Local authorities shall be entitled, within national economic policy, to adequate financial resources of their own, of which they may dispose freely within the framework of their powers.
From the outset, it should be noted that the Latvian system of local government finances is homogeneous around the country. Therefore, there are no specificities or differences between regular municipalities and “cities”. Apart from the Law on Local Government, the key pieces of legislation in this field are the Act on the Budgets and Financial Management of 1994, Act on Local Governments Budgets of 1995, as amended, the Act on Local Government finance equalisation of 2015, and the Act on Taxes and fees of 1995, as amended.
The main sources of local income are formed by tax revenues, non-fiscal income and transfers. From a technical point of view, there are no “true” local taxes in Latvia, but apportionments in the collection of some State taxes. The structure of local governments revenues (2017 data) is the following: (a) tax revenue: 63.5%; (b) transfers, 29.4%; (c) self-earned revenue: 5.2%; (d) non-tax revenues: 1.8%; (e) donations: 0.1%; and (f) foreign financial assistance: 0.1%. According to the Ministry of Finance, these sources of revenue are sufficiently diverse. During the consultation procedure, the Latvian Association of Local and Regional Authorities stressed that only 40% of these 63.5% goes directly to the local government, whose residents create these taxes (pure own revenue from taxes are 25.4% of all). Other part is redistributed through equalisation system. Therefore the Association considered that fiscal autonomy is not satisfactory.
The different sources of financing for Latvian local governments may be presented as follows:
i. Tax revenue
This is the most important source of revenue for local authorities. In quantitative terms, the total amount of tax revenue for local authorities was 1,174.4 M € in 2012; 1,256.2 M € in 2013; 1,316.4 M € in 2014; 1,362.8 M € in 2015; 1,469 M € in 2016 and 1,548 M € in 2017 (expected). As noted supra, there are no local taxes in the technical sense of the meaning. Local authorities receive a percentage (share) of some State taxes, which in the case of the real estate tax is 100%. That is, each local authority receives a percentage of the total tax collected in its territory. These shared taxes are:
The personal income tax: this is a State tax, regulated and collected at State level. Since 2015, the State Revenue Service is responsible for collecting personal income tax in Latvia. The total collection of this tax in a given local entity is later partially redistributed to that local authority, based on residence criteria (number of “de iure” inhabitants). In 2017, each local authority will receive 80% of the tax collected in its territory (expected). As a consequence, a local authority with wealthy residents will receive more money than a similar authority with the same number of inhabitants but having less economic capacity. Therefore, it could be argued whether this type of revenue is in reality true “tax revenue” in the technical meaning of the word, or rather “transfers” from the State. In any case, this is the most important source of “tax revenue” for local authorities, in quantitative terms. This receipt represents 84.8% of the total tax revenue in the local governments budgets.
Real estate tax: this State tax hits all land slots and buildings, either used for commercial or housing purpose (since 2010). The limits for tax rate is determined by State laws and regulations on the basis of the cadastral value of the slot or construction. Municipalities collect the real estate tax, and they have a limited power to determine the tax rate. For instance, they may decide to reduce the general tax rate up to a certain amount, something that is used by some local entities to revitalise business activities or to attract new local residents. Local authorities receive 100% of the tax collection. Consequently, this is probably the only tax that is the closest to the notion of “local tax”. In 2017, this receipt represents roughly 13.8% of the total tax revenue in the local governments budget.
Taxes on lotteries and gambling: Local authorities receive a share of 25% of this tax. In 2017, this source of tax revenue represents 0.5% of the total tax revenue in the local governments budget.
Natural resources tax: Local authorities have a share on different taxes, such as the tax on pollution (60%), the tax on radioactive waste (30%) and 100% from the tax on incineration of dangerous waste. In 2017, this source of tax revenue represents 0.9% of the total tax revenue in the local governments budget.
