidies received from the central or other run an operating deficit. local government within the context of partnership through investment projects. Consequently, local governments have substantial operating surpluses, or gross savings, which are 3. Reimbursement of value-added taxes (VAT) often over 10 percent of total operating revenues by the central government for the work it (see Figure 10, Appendix). Additionally, all lev- does. In 2014, regions within metropolitan els of local government have positive net savings France received about 434 million euros from (gross savings/debt reimbursement) of 7 percent the compensation fund for VAT, a figure that of all local government spending combined, as of has steadily declined since 2010. 2013 (Figure 5). It is important to note that as of 2014, both investment spending and savings have 4. European subsidies, notably in the context of European Structural and Investment Funds (ESIF) that represent a small portion of Figure 5. Net savings as a percentage of total expenses (all local levels of government) Figure 6. Gross savings

12% 100% 90% 10% 80% 70% 8% 60% 50% 6% 40% 30% 4% 20% 10% 2% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 0% Region epartment Communal bloc 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: DGFiP Source: DGFiP

36 “Les finances des collectivités locales,” Collectivités territoriales, Cour des comptes, October 13, 2015.https://www.ccomptes.fr/Accueil/ Publications/Publications/Les-finances-publiques-locales3.

34 Fiscal Federalism and Governance in the European Union regional investment, roughly 2.9 billion euros per year allocated to regional councils. Over the period of 2014-2020, regional councils will receive about 20 billion euros, accounting for over 75 percent of all ESIF financing allocated to France (see Table 2, Appendix).

Figure 7. Investment revenue as a percentage of total revenue

25%

20%

15%

10%

0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Region epartment Communal bloc Source: DGFiP

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 35 DEBT ments, contrary to the central government and the harges related to debt reimbursement (includ- social security administration, may borrow only to Cing interest) are below 10 percent of the total finance investment expenditures. In other words, budget of all local governments, including regions local governments are not allowed to borrow to fi- with strong investment policies (Figure 8). More- nance operating expenditures. These expenditures over, the contribution of local governments to the make up two-thirds of total spending at the local general equilibrium of French public finances—in level. Thus, limiting borrowing to investment ex- respect to the Maastricht criteria,37 which states penditures reduces the risk of incurring high debt. that national debt cannot exceed 60 percent of GDP—varies depending on the year and is often slightly positive or close to zero. Figure 9: Debt as a Percentage of Total Public Debt

Figure 8: Debt reimbursement as a 100% percentage of total spending 90% 80% 12% 70% 60% 10% 50% 40% 8% 30% 20% 6% 10% 0% 2010 2011 2012 2013 2014 4% Region epartment Communal bloc 2% Source: DGFiP

0% The overall debt level of local collectivities is rather moderate as local governments account for less 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 than 9 percent of public debt, while local expen- Region epartment Communal bloc ditures represent about 20 percent of total public Source: (DGFiP) spending (including social spending). The overall debt ratio to total expenditure stands at 58.8 per- Local government debt is relatively low. Currently, cent on average. Based on historic gross savings local governments hold 9 percent of public debt, data, it would, on average, take local governments while the social security administrations and the five years to zero their balance sheets, assuming all central government represent 11 percent and 80 annual savings would be applied toward debt re- percent of public debt, respectively.38 Relative- payment. ly low debt at the local level can be attributed to national regulations on borrowing. Local govern-

37 “Finances Locales: La baisse des dotations de l’Etat en question,” Vie publique, Direction de l’information légale et administrative (DILA), last modified November 26, 2011.http://www.vie-publique.fr/actualite/alaune/finances-locales-baisse-dotations-etat-question-20141126.html . 38 “Quelles sont les dotations de l’Etat aux collectivités?” Vie publique, DILA, http://www.vie-publique.fr/decouverte-institutions/finances- publiques/collectivites-territoriales/ressources/quelles-sont-dotations-etat-aux-collectivites.html.

36 Fiscal Federalism and Governance in the European Union Box 6. Local debt and the Maastricht criteria

Adopted in 1991 and taking effect in 1993, the Maas- other than shares, which are treasury bonds tricht Treaty established the European Union and (BTF and BTAN), fungible treasury bonds outlined five convergence criteria in an attempt to (OAT), euro medium-term notes (EMTN), forward the creation of the European economic and as well as loans; excluded are derivative monetary community. The European convergence products and other accounts payable. criteria, also referred to as the Maastricht criteria, centered on fiscal, debt, and deficit obligations • It is calculated as gross debt insofar as lia- placed on member states that expressed interest in bilities are not subtracted from the financial adopting a single currency, the euro. Criteria relating assets of general governments. to government budget deficit and debt to GDP ratio are of particular importance when considering local • Debt is consolidated; therefore, the elements government spending and budgeting within France. of a government’s debt held by another government are excluded from debt cal- The two criteria that concern government finance re- culations. For example, deposits of general quire that the member states must not have a public governments with the treasury are excluded finance deficit that exceeds 3 percent of GDP for all from calculations. general government and that the public debt cannot be more than 60 percent of GDP. When accounting • Debt in the sense of Maastricht is evaluated for debt in relation to the Maastricht criteria, public in nominal value, that is, at the repayment debt encompasses all areas of the national account— value of the principal. As such, accrued in- including the accounts of local governments. Addi- terest not due or fluctuations in the prices of tionally, public debt is specifically defined in relation securities are not included in the evaluation to the convergence criteria as follows: of instruments, whereas the re-evaluation of the securities repayment value indexed • Public debt does not include all financial lia- to inflation (OATi, BTANi and CADESi) is bilities but only cash and deposits, securities taken into account.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 37 PARTNERSHIP AND COOPERATION development. Similarly, the ESIFs are deployed he French system is notable for broad and within regions to develop local research and inno- Box 7. Public-private partnerships in France Tmultilevel cooperation between the local and vation capacities. central governments, within local governments, The history of public-private partnerships and among various levels of local government and Co-financing among local governments. Under- (PPPs) is inconsistent, characterized by periods the private sector. taken in collaboration with the central govern- of strong and weak reliance on the relationship ment, these agreements occur on a yearly or mul- between the public and private sectors. France tiyear basis, not to exceed three to five years. The has a long history of state intervention and over- The financial relationship between local co-financing system provides financial support for sight; for much of the 20th century, PPPs played and central government a role in creating a semblance of cohesion in cultural affairs (such as the opera, theater, and pro- public service delivery among the large number Vertical interactions can be divided into three fessional training institutions), academic research, of communes. However, the focus on PPPs from types of activities: sports, tourism, small businesses, and the unem- both the government and the private sector has ployed. Co-financing provides a perfect example increased substantially. Since 2004 over 18 bil- Transfers from the central to the local govern- of the mille-feuille, or multilayered political sys- lion euros have been invested in PPPs in various ment. There are three specific types of transfers tem, in action. It creates a process through which economic sectors, such as transport, health, and energy efficiency. Two types of PPPs are mainly from the central to local government. First, there is stakeholders can present on the current state of used in France: concession agreements (which the “general operating grant,” a substantial figure their respective regions. Although recent structur- help to sponsor major infrastructure projects) that can be used by local governments without real reforms, addressed in previous sections, tried to and partnership contracts (which function akin strictions but has recently undergone some re- simplify territorial structures and clarify the di- to a private finance initiative, with private orga- form. In 2014, Prime Minister Manuel Valls an- vision of competencies and financing, consistent nizations contributing a majority of the funds to nounced that to decrease public spending, the difficulties in tracking real financial flows remain. projects). In 2014, the EU issued directives on how public concessions and PPPs ought to be le- transfers from the central government to the local gally governed, for partnerships above a certain 39 government will be reduced in 2015-2017. By financial threshold. The French government be- 2015, the general operating grant stood at 36.6 bil- The role of the private sector gan incorporating these into law in April 2016 to lion euros, down from 40.1 billion euros in 2014. The implementation of public policy, particularly simplify the legal regime. The second category of transfer is the “general at the local level, is a unique form of collaboration equipment grant,” which assists local government between the private and public sectors. France financing of infrastructure and other investment uses the delegation of public services (DSP) mod- projects. The third type is the “compensation el, délégation de service public, under which risks grant,” which compensates local government for associated with investment and exploration (for the loss of revenues due to the transfer of compe- the construction of a new public service, for in- tencies.40 stance) are shared between the private sector and the government. The private sector does not play Formalized expenditures. Covering investment a major role at the local level. Public-private part- and intervention, these expenditures are seen in nerships (PPPs) are undertaken at the central gov- the context of planning contacts or ESIFs, which ernment level. are distributed over a seven-year period. In France, the planning contract (contrat de plan) is Contracts and collaboration are generally initiated an agreement between the central government and by the public sector. Private firms submit propos- a region on the programming and financing of im- als for the inspection and approval of government portant multiyear projects, such as infrastructure authorities to manage and operate a local public

39 “Debt in the sense of Maastricht (national accounts),” National Institute of Statistics and Economic Studies (Insee). http://www.insee.fr/en/ methodes/default.asp?page=definitions/dette-sens-maastricht.htm. 40 “Les finances publiques locales,” Collectivités territoriales, Cour des comptes, October 13, 2015.https://www.ccomptes.fr/Accueil/Publications/ Publications/Les-finances-publiques-locales3.

38 Fiscal Federalism and Governance in the European Union PARTNERSHIP AND COOPERATION ed as a result of a DSP agreement. In most cases, he French system is notable for broad and Box 7. Public-private partnerships SEMs are governed by locally elected officials to in France Tmultilevel cooperation between the local and ensure efficient operation. central governments, within local governments, The history of public-private partnerships and among various levels of local government and (PPPs) is inconsistent, characterized by periods Unlike other countries, France rarely uses the the private sector. of strong and weak reliance on the relationship “build-operate-transfer” model. There are a few between the public and private sectors. France exceptions, notably in the transport infrastruc- has a long history of state intervention and over- ture sector. Other forms of PPPs include partner- The financial relationship between local sight; for much of the 20th century, PPPs played ship contracts (CPs), contrats de partenariat, in and central government a role in creating a semblance of cohesion in public service delivery among the large number which a private firm is granted management of a Vertical interactions can be divided into three of communes. However, the focus on PPPs from public authority in exchange for rental or yearly types of activities: both the government and the private sector has usage fees. While there have been many attempts increased substantially. Since 2004 over 18 bil- to launch PPPs in various sectors at the local level Transfers from the central to the local govern- lion euros have been invested in PPPs in various (infrastructure, hospitals, prisons, etc.), the central ment. There are three specific types of transfers economic sectors, such as transport, health, and government continues to be the main partner in energy efficiency. Two types of PPPs are mainly from the central to local government. First, there is used in France: concession agreements (which public-private arrangements. Historically, PPPs the “general operating grant,” a substantial figure help to sponsor major infrastructure projects) have been met with little success. that can be used by local governments without re- and partnership contracts (which function akin strictions but has recently undergone some re- to a private finance initiative, with private orga- Relatively low returns to, and interest in, PPPs il- form. In 2014, Prime Minister Manuel Valls an- nizations contributing a majority of the funds to lustrate a major hurdle for cooperative efforts be- nounced that to decrease public spending, the projects). In 2014, the EU issued directives on tween private and public actors at the local level. how public concessions and PPPs ought to be le- transfers from the central government to the local gally governed, for partnerships above a certain Generally, elected officials have a vested interest 39 government will be reduced in 2015-2017. By financial threshold. The French government be- in maintaining control over the decisionmaking 2015, the general operating grant stood at 36.6 bil- gan incorporating these into law in April 2016 to process, reflected in the success and popularity lion euros, down from 40.1 billion euros in 2014. simplify the legal regime. of DSPs and SEMs. An additional limiting factor The second category of transfer is the “general for the growth of PPPs can be found in a negative equipment grant,” which assists local government reputation of public-private endeavors caused by financing of infrastructure and other investment service. Most contracts are created with an under- past high-profile failures. Several large financial projects. The third type is the “compensation standing that the government will maintain long- groups, such as Engie, Veoila, and Vinci have grant,” which compensates local government for term control and management of the service and undertaken disappointing PPP ventures, which the loss of revenues due to the transfer of compe- will play a central role in billing and price setting. fueled disenchantment with such arrangements tencies.40 This form of collaboration incorporates a variety near the end of the 20th century. One particular- of public-private relationships and risk-sharing ly damaging scandal involved the construction of Formalized expenditures. Covering investment agreements related to investment and exploitation. the Channel Tunnel, which faced severe setbacks and intervention, these expenditures are seen in and delays across several decades. Overall, the PPP the context of planning contacts or ESIFs, which Related to DSP arrangements, semi-public compa- model is neither well-received nor overly popular are distributed over a seven-year period. In nies (SEMs), sociétés d’économie mixte, is another in France, as it is often viewed as involving un- France, the planning contract (contrat de plan) is fairly popular form of public-private partnership. equal risk distribution or cost at a higher rate than an agreement between the central government and In this instance, private firms are created through a publicly controlled services, particularly in a coun- a region on the programming and financing of im- pooling of public and private capital, although the try where people are not accustomed to paying for portant multiyear projects, such as infrastructure latter provides the majority of funding to deliver public goods. a public service. These companies are often creat-

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 39 CONCLUSION 2. Recent legislation imposes significant ecause of recent reforms, France is experienc- changes. The MAPTAM and NOTRE legis- Bing substantial shifts that affect the finance lation have effectively combined several com- and governance of local governments: mune and department governments through the creation of metropolises, removed the gen- 1. Local government finance faces new con- eral competency clause for the departments straints because of the loss of autonomy to and regions, reduced the number of regions central control, low global growth that has re- from 22 to 13, and altered organizational sys- duced taxable assets and revenues, and a grow- tems of support for intra-urban transportation ing decline of government transfers that be- and small enterprises at the regional level. gan in 2011. Additionally, local governments should continue to expect diminishing trans- These changes have attempted to simplify the mul- fers from the central government, by an esti- tilayered bureaucracy and local public policy while mated 3.5 billion euros per year through 2017. bringing French administrative systems more Communal-bloc governments have begun to closely in line with the practices and standards of divest from non-mandatory responsibilities, neighboring countries without creating a federal and there has been a significant reduction in state. Although it is too early to assess the results investment, predominantly by communes and of the reforms, many analysts believe that the in- departments, as they bear the brunt of social stitutional results (with a few exceptions) may fall expenditure. Forecasts for demands on social short of initial expectations. spending are particularly bleak for departmental governments because of a projected growth in unemployment rates and a rapidly aging population, which promise to be a significant drain on their resources.

