36224 V. 2 ANNEX 1: Municipal Sources of Finance Prior to 2004 1. Municipal Revenues 1. The sources of financing for municipalities are: revenues from municipal and Public Disclosure Authorized shared taxes, capital transfers, current transfers, donations, and loans. Current revenues include: sales taxes, property taxes, other local taxes, tariffs and duties, registration fees, shared taxes, and fines. These revenues used to be higher in the early nineties but progressively declined mostly because of tax reforms which limited the taxing capabilities of municipalities. In 2002 the total amount raised by all Nicaraguan municipalities was C$ 432 million (US$ 30 million, 0.7% of GDP). Most of the revenues used to come from the sales tax whose rate was decreased from two percent to one percent in 1997, in addition, a significant number of mandated exonerations reduced considerably the resources available to local municipalities. The property tax was supposed to compensate for these revenue losses. However, municipalities were reluctant and/or unable to raise enough revenues with the property tax. The main problems were lack of clear property rights and funds to administer locally property taxes.1 The remaining source of current fiscal revenues -the vehicle tax, registrations fees, stamp Public Disclosure Authorized duties- had a relative smaller role. 2. Municipalities received a substantive support directly for the donors’ community. Some funds are given to municipalities and are often earmarked for specific investment projects. Beside financing directly municipalities, donors also finance FISE (Fondo Inversion Social de Emergencia), INIFOM (Instituto Nicaraguense de Fomento Municipal), IDR (Instituto de Desarrollo Rural), which are central government agencies in charge of local development. Finally, a consistent amount of funds is not even registered in the municipal budgets and are administered separately. 3. Table 2 illustrates municipalities’ financing in recent years. In Managua, most of Public Disclosure Authorized financing came from current local revenues; this is not surprising given that the income of the country is concentrated in the capital. In the rest of the municipalities, current revenues barely covered current expenditure while capital expenditure was largely financed by transfers from the central governments. Grants from international donors also contributed to the funding of municipalities. 2. Transfers prior to 2004 4. The central government used to transfer about 1 percent of fiscal revenues to municipalities every year. The amount of the transfer was bargained every year in the context of the annual budgetary process given that there was no law mandating its amount. The transfer was divided among municipalities with the goal of guaranteeing a minimum amount of current revenue per capita to municipalities (30 percent) and of giving incentives to enhance collection of property taxes (40 percent), the rest was Public Disclosure Authorized divided equally among municipalities (30 percent) . At least 80 percent of the transfers 1 A study by DANIDA found that only 30 percent of potential revenues form IBI was collected in a subset of municipalities. - 1 - had to be spent on investment. To obtain the funds earmarked for investment the municipalities had to present an investment plan to INIFOM, which was responsible for approval. If the project was approved, an amount approximately equivalent to 30 percent was disbursed immediately and the rest was transferred in quotas. 5. The pre-2004 system of transfers was perceived as unsatisfactory for several reasons: a) the total amount of transfer was uncertain given that it was decided in the course of the discussion of the central government budget every year. Municipalities could not do any multi-annual programming exercise given that the precise amount of the transfer was known only during the year. b) the sharing criteria were highly questionable. For instance, giving incentives to the collection of property tax is right in principle but it is very difficult to implement given the uncertainty about the revenue capacity. Moreover, the criterion of giving a fixed amount for municipalities gave the wrong incentive to create new municipalities. Municipalities complained that the amount of transfer was insufficient to cover their mandates The shortcomings of this system of transfers together with the necessity of carrying out the constitutional mandate have led to the Law regulating the transfer system. Table 1 (Annex 1) – Composition of expenditure – Municipalities and