Apart from true “tax revenue”, municipalities and cities (under the Taxes and Fees Act), can collect revenue of fiscal nature such as different fees and charges, of which they can determine the rate. Charges or fees may be imposed on different activities, such as: services rendered by the local administration; the issuance of official documents and certificates; conducting trade in public places; the ownership of animals; the placement of advertisements, the delivery of construction permits or of other licenses, etc.
Transfers and subsidies from the State budget:
In Latvia, most of the State grants received by local authorities are earmarked, that is, they are granted for specific purposes. In general, these “specific” purposes are functions that the local authorities are obliged to deliver on the basis of legal mandates. Those transfers include, in particular, grants for the remunerations of teachers, for school transportation, for road maintenance and construction and for the co-financing projects under EU funds. The only non-earmarked grant is the State contribution to the Local Government Finance Equalisation Fund, which is presented infra.
In recent years, the share of transfers in the total structure of local financing has been above 20% (29.4% in 2017, expected). In 2014, State budget transfers to local governments’ budgets (including funding for the EU policy instruments and other external financial assistance projects) were in the amount of 605 million €. This means 2.6% of the GDP. In 2015, this figure was 603 million €, which meant 2.5% of the GDP.
Local authorities may benefit from the several EU funds established in the domain of urban development, rural development and other fields related to the municipal life. However, these revenues are in no way stable or periodic and depend on a large series of factor which mainly stand outside the municipalities reach. Moreover, some local representatives told the delegation that in most of the cases they don’t apply to EU funding for projects because they are required to co-finance a percentage of the project, something which is out of their financial means.
iii. Non-tax revenue
Latvian local authorities may obtain and collect revenues that do not have taxing nature. Among those sources of income (that are per se variable) stand the following ones:
Revenue from commercial activities of local companies and revenue from the ownership of property (sale of movable and immovable property).
Revenue from property (rents).
Collection of traffic fines and other administrative offences due to the violation of local binding regulations. For instance, in the case of Riga this revenue represents roughly 5 M € (2016 figures).
Financial operations: local authorities may ask for loans from the public banking sector (see below).
Once the different sources or revenues have been presented, it should be assessed whether the principles of sufficiency and commensurability of the local finances are recognised in domestic legislation. Apparently, those principles are not proclaimed explicitly neither by the Constitution nor by regular legislation. However, the Law on Local Governments includes different important provisions in this sense. For instance, this statute provides that whenever a new “autonomous” competence is transferred to the local authorities, “the law which determines the performance of such functions shall concurrently determine the new source of revenue for the local governments” (art. 7). It is difficult to ascertain whether this provision is properly followed in every case of assignment of new competences. According to a Latvian scholar: “in practice, however, these procedures are not always followed, thus not allowing the local governments to fulfill all compulsory tasks”.
Another example is the provision regulating “delegated functions”. In this case, the Law provides that the resources that were so far are provided for in the State budget for the performance of such functions shall be transferred to local governments concurrently (art. 9). Therefore, there is a mild and partial recognition of those principles.
According to the Ministry of Finance, local governments are provided with stable tax revenue in the long term period and the central government tries to ensure the sufficiency of local finances by different means, apart from the equalisation mechanism. For instance, the Minister of Finance told the Delegation that in the next years it is expected that the tax revenues of local governments (especially those stemming from the Personal Income Tax) will decrease due to tax relief reforms aiming at boosting the economy. Thus, in order to compensate for this loss of revenue the Government is going to establish a “special compensatory transfer” for the local governments, with a planned budgetary allocation of 13.3 M € in 2018, 135.9 M € in 2019 and 224.7 M € in 2020.
In order to appraise the sufficiency of local government finances, several indicators may be used. To begin with, we can identify the share of local government tax revenue in the general government tax revenue. This indicator is pretty favourable to Latvian local authorities, for this percentage was calculated (by Eurostat) in 19.4% for the year 2015, while the average for the EU was 10.4%.This is the fourth bigger in the EU (only surpassed by Finland, Denmark and Sweden). The Minister of Finance told the Delegation that with the adoption of the “compensatory” measure mentioned supra, the local government will keep the percentage around 19.5%, even in a scenario or decrease in tax collection.