40 Fiscal Federalism and Governance in the European Union APPENDIX

Table 1. Expenditures powers transferred to local authorities (in EUR mil) 2005 2010 2013 13/12 in% Departments Welfare 25928 33678 36909 2.8 including Revenu de solidarité active (RSA) 6696 8603 9575 3.9 Allocation Personnalisée d’autonomie (APA) 4113 5372 5662 1.5 Colleges 3345 4304 4100 -3.6 Fire and rescue services 1740 2386 2493 -1 Regions Teacher training (continuous and apprent.) 3468 5052 5151 0.7 Education 3964 6326 6020 -1.8 Passenger rail 2859 3195 4108 12.4 Sources: Direction générale des collectivités locales (DGCL); DGFiP

Figure 10. Gross savings as a Figure 11: Gross savings as a percentage of total operating revenue percentage of total expenses

40% 40%

35% 35%

30% 30%

25% 25%

20% 20%

15% 15%

10% 10%

5% 5%

0% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Region epartment Communal bloc Region epartment Communal bloc

Source: DGFiP Source: DGFiP

Table 2. European Structural and Investment Funds, 2014-2020 (in EUR mil)

ERDF ESF EAFRD EMFF Youth Employment Total Percentage Regional Council 7994 1956.7 10308.6 0 94.2 20353.5 76.1% Others 432.1 4070.2 1076.2 588 216 6382.5 23.9% Total 8426.1 6026.9 11384.8 588 310.2 26736 100.0% Source: General Commission for Equal Territories

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 41 Fiscal and Federal Structures in Germany

CAROLINE CONROY

ities worldwide are facing growing challenges, the capacity and capabilities of lower-level govern- Cas a result of rising urbanization, citizens’ ex- ments. The division of power and responsibilities pectations of better local services, migration, and is influenced by the principle of subsidiarity and environmental concerns, among others. That such an emphasis on the merits of local autonomy. challenges have to be met in a context of tightening resource constraints adds urgency to the im- In keeping decisionmaking and federal structures peratives of effectiveness and efficiency in local as close to the citizen as possible, the German sys- spending, and of growth-friendly, sustainable, and tem endows authority and responsibility to the equitable generation of local revenues. Cities are lowest administrative level so that it can correct- meeting these imperatives in different ways and ly and efficiently carry out necessary functions. with different degrees of success. In the event that local or state officials are either politically or economically incapable of meeting The Brookings Project on 21st Century City Gov- their obligations, responsibility is shifted to higher ernance explores the norms, institutions, and net- levels of government. As a rule, the size of local works that power successful cities in a complex authority often determines functional capacity; world. This background paper aims to contribute therefore, larger municipalities are endowed with to the project by providing a brief, yet comprehen- more powers and responsibilities. sive, overview of local and national fiscal systems and governance structures in Germany. Overall governance CONSTITUTIONAL AND LEGAL The Federal Republic of Germany is a multiparty STRUCTURE parliamentary democracy. Executive leadership is federal parliamentary republic, Germany has divided between a chief of state, the federal pres- A long favored local self-governance. Lower ad- ident, and a head of government, the chancellor. ministrative divisions have a relatively high degree The legislative branch consists of two houses: the of autonomy, although legislative and financial Bundesrat (Federal Council), which serves in an powers are strongly centralized, which often limits advisory capacity and is the upper house of par-

41 Although the German legislature is often defined as a bicameral parliament, this terminology is somewhat disputed. The Bundesrat serves as a representative body for state governments, and its status as a second chamber has been contested on multiple occasions at the Federal Constitutional Court.

42 Fiscal Federalism and Governance in the European Union liament, and the Bundestag (Federal Assembly).41 of the two legislative chambers that consists of state The national constitution, or Basic Law, is guid- representatives. In this way, states are active in the ed by the principles of popular sovereignty and formulation of legislation and decision-making. As was designed to protect against the dominance Germany is a parliamentary system, the division of a strong central government. The constitution between the legislative and executive branches is also seeks to create equivalent living standards less distinct than in democratic systems as federal throughout the country. ministers serve at the leisure of the parliament.

For the sake of analysis, the governance structure The organizational and self-governing abilities of will be separated into three levels: federal (Bund), the 16 states, while expansive, are inherently lim- state (Bundesland or Land), and local administra- ited by the federal government, which predomi- tive units.42 Power is dispersed among regional gov- nantly controls tax legislation and establishes an ernments through the vertical separation of pow- equalization scheme among the federation, the ers. Rules regarding budgets, spending, transfers, state, and local authorities. Additionally, the feder- and intervention are established in the Basic Law, al government has the right to set broad standards which defines many elements of federal and state and targets for areas such as higher education, land interactions. Because Germany is a member of management, and regional planning, although the European Union (EU) and the Economic and states have some latitude in implementation. Monetary Union, key aspects of German finance and affairs are under the control of EU authorities. Level 2: State (Länd) Bias toward local governance ensures that each of Level 1: Federation (Bund) the 16 federal states has considerable regional pow- Given an emphasis on popular sovereignty, the er and control. Each state has a unique constitu- powers of the executive authority of the federal tion, parliament, government, and courts. Within government are limited to areas that typically fall its jurisdiction, each state is responsible for educa- under the purview of the sovereign state, namely tion, culture, and domestic security (police force, foreign policy, national defense, issuance of cur- fire protection, etc.). The devolution of responsibil- rency, etc.43 Any powers not explicitly assigned to ities varies among states because of their ability to the federal government fall to state governments. individually determine management arrangements and competency delegation, and to establish elec- Legislative authority is concentrated at the federal toral laws concerning districts and municipalities. level. The Basic Law grants the federal government Therefore, each state has a distinct governance the right to issue legislation if a uniform law is structure and political climate. Aspects of geogra- deemed necessary for the whole of Germany, even phy, population density, and size also contribute to if such legislation falls outside the scope of desig- variation in the structure and allocation of power nated federal authority.44 While the federal govern- for regional and local governments. ment often dominates the legislative process, any federal law that affects the states or their local au- As parliamentary republics in their own right, each thorities requires the consent of the Bundesrat, one Land has a head of state, the Ministerpräsident.45

42 The district division can be further subdivided into intermediate and local administrative levels. As particular governance structures vary among Länder, specific terminology for divisions of local government is quite complex. This paper will analyze the properties and organization of the most common groupings of districts, and the municipal authorities and division that are nested within. 43 Article 87, Basic Law. 44 Disagreements are arbitrated by the Constitutional Court in the instance of Bund-Länder disputes. Such disputes are most commonly resolved via multilateral bargaining and consensus seeking among party lines. 45 The city-states of Berlin, Bremen, and Hamburg are headed not by premiers but by mayors, whose titles are variations onBürgermeister .

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 43 Box 1: Executive and legislative terminology

Federal president majority or first past the post, while the other half Head of state, the federal president represents Ger- are elected from Länder party lists, proportional. many at home and abroad. Duties include conclud- Therefore, Germans vote twice in elections—the first ing international treaties, appointing foreign envoys, to select their local representative and the second for appointing and dismissing the federal chancellor, a particular political party, which determines the rel- dissolving the Bundestag, signing laws, appointing ative representation for each party within the Bund- and dismissing federal judges and civil and military estag. Officially, the Bundestag has 598 permanent servants, exercising the power to pardon, and award- seats but can expand to include overhang or balance ing honors. The president is elected via the Federal seats to maintain proportionality. The Bundestag is Convention, which consists of all members of the headed by a presidium consisting of a president, who Bundestag and an equal number of members elect- is selected by members from the largest parliamen- ed by parliaments of the Länder, determined based tary group, and vice presidents who are elected after on state population. Election takes place via a secret the selection of the president. ballot, with no prior debate. Candidates can be proposed by any member of the convention, and the Bundesrat: Federal Council winner is selected by absolute majority. Members of the Bundesrat, the representative body for the Länder (states) at the federal level, are not di- Bundeskanzler: Federal chancellor rectly elected but appointed by Länder governments The central executive authority, the federal chancel- in delegations. The terms and duration of their ser- lor, is elected via a secret ballot in the Bundestag. The vice are tied to the specific state government. Each nominee for the chancellorship is proposed by the member has a dual role as minister, or minister-pres- federal president and generally comes from, and is ident/mayor, in their respective state while also hold- the chair leader of, the majority party. The election ing federal office. Unlike in the Bundestag, members process can take up to three rounds of voting, but of the Bundesrat must vote as a bloc, based on their can be completed in the first round if an absolute home state. Each state is allocated a minimum of majority (or chancellor majority) is reached; oth- three votes, but can be assigned up to six based on erwise up to two subsequent rounds of voting can population size. The Bundesrat president is appoint- be triggered. Chancellors are typically elected every ed yearly, based on a rotational cycle that is organized four years, with the seating of a new session of the by state population size and in keeping with the prin- Bundestag. There are no term limits. Specific duties ciple of equal state representation. Appointment does of the office include the nomination of ministers of not correspond to party-political considerations; the the federal cabinet, setting of policy guidelines and president must hold the position of minister-pres- agendas (Richtlinienkompetenz) for the government ident, or state premier, and the two vice presidents and federal ministries, are always the former and future Bundesrat president. The Bundesrat president convenes and chairs Bundestag: Federal Parliament all plenary sessions, is the legal representative to the Members of the Bundestag, comprising (at the mo- federal government, and will assume the role and re- ment) 630 representatives, are appointed via free and sponsibilities of the federal president if the office falls direct elections every four years. Half of the mem- prematurely vacant or the current federal president is bers are directly elected from local constituencies, unable to assume his role.

This position corresponds to the role of the federal members of the Landtag, a unicameral body, are chancellor, and state premiers are elected by their generally elected via party-list proportional repre- respective state parliaments, the Landtag. Premiers sentation and serve terms lasting four to five years. represent their individual state in the Bundesrat and abroad, and have a fair deal of influence on the na- State governments cooperate horizontally and tend tional level. Although state elections vary somewhat, to present a united front at the federal level. Through

44 Fiscal Federalism and Governance in the European Union the Bundesrat, states can exercise concurrent legis- Box 2: City-States ( ) lative power in tandem with the Bundestag. Areas covered by concurrent legislation include civil and The cities of Berlin and Hamburg are denoted as criminal law, public welfare, some economic leg- city-states and therefore function as both Land islation, labor regulations, promotion of research, and municipal governments. Due to their small environmental protection, and regional planning. size, these entities are subdivided solely into bor- While decisions made within Bundesrat commit- oughs. This somewhat simplified organization tees require a simple majority, there is a strong structure is echoed in the administration of these precedent of coordination among state represen- cities, as there are no parallel institutions that serve the needs of only the municipality or the lo- tatives. State administrators have often relied on cal population. Berlin and Hamburg are admin- inter- and intra-state dialogues to establish polit- istered by a two-tier government. The legislature, ical agreements before committee votes on formal or parliament, represents the local population decisions. In the case of disagreement within coa- and elects the mayor of the city. The governing lition-led state governments, the coalition parties mayor holds a dual role, as they also serve as the generally abstain from voting in the Bundesrat. minister-president of the senate and state. The senate consists of a small number of appointed This indicates some level of solidarity among state ministers, limited to eight in Berlin and 12 in leadership as well as a communal hesitancy to side Hamburg, who are appointed by the mayor and with the federal government against the interest of elected by the state parliament. a fellow state. The Free Hanseatic City of Bremen State governments share power in areas such as Geographically the smallest Land, Bremen exists in a rather unique state. Although it is often cate- justice, social welfare, and law. Each Land has ex- gorized as a city-state, Bremen occupies a unique clusive legislative control in relation to culture, space in the sphere of subnational government as education, local authority, and police matters. This the only Zwei-Städte-Staat, or two-city state, as it includes punishment for crimes, care for the elder- consists of the cities of Bremen and Bremerhav- ly and disabled, and salaries and benefits for public en. Although the Land is governed by a single, employees. Additionally, the state government has directly elected legislature, the municipalities are administered separately. In Bremen, the city is the right to deviate from federal legislation in cer- governed by two locally elected mayors, one of tain areas (higher education, environmental pro- whom also serves as the president of the senate, tection, etc.). and those representatives to the senate who were elected by the city. In contrast, Bremerhaven It is important to note that there is a fair amount elects a municipal assembly that is distinct from of structural variation among state governments, the state legislature, which is led by a head mayor and a second mayor. Additionally, unlike in other particularly in relation to official titles and the Länder, the president of the Bremen senate lacks need for parliamentary approval for premier-ap- the ability to set policy guidelines as the senate pointed ministers. This is a particular issue for the decides matters via simple majority. city-states of Berlin, Bremen, and Hamburg. De- spite differences in terminology, the governance structure of city-states closely mirrors that of the federal states. Overall, state governance systems are fairly uniform and operate in harmony and cooperation with one another.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 45 Table 1: Administrative divisions Box 3: Regional government Administrative Population Regional division range Number classification Due to variability in Länder governance arrange- Länder 664,000-18 mil 16 NUTS-1 ments, both two-tier and three-tier administra- Regierungsbezirke 516,000-5.2 mil 38 NUTS-2 tive organizations exist within German states. Kreise 35,000-3.4 mil 402 NUTS-3 The majority ofLänder exhibit a two-tier system, where the state government exists directly above Verwaltungs- n/a 1481 LAU-1 gemeinschaften intermediate/local governments. However, there exists an administrative level between state and Gemeinden n/a 12066 LAU-2 Kreis, the Regierungsbezirk (regional district), a Source: Eurostat46 feature of the three-tiered system. The regional authorities lack legislative competencies and are Level 3: Municipal and local institutional primarily concerned with administrative de- arrangements cisions and enforcement of municipal govern- This section covers the intermediate and local ad- ments. The associated governing body is theBe - zirksregierung, regional government, which is led ministrative divisions. While municipal structures by the Regierungspräsident, the region president. are not a discrete tier, they function with a fair degree of autonomy within the state administration. This division has limited presence within modern Additionally, state governments may appoint an Germany, as only four Länder (Baden-Württem- official to oversee state affairs at the intermediate berg, Bavaria, Hesse and North Rhine-Westpha- administrative level, thereby maintaining local lia) use this administrative division. In 2000, state governments began to phase out or abolish the oversight. Municipalities have the constitution- designation in favor of different agglomerations, al right to elect own representation and regulate or simply reassigned the competencies to munic- 47 local affairs. By ensuring local self-governance, ipal authorities. The termRegierungsbezirk is not the German federalist system provides for limit- universally used across states, as some Länder use ed municipal financial autonomy and heightened different terminology, such as Direktionsbezirke, political mobilization at the local level. Although to describe similar territorial classifications. Al- though the administrative district has begun to the central government does not officially oversee fade in many federal states, it remains a robust municipal activity, state governments may appoint unit within Baden-Württemberg and North an official to oversee affairs, thereby maintaining Rhine-Westphalia. local oversight.