Central Government Table 1a - Expenditures - Managua (% total expenditures) goods and social security Capital Total Expenditure wages services contributions Investment Others (%GDP) 2 1990 20 64 2 13 1 0.60 1991 29 40 2 26 3 1.01 1992 34 39 1 20 6 1.20 1993 36 30 0 27 6 1.09 1994 36 26 - 32 7 1.03 1995 38 30 0 23 9 0.87 1996 46 31 2 11 10 0.77 1997 37 20 5 27 12 0.85 1998 36 26 4 23 11 0.78 1999 37 25 3 27 7 0.85 2000 38 25 4 22 11 0.75 2001 44 27 6 15 8 0.72 2002 40 25 5 23 8 0.70 2003 27 25 4 38 6 0.98 Source: Authors’ elaboration based on data from Central Bank of Nicaragua Table 1b - Expenditures - Rest of Municipalities (% total expenditures) social security Capital Total wages goods and services contributions Investment Others Expenditures 1990 23 60 - 15 3 0.16 1991 32 41 - 20 7 0.74 1992 35 37 - 21 6 0.79 2 Based on old, not revised, GDP data. - 2 - 1993 37 39 - 18 6 0.83 1994 31 36 - 29 4 0.98 1995 30 36 - 30 5 0.98 1996 28 32 - 36 4 0.75 1997 31 38 - 28 2 0.88 1998 26 36 - 32 6 0.85 1999 29 31 - 35 4 0.75 2000 25 26 - 46 3 0.90 Source: Authors’ elaboration based on data from Central Bank of Nicaragua Table 1 c - Expenditures - Central Government (% total expenditures) goods and debt Current Capital Capital Total Expenditure wages services interest Transfers Transfers Investment Other (%GDP) 1990 21 61 0 14 2 3 - 21.51 1991 30 28 4242 8316.60 1992 30 20 10 18 9 12 1 17.33 1993 27 20 14 14 15 9 1 16.89 1994 22 16 17 16 12 15 2 18.83 1995 20 11 13 19 17 17 3 18.29 1996 17 19 10 19 14 21 0 18.06 1997 17 13 16 20 17 17 0 17.91 1998 19 15 15 19 14 18 - 18.50 1999 17 13 7162124222.52 2000 16 12 9201826023.49 2001 17 15 10 21 18 19 1 24.57 2002 21 11 14 21 12 20 - 20.90 2003 1/ 20 10 18 19 13 21 -0 20.05 1/ : Updated to November 2003. Source: Authors’ elaboration based on data from Central Bank of Nicaragua Table 2 (Annex 1) – Composition of revenues - – Municipalities and Central Government Table 2a - Revenues - Managua (% Revenues) Current Current Capital Total Revenues Revenues Transfers Transfer Others grants (%GDP) 1990 32 53 15 - - 0.57 1991 85 6 - - 9 0.99 1992 91 7 1 - 1 1.14 1993 86 2 1 - 11 1.03 1994 87 - 1 - 12 1.01 1995 98 - 2 - - 0.83 1996 100 - - - - 0.76 1997 93 - 6 - 0 0.85 1998 100 - - - 0 0.86 1999 100 - - - - 0.92 2000 96 - 0 3 - 0.82 2001 94 - - 3 4 0.79 2002 97 - - 3 - 0.76 2003 96 - - 4 - 0.84 Source: Authors’ elaboration based on data from Central Bank of Nicaragua Table 2b - Revenues - Rest of Municipalities (% Revenues) Current Current Capital Total Revenues Revenues Transfers Transfers Others grants (%GDP) 1990 73 15 10 - 2 0.16 1991 89 2 5 - 4 0.70 - 3 - 1992 87 2 7 - 4 1.06 1993 84 2 10 - 5 0.86 1994 64 1 24 - 11 1.15 1995 64 1 25 - 10 1.16 1996 55 1 35 - 9 0.84 1997 78 1 14 - 7 1.01 1998 69 3 18 - 10 0.98 1999 66 8 14 - 12 0.81 2000 51 9 33 - 8 1.01 Source: Authors’ elaboration based on data from Central Bank of Nicaragua Table 2c - Revenues - Central Government (% GDP) Current Current Capital Total Revenues Revenues Transfers Revenues Others grants (%GDP) 1990 91 - 0 - 9 9.97 1991 62 - 1 - 37 19.12 1992 82 - 1 - 17 15.30 1993 71 - 2 - 27 16.86 1994 80 - 1 - 19 15.65 1995 71 - 2 - 28 18.01 1996 75 - 1 - 24 17.15 1997 85 - 0 - 15 17.15 1998 89 - 0 - 10 17.41 1999 78 - 0 - 22 19.62 2000 69 - 0 13 17 21.70 2001 77 - 0 5 17 18.27 2002 75 - 0 2 23 19.96 2003 1/ 77 - 0 0 23 19.11 1/ : Updated to November 2003. Source: Authors’ elaboration based on data from Central Bank of Nicaragua - 4 - ANNEX 2: Experience with Decentralization in Selected Latin American Countries3 The Fiscal Experience 1. Over the past years, several Latin American countries have moved towards decentralization in spending and, to a lesser extent, revenues raising. The reasons for this evolution are manifold. The political climate has evolved in favor of more direct and democratic forms of government. The increase in income has led to the expectation of better and citizen-oriented public sector services. Moreover, several economists have argued that decentralization of spending responsibility can entail significance welfare gains (see Ter-Minassian, 1997). 2. Countries in Latin American have joined the trend only recently but have been quite aggressive in pursuing fiscal decentralization. Four facts explain the new interest in decentralization. First, the experience of authoritarian and very centralized regimes created a demand for more direct forms of democracy in which the power is less concentrated at the center; a decentralized system would attenuate social tensions and reduce the possibility of a reversal to an authoritarian regime.