Another indicator is the share of the local government total revenue in the general revenue of the public sector. In this sense, this proportion in 2015 was 26.7%, while the average in the EU was 24.5% (Eurostat data). Here, the indicator is the ninth higher in the EU, although the same caveat should be made here (absence of other territorial levels in the country). That indicator was identified at 23% by the 2011 monitoring report on Latvia. Therefore, a certain progress is visible.
For what concerns the position of the local leader on the matter of financing, most of them stated that in general terms they were satisfied with the present arrangements, although the system has some negative aspects and perspectives: first, they complain that in too many cases, the law attributes new competences to local authorities, without providing for adequate and “fresh” new financial resources. Second, sometimes the law attributes new competences but does not clarify what “type” of competence is the new one (among the different types regulated in the Law). This apparently has a negative financial impact because some competences are financed in one way and others are financed differently.
Third, local representatives expected a reduction of income due to the tax relief measures that have been adopted by the Government. Since the tax rates for the personal income tax have been reduced (from 23% to 20%), the national tax collection will be lower and they fear that their revenue will be reduced accordingly. It remain to be seen whether the “compensatory” measures that the Minister of Finance presented to the Delegation are finally adopted and they compensate “adequately” for this loss of income. Fourth, the LPS also expressed dissatisfaction about the current equalisation mechanism, because they understand that it is not fair and that the State should contribute with more monies. In the present situation, the equalisation Fund is mostly financed by the local authorities themselves and this does not help reducing the strong disparities among rich and poor local entities in the country. Fifth, LPS complained that the present system of local government financing is too dependent on governmental annual decisions and on periodic negotiations. This means that the total resources, the different percentages and elements of the revenue may change from year to year. This situation, according to LPS does not allow the local governments to conduct long-term planning, because they cannot be sure of what resources they will have during the following years. Consequently, they ask that all these different variables be laid down into a legal rule.
In the domain of budgeting and expenditures, municipalities and cities are free to draft and to approve their own budgets, but they must respect the budget structure established by the Law. The local council is the competent authority to approve the budget. Local authorities are in theory autonomous in deciding their spending priorities, and the central government or other State authorities cannot in principle interfere with the municipalities budgetary autonomy. In this sense, the Ministry of Finance respects the autonomy of local authorities and does not address binding instructions or guidelines in the domain of budgeting. State institutions are not allowed to interfere with the drafting and execution of the local budgets. However, in practice many of their expenditures aim at paying obligatory functions. Thus, in the year 2014 the total expenditure of local governments was 2,192.4 million €. The major expenses (40.8 % of the total expenses) were for education: 894.6 million €. Expenses for some other fields were: economic activities: 374.7 million € (17.1%); social protection: 204.1 million € (9.3%); recreation and culture: 194 million € (8.8%); general public services: 182.2 million € (8.3%); environmental protection: 46.2 million € (2.1%).
According to the Law on Local Governments, the local council must call at least once a year a private sworn auditor or auditing company, for the revision of the budget implementation and the preparation of the annual report. Besides it, local authorities may set up their own internal auditing commissions. Based on the report of the auditor (which has to be published) the State Audit Office issues an annual statement on the reports on the local government budget what is the part of report on state budget and local government budgets (see point 4.7, supra).
Finally, and as far as municipal property is concerned, Latvian local authorities have their own property, goods and assets. The right to own land and real estate property is fully recognised to local authorities, and they freely manage their own assets and properties. For instance, they own the local streets, roads, parks, cemeteries, administrative buildings and facilities, schools, kindergartens, culture clubs, libraries, sport halls etc. The key piece of legislation in this field is again the Law on Local Governments, which lays down general guidelines at arts. 77 and 78.
Consequently, the Delegation concludes that article 9, paragraphs 1 to 4 and 7 of the Charter are respected in Latvia.