While the administration of municipalities and subcategories that vary, both in form and name, counties is delegated to state governments, local among states. This paper primarily focuses on mu- services are commonly devolved to municipal au- nicipalities (Kommunen or Gemeinden) and local thorities. Delegated tasks are separated into man- government institutions, namely districts (Kreise) datory and optional services; the exact division or associations of municipalities (Gemeindever- varies among states. bände or Verbandsgemeinden). There are smaller subdivisions as well as different municipality and Despite some commonality, there is no uniform community designations, dependent on state ad- administrative structure across the regions. Local ministrative structure, population, and territorial administrative units can be divided into several classification.

46 The NUTS classification system (Nomenclature des unités territoriales statistiques) used by the EU does not perfectly correspond to the administrative divisions that exist within Germany. For example, it is important to note that while NUTS denotes Regierungsbezirke as NUTS- 2, this unit also captures data from other administrative levels, such as Berlin, which does not fit the administrative district designation. 47 Article 28, Basic Law.

46 Fiscal Federalism and Governance in the European Union Municipalities As in other European countries, such as France Although there is considerable variation within and Italy, state-level governments have begun to state constitutions, state governments typically consider territorial reforms in an effort to reduce recognize local authority to manage municipal the number of smaller municipalities. These efforts functions with minimal intrusion. The particu- are distinct from the territorial reorganization that lar governing arrangements are set by state par- occurred in the 1990s after reunification. Future liaments and codified through municipal Ge( - plans for reorganization have more support in the meindeordnung or Kreisordnung) statutes. old, or West German, states such as Baden-Würt- temberg, that seek to merge municipalities with The smallest legal entity in Germany, towns or mu- fewer than 1,000 residents and set population re- nicipalities (Gemeinden), is led by local councils or quirements for territorial designations. Although assemblies, depending on the state and size of ad- newer, or East German, states have made progress ministrative unit. Members are typically selected via in reducing the number of smaller municipalities, direct and secret elections and serve five-year terms, there has been reluctance to centralize power. except in Bavaria and Bremen where terms last four and six years, respectively. Assembly powers are distinct from those of local mayors, and they are solely Intermediate institutional arrangements responsible for municipal boundaries, issuing local Smaller towns and municipalities typically co- bylaws, and approving local budgets. Mayors are sim- alesce to form districts or associations, often ilarly selected by popular vote, giving the office strong termed Kreise or Gemeindeverbände, and are di- local accountability and legitimacy. Mayors are gen- vided into rural and urban groupings. Such ar- erally the head of the local government and are tasked rangements allow local administrations to coordi- with chairing the local representative body, enforcing nate functions and delivery of services (typically decisions of the local council, and managing general education, health, and infrastructure services) that administration, although this is not the case in every smaller entities are incapable of providing because state. In some jurisdictions, they may have the ability of size or resource limitations. Although the pow- to appoint members of the executive body. ers and jurisdiction of these entities encompass the functions of multiple municipalities, districts have Administrative structure at the local level is var- the same vertical ranking as municipal govern- ied. Typically, larger cities have special status with- ments. Governing assemblies within districts are in their respective state and are granted the rights commonly termed Kreistag, a directly elected as- and responsibilities of municipalities and counties sembly that is headed by a president, the Landrat. (termed Kreisfreie Stadt). Such district-free, or independent, cities are home to about one-third of the total population. Alternative intermedi- Powers and functions of local government ate administrative associations are numerous but entities generally consist of groupings of municipalities The autonomy and organization of local govern- that have been assigned tasks that are generally ments resemble structures found at the state and reserved for county governments. Municipalities federal levels. Local governments have the authority typically have municipal parliaments, which are to organize, appoint staff, shape territory via urban structurally similar to state parliaments, and are development, pass municipal bylaws, set budgets, headed by democratically elected mayors. Larger and raise local taxes (such as dog, entertainment or municipalities may also have subordinate districts Land tax). By law, local governments must provide that assist in service provision and coordination, general domestic security, health care, town plan- but these structures vary greatly across regions. ning and construction, maintenance of primary

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 47 schools, management of waterways and sewage, cal governments to advocate for particular agendas, social and youth welfare, urban development and influence legislation, and share operational knowl- regeneration, and construction of shared leisure edge. Additionally, the Federation of Municipal As- areas. In addition to mandatory responsibilities, lo- sociations (Bundesvereinigung der kommunalen cal administrations may also influence the creation Spitzenverbände) combines the associations for cit- of incentives for economic growth, housing, social ies, towns, municipalities, and counties to represent welfare, cultural affairs, maintaining public trans- local German interests at the EU level. This body is port infrastructure, and managing energy supplies. led by the Association of Cities.

District and municipal association authorities must provide building and maintenance support, Box 4: Formal intragovernmental spatial planning at the district level, construction, cooperation fire protection, disaster services, nature protection, Gesamtstaat (Whole Level) maintenance of parks, social and youth welfare, Coordination and cooperation between the fed- building and upkeep of hospitals, schools and tech- eration and state governments are not limited to nical colleges; waste collection and disposal; food interactions with the Bundesrat. At this level, both supervision; animal protection; and treatment of parties are given equal status and decisions require aliens. Other areas of administration and control consensus, and often approval by both legislatures. are often supra-municipal powers, which require A leading institution for these interactions is the Conference of Heads of Government of the Fed- cooperation with local (city/village) governments eration and the Länder (Ministerpräsidentenkon- and authorities. Such shared duties include sup- ferenz, MPK). Additional avenues of cooperation porting cultural activities, maintaining public can be found via coordinating bodies of political libraries, and promoting economic activity and parties and interparliamentary coordination. tourism. Some state powers have been devolved to the local level in the case of medium-sized towns Bundesstaat (Federation) Constitutionally organized relations between and urban municipalities. These include registra- Bund and Länder institutions. Primarily con- tion of births, deaths, marriages, etc.; running of ducted via, and housed within, the Bundesrat, elections; census taking; registration of non-na- decisions are informed by committee meetings tives; registration of vehicles; traffic management; and are often subject to majority voting rules. Of and the supervision of food and related industries. particular note are the Missions of the Länder to the Federation. The Committee of Mediation plays a key role in mediating any disagreements Based on the equal jurisdictional status of munici- between the Bundesrat and the Bundestag. palities and groupings of municipalities, the powers and functions of all encompassed entities are fairly State Level similar. While the specific functions of municipal Primarily horizontal coordination among states administration will be discussed in the next sub- which excludes the federal level entirely. Coop- section, district and association institutions have eration can occur among state premiers, Confer- ence of Minister-Presidents, and state ministers. several voluntary structures that enable leadership to act and advocate at both the federal and state Local-Federal levels. These include groups such as the German Several associations of local and regional authorities Association of Cities (Deutscher Städtetag), the represent local communities both at the federal level German Association of Towns and Municipalities and to the European Union. The three primary asso- (Deutscher Städte- und Gemeindebund) and the ciations facilitate coordination among local governments and allow the local administration to influ- German County Association (Deutscher Landkrei- ence federal legislation and promote local agendas. stag). Coordination within these groups enables lo-

48 Fiscal Federalism and Governance in the European Union PRINCIPLES OF FISCAL arrangements for projects such as coastal protec- MANAGEMENT AND ORDERS OF tion and social benefits, and through its legislative MAGNITUDE abilities. The financial equalization systemFinan ( - iscal management and government finance zausgleich) and tax appropriationprocess ensures Facross subnational governments is fairly com- that states are partially dependent on transfer plex in Germany. Subnational fiscal responsibilities payments that are often under the purview of the are established by federal and state constitutions, Constitutional Court (particularly in the case of as well as national and local bylaws. Government supplementary federal grants, or Bundesergänzu- finance and regulations are centered on the con- ngszuweisungen). As a general rule, the federal cept of burden sharing, which ensures that each government may directly finance only those tasks administrative level is responsible for financing its specifically assigned to it under the constitution. individual expenditures. This extends to delegated tasks, a particular issue as state governments allo- Level 2: State cate and assign tasks and service provision to local While states do participate in tax legislation authorities. through the Bundesrat, they are often excluded from discussions on the volume of taxation.48 As Although subnational governments account for state governments lack tax-setting autonomy for a a significant portion of expenditure and are the majority of significant taxes and are subject to a primary vehicles for tax, and revenue, collection, federal equalization scheme, their total revenue is local government budgets are fairly constrained. more or less fixed on an annual basis. This signifi- Budgetary limitations stem from the primacy of cantly limits the fiscal autonomy of states, as their the federal government over taxation policies. The revenue sources are often constrained by a reliance central government has a very broad system of fi- on federally redistributed taxes and, to a lesser de- nancial equalization; a multistep process that in- gree, central grants. volves the pooling, and redistribution, of state and federal tax revenue through a series of vertical and State governments have some level of control over horizontal transfers. Therefore, the financial status spending and executive responsibilities. Individ- of local governments is fairly dependent on deci- ual states must finance their own administrative sions undertaken at the federal level. This system expenditure. Like the federal government, state of fiscal transfers, as well as the overall status of governments are responsible for medium-term government revenue and expenditure, will be dis- budgetary planning that incorporates political, so- cussed at greater length in the following sections. cial, and economic agendas of ruling parties. The Stability Council, discussed at greater length in another section, coordinates medium- and long- Division of fiscal competencies term budget planning between the federal and state governments while ensuring proper budget- Level 1: Federation ary discipline. In recent years, state governments The federal level controls the revenue, levels, and have exercised greater levels of autonomy in terms rates of the most significant taxes, including val- of borrowing, particularly in the areas of capital ue-added (VAT), income, and corporate taxes. As market financing. Such latitude is inherently limit- such, the Bund exerts a fair amount of influence ed by a constitutional rule on federal indebtedness, over state government through joint financing referred to as the debt brake. Instituted in 2010,

48 Bundesrat consent is required for federal legislation that affects any tax in which part of the revenue is allocated to state or municipal governments.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 49 the debt brake focuses on limiting permissible net diture side. Local administrations have relatively borrowing at the state and federal levels to ensure little control over certain factors, such as the num- structurally balanced budgets. This concept will be ber of asylum seekers or school-aged children, that discussed in greater length in a subsequent section. dictate significant aspects of mandatory spending. Additionally, as state governments are responsible for the administration of most public services, Box 5: Refugee resettlement and taxes, and state and federal laws, associated costs management represent a significantly higher percentage of state budgets. State and local governments have public- German ministries anticipate up to 3.6 million refugees living in the country by 2020. The rap- ly expressed frustration with the burden-sharing id influx of the refugee population has led to in- arrangement. creased intergovernmental tensions, as local and state governments continue to shoulder most Level 3: Municipal and local institutional ar- relocation and assimilation costs. The issue of rangements relocation and assimilation funding crystallizes Despite a lack of substantial control over signifi- key issues facing municipal administration and capacity, particularly the ways in which cities cant tax levels, states and municipalities collect the must tackle rising administrative costs with lim- bulk of taxes. Local governments can raise revenue ited increases in federally allocated revenue. The from local taxes, service fees, and internal credit federal government, under the direction of Ange- sources as well as receive funding from general or la Merkel, has strongly supported an open-door specific grants from higher levels of government policy which has placed a great deal of financial, within the constraint of fiscal rules on borrowing. social, and political strain on state and city governments. In terms of mandatory fiscal expenditures, local governments are often required to provide welfare While the German government has extolled the support and assistance yet have more flexibility in long-term economic benefits of increased migra- optional activities such as cultural funding. Man- tion, in the short term, municipalities and state agement of service provision, and budgetary rules, governments face the logistical and financial chal- vary state by state and are affected by several fac- lenge of housing and caring for asylum seekers. In June 2016, the 16 federal states demanded addi- tors, such as the average size of municipality. tional funding of 8.8 billion euros over a three-year period to cover refugee costs, citing complaints Local budgets are subject to limited revision and that the federal government had not sufficient- approval, primarily limited to ensure legality of ly shared associated expenses. Finance Minister local financing and to supervise the use of funds Wolfgang Schäuble categorically denied additional for mandatory delegated tasks. Budgets for lo- funding requests, contributing to increased political tensions between the state and federal gov- cal entities consist of an operating budget and a ernments, as well as among the Christian Social capital expenditure budget. As a general rule, the Union and Christian Democratic parties. operating budget must be balanced, although legislation allows for some exceptions. Intermediate governments have circumvented balanced-budget It is important to note, however, that while state requirements through a variety of measures, such governments are responsible for their own financ- as public corporations and foundations. es, they face significant constraints on the expen-

50 Fiscal Federalism and Governance in the European Union REVENUES AND REVENUE Figure 1. Revenue of the overall public SHARING budget by levels, percentage of GDP n Germany, all levels of government are allotted 20% Ia share of the public budget, which covers part of affiliated expenditures. State and local govern- 18% ments have some authority to bolster own revenue via local taxes and fees, although this income 16% represents a relatively small percentage of revenue. Concomitant financing (Konnexitätsprinzip) dic- 14% tates that any delegated responsibility to the mu- 12% nicipal level must be adequately financed by the state government. Administrative demands, paired 10% with the expansive responsibilities and delegated tasks, can in part account for the relative similar- 8% ities in the overall public budgets of the state and 6% federal governments. 2010 2011 2012 2013 2014 2015

Federation The public finance system relies primarily on tax Lnder revenue and central grants to cover government Municipalities and Associations of municipalities expenditure. Tax collection, as well as local income Source: Destatis tax levels, varies across regions, but the national financial equalization system, discussed in the next section, seeks to create equivalent living con- Allocation of taxation abilities/ ditions and service delivery. Central grants seek to responsibilities fill financing gaps when redistributed tax revenue Subnational governments are quite limited in their cannot cover all expenses. Unfortunately, munici- ability to alter tax legislation. The bulk of fiscally pal and city governments have often claimed that significant taxes, namely joint taxes,49 are set by the fiscal transfers from the state and federal govern- central parliament, which account for over 70 per- ments are insufficient for all delegated tasks. cent of cash tax revenue overall. Paired with federal taxes, the central government has a dominant In 2012, a Congress Delegation sent by the Coun- influence over more than 80 percent of annual tax cil of Europe noted several instances in which lo- revenue. Since state governments bear the brunt of cal governments could not finance delegated tasks administrative duties, the enforcement and collec- through relevant financial transfers and central tion of taxes fall primarily to local governments. grants. In these cases, local governments were forced to rely on local resources to finance delegat- Despite limited input, state government revenues ed tasks, instead of local public services, which un- are reallocated for national redistribution. This di- dermines the function of own local revenues and vision of power has created national tensions over demonstrates flaws with the system. the fairness of redistribution, but has also caused divergence in tax enforcement across local governments.

49 Joint taxes refer to the particular taxes that are pooled into the joint system, wherein the federal government designates particular taxes for central consolidation and redistribution.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 51 Figure 2. Cash tax revenue by level, percent of own resources. Revenues from services percentage are often used to subsidize local infrastructure projects. 100% 90% Although state and municipal governments do ac- 80% quire limited resources from service fees and lo- 70% cal taxes, the revenue streams from these sources 60% are often negligible.51 To finance public expendi- 50% tures, Länder governments rely heavily on debt as 40% a primary source of discretionary financing. This 30% source of financing is dramatically changing due 20% to the introduction of the debt break, which will be 10% discussed in greater detail in a later section. 0% 2010 2011 2012 2013 2014 2015

Custom duties Federal taxes Financial equalization and Local taxes oint taxes intergovernmental transfers Lnder taxes Due to restrictions on the revenue-raising and Source: Destatis tax-setting capabilities of state governments, there is a particular reliance on federal transfers, via the equalization system, and borrowing to finance both Local sources of own revenue current and capital expenditures in some states.52 Excluding central grants and revenue from federal In an effort to increase national solidarity and to equalization, the primary source of local own rev- ensure that local authorities have the resources enue comes from local taxes (e.g., local excise and necessary to perform their mandated tasks, Ger- entertainment taxes). The specific taxes, and their many has adopted a system of financial equaliza- rates, are determined by respective local author- tion aimed at reducing regional discrepancies. ities, causing a great deal of variation. The trade and real estate tax represent the bulk of local tax- The federal financial equalization system in Ger- es.50 State-controlled taxes include real property many can be divided into four phases, which rep- tax and estate tax, although these and similar taxes resent different forms of redistribution and wealth account for a very small percentage of overall tax transfers. The system deals primarily with total tax revenue. revenue, collected at the federal, state, and local levels, which is centrally pooled and then redis- Local authorities can set fees and user charges for tributed to relevant authorities. It is important to public services at their own discretion, within rea- note that the federal government is entitled to the son and in relation to cost of service delivery. At revenue from all federal taxes, which include du- the local level, fees for services such as electricity ties and the insurance tax. and wastewater treatment accounted for about 35

50 Municipal trade tax consists of fees levied by local authorities on business profits, and rates typically fall between 14 and 17 percent. The municipal real estate tax is levied on local immovable property within a district regardless of business or private designation of the property. Additional local taxes include tax on dog licenses and secondary home taxes. 51 Although receipts from state taxes vary somewhat on a state-by-state basis, overall revenue from state taxes account for about 7.56 percent of state tax resources, based on 2016 estimates from the Federal Ministry of Finance. 52 This differs among states. Some states do not receive vertical grantsBundesergänzungszuweisungen ( ) and are (as of now) not dependent on borrowing (e.g., Bavaria); others (especially the eastern states) are particularly dependent on horizontal and vertical transfers.

52 Fiscal Federalism and Governance in the European Union First stage: Vertical distribution Second stage: Horizontal redistribution First, total tax revenue is distributed from the fed- State governments are entitled to the revenue from eral to state and local governments, after which state-administered taxes in their territory, accord- the Länder distribute supplementary revenue ing to the principle of local revenue. This primarily grants to local authorities. Affected taxes include concerns personal and corporate income tax. Rev- income, corporation, and VAT taxes, also referred enues of those taxes are redistributed based on the to as joint taxes. This grouping constitutes a major principle of residence, with corporate taxes being percentage of all tax revenue. Additionally, state distributed in areas where the company is head- taxes, such as inheritance and transactional taxes, quartered. VAT is excluded from this process and are included in the pooled revenue. Generally, rev- is instead allocated as a means of supplementing enue from local-level taxes such as real property, revenues when an individual state’s share of in- trade, and local excise taxes will remain with local come, corporation, and Land tax falls below the governments. In 2015, the federal government re- per capita average of all Länder. Up to 25 percent of ceived 42.5 percent of the income tax, half of the the state portion (45.5 percent) of VAT revenue is corporation tax, and 52 percent of VAT. At the available for supplemental redistribution. The allo- state level, Länder received the remainder of the cation of supplemental VAT revenue is not reallo- corporation tax, the same share of income tax as cated solely on a per capita redistribution scheme, the federal government, and 45.5 percent of the although it does take into account a state’s relative VAT. This left local governments with 15 percent tax revenue. The remaining share of VAT revenue of income tax revenue and about 2 percent of VAT. is then distributed by individual state population.

Figure 3. Distribution of tax revenue, by Figure 4. VAT revenue equalization53 level as percentage of GDP;54 dotted lines denote net payers 100% 15% 90% 80% 10% 70% 60% 5% 50% 0% 40% 30% -5% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20% -10% 10%

0% -15% 2011 2012 2013 2014 2015

EU Lnder -20% Municipalities and Federation NW HE HH TH Associations of BY RP HB BB municipalities BW SH SN MV NI SL ST BE Source: BMF Source: Federal Ministry of Finance (BMF)55

53 Indicates the difference between distribution under applicable law and full distribution by population. 54 State abbreviations are listed in Appendix 1. 55 Ibid.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 53 Third stage: Fiscal equalization among are aimed at helping states meet their financial states burdens. Grants are separated into two categories: Moving from redistribution of joint taxes among general supplementary federal grants and supple- the federal and state governments, the third tier mentary federal grants for special needs. General of fiscal equalization takes place among state gov- supplementary grants are allotted to states whose ernments (Länder). To implement and enforce financial capacity per inhabitant, after state-level a system of resource transfers, individual states redistribution of revenues, is below 99.5 percent. must measure their fiscal capacity and the needs of Supplementary grants for special needs help spe- local and state governments. Financial capacity is cific states meet the demands of unique burdens measured by taking the sum of state receipts and a and are unrelated to their ability to meet their fi- percentage of local authority receipts, 64 percent, nancial obligations.57 In 2014, the volume of gener- and dividing that by the financial requirement for al supplementary allocations drastically increased state residents.56 This system is fairly controversial; by 0.3 billion euros in 2013 to 3.5 billion euros. while it provides an accurate reference of financial capacity, it assumes a standard fiscal burden on Since reunification, Eastern German states have each resident across states and does not take into received special-need supplementary grants under account governance structure, demographics, and the terms of the Solidarity Pact II. These trans- financial legacies. This process is partially adjusted fers will continue until 2019 and are, unlike oth- for limited population inflation for the city-states er grants, earmarked for improvements in infra- of Berlin, Bremen, and Hamburg (respective pop- structure and increasing local fiscal capacity. These ulations are adjusted to about 135 percent) and grants account for a substantial source of income for the states of Brandenburg, Mecklenburg-West for recipient states and are more restricted than Pomerania, and Saxony-Anhalt. other supplementary grants. As with the equalization system, the solidarity pact is a point of con- Financial equalization among states does not tention between West and East German states. In strive to completely equalize tax revenues across 2012, a group of mayors from West German cit- districts. Redistribution efforts typically lift under- ies publicly called for an end to the solidarity pact performing states’ revenue to about 90 percent of system, claiming that years of transfer payments the national average; adjustments are calculated contributed to the deteriorating financial state and using a linear progressive schedule. This helps to infrastructure of many cities, particularly in the protect fiscal autonomy and limit adverse growth industrial Ruhr. Essen serves as a prime example, incentives. as the city had undertaken 2.1 billion euros in debt by 2012, a third of which was directly used to finance its solidarity contributions. Fourth stage: Vertical grants to financially weak states Financial assistance to German states is not limit- The final stage of the equalization system is a series ed to transfers to East German states. In 2009, the of supplementary vertical grants from the federal federal government adopted the Consolidation As- government to financially weak states. This com- sistance Act, which grants fiscal consolidation as- plements horizontal revenue transfers and helps sistance to the five smallest states (Berlin, Bremen, eliminate gaps in financial capacity not achieved Saarland, Saxony-Anhalt, and Schleswig-Hol- via other redistribution methods. All federal grants stein) to help them meet the requirements of the

56 Financial requirement per inhabitant is assumed to be the same across Länder, with exceptions made for city-states (whose population is notionally increased by 35 percent) because of relatively small populations. 57 Funds from supplementary federal grants for special needs are not legally tied to a specific purpose.

54 Fiscal Federalism and Governance in the European Union Box 6. Challenges to the future of the financial equalization system

In 2019 the federal financial equalization system will set the stage for the digitization of the tax system. Un- expire. Efforts to renew and reintroduce the com- fortunately, this consensus was short-lived, and at the pensation mechanism have brought federal and state end of November a joint statement was released by the tensions to the forefront of national political debate. Länder governments rejecting a draft bill from Minis- ter of Finance Wolfgang Schäuble. Financial transfer systems, in one form or another, have existed in Germany since the 1950s. Mecha- Local media reported discontent among state leader- nisms typically sought to create a minimum stan- ship, who believed that Schäuble overstepped terms of dard of living, or equivalent conditions, across state the initial agreement, which was reached on October 14 governments to support national solidarity. While at a federal-state summit, and that the bill in its current tax transfers have provided real benefits across the form significantly extended the legislative competencies country, particularly in the years following reunifi- of the federal government at the expense of the state and cation, the current system has created unforeseen federalism.*** More specifically, state leadership reject- complications. Over the last two decades, several ed endowing the Stability Council with complete con- states have consistently been net contributors, lead- trol over debt limits for individual states, a clause that ing to protests from state leadership that view the would allow the federal government to dictate the local system as an unfair burden that reduces their bud- fiscal administration, and stipulations tied to restruc- gets and limits their ability to provide basic services. turing funds among other concerns. This rejection has This fact, paired with complications associated with triggered a new round of meetings between the heads implementing the debt brake by 2020, has led to a of the federal and state Chancellery. As the proposed re- unified push by Länd leadership for greater tax au- forms to the equalization system would require amend- tonomy and a fundamental restructuring of future ing aspects of the Basic Law, there is a particular sense of financial relations between levels of government. urgency to pass the reform as quickly as possible.

The heads of state governments and federal leadership Efforts to reform the fiscal transfer system predate the (Regierungschefinnen und Regierungschefs von Bund current negotiations. In 2013, Bavaria and Hesse, net und Ländern) held series of meetings and conferences payer states that see more than 10 percent of their state throughout 2016 in an attempt to craft a new com- budgets reallocated per year, petitioned the federal pensation system. The conference of minister-pres- government to introduce a cap on state transfers and idents has presented a united front at negotiations*, implement an incentive program that would encourage and in October it seemed that an agreement had been net receiver states to balance their finances. In Decem- reached establishing new regulations for 2020 that ber 2015, state leaders set forth a joint proposal that significantly reduced the financial burden for state would have scrapped horizontal financial equalization governments, strengthened the Stability Council, in- in favor of a mechanism that redistributed turnover tax creased the fiscal capacity for state governments, and revenues that would target structurally weak states. debt brake by 2020. Special considerations were Central grants made for these governments, because they have a relatively small share of the population and will Central grants are distinct from federal transfers therefore face the greatest difficulties in reducing or the equalization system. As of 2006, the federal long-term structural deficits. Additionally, small- government cannot directly finance projects and er states often receive special-need supplementa- services transferred to local governments.59 Trans- ry grants to compensate for higher administrative fers from state governments have been found to be costs. insufficient to cover the delegated administrative

58 There are several crucial exceptions, particularly regarding investment projects at the state or municipal level that would prevent drastic economic disturbances, promote economic growth, alleviate undue financial burden, or enable economic equalization across the territory. Such exceptions are often determined via federal legislation or executive agreements.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 55 and budgetary costs for local authorities. This has to the Europe 2020 Strategy, focusing on smart, necessitated the increasing use of local revenues to sustainable, and inclusive growth at the regional supplement operational costs for services allocat- level. ed by state governments This fact is problematic insofar as the system of transfers was initially set ESI Funds are allocated at the regional level via op- up to ensure that the state would finance delegat- erational programs that conform to the specific as- ed tasks through transfers, ensuring that local au- pects of individual partnership agreements. There- thorities could use own local revenue to fund local fore, individual state governments are responsible public services, as defined by their constitutions, for implementing related programs and providing also known as concomitant financing. progress updates to the European Commission to ensure continued financing from the EU. While state governments manage program operations, European Structural and Investment the federal government, via various ministries, co- Funds (ESI Funds) ordinates all ESI funds, sets policy objectives, and As part of the EU Cohesion and Structural Poli- represents the interests of the country in relation cy, public funds are made available to member to structural policy to the European Union. states to promote and reinforce economic, social, and territorial solidarity across regions. For the For the current programming period, allocated 2014-2020 period, Germany was allocated a to- ESI Funds will target energy and climate issues, tal of 27.87 billion euros from the collective ESI promote youth labor market and skills, provide Funds. These funds were allocated as part of the skills training to disadvantaged groups, strengthen Multiannual Financial Framework and consist of biodiversity, improve regional resilience, increase five component financial instruments: European competitiveness and innovation in small and me- Regional Development Fund (ERDF), Cohesion dium-sized enterprises, and increase innovative Fund59 (CF), European Agricultural Fund for Ru- capacity within research and industry. As funding ral Development (EAFRD), European Maritime is targeted at the regional level, operational pro- and Fisheries Fund (EMFF), and European Social grams often benefit at the lowest administrative Fund (ESF). This round of funding is closely tied level.

59 The Cohesion Fund primarily targets economic and social disparities among EU member states, and is therefore limited to states whose gross national income per inhabitant is below the 90 percent EU average. Germany does not qualify to receive any funding through this instrument.

56 Fiscal Federalism and Governance in the European Union EXPENDITURE Figure 5. Expenditure of the overall asic Law guarantees autonomy to the federal public budget by level from Q1 to Q4, Band state governments in reference to budget percentage of GDP management. The budgets of local and state gov- 20% ernments are subject to review by the Financial Planning Council, chaired by the Federal Ministry 18% of Finance. The council’s decisions and agreements are non-binding and inevitably, budgetary deci- 16% sions taken at the state level are not coordinated among states or with the central government. 14%

12% Basic Law mandates that the federal and state governments finance their own expenditures. Given 10% the governance structure and delegation of primary and mandatory duties, local expenditures fall 8% primarily under state regulation and financing, as 6% the federal government is particularly limited in 2010 2011 2012 2013 2014 2015 its local competencies. As duties and powers are Federation delegated to respective local authorities, there is Lnder a concurrent obligation to provide implementing Municipalities and Associations of municipalities actors with sufficient funds. Source: Destatis

Länd specific and mandatory PPP activity is recorded in the national budget. expenditure60 As of 2014 there were 18 active projects, totaling Unfortunately, state governments are often fairly about 24 million euros in expenditure. Due to the constrained by structural factors in terms of an- division of responsibilities and the devolution of nual expenditure obligations. Realities such as functions and services, subnational spending on population aging, the number and percentage of PPPs is significantly higher than federal spending. school-aged children and pensioners, and region- Estimates reported by the Finance Ministry place al price disparities often play an important role in the local PPP volume at 7.5 billion euros as of 2013. dictating local spending levels. Unfortunately, a lack of reporting requirements for local projects has led to imperfect statistics on the Public-private partnerships (PPPs) size of the local PPP market. Public investment in Germany has been relatively low, particularly in comparison with investment The dominant size of state and local government rates in advanced economies. At the federal level, PPP expenditure is related to the constitutionally PPPs are used in a limited capacity, typically reassigned, and devolved, functions and obligations. lating to the maintenance of federal transporta- Land and lower-level administrations are respon- tion, namely highways. In general, the build-op- sible for all mandatory services, but also have a fair erate-transfer (BOT) model is preferred. Federal amount of autonomy when it comes to the dele-

60 Sections relating to subnational expenditure have been limited as each administrative level bears the financial burden for mandatory and optional service provision, such as social assistance and transportation. The responsibilities and functions assigned to various levels of government, discussed in a previous section, are accounted within federal, state, and local governments. In the interest of brevity, these competencies and associated fiscal responsibilities will not be reiterated at length.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 57 gation of services and responsibilities and have Public funds, institutions, and enterprises the right to contract outside service providers. (FEU) Although most public investment is executed by Public investment has been particularly low relative local, or municipal, governments, regional bud- to other OECD countries. Defined as non-market get constraints as well as a lack of financial con- producers that are controlled by the government, trol have hindered investment projects across the FEUs hive off tasks from the core public budget, country. such as water and energy supply enterprises. These companies provide services or support economic Based on estimates from Partnerships Germany activity. In national accounting, FEUs are excluded (ÖPP Deutschland AG), a federally established from public investment accounting. According to PPP competency and consulting center, there were a 2012 DIW Berlin study, FEUs contributed about about 230 regional projects as of 2016. Overall, lo- 11 billion euros to net investment overall, with cal public infrastructure investment is particularly 4.8 billion euros invested at the municipal level. low across the country. Declining infrastructure In 2013, there were a total of 15,314 registered investment, which has fallen from 25 percent of FEUs61 with proceeds exceeding 513 billion euros. total economic output in the early 1990s to 19.7 Outsourcing of core responsibilities occurs over- percent in 2013, has contributed to growing con- whelmingly at the municipal level.62 About two- cerns for the health of public infrastructure. The thirds of FEUs provide water, sanitation, energy German Institute for Economic Research (DIW supply, and real estate activities. Berlin) estimated in 2013 that the annual investment gap was 3 percent of GDP, outstripping the Chart 6: Number of public funds, EU average of 2 percent. This gap translates to a institutions, and enterprises (FEU) by missing 80 billion euros in investment per year. owner

100% There has been a push for PPP reform and increased 90% investment at the local and federal levels. In 2012, 80% both the Social Democratic Party and the Greens 70% submitted initiatives to the Bundestag calling for in- 60% creased transparency and consensus on PPPs in infrastructure. Additionally, the federal government 50% created the Municipal Investment Promotion Act 40% (Kommunalinvestitionsförderungsgesetz), which 30% established special funds to promote investment in 20% financially weak municipalities, to be delivered as 10% 0% public works. This program will free up to 20 bil- 2011 2012 2013 2014 2015 lion euros for investment, of which 7 billion has been earmarked for public transportation, digital Federation Land Municipality infrastructure, energy efficiency, climate change, Source: Destatis urban development, and resilience with 3.5 billion allotted specifically for municipalities. The funds are available until 2018, and Partnerships Germany anticipates that these measures will help bolster the local PPP market.

61 Excluding small corporations. 62 Municipal level includes ownership by city-states.

58 Fiscal Federalism and Governance in the European Union BORROWING AND DEBT Figure 7. Financial balance of the n terms of budgetary control, the federal constitu- overall public budget by level, ratio of Ition grants state governments relative autonomy— GDP which is extended to municipal administrations. 0.1 Although federal and state budgets are required to be balanced63 without revenue from credits, state 0.05 governments can regulate budget details within their constitutional powers. As discussed in previ- 0 ous sections, tax revenues and central transfers are 2010 2011 2012 2013 2014 2015 often insufficient to cover all related government -0.05 expenses. In these instances, subnational govern-

ments have several options to cover budgetary gaps. -0.1 Outside of local tax revenue, local governments can shore up administrative budgets through several -0.15 different financing options. -0.2 Basic Law places specific limitation on the borrow- Federation ing of funds at the state and federal levels. Article Lnder 115 stipulates that borrowing activity can be sub- Municipalities and Associations of municipalities ject to authorization by federal law and outlines a general rule that federal revenue obtained by Source: Federal Office of Statistics (Destatis) borrowing shall not exceed 0.35 percent in relation to the nominal gross domestic product. For the states, this limit is set to 0 percent as of 2020. While subnational governments are prohibited It further outlines general practices of extraordi- from declaring bankruptcy, the issue of local debt nary borrowing practices, including reduction is quite nuanced. The federal constitution out- procedures.64 Within these limits, local govern- lines specific instances in which federal assistance ments can finance their expenditures through to states facing financial difficulty is permissible. loans. Generally, smaller municipalities primarily Under Article 104b, the federal government is al- rely on local savings banks and internal loans to lowed to provide state governments with financial finance short-term gaps. If local governments re- assistance for important investments undertaken quire longer-term financing, relevant authorities by state or municipal governments.65 In previ- must get the approval of the state interior minister, ous years, particularly indebted states have sued who will try to ensure that local governments do the federal government for bailout assistance. A not run the risk of insolvency. Given strict bud- prominent example of such action occurred in get constraints and oversight, municipal and local 1992, when the Constitutional Court granted Saa- governments tend to have relatively low debt rates rland and Bremen a federal bailout, in the form of when compared with higher government levels. conditional grants to alleviate the public debt burden. In less drastic cases, it is common for Land

63 Article 109, Basic Law 64 Flexibility is allowed in the case of natural disasters, emergency scenarios, and unique situations that threaten the financial stability of the government. Restrictions and regulations regarding borrowing are outlined within individual state constitutions, although the historic exceptions to debt and borrowing limits have led to instances of high debt spending and fiscal imbalance among several states. 65 These investments are limited insofar as they either avert a disturbance to the overall economic equilibrium of the state or country, seek to equalize economic capabilities, or promote economic growth (these are quite general limitations, hardly a constraint). Additionally, the federal government may provide direct financial assistance in the instances of natural disasters or exceptional emergencies that both occurred beyond governmental control and threaten the financial stability of the government.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 59 government, via supervisory authorities, to enact tainability of public finance at the federal and state financial rescue programs and remedial measures levels. The role of the Stability Council is set out to rehabilitate local finances. under Basic Law and includes a mandate to avert budget crises and, in the case of looming crises, to implement fiscal restructuring. Soon after it was Federal and local debt issuance formed, the Stability Council did declare a need to German state governments can issue bonds in reform in the face of a looming financial crisis for their own right, an option that individual states four states. In recent years, the council has focused have embraced at different levels over time. In re- more heavily on monitoring state compliance with cent years, many Länder budgets have drastical- federally set deficit ceilings and providing consoli- ly shifted from loan to capital market financing. dation assistance. The council, along with other -fi From 2000 to 2013, Länder bonds outpaced direct nancial advisory and expert boards in the country, loans and accounted for about 60 percent of total was involved in the submission of and revisions to state debt. Despite the differences in the debt lev- the German Stability Program. els, economic output, and liquidity of individual states, historic yield spreads between federal and state bonds were relatively low until 2008. Debt brake Approved in 2009, the Schuldenbremse, or debt Subnational governments have had fairly limited brake, is an amendment to the Basic Law that pro- deficits, and most states have high credit ratings.66 vides clear budget constraints. Predating the Euro- Strong ratings have been attributed to joint liabili- pean debt crisis, the debt brake was introduced in ty between the federal and state governments and response to debt-to-GDP ratios in Germany that have rewarded reforms implemented in prepara- exceeded the 60 percent threshold established in tion for the debt brake. This mechanism was intro- the Maastricht Treaty. Responding to the financial duced in 2009 as part of the second federal reform. strain caused by reunification measures, in partic- While the budget position of individual Länder is ular the Solidaritätszuschlag (solidarity surcharge), fairly variable, recent federal legislation aimed at the federal government sought to eliminate, or limiting public debt throughout all government significantly reduce, structural deficits throughout levels has had a great deal of success in controlling public budgets, affecting local fiscal policy. local finances. The particulars of expenditure limitations and regulations will be discussed at greater The debt brake provides both a target and a time- length in a later passage. line for the federal and state governments to improve the sustainability of public finances and fiscal coordination across administrative levels. An Stability Council additional concern that prompted the change in The Stability Council comprises the federal min- the national fiscal policy was the rapid increase in ister of finance, the federal minister for economic the national debt-to-GDP ratio in the aftermath affairs and energy, and the finance ministers of the of the global financial crisis. In seeking balance to Länder. Together with Germany’s debt brake rules, public finances, the debt brake limits the ability to the creation of the Stability Council in 2010 aimed run cyclically adjusted budget deficits (structural to strengthen the fiscal institutional framework deficits) at the federal and state levels. According- and refocus the government on the long-term sus- ly, the structural federal deficit cannot exceed 0.35

66 As of November 2015, seven German states maintained their AAA long-term foreign credit rating from Fitch Ratings. Along with reaffirming a stable outlook for the individual states, the rating company also reaffirmed a short-term foreign currency issuer default rating of F1+.

60 Fiscal Federalism and Governance in the European Union Figure 8. Total government debt as a have balanced structural budgets. As of early 2016, percentage of GDP, Maastricht debt the Stability Council announced that both Berlin level and Schleswig-Holstein should complete their budgetary recovery procedures, although Bremen 85 and Saarland will continue to need assistance be- 80.5 79.3 cause of high deficits and debt levels. 80 77.9 77.1 74.7 75 72.6 Chart 9: Debt to GDP by Länder,68 2014 70 0.8 65.1 65 0.7 HB 60 0.6 SL 55 0.5 BE ST 0.4 50 NW SH RP TH 2008 2009 2010 2011 2012 2013 2014 BB MV 0.3 NI Source: Deutsche Bundesbank HE HH 0.2 BW 0.1 BY percent of GDP, starting in 2016. State govern- SN ments face tighter restrictions, as they are banned 0.0 from running any structural deficit. States have Source: Destatis and Statistical Offices of theLänder been given until 2020 to meet new budgetary requirements. In the past, individual states set limitations on net The debt brake underpins EU fiscal governance borrowing levels in their respective constitutions, rules, which will be addressed at greater length in but vague definitions regarding volumes of invest- the following section, and effectively replaced the ment and exemption clauses helped create exces- long-standing “golden rule” of German public fi- sive debt in some states. Tools such as the debt nance.67 Similar to the golden rule, the debt brake brake, or internally imposed debt limitations with- allows for flexibility in times of crisis but focus- in specific states, have attempted to tackle high es on structural net borrowing to ensure that the government debt. debt-to-GDP ratio is reduced on a sustained and long-term basis with the aim of achieving long- term growth and sustainable development. Al- Elimination of structural deficit though the debt brake is relatively new, there has As a member of the EU, Germany’s financial min- been some success in lowering the debt-to-GDP istry is required to submit a medium-term fiscal ratio. The financial balance within states remains plan to the Economic and Financial Affairs Coun- somewhat varied, although the majority of Länder cil.69 Strong fiscal policy and favorable conditions

67 Before 2009, Basic Law mandated that debt could not exceed investment spending, with notable exceptions. 68 State abbreviations are listed in Appendix 1. 69 The Economic and Financial Affairs Council, or Ecofin, is a configuration of the Council of the European Union and is responsible for economic policy, taxation, and the regulation of financial services. It also manages economic relations with external countries. The Ecofin council prepares the EU’s annual budget and coordinates economic policies of member states with the aim to increase economic and budgetary convergence.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 61 have led to solid postings of growth and domestic cits on all levels. Länder were assisted in achieving robustness. After peaking in 2010, general govern- these surpluses in part by the Consolidation As- ment debt has fallen, and the debt-to-GDP ratio sistance Act, which provided for a fixed amount of is expected to decline consistently to below 60 financial assistance to fiveLänder , financed from percent by 2020. Still, the German economy must the federation and the Länder, subject to condi- be prepared for imminent challenges, such as the tionality including the elimination of the structur- normalization of these favorable interest rates and al deficit in those five Länder by 2020. From 2016 impactful demographic changes due to aging and to 2019, the federal government will support the high migration into the country because of the Länder with an additional 500 million euros per refugee crisis. That said, in 2014, Germany had a year, given that the responsibility of assimilating general government budget without a deficit for and assisting the large number of refugees in the the third year in a row. The government surplus country will fall primarily to local and regional au- in 2015 (0.3 percent of GDP at the federal level thorities. This base figure has been increased, and and 0.1 percent of GDP at the level of the Länder supplemented by additional funds, as the refugee and local authorities) has made it possible for the population continues to expand. government to balance its budget by avoiding defi-

62 Fiscal Federalism and Governance in the European Union ROLE OF THE EUROPEAN UNION member states to outline a comprehensive medi- s a founding member of the European Union, um-term fiscal objective. Countries must demon- AGermany has seen European policy play an strate the stability of their own public finances, or increasingly important role in domestic affairs in at least demonstrate conscious and rapid progress recent years. The EU has assumed control over sev- toward a stable budget. The corrective arm comes eral competencies that cover monetary, foreign, and into force when a country’s deficit rises above 3 security policies. These include monetary policy, percent of its GDP, or its public debt-to-GDP ra- competition rules, environmental policies (such as tio rises above 60 percent, and is not shown to be conservation), commercial policies, and the nego- diminishing at a sufficiently rapid pace. Under tiation of some international agreements. The EU the Excessive Deficit Procedure, countries receive shares various competencies, such as social and warnings and guidelines for the future of their economic policies, and can enact regulations that public finances, and in some cases are sanctioned affect national governance at all administrative lev- or fined. Continued overspending and increases in els. The federal government and the Bundestag play debt can even lead to an interest-bearing fine of the largest roles in influencing European policy. 0.2 percent of the country’s GDP. When the Ex- cessive Deficit Procedure is triggered, the efforts Germany holds 96 seats in the European Parlia- of the country in question are evaluated through ment (EP), down from 99 in 2014 because of the an Assessment of Effective Action to see if external application of the Lisbon system, which capped events have affected public finances, despite the the number of allotted seats at 96. As the country country’s best efforts. Events such as an EU-wide with the largest population, Germany commands or global economic downturn diminish the likeli- the highest number of members of the European hood of sanctions and fines from the SGP Council. Parliament (MEPs), although membership is allocated via digressive proportionality. MEPs are The SGP was very much the brainchild of larger eco- elected every five years via a closed-list propor- nomic powers in the late 1990s; Germany and France tional system, whereby votes are cast for political played key roles in its formation. The implementation parties which in turn appoint MEPs. Until 2014, of the SGP arguably spurred the creation of Germa- political parties had to meet an electoral threshold ny’s own Stability Council, which controls the bor- of 5 percent (Sperrklausel, or exclusion clause) to rowing practices of the state governments to ensure be eligible for a seat in the EP. Following a series that irresponsible local spending does not affect the of legal battles, the 2014 European election saw the state of national public finances. The SGP, however, threshold requirement abolished and the election has come under consistent criticism since the early of fringe political parties. 2000s for its constraining fiscal rigidity and inconsistent application across member states. For instance, when Germany and France crossed the 3 percent of Stability and Growth Pact and the GDP spending limit in 2003, they rallied member Excessive Deficit Procedure state finance ministers to stop the imposition of any The Stability and Growth Pact (SGP) is an agree- sanctions, setting a precedent for the inconsistent ment among the members of the European Union application of fiscal discipline across the EU. Recent to encourage the pursuit of stable and sustainable reforms under the Open Method of Coordination in fiscal policy. The pact came fully into force in 1999 2011, however, have proven to be promising in their and consisted of two arms: the preventive arm and acknowledgment of the need for flexibility within the the corrective arm. The preventive arm requires all financial constraints of the SGP.70

70 Reforms adopted under the Open Method of Coordination primarily refer to the creation of the Euro Plus Pact. Created in response to the 2010 debt crisis, the pact aimed to increase economic and fiscal discipline.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 63 Since 2012, the German general government bud- In 2015, Germany had a registered government get has met the requirements of the Stability Pro- surplus of 0.7 percent, second to only Luxembourg gram by being close to balanced. As reflected in within the euro area and EU28 countries. That be- Chart 8, general government debt peaked in 2010 ing said, government debt as a percentage of GDP but was quickly reined in after the adoption of a remains relatively high, at 71.2 percent, although federal budget that eliminated new borrowing. In the euro area and EU28 average debt-to-GDP ratio 2016, the Federal Ministry of Finance estimated remains higher at 90.7 and 85.2 percent, respec- that the annual government debt-to-GDP ratio tively. would fall under 60 percent by 2020, allowing Ger- many to fall below the Maastricht limit.

Chart 10: Net borrowing/net lending by level, bn euros

20 1%

0 0% 2010 2011 2012 2013 2014 2015 -20 -1%

-40 -2%

-60 -3%

-80 -4%

-100 -5% Central government State government Local government eficit ratio (Net borrowing/ net lending in % of GP) Source: Destatis

64 Fiscal Federalism and Governance in the European Union APPENDIX 1

Länder Abbreviation Baden-Württemberg BW Bavaria BY Berlin BE Brandenburg BB Bremen HB Hamburg HH Hesse HE Mecklenburg-West Pomerania MV Lower Saxony NI North Rhine-Westphalia NW Rhineland-Palatinate RP Saarland SL Saxony SN Saxony-Anhalt ST Schleswig-Holstein SH Thuringia TH

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 65 REFERENCES Eurostat. “Provision of Deficit and Debt Data For 2015— Second Notification,” news release 204/2016, Octo- Bach, Stefan, Guido Baldi, Kerstin Bernoth, Björn ber 2016. Bremer, Beatrice Farkas, Ferdinand Fichtner, Mar- cel Fratzscher, and Martin Gornig. “More Growth Federal Ministry of Finance (Germany). “The Federal through Higher Investment.” DIW Economic Bul- Financial Equalisation System in Germany.” letin 8 (2013). Federal Ministry of Finance (Germany). PPP-Projekt- Börzel, Tanja A. States and Regions in the European datenbank. Öffentlich-private Partnerschaft. Union: Institutional Adaptation in Germany and Spain. Cambridge: Cambridge University Press, Federal Ministry of Finance (Germany). “German Sta- 2002. bility Programme: 2012 Update,” 2012.

Breuer, Rayna. “German Court Boosts Small Parties’ Federal Ministry of Finance (Germany). “German Sta- Chances in European Parliament,” Deutsche Welle, bility Programme: 2015 Update,” 2015. February 26, 2014. Federal Ministry of Finance (Germany). “Ergebnisse Bundesregierung (Federal Government). “Konferenz des Länderfinanzausgleichs 2014,” Monatsbericht, der Regierungschefinnen und Regierungschefs von March 2015. Bund und Ländern am 14. Oktober 2016 in Berlin – Beschluss,” press release 369, October 14, 2016. Federal Ministry of Finance (Germany). “Continuing with No New Borrowing,” National Budget 2016- Council of Europe. “The Situation of Local Finances in 2019, March 2015. the Federal Republic of Germany,” Rapport CPL (6) 3 Part II, Congress of Local and Regional Au- Federal Ministry of Finance (Germany). “Germany’s thorities, 1999. General Government Budget Is Sustainably Bal- anced,” Public Finances, April 2015. Deutsche Bundesbank. “The Reform of Financial Rela- tions in the German Federal System,” monthly re- Federal Ministry of Finance (Germany). “German Sta- port, September 2014. bility Programme: 2016 Update,” 2016.

Deutsche Bundesbank. “Monthly Report,” February Federal Ministry of Finance (Germany). “Förderung 2016. von Investitionen finanzschwacher Kommunen,” Länderfinanzausgleich, February 2016. European Commission. “Regions in the European Union—Nomenclature of Territorial Units for Sta- Gornig, Martin, Claus Michelsen, and Kristina van tistics NUTS 2010/EU-27,” Eurostat Methodolo- Deuverden. “Local Public Infrastructure Showing gies & Working Papers, 2011. Signs of Wear and Tear.” DIW Economic Bulletin 42/43 (2015). European Commission, Directorate-General for Eco- nomic and Financial Affairs.Public finances in Hofreiter, Anton. “Transparenz in Public Privat Part- EMU 2012, 2012. nerships im Verkehrswesen.” Drucksache 17/5258, Deutscher Bundestag, March 2011. European Commission. “European Commission Adopts ‘Partnership Agreement’ with Germany Jochimsen, Beate, and Robert Nuscheler. “The Political on Using EU Structural and Investment Funds for Economy of the German Länder Deficits.” Discus- Growth and Jobs in 2014-2020,” press release, May sion paper 2005/6, Free University Berlin, School 22, 2014. of Business & Economics, 2005.

European Commission. “Germany,” European Struc- Lövgren, Britt-Marie. “Local and Regional Democracy tural and Investment Funds Country Fact Sheet, in Germany.” Draft recommendation CG (22)7, April 2016. Congress of Local and Regional Authorities Moni- toring Committee, Council of Europe, March 2012.

66 Fiscal Federalism and Governance in the European Union Lübke, Astrid. “Fiscal Discipline between Levels of Seitz, Helmut. “Subnational Government Bailouts in Government in Germany.” OECD Journal on Bud- Germany.” IDB Research Network working paper geting 5, no. 2, 2005. no. R-396, Inter-American Development Bank, 2000. Organization for Economic Co-operation and Devel- opment. “Budget Review: Germany,” OECD Jour- Spiegel Online. “Poor Western Cities Fed Up with Fund- nal on Budgeting 14, no. 2, 2014. ing East.” March 20, 2012.

Partnerschaften Deutschland. “Optimistischer Ausblick Spiegel Online. “A Nation Slowly Crumbles.” September nach verhaltenem ÖPP-Start 2015,” press release, 18, 2014. 2015. Zipfel, Frank, and Jochen Zimmer. Länder bonds. DB Reuters. “Bund-Länder-Streit über Finanzreform flam- Research, Deutsche Bank AG, 2013. mt wieder auf.” Nov. 28, 2016.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 67 Features of Territorial Governance in Europe

BERNARD SOULAGE IN COLLABORATION WITH NICOLAS LÉTÉ

his analysis is provided within a context of a ed, possibly the most affected, by budget cuts. This Tmovement in favor of decentralization, witnessed article will look at the specific consequences which more or less worldwide. This movement has strongly then arise for them. manifested itself on topics linked to the fight against climate change or to local economic development, It remains nonetheless true that local and region- where the various levels of local governments (cities, al authorities are the source of the major share of metropolitan areas, provinces, regions, federal gov- public investment, and, as we will see, this share is ernments) have taken a growing role in the debates increasing. and political engagements in different countries. In this context, reforms and the global operations Nevertheless, this decentralization movement that constrain local and regional authorities have a shows significant disparities, resulting both from crucial impact on the competitiveness, sustainable governments that do not want to see internal out- development, and social cohesion of European breaks of opposition and from the difficulty for countries. local and regional authorities in taking on the responsibilities that they demand. This paper mainly focuses on the synthesis of three studies and therefore aims at, but is not limited to, Further, the movement was followed or even pre- highlighting various trends of so-called multilevel ceded by the financial crisis of the past 10 years governance, which is a key issue for European gov- which has, in most countries, put considerable ernance. We aim to highlight the convergence to- pressure on public finances, whether those of cen- ward a trend of a growing power allocated to local tral governments or of local and regional author- governments in the three countries, as well as the ities. persistence of models specific to these countries. Still, the most important topic seems to be the state In this context of crisis, local and regional author- of the exact relationship among the levels of local ities, particularly in Europe, are powerfully affect- governments in a globalizing world.

68 Fiscal Federalism and Governance in the European Union THE PROCESS OF Convergent trends DECENTRALIZATION AND However, since this period at the end of the “Glo- DEVOLUTION OF POWERS IN THE rious Thirty” in Europe, there has been a trend THREE COUNTRIES toward convergence among these three countries at the level of institutional organization and, in The different systems particular, organization of local and regional authorities. Very different points of departure The three systems that we are examining have The main features of these trends, some of which very different origins, whether considered from a are detailed below, concern, on the one hand, the broad, historical perspective beyond World War II increase in power at the regional level—in France, or considered in terms of the consequences of the very modestly from 1963 to 1982 and then in a war. more determined manner; in Italy, through continuous development over the past 20 years; and In effect, France has had a centralized structure in Germany, as a result of economic success, more for centuries, and the few attempts at decentral- and more powers being given to Länder—and, on ization that were realized through the revolution, the other hand, inter-municipal cooperation both and then through the birth of the republic, were at the city level through the creation of urban ag- primarily initiated by the national government, for glomerations or metropolises and, rurally, through example, through the creation of departments. groupings at the community level in France and Italy or at district (Kreis) level in Germany. Italy exhibits radically different characteristics. The country was founded less than two centuries One trend that is less often highlighted is of great ago by bringing together very small structures, importance for our considerations. mostly resulting from a very strong urban archi- tecture, from “principalities” handed down from It pertains to the number of levels of local authori- the Renaissance, and from large-scale urbaniza- ties. It is common belief that the efficiency of local tion movements from the middle of the last mil- public policies is hindered by the juxtaposition of lennium. the different regional authorities (cities, provinces, regions). From there emerges the habit to refer to Germany’s creation is broadly contemporaneous the French institutional “mille-feuille,” noting that to Italy, and the country is predominantly con- France has at least five levels of local authorities: stituted of Länder (in English, we would refer to communes, inter-municipal associations, depart- counties and regions). But World War II imposed a ments, regions, and the central government, or radical transformation on the country, determined even six if we add the European Union. Thus, we by the Allied victors, requiring a radical federal- can see that Italy has had, for a long time, a system ism to avoid any reconstruction of an all-powerful showing close parallels to this, and that Germany, state in Germany. which did not have a province-type system (and thus had one less level), has created this system in We can see, then, that the three countries, present, several key Länder, for example, Baden-Württem- from the point of view of territorial organization, berg and Bavaria. Therefore, the relative number very important historical differences even within a of local authorities, which is often used to explain relatively recent period, for example, at the end of the differences in performance in the three coun- the 1960s or 1970s. tries, seems much less important.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 69 The most important trend within the three coun- The respective powers of each local tries is the rise of urbanization and, more specif- government level in the three countries ically, the growth of metropolitan areas in zones where the population exceeds 300,000 to 400,000 Powers common to all inhabitants. Moreover, we can see the rise of the regional and metropolitan phenomena is not with- In the countries studied, a certain number of pow- out difficulties or conflict. ers are delegated to local authorities, sometimes with different beneficiaries but broadly indicative Persistent differences of the same structure. In spite of the trends cited above, the differences in territorial structure among the three countries Delegated powers chiefly include: remain significant. • Organization of the territorial planning A major difference concerns the constitutional and and development system most often at the legislative role of the Länder in Germany and, to a city and regional levels. lesser extent, of the Italian regions. • The same applies for all water and sanita- This is reflected by the ability—at the level just -be tion matters. low central government level—to prescribe laws and regulations and even to exercise control over • Urban mobility and urban transport, which local authorities at lower levels. This is prohibit- are most often delegated to community and ed in France and constitutes a clear distinguishing inter-municipal level, inter-urban trans- factor among the three systems. port being delegated to regional level.

There is also a notable difference in terms of partic- • Sports and culture undoubtedly constitute ipation of the local authorities in the general gov- one of the most important domains of pow- erning process of central governments and, in par- ers for local authorities, to the extent that, ticular, in the legislative process. Germany, through in Germany, for example, there is practical- the Bundesrat, instituted a formal system of repre- ly no federal intervention in this area. sentation for local authorities and, in particular, for the Länder in the legislative process. Italy wanted to • Education, at least in terms of construction establish the same system at the time of the rejected of buildings, their maintenance, and ser- referendum of December 2, 2016. In France there is vices revolving around the school system, no such system, and it serves us to recall that Charles is delegated to local authorities with iden- de Gaulle left power in 1969 after the defeat of a ref- tical distinctions among educational levels. erendum similar to the recent referendum in Italy, which was to give more power to the regions and • Social support, particularly for young chil- was to radically modify the legislative balance be- dren (crèches, preventive health care, etc.) tween the National Assembly founded on universal and for the elderly or dependent people. suffrage and a Senate representing local authorities. Greater powers in Germany and Italy As discussed below, these institutional differences As the result of its federal character, Germany has are also articulated with major differences in terms attributed much greater powers to local authorities of powers exercised and finance flows. and, in particular, to the Länder.

70 Fiscal Federalism and Governance in the European Union Italy has also tended to significantly increase the period, means of deconcentration72 and decentral- power allocated to regions and other local govern- ization73 to give greater autonomy to institutions ments. This process started with the decentraliza- in this area. tion laws of the 1970s and 1980s and the creation of the Regioni a Statuto Ordinario. During the The crucial matter of economic and innovation 1990s, this decentralization process strengthened policy. under the pressure of wealthy residents in the North, demanding larger fiscal autonomy.71 This Beyond an appearance of fairly considerable sim- process was halted by the 2008 financial crisis and ilarity in terms of the question of support for in- the tightening of central government transfers to- novation and economic development, there is a ward local governments. real differentiation between Germany and Italy on one hand and France on the other. This broad- This is notable, specifically with respect to health ly reflects the overall organizational differences of care, a subject of intense debate in Italy at the time the economic systems, particularly their small to of the recent referendum, but also with respect to medium-sized enterprises (SMEs) and their per- the economy, community policing, and even, more formance rankings, particularly with regards to broadly, security. exports.

We have seen recently that the question of refugees Therefore, in Germany and to a lesser extent in It- is largely addressed at regional and Länder level in aly, by means of “industrial districts,” powers and Italy and Germany, while, in France, the topic is al- resources in terms of economic development and most solely dealt with by the national government. innovation have long been based at the regional level. Even though Germany has programs that aim Finally, remains the very important question of to reinforce these regional ecosystems—68 percent skills transfer through education (educational pro- and 80 percent of the budgets of the German Re- grams, hiring and training of teachers, organiza- search Foundation and the Fraunhofer, respective- tion of the different school cycles) at the regional ly, are financed by the central government74—the level. This issue extends beyond the construction Länder have a notable financial economy concern- of buildings and associated services (school cafete- ing research and innovation which provides strong rias, receptions, day care), which allow the smooth support for small and medium-sized enterprises provision of educational services. Germany had a (SMEs) and their exports.75 very decentralized system, which simultaneously comprises “education” and the buildings and asso- Budget allocations provided for these policies are ciated services. However, outcomes being judged incomparable, for example, between Germany and to be very poor at the start of the 2000s led to a cer- France. In France, this issue was only addressed in- tain amount of recentralization of curricula, qual- directly at the time of the first real decentralization ifications, and establishments. By contrast, France in 1982. It was better addressed recently when laws and Italy were constantly seeking, over the same were passed in 2015—notably ones giving regions

71 Ter-Minassian, Teresa, 2016. “Local finances in Italy.” Brookings Project on 21st Century City Governance. 72 Deconcentration is an administrative organizational technique that consists, for the central State, in distributing its own civil servants and competencies to administrative authorities representing the central State in local and regional districts. These authorities have no autonomy. 73 Decentralization is a territorial process of the central State that consists of transferring competencies from the central State to new local and regional entities, with a distinct legal personality and with political autonomy. 74 Federal Ministry of Education and Research. 75 Sellenthin, Mark O., and Christian Rammer, 2007. “R&D Policy in Baden-Württemberg: A Focus on Governance Structures and Technology Transfer.” Funded by the European Commission—DG Research.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 71 the authority to manage the European Structural and the metropolises, each wishing to demonstrate and Investment Funds, which are largely centered that it is better-placed to facilitate harmonious de- on innovation and SMEs—but it still remains, to velopment of the local industrial fabric and econ- quite a great extent, a matter for the State in con- omy. The most emblematic case is that of France, trast with the preceding countries. In France, the where the decentralization law of 2015 could not central government remains, by far, the largest fi- really settle who is doing what in this area. In fact, nancial backer for innovation. This does not help the regional schemes for economic development, in consolidating the legitimacy of regions as driv- innovation, and internationalization are formulat- ers of regional economies, despite the responsibil- ed by the region. Still, the metropolis can object to ity of regional economic development delegated to it within its vicinity in cases where there is a dis- regions and metropolises.76 For instance, 87.2 per- agreement at the regional level. cent of innovation financing in France is done at the central government level against 5.4 percent at Our feeling is, however, that a strong and coher- the regional level.77 ent economic development and innovation policy at the metropolitan level is key for each country’s This issue constitutes, in the three countries, an overall development strategy and for their ability ongoing source of conflict between the regions to adapt to globalization.

76 NOTRE Law of 2015. 77 Les aides à l’innovation en France (2014, CNEPI).

72 Fiscal Federalism and Governance in the European Union FUNDING Figure 2. Expenditure of the overall public budget by level from Q1 to Q4, Increasing impact and constrained million euros (Germany) revenue 400000

An increasing impact on GDP The share of spending by local authorities in the 350000 GDP of the three countries has been constantly increasing over the last 30 or so years as we can see 300000 here. 250000 Figure 1. Local government expenditures as a percentage of total 200000 public spending (France)

22% 150000 2009 2010 2011 2012 2013 2014 2015 2016 21% Federation Lnder 20% Municipalities and Associations of municipalities

19% Source: Destatis

18% Nevertheless, and despite considerable develop- 17% ments, particularly in France, this share remains much differentiated according to the country. 16% Thus, France, where the spending of local authori- 15% ties has increased from less than 8 percent of GDP in 1980 to 11 percent in 2005 and 11.8 in 2014,

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 remains the country of the three where local au- Source: Insee, National accounts, Base 2010 thorities’ share of GDP is the smallest. We can also observe a substantial development in France and

Table 1. Local government expenditures within public spending (Italy)

2010 2011 2012 2013 2014 State 482.5 445.3 451.1 455.8 463.3 Other central governments 75.7 75.9 78.9 82.0 84.8 Local public administrations 229.8 235.3 244.0 252.2 251.5 Local authorities 210.1 215.5 223.1 231.0 229.6 Social security administration 515.6 532.4 550.2 562.3 575.3 Total public administration 1128.0 1151.5 1186.0 1207.1 1226.7

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 73 in Italy in the allocation of spending among the The same applies for the largeLänder in Germany local authority levels for the benefit of the regions thanks to their own funds, which they obtain as and inter-municipalities (under whatever name) the result of their strong economic development. and to the detriment of basic municipal units and provinces (or departments in France). Thus, without covering the case of Spain (where nearly the total revenue of local authorities comes A very different tax autonomy from State transfers, except in the Basque Coun- This is an absolutely key point of this comparative try), it is noted that even in Germany, the most de- study. The preceding papers on the three coun- centralized country, there is no real tax autonomy tries clearly show differences among the revenue for local authorities. systems of the local and regional authorities. The share of transfers from the central government in Extremely differentiated equalization practices this revenue by means, in particular, of allocations The present analysis of the revenue of local author- of the central government budget is indicated in ities follows the preceding logic to show that de- the table below. Unfortunately, we do not have vi- centralization does not, in any sense, mean signif- able data on Italy. icant tax and fiscal autonomy for local authorities.

Table 2. Share of mandatory In effect, contrary to popular belief,there is no deductions by beneficiary nexus between the degree of decentralization administrative entities, in percent of and the degree of tax autonomy. We could even total mandatory deductions, 2012 say that in the three countries there is inverse pro- Germany France portionality between the degree of decentralization and the real degree of tax autonomy once we Central government 46 86 have considered the process of revenue equaliza- Local and regional authorities 49 13.5 tion. European Union 5 0.5 Sources: BMF, Insee Thus, in Germany, the constitution explicitly provides that revenue from local authorities of dif- Differences emerge, although it must also be em- ferent levels may not deviate from the average by phasized that, even within each country, there are more than 10 percent, which is an extremely small considerable variations in the tax autonomy of deviation. Evidently, this presupposes very consid- each local authority or authority level. For exam- erable equalization between local authorities and a ple, in France, though the average tax autonomy of centralized system enabling such equalization. The the local authorities amounts to less than 40 per- article focused on Germany presents the details of cent of their funds, the case of Lyon, studied in de- this mechanism which we find to a lesser degree tail in another publication, shows that, under cer- in Italy within a particularly complex system, and tain conditions, local authorities may have greater which is extremely poorly developed in France in autonomy. This comes from the fact that the local spite of recent efforts. authority benefits from resources from the former Grand Lyon metropolis and the former Rhone We should emphasize a particular question here, department—since the two merged—as well as which is very often invoked when studying equal- the local economic force the merger has created, ization in France, particularly where this equal- which offers important fiscal revenues based on ization among local authorities is very weak. the rents from local enterprises. Administrative units, such as the large cities and metropolises, notably Paris and Lyon, benefit from

74 Fiscal Federalism and Governance in the European Union the greatest revenue per inhabitant and contrib- funds for local authorities whether provided by the ute fairly little to equalization between local and central government or self-generated. This situa- regional authorities. At the same time, these cities tion serves as the key difference between the three insist that local authorities make significant con- countries studied here and other European coun- tributions to the overall equalization of fiscal rev- tries. In Greece and Poland, for example, where enue at the national level. At the same time, the the structural funds can reach up to 2.35 percent development policies of the larger metropolitan of GDP, the funds have a considerable effect on areas ensure very high income, which in turn gen- public decisions. erates high fiscal revenue (value-added or income taxes, for example) that is reallocated to the central In addition to this, there is some funding from Eu- government, which is then distributed to various ropean programs directly managed by the Europe- local authorities that do not fall under their local an Commission, notably research and innovation authority. This issue is the subject of great debates programs.78 But these also amount to only a few in France, Germany, and Italy (and, incidentally, hundred million euros maximum per year within in Spain and Catalonia), as it is one of the topical budgets that run into tens of billions for the ma- key points of claims for regional autonomy in the jor local authorities that we have studied here. For regions governed by the Lega Nord in Italy or by example, the four motors for Europe—Auvergne- the richest Länder in Germany. Rhône-Alpes, Baden-Württemberg, Catalonia, and Lombardy—captured about 1.6 billion euros To our knowledge, there are only a few studies on from the Horizon 2020 program between 2014 this subject, which are extremely significant and and September 2016, while the total annual budget useful for any interpretation of actual redistribu- of the Auvergne-Rhône-Alpes region, the smallest tion of revenue in the various countries. of the four, is 3.685 billion euros per year. More- over, beyond financing, it is important to note that Relatively little impact from the European Union these policies, notably the cohesion policies based It is notable that the European Union contributes on the FESI, contribute to a harmonization of Eu- little to the revenue of local authorities in Western ropean policies notably as they relate to research Europe compared with Central and Eastern Eu- and innovation (i.e., regional strategies for smart rope. specialization). Therefore, the cooperation among regions is facilitated through these policies and The core European funding for local and regional creates a Europeanization of value chains, favor- authorities comes from what are referred to as the able to regional economic development. cohesion policies notably implemented through the European Structural and Investment Funds (FESI in French), which are principally intended Financial balances to promote territorial and social cohesion as well as innovation and sustainable development. By Increasingly constrained finances and large, these funds concern investment expen- The finances of the local and regional authorities diture, and in countries such as Germany, France, of the three countries studied present relatively or Italy, where the share in the national economy convergent trends owing to increasing constraints is much less than 1 percent of GDP, this merely imposed on these authorities. represents, at best, a leverage effect on the other

78 Horizon 2020 is the EU research and innovation program with nearly 80 billion euros in funding available between 2014 and 2020 for the entire European Union.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 75 Part of these constraints result from the features expenditure is very considerable even with a slight presented in the preceding paragraph and, notably, increase in salaries. Indeed, with protected employ- the constant influence of States on the finances of ees (this implies lifetime job security and a contin- these local authorities. Thus, as a logical continua- uous salary increase with age), local governments tion of policies of “budgetary austerity” implement- have relatively little control over the evolution of ed in Europe, nations have greatly reduced their their expenditures. This phenomenon, in techni- support of local authorities whether such support is cal terms, is referred to as the “age-technical skills provided through direct allocations or through the shift.” In the three countries, salaries in the civil equalization mechanisms outlined above. service are largely tied to employment seniority and a smooth quasi-automatic career progression, Evidently, the weak growth experienced by the leading to a quasi-automatic increase in the annual European Union over a considerable number of wage bill. Thus, the scissor effect previously evoked years, in particular since the financial crisis of is composed of the differential growth of revenue 2007-2008, has similarly not helped the situation and expenditure to the disadvantage of revenue. for self-generated revenue for local authorities, as, Every element associated with the self-sustainabili- for a relatively significant proportion, this revenue ty of local authorities is affected by this. is directly dependent on business and household funds and often with a fiscal elasticity coefficient These striking elements in the countries observed greater than 1. We can thus observe a sharp decline result in relatively weak investment capacity and in the growth of revenue of these local authorities thus a decrease in public investment by local and but also, to a lesser extent, in their spending which regional authorities in addition to that of the State. has a considerable impact on overall economic Germany and Italy, and France to a lesser extent, growth to the extent that the investments by local strongly exhibit this decline in public investment, and regional authorities are the main victims of particularly at infrastructure level, which has led these constraints on local finances. to well-known problems in these countries. For example, in Italy, investment from local authorities A powerful “scissor effect” fell 34 percent between 2009 and 2014.79 In view of this increasingly small variation of local authorities’ global revenue (self-generated or from Increasing regulatory intervention by the cen- external allocations), there is a so-called “scissor tral government effect” between expenditure and revenue. The scis- Added to factors related to the economic environ- sor effect corresponds to a decrease in recurring ment, spending structures, and revenue of local revenue (due to a decline in central government authorities are factors connected to macro-eco- transfers) coupled with the increase in recurring nomic regulation that have been implemented in expenditures (for example, due to the increasing Europe and in EU Member States over the past de- wage bill). This scissor effect presents a significant cade, and particularity in the eurozone. particularity with regard to public local authorities (made up of “protected employees”) which is very We can observe, in the three countries, increasing well-known at State level and is also found at the pressure by central governments on local and local level. Public local authorities are most often regional authorities to limit their deficits great- in charge of public services mostly comprising ly and even to show a surplus. This is meant to personnel spending (e.g., the health, education, or reduce their contribution to the national deficit, security sectors). Thus, the slippage in operating thus allowing EU member states to respect their

79 Ter-Minassian, Teresa. 2016. “Local finances in Italy.” Brookings Project on 21st Century City Governance.

76 Fiscal Federalism and Governance in the European Union communal obligations, notably the Maastricht cri- were receiving, when they themselves were not run- teria as defined in the Stability and Growth Pact ning an excessive deficit (contrary to their central and 2012 EU budgetary agreements.80 Each coun- government). This discussion, deeply symbolic of try, of course, has its own means of ensuring such the reality of the autonomy of local authorities, has convergence. still not led to a direct action: In December 2016, amid its excessive deficit, Spain was threatened with For example, since 2001, local and regional gov- the suspension of the disbursement of the European ernments in Italy have been subject to internal Structural and Investment funds, while some of its stability agreements, which set targets for budget- regions had balanced accounts. However, the Eu- ary imbalances and limit the potential increase in ropean Council is holding off on voting for these expenditures at the local level. When these stan- sanctions. This debate provides a significant picture dards are not met, the central government has the of the desire to include local and regional author- right to reduce or halt government transfers to ities within the European Union’s comprehensive the local or regional authorities. The system has approach to budgetary regulation. It is worth noting proved efficient as, during the 2013-2014 period, that France and Italy could find themselves in the only 1.5 percent of municipalities failed to respect same situation as Spain in the near future. the objectives. These municipalities are mainly located in the South and Sicily. In 2009 Germa- ny’s constitution was amended to introduce the Debt Schuldenbremse (“debt brake”), a balanced budget provision. The amendment sets quantitative tar- Regulations specific to each country gets, within a specific timeframe, for the central It must first be underlined that each country stud- and federated government in order to improve the ied presents specific characteristics in terms of fis- durability of public finance and fiscal coordination cal law and, in particular, the borrowing capacity among the different levels of government. of local and regional authorities. Thus, France pro- hibits any current deficit by local authorities but We also note that the European Union intervenes does not present any formal limitation in respect through the cohesion policy and the FESI to pro- to their debt ratio. Only a current deficit may en- mote the reduction in its member states’ public defi- able intervention by a government authority such cit. Therefore, Article 2381 of the regulation on the as the prefect. general cohesion policy allows for the total or par- tial suspension of payments through the policy if a In contrast, in Germany, and to a lesser extent in member country does not respect the Maastricht Italy, regulations were recently passed—such as criteria from the Stability and Growth Pact. This is the Schuldenbremse and stability pacts mentioned commonly called a macroeconomic conditionality. above—to limit the debt of local authorities, in par- The European regions, which manage the FESI, are ticular, by regulating the operating expenditure/ opposed to this “double punishment” which could operating revenue ratio and debt ratios. In Germa- lead to the suspension of the European fund they ny, these new rules should lead to a reduction in

80 The Stability and Growth Pact adopted at the Amsterdam European Council of June 1997 is the first instrument simultaneously adopted by all 15 member states in the aim to harmonize their budgetary policies and avoid the creation of excessive public deficits. This tool, which applies to every EU member country, states that public deficit cannot exceed 3 percent of GDP and that public debt cannot exceed 60 percent of GDP. If a member state fails to respect this criterion, it could face a procedure for excessive deficits as mandated by Article 126 of the treaty on the functioning of the European Union. These dispositions were further strengthened by the fiscal compact adopted on January 30, 2012, and signed March 2, 2012, by all the EU member states except the United Kingdom and the Czech Republic. 81 The European regulation no. 1303/2013 of the European Parliament and the council of December 17, 2013, on the common dispositions in relation to the European Regional Development Fund, the European Social Funds, the Cohesion Fund, the Agricultural Fund for Rural Development, and European Maritime and Fisheries Fund.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 77 public debt to levels below 60 percent of GDP by partnerships that we will examine in the follow- 2020. As of 2015, Germany’s budgetary surplus is ing paragraph; through leasing—or leasing-pur- spread out in the following way: 0.3 percent at the chase—mechanisms that they have often increased central level and 0.1 percent at the Länder and oth- over recent decades; or through local company er local governments level. commitments of semi-public company types in France or Stadtwerke in Germany. Unfortunately, A trend toward increased debt we do not have precise data on this topic, as they In view of the preceding features, the general ten- are off-balance-sheet accounts. dency in the three countries is toward an increase in the debt ratio of local and regional authorities; however, three particular tendencies should Recourse to private capital be noted: Low-level privatization in the strict sense of the • Local authorities’ debt remains substantial- term ly lower than the debt of central govern- The three countries do not showsignificant pri- ments, particularly in France and Italy, as vatization of local public services in the imple- these local and regional authorities account mentation of public policies and exercise of the for less than 10 percent of the national debt powers with which the local and regional author- (9.5 percent in France in 2013). In Germa- ities are endowed. However, this is only true if we ny, the Länder’s debt makes up 30 percent are referring to privatization in the strict sense of of the German public debt, while the debt the term, as in the totality of powers (including of other German local authorities makes up pricing) being given to private capital to imple- only 7 percent of total public debt. ment public policy without participation of the local authority in its financing. If we were to make • Local authorities within each country pres- comparisons with the United Kingdom, for exam- ent levels of debt peculiar to each level of ple, we would see very big differences, which do local authority. Thus, Länder or regions not feature here. present relatively high debt ratios, but these are local authorities where the share of in- Linking of public and private funding vestment in total spending is higher. In Rather, we observe in these three countries one or France, local governments financed 58.8 another form of linking between private and pub- percent of public investment in 2013. lic funding. This takes the form of public-private partnerships in the Anglo-Saxon sense of the term • Finally, local and regional authorities are and, in particular, of “build-operate-transfer.” But considered high-quality borrowers since, we rarely see cases that are truly similar to the in the three countries, a number of them Anglo-Saxon cases where transport infrastruc- benefit from upper-limit financial ratings. tures and mobility are concerned, or even development associated with health care or security, for Off-balance-sheet commitments hospitals or prisons. It is nonetheless worth noting the levels of off-balance-sheet commitments of the local and regional Beyond PPPs, this linking presents characteristics authorities studied here. specific to each country. France is characterized by the delegation of public services model, which The large, local authorities are often holders is really just a watered-down version of privat- of commitments either through public-private ization and, furthermore, is often implemented

78 Fiscal Federalism and Governance in the European Union by semi-public companies which French law re- that holds Germany to be spearheading openness quires to be overwhelmingly publicly funded. In to competition in Europe. this case, the political authority of the local and regional authority remains greatly, even completely, A weak impact all in all dominant. Considering the overall picture of the place of private funding within the economic system of lo- Italy has very many local companies held entirely cal authorities in the three countries studied, we by local authorities which operate under private find a relatively minor impact from either former law but remain very greatly dependent on public traditions of “municipal socialism,” or recent ten- money. As indicated in Teresa Ter-Minassian’s re- dencies to keep or bring within public control ser- view of fiscan conditions in Italy, many companies vices that were more or less handed over to private are often fairly inactive and a huge clean-up opera- groups that often abused these circumstances. tion has been initiated by the government authorities. This was to be strengthened by the reforms In addition, low interest rates have not provided an provided by the end-2016 referendum. impetus to turn toward private funding or leasing, and the economic and financial crisis has slowed The most interesting case is that of Germany, investment, so we can see that private funding is which has the special case of Stadtwerke. These are not determinative and that it is uncertain that it considered by many observers to be anti-liberal will play an increasing role in these countries. monsters that bring together, at city or Länder level, a collection of local public services that are fre- This is one of the reasons that the large corpora- quently confounded with a great deal of account- tions, particularly in France and Germany, consti- ing and financial chaos mixing sources of income tuting local public service providers are increas- and deficit without competition being genuinely ingly looking outside Europe to find sources of effective in these sectors. These reveal a Germany growth that they no longer find within their na- that is very different from that of public perception tional territory.

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 79 CONCLUSIONS AND OUTLOOK We can note, in particular, among these tendencies, the issues of an aging population, the per- Diversified but convergent structures sistence in many instances of unemployment, and, In the three countries, the structures of local au- more recently, the tremendous influx of refugees thorities are the result of long-standing traditions and immigrants. Added to the decrease in funds and histories that are reflected in fairly consider- allocated by the national government and the de- able diversity. crease of self-generated funds, these tendencies are leading to a significant decline in the capacity of Nevertheless, we can observe a convergence these local authorities to act. around the city (or metropolis)-region pairing to the detriment of basic municipal units and provinces or departments. Troubling financial difficulties Taken together, these tendencies indicate very However (and the Italian referendum has only considerable financial difficulties for local author- served to confirm this), it is very difficult to phase ities that are not used to experiencing this and out the territorial level in any of the countries. which, by contrast, have developed strong policies of investment either in infrastructures or in inno- For our part, and in contrast with many observ- vations and economic development. This situation ers, we are not very surprised by this difficulty, creates great uncertainty for the future of public for two reasons. On the one hand, there is such a policy in Europe and the continent’s ability to con- need for proximity among populations suffering tinue to promote a model of development broadly the upheaval of globalization that they become founded on urban life (“urbanité”). schizophrenic, hoping for rationalization to “avoid the waste” involved but also showing opposition as soon as this involves the local authority to which Strengthened partnerships they belong. On the other hand, there is the resis- Faced with these circumstances of greater finan- tance of local elected representatives committed to cial difficulty and the decline in government in- their mandate and able to influence a significant tervention, one of the most powerful responses part of the population. by local and regional authorities consists of devel- oping partnerships in different forms. The major Nonetheless, profound uncertainty remains over partners are, of course, local authorities of similar what will happen to the basic units that form mu- level, whether located domestically or in another nicipalities, particularly in France, where they country. We can see this happening in the estab- are especially numerous (36,000), but also in Italy lishment of very many international networks of (8,000) and Germany (11,250), predominantly local authorities, notably over the last few years, within large agglomerations where the ascent of focused on the issues of climate change or on de- metropolises affords much less influence to each veloping innovation. municipal unit within them. This politics of partnership is also found among dif- ... facing common underlying trends ferent levels of public local authorities. In France, this has been the case for a long time focusing The local and regional authorities examined here on the issue of Central Government-Region con- face underlying trends that are broadly the same, tracts. This approach has been closely studied in entailing obligations that must be analyzed to as- other European countries. The increasingly con- sess the path ahead. tractual policy which unites the European Union

80 Fiscal Federalism and Governance in the European Union with local, European authorities, by means of sev- France, for its part, mistrusted local authorities en-year European funding cycles, should also be and continued to promote a “Colbertist” model. factored in. Today, at the confluence of the rise of the regional This tendency toward partnership and coopera- phenomenon and the desire to promote a “green tion should be studied in the medium term, as it economy,” it seems that local authorities—in the may be an appropriate response to the scarcity of studied countries and the ones in many OECD funds and the necessity of more rapid adaptation countries, starting with the United States—have, based on cooperation. to a certain extent, taken leadership of territorial economic development, basing it on SMEs and start-ups. Weak role played by the private sector In spite or because of the deteriorated financial sit- Is this a sustainable tendency? As things stand, we uation of local and regional authorities, we do not would consider this to be entirely realistic. And see a large role being given to the private sector that leads us to a final question. in the design of the public policies examined, and nothing leads us to assume that this will change over the next few years. There is, therefore, a con- Can we speak of a so-called glocalization siderable difference when contrasted with coun- in Europe? tries such as the United Kingdom, the United At the end of this study, we can answer that ques- States, and even China. One of the questions to be tion in the affirmative. asked of Europe is whether this model, to which the countries examined remain very committed, Whether we are talking about the aspirations has long-term viability. of populations, the impecuniosity of States, the metropolization dynamic and networking of metropolises, or the rise of infra-national structures The challenge of economic development of regional or Länder type, all of the ingredients Among the questions invoked here, the role of appear to be assembled for a new territorial dy- local and regional authorities within the coun- namic to fall into place. Receptivity to globaliza- tries’ economic development dynamics is cer- tion rests on the capacity of territories to adapt and tainly, today, the most important and the most respond, especially in countries whose compara- debated question. tive advantage predominantly stems from innovation and service economies. This response is also In this respect the models of the three countries adapted to the aspiration of populations to hold undoubtedly exhibited the most differences one or on to neighborhood bonds. From which stems the two decades ago. word “glocalization,” a fusion of “globalization” and “localization.” Germany has always relied on local and regional authorities to promote innovation and local devel- It is, perhaps, in this new articulation among the opment. territorial levels that the principal opportunity for the European model to survive resides along with Italian local authorities supported a strong local its ability to differentiate itself from other models, and entrepreneurial dynamic by means of “indus- which are apparently more competitive. trial districts.”

Global Economy and Development at Brookings Centennial Scholar Initiative at Brookings 81 However, sometimes different dynamics are in progress on other continents and, in particular, among emerging countries. It will always be interesting to review these against a few lessons learned from the analysis of these three European countries and their local and regional authorities.

82 Fiscal Federalism and Governance in the European Union The Brookings Institution 1775 Massachusetts Ave., NW Washington, D.C. 20036 brookings